##### Table of Contents



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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549




FORM 10-K



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|  |  |                                                                                     
|- |  | ------------------------------------------------------------------------------------
|x |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934

For the fiscal year ended December 31, 2003

OR

|  |  |                                                                                         
|- |  | ----------------------------------------------------------------------------------------
|o |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934

For the transition period from to

0-49813
(Commission file number)________________

MARINER HEALTH CARE, INC.

(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            |  |                    
|Atlanta, Georgia                         |  | 30346              
|(Address of principal executive offices) |  | (Zip code)         

(678) 443-7000
(Registrants telephone number, including area code)



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Securities Registered Pursuant to Section 12(b) of the Act: None



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Securities Registered Pursuant to Section 12(g) of the Act:
Common stock, par value $0.01 per share
Warrants to purchase common stock

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

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

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes x No o

The aggregate market value of the outstanding common stock, par value $.01
per share (the Common Stock), held by non-affiliates of the registrant as of
June 27, 2003 (the last business day of the registrants most recently
completed second fiscal quarter) was $46,884,855, based on the last sale
price for the Common Stock of $4.40 per share as reported on the OTC-BB on said
date. For purposes of the foregoing sentence only, all directors are assumed to
be affiliates.

There were
20,007,500 shares of Common Stock issued and outstanding as of
March 12, 2004.

Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes x No o

DOCUMENTS INCORPORATED BY REFERENCE
None.



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TABLE OF CONTENTS



|                                                 |                                                                                               |  |  |  |  |  |  | 
|------------------------------------------------ | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I                                          
|                                                 | ITEM 1. BUSINESS                                                                             
|                                                 | ITEM 2. PROPERTIES                                                                           
|                                                 | ITEM 3.LEGAL PROCEEDINGS                                                                     
|                                                 | ITEM 4.SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                   
|PART II                                         
|                                                 | ITEM 5.MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS                 
|                                                 | ITEM 6. SELECTED FINANCIAL DATA                                                              
|                                                 | ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|                                                 | ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                          
|                                                 | ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                          
|                                                 | ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 
|                                                 | ITEM 9A. CONTROLS AND PROCEDURES                                                             
|PART III                                        
|                                                 | ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                                  
|                                                 | ITEM 11. EXECUTIVE COMPENSATION                                                              
|                                                 | ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT                      
|                                                 | ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                      
|                                                 | ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES                                              
|                                                 | ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K                     
|SIGNATURES                                      
|CONSOLIDATED BALANCE SHEETS                     
|CONSOLIDATED STATEMENTS OF OPERATIONS           
|CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY 
|CONSOLIDATED STATEMENTS OF CASH FLOWS           
|EX-2.6 MASTER TRANSACTION AGREEMENT             
|EX-4.5 SERIES A 8 1/4% SENIOR SUBORDINATED NOTE 
|EX-4.6 SERIES B 8 1/4% SENIOR SUBORDINATED NOTE 
|EX-4.7 INDENTURE DATED AS OF DECEMBER 19, 2003  
|EX-10.23 FIRST AMENDMENT TO SETTLEMENT AGREEMENT
|EX-10.24 REGISTRATION RIGHTS AGREEMENT          
|EX-10.25 CREDIT AND GUARANTY AGREEMENT          
|EX-10.26 PLEDGE AND SECURITY AGREEMENT          
|EX-10.27 2003 OUTSIDE DIRECTORS' STOCK INCENTIVE
|EX-21 SUBSIDIARIES OF THE COMPANY               
|EX-23 CONSENT OF ERNST & YOUNG LLP              
|EX-31.1 SECTION 302 CERTIFICATION OF THE CEO    
|EX-31.2 SECTION 302 CERTIFICATION OF THE CFO    
|EX-32.1 SECTION 906 CERTIFICATION OF THE CEO    
|EX-32.2 SECTION 906 CERTIFICATION OF THE CFO    



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##### Table of Contents



MARINER HEALTH CARE, INC.

TABLE OF CONTENTS

|         |  |                                                                                       |  |     
|-------- |  | ------------------------------------------------------------------------------------- |  | ----
|         |  |                                                                                       |  | Page
|         |  |                                                                                       |  |     
|Part I   |  |                                                                                       |  |     
|Item 1   |  | Business                                                                              |  | 1   
|Item 2   |  | Properties                                                                            |  | 22  
|Item 3   |  | Legal Proceedings                                                                     |  | 24  
|Item 4   |  | Submission of Matters to a Vote of Security Holders                                   |  | 25  
|Part II  |  |                                                                                       |  |     
|Item 5   |  | Market for Registrants Common Equity and Related Stockholder Matters                 |  | 26  
|Item 6   |  | Selected Financial Data                                                               |  | 29  
|Item 7   |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 33  
|Item 7A  |  | Quantitative and Qualitative Disclosures About Market Risk                            |  | 54  
|Item 8   |  | Financial Statements and Supplementary Data                                           |  | 55  
|Item 9   |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure  |  | 56  
|Item 9A  |  | Controls and Procedures                                                               |  | 56  
|Part III |  |                                                                                       |  |     
|Item 10  |  | Directors and Executive Officers of the Registrant                                    |  | 57  
|Item 11  |  | Executive Compensation                                                                |  | 60  
|Item 12  |  | Security Ownership of Certain Beneficial Owners and Management                        |  | 65  
|Item 13  |  | Certain Relationships and Related Transactions                                        |  | 66  
|Item 14  |  | Principal Accountant Fees and Services                                                |  | 66  
|Item 15  |  | Exhibits, Financial Statement Schedules and Reports on Form 8-K                       |  | 66  

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PART I




ITEM 1. BUSINESS

GENERAL

Our company was formed through a series of business combinations commencing
with the November 1997 merger of Living Centers of America, Inc., or LCA (a
predecessor to Mariner Health Care, Inc.), and GranCare, Inc. Following this
transaction, we changed our name to Paragon Health Network, Inc., or Paragon.
In July 1998, following a merger with Mariner Health Group, Inc., or MHG, we
changed our name to Mariner Post-Acute Network, Inc., or MPAN. On January 18,
2000, or the Petition Date, we filed voluntary petitions under Chapter 11 of
the United States Bankruptcy Code, or the Bankruptcy Code, with the United
States Bankruptcy Court for the District of Delaware, or the Bankruptcy Court.
Our joint plan of reorganization, or the Joint Plan, filed with the Bankruptcy
Court was confirmed, as amended, on April 3, 2002. The effective date of our
Joint Plan was May 13, 2002, or the Effective Date, which is the date we
emerged from bankruptcy. As part of our emergence from bankruptcy, we changed
our name to Mariner Health Care, Inc. In December 2001, we changed our fiscal
year end from September 30 to December 31. As used in this Annual Report on
Form 10-K, unless the context indicates otherwise, references to we, us, our, Mariner or similar terms include
Mariner Health Care, Inc. and its operating subsidiaries.

Our principal executive office is located at One Ravinia Drive, Suite 1500,
Atlanta, Georgia 30346 and our telephone number at that address is (678)
443-7000. Our web address is www.marinerhealthcare.com.

DESCRIPTION OF BUSINESS

Mariner Health Care, Inc., through its operating subsidiaries, is one of the
largest providers of skilled nursing and long-term health care services in the United States, based
on net revenue, the number of facilities operated and licensed beds. We
provide these services primarily through the operation of skilled nursing
facilities (which include skilled nursing facilities
under Medicare and nursing facilities under Medicaid) and long-term acute care hospitals, or LTACs. Skilled nursing
services and LTACs also constitute our reportable business segments
under generally accepted accounting principles in the United States of America,
or GAAP. As of December 31, 2003, we operated 256 skilled nursing facilities
and eight stand-alone assisted living facilities with an aggregate of 31,489
licensed beds. We own 70% of our facilities. As of December 31,
2003, we also operated eleven LTACs with 613 licensed beds. Our
facilities are located in 23 states with significant concentrations in Texas,
North Carolina, California, Colorado, South Carolina, and Maryland and clusters in twelve
geographic markets in nine of the states in which we operate.

Our skilled nursing facilities provide 24-hour care to patients requiring
assistance with one or more activities of daily living. These services are
supplemented by rehabilitation services including physical, occupational and
speech therapy. In addition, we operate specialized units in a number of our
skilled nursing facilities that provide sub-acute, or intensive, institutional
type medical care to patients with complex medical conditions. Through our
LTACs, we provide more intensive care to patients discharged from short-term
acute care hospitals than can be provided in a typical skilled nursing facility
or other setting. In all facilities, inpatient care is provided by registered
nurses, licensed practical nurses and certified nurses aides under the
supervision of a director of nursing. Each facility also contracts with a local
physician to serve as its medical director.

Skilled Nursing Services

Inpatient services provided through
our skilled nursing facilities constitute our
primary service offering. During the year ended December 31, 2003
these services accounted for 93.0% of our total revenue. For the twelve months ended
December 31, 2002, the three months ended December 31, 2001 and for the fiscal
year ended September 30, 2001, skilled nursing services accounted for
93.4%, 93.5%
and 93.8% of our total revenue, respectively.
See Item 8, Note 21 to the
consolidated financial statements included elsewhere herein for
information regarding revenues from external customers, operating
profit (loss) and total assets of our skilled nursing services
segment for the year ended December 31, 2003, the eight
months ended December 31, 2002, the four months ended
April 30, 2002, the three months ended December 31, 2001
and fiscal year ended September 30, 2001.

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Our skilled nursing facility revenue
is dependent on payor mix, acuity mix and occupancy level as
summarized in the table below.

Three Months Ended*March 31,
    
    June 30,
    
    September 30,
    
    December 31,
    
    March 31,
    
    June 30,
    
    September 30,
    
    December 31,2002
    
    2002
    
    2002
    
    2002
    
    2003
    
    2003
    
    2003
    
    2003Skilled nursing services:Occupancy
    
    
    85.5
    %
    
    
    84.9
    %
    
    
    85.0
    %
    
    
    85.7
    %
    
    
    85.5
    %
    
    
    85.5
    %
    
    
    86.2
    %
    
    
    85.5
    %Patient days (in thousands):Medicaid
    
    
    1,903
    
    
    
    1,854
    
    
    
    1,857
    
    
    
    1,833
    
    
    
    1,753
    
    
    
    1,781
    
    
    
    1,825
    
    
    
    1,661Medicare
    
    
    365
    
    
    
    351
    
    
    
    355
    
    
    
    357
    
    
    
    374
    
    
    
    373
    
    
    
    365
    
    
    
    326Private & other
    
    
    573
    
    
    
    545
    
    
    
    542
    
    
    
    530
    
    
    
    510
    
    
    
    509
    
    
    
    523
    
    
    
    476Total
    
    
    2,841
    
    
    
    2,750
    
    
    
    2,754
    
    
    
    2,720
    
    
    
    2,637
    
    
    
    2,663
    
    
    
    2,713
    
    
    
    2,463Average rate per day:Medicaid
    
    $
    110.40
    
    
    $
    110.83
    
    
    $
    112.23
    
    
    $
    112.99
    
    
    $
    113.44
    
    
    $
    113.82
    
    
    $
    116.84
    
    
    $
    117.35Medicare
(Part A only)
    
    
    318.54
    
    
    
    316.40
    
    
    
    316.41
    
    
    
    294.67
    
    
    
    295.23
    
    
    
    300.37
    
    
    
    301.63
    
    
    
    320.92Private & other
    
    
    160.67
    
    
    
    163.98
    
    
    
    163.97
    
    
    
    175.11
    
    
    
    166.58
    
    
    
    172.96
    
    
    
    173.77
    
    
    
    176.22


*For all periods presented, amounts have been adjusted to exclude discontinued operations.

98.0% of our skilled nursing facilities are certified for participation in the
Medicare program and 99% are certified for participation in the Medicaid
programs (Medicare and Medicaid were established in 1965 by the Medicare and
Medicaid Bill, Title XVIII and Title XIX of the Social Security Act
of 1935, H.R. 7260, as amended, or the Social Security Act, and the
terms Medicare and Medicaid refer to the programs established under the
Medicare and Medicaid Bill, as amended). During the year ended
December 31, 2003, Medicare and Medicaid accounted for
30% and
51.2% of our skilled nursing facility
revenue, respectively. During the twelve months ended December 31, 2002,
Medicare and Medicaid accounted for 29.8% and 51.5% of our skilled nursing facility revenue,
respectively. During the three months ended December 31, 2001, Medicare and
Medicaid accounted for 28.0% and 54.3% of our skilled nursing
facility revenue, respectively. During the
fiscal year ended September 30, 2001, Medicare and Medicaid
accounted for 27.0%
and 52.4% of our revenue, respectively.

Substantially all patients in our skilled nursing facilities receive assistance
with one or more activities of daily living, or ADL, including feeding,
bathing, dressing, eating, transportation and related services.
These services are supplemented by rehabilitation services including physical,
occupational and speech therapy, which we provide in our skilled nursing
facilities. In addition, we operate specialized units in a number of our
skilled nursing facilities that provide sub-acute, or intensive, institutional
type medical care to patients with complex medical conditions. These specialty
units offer, among other things, enteral therapy, intravenous therapy,
specialized wound management and ventilator, tracheotomy, cancer and HIV care.
We also offer specialized services in some of our facilities for residents with
Alzheimers disease.

Included in the operating results set
forth above are services furnished by our eight freestanding assisted living
facilities that provide furnished rooms and suites designed for individuals who
are either able to live independently within a sheltered community or who
require minimal supervision. For assisted living residents, we provide basic
ADL assistance combined with access to higher acuity settings should a
residents health condition dictate the need for more intensive services.
Certain of our skilled nursing facilities also include assisted living
operations and apartment units located on the same campus as the skilled
nursing facility.

Long-Term Acute Care Hospitals

As of December 31, 2003, we owned one and leased or managed
ten LTACs, encompassing 613 licensed beds in four states. In
addition to providing the types of services described above in
connection with our skilled nursing facilities, LTACs accommodate the
relatively high sub-acute clinical needs of patients discharged from a
short-term acute-care hospital when the patients condition warrants more
intensive care than can be provided in a typical skilled nursing facility or
other setting. All of our LTACs are certified for participation in the
Medicare, and ten are certified for participation in the Medicaid,
programs. During the year ended December 31, 2003 inpatient
services provided through our LTACs accounted for
7.0% of our total revenue. For the twelve months
ended December 31, 2002, the three months ended
December 31, 2001 and fiscal year ended September 30, 2001,
LTAC services accounted for 6.5%,
6.4% and 6.1% of our total revenue,
respectively. See Item 8, Note 21 to the consolidated
financial statements included elsewhere herein for information
regarding revenues from external customers, operating profit (loss)
and total assets of our LTAC segment for the year ended
December 31, 2003, the eight months ended December 31,
2002, the four months ended April 30, 2002, the three months
ended December 31, 2001 and fiscal year ended September 30,
2001.

Our LTAC segment revenue is dependent on payor mix, acuity mix and occupancy level as summarized in the table set forth below.

Three Months EndedMarch 31,
    
    June 30,
    
    September 30,
    
    December 31,
    
    March 31,
    
    June 30,
    
    September 30,
    
    December 31,2002
    
    2002
    
    2002
    
    2002
    
    2003
    
    2003
    
    2003
    
    2003LTAC:Occupancy
    
    
    85.5
    %
    
    
    85.7
    %
    
    
    75.5
    %
    
    
    74.3
    %
    
    
    74.5
    %
    
    
    66.3
    %
    
    
    65.2
    %
    
    
    70.5
    %Patient days (in thousands):Medicare
    
    
    33
    
    
    
    33
    
    
    
    29
    
    
    
    29
    
    
    
    28
    
    
    
    25
    
    
    
    25
    
    
    
    28Private & other
    
    
    2
    
    
    
    3
    
    
    
    3
    
    
    
    3
    
    
    
    4
    
    
    
    3
    
    
    
    4
    
    
    
    4Total
    
    
    35
    
    
    
    36
    
    
    
    32
    
    
    
    32
    
    
    
    32
    
    
    
    28
    
    
    
    29
    
    
    
    32Average rate per day:Medicare
    
    
    759.12
    
    
    
    754.51
    
    
    
    807.12
    
    
    
    831.38
    
    
    
    865.51
    
    
    
    960.92
    
    
    
    967.59
    
    
    
    874.26Private & other
    
    
    1,398.61
    
    
    
    1,519.31
    
    
    
    1,880.55
    
    
    
    1,681.14
    
    
    
    1,556.29
    
    
    
    1,481.17
    
    
    
    1,481.05
    
    
    
    1,640.29


100% of our LTACs are certified for participation in the
Medicare program and 83% are certified for participation in the Medicaid
programs, although Medicaid revenue does comprise a material portion
of our LTACs total revenues. During the year ended
December 31, 2003, the twelve months ended December 31,
2002, the three months ended December 31, 2001 and fiscal year
ended September 30, 2001, Medicare accounted for 82.3%, 88.6%, 80.8%,
and 80.9% of our LTAC
revenue, respectively.

INDUSTRY

We compete in the long-term care industry. The long-term care industry includes
companies that offer post-acute, sub-acute or general health care services such
as skilled nursing care, long-term home care services and other support
services, primarily to elderly patients. Within the long-term care industry, we
focus specifically on the approximately $100 billion United States nursing home
market through the operation of our skilled nursing facilities and LTACs. There
are approximately 16,500 nursing homes with approximately 1.8 million total
beds certified to provide Medicare and/or Medicaid services in the United
States. The nursing home industry is highly fragmented. The ten largest
for-profit chains combined control approximately 15% of the industrys beds,
with the largest company operating just under 3% of the industrys beds. We
primarily target individuals in need of long-term medical care or requiring
assistance to function on a daily basis.

The primary difference between a skilled nursing facility, an LTAC and other
senior health care facilities, such as assisted living facilities, is the level
of care each is capable or licensed to provide. Skilled nursing facilities
provide room, board and a variety of other skilled nursing and rehabilitation
services to their residents and are usually certified to participate in the
Medicare and Medicaid

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programs. LTACs are licensed as hospitals and are also eligible to become
certified to participate in the Medicare and Medicaid programs. Individuals
enter these facilities when they are in need of a high level of medical
attention on a daily basis for serious ailments such as cancer or recovery from
major surgery, or have recently experienced a major event, such as a heart
attack or stroke. Assisted living facilities do not provide skilled nursing
care and generally do not participate in the Medicare or Medicaid programs.
Assisted living facilities provide residents the freedom of living in an
apartment with assistance available if necessary to deal with daily chores or
duties. Certain daily activities, such as cooking and housekeeping services,
which ordinarily would be done by the individuals, may be performed for them by
the facility.

The aging population and increased life expectancies are the primary growth
drivers for both skilled nursing services and assisted living. According to the
United States Census Bureau, in 2000, there were approximately 35 million
Americans aged 65 or older, comprising approximately 13% of the total United
States population. The number of Americans aged 65 or older is expected to
climb to approximately 40 million by 2010 and to approximately 54 million by
2020.

In addition to positive demographic trends, the demand for the services
provided by long-term care facilities is expected to increase substantially
during the next decade due primarily to the impact of cost containment measures
by government and private-pay sources resulting in higher acuity patients being
transferred more quickly from hospitals to less expensive care settings such as
skilled nursing facilities and LTACs. National nursing home expenditures are
expected to grow from $103.7 billion in 2002 to $178.8 billion in 2012,
representing a 5.6% compounded annual growth rate. We believe that these trends
will support a growing demand for the services provided by nursing, assisted
living facility and LTAC operators that deliver efficient, cost-effective and quality
long-term health care services, and that support a full range of needs and
acuity levels.

REIMBURSEMENT

Medicare and Medicaid

The Medicare program is a nationwide, federally funded health insurance program
for certain elderly persons, disabled persons and persons with end-stage renal
disease. The Medicaid program is a joint federal-state funded cooperative
arrangement established for the purpose of enabling states to furnish medical
assistance on behalf of aged, blind or disabled individuals, members of
families with dependent children and specified other groups, whose income and
resources are insufficient to meet the costs of necessary medical services. All
of our nursing facilities and hospitals are licensed under applicable state
law, and nearly all are certified or approved as providers or suppliers under
applicable Medicare and state Medicaid programs.

Prospective Payment Reimbursement for Medicare Certified Skilled Nursing Facilities

Medicare certified skilled nursing facilities are reimbursed under a
prospective payment system, or PPS, for inpatient Medicare services. PPS
commenced in 1998 when the Balanced Budget Act of 1997, or the
Balanced Budget Act, which was signed into law on
August 5, 1997 and effective on and after July 1, 1998, amended the Medicare
program by revising the payment system for skilled nursing facilities.
Specifically, the Balanced Budget Act required the establishment of PPS under
which Medicare Part A payments are prospectively determined for skilled nursing
facilities for cost reporting periods beginning on or after July 1, 1998. Under
PPS, skilled nursing facilities receive a fixed per diem rate for each of their
Medicare Part A patients. Included in this per diem rate are payments for
ancillary services, such as pharmacy and rehabilitation therapy services, that
historically were provided to many of our skilled nursing facilities by our
pharmacy and therapy subsidiaries. Overall, the implementation of PPS resulted
in a dramatic decrease in Medicare Part A reimbursement to skilled nursing
facilities.

As a result of the impact of PPS on the long-term care industry, Congress twice
passed legislation intended to mitigate temporarily the reduction in Medicare
reimbursement rates for skilled nursing facilities under PPS. As of October 1,
2002, a 4% across-the-board increase in resource utilization groups
reimbursement rates, or RUGs, and a 16.7% increase in the nursing component
provided for in a combination of the Medicare Balanced Budget
Refinement Act of 1999, or the Balanced Budget Refinement Act, and
the Medicare, Medicaid, and SCHIP Benefits Improvement and Protection
Act of 2000, or the Benefits Improvement and Protection Act, expired. The expiration of these
temporary measures is commonly referred to as the Medicare Reimbursement Cliff.
In addition to the Medicare Reimbursement Cliff provisions, other add ons
included in this mitigating legislation will expire when the Centers for
Medicare and Medicaid Services, or CMS, which is the agency within the
Department of Health and Human Services, or DHHS, that oversees Medicare and
Medicaid, publishes a refined Medicare skilled nursing facility reimbursement
system to account for higher acuity patients. On August 4, 2003, CMS issued the
final skilled nursing facility PPS rule for fiscal year 2004, which delays
implementation of the refinements until at least October 1, 2004. However, President
Bushs proposed fiscal year 2005 budget indicates that the refinements will not
be implemented before September 30, 2005. The August 4, 2003 rule also includes
an inflation update and a correction of past forecast errors that together
increase the fiscal year 2004 skilled nursing facility PPS base rates by a
total of 6.26%. CMS estimates that the rate update will increase reimbursement
by approximately $850 million in fiscal year 2004, raising Medicare payment
rates per patient day by

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approximately $19 (although the actual increase will vary from facility to
facility because of geographic wage adjustments and variances in patient
acuity).

Fee for Service Reimbursement for Medicare Certified Skilled Nursing Facilities

We are also reimbursed for specified services, such as rehabilitation therapy
services, provided to Medicare skilled nursing facility patients under the
Medicare Part B benefit. The Balanced Budget Act also contained provisions
affecting outpatient rehabilitation agencies and providers, including a 10.0%
reduction in operating and capital costs for 1998, a fee schedule for therapy
services beginning in 1999 and the application of per beneficiary therapy caps
applicable to all outpatient rehabilitation services beginning in 1999.
Specifically, this act set a maximum per beneficiary amount, or limit, per
provider for physical therapy and speech pathology, and another limit for
occupational therapy. Subsequent legislation suspended implementation of these
caps through 2002. CMS began enforcing the therapy caps on September 1, 2003
(the inflation-adjusted amounts for 2003 were $1,590). The Medicare
Prescription Drug, Improvement, and Modernization Act of 2003 suspends
application of the therapy cap from the date of enactment (i.e., December 8,
2003) through calendar year 2005. This provision will not be applied
retroactively to beneficiaries who exceeded their caps prior to the date of
enactment. At this time, we are unable to quantify the impact of this
legislation on our financial condition and results of operations.

The Balanced Budget Refinement Act also excluded certain items and services
from the formerly all-inclusive skilled nursing facility per diem rates.
Specifically, the following items and services are now separately reimbursable
outside of the PPS rates: (i) ambulance services furnished to an individual in
conjunction with renal dialysis services; (ii) chemotherapy items and
administration services (as identified by certain Healthcare Common Procedure
Coding System, or HCPCS, codes); (iii) radioisotope services (as identified by
certain HCPCS codes); and (iv) customized prosthetic devices (artificial limbs)
and other custom prostheses if provided to a skilled nursing facility patient
and intended to be used after discharge (as identified by certain HCPCS codes
and other circumstances articulated by CMS). Payments for such items and
services are made under Part B to the provider of the service, in conformance
with Part B payment rules. Although these items are reimbursed separately from
the PPS rate, CMS, as directed by the Balanced Budget Refinement Act, has
adjusted the PPS payment rates to reflect the fact that these items and
services have been excluded.

Recent Modifications to Nursing Home Reimbursement under Medicaid

The Balanced Budget Act contained a number of changes affecting the Medicaid
program. Significantly, the law repealed the Boren Amendment, which required
state Medicaid programs to reimburse nursing facilities for the costs that are
incurred by efficiently and economically operated nursing homes. Since that
repeal, many states where we maintain significant operations have sought to
lower their nursing home payment rates, and several have succeeded. It is
unclear at this time the extent to which additional state Medicaid programs
will adopt changes in their Medicaid reimbursement systems, or, if adopted and
implemented, what effect these initiatives would have on us. Additionally,
rising Medicaid costs and decreasing state revenue caused by current economic
conditions have prompted an increasing number of states to cut Medicaid funding
and/or tighten eligibility requirements as a means of balancing their state
budgets. We cannot assure you that future changes in Medicaid reimbursement
rates to nursing facilities will not have a material adverse effect on us.
Further, the Balanced Budget Act allows states to mandate enrollment in managed
care systems without seeking approval from the Secretary of Health and Human
Services for waivers from specified Medicaid requirements as long as certain
standards are met. While these managed care programs have historically exempted
institutional care, some states use managed care financing for at least a
portion of their long-term care programs. Effective for Medicaid services
provided on or after October 1, 1997, states have considerable flexibility in
establishing payment rates. We cannot predict whether any additional states
will change the Medicaid reimbursement systems for long-term care facilities
from cost-based or fee-for-service to managed care negotiated or capitated
rates or otherwise affect the level of payments to us.

On January 12, 2001, the Secretary of Health and Human Services issued final
regulations to implement changes to the Medicaid upper payment limit
requirements, which became effective May 14, 2002. The purpose of the rule is
to stop states from using specified accounting techniques to obtain extra
federal Medicaid matching funds that are not necessarily spent on health care
services for Medicaid beneficiaries. Although the rule is being phased in over
eight years to reduce the adverse impact on certain states, the rule eventually
could result in decreased federal funding to those state Medicaid programs that
have used these accounting techniques to enhance their federal funding, which,
in turn, could prompt such states to reduce Medicaid reimbursements to
providers, including nursing facilities. CMS announced additional restrictions
on such funding in January 2002, and the agency could consider further
limitations in the future. Moreover, President Bushs proposed fiscal year
2005 budget, if adopted by Congress, would restrict the use of certain
intergovernmental transfers and limit federal reimbursement to a state to the
cost of the Medicaid services provided.

Medicare Reimbursement for Long-Term Acute Care Hospitals

In 2002, CMS implemented rules that replaced the reasonable cost-based payment
system for LTACs with a prospective payment system for LTACs, or LTAC PPS. As
of October 1, 2002, and subject to a five-year phase-in period during which
reimbursement is

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based on a blend of federal rates and a cost-based reimbursement system
(although some facilities can elect to adopt the full federal rates
immediately), LTACs are paid under this new LTAC PPS. We have elected to adopt
the full federal rates immediately. LTAC PPS uses information from patient
records to classify patients into distinct long-term care diagnosis related
groups, based on clinical characteristics and expected resource needs. Separate
per-discharge payments are calculated for each diagnosis related group. Our
experience under LTAC PPS has been positive. On January 30, 2004, CMS
published a proposed rule that would increase Medicare LTAC PPS rates by 2.9
percent, effective July 1, 2004, and make certain policy changes affecting LTAC
payment and classification policy. In addition, on February 10, 2004,
Representative Fortney Pete Stark (D-CA) introduced legislation that would
impose a temporary moratorium on new long-term care hospital beds pending
DHHS review of Medicare LTAC
hospital payment policy. We cannot predict whether Congress will adopt this
legislation, or whether Congress or CMS will impose other restrictions on LTACs
in the future.

Additional Medicare Legislation  Medicare Prescription Drug, Improvement, and Modernization Act of 2003

On December 8, 2003, President Bush signed into law the Medicare Prescription
Drug, Improvement, and Modernization Act of 2003. The legislation contains
numerous provisions regarding Medicare services, most notably an outpatient
prescription drug benefit. Among the other provisions, the legislation contains
a two year moratorium on the limitation on Part B therapy services. In
addition, the new law provides a temporary 128 percent increase in the RUG
payment for skilled nursing facility residents with acquired immune deficiency
syndrome, or AIDS, applicable to services furnished on or after October 1,
2004. The legislation also requires the DHHS Secretary to provide in a
beneficiarys explanation of Medicare benefits information about the number of
days of coverage remaining under the skilled nursing facility benefit and the
spell of illness involved, and to make information publicly available regarding
whether skilled nursing facilities are participating in the Medicare program.
The law also requires hospital discharge plans to include an assessment of a
patients need for skilled nursing facility care and information on the
availability of skilled nursing facility services near a patients home. The
legislation directs the DHHS Secretary to establish pilot projects in up to 10
states to identify efficient, effective and economical procedures for
long-term care facilities and other providers to conduct background checks on
direct patient access employees. Moreover, the physician fee schedule, under
which certain Medicare Part B services are reimbursed, is affected by the
legislation. The proposed 4.5% decrease in the conversion factor for calendar
year 2004 and the additional decrease in 2005 are blocked. Instead, the
conversion factor for physician services will increase by at least 1.5% in 2004
and 2005. The legislation also modifies the formula for calculating the
sustainable growth rate in an attempt to prevent wide swings in physician
payments based on year-to-year changes in economic performance. This
legislation contains numerous other provisions that may affect Medicare costs,
and at this time, we are unable to predict its effect on our business or
operations.

Intergovernmental Transfers

Certain taxes that we pay to state governments are used as mechanisms to
increase the amount of money that states receive, in turn, from the federal
government. These monies are usually returned to providers in the form of
higher Medicaid rates. This state tax scheme relies upon state
intergovernmental transfers as the legal funding mechanism to increase federal
financial participation (the federal portion of Medicaid funding). The
Presidents 2005 budget calls for federal legislation to restrict states from
using such intergovernmental transfer and proposes to limit Medicaid payments
to the cost of providing services to Medicaid beneficiaries. We cannot predict
whether or how this legislation, if passed will impact the taxes we pay to
states, our revenues, or the revenues we receive for Medicaid services.

GOVERNMENT REGULATION

General

The health care industry is subject to extensive regulation by a number of
governmental entities at the federal, state and local levels. The industry is
also subject to frequent regulatory change. Our business is impacted not only
by those laws and regulations that are directly applicable to us, but also by
other laws and regulations that are applicable to our managed care and other
patients. If we fail to comply with the laws and regulations directly
applicable to our business, we could suffer civil, administrative and/or
criminal penalties and we could be excluded from participating in Medicare,
Medicaid and other federal and state health care programs.

The federal government made a policy decision to significantly increase the
financial resources allocated to enforcing the health care fraud and abuse
laws. In addition, private insurers and various state enforcement agencies have
increased their level of scrutiny of health care claims in an effort to
identify and prosecute fraudulent and abusive practices in the health care
area.

Licensure, Certification, Survey and General Regulation

Our skilled nursing facilities and LTACs are licensed under applicable law to
the extent necessary. Our skilled nursing facilities and LTACs, and certain
professionals providing the services in those facilities, are also certified or
approved as providers under one or

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more of the Medicaid and Medicare programs. Also, our long-term care
facilities must comply with certain requirements to participate either as a
skilled nursing facility under Medicare or a nursing facility under Medicaid.
Failure to substantially comply with these requirements may result in
sanctions, including termination of the facilitys Medicare and Medicaid
provider agreements, after which the facility would be unable to receive
payment for services provided to Medicare or Medicaid patients until the
facility reapplies or is otherwise reinstated or recertified to participate in
Medicare or Medicaid. Licensing, certification and other applicable standards
vary from jurisdiction to jurisdiction and are revised periodically. We cannot
assure you that we will be able to maintain compliance with these regulatory
requirements at all times, or that we will not be required to expend
significant resources to do so.

Certificate of need statutes and regulations control the development and
expansion of health care services and facilities in some states. This process
is intended to promote quality health care at the lowest possible cost and to
avoid the unnecessary duplication of services, equipment and facilities.
Certificate of need or similar laws generally require that approval be obtained
from the designated state health planning agency for certain acquisitions and
capital expenditures, and that such agency determine that a need exists prior
to the expansion of existing facilities, construction of new facilities,
addition of beds, acquisition of major items of equipment or introduction of
new services. Additionally, several states have instituted moratoria on new
certificates of need or the approval of new beds. We do not expect these
changes to have a material impact on our business.

Referral Restrictions and Fraud and Abuse

The anti-kickback provisions in the federal Medicare and Medicaid programs
prohibit the knowing and willful solicitation or receipt of any remuneration
in return for referring an individual or for recommending or arranging for
the purchase, lease or ordering of any item or service for which payment may be
made under Medicare, Medicaid or other federal health care programs. In
addition, the statute prohibits the offer or payment of remuneration to
induce a person to refer an individual or to recommend or arrange for the
purchase, lease, or ordering of any item or service for which payment may be
made under the Medicare, Medicaid or other federal health care programs. The
penalties for violating the anti-kickback statute include imprisonment for up
to five years, fines up to $25,000 per violation or both, and possible
exclusion from federal health care programs such as Medicare and Medicaid.

Violations of the anti-kickback statute, pursuant to the Balanced Budget Act,
now also give rise to civil monetary penalties of $50,000 per act and treble
the remuneration involved without regard to whether any portion of that
remuneration relates to a lawful purpose. The statute contains safe harbor
exceptions including those for certain discounts, group purchasing
organizations, employment relationships, management and personal services
arrangements, health plans and certain other practices as defined in
regulations. The safe harbors include certain provisions, which, if met, will
assure health care providers and other parties that they will not be prosecuted
under the anti-kickback statute. Although full compliance with a safe harbor
ensures against prosecution under the anti-kickback statute, the failure of a
transaction or arrangement to fit within a specific safe harbor does not
necessarily mean that the transaction or arrangement is illegal or that
prosecution will be pursued. Arrangements or transactions that fail to satisfy
the applicable safe harbor criteria, however, risk increased scrutiny and
possible sanctions by enforcement authorities.

The Ethics in Patient Referral Act of 1989, or the Stark Law, prohibits
physician referrals of Medicare and Medicaid patients to an entity providing
designated health services if the physician or an immediate family member has
any financial arrangement with the entity and no statutory or regulatory
exception applies. The Stark Law also prohibits the entity from billing for any
prohibited referral. In 1998, CMS published proposed rules for the remaining
designated health services, and in January 2001, CMS published a final rule
that it characterized as the first phase of what will be a two-phase final
rule. Phase I of the final rule became effective on January 4, 2002, except for
a provision relating to physician payment arrangements, which became effective
on January 6, 2003. At present, it is unclear when CMS will publish Phase II of
the final rule.

There are other provisions in the Social Security Act and in other federal and
state laws authorizing the imposition of penalties, including fines and
exclusion from participation in Medicare and Medicaid, for various billing and
other offenses.

In addition, many states have analogous laws to the federal anti-kickback
statute and the Stark Law. These laws may extend the scope of liability
regarding prohibited remuneration for referrals and specified physician
financial relationships, to non-government payors such as insurers or even
private payors. Both the scope and exceptions for such conduct vary from state
to state.

The Health Insurance Portability and Accountability Act, or HIPAA (see Federal
Privacy and Transaction Regulations below in this Item 1 for a more detailed
discussion of the impact of HIPAA on our business), also created two new
federal crimes: health care fraud and false statements relating to health care
matters. The health care fraud statute prohibits knowingly and willfully
executing a scheme to defraud any health care benefit program, including
private payors. A violation of this statute is a felony and may result in
fines, imprisonment or exclusion from government-sponsored programs such as the
Medicare and Medicaid programs. The false statements statute prohibits
knowingly and willfully falsifying, concealing or covering up a material fact
or making any materially false, fictitious or fraudulent statement in
connection with the delivery of or payment for health care benefits, items or
services. A violation of this statute is a felony and may result in fines or
imprisonment.

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Additionally, HIPAA granted expanded enforcement authority to DHHS and the U.S.
Department of Justice and provided enhanced resources to support the activities
and responsibilities of the Office of Inspector General and Department of
Justice by authorizing large increases in funding for investigating fraud and
abuse violations relating to health care delivery and payment. The Balanced
Budget Act also includes numerous health care fraud provisions, including new
civil monetary penalties for contracting with an excluded provider; new surety
bond and information disclosure requirements for providers and suppliers,
including home health agencies (these surety bond requirements are currently on
hold); and an expansion of the mandatory and permissive exclusions added by
HIPAA to any federal health care program (other than the Federal Employees
Health Benefits Program).

False claims are prohibited under criminal and civil statutes. Criminal
provisions prohibit filing false claims or making false statements to receive
payment or certification under Medicare or Medicaid, or failing to refund
overpayments or improper payments; violations of these provisions are felonies
punishable by up to five years imprisonment, fines of up to $25,000 or both.
Civil provisions of the Federal False Claims Act, 31 U.S.C.
§§3729-3733, or the False Claims Act, prohibit the knowing filing of
a false claim or the knowing use of false statements to obtain payment;
penalties for violations are fines of not less than $5,500 nor more than
$11,000, plus treble damages, for each claim filed. Suits alleging false claims
can be brought by individuals, including employees and competitors. In
addition, various states have enacted laws modeled after the False
Claims Act.

In addition to actions brought by private parties, we believe that governmental
enforcement activities have increased at both the federal and state levels. We
cannot assure you that substantial amounts will not be required to be expended
by us to cooperate with these investigations and proceedings or to defend
allegations arising therefrom. If it is found that any of our practices failed
to comply with any of the anti-fraud provisions discussed above, we could be
materially adversely affected.

We are unable to predict the effect of future administrative or judicial
interpretations of the laws discussed above, or whether other legislation or
regulations on the federal or state level in any of these areas will be
adopted, what form any legislation or regulations may take, or their impact on
us. We cannot assure you that such laws will ultimately be interpreted in a
manner consistent with our practices.

Federal Privacy and Transaction Regulations

Other federal legislation requires major changes in our transmission and
retention of health information. HIPAA mandates, among other things, the
adoption of standards for the electronic exchange of health information in an
effort to encourage overall administrative simplification and enhance the
effectiveness and efficiency of the health care industry. Among the standards
that DHHS has adopted or is expected to adopt pursuant to HIPAA are standards
for the following: electronic transactions and code sets; unique identifiers
for providers, employers, health plans, and individuals; security and
electronic signatures; and privacy. Sanctions for failing to comply with HIPAA
include criminal and civil penalties.

Although HIPAA was intended ultimately to reduce administrative expenses and
burdens within the health care industry, we believe that the law will require
significant and costly changes to current practices. DHHS has released several
final rules to date to implement various HIPAA administrative simplification
requirements, the most significant of which mandate the use of new standards
for specified health care transactions and seek to protect the privacy and
security of health information. The first rule requires the use of uniform
standards for common health care transactions, including health care claims
information, plan eligibility, referral certification and authorization, claims
status, plan enrollment and disenrollment, payment and remittance advice, plan
premium payments and coordination of benefits. While we initially were
required to comply with the transaction standards by October 16, 2002, Congress
passed legislation that extended the deadline to October 16, 2003 for those
HIPAA-covered entities that submitted a timely compliance plan to the DHHS. We
submitted a compliance plan and were granted the deadline extension. On
September 23, 2003, DHHS acknowledged that not all of the health care providers
and health plans, state Medicaid offices and third party payors are capable of
accepting claims transactions in a manner that is compliant with the HIPAA
Standard Transactions and Code Set specifications. Therefore, DHHS has agreed
to allow covered entities to accept both HIPAA-compliant and non-compliant
transactions until such time as DHHS determines that compliance has been
achieved. Our claims are submitted by paper claims, direct data entry or
through the use of a health care clearinghouse. Our clearinghouse has advised
us that it has been testing and is currently compliant with the Standard
Transactions and Code Set specification. We are prepared to utilize our
contingency plan if necessary. Although we can make no assurances, we do not
anticipate that our liquidity will be adversely affected during the transition
or when the standard ultimately is enforced.

The second rule imposes new standards relating to the privacy of individually
identifiable health information. These standards not only require our
compliance with rules governing the use and disclosure of protected health
information, but they also require us to obtain satisfactory assurances that
any business associate to whom such information is disclosed will safeguard the
information. The privacy standards were issued on December 28, 2000, with
further modifications adopted in August 2002. The standards became effective
on April 14, 2001, with a compliance date of April 14, 2003 for most covered
entities.

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DHHS also has issued rules, among other things, to specify a series of
administrative, technical and physical security procedures we must implement to
assure the confidentiality of electronic protected health information. The
security standards are effective April 21, 2003, with a compliance date of
April 21, 2005 for most covered entities. Most recently, DHHS published a rule
in January 2004 announcing the adoption of the National Provider Identifier as
the standard unique health identifier for health care providers to use in
filing and processing health care claims and other transactions. The rule is
effective May 23, 2005, with a compliance date of May 23, 2007.

Nursing Home Quality Initiative

In April 2002, DHHS announced the Nursing Home Quality Initiative pilot program
for the states of Colorado, Florida, Maryland, Ohio, Rhode Island and
Washington. This program, which is designed to provide consumers with
comparative information about nursing home quality measures, rated every
nursing facility and skilled nursing facility operating in these states on nine
quality-of-care indicators. The quality of care indicators include measures
such as percentages of patients with infections, bedsores and unplanned weight
loss.

On November 12, 2002, DHHS announced that the program was being launched
nationwide. For the national project, minor modifications were made to the list
of quality measures. DHHS now is using ten quality measures falling into two
categories  six for chronic care patients (long-term stay residents) and four
for post-acute care patients (short-term patients). On November 13, 2002, CMS
published advertisements in newspapers in every state that included a sampling
of the quality data, and the complete data is available on the Internet. On
January 22, 2004, CMS unveiled an updated Nursing Home Compare website that
includes enhanced nursing home quality measures and easier navigation for
consumers.

Nurse Staffing Issues

We operate a number of skilled nursing facilities in California, which has
enacted legislation establishing minimum staffing requirements for skilled
nursing facilities. Certain other states in which we operate skilled nursing
facilities have adopted minimum staffing and additional states may also
establish similar requirements in the future. Our ability to satisfy these
requirements will depend upon our ability to attract and retain qualified
nurses, certified nurses assistants and other staff. Failure to comply with
these requirements may result in the imposition of fines or other sanctions.
See Risk Factors  Risks Relating to Our Business, below in this Item 1 for a
more detailed discussion of the effects of nurse staffing regulations and
issues on our business.

CORPORATE INTEGRITY AND COMPLIANCE PROGRAMS

Corporate Integrity Agreement

On April 3, 2002, as a condition of the Global Settlement discussed below in
this Item 1 under the caption Global Settlement, we entered into a Corporate
Integrity Agreement with the DHHS Office of Inspector General, or the Corporate
Integrity Agreement, to promote our compliance with the requirements of
Medicare, Medicaid and all other federal health care programs. The Corporate
Integrity Agreement is effective for five years beginning April 3, 2002. Under
the Corporate Integrity Agreement, we agreed to review, and are reviewing, our
current corporate compliance infrastructure and are implementing additional
quality improvement programs and internal financial controls in our facilities
and regional and corporate offices. We believe we have retained sufficient
flexibility under the Corporate Integrity Agreement to enable us to focus our
efforts on developing improved systems and processes for providing quality
care. We believe that many of the requirements of the Corporate Integrity
Agreement essentially codify our existing policies.

The Corporate Integrity Agreement includes compliance requirements that
obligate us to:



| |  |  | adopt and implement written standards on federal health care program
requirements relating to financial and quality of care issues;                                                                                                                                                                                                                                                                                                                                                                       
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | conduct training each year for all employees to promote compliance
with federal health care requirements. In addition, we will continue to
operate our internal compliance hotline;                                                                                                                                                                                                                                                                                                                       
|
| |  |  | put in place a comprehensive internal quality improvement program,
which includes establishing committees at the facility and corporate
levels to review quality-related data, direct quality improvement
activities and implement and monitor corrective action plans. We have
retained an independent quality monitor to evaluate the effectiveness
and reliability of our internal quality control system. The independent
quality monitor will report its findings to the Office of Inspector
General;

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| |  |  | conduct an ongoing evaluation and enhancement our current system of
internal financial controls to promote compliance with federal health
care program requirements on billing and related financial issues,
including a variety of internal audit and compliance reviews. We have
retained an independent review organization to evaluate the integrity
and effectiveness of our internal billing systems. The independent
review organization will report annually its findings to the Office of
Inspector General;                                                                                       
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | notify the Office of Inspector General within 30 days of our
discovery of any ongoing investigation or legal proceeding conducted or
brought by a governmental entity involving any allegation that we have
committed a crime or engaged in a fraudulent activity, and within 30
days of our determination that we have received a substantial
overpayment relating to any federal health care program or any other
matter that a reasonable person would consider a potential violation of
the federal fraud and abuse laws or other criminal or civil laws related
to any federal health care program; and
|
| |  |  | submit annual reports to the Office of Inspector General
demonstrating compliance with the terms of the agreement, including the
findings of our internal audit and review program.                                                                                                                                                                                                                                                                                                                                                                                                                         

The Corporate Integrity Agreement contains standard penalty provisions for
breach, which include stipulated cash penalties ranging from $1,000 per day to
$2,500 per day for each day we are in breach of the agreement. If we fail to
remedy a breach in the time specified in the agreement, we can be excluded from
further participation in federal health care programs.

Compliance Program

In March 2000, the Office of Inspector General issued guidance to help nursing
facilities design effective voluntary compliance programs to prevent fraud,
waste and abuse in health care programs, including Medicare and Medicaid. The
guidance recommends that nursing facilities enact procedures and policies in
prevention of fraud, waste and abuse. We voluntarily adopted a compliance
program in early 1998 for all of our facilities, and believe that this
compliance program substantially incorporates the guidance that the Office of
Inspector General has recommended be included in such programs. As
indicated above, in
connection with the Global Settlement, we entered into the Corporate Integrity
Agreement, which is intended to promote our compliance with the requirements of
Medicare, Medicaid and all other federal health care programs.

The purpose of our compliance program is to address compliance issues,
communicate issues to our chief executive officer, or Chief Executive Officer,
and board of directors, or Board of Directors, monitor our fraud and abuse
hotline and assure ethical and legal conduct by management and employees. The
compliance program is managed by our compliance officer who works closely with
the human resources, legal and operations departments on compliance training
issues quality of care issues and legal matters involving compliance issues.

One important part of our compliance program is the maintenance of a toll-free
hotline whereby individuals can anonymously report suspected violations of laws
or our policies without fear of reprisal or retribution. The hotline telephone
number is prominently posted in all of our skilled nursing facilities and other
areas where we have operations. Employees, patients and family members are
encouraged to call the hotline to report any potential issues they might note.
Upon report of a call, our compliance department investigates the issue and, if
necessary, communicates with the appropriate corporate departments in order to
resolve the issue. Employees are assured that any calls to the hotline will not
result in any retribution by us. We believe this program has been highly
successful and will help identify trends and potential problem areas in a
timely fashion for quick remediation.

We have also implemented a comprehensive background check initiative aimed at
improving the quality of our workforce and reducing employee turnover. To the
best of our knowledge, this program meets or exceeds all state and federal
regulatory requirements for background checks.

INSURANCE

Insurance related costs in the long-term care industry continue to rise at a
dramatic rate. This primarily includes professional liability and general
liability, or PL/GL, insurance and claims, workers compensation insurance and
costs, and directors and officers liability programs. Historically, costs for
PL/GL programs were of particular concern in Texas where we maintain
significant operations.

As of September 1, 2003, a law enacting tort reform in Texas became effective.
We operate 82 facilities (including six LTACs) in Texas. Among other things,
the law imposes a $250,000 cap on the non-economic damages (such as pain and
suffering) that claimants can recover in a malpractice lawsuit against a health
care institution. The law also imposes an aggregate $500,000 cap on the amount
of such damages that claimants can recover in malpractice lawsuits against more
than one health care institution. Finally, the law

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revises an existing $1.5 million cap (subject to future adjustment for
inflation) on recovery in wrongful death and survivor actions by requiring that
this cap be imposed on a per claimant rather than per defendant basis and by
including punitive damages in the awards subject to the cap. We believe this
reform should reduce our liability exposure in Texas for future periods.

Additionally, effective October 1, 2003, we sold 18 skilled nursing facilities
and terminated one lease for a skilled nursing facility, all of which were
located in Florida. On November 30, 2003, we terminated capital leases
associated with an additional seven skilled nursing facilities located in
Florida. We also terminated the operating leases on the two remaining skilled
nursing facilities we operated in Florida effective November 30, 2003 and
December 31, 2003. As a result of these transactions, we have no remaining
skilled nursing facilities in Florida. Given that Florida has been a highly
litigious state, we believe exiting the state should reduce our liability
exposure for future periods.

In spite of the positive developments mentioned above, a significant increase
in the frequency and severity of PL/GL claims continues in our industry and is
spreading to other states, particularly Mississippi. Insurance markets have
responded to this significant increase by severely restricting the availability
of PL/GL insurance coverage. As a result of these changes, fewer companies are
engaged in insuring long-term care companies for PL/GL losses, and those that
do offer insurance coverage do so at a very high cost. We anticipate this trend
will continue and that our PL/GL costs will continue to increase. These
increases have already had an adverse effect on our operations. No assurance
can be given that our PL/GL costs will not continue to rise or that PL/GL
coverage will be available to us in the future. In the event that PL/GL
insurance coverage becomes cost prohibitive to maintain or unavailable in some
markets, we may be forced to re-evaluate our continued operations in those
markets or the amount of insurance coverage that we maintain.

Due to the rising cost and limited availability of PL/GL insurance, we
currently purchase excess PL/GL liability insurance only and maintain an
unaggregated $1.0 million self-insured retention per claim in all states except
Colorado, where we maintain first dollar coverage. Additionally, we currently
self-insure the first $0.5 million of each employee injury claim. Because we
are largely self-insured on both of these programs, there is no limit on the
maximum number of claims or amount for which we can be liable in any policy
period. Although we base our loss estimates on independent actuarial
analyses completed semi-annually based on the information we have to date, the amount of the losses could exceed
our estimates. In the event our actual liability exceeds our estimates for any
given period, our results of operations and financial condition could be
materially adversely impacted.

PAYORS

We receive payments for services
rendered to patients at both our skilled nursing facilities and LTACs from the federal
government under Medicare, from the various states where we operate under
Medicaid and from private and other payors. We classify payments from
individuals who pay directly for services without governmental assistance
through the Medicare or Medicaid programs as private pay revenue. The private
pay classification also includes revenue from managed
care companies, commercial insurers, Veterans Administration contractual
payments and payments for services provided under contract management programs.
Managed care as a payor source to nursing home operators is expected to
increase over the next several years. However, revenue from managed care payors
does not constitute a significant portion of our revenue at this time.

In connection with the operation of
both our skilled nursing facilities and LTACs, we have historically received, and expect to continue to receive, a majority of
our revenue from federal and state governments and governmental entities. Other
than being excluded from the Medicare program or from a state Medicaid program
in a state in which we have a significant concentration of either
type of facility, we do
not expect that the loss of a single payor or group of related payors would
have a material adverse effect on our business or revenue. For the
year ended December 31, 2003, 81.2% of the revenue
for our skilled nursing services segment came from Medicare and
state Medicaid programs. For the year ended December 31, 2003,
82.7% of the revenue for our LTAC
segment came from Medicare and state Medicaid programs. Because we receive a majority of our revenue from the
sources indicated above, there are no individual patients or customers or
related groups of patients or customers that account for a significant portion
of our revenue.

With respect to both our skilled
nursing facilities and our LTACs, our revenue and profitability are affected by ongoing efforts of third-party
payors to contain health care costs by limiting reimbursement rates, increasing
case management review and negotiating reduced contract pricing. The federal
Medicare program restricts coverage to patients who require skilled care,
whereas state-administered Medicaid programs generally provide more restricted
coverage and lower reimbursement rates than private pay sources. The sources
and amounts of our patient revenue are determined by a number of factors,
including licensed bed capacity of our facilities, occupancy rate, payor mix,
type of services rendered to the patient and rates of reimbursement among payor
categories (private and other payors, Medicare and Medicaid). Changes in the
mix of our patients among the private and other payors, Medicare and Medicaid
categories, as well as changes in the quality mix, significantly affect the
profitability of our operations. Historically, on a per patient basis, private
pay patients have been the most profitable and Medicaid patients have been the
least profitable. Historically, our LTACs have had a higher
proportion of Medicare and private pay patients than our skilled nursing facilities,
making them more profitable on a per patient basis than our skilled
nursing facilities. Also, we have historically derived higher revenue from
providing specialized medical services than from providing routine inpatient
care.

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MARKETING

We recently have centralized our
skilled nursing services sales and marketing efforts under one
department head. This newly created department focuses on negotiating and
obtaining managed care contracts at both the regional and national level as
well as increasing our Medicare census. In addition, this department focuses on
training local sales teams on obtaining patient referrals.

In marketing our skilled nursing and
LTAC patient services, we pursue a two-tiered strategy. We promote
our facilities programs and services first to payors and managed care
organizations at the regional level and second to health care professionals
responsible for discharging patients at local hospitals at the individual
facility level. At the regional level, our marketing personnel seek to
establish relationships with payors and managed care organizations, which are
increasingly important sources of referrals for sub-acute patients. We develop
contractual relationships with these payors and organizations on a local,
regional and national basis.

Local market coordinators focus on establishing and maintaining cooperative
relationships and networks with physicians, acute-care hospitals and other
health care providers, with an emphasis on specialists who treat ailments
involving long-term care and rehabilitation. Marketing programs targeting
managed care payors are also being implemented at both the local and national
level. Ongoing assessment of patient and physician satisfaction with our
services allows for improvements in service and clinical performance.

We desire to take advantage of other opportunities for increased profitability,
including arrangements with managed care organizations such as health
maintenance organizations, or HMOs, which we believe may increase our sub-acute
care business. Typically, patients referred by managed care organizations,
including HMOs and preferred provider organizations, generate higher revenue
per patient day than Medicaid patients as a result of the higher acuity needs
of the referrals. We believe that our ability to provide sub-acute and
specialty medical services at a lower cost than acute-care hospitals is a
competitive advantage in providing services to these payor sources. We also
believe that our focus on important operations and our continued implementation
of standardized processes better allows us to meet the needs of these higher
acuity residents.

SUPPLIERS

We purchase our supplies from a
variety of independent suppliers for both our skilled nursing
facilities and LTACs. However, we
typically focus on one or two national suppliers in each product category in an
effort to maximize delivery efficiency and gross margins. Although we have firm
purchase commitments with some of our national suppliers, we believe that we
are not dependent upon any one supplier, and believe that several alternative
suppliers can provide our supplies if the relationship with a national supplier
is terminated. We recently established an internet-based purchasing solution
designed to ensure best product and pricing for our facilities on an aggregate
basis. This system, known as OASIS, also leverages the purchasing power of
several other long-term care providers who participate in a group purchasing
organization.

COMPETITION

The long-term care industry is segmented into a variety of competitive areas
that market similar services. Competitors for our skilled nursing
facilities include other nursing homes,
hospitals, extended care centers, assisted living facilities, retirement
centers and communities and home health and hospice agencies. Many operators of
acute-care hospitals offer or may offer post-acute services in the future.
These operators would have the competitive advantage of being able to offer
services to patients at their affiliated post-acute care operations.
Skilled
nursing facilities and LTACs historically have competed on a local basis with other
long-term care providers, and our competitive position will vary from center to
center within the various communities we serve. Significant competitive factors
include the quality of care provided, reputation, location and physical
appearance of the skilled nursing facilities and, in the case of private pay
residents, charges for services. For
both our skilled nursing facilities and LTACs, since there is little price competition with
respect to Medicaid and Medicare residents, the range of services
provided that are covered by Medicaid and Medicare as well as the
location and physical condition of our facilities will significantly affect our
competitive position in our markets with respect to such residents.

Within some of our skilled nursing facilities, we operate specialized units
providing sub-acute care. These specialized units generally have a higher
staffing level per patient than our other inpatient facilities and compete with
acute-care and rehabilitation hospitals, which we believe typically charge
rates higher than those charged by our specialty units. In the future, however,
these or other hospitals may offer these or other services at rates less than
we charge, which could force us to lower our rates or service fewer patients,
adversely affecting our financial condition and results of operations.

During the past several years, our
skilled nursing facilities have experienced a decline in our private pay
census. We believe this is in large part due to the significant number of assisted
living facilities that were constructed during the 1990s and which have newer
physical plants but are largely unregulated. Additionally, North Carolina
recently started to certify assisted living facilities for participation in the
Medicaid program. While assisted living facilities generally are not equipped
or staffed to care for the typical skilled nursing facility patient, we believe
that in the near term we are vulnerable to assisted living facilities with
respect to our private pay patients.

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EMPLOYEES

We currently employ approximately 35,000 full and part-time employees and
believe our relations with our employees are generally good. We depend upon
skilled personnel, such as nurses, as well as unskilled labor, to staff our
facilities. In some areas in which we operate there is a labor shortage that
could have a material adverse effect upon our ability to attract or retain
sufficient numbers of skilled personnel or impair our ability to attract or
retain sufficient numbers of unskilled labor personnel at reasonable wages.

We have unionized facilities in California, Michigan, Wisconsin, Maryland,
Ohio, and West Virginia. We have collective bargaining agreements with unions
representing employees at 26 facilities. In addition, a union represents
employees at another of our facilities without a collective bargaining
agreement.

Of our 13 unionized facilities in California, twelve are represented by the
Service Employees International Union, or SEIU, and of those eleven are subject
to a regional master collective bargaining agreement. One facility does not
have a collective bargaining agreement. The Company and the SEIU currently are
in negotiations. The other unionized facility in California is represented by
the International Brotherhood of Teamsters, or the Teamsters. The SEIU and the
Teamsters primarily represent certified nursing assistants, dietary workers and
laundry and housekeeping employees. In five of the 13 facilities, licensed
nurses also are represented by the relevant union. The agreement with the SEIU
expires on June 15, 2004, with a wage and benefit re-opener for the third year
of the contract (which is currently being negotiated). The Teamsters agreement
expired on December 31, 2002 and has been extended indefinitely pending
negotiations.

In addition, the Company joined other long-term care providers, community
groups and the SEIU in California to form an alliance called California United
for Nursing Home Care. In return for the SEIUs political support against
MediCal reimbursement cuts, and in favor of tort and reimbursement reform, the
providers signed a neutrality agreement allowing the SEIU uncontested access to
a certain number of facilities depending on the progress of tort reform and
reimbursement rates.

In Michigan: (i) six of our facilities have a regional master collective
bargaining agreement with the SEIU; (ii) one facility has an agreement with the
American Federation of State, County, and Municipal Employees, or AFSCME; and
(iii) one of our facilities has an employee council. The agreement with the
SEIU expires on May 1, 2004, with a wage and benefits re-opener for the second
and third year of the agreement. The AFSCME agreement had an expiration date of
September 30, 2003, but continues to be in effect from year to year in the
absence of a notice to terminate or amend the agreement. The current employee
council agreement expires on September 30, 2004.

In Maryland, the SEIU represents employees at three of our facilities. The
agreements expire on December 31, 2004, January 15, 2005 and January 31, 2005.

In Wisconsin, there is one facility where the workers are represented by the
SEIU. The SEIU agreement relating to that facility will expire on August 1,
2004. The SEIU also represents employees at our facility in West Virginia. The
SEIU agreement for the West Virginia facility will expire on March 1, 2005. In
Ohio, there is one facility where the employees are represented by the Hotel
Employees and Restaurant Employees Union. This agreement will expire on June
30, 2005.

We cannot predict the effect that continued union representation or future
organizational activities will have on our business. In California and
Michigan, the SEIU has in the past engaged in informational picketing before
agreements were reached. However, neither the aforementioned organizations, nor
any others, have caused any material work stoppages in the past. We cannot
assure you that we will not experience a material work stoppage in the future.

ENVIRONMENTAL MATTERS

We are subject to various federal, state and local laws and regulations
governing the use, discharge and disposal of hazardous materials, including
medical waste products. Compliance with these laws and regulations is not
expected to have a material effect on us. It is possible, however, that
environmental issues may arise in the future that we cannot now predict.

BANKRUPTCY AND REORGANIZATION

On January 18, 2000, we filed voluntary petitions for relief in the Bankruptcy
Court under the Bankruptcy Code. In connection with our emergence from
bankruptcy, our Joint Plan was confirmed by the Bankruptcy Court on April 3,
2002 and was effective on May 13, 2002. For a discussion of the impact of the
bankruptcy on the presentation of the consolidated financial statements
appearing elsewhere in this Annual Report on Form 10-K, see Item 7,
Managements Discussion and Analysis of Financial Condition and Results of
Operation.

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GLOBAL SETTLEMENT

As part of our emergence from our bankruptcy, we reached a settlement with the
United States to resolve certain claims of the United States government against
us that arose prior to the Petition Date. This settlement is referred to as the
Global Settlement. United States Claims are those claims or causes of action
asserted by or on behalf of the United States seeking remedies of any kind:



| |  |  | under the False Claims Act, the
Civil Monetary Penalties Law, 42 U.S.C §1320a-7a, or the
Civil Monetary Penalties Law, and the
Program Fraud Civil Remedies Act of 1986, 31 U.S.C
§§3801-3812, or the Program Fraud Civil Remedies Act, and/or other statutory or common law
doctrines of payment by mistake, unjust enrichment, breach of contract,
or fraud;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | for administrative overpayments, including claims or causes of action
for services rendered or products supplied under Medicare, the TRICARE
Program, or any other federal health program;                                                                                                                                                                    
|
| |  |  | for specified civil monetary penalties;                                                                                                                                                                                                                                                                                                                       
|
| |  |  | arising under any provider or similar agreement with the United States; and                                                                                                                                                                                                                                                                                   
|
| |  |  | for permissive exclusion from Medicare, Medicaid and other federal health programs.                                                                                                                                                                                                                                                                           

The Global Settlement was approved by the Bankruptcy Court and became effective
on April 3, 2002. Under the Global Settlement, which applies to any facility
operated by us at any time prior to the date the Global Settlement became
effective:



| |  |  | all Medicare claims and debts arising prior to the Petition Date were
released as between CMS and us;                                                                                                                                                                                                                                     
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the United States approved a settlement of Medicare administrative
appeals related to disallowances under the prudent buyer principle, or
the Prudent Buyer Settlement, and we waived our rights to collect any
amounts due under the Prudent Buyer Settlement;                                                                           
|
| |  |  | CMS adjusted specified Medicare PPS base year cost reports to accurately calculate PPS rates;                                                                                                                                                                                                                                             
|
| |  |  | CMS agreed to pay us $3.0 million;                                                                                                                                                                                                                                                                                                        
|
| |  |  | the Department of Justice released us from certain covered conduct
alleged within six qui tam lawsuits and other disputes under the Federal
False Claims Act;                                                                                                                                                                           
|
| |  |  | we agreed to be responsible for any attorney fees sought by qui tam
relators counsel;                                                                                                                                                                                                                                                    
|
| |  |  | the United States waived any claims for (a) Medicare reimbursement
for two voluntary disclosures made by us to the United States and (b)
Medicare reimbursement related to an Office of Inspector General
investigation;                                                                                                                  
|
| |  |  | we agreed to enter into the Corporate Integrity Agreement;                                                                                                                                                                                                                                                                                
|
| |  |  | we rejected and terminated specified provider agreements for discontinued operations;                                                                                                                                                                                                                                                     
|
| |  |  | all cost years ending on or before the petition date were fully and finally resolved by the Global Settlement;                                                                                                                                                                                                                            
|
| |  |  | for cost years that span the petition date, CMS agreed to settle the
cost reports for these years, and we retained our rights to appeal or
request the reopening of such years, but any relief awarded relating to
those years will be pro-rated so that the prepetition portion is waived
and the post petition portion is preserved; and
|
| |  |  | as part of the cure for the assumption of Medicare provider
agreements, or in the case of any rejected and terminated provider
agreements, we agreed to pay any portion of a Medicare overpayment or
civil monetary penalty that accrued after the petition date.                                                                         

In accordance with GAAP, we recorded a charge of approximately $33.4 million
relating to the Global Settlement in our statement of operations for the fourth
quarter of the fiscal year ended September 30, 2001.

AVAILABLE INFORMATION

Our web address is www.marinerhealthcare.com. Our reports on Form 10-K, Form
10-Q and Form 8-K, as well as amendments to

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those reports, are available free of charge on our website as soon as
reasonably practicable after we file or furnish the reports with the Securities
and Exchange Commission, or the SEC. In addition, you may request a copy of
these filings (excluding exhibits) at no cost by writing us at Mariner Health
Care, Inc., c/o Investor Relations, One Ravinia Drive, Suite 1500, Atlanta,
Georgia 30346.

RISK FACTORS

You should carefully consider the risk factors set forth below, as well as the
other information contained in this Annual Report on Form 10-K. The risks
described below are not the only risks facing us. Additional risks and
uncertainties not currently known to us or that we currently deem to be
immaterial may also materially and adversely affect our business operations.
Any of the following risks could materially adversely affect our business,
financial condition or results of operations

Risks Relating to Our Company

We depend on reimbursement from Medicare, Medicaid and other third-party payors
and reimbursement rates from such payors may be reduced.

We derive a substantial portion of our revenue from third-party payors,
including the Medicare and Medicaid programs. For the twelve months ended
December 31, 2003, we derived approximately 81.2% of our total revenue from
the Medicare and Medicaid programs. Third-party payor programs are highly
regulated and are subject to frequent and substantial changes. Changes in the
reimbursement rate or methods of payment from third-party payors, including the
Medicare and Medicaid programs, or the implementation of other measures to
reduce reimbursements for our services has in the past, and could in the
future, result in a substantial reduction in our revenues and operating
margins. Additionally, net revenue realizable under third-party payor
agreements can change after examination and retroactive adjustment by payors
during the claims settlement processes or as a result of post-payment audits.
Payors may disallow requests for reimbursement based on determinations that
certain costs are not reimbursable or reasonable because additional
documentation is necessary or because certain services were not covered or were
not reasonable and medically necessary. There also continue to be new
legislative and regulatory proposals that could impose further limitations on
government and private payments to health care providers. In some cases, states
have enacted or are considering enacting measures designed to reduce their
Medicaid expenditures and to make changes to private health care insurance. We
cannot assure you that adequate reimbursement levels will continue to be
available for the services provided by us, which are currently being reimbursed
by Medicare, Medicaid or private third-party payors. Further limits on the
scope of services reimbursed and on reimbursement rates could have a material
adverse effect on our liquidity, financial condition and results of operations.
It is possible that the effects of any of the Medicare Reimbursement Cliff,
further refinements to PPS that result in lower payments to us or cuts in state
Medicaid funding could have a material adverse effect on our results of
operations. See Item 1, Business  Reimbursement.

We conduct business in a heavily regulated industry, and changes in, or
violations of, regulations may result in increased costs or sanctions that
reduce our revenue and profitability.

In the ordinary course of our business, we are regularly subject to inquiries,
investigations and audits by federal and state agencies to determine whether we
are in compliance with regulations governing the operation of, and
reimbursement for, skilled nursing facilities and LTACs. These regulations
include those relating to licensure, conduct of operations, ownership of
facilities, construction of new and additions to existing facilities, allowable
costs, services and prices for services. In particular, various laws, including
federal and state anti-kickback and anti-fraud statutes, prohibit certain
business practices and relationships that might affect the provision and cost
of health care services reimbursable under federal and/or state health care
programs such as Medicare and Medicaid, including the payment or receipt of
remuneration for the referral of patients whose care will be paid by federal
governmental programs. Sanctions for violating the anti-kickback and anti-fraud
statutes include criminal penalties and civil sanctions, including fines and
possible exclusion from governmental programs such as Medicare and Medicaid.

In addition, the Stark Law broadly
defines the scope of prohibited physician referrals under federal health care
programs to providers with which they have ownership or other financial
arrangements. Many states have adopted, or are considering, legislative
proposals similar to these laws, some of which extend beyond federal health
care programs, to prohibit the payment or receipt of remuneration for the
referral of patients and physician referrals regardless of the source of the
payment for the care. These laws and regulations are complex and limited
judicial or regulatory interpretation exists. We cannot assure you that
governmental officials charged with responsibility for enforcing the provisions
of these laws and regulations will not assert that one or more of our
arrangements are in violation of the provisions of such laws and regulations.

The regulatory environment surrounding the long-term care industry has
intensified, particularly for larger for-profit, multi-facility providers like
us. The federal government has imposed extensive enforcement policies resulting
in a significant increase in the number

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of inspections, citations of regulatory deficiencies and other regulatory
sanctions, including terminations from the Medicare and Medicaid programs,
denials of payment for new Medicare and Medicaid admissions and civil monetary
penalties. If we fail to comply, or are perceived as failing to comply, with
the extensive laws and regulations applicable to our business, we could become
ineligible to receive government program reimbursement, be required to refund
amounts received from Medicare, Medicaid or private payors, suffer civil or
criminal penalties, suffer damage to our reputation in various markets or be
required to make significant changes to our operations. We are also subject to
federal and state laws that govern financial and other arrangements between
health care providers. These laws often prohibit certain direct and indirect
payments or fee-splitting arrangements between health care providers that are
designed to induce the referral of patients to a particular provider for
medical products and services. Possible sanctions for violation of any of these
restrictions or prohibitions include loss of eligibility to participate in
reimbursement programs and/or civil and criminal penalties. Furthermore, some
states restrict certain business relationships between physicians and other
providers of health care services. Many states prohibit business corporations
from providing, or holding themselves out as a provider of, medical care. From
time to time, we may seek guidance as to the interpretation of these laws;
however, there can be no assurance that such laws will ultimately be
interpreted in a manner consistent with our practices. In addition, we could be
forced to expend considerable resources responding to an investigation or other
enforcement action under these laws or regulations. Furthermore, should we lose
licenses or certifications for a number of our facilities as a result of
regulatory action or otherwise, we could be deemed in default under some of our
agreements, including agreements governing outstanding indebtedness. We also
are subject to potential lawsuits under a federal whistleblower statute
designed to combat fraud and abuse in the health care industry. These lawsuits
can involve significant monetary awards to private plaintiffs who successfully
bring these suits.

We have established policies and procedures that we believe are sufficient to
ensure that our facilities will operate in substantial compliance with these
anti-fraud and abuse requirements. While we believe that our business practices
are consistent with Medicare and Medicaid criteria, those criteria are often
vague and subject to change and interpretation. Aggressive anti-fraud actions,
however, could have an adverse effect on our financial position, results of
operations and cash flows. See Item 1, Business 
Government Regulation.

We face additional federal requirements that mandate major changes in the
transmission and retention of health information. HIPAA was enacted to ensure,
first, that employees can retain and at times transfer their health insurance
when they change jobs, and second, to simplify health care administrative
processes. This simplification includes expanded protection of the privacy and
security of personal medical data and requires the adoption of standards for
the exchange of electronic health information. Among the standards that the
Secretary of Health and Human Services has adopted pursuant to HIPAA are
standards for the following: electronic transactions and code sets, unique
identifiers for providers, employers, health plans and individuals, security
and electronic signatures, privacy and enforcement. Although HIPAA was intended
to ultimately reduce administrative expenses and burdens faced within the
health care industry, we believe that implementation of this law has resulted
and will continue to result in additional costs. Failure to comply with HIPAA
could result in fines and penalties that could have a material adverse effect
on us. See Item 1, Business  Government Regulation.

We are unable to predict the future course of federal, state and local
regulation or legislation, including Medicare and Medicaid statutes and
regulations, or the intensity of federal and state enforcement actions. Our
failure to obtain or renew required regulatory approvals or licenses or to
comply with applicable regulatory requirements, the suspension or revocation of
our licenses or our disqualification from participation in certain federal and
state reimbursement programs, or the imposition of other harsh enforcement
sanctions could have a material adverse effect upon our operations and
financial condition.

Significant legal actions, which are commonplace in our industry, could subject
us to increased operating costs and substantial uninsured liabilities, which
would materially and adversely affect our liquidity and financial condition.

As is typical in the health care industry, we are and will continue to be
subject to claims that our services have resulted in resident injury or other
adverse effects. We, like our industry peers, have experienced an increasing
trend in the frequency and severity of PL/GL claims and litigation asserted
against us. In some states in which we have significant operations, insurance
coverage for the risk of punitive damages arising from PL/GL claims and/or
litigation may not, in certain cases, be available due to state law
prohibitions or limitations of availability. We cannot assure you that we will
not be liable for punitive damage awards that are either not covered or are in
excess of our insurance policy limits. We also believe that there has been, and
will continue to be, an increase in governmental investigations of long-term
care providers, particularly in the area of Medicare/Medicaid false claims, as
well as an increase in enforcement actions resulting from these investigations.
Insurance is not available to cover such losses. Any adverse determination in a
legal proceeding or governmental investigation, whether currently asserted or
arising in the future, could have a material adverse effect on our financial
condition.

Due to the rising cost and limited availability of PL/GL insurance, we
currently purchase excess PL/GL insurance only and maintain an unaggregated
$1.0 million self-insured retention per claim in all states except Colorado,
where we maintain first dollar coverage. Additionally, we currently self insure
the first $0.5 million of each employee injury claim. Because we are largely
self-insured on both

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of these programs, there is no limit on the maximum number of claims or amount
for which we can be liable in any policy period. Although we base our loss
estimates on independent actuarial analyses using the information we have to
date, the amount of the losses could exceed our estimates. In the event our
actual liability exceeds our estimates for any given period, our results of
operations and financial condition could be materially adversely impacted. In
addition, our insurance coverage might not cover all claims made against us nor
continue to be available at a reasonable cost, if at all. If we are unable to
maintain our current insurance coverage, if judgments are obtained in excess of
the coverage we maintain, if we are required to pay uninsured punitive damages,
or if the number of claims settled within the $1.0 million self-insured
retention currently in place significantly increases, we could be exposed to
substantial additional liabilities. We cannot assure you that we can continue
to obtain insurance coverage similar to that which we currently maintain
without paying substantially higher premiums, or at all, that current or future
coverage will be adequate to satisfy adverse determinations against us or that
the number of claims within the self-insured retention will not increase.

The cost to replace or retain qualified nurses, health care professionals and
other key personnel may adversely affect our financial performance, and we may
not be able to comply with certain states staffing requirements.

We could experience significant increases in our operating costs due to
shortages in qualified nurses, health care professionals and other key
personnel. The market for these key personnel is highly competitive. We, like
other health care providers, have experienced difficulties in attracting and
retaining qualified personnel, especially facility administrators, nurses,
certified nurses aides and other important health care providers. Our LTACs
are particularly dependent on nurses for patient care. There is currently a
shortage of nurses, and trends indicate this shortage will worsen in the
future. The difficulty our skilled nursing facilities are experiencing in
hiring and retaining qualified personnel has increased our average wage rate.
We may continue to experience increases in our labor costs primarily due to
higher wages and greater benefits required to attract and retain qualified
health care personnel. Our ability to control labor costs will significantly
affect our future operating results.

We operate a number of skilled nursing facilities in California, which has
enacted legislation establishing minimum staffing requirements for skilled
nursing facilities operating in that state. Each skilled nursing facility in
California must satisfy established minimum nursing hours of direct care per
resident per day. Certain other states in which we operate skilled nursing
facilities have adopted minimum staffing standards and additional states may
also establish similar requirements in the future. Our ability to satisfy these
requirements will depend upon our ability to attract and retain qualified
nurses, certified nurses assistants and other staff. Failure to comply with
these requirements may result in the imposition of fines or other sanctions. If
states do not appropriate sufficient additional funds (through Medicaid program
appropriations or otherwise) to pay for any additional operating costs
resulting from minimum staffing requirements, our profitability may be
adversely affected.

We have collective bargaining agreements with unions representing employees at
26 of our facilities. One of these collective bargaining agreements expired on
December 31, 2002, a number are set to expire over the next year and we cannot
accurately predict the outcome of any related negotiations. Although workers
are continuing to perform services under the expired contract and while we have
not experienced material work stoppages in the past and believe our relations
with our unionized employees are generally good, we cannot assure you that we
will not experience a work stoppage or incur additional administrative expenses
associated with union representation of our employees.

Future acquisitions may be difficult to complete, use significant resources, or
be unsuccessful and could expose us to unforeseen liabilities.

We may selectively pursue acquisitions in our target markets. Acquisitions may
involve significant cash expenditures, debt incurrence, capital expenditures,
additional operating losses, amortization of the intangible assets of acquired
companies, dilutive issuances of equity securities and other expenses that
could have a material adverse effect on our financial condition and results of
operations. Acquisitions also involve numerous other risks, including
difficulties integrating acquired operations, personnel and information
systems, diversion of managements time from existing operations, potential
losses of key employees or customers of acquired companies, assumptions of
significant liabilities, exposure to unforeseen liabilities of acquired
companies and increases in our indebtedness.

We cannot assure you that we will succeed in obtaining financing for any
acquisitions at a reasonable cost or that any financing will not contain
restrictive covenants that limit our operating flexibility. We also may be
unable to operate acquired facilities profitably or succeed in achieving
improvements in their financial performance.

We also may face competition in acquiring any facilities. Our competitors may
acquire or seek to acquire many of the facilities that would be suitable
acquisition candidates for us. This could limit our ability to grow by
acquisitions or increase the cost of our acquisitions.

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Provision for losses in our financial statements may not be adequate.

Loss provisions in our financial statements for self-insured programs are made
on an undiscounted basis in the relevant period. These provisions are based on
internal and external evaluations of the merits of individual claims, analysis
of claims history and independent actuarially determined estimates. The
external analysis is completed by a certified actuary with extensive experience
in the long-term care industry. Our management reviews the methods of
determining these estimates and establishing the resulting accrued liabilities
frequently, with any material adjustments resulting therefrom being reflected
in current earnings. Although we believe that our provisions for self-insured
losses in our financial statements are adequate, the ultimate liability may be
in excess of the amounts recorded. In the event the provisions for loss
reflected in our financial statements are inadequate, our financial condition
and results of operations may be materially affected.

Implementation of a new information technology infrastructure could cause
business interruptions and negatively affect our profitability and cash flows.

We are in the process of implementing a new information technology
infrastructure to improve customer service, enhance operating efficiencies and
provide more effective management of business operations. Implementation of the
new system and software carries risks such as cost overruns, project delays and
business interruptions and delays. If we experience a material business
interruption as a result of the implementation of our existing or future
information technology infrastructure or are unable to obtain the projected
benefits of this new infrastructure, it could adversely affect us and could
have a material adverse effect on our business, results of operations,
financial condition and cash flows.

We recently emerged from a Chapter 11 bankruptcy reorganization, have a history
of losses and may not become profitable.

Because we recently emerged from bankruptcy and have a history of losses, we
cannot assure you that we will grow or achieve and maintain profitability in
the near future, or at all. We emerged from our Chapter 11 bankruptcy
reorganization as a new reporting entity on May 13, 2002. Prior to our
reorganization, we incurred net losses of approximately $1,778.3 million in
1999, $59.0 million in 2000 and $33.4 million in 2001. If we cannot achieve and
maintain profitability, our financial condition and results of
operations may be materially affected.

You may not be able to compare our historical financial information to our
current financial information, which will make it more difficult to
assess our future prospects.

In December 2001, we elected to change our fiscal year end from September 30 to
December 31. As a result our historical financial information contains
information regarding the three-month transition period from
October 1, 2001
to December 31, 2001 and makes a review of our historical financial data more
complex. In addition, as a result of our emergence from bankruptcy, we are
subject to the
fresh start reporting prescribed by GAAP. Accordingly, unlike other companies
that have not previously filed for bankruptcy protection, certain aspects of
our financial condition and results of operations are not comparable to the
financial condition and results of operations reflected in our historical
financial statements contained elsewhere herein. Without historical
financial statements to compare to our current performance, it may be more
difficult for you to assess our future prospects.

If we fail to compete effectively with other health care providers, our
revenues and profitability may decline.

The long-term health care services industry is highly competitive. Our nursing
centers compete on a local and regional basis with other nursing centers and
other long-term health care providers. Some of our competitors facilities are
located in newer buildings and may offer services not provided by us or are
operated by entities having greater financial and other resources than us. Our
skilled nursing facilities and LTACs face competition from general acute care
hospitals and long-term hospitals that provide services comparable to those
offered by our skilled nursing facilities and LTACs. Many competing general
acute care hospitals are larger and more established than our facilities. We
may experience increased competition from existing hospitals as well as
hospitals converted, in whole or in part, to specialized care facilities.

The long-term care industry is divided into a variety of competitive areas that
market similar services. These competitors include nursing centers, hospitals,
extended care centers, assisted living facilities, home health agencies and
similar institutions. Our facilities generally operate in communities that also
are served by similar facilities operated by our competitors. Certain of our
competitors are operated by not-for-profit, non-taxpaying or governmental
agencies that can finance capital expenditures on a tax exempt basis and that
receive funds and charitable contributions unavailable to us. Our facilities
compete based on factors such as our reputation for quality care; the
commitment and expertise of our staff and physicians; the quality and
comprehensiveness of our treatment programs; the physical appearance, location
and condition of our facilities and to a limited extent, the charges for
services. In addition, we compete with other long-term care providers for
customer referrals from hospitals. As a result, a failure to compete
effectively with respect to referrals may have an adverse impact on our
business. Many of these competing companies have greater financial and other

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resources than we have. We cannot assure you that increased competition in the
future will not adversely affect our financial condition and results of
operations.

Possible changes in the case mix of patients as well as payor mix and payment
methodologies may significantly affect our profitability.

The sources and amounts of our patient revenues will be determined by a number
of factors, including licensed bed capacity and occupancy rates of our
facilities, the mix of patients and the rates of reimbursement among payors.
Likewise, reimbursement for therapy services will vary based upon payor and payment methodologies. Changes in the
case mix of the patients as well as payor mix among private pay, Medicare and
Medicaid will significantly affect our profitability. Particularly, any
significant increase in our Medicaid population could have a material adverse
effect on our financial position, results of operations and cash flow,
especially if states operating these programs continue to limit, or more
aggressively seek limits on, reimbursement rates.

If we fail to comply with our Corporate Integrity Agreement, we could be
subject to severe sanctions.

On April 3, 2002, as part of Global Settlement, we entered into a Corporate Integrity Agreement to promote
our compliance with the requirements of Medicare, Medicaid and all other
federal health care programs. Under the Corporate Integrity Agreement, we have
reviewed and are implementing our corporate compliance infrastructure and
implementing additional quality improvement programs and internal financial
controls in our facilities and regional and corporate offices. The Corporate
Integrity Agreement is effective for five years beginning April 3, 2002. Our
failure to comply with the material terms of this agreement could lead to
suspension or exclusion from further participation in federal health care
programs, including Medicare and Medicaid, which during the twelve months ended
December 31, 2003 accounted for 81.2% of our total revenues. Any of these sanctions
would have a material adverse effect on our financial condition and results of
operations.

Private third-party payors continue to try to reduce health care costs.

Private third-party payors are continuing their efforts to control health care
costs through direct contracts with health care providers, increased
utilization review and greater enrollment in managed care programs and
preferred provider organizations. These private payors increasingly are
demanding discounted fee structures and the assumption by health care providers
of all or a portion of the financial risk. We could be adversely affected by
the continuing efforts of private third-party payors to contain the amount of
reimbursement we receive for health care services. We cannot assure you that
reimbursement payments under private third-party payor programs will remain at
levels comparable to present levels or will be sufficient to cover the costs
allocable to patients eligible for reimbursement pursuant to such programs.
Future changes in the reimbursement rates or methods of private third-party
payors, including the Medicare and Medicaid programs, or the implementation of
other measures to reduce reimbursement for our services could result in a
substantial reduction in our net operating revenues. Finally, as a result of
competitive pressures, our ability to maintain operating margins through price
increases to private patients is limited.

We are exposed to market risk due to the fact that borrowings under our senior credit facility are or will be subject to wide fluctuations based on
changing interest rates.

Market risk is the risk of loss arising from adverse changes in market rates
and prices, such as interest rates, foreign currency exchange rates and
commodity prices. Our primary exposure to market risk is interest rate risk
associated with variable borrowings under our senior credit
facility, or Senior Credit Facility, entered into with a syndicate of lenders on
December 19, 2003 which provides for a $135.0 million term
loan facility, or Term Loan, (which was drawn in full) and a
$90.0 million revolving credit facility, or Revolving Credit
Facility. Since our Senior Credit Facility provides for variable
rates, if market interest rates rise, so will our
required interest payments on borrowings under the Senior Credit Facility.
We do not currently have any mechanism in place to manage, or hedge, the market
risk associated with our variable rate debt.

Risks Relating to Our Substantial Indebtedness

Our substantial level of indebtedness could adversely affect our financial
condition.

We have a substantial amount of debt requiring significant interest payments.
On December 31, 2003, we had total debt of approximately
$389.6 million, of
which $135.0 million consisted of borrowings under our Senior Credit
Facility. We also have $90.0 million in available borrowings
under the Revolving Credit Facility component of our Senior Credit Facility
although $34.6 million of borrowing capacity under the Revolving
Credit Facility was utilized for letters of credit outstanding as of
December 31, 2003. Finally, we have outstanding senior
subordinated debt consisting of $175.0 million aggregate principal amount 8 1/4% Senior
Subordinated Notes due December 15, 2013, or Notes. We had stockholders equity of
approximately $256.2 million at December 31, 2003. As of December 31, 2003, our total indebtedness
under the Senior Credit Facility, total indebtedness under the Notes,
non-recourse indebtedness of subsidiary, capital leases, total
debt, total stockholders equity, total capitalization and ratio of total debt to total capitalization were
as follows:

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|                                                    |                      |   |                       |       | 
|--------------------------------------------------- | -------------------- | - | --------------------- | ----- | 
|                                                    |                      |   | December 31, 2003    
|                                                    |                      |   |                      
|                                                    |                      |   | (dollars in
millions)
|Total indebtedness under
the Senior Credit Facility |                      | $ | 135.0                 |      
|Total indebtedness under the Notes                  |                      |   | 175.0                 |      
|Non-recourse indebtedness of subsidiary             |                      |   | 59.7                  |      
|Capital leases                                      |                      |   | 19.9                  |      
|                                                    |                      |   |                       |      
|Total debt                                          |                      |   | 389.6                 |      
|Total stockholders equity                          |                      |   | 256.2                 |      
|                                                    |                      |   |                       |      
|                                                    | Total capitalization |   | $                     | 645.8 | 
|                                                    |                      |   |                       |      
|Ratio of total debt to total capitalization         |                      |   | 60.3                  | %    

Our substantial indebtedness could have important consequences to you. For
example, it could:



| |  |  | make it more difficult for us to satisfy our financial obligations,
including those with respect to our Senior Credit Facility and our
Notes;                                                                                                                                                        
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | increase our vulnerability to general adverse economic and industry
conditions, including material adverse regulatory changes such as
reductions in reimbursement;                                                                                                                                   
|
| |  |  | limit our ability to obtain additional financing to fund future
working capital, capital expenditures and other general corporate
requirements, or to carry out other aspects of our business plan;                                                                                                  
|
| |  |  | require us to dedicate a substantial portion of our cash flow from
operations to payments on indebtedness, thereby reducing the
availability of such cash flow to fund working capital, capital
expenditures or other general corporate purposes, or to carry out other
aspects of our business plan;
|
| |  |  | require us to pledge as collateral substantially all of our assets;                                                                                                                                                                                                                                  
|
| |  |  | require us to maintain certain debt coverage and financial ratios at
specified levels, thereby reducing our financial flexibility;                                                                                                                                                                   
|
| |  |  | limit our ability to make material acquisitions or take advantage of business opportunities that may arise;                                                                                                                                                                                          
|
| |  |  | expose us to fluctuations in interest rates, to the extent our borrowings bear variable rates of interest;                                                                                                                                                                                           
|
| |  |  | limit our flexibility in planning for, or reacting to, changes in our business and the industry; and                                                                                                                                                                                                 
|
| |  |  | place us at a competitive disadvantage compared to our competitors that have less debt.                                                                                                                                                                                                              

In addition, the indenture governing the Notes and the Senior Credit Facility
contain financial and other restrictive covenants limiting our ability to
engage in activities that may be in our long-term best interests. Our failure
to comply with those covenants could result in an event of default which, if
not cured or waived, could result in the acceleration of some or all of our
debts.

We are permitted to incur substantially more debt, which could further
exacerbate the risks described above.

We and our subsidiaries may be able to incur substantial additional
indebtedness in the future. The terms of our indenture governing the Notes and
the credit agreement governing our Senior Credit Facility do not completely
prohibit us or our subsidiaries from incurring additional indebtedness. Our
Senior Credit Facility that permits borrowings of up to $225.0 million which
includes a Revolving Credit Facility that permits borrowings up to $90.0
million. We are also permitted to incur additional indebtedness in an aggregate
principal amount not to exceed $65.0 million either under our Senior Credit
Facility or by the issuance of additional notes under the indenture governing
the Notes or through a mortgage loan transaction with one or more lenders in
order to repay indebtedness owed by certain of our non-guarantor subsidiaries.
If new debt is added to our current debt levels, the related risks that we now
face could intensify.

To service our indebtedness, we will require a significant amount of cash, the
availability of which depends on many factors beyond our control.

Our ability to make payments on and to refinance our indebtedness, including
the Senior Credit Facility and the Notes, and to fund planned capital
expenditures, will depend on our ability to generate cash in the future. This,
to a certain extent, is subject to general

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economic, financial, competitive, legislative, regulatory and other factors
that are beyond our control.

Cost containment and lower reimbursement levels relative to inflationary
increases in cost by third-party payors, including federal and state
governments, have had a significant impact on the health care industry and on
our cash flows. Our operating margins continue to be under pressure because of
continuing regulatory scrutiny and growth in operating expenses, such as labor
costs and insurance premiums. In addition, as a result of competitive
pressures, our ability to maintain operating margins through price increases to
private patients is limited.

We may not have access to the cash flow of certain subsidiaries and joint
venture entities. In addition, the financial information appearing elsewhere in
this Annual Report on Form 10-K also includes, unless otherwise indicated, the
results of operation and other financial information of certain joint venture
entities.

We cannot assure you that our business will generate sufficient cash flow from
operations, that anticipated revenue growth and improvement of operating
efficiencies will be realized or that future borrowings will be available under
our Senior Credit Facility in an amount sufficient to enable us to service our
indebtedness or to fund our other liquidity needs. We may need to refinance all
or a portion of our indebtedness on or before maturity, sell assets, curtail
discretionary capital expenditures or file for bankruptcy. We cannot assure you
that we will be able to refinance any of our indebtedness on commercially
reasonable terms or at all.

If we fail to meet our payment or other obligations under our Senior Credit
Facility, the lenders under our Senior Credit Facility could foreclose on, and
acquire control of, substantially all of our assets.

In connection with the incurrence of indebtedness under our Senior Credit
Facility, the lenders under such facility received a pledge of all of the
capital stock of our existing domestic subsidiaries and any future domestic
subsidiaries. Additionally, these lenders generally will have a lien on
substantially all of our domestic assets, including our existing and future
accounts receivable, cash, general intangibles, investment property, equipment
and real property. As a result of these pledges and liens, if we fail to meet
our payment or other obligations under our Senior Credit Facility, the lenders
under the Senior Credit Facility would be entitled to foreclose on
substantially all of our assets and liquidate these assets. Under those
circumstances, we may not have sufficient funds to service our day-to-day
operational needs or to make payments on other indebtedness, including the
Notes. Any foreclosure by the lenders under our Senior Credit
Facility would have a material adverse effect on our financial
condition.

The indenture for the Notes and the Senior Credit Facility restrict our ability
and the ability of most of our subsidiaries to engage in some business,
financial and corporate actions.

The indenture for the Notes and the Senior Credit Facility, among other things,
impose significant operating and financial restrictions on us. These
restrictions, among other things, limit our ability and that of our restricted
subsidiaries to:



| |  |  | incur or guarantee additional indebtedness;                                                                     
| | - |  | ----------------------------------------------------------------------------------------------------------------
|
| |  |  | issue preferred stock;                                                                                          
|
| |  |  | pay dividends or make other distributions to our shareholders;                                                  
|
| |  |  | repurchase or redeem our stock;                                                                                 
|
| |  |  | make other restricted payments and investments;                                                                 
|
| |  |  | create liens;                                                                                                   
|
| |  |  | incur restrictions on the ability of our or their subsidiaries to pay dividends or other payments to us or them;
|
| |  |  | sell or otherwise dispose of certain assets;                                                                    
|
| |  |  | consolidate, merge or sell all of our assets;                                                                   
|
| |  |  | enter into sale leaseback transactions;                                                                         
|
| |  |  | prepay, redeem or repurchase subordinated debt;                                                                 
|
| |  |  | enter into transactions with affiliates; and                                                                    

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| |  |  | engage in certain business activities.
| | - |  | --------------------------------------

Our failure to comply with obligations under the indenture for the Notes may
result in an event of default under the indenture. A default, if not cured or
waived, may permit acceleration of our other indebtedness, including the Senior
Credit Facility. We cannot be certain that we will have funds available to
remedy these defaults. If our indebtedness is accelerated, we cannot be certain
that we will have sufficient funds available to pay the accelerated
indebtedness or that we will have the ability to refinance the accelerated
indebtedness on terms favorable to us or at all.

In addition, our Senior Credit Facility requires us to maintain specified
financial ratios (such as lease-adjusted leverage, senior leverage and fixed
charge coverage) and satisfy other financial tests. We cannot assure you that
these covenants will not adversely affect our ability to finance our future
operations or capital needs or to pursue available business opportunities.
These covenants may also limit our ability to plan for or react to market
conditions, meet our capital needs and may otherwise restrict our activities
and business plans. A breach of any of these covenants or our inability to
maintain the required financial ratios could result in a default in respect of
the related indebtedness. If a default occurs, the relevant lenders could elect
to declare the indebtedness, together with accrued interest and other fees, to
be immediately due and payable and proceed against any collateral securing that
indebtedness.

SPECIAL NOTE ABOUT FORWARD-LOOKING STATEMENTS

Certain statements in this Annual Report on Form 10-K may constitute
forward-looking statements as defined in Section 27A of the Securities Act of
1933, as amended, or the Securities Act, Section 21E of the Securities Exchange
Act of 1934, as amended, or the Exchange Act, the Private Securities Litigation
Reform Act of 1995, or the PSLRA, or in releases made by the SEC, all as may be
amended from time to time. Any such forward-looking statements reflect our
beliefs and assumptions and are based on information currently available to us.
Forward-looking statements are only predictions and involve known and unknown
risks, uncertainties and other factors that are, in some cases, beyond our
control and that may cause our actual results, performance or achievements, or
industry results, to be materially different from any future results,
performance or achievements expressed or implied by such forward-looking
statements. These cautionary statements are being made pursuant to the
Securities Act, the Exchange Act and the PSLRA with the intention of obtaining
the benefits of the safe harbor provisions of such laws. We caution investors
that any forward-looking statements we make are not guarantees or indicative of
future performance. For additional information regarding factors that may cause
our results of operations to differ materially from those presented herein,
please see Item 1, Risk Factors contained in this Annual Report on Form 10-K.

You can identify forward-looking statements as those that are not historical in
nature, particularly those that use terminology such as may, will,
should, expect, anticipate, contemplate, estimate, believe, plan,
project, predict, potential or continue, or the negative of these or
similar terms. These forward-looking statements may include, but are not
limited to:



| |  |  | statements concerning demographic trends, industry trends, business strategy and competitive strengths;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | statements contained in Item 1, Risk Factors;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|
| |  |  | statements contained in Item 7, Managements Discussion and Analysis
of Financial Condition and Results of Operations, and the notes to our
consolidated financial statements, such as our ability to meet our
liquidity needs, scheduled debt and interest payments, and expected
future capital expenditure requirements; the expected changes in and
effects of government regulation on our business; the expected costs and
certain expenses in fiscal years 2004 and 2005 and the foreseeable
future; and estimates in our critical accounting policies, including our
allowance for doubtful accounts, any anticipated impact of long-lived
asset impairments and our ability to provide for loss reserves for
self-insured programs; and
|
| |  |  | statements contained in Item 1, Business, such as those concerning
our business strategy, competitive strengths, corporate integrity
programs, insurance coverage, environmental matters, government
regulations and the Medicare and Medicaid programs, reimbursement for
services provided and legal proceedings.                                                                                                                                                                                                                                                                                                                                                                                                                             

In evaluating these forward-looking statements, you should consider the
following factors, as well as others contained in our public filings from time
to time, which may cause our actual results to differ materially from any
forward-looking statement:



| |  |  | our existing and future indebtedness and debt service obligations;                                                                                               
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | changes in reimbursement rates or methods of payment from Medicare
and Medicaid or the implementation of other measures to reduce
reimbursement for our services;
|
| |  |  | the expiration of enactments providing for additional governmental funding;                                                                                      

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| |  |  | changes in payor mix, case mix and payment methodologies;                                                                                                                                                                                                
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the impact of existing governmental regulations and changes in, or the failure to comply with, governmental regulations;                                                                                                                                 
|
| |  |  | the ability to control costs, implement measures designed to enhance
operating efficiencies (including any problems with technology platforms
employed to implement such measures) and generate cash flow to meet
operational and financial requirements;
|
| |  |  | pending and future legislative proposals for health care or tort reform;                                                                                                                                                                                 
|
| |  |  | competition in our industry;                                                                                                                                                                                                                             
|
| |  |  | the ability to attract and retain qualified personnel at a reasonable cost;                                                                                                                                                                              
|
| |  |  | changes in current trends in the cost and volume of professional liability and general liability claims and risks;                                                                                                                                       
|
| |  |  | possible investigations or proceedings against us initiated by states or the federal government;                                                                                                                                                         
|
| |  |  | state regulation of health care providers;                                                                                                                                                                                                               
|
| |  |  | unavailability of adequate insurance coverage on reasonable terms;                                                                                                                                                                                       
|
| |  |  | an increase in insurance costs and potential liability for losses not covered by, or in excess of, our insurance;                                                                                                                                        
|
| |  |  | an increase in senior debt or reduction in cash flow upon our purchase or sale of assets;                                                                                                                                                                
|
| |  |  | our ability to obtain financing on terms favorable to us;                                                                                                                                                                                                
|
| |  |  | our ability to successfully engage in strategic acquisitions;                                                                                                                                                                                            
|
| |  |  | an economic downturn or changes in laws affecting our business in those markets in which we operate; and                                                                                                                                                 
|
| |  |  | acts of God or public authorities, war, civil unrest, terrorism, fire, floods, earthquakes and other matters beyond our control.                                                                                                                         

Any subsequent written or oral forward-looking statements attributable to us or
persons acting on our behalf are expressly qualified in their entirety by the
cautionary statements set forth or referred to above, as well as the risk
factors contained in this Annual Report on Form 10-K. Except as required by
law, we disclaim any obligation to update such statements or to publicly
announce the result of any revisions to any of the forward-looking statements
contained in this Annual Report on Form 10-K to reflect future events or
developments.




ITEM 2. PROPERTIES

As of December 31, 2003, we operated an aggregate of 264 owned, leased or
managed skilled nursing facilities and assisted living facilities, of which 184
are owned, mortgaged or subject to capital leases, as indicated in the columns
below. We have 76 facilities under operating leases and manage four additional
skilled nursing facilities. As of December 31, 2003, we also
operated eleven
LTACs of which one is owned and ten of which are leased or managed. Our facilities that are leased are subject to long-term leases
or subleases that require us, among other things, to fund all applicable
capital expenditures, taxes, insurance and maintenance costs. Many of the
leases contain renewal options to extend their terms.

Since September 30, 2003, we have sold 19 skilled nursing facilities and
terminated operating and capital leases with respect to an additional eleven
skilled nursing facilities in Florida and Louisiana, resulting in a
$56.9
million reduction in indebtedness under our previous senior credit facility
(which we refinanced on December 19, 2003), an $11.4 million retirement of
facility specific mortgage indebtedness and a $29.8 million elimination of
capital lease indebtedness. These 30 skilled nursing facilities contained 4,025
beds, generated $179.4 million in revenue for the year ended December
31, 2003 and had an operating loss during such period. The 19 owned skilled
nursing facilities were sold for gross proceeds of $35,813 per bed. This
represents the divestiture or termination of all 27 of the skilled nursing
facilities we operated in Florida and all three skilled nursing facilities we
operated in Louisiana. Given that Florida has been a highly litigious state, we
believe that these divestitures should reduce our liability exposure for future
periods.

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We have three properties whose leases are set to expire through the end of
2004, all of which contain renewal options. We are currently
operating two skilled nursing facilities under expired leases which we are attempting to
transfer to a new owner. We are also currently in litigation with the landlord
of five skilled nursing facilities located in Georgia as to whether
leases are currently in effect. We are evaluating our options with respect to
these facilities.

We also lease five locations for corporate and regional offices. This includes
our corporate headquarters located in Atlanta, Georgia, which lease was
recently renewed and is set to expire in March 2010, our LTAC headquarters and
southwest regional offices located in Austin, Texas, our northeast regional
office located in Baltimore, Maryland, and our shared services center located
in Houston, Texas. We consider our properties to be well maintained and in
suitable condition for the conduct of our business.

The following table provides information concerning the nursing facilities
operated by us as of December 31, 2003.

|               |  |          |     |            |  |         |    |       |  |         |   |  |  |  |     |  |  |  |        | 
|-------------- |  | -------- | --- | ---------- |  | ------- | -- | ----- |  | ------- | - |  |  |  | --- |  |  |  | ------ | 
|State          |  | Owned(1) |     | Leased (2) |  | Managed |    | Total |  | Beds(3)
|               |  |          |     |            |  |         |    |       |  |        
|Alabama        |  |          | 7   |            |  |         |   |       |  |         |  |  |  |  | 7   |  |  |  | 809    | 
|California     |  |          | 8   |            |  |         | 21 |       |  |         | 1 |  |  |  | 30  |  |  |  | 3,528  | 
|Colorado       |  |          | 28  |            |  |         | 2  |       |  |         |  |  |  |  | 30  |  |  |  | 3,157  | 
|Connecticut    |  |          | 2   |            |  |         |   |       |  |         |  |  |  |  | 2   |  |  |  | 250    | 
|Georgia        |  |          | 3   |            |  |         | 6  |       |  |         |  |  |  |  | 9   |  |  |  | 1,175  | 
|Illinois       |  |          | 4   |            |  |         | 2  |       |  |         |  |  |  |  | 6   |  |  |  | 656    | 
|Maryland       |  |          | 10  |            |  |         | 1  |       |  |         |  |  |  |  | 11  |  |  |  | 1,709  | 
|Massachusetts  |  |          | 2   |            |  |         |   |       |  |         |  |  |  |  | 2   |  |  |  | 227    | 
|Michigan       |  |          | 9   |            |  |         |   |       |  |         |  |  |  |  | 9   |  |  |  | 1,265  | 
|Mississippi    |  |          | 1   |            |  |         | 8  |       |  |         | 2 |  |  |  | 11  |  |  |  | 1,235  | 
|Nebraska       |  |          | 7   |            |  |         |   |       |  |         |  |  |  |  | 7   |  |  |  | 581    | 
|North Carolina |  |          | 29  |            |  |         | 2  |       |  |         |  |  |  |  | 31  |  |  |  | 3,944  | 
|Ohio           |  |          | 1   |            |  |         |   |       |  |         |  |  |  |  | 1   |  |  |  | 93     | 
|Pennsylvania   |  |          | 2   |            |  |         |   |       |  |         |  |  |  |  | 2   |  |  |  | 205    | 
|South Carolina |  |          | 3   |            |  |         | 9  |       |  |         |  |  |  |  | 12  |  |  |  | 1,546  | 
|Tennessee      |  |          | 2   |            |  |         | 4  |       |  |         |  |  |  |  | 6   |  |  |  | 689    | 
|Texas          |  |          | 56  |            |  |         | 19 |       |  |         | 1 |  |  |  | 76  |  |  |  | 9,031  | 
|Virginia       |  |          |    |            |  |         | 2  |       |  |         |  |  |  |  | 2   |  |  |  | 166    | 
|West Virginia  |  |          | 1   |            |  |         |   |       |  |         |  |  |  |  | 1   |  |  |  | 186    | 
|Wisconsin      |  |          | 5   |            |  |         |   |       |  |         |  |  |  |  | 5   |  |  |  | 634    | 
|Wyoming        |  |          | 4   |            |  |         |   |       |  |         |  |  |  |  | 4   |  |  |  | 403    | 
|               |  |          |     |            |  |         |    |       |  |         |   |  |  |  |     |  |  |  |        | 
|Total          |  |          | 184 |            |  |         | 76 |       |  |         | 4 |  |  |  | 264 |  |  |  | 31,489 | 
|               |  |          |     |            |  |         |    |       |  |         |   |  |  |  |     |  |  |  |        | 



---

|(1) |  | Includes eleven facilities subject to mortgage, six facilities subject to
capital leases and five facilities in which we have an ownership interest
of 50% or more and which are included in our consolidated statements of
operations. Also includes a total of eight assisted living facilities,
which includes one facility located in each of Alabama, California,
Nebraska, Texas and Wyoming and three facilities located in Colorado.                                                                                                                                                                                   
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | Includes five leased facilities in Georgia that we currently operate, but
whose lease terms are currently being disputed with the landlord. The
landlord filed a declaratory action against us in
February 2004 in an
attempt to obtain a ruling that the leases have expired. Although we
have not yet answered this declaratory action, we intend to vigorously
dispute the landlords contentions. While we are not able to predict the
outcome of this action, we do
not believe that the resolution of this proceeding will have a material
adverse effect on our financial position, results of operations or cash
flows.
|   
|(3) |  | Managed facilities account for 541 licensed beds.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   
|    |  | The following table provides information concerning the LTACs operated by
us as of December 31, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

|          |       |       |                      |        |           |         |   |       |  |               |   |   |  |  |   |    |  |  |     |     | 
|--------- | ----- | ----- | -------------------- | ------ | --------- | ------- | - | ----- |  | ------------- | - | - |  |  | - | -- |  |  | --- | --- | 
|          |       |       | Number of Facilities |        |           |         |  
|          |       |       |                      |        | Number of
|State     |       | Owned |                      | Leased |           | Managed |   | Total |  | Licensed Beds
|          |       |       |                      |        |           |         |   |       |  |              
|Arizona   |       |       |                     |        |           |         | 1 |       |  |               |  |   |  |  | 1 |    |  |  | 34  |    
|Louisiana |       |       | 1                    |        |           |         | 2 |       |  |               |  |   |  |  | 3 |    |  |  | 172 |    
|Ohio      |       |       |                     |        |           |         |  |       |  |               | 1 |   |  |  | 1 |    |  |  | 30  |    
|Texas     |       |       |                     |        |           |         | 6 |       |  |               |  |   |  |  | 6 |    |  |  | 377 |    
|          |       |       |                      |        |           |         |   |       |  |               |   |   |  |  |   |    |  |  |     |    
|          | Total |       |                      | 1      |           |         |   | 9     |  |               |   | 1 |  |  |   | 11 |  |  |     | 613 | 
|          |       |       |                      |        |           |         |   |       |  |               |   |   |  |  |   |    |  |  |     |    

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ITEM 3. LEGAL PROCEEDINGS

General

From time to time, we have been party to various legal proceedings in the
ordinary course of business. As is typical in the health care industry, we are
and expect to remain subject to claims that our services have resulted in
resident injury or other adverse effects. In addition, resident, visitor and
employee injuries will also subject us to the risk of litigation. The health
care industry in general continues to experience an increasing trend in the
frequency and severity of litigation and claims. There are currently no
outstanding uninsured litigation matters against us that we believe could have
a material adverse effect on us. Below is a summary of our major
outstanding litigation.

Royal Surplus Lines Litigation

On June 11, 2001, one of our prior liability insurance carriers, Royal Surplus
Lines Insurance Company, or Royal, commenced an adversary proceeding in the Bankruptcy
Court, styled Royal Surplus Lines Insurance Company v. Mariner Health Group et
al., Adversary Proceeding No. A-01-4626 (MFW). In its complaint, Royal sought
among other things, declaratory judgments that it would not be required to
insure some claims falling under two PL/GL policies issued to one of our
subsidiaries by Royal. One of our prior excess liability insurance carriers,
Northfield Insurance Company, or Northfield, moved to intervene in the Royal
adversary proceeding on July 25, 2001. We did not oppose the motion to
intervene, and it was granted.

Prior to the parties engaging in any significant discovery, they agreed to
mediate the issues arising out of the Royal adversary proceeding. After the
mediation, Royal agreed to dismiss its complaint without prejudice, we agreed
to dismiss our counterclaim without prejudice, and Royal and we agreed to work
together to resolve claims in an alternative dispute resolution procedure.
Northfield did not agree to dismiss its complaint in intervention. Accordingly,
Northfield and we are currently engaging in discovery. We have also filed a bad
faith counterclaim against Northfield arising out of its claims handling and
litigation tactics.

In April 2003, Northfield filed an insurance coverage action against us in the
United States District Court for the Northern District of Georgia. Northfield
seeks a declaration that it is not obligated to provide insurance coverage to
us in connection with a personal injury and wrongful death lawsuit filed
against us styled Louise Sherry Fisher, Individually, as Representative of all
Wrongful Death Beneficiaries, and Legal Heir of the Estate of Vestal Grant
Fisher, deceased v. Mariner Post-Acute Network, Inc., et al., No. 2000-40818
(28th Judicial District, Harris County, Tex.), referred to as the Fisher
Action. Northfield alleges that its coverage obligation was discharged by our
failure to accept a reasonable settlement demand in the Fisher Action, and by
our conduct and alleged refusal to cooperate in the defense of that case. In
addition to seeking a declaratory judgment, Northfield asserts claims for
breach of contract and negligence. Northfield seeks unspecified damages,
including recovery of the amount it paid to settle the Fisher Action, as well
as attorneys fees and costs.

We filed an answer to Northfields complaint on May 5, 2003, denying that
Northfield is entitled to the relief it seeks and raising certain affirmative
defenses to Northfields claims. On May 5, 2003, we also filed a motion to
transfer the case to the United States District Court for the District of
Delaware, where, on August 7, 2001, Northfield instituted an adversary
proceeding against us regarding insurance coverage issues arising out of the
Fisher Action. That adversary proceeding is styled Northfield Insurance
Company v. Mariner Post-Acute Network, Inc., et al., Adversary Case No.
A-01-4626. On October 6, 2003, the United States District Court for the
Northern District of Georgia granted our motion to transfer and transferred
this case to the United States District Court for the District of Delaware. On
October 23, 2003, the case was referred to the Bankruptcy Court, where it is
now pending.

On October 16, 2003, we filed a motion for summary judgment and on November 11,
2003, Northfield filed a cross-motion for summary judgment. Both motions are
pending. Discovery is ongoing. While no trial date has been set, a
mediation is planned for the first quarter of 2004.

PricewaterhouseCoopers Litigation

In August 2002, we filed a complaint in the State Court of Fulton County,
Georgia against PricewaterhouseCoopers, LLP, or PWC, and several former
officers of MHG referred to as the Individual Defendants. The Fulton County
action asserts claims for fraud and breach of fiduciary duty against the
Individual Defendants and claims for fraud, professional negligence, negligent
misrepresentation and aiding and abetting breach of fiduciary duty against PWC.
Many of these claims arise from the July 1998 acquisition of MHG by Paragon, one of our predecessors. Other claims arise
from duties that we believe the Individual Defendants breached as officers of
MHG and MPAN, our successor following the MHG
acquisition. In the Fulton County action, we are seeking actual damages
(including compensatory and consequential damages) and punitive damages, in an
amount to be determined at trial. Discovery is ongoing.

In response to the action we commenced in Fulton County, the Individual
Defendants filed an action in Chancery Court in Delaware in September 2002
styled Stratton et al. v. Mariner Health Care, Inc., Civil Action No. 19879-NC.
In the Chancery Court action, the Individual Defendants generally claim they
are not liable for the claims asserted in the Fulton County action and that we
are

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##### Table of Contents



| | 
| | 

contractually and statutorily obligated to indemnify them against the
claims in the Fulton County action. We removed the Chancery Court action to the
Bankruptcy Court, at which time the
action was assigned Adversary Case Nos. 02-5604 and 02-5606 in Chapter 11 Case
Nos. 00-0113 (MFW) and 00-00215 (MFW). After removal, we answered the
complaint and filed counterclaims. The Individual Defendants moved to remand
the action back to the Chancery Court. We opposed the motion. On December 16,
2003, the Bankruptcy Court denied the Individual Defendants remand motion and
dismissed their claims holding, among other things, that the Individual
Defendants indemnification claims had been discharged by confirmation of our
Joint Plan. The Individual Defendants have filed a motion to alter or amend
judgment, which is pending.

After the Individual Defendants filed the Chancery Court action, we also filed
an adversary proceeding in the Bankruptcy Court styled Mariner Health Care,
Inc. v. Stratton et al., United States Bankruptcy Court for the District of
Delaware, Chapter 11 Case Nos. 00-00113 (MFW) and 00-00215 (MFW), Adversary
Case No. 02-05598 (consolidated with Adversary Case No. 02-05599). In this
enforcement action, we generally alleged that we do not have any obligation to
indemnify the Individual Defendants and the Individual Defendants pursuit of
their indemnification claims violated our discharge in bankruptcy. The
Individual Defendants filed counterclaims generally alleging that we have an
obligation to indemnify them against the claims in the Fulton County action and
that we are estopped from asserting those claims. We have moved to dismiss the
Individual Defendants estoppel counterclaim. The Individual Defendants opposed
the motion, and on April 10, 2003, the Bankruptcy Court granted the motion to
dismiss.

After we filed the Fulton County action, William R. Bassett as Trustee for the
Charlotte R. Kellett Irrevocable Trust, as Trustee for the Samuel B. Kellett,
Jr. Irrevocable Trust, as Trustee for the Stiles A. Kellett, III Irrevocable
Trust and as Trustee for the Barbara K. Kellett Irrevocable Trust, Kellett
Family Partners, L.P. f/k/a Kellett Partners, L.P., Samuel B. Kellett, Stiles
A. Kellett, Jr. and SSK Partners, L.P., filed an action in the Superior Court
of Cobb County, Georgia against PWC and the Individual Defendants based on
claims arising out of MHGs acquisition of Convalescent Services, Inc. in 1995
because of the Individual Defendants and PWCs alleged misrepresentations.
This action is William R. Bassett, et al. v. PricewaterhouseCoopers, LLP, et
al., Superior Court of Cobb County, Georgia, Case No. 02-1-8314-35. The
plaintiffs in the Cobb County action seek damages in excess of $200 million.
The Individual Defendants added us as a third-party defendant in the Cobb
County action seeking to recover on indemnification claims similar to those
made by them in the Chancery Court action, and which are now pending, and
subject to resolution before the Bankruptcy Court in the enforcement action.
In November 2003, the Individual Defendants dismissed us without prejudice from
the Cobb County action.

Indemnity Insurance Company of North America Litigation

In May 2003, we filed a complaint in the United States District Court for the
Eastern District of Texas, Beaumont Division, entitled Mariner Health Care,
Inc. v. Indemnity Insurance Company of North America, Inc., Case No. 103 CV
0279. We are seeking a declaratory judgment determining our rights and the
obligations of Indemnity Insurance Company of North America, Inc., or IINA,
under an IINA policy of insurance regarding property damage and related losses
at our facilities in Beaumont and Houston, Texas caused by Tropical Storm
Allison in June 2001. We additionally assert breach of contract and unfair
claims handling practices claims against IINA. We further seek statutory
damages, punitive damages and attorneys fees under Texas Insurance Code and
the Texas Civil Practice and Remedies Code. IINA has answered our complaint
and the parties are in the process of pretrial discovery, with an anticipated
trial date in the third quarter of 2004.

On January 30, 2004, Mariner moved to amend its complaint to include, as
plaintiffs, Mariners affiliates Cornerstone Health Management Company, Mariner
Health Care of Nashville, Inc. and Living Centers of Texas, Inc., and to make
other conforming amendments. This motion is pending.

While we are not able to predict the outcome of any of these matters, based on
currently available facts we do not believe that the resolution of any of these
proceedings will have a material adverse effect on our financial position,
results of operations or cash flows.




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

Not applicable. There were no matters submitted to a vote of our security
holders during the fourth quarter of 2003.

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##### Table of Contents






PART II




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

Market Information

All shares of our common stock held by stockholders prior to our filing for
bankruptcy were cancelled in connection with our emergence from bankruptcy. To
satisfy some of our prepetition claims, we issued new shares of Common Stock to
certain claimholders in connection with our emergence from bankruptcy. On May
13, 2002, the Common Stock first became eligible for quotation on the OTC
Bulletin Board. Our Common Stock is quoted under the symbol MHCA. As a
result, the following table only contains information relating to the Common
Stock issued since our emergence from bankruptcy and illustrates the high and
low bid quotations per share of our Common Stock, as reported on the OTC
Bulletin Board.

|                                             |  |                    |       |     |  |   |       | 
|-------------------------------------------- |  | ------------------ | ----- | --- |  | - | ----- | 
|                                             |  | Bid Quotations for
|                                             |  | Common Stock      
|                                             |  |                   
|                                             |  | High               |       | Low
|                                             |  |                    |       |    
|2004

First Quarter (through March 12, 2004) |  | $                  | 23.25 |     |  | $ | 19.25 | 

|               |  |      |       |     |  |   |       | 
|-------------- |  | ---- | ----- | --- |  | - | ----- | 
|               |  | High |       | Low
|               |  |      |       |    
|2003           |  |      |       |     |  |   |       | 
|First Quarter  |  | $    | 6.30  |     |  | $ | 2.85  | 
|Second Quarter |  | $    | 4.80  |     |  | $ | 2.50  | 
|Third Quarter  |  | $    | 13.30 |     |  | $ | 4.25  | 
|Fourth Quarter |  | $    | 22.30 |     |  | $ | 10.45 | 

|                                   |  |      |       |     |  |   |       | 
|---------------------------------- |  | ---- | ----- | --- |  | - | ----- | 
|                                   |  | High |       | Low
|                                   |  |      |       |    
|2002                               |  |      |       |     |  |   |       | 
|Second
Quarter (from May 13, 2002) |  | $    | 14.00 |     |  | $ | 12.75 | 
|Third Quarter                      |  | $    | 13.25 |     |  | $ | 7.00  | 
|Fourth Quarter                     |  | $    | 7.75  |     |  | $ | 4.10  | 

Holders

As of March 12, 2004, there were
22 holders of record of our Common Stock.

Dividends

We have never paid dividends on our Common Stock and do not intend to pay cash
dividends for the foreseeable future. It is our present policy to retain
earnings to finance our future operations and growth, as well as repay
outstanding indebtedness. In addition, our debt instruments contain negative
covenants that restrict, among other things, our ability to pay dividends. Any
determination to pay dividends will be dependent upon results of operations,
financial condition, contractual restrictions, restrictions imposed by
applicable laws and other factors deemed relevant by our Board of Directors.

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##### Table of Contents



Securities Authorized for Issuance Under Equity Compensation Plans

The following table provides information about our Common Stock that may be
issued under our equity compensation plans as of December 31,
2003.

Equity Compensation Plan Information Table

|                                                           |       |                     |                      |                     |                      |                          |                           |       |                         |   |                      |         | 
|---------------------------------------------------------- | ----- | ------------------- | -------------------- | ------------------- | -------------------- | ------------------------ | ------------------------- | ----- | ----------------------- | - | -------------------- | ------- | 
|                                                           |       |                     |                      |                     |                      |                          |                           |       |                         |   | Number of securities
|                                                           |       |                     | Number of securities |                     |                      |                          |                           |       | remaining available for
|                                                           |       |                     | to be issued         |                     | Weighted-average     |                          | future issuance under    
|                                                           |       |                     | upon exercise of     |                     | exercise price of    |                          | equity compensation plans
|                                                           |       |                     | outstanding options, |                     | outstanding options, |                          | (excluding securities    
|Plan Category                                              |       | warrants and rights |                      | warrants and rights |                      | reflected in column (a))
|                                                           |       |                     |                      |                     |                      |                         
|Equity compensation plans approved by security holders     |       | 1,916,0601          |                      | $                   | 15.74                |                          |                           |       | 61,962                  |  
|Equity compensation plans not approved by security holders |       |                     | 52,500               |                     |                      | 2                       |                           |       | 122,500                 | 3
|                                                           |       |                     |                      |                     |                      |                          |                           |       |                         |   |                      |        
|                                                           | Total |                     |                      | 1,968,560           |                      |                          | $                         | 15.74 |                         |   |                      | 184,462 | 
|                                                           |       |                     |                      |                     |                      |                          |                           |       |                         |   |                      |        



---

|(1) |  | Our equity compensation plans were approved the Bankruptcy Court and our
Board of Directors on May 12, 2002 in connection
with our emergence from bankruptcy, which under the securities laws is
treated as stockholder approval.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(2) |  | Since the securities issued under
the 2003 Outside Directors Plan were restricted stock units
there is no weighted-average exercise price.                                                                                    
|(3) |  | Includes 37,500 shares of
restricted stock issuable under our 2003 Outside Directors Plan the
issuance of which was deferred at the election of three of our
outside directors until such
time as they cease to be directors.   

2002 Stock Incentive Plan

On May 16, 2002, the Board of Directors adopted the Mariner Health Care, Inc.
2002 Stock Incentive Plan, or the 2002 Stock Incentive Plan. This plan is
intended to meet the requirements of the federal tax provisions contained in
Section 162(m) of the Internal Revenue Code. The purpose of the 2002 Stock
Incentive Plan is to allow us to attract and retain qualified officers and key
employees and to provide these individuals with an additional incentive to
devote themselves to our future success. Additionally, we believe that awards
under the 2002 Stock Incentive Plan will more closely align the interests of
our personnel with the interests of our stockholders.

A total of 1,978,022 shares of Common Stock are reserved for issuance under the
2002 Stock Incentive Plan. At December 31, 2003, there were options to purchase
1,916,060 shares of Common Stock outstanding under the 2002 Stock
Incentive Plan. The number of
shares of Common Stock reserved is subject to adjustment in the event of stock
dividends, stock splits, recapitalizations or similar events. Each option
granted has a term of ten years. Options granted to key employees vest in equal
annual installments over four years, with the exception of the options granted to our Chief Executive Officer, which will vest in accordance with the
terms set forth in his employment agreement at the rate of 8.33% per calendar
quarter, with any remaining options vesting at the end of three years. The
Compensation Committee of the Board of Directors, or the Compensation
Committee, administers the 2002 Stock
Incentive Plan and determines the persons to whom, and the
times at which, awards will be granted, the types of awards to be granted and
all other related terms and conditions of the awards, subject to any
limitations in the 2002 Stock
Incentive Plan. The terms and conditions of each award are set forth
in written agreements with each participant.

All of our officers and key employees are eligible to participate in the 2002
Stock Incentive Plan. Currently, approximately 114 individuals participate in
the 2002 Stock
Incentive Plan. The 2002 Stock Incentive Plan provides for awards in the form of qualified and
non-qualified stock options, stock appreciation rights, shares of restricted
stock, stock grants and performance share awards.

The exercise price per share of any stock option must be less than or equal to
the fair market value of a share of Common Stock at the time of grant. No
participant may receive stock options or stock appreciation rights under the
2002 Stock Incentive Plan in any calendar year for more than 439,560 shares.

Employee Stock Option Exchange

In the second quarter of 2003, the Board of Directors approved a voluntary
stock option exchange program whereby we offered employees the opportunity to
exchange options having an exercise price of $20.12 for an equal number of new
options. Non-employee members of the Board of Directors were not eligible to
participate in the exchange program.

Under the terms of the program, in order to participate, eligible employees
were required to tender all of their options that were granted with an exercise
price of $20.12 in exchange for a commitment by us to grant new options under
the program six-months and one day following the closing date of the offering
period (the date of legal cancellation of the tendered options), with an
exercise price

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##### Table of Contents



per share equal to the greater of $8.00 or the fair market value
of our Common Stock at that time, whichever is higher. On June 14, 2003, we
canceled options to purchase 1,563,560 shares of our Common Stock. Effective
December 16, 2003, the Compensation Committee granted new options pursuant to
the 2002 Stock Incentive Plan to purchase 1,441,060 shares of our Common Stock
to the participating employees, for which the grant date fair market value was
determined to be $18.08. These options will vest in three equal annual
installments beginning on the first anniversary of the date of grant of the new
options, with the exception of the options to be granted to our Chief Executive
Officer, which will vest in accordance with the terms set forth in his
employment agreement at the rate of 8.33% per calendar quarter,
commencing from the December 16, 2003 grant date referred to
above with any
remaining options vesting at the end of three years.

2003 Outside Directors
Stock Incentive Plan

The 2003 Outside Directors Stock
Incentive Plan, or 2003 Outside Directors Plan, provides us with the ability to grant each
non-employee director restricted Common Stock (which a director may elect to
defer the right to receive) and/or non-qualified stock options to purchase
shares of Common Stock. The 2003 Outside Directors Plan replaced the Mariner Health Care, Inc.
2002 Outside Directors Stock Option Plan. The 2003 Outside
Directors Plan is administered by the Compensation
Committee, and the Compensation Committee has the authority in its sole
discretion to interpret, make grants under, make all other determinations and
take all other actions it deems necessary or advisable for the implementation
and administration of the 2003 Outside Directors Plan or any agreements thereunder. The
terms and conditions of each award made under the 2003 Outside
Directors Plan are set
forth in individual agreements between the relevant director and us.

Directors who are not employees are eligible to receive restricted Common Stock
or options under the 2003 Outside Directors Plan. The exercise price per share
of any stock option must be equal to the fair market value of a share of our
Common Stock at the time of grant. A total of 175,000 shares of our Common
Stock are reserved for issuance under the 2003 Outside Directors Plan. Shares
subject to restricted stock grants or options that expire or are terminated are
again available for grant under the 2003 Outside Directors Plan. At December 31, 2003, 52,500 shares
of restricted stock had been granted. At their option, four of the six
directors entitled to receive shares of restricted Common Stock elected to
defer receipt of such shares pursuant to the terms of deferred restricted stock
agreements entered into as of December 16, 2003. Although there are no current
outstanding option grants under the 2003 Outside Directors Plan, any
options granted in the future would expire at the earlier of ten years after
the date of grant or one year after the director ceases to be a director. Any
options that may be granted to outside directors in the future would vest 25%
on the date of the grant, with the remaining options vesting in equal annual
installments over three years. The number of shares of Common Stock and the
exercise price per share for the options would be subject to adjustment in the
event of stock dividends, stock splits, recapitalizations and similar events.
In the event of a merger, tender offer or similar event, the Compensation
Committee may also adjust any option grants, as it deems appropriate, including
accelerating the options or swapping them for cash consideration
of equivalent value.

Director Stock Option Exchange

On July 30, 2003, the Compensation Committee approved a program to allow
outside directors to surrender their options to purchase shares of Common Stock
with an exercise price per share of $20.12, which were granted on May 16, 2002,
in exchange for restricted shares of Common Stock (which a director may elect
to defer the right to receive) to be granted under the 2003 Outside Directors Plan. The
program allowed for a number of shares to be issued to participating directors
equal to 30% of the number of options surrendered. Pursuant to the program each
outside director, other than the Chairman of the Board of Directors, received
an offer to exchange his options in return for a grant of 7,500 restricted
shares of Common Stock and the Chairman of the Board of Directors received an
offer to exchange his options in return for a grant of 15,000 restricted shares
of Common Stock. The shares will vest according to the original vesting
schedule of the surrendered options, hence 50% of each directors restricted
shares have vested and the remaining 50% will vest over the next two years on
May 16, 2004 and May 16, 2005.

Recent Sales of Unregistered Securities

We have had no unregistered sales of
equity securities during the fiscal year ended December 31, 2003.

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##### Table of Contents






ITEM 6. SELECTED FINANCIAL DATA

The following selected financial data
should be read in conjunction with Item 7, Managements Discussion and Analysis of Financial Condition
and Results of Operations, and the consolidated financial statements and
related notes appearing elsewhere in this Annual Report on
Form 10-K. The following selected
financial data for the Reorganized Company (as that term is explained
in the subsequent paragraph) for the year ended December 31,
2003, for the eight months ended December 31, 2002, for the Predecessor
Company (as that term is explained
in the subsequent paragraph) for the four months ended April 30, 2002, and for the three-months
ended December 31, 2001 was prepared using the consolidated financial
statements that appear elsewhere in this Annual Report on
Form 10-K. The selected financial data
for the three months ended December 31, 2000 and the years ended
September 2000 and 1999 were prepared using our
consolidated financial statements included in the Predecessor Companys
publicly filed documents.

Upon emergence from Chapter 11 proceedings, we adopted fresh-start reporting
in accordance with the American Institute of Certified Public Accountants
Statement of Position 90-7, Financial Reporting by Entities in Reorganization
Under the Bankruptcy Code, hereafter referred to as SOP 90-7. In connection
with our adoption of fresh-start reporting, our reorganization value was
allocated to our assets and liabilities on a basis that is substantially
consistent with the purchase method of accounting. Although our Joint Plan
became effective on May 13, 2002, for financial reporting purposes, the
effective date of our Joint Plan was May 1, 2002. Our consolidated financial
statements for periods after our adoption of fresh-start reporting are not
comparable with those prepared before our Joint Plan was confirmed because
they are, in effect, those of a new entity. Consequently, the consolidated
balance sheet data at December 31, 2003 and 2002 is labeled Reorganized
Company and reflects the effect of our Joint Plan and the associated
adjustments. Additionally, the consolidated statement of operations data for
the year ended December 31, 2003 and for the eight months ended December 31,
2002 relates to periods after our adoption of fresh-start reporting and is
also labeled Reorganized Company. Periods presented prior to May 1, 2002
have been designated Predecessor Company.

The consolidated statement of operations data for the twelve months ended
December 31, 2002 labeled Combined Predecessor Company and Reorganized
Company reflects combined results of our Predecessor Company and the
Reorganized Company, is not a presentation in accordance with
accounting principles generally accepted in the United States of
America, or GAAP, and is presented solely for convenience
purposes, as certain items are compared and discussed in Item 7, Managements Discussion and Analysis of Financial Condition and Results of
Operations.

A black line has been drawn between the accompanying consolidated financial
statements to distinguish for accounting purposes between the Reorganized
Company and the Predecessor Company. All numbers are in thousands except per
share amounts and statistical data.

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##### Table of Contents



CombinedPredecessorCompany andReorganized
    
    Reorganized
    
    ReorganizedCompany
    
    Company
    
    Company
    
    
    Predecessor CompanyYear
    
    Twelve Months
    
    Eight Months
    
    
    Four Months
    
    Three Months
    
    Three MonthsEnded
    
    Ended
    
    Ended
    
    
    Ended
    
    Ended
    
    EndedDecember 31,
    
    December 31,
    
    December 31,
    
    
    April 30,
    
    December 31,
    
    December 31,2003
    
    2002
    
    2002
    
    
    2002
    
    2001
    
    2000(unaudited)Statement of Operations DataNet revenue
    
    $
    1,715,367
    
    
    $
    1,754,073
    
    
    $
    1,163,006
    
    
    
    $
    591,067
    
    
    $
    450,542
    
    
    $
    462,779Costs and expensesOperating expensesWage and related costs
    
    
    1,015,007
    
    
    
    1,021,978
    
    
    
    679,938
    
    
    
    
    342,040
    
    
    
    261,114
    
    
    
    274,780Supplies
    
    
    100,490
    
    
    
    107,751
    
    
    
    71,285
    
    
    
    
    36,466
    
    
    
    28,901
    
    
    
    30,333Insurance
    
    
    78,871
    
    
    
    85,942
    
    
    
    55,392
    
    
    
    
    30,550
    
    
    
    24,172
    
    
    
    22,175Divestiture related charges
    
    
    49,564
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Provision for bad debt
    
    
    20,345
    
    
    
    32,105
    
    
    
    8,347
    
    
    
    
    23,758
    
    
    
    7,080
    
    
    
    9,476Rent expense
    
    
    35,650
    
    
    
    38,454
    
    
    
    25,463
    
    
    
    
    12,991
    
    
    
    10,393
    
    
    
    14,770Other
    
    
    294,779
    
    
    
    298,741
    
    
    
    200,721
    
    
    
    
    98,020
    
    
    
    71,613
    
    
    
    62,435Total operating expenses
    
    
    1,594,706
    
    
    
    1,584,971
    
    
    
    1,041,146
    
    
    
    
    543,825
    
    
    
    403,273
    
    
    
    413,969General and administrative
expenses
    
    
    99,103
    
    
    
    72,285
    
    
    
    47,072
    
    
    
    
    25,213
    
    
    
    18,943
    
    
    
    18,473Depreciation and amortization
    
    
    37,082
    
    
    
    34,320
    
    
    
    22,764
    
    
    
    
    11,556
    
    
    
    10,928
    
    
    
    11,251Gain on sale of divested
facilities
    
    
    (25,197
    )
    
    
    2,122
    
    
    
    2,122
    
    
    
    
    
    
    
    
    
    
    
    
    Impairment of long-lived assets
    
    
    
    
    
    
    84,600
    
    
    
    84,600
    
    
    
    
    
    
    
    
    
    
    
    
    Total costs and expenses
    
    
    1,705,694
    
    
    
    1,778,298
    
    
    
    1,197,704
    
    
    
    
    580,594
    
    
    
    433,144
    
    
    
    443,693Operating income (loss)
    
    
    9,673
    
    
    
    (24,225
    )
    
    
    (34,698
    )
    
    
    
    10,473
    
    
    
    17,398
    
    
    
    19,086Other (expense) incomeInterest expense
    
    
    (36,493
    )
    
    
    (29,890
    )
    
    
    (26,972
    )
    
    
    
    (2,918
    )
    
    
    (3,398
    )
    
    
    (3,125
    )Loss on write-off of deferred
financing costs
    
    
    (5,941
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Interest income
    
    
    2,747
    
    
    
    6,639
    
    
    
    5,485
    
    
    
    
    1,154
    
    
    
    2,602
    
    
    
    2,464Reorganization items
    
    
    
    
    
    
    1,394,309
    
    
    
    
    
    
    
    
    1,394,309
    
    
    
    (13,153
    )
    
    
    (8,102
    )Other
    
    
    1,345
    
    
    
    1,159
    
    
    
    (336
    )
    
    
    
    1,495
    
    
    
    (15
    )
    
    
    (1,287
    )(Loss) income from continuing
operations
before income taxes
    
    
    (28,669
    )
    
    
    1,347,992
    
    
    
    (56,521
    )
    
    
    
    1,404,513
    
    
    
    3,434
    
    
    
    9,036(Benefit) provision for income
taxes
    
    
    (6,142
    )
    
    
    1,179
    
    
    
    1,323
    
    
    
    
    (144
    )
    
    
    (25
    )
    
    
    (197
    )(Loss) income from continuing
operations
    
    
    (22,527
    )
    
    
    1,346,813
    
    
    
    (57,844
    )
    
    
    
    1,404,657
    
    
    
    3,459
    
    
    
    9,233Discontinued operations(Loss) income from discontinued
operations, net of tax
    
    
    (1,583
    )
    
    
    (254
    )
    
    
    (470
    )
    
    
    
    216
    
    
    
    936
    
    
    
    677Gain on sale of discontinued
operations, net of tax
    
    
    11,314
    
    
    
    29,082
    
    
    
    
    
    
    
    
    29,082
    
    
    
    
    
    
    
    Net (loss) income
    
    $
    (12,796
    )
    
    $
    1,375,641
    
    
    $
    (58,314
    )
    
    
    $
    1,433,955
    
    
    $
    4,395
    
    
    $
    9,910(Loss) income per shareBasic and diluted(Loss) income from continuing
operations
    
    $
    (1.13
    )
    
    $
    67.34
    
    
    $
    (2.89
    )
    
    
    $
    19.06
    
    
    $
    0.05
    
    
    $
    0.13(Loss) income from
discontinued operations
    
    
    (0.08
    )
    
    
    (0.01
    )
    
    
    (0.03
    )
    
    
    
    
    
    
    
    0.01
    
    
    
    Gain on sale of discontinued
operations
    
    
    0.57
    
    
    
    1.45
    
    
    
    
    
    
    
    
    0.40
    
    
    
    
    
    
    
    Net (loss) income per share
    
    $
    (0.64
    )
    
    $
    68.78
    
    
    $
    (2.92
    )
    
    
    $
    19.46
    
    
    $
    0.06
    
    
    $
    0.13Shares used in computing
(loss) income per shareBasic and diluted
    
    
    20,001
    
    
    
    20,000
    
    
    
    20,000
    
    
    
    
    73,688
    
    
    
    73,688
    
    
    
    73,688Operating StatisticsNumber of facilities (end of
period) (1)
    
    
    264
    
    
    
    297
    
    
    
    293
    
    
    
    
    307
    
    
    
    317
    
    
    
    364Average occupancy rate (1)
    
    
    85.7
    %
    
    
    86.1
    %
    
    
    86.1
    %
    
    
    
    86.2
    %
    
    
    86.2
    %
    
    
    86.6
    %Revenue by payor source (2)Medicaid
    
    
    47.7
    %
    
    
    48.1
    %
    
    
    48.3
    %
    
    
    
    47.6
    %
    
    
    48.8
    %
    
    
    50.6
    %Medicare
    
    
    33.5
    %
    
    
    33.6
    %
    
    
    33.1
    %
    
    
    
    34.6
    %
    
    
    31.3
    %
    
    
    27.7
    %Private and other
    
    
    18.8
    %
    
    
    18.3
    %
    
    
    18.5
    %
    
    
    
    17.8
    %
    
    
    19.9
    %
    
    
    21.7
    %
  (1)
    
    Includes skilled nursing services.(2)
    
    Includes skilled nursing services and LTAC. 30




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##### Table of Contents



Predecessor CompanyFiscal Year Ended September 30,2001
    
    2000
    
    1999Statement of Operations DataNet revenue
    
    $
    1,840,654
    
    
    $
    1,849,578
    
    
    $
    1,961,162Costs and expensesOperating expensesWage and related costs
    
    
    1,043,133
    
    
    
    1,104,885
    
    
    
    1,252,572Supplies
    
    
    120,768
    
    
    
    129,332
    
    
    
    128,366Insurance
    
    
    94,837
    
    
    
    80,001
    
    
    
    34,324Provision for bad debt
    
    
    26,523
    
    
    
    42,266
    
    
    
    121,498Rent expense
    
    
    49,767
    
    
    
    70,786
    
    
    
    81,903Other
    
    
    343,898
    
    
    
    271,918
    
    
    
    132,400Total operating expenses
    
    
    1,678,926
    
    
    
    1,699,188
    
    
    
    1,751,063General and administrative expenses
    
    
    73,957
    
    
    
    97,592
    
    
    
    277,499Depreciation and amortization
    
    
    48,687
    
    
    
    42,600
    
    
    
    113,477Gain on sale of divested facilities
    
    
    
    
    
    
    
    
    
    
    242,735Loss on settlement with government
    
    
    33,410
    
    
    
    
    
    
    
    Impairment of long-lived assets
    
    
    
    
    
    
    19,413
    
    
    
    995,932Total costs and expenses
    
    
    1,834,980
    
    
    
    1,858,793
    
    
    
    3,380,706Operating income (loss)
    
    
    5,674
    
    
    
    (9,215
    )
    
    
    (1,419,544
    )Other (expenses) incomeInterest expense
    
    
    (4,613
    )
    
    
    (71,305
    )
    
    
    (203,815
    )Loss on write-off of deferred financing costs
    
    
    
    
    
    
    
    
    
    
    Interest income
    
    
    6,005
    
    
    
    11,365
    
    
    
    9,075Reorganization items
    
    
    (47,721
    )
    
    
    (10,816
    )
    
    
    Other
    
    
    (462
    )
    
    
    2,261
    
    
    
    771Loss from continuing operations
before income taxes
    
    
    (41,117
    )
    
    
    (77,710
    )
    
    
    (1,613,513
    )(Benefit) provision for income taxes
    
    
    (5,706
    )
    
    
    (20,196
    )
    
    
    1,789Loss income from continuing operations
    
    
    (35,411
    )
    
    
    (57,514
    )
    
    
    (1,615,302
    )Discontinued operationsIncome (loss) from discontinued
operations, net of tax
    
    
    2,016
    
    
    
    (1,471
    )
    
    
    (162,980
    )Gain on sale of discontinued
operations, net of tax
    
    
    
    
    
    
    
    
    
    
    Net Loss
    
    $
    (33,395
    )
    
    $
    (58,985
    )
    
    $
    (1,778,282
    )(Loss) income per shareBasic and dilutedLoss from continuing operations
    
    $
    (0.48
    )
    
    $
    (0.78
    )
    
    $
    (21.99
    )Income (loss) from discontinued operations
    
    
    0.03
    
    
    
    (0.02
    )
    
    
    (2.22
    )Gain on sale of discontinued operations
    
    
    
    
    
    
    
    
    
    
    Net loss
    
    $
    (0.45
    )
    
    $
    (0.80
    )
    
    $
    (24.21
    )Shares used in computing loss per shareBasic and diluted
    
    
    73,688
    
    
    
    73,688
    
    
    
    73,459Operating StatisticsNumber of
facilities (end of period)(1)
    
    
    326
    
    
    
    364
    
    
    
    413Average
occupancy rate(1)
    
    
    87.4
    %
    
    
    86.1
    %
    
    
    85.4
    %Revenue by
payor source(2)Medicaid
    
    
    49.2
    %
    
    
    50.8
    %
    
    
    46.8
    %Medicare
    
    
    30.2
    %
    
    
    27.4
    %
    
    
    27.5
    %Private and other
    
    
    20.6
    %
    
    
    21.8
    %
    
    
    25.7
    %
  (1)
    
    Includes skilled nursing services.(2)
    
    Includes skilled nursing services and LTAC. 31




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##### Table of Contents



|                                              |  |                     |           |              |                     |   |              |      |               |      |               |            |               |      |   |            |   |  |   |            |   |  |   |            |  
|--------------------------------------------- |  | ------------------- | --------- | ------------ | ------------------- | - | ------------ | ---- | ------------- | ---- | ------------- | ---------- | ------------- | ---- | - | ---------- | - |  | - | ---------- | - |  | - | ---------- | -
|                                              |  | Reorganized Company |           |              | Predecessor Company
|                                              |  |                     |           |              |                    
|                                              |  | December 31,        |           | December 31, |                     |   | December 31, |      | September 30, |      | September 30, |            | September 30,
|                                              |  | 2003                |           | 2002         |                     |   |              | 2001 |               | 2001 |               | 2000       |               | 1999
|                                              |  |                     |           |              |                     |   |              |      |               |      |               |            |              
|Balance Sheet Data                            |  |                     |           |              |                     |   |              |      |               |      |               |            |               |      |   |            |   |  |   |            |   |  |   |            |  
|Cash and cash equivalents                     |  | $                   | 41,934    |              |                     | $ | 38,618       |      |               |      | $             | 213,740    |               |      | $ | 209,050    |   |  | $ | 170,468    |   |  | $ | 71,817     |  
|Receivables                                   |  |                     | 234,098   |              |                     |   | 264,092      |      |               |      |               | 238,736    |               |      |   | 241,860    |   |  |   | 246,695    |   |  |   | 307,571    |  
|Property and equipment, net                   |  |                     | 544,356   |              |                     |   | 567,260      |      |               |      |               | 412,965    |               |      |   | 416,026    |   |  |   | 439,044    |   |  |   | 459,553    |  
|Working capital                               |  |                     | 56,004    |              |                     |   | 116,566      |      |               |      |               | 347,641    |               |      |   | 334,444    |   |  |   | 331,711    |   |  |   | (1,829,065 | )
|Total assets                                  |  |                     | 1,107,734 |              |                     |   | 1,178,738    |      |               |      |               | 1,222,355  |               |      |   | 1,230,978  |   |  |   | 1,247,635  |   |  |   | 977,728    |  
|Long-term debt,
including current
portion (1) |  |                     | 389,636   |              |                     |   | 484,762      |      |               |      |               | 2,112,418  |               |      |   | 2,116,755  |   |  |   | 2,147,756  |   |  |   | 2,146,434  |  
|Stockholders equity
(deficit)                |  |                     | 256,153   |              |                     |   | 268,395      |      |               |      |               | (1,467,260 | )             |      |   | (1,471,509 | ) |  |   | (1,440,177 | ) |  |   | (1,386,019 | )
|Total capitalization                          |  |                     | 645,789   |              |                     |   | 753,157      |      |               |      |               | 645,158    |               |      |   | 645,246    |   |  |   | 707,579    |   |  |   | 760,415    |  



---

|(1)   
Long-term debt, including current portion, included $2,052,730 and
$2,057,067 as liabilities subject to compromise at December 31, 2001 and
September 30, 2001, respectively. At September 30, 2000 all long-term debt,
including current portion, was classified as liabilities subject to compromise.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

32



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##### Table of Contents






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

The following is a discussion of our results of operations and current
financial position. This discussion should be read in conjunction with our
consolidated financial statements and related notes included elsewhere in this
report and the selected financial data included in Item 6. Our discussion of
our results of operations and financial condition includes various
forward-looking statements about our markets, the demand for our services, and
our future results. These statements are based on certain assumptions that we
consider reasonable. For information about risks and exposures relating to our
business and our company, you should read the section entitled Risk Factors
included under Item 1 above.

The following discussion includes EBITDA which is a non-GAAP financial measure.
For purposes of Regulation G promulgated by the SEC, or
Regulation G, a non-GAAP financial measure is a numerical
measure of a registrants historical or future financial performance, financial
position or cash flows that excludes amounts, or is subject to adjustments that
have the effect of excluding amounts, that are included in the most directly
comparable financial measure calculated and presented in accordance with GAAP
in the statement of operations, statement of stockholders
equity, balance sheet or statement of cash flows (or
equivalent statements) of the registrant; or includes amounts, or is subject to
adjustments that have the effect of including amounts, that are excluded from
the most directly comparable financial measure so calculated and presented. Pursuant to the requirements of
Regulation G, we have provided reconciliations of the non-GAAP financial
measures to the most directly comparable GAAP financial measures.

Management believes that the presentation of EBITDA provides useful information
to investors regarding our results of operations because it is useful for
trending, analyzing and benchmarking the performance and value of our business.
We use EBITDA primarily as a performance measure and believe that the GAAP
financial measure most directly comparable to EBITDA is net (loss) income. We
use EBITDA as a measure to assess the relative performance of our
business units, as
well as the employees responsible for operating such business units. EBITDA is
useful in this regard because it does not include such costs as interest
expense, expense loss on write-off of deferred financing costs, interest
income, income taxes and depreciation and amortization expense which may vary
from business unit to business unit depending upon such factors as the method
used to finance the original purchase of the business unit or the tax law in
the state in which a business unit operates. By excluding such factors when
measuring financial performance, many of which are outside of the control of
the employees responsible for operating our business units, management is
better able to evaluate operating performance of the business unit and the
employees responsible for business unit performance. Consequently, management
uses EBITDA to determine the extent to which our employees have met performance
goals, and therefore may or may not be eligible for incentive compensation
awards. We also use EBITDA in our annual budget process. We believe EBITDA
facilitates internal comparisons to historical operating performance of prior
periods and external comparisons to competitors historical operating
performance. Although we use EBITDA as a financial measure to assess the
performance of our business, the use of EBITDA is limited because it does not
consider certain material costs necessary to operate our business. These costs
include the cost to service our debt, the non-cash depreciation and
amortization associated with our long-lived assets, and the cost of our federal
and state tax obligations. Because EBITDA does not consider these important
elements of our cost structure, a user of our financial information who relies
on EBITDA as the only measure of our performance could draw an incomplete or
misleading conclusion regarding our financial performance. Consequently, a user
of our financial information should consider net (loss) income an important
measure of our financial performance because it provides the most complete
measure of our performance.

We define EBITDA as net
(loss) income before taxes, interest expense and depreciation
and amortization. Other companies may define EBITDA differently and, as a
result, our measure of EBITDA may not be directly comparable to EBITDA of other
companies. EBITDA does not represent net income (loss), as defined by GAAP.

EBITDA should be considered in addition to, not as substitutes for, or superior
to, GAAP financial measures or as indicators of operating performance.

We also present certain adjustments to
EBITDA that exclude impairment of long-lived assets, gain on sale of
discontinued operations net of tax, reorganization items, (gain) loss
on sale of divested facilities, divestiture related charges and loss
from operations of divested facilities. These adjustments are
presented because this is the formula used to calculate compliance
with certain ratios appearing in our Senior Credit Facility and the
indenture governing the Notes. The adjustments to EBITDA presented
below are reconciled to net (loss) income, which we believe is the
most directly comparable GAAP financial measure.

Overview

We are one of the largest providers of
long-term health care services in the
United States, based on net revenue and the number of facilities we operate and
licensed beds. We provide these services primarily through the operation of
skilled nursing facilities and LTACs. We
currently operate 256 skilled nursing facilities and eight stand-alone assisted
living facilities with an aggregate of 31,489 licensed beds. We own
70% of our facilities. We also operate eleven LTACs with
613 licensed beds. Our
facilities are located in 23 states with significant concentrations in Texas,

33



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##### Table of Contents



North Carolina, California, Colorado,
South Carolina, and Maryland and clusters in twelve
geographic markets in nine of the states in which we operate.

From January 18, 2000 until May 13, 2002, we operated our businesses as a
debtor-in-possession subject to the jurisdiction of the Bankruptcy Court. On
May 13, 2002, the Joint Plan became effective and we emerged from bankruptcy. In connection with our emergence from
bankruptcy, we changed our name to Mariner Health Care, Inc.

Services provided at our skilled
nursing facilities and assisted living facilities are our
primary service offering and account for over 90% of our
revenue and cash flows. Through our skilled nursing facilities, we provide
24-hour care to patients requiring skilled nursing services, including
assistance with ADL, therapy and
rehabilitation services. Our LTACs accommodate the relatively high acuity needs
of patients discharged from short-term, acute-care hospitals when the patients
condition warrants more intensive care than can be provided in a typical
nursing facility.

The following table sets forth our
revenues, operating profit (loss) and
depreciation and amortization for our two reportable segments,
skilled nursing services and LTACs. The Other category
consists primarily of corporate items not considered to be an
operating segment and
includes cash, property plant and equipment, goodwill, restricted
investments, notes receivable and deferred financing costs. The
operating profit (loss) is defined as net revenue less operating and general and administrative expenses.

|                                     |  |              |           |       |  |       |         |       |  |   |         |   |  |   |           | 
|------------------------------------ |  | ------------ | --------- | ----- |  | ----- | ------- | ----- |  | - | ------- | - |  | - | --------- | 
|                                     |  | Nursing Home |           |       |  |       |         |       |  |   |         |   |  |  
|                                     |  | Services     |           | LTACs |  | Other |         | Total
|                                     |  |              |           |       |  |       |         |      
|Reorganized Company                  |  |              |           |       |  |       |         |       |  |   |         |   |  |   |           | 
|Year Ended December 31, 2003         |  |              |           |       |  |       |         |       |  |   |         |   |  |   |           | 
|Revenue from external customers      |  | $            | 1,594,693 |       |  | $     | 119,266 |       |  | $ | 1,408   |   |  | $ | 1,715,367 | 
|Operating
profit (loss)              |  |              | 105,108   |       |  |       | 15,139  |       |  |   | (98,689 | ) |  |   | 21,558    | 
|Depreciation and amortization        |  |              | 32,015    |       |  |       | 1,571   |       |  |   | 3,496   |   |  |   | 37,082    | 
|Total
assets                         |  |              | 765,543   |       |  |       | 22,849  |       |  |   | 319,342 |   |  |   | 1,107,734 | 
|Eight Months Ended December 31, 2002 |  |              |           |       |  |       |         |       |  |   |         |   |  |   |           | 
|Revenue from external customers      |  | $            | 1,087,974 |       |  | $     | 76,294  |       |  | $ | (1,262  | ) |  | $ | 1,163,006 | 
|Operating
profit (loss)              |  |              | 117,613   |       |  |       | 7,631   |       |  |   | (50,456 | ) |  |   | 74,788    | 
|Depreciation and amortization        |  |              | 20,463    |       |  |       | 724     |       |  |   | 1,577   |   |  |   | 22,764    | 
|Total
assets                         |  |              | 808,789   |       |  |       | 42,921  |       |  |   | 327,028 |   |  |   | 1,178,738 | 
|                                    
|Predecessor Company                  |  |              |           |       |  |       |         |       |  |   |         |   |  |   |           | 
|Four Months Ended April 30, 2002     |  |              |           |       |  |       |         |       |  |   |         |   |  |   |           | 
|Revenue from external customers      |  | $            | 550,919   |       |  | $     | 37,075  |       |  | $ | 3,073   |   |  | $ | 591,067   | 
|Operating
profit (loss)              |  |              | 40,785    |       |  |       | 3,384   |       |  |   | (22,140 | ) |  |   | 22,029    | 
|Depreciation and amortization        |  |              | 10,722    |       |  |       | 277     |       |  |   | 557     |   |  |   | 11,556    | 
|Total
assets                         |  |              | 1,036,127 |       |  |       | 77,284  |       |  |   | 175,894 |   |  |   | 1,289,305 | 
|Three Months Ended December 31, 2001 |  |              |           |       |  |       |         |       |  |   |         |   |  |   |           | 
|Revenue from external customers      |  | $            | 421,140   |       |  | $     | 28,680  |       |  | $ | 722     |   |  | $ | 450,542   | 
|Operating
profit (loss)              |  |              | 44,255    |       |  |       | 2,292   |       |  |   | (18,221 | ) |  |   | 28,326    | 
|Depreciation and amortization        |  |              | 9,019     |       |  |       | 388     |       |  |   | 1,521   |   |  |   | 10,928    | 
|Total
assets                         |  |              | 699,167   |       |  |       | 61,349  |       |  |   | 461,839 |   |  |   | 1,222,355 | 
|Fiscal Year Ended September 30, 2001 |  |              |           |       |  |       |         |       |  |   |         |   |  |   |           | 
|Revenue from external customers      |  | $            | 1,726,259 |       |  | $     | 111,638 |       |  | $ | 2,757   |   |  | $ | 1,840,654 | 
|Operating
profit (loss)              |  |              | 151,948   |       |  |       | 7,023   |       |  |   | (71,200 | ) |  |   | 87,771    | 
|Depreciation and amortization        |  |              | 37,068    |       |  |       | 1,870   |       |  |   | 9,749   |   |  |   | 48,687    | 
|Total
assets                         |  |              | 897,309   |       |  |       | 64,254  |       |  |   | 269,415 |   |  |   | 1,230,978 | 

On January 6, 2002, we consummated the sale of our institutional pharmacy
services business, or the APS Division, to Omnicare, Inc., or Omnicare for a
cash closing price of $97.0 million and up to $18.0 million in future payments,
depending upon certain post-closing operating results of the APS Division,
referred to as Earnout Payments. The results of the APS division have been
treated as a discontinued operation in accordance with GAAP. During the four months ended April
30, 2002, we realized a gain on the sale of the APS Division of $29.1 million.
During the three months ended March 31, 2003, we earned and received the first
Earnout Payment of $6.0 million, at which time a gain of $3.6 million, net of
taxes of $2.4 million was recorded. On July 23, 2003, we entered into an
agreement with Omnicare whereby all conditions for the remaining Earnout
Payments were considered to have been met and we received the remaining $12.0
million on August 5, 2003, at which time we recorded a gain of $7.2 million,
net of taxes of $4.8 million.

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Recent Developments

Refinancing

On December 19, 2003, we entered
into our Senior Credit Facility which provides for a $135.0 million term loan facility and
a $90.0 million revolving credit facility. The Term Loan was drawn in full on
December 19, 2003. As of December 31, 2003, there were no borrowings under the
Revolving Credit Facility, although we utilized $34.6 million of borrowing
capacity under the Revolving Credit Facility to issue letters of
credit on December 19, 2003 to replace or support letters of credit issued under our previous senior
credit facility and other loan arrangements. Also on December 19, 2003, we
consummated an offering for $175.0 million aggregate principal amount of 8.25%
senior subordinated notes due December 15, 2013. The Notes are unsecured
senior subordinated obligations and will be subordinated in right of payment to
our Senior Credit Facility, other existing senior indebtedness and future
senior indebtedness. We used the net proceeds of our Senior Credit
Facility and notes, among other things, to redeem the then existing second
priority notes, and repay our previous senior credit facility and to pay fees
and expenses associated with the Senior Credit Facility and the Notes financing transactions.

Medicare Base Rates

On October 1, 2003, the final
rules for Medicare PPS for skilled nursing facilities for federal year 2004 became effective. The
final rules increase the reimbursement base rates for the federal governments
year 2004 by 6.26%. The 6.26% increase has two components: a 3.00% increase in
the annual update factor (representing an approximate $9 increase in our
average Medicare payment rate per patient day) and a 3.26% upward adjustment in
base rates correcting previous forecast errors (representing an approximate $10
increase in our average Medicare payment rate per patient day). During the year
ended December 31, 2003, our average Medicare rate per patient day was $308 and
total Medicare patient days in our skilled nursing facilities were 1.3 million,
excluding Florida and Louisiana.

Divestiture of Facilities in Florida and Louisiana

During the quarter ended
December 31, 2003, we sold 19 skilled nursing
facilities and terminated operating and capital leases with respect to an
additional eleven skilled nursing facilities in Florida and Louisiana for net
cash proceeds of $73.1 million and a $13.1 million five-year subordinated
promissory note with an annual interest rate of 8%. These divestitures
resulted in a $56.9 million reduction of debt, an $11.4 million retirement of
facility specific mortgage indebtedness and a $29.8 million elimination of
capital lease indebtedness. We recognized a pre-tax gain on sale of assets of
$25.2 million related to the divestitures that did not qualify for discontinued
operations presentation. In addition, in connection with exiting the
operations of the divested facilities, we
recorded pre-tax charges of $49.6 million consisting of $24.0 million for bad
debt expense, $21.0 million of insurance expense for
professional liability claims, of which $6.0 million related to
the purchase of tail insurance coverage, and
$4.6 million for exit and other costs, which are included in our operating
expenses for the year ended December 31, 2003. The operations and cash flows
of certain of the facilities sold during the fourth quarter ended December 31,
2003 have been reclassified to discontinued operations. For these facilities,
we have recorded a $1.1 million gain, net of tax, which is included in gain on
sale of discontinued operations in the accompanying consolidated statements of
operations.

These transactions represent the divestiture or termination of all 27 of the
skilled nursing facilities we operated in Florida and all three skilled nursing
facilities we operated in Louisiana. Given that Florida has been a highly
litigious state, we believe that these divestitures should reduce our liability
exposure for future periods.

Texas Tort Reform

As of September 1, 2003, a law enacting tort reform in Texas became effective.
We operate 76 skilled nursing facilities and six LTACs in Texas.
Among other things, the law imposes
a $250,000 cap on the non-economic damages (such as pain and suffering) that
claimants can recover in a malpractice lawsuit against a health care
institution. Among other things, the law also imposes an aggregate $500,000 cap on the amount of
such damages that claimants can recover in malpractice lawsuits against more
than one health care institution. Finally, the law revises an existing $1.5
million cap (subject to future adjustment for inflation) on recovery in
wrongful death and survivor actions by requiring that this cap be imposed on a
per incident rather than per defendant basis and by including punitive damages
in the awards subject to the cap. We believe this reform should reduce our
liability exposure in Texas for future periods. However, we experienced a
large increase in the number of suits filed between the date the legislation
was passed and the effective date of the legislation, which we believe could
have an adverse effect on our loss history and professional and general
liability costs with respect to prior periods when these cases are finally
adjudicated or settled under the old law.

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Our Industry

We compete in the long-term care industry. The long-term care industry includes
companies that offer post-acute, sub-acute or general health care services such
as skilled nursing care, long-term home care services and other support
services, primarily to elderly patients. Within the long-term care industry, we
focus specifically on the approximately $100 billion United States nursing home market
through the operation of our skilled nursing facilities and LTACs. There are
approximately 16,500 nursing homes with approximately 1.8 million total beds certified to provide Medicare
and/or Medicaid services in the United States. The nursing home industry is
highly fragmented. The ten largest for-profit chains combined control 15% of
the industrys beds, with the largest company operating just under 3% of the
industrys beds.

The aging of the population and increased life expectancies are the primary
driving forces behind the growth of our business. We believe that positive
demographic trends imply that there will be a growing demand for the services
offered by health care providers that deliver the most efficient, responsive,
cost effective and high quality eldercare services. We are continually engaged
in various efforts to improve our profitability by focusing on key operational
initiatives, including: improving the quality of our payor mix, increasing our
rate of occupancy, improving nursing staff scheduling and retention, reducing
reliance on overtime compensation and temporary nursing agency services, and
capitalizing on best demonstrated practices in various areas of cost control.
As a result, we believe we will be well positioned to take advantage of the
favorable demographic and growth trends in our industry.

In addition to positive demographic trends, the demand for the services
provided by long-term care facilities is expected to increase substantially
during the next decade due primarily to the impact of cost containment measures
by government and private-pay sources resulting in higher acuity patients being
transferred more quickly from hospitals to less expensive care settings such as
skilled nursing facilities and LTACs. National nursing home expenditures are
expected to grow from $103.7 billion in 2002 to $178.8 billion in 2012,
representing a 5.6% compounded annual growth rate. We believe that these trends
will support a growing demand for the services provided by nursing and assisted
living facility operators that deliver efficient, cost-effective and quality
long-term health care services and that support a full range of needs and
acuity levels.

Reimbursement Issues

We derive a substantial portion of our revenue from third-party payors,
including the Medicare and Medicaid programs. For the year ended
December 31, 2003, we derived approximately 81.2% of the total revenue for our
skilled nursing facilities segment from the
Medicare and Medicaid programs and
82.7% of the total revenue for our
LTAC segment from the Medicare and Medicaid programs. Third-party payor programs are highly
regulated and are subject to frequent and substantial changes. Changes in the
reimbursement rate or methods of payment from third-party payors, including the
Medicare and Medicaid programs, or the implementation of other measures to
reduce reimbursements for our services has in the past, and could in the
future, result in a
substantial reduction in our revenues and operating margins. Additionally, net
revenue realizable under third-party payor agreements can change after
examination and retroactive adjustment by payors during the claims settlement
processes or as a result of post-payment audits. Payors may disallow requests
for reimbursement based on determinations that certain costs are not
reimbursable or reasonable because additional documentation is necessary or
because certain services were not covered or were not reasonable and medically
necessary. There also continue to be new legislative and regulatory proposals
that could impose further limitations on government and private payments to
health care providers. In some cases, states have enacted or are considering
enacting measures designed to reduce their Medicaid expenditures and to make
changes to private health care insurance. We cannot assure you that adequate
reimbursement levels will continue to be available for the services provided by
us, which are currently being reimbursed by Medicare, Medicaid or private
third-party payors. Further limits on the scope of services reimbursed and on
reimbursement rates could have a material adverse effect on our liquidity,
financial condition and results of operations. It is possible that the effects
of any of the Medicare Reimbursement Cliff, further refinements to Medicare
PPS that result in lower
payments to us or cuts in state Medicaid funding could have a material adverse
effect on our results of operations. See Item 1, Business
 Government Regulation.

In recent years, Congress has enacted three significant laws that have
dramatically altered payments for skilled nursing services. Beginning with the
passage of the Balanced Budget Act,
payments for Medicare services were reduced and extensive changes in the
Medicare and Medicaid programs were made. Congress twice passed legislation
intended to mitigate temporarily the reduction in Medicare reimbursement rates
for skilled nursing facilities caused by the Balanced Budget Act. These bills
were the Balanced
Budget Refinement Act, and the Benefits Improvement and
Protection Act. As of October 1, 2002, a 4% across-the-board
increase in RUGs reimbursement rates and a 16.7% increase
in the nursing component provided for in these acts expired. The expiration

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of
these increases is commonly referred to as the Medicare Reimbursement Cliff. We
believe the Medicare Reimbursement Cliff resulted in an approximate $25
reduction in our average Medicare rate per patient day. The final year 2004
PPS rules for skilled nursing facilities however,
partially mitigated some of the effects of the Medicare Reimbursement Cliff.
The final rules provided for an upward 3.26% adjustment to the base rates and a
3.0% increase in the annual update factor. These changes are estimated to
increase our Medicare payment rates by $19 per patient day. The final rules
also provide for the continuation through September 30, 2004 of certain payment
add-ons, which were authorized in the Balanced Budget Refinement Act and the
Benefits Improvement and Protection Act to compensate for the cost of providing
services to higher acuity patients. However, President Bushs proposed fiscal
year 2005 budget indicates that refinements will not be implemented until
September 30, 2005. Medicaid programs, which are administered at the state level and are a
significant source of our revenues, are impacted by fluctuations in state
budgets. The recent economic downturn has had a detrimental effect on state
revenues in most regions of the United States. Given that Medicaid outlays are
a significant component of state budgets, we expect continuing cost containment
pressures on Medicaid outlays for skilled nursing services in the states in
which we operate. State budget shortfalls have helped to elevate issues related
to Medicaid onto the national agenda, which may result in additional federal
support for the state-run Medicaid programs. Certain taxes that we pay to state governments are used as mechanisms to
increase the amount of money that states receive, in turn, from the federal
government. These monies are usually returned to providers in the form of
higher Medicaid rates. This state tax scheme relies upon state
intergovernmental transfers as the legal funding mechanism to increase federal
financial participation (the federal portion of Medicaid funding). The
Presidents 2005 budget calls for federal legislation to restrict states from
using such intergovernmental transfer and proposes to limit Medicaid payments
to the cost of providing services to Medicaid beneficiaries. We cannot predict
whether or how this legislation, if passed will impact the taxes we pay to
states, our revenues, or the revenues we receive for Medicaid services. Basis of Presentation The following managements discussion and analysis should be read in
conjunction with our consolidated financial statements and the related notes
appearing elsewhere in this report. Our consolidated financial statements and
the related notes appearing elsewhere in this report have been prepared in
accordance with GAAP.
The preparation of financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities at the date of the
financial statements, and the reported amounts of revenue and expenses during
the reporting period. Although these estimates are based on managements
knowledge of current events, they may ultimately differ from actual results as
a result of a number of factors, including those discussed elsewhere in this
report and in our other public filings from time to time. In connection with our emergence from bankruptcy, we reflected the terms of the
Joint Plan in our consolidated financial statements by adopting the principles
of fresh-start reporting in accordance with SOP 90-7. Although our Joint Plan
became effective on May 13, 2002, for financial reporting purposes the
effective date of our Joint Plan was May 1, 2002. Under fresh-start reporting,
a new entity is deemed to be created for financial reporting purposes and the
recorded amounts of assets and liabilities are adjusted to reflect their
estimated fair values. Since fresh-start reporting materially changed the
amounts recorded in our consolidated financial statements, a black line
separates the financial data pertaining to periods after our adoption of
fresh-start reporting from the financial data pertaining
to periods prior to our adoption of fresh-start reporting to signify the
difference in the basis of preparation of financial information for each
respective entity. As a result of the adoption of fresh-start
reporting, our consolidated financial statements show periods after
May 1, 2002 as Reorganized Company periods and
periods prior to May 1, 2002 as Predecessor Company
periods. Similarly, references in this Managements Discussion
and Analysis of Financial Condition and Results of Operations to
periods after May 1, 2002 are indicated by use of the term
Reorganized Company and periods prior to May 1, 2002
are indicated by  use of the term Predecessor Company.
The Reorganized Company adopted the accounting policies of the
Predecessor Company upon emergence from bankruptcy. In accordance
with the fresh-start reporting provisions of SOP 90-7, the
Company also adopted changes in accounting principles that were
required in the consolidated financial statements of the Reorganized
Company within the twelve-month period subsequent to the Effective
Date. Between the Petition Date and the Effective Date, we operated our business as a
debtor-in-possession subject to the jurisdiction of the Bankruptcy Court.
Accordingly, our consolidated financial statements prior to the adoption of
fresh-start reporting on May 1, 2002 have been presented in conformity with SOP
90-7 and were prepared on a going concern basis which assumed continuity of
operations and realization of assets and settlement of liabilities and
commitments in the ordinary course of business. As a result of our adoption of fresh start reporting, the book value of our
fixed assets and amortization schedules have changed. Because of our adoption
of fresh-start reporting, you will not be able to compare certain financial
information reflecting our results of operations and financial condition to
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Comparability of Financial Information Also in connection with our emergence, we restructured some of our operations
in order to operate more efficiently, and divested some of our under-performing
assets. With respect to operating results, we believe that the business segment
operating income of our Predecessor Company is generally comparable to that of
the Reorganized Company, excluding facilities that have been divested. While
there have been no material changes in our strategy or the operation of our
business, capital costs of our Predecessor Company that were based on
pre-petition contractual agreements and historical costs are generally not
comparable to those of the Reorganized Company as a result of the divestiture
of under-performing facilities and the extinguishment of a significant amount
of indebtedness. Rent expense of our Predecessor Company was partially derived
from leases that were terminated before our emergence from bankruptcy and are
not obligations of the Reorganized Company. Interest expense of our Predecessor
Company was based upon the terms of our pre-petition long-term debt obligations
and was materially different from that of the Reorganized Company as a result
of the extinguishment of debt in bankruptcy. Depreciation expense of our
Predecessor Company was based upon the historical cost of property and
equipment. Depreciation expense of the Reorganized Company is based upon the
fair value of property and equipment as of May 1, 2002. Amortization expense of
our Predecessor Company was based upon the estimated useful life of recorded
goodwill. Upon adoption of Statement of Financial Accounting Standard No. 142,
Goodwill and Other Intangible Assets on January 1, 2002, amortization expense
was discontinued. Amortization expense is excluded from the consolidated
statement of operations for our Predecessor Company in 2002 and amortization
expense is not recorded in the consolidated statements of operations of the
Reorganized Company. For these reasons, the reported financial position and
cash flows of our Predecessor Company generally are not comparable to those of
the Reorganized Company. In connection with the restructuring of our debt in accordance with the Joint
Plan, we recorded a gain of $1,229.6 million. Other significant adjustments
were also recorded to reflect the provisions of the Joint Plan and the fair
values of the assets and liabilities of the Reorganized Company. For accounting
purposes, these transactions have been reflected in the operating results of
our Predecessor Company for the four months ended April 30, 2002. Critical Accounting Policies and Estimates The accompanying consolidated financial statements have been prepared in
conformity with GAAP.
The accounting policies discussed below are considered by management to be
critical to an understanding of our financial statements because their
application requires significant judgment and reliance on estimations of
matters that are inherently uncertain. Certain risks related to these critical
accounting policies are described in the following paragraphs. Revenue Recognition We have agreements with third-party payors that provide for payments to our
skilled nursing facilities. These payment arrangements may be based upon
prospective rates, reimbursable costs, established charges, discounted charges
or per diem payments. Revenue is reported at the estimated net realizable
amounts from Medicare, Medicaid, other third-party payors and individual
patients for services rendered. Retroactive adjustments that are likely to
result from future examinations by third-party payors are accrued on an
estimated basis in the period the related services are rendered and adjusted as
necessary in future periods based on final settlements. There is a possibility
that recorded estimates may change by a material amount. Consistent with
health care industry accounting practices, changes to these third-party revenue
estimates are recorded in the year of change or at the time the adjustment
becomes known. Receivables Receivables consist primarily of amounts due from the Medicare and Medicaid
programs, other government programs, managed care health plans, commercial
insurance companies and individual patients. Allowances for doubtful accounts
are established to the extent that a portion of these receivables may become
uncollectible. In establishing the allowance for doubtful accounts, the
Company
considers a number of factors, including the age of the accounts, changes in
collection patterns, the composition of patient accounts by payor type, the
status of ongoing disputes with third-party payors and general industry
conditions. Changes in these estimates are charged or credited to the results
of operations in the period of the change. If circumstances occur, such as an
economic downturn, higher than expected defaults or denials, or reduced
collections, the estimates of the recoverability of our receivables could be
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Our provision for bad debt totaled $42.4 million, $30.0 million, $7.8 million
and $27.8 million for the year ended December 31, 2003, the twelve months ended
December 31, 2002, the three months ended December 31, 2001 and the fiscal year ended
September 30, 2001, respectively which represented 2.5%, 1.7%, 1.7%, and 1.5%
of net revenue for the respective periods. Our allowance for doubtful accounts related to patient accounts receivable was
$97.4 million and $73.0 million as of December 31, 2003 and 2002, respectively
which represented 30.8% and 25.6% of patient accounts receivable at December
31, 2003 and 2002, respectively. The increase in the provision for bad debts
during the year ended December 31, 2003 as compared to the twelve months ended
December 31, 2002, as well as the increase in the allowance for doubtful
accounts balance at December 31, 2003 as compared to December 31, 2002, are
primarily a result of $24.0 million additional bad debt expense during the
quarter ended December 31, 2003 related to facilities divested during the
quarter. During the twelve months ended December 31, 2002, we recorded
additional bad debt expense of $10.8 million, which related primarily to
receivables of divested facilities. Accrued Insurance Obligation for Professional and General Liability PL/GL costs for the long-term care industry have
become increasingly expensive and difficult to estimate. Specifically, rising
costs of eldercare malpractice litigation, and losses stemming from these
malpractice lawsuits and a constriction of insurers have caused many insurance
carriers to raise the cost of insurance premiums or refuse to write insurance
policies for nursing homes. These problems are particularly acute in Florida
where, because certain laws allow for significantly higher liability awards
than in other states, PL/GL costs have
increased substantially. In the year ended December 31, 2003, we divested all
of our skilled nursing facilities in Florida. We are currently self-insured for individual claims up to $1.0 million for
professional liability, except in Colorado, where we maintain first dollar
coverage. The accrued insurance obligation related to self-insured losses for
professional liability are recorded on an undiscounted basis and are based upon
internal and external evaluations of the merits of individual claims, analysis
of claims history and independent actuarially determined estimates. The
methods of determining these estimates and establishing the resulting accrued
insurance obligation and provision for loss are reviewed periodically by the
Companys management, with any resulting material adjustments being reflected
in current earnings. During the fourth quarter of the year ended December 31,
2003, we recorded a charge of $21.0 million for additional insurance expense,
related to exiting the operations of the facilities divested in Florida, of which
$6.0 million related to the purchase of tail
insurance coverage. We believe that we are
adequately reserved for any future claims made in connection with the divested
Florida facilities, however actual results could differ and have a material
impact on our consolidated financial statements. Insurance expense for professional liability
was $98.6 million for the year ended December 31, 2003,
including $21.0 million related to the Florida divestitures,
$85.9 million for the
twelve months ended December 31, 2002, $24.0 million for the three months ended December 31, 2001 and
$91.2 million for the fiscal year ended September 30, 2001. Although management believes that the
accrued insurance obligation is adequate,
the ultimate liability may be in excess of or less than the amounts recorded.
Changes in the number of PL/GL and increasing costs
to settle these claims could significantly impact the accrued insurance
obligation. A relatively small variance between our estimated and ultimate
actual number of claims or average cost per claim could have a material impact,
either favorable or unfavorable, on the adequacy of the accrued insurance
obligation. Accounting for Income Taxes The provision for income taxes is based upon our estimate of taxable income or
loss for each respective accounting period. We recognize an asset or liability
for the deferred tax consequences of temporary differences between the tax
basis of assets and liabilities and their reported amounts in the financial
statements. These temporary differences will result in taxable or deductible
amounts in future years when the reported amounts of assets are recovered or
liabilities are settled. We also recognize as deferred tax assets the future
tax benefits from net operating and capital loss carry forwards. We have limited operating experience as a Reorganized Company. Furthermore,
there are significant uncertainties with respect to future Medicare payments to
both our skilled nursing facilities and LTACs that could affect materially the
realization of some of our deferred tax assets. Accordingly, a valuation
allowance is provided for deferred tax assets because the realizability of the
deferred tax assets is uncertain. 39




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If all or a portion of the Predecessor Company deferred tax asset is realized in
the future, or considered more likely than not to be realized by us, the
reorganization intangible recorded in connection with fresh-start reporting
will be reduced accordingly. If the reorganization intangible is eliminated in
full, other intangible assets will then be reduced, with any excess treated as
an increase to capital in excess of par value. At December 31, 2003,
we estimate that there remains $563.0 million of net
operating loss, or NOL, carryforwards relating to the Predecessor Company, utilization of which is
subject to limitations. The income tax benefit of any NOL
carryforward utilization, if any, will be applied first as a
reduction to reorganization value in excess of amounts allocable to
identifiable assets and, thereafter, as a direct addition to paid
capital, pursuant to SOP 90-7, at such time it is assured. If there is a
cumulative ownership change involving shareholders who own 5% or more
of our Common Stock of more than 50% during the two year period
following our emergence from bankruptcy (May 13, 2002), the
remaining NOL carryforwards will be forgone with no net impact to our
consolidated financial statements. This could result in higher future
tax payments if we are profitable. Asset Impairment Long-lived Assets We review the carrying value of our long-lived assets for impairment whenever
events or circumstances indicate that the carrying amount may not exceed the
future undiscounted cash flows or an adjustment to the amortization period is
necessary in accordance with Statement of Financial Accounting Standards No.
144, Accounting for the Impairment or Disposal of Long-lived Assets, or SFAS
No. 144. These indicators of impairment can include, but are not limited to, a
history of operating losses with expected future losses, changes in the
regulatory environment affecting reimbursement, decreases in cash flows or cash
flow deficiencies, changes in the way an asset is used in the business, and
commitment to a plan to sell or otherwise dispose of an asset. For the twelve months ended December 31, 2002, we retained a qualified
independent valuation group to assist in our review of the carrying amount of
our property and equipment in conjunction with the annual review of the
carrying value of our reorganization value in excess of amounts allocable to
identifiable assets. This review indicated that property and equipment was
impaired by $27.3 million during the fourth quarter of the twelve months ended
December 31, 2002, and accordingly, we recognized an impairment charge to our
long-lived assets. There was no impairment charge for the year ended December
31, 2003. Impairment of Reorganization Value in Excess of Amounts Allocable to
Identifiable Assets and Goodwill Reorganization value in excess of amounts allocable to identifiable assets, or
excess reorganization value, represents the portion of reorganization value
that could not be attributed to specific tangible or identified intangible
assets recorded in connection with our adoption of fresh-start reporting. In lieu of amortization, we are required to review the excess reorganization
value and goodwill for impairment at least annually or more frequently if
events or changes in circumstances indicate the asset might be impaired. Our
annual impairment test date is October 1. We engage an independent expert to
assist in the analysis to determine if there is any impairment. This analysis
indicated that the excess reorganization value was impaired by $57.3 million
for the twelve months ended December 31, 2002, and accordingly, we recognized
an impairment charge. There was no impairment charge for the year ended
December 31, 2003. The impairment analyses included estimating the undiscounted and discounted
cash flows to be generated by each business unit or facility, primarily over
the remaining life of the primary asset, and reducing the carrying value of the
asset to the estimated fair value when the total estimated undiscounted and
discounted cash flows was less than the carrying value of the asset.
If the estimated fair value was in excess of the carrying value, no
impairment charge was recorded. In estimating the
undiscounted and discounted cash flows for our skilled nursing
facilities, assisted living facilities and LTACs, we primarily used our internally prepared budgets and
forecast information, with certain probability adjustments, including, but not
limited to, the following items: Medicare and Medicaid funding; overhead costs;
capital expenditures; and patient care liability costs. In order to estimate
the fair values, a discounted cash flow approach was
used, supplemented by public resource information on valuations of sales transactions by region of the country. Where the estimated
undiscounted cash flows were negative, the fair values were estimated based on
discounted public resource information, sales values or estimated salvage
value. A substantial decline in the estimated future cash flows for these
facilities or businesses could materially change the estimated fair values of
these assets, possibly resulting in an additional impairment. Assets Held for Sale and Discontinued Operations SFAS No. 144 also addresses the accounting for and disclosure of long-lived
assets to be disposed of by sale. Under SFAS No. 144, when a long-lived asset
or group of assets or disposal group meets certain criteria set forth in SFAS
No. 144, including a commitment by a company to a plan to sell the long-lived
asset or disposal group within one year, the long-lived asset or disposal group
will be measured at the lower of its carrying value or fair value less costs to
sell and classified as held for sale on the consolidated balance sheet and is
no longer depreciated. 40




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##### Table of Contents



If additional criteria are met under SFAS No. 144, the related operations and
cash flows of the long-lived asset or disposal group will be reported as
discontinued operations in the consolidated statements of operations, with all
comparable periods restated. Recent Accounting Pronouncements In May 2003, the
Financial Accounting Standards Board, or FASB, issued Statement of Financial Account Standard No. 150,
Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity, or SFAS 150. SFAS No. 150 improves the accounting
for certain financial instruments that under the previous guidance, issuers
could account for as equity. SFAS No. 150 requires that those instruments be
classified as liabilities in statements of financial position. This statement
is effective for financial instruments entered into or modified after May 31,
2003. On October 29, 2003, FASB deferred for an indefinite period the
application of the guidance in SFAS No. 150. FASB decided to defer the
application of SFAS No. 150 until it could consider some of the resulting
implementation issues associated with the measurement and recognition issues.
We have not determined the resulting impact of the adoption of this statement
on our consolidated financial position, results of operations or cash flows. In April 2003, FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities, or SFAS 149, which is
effective for contracts entered into or modified after June 30, 2003 and for
hedging relationships designated after June 30, 2003. SFAS No. 149 amends and
clarifies accounting and reporting for derivative instruments. In particular,
this statement amends certain other pronouncements and clarifies the
circumstances under which a contract with an initial investment meets the
characteristics of a derivative and when a derivative contains a financial
component. The guideline should be applied prospectively. The adoption of
SFAS 149 did not have a material impact on our consolidated financial position,
results of operations or cash flows. In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities, an Interpretation of ARB
No. 51, or FIN 46, which
addresses the consolidation of entities whose equity holders have either (a)
not provided sufficient equity at risk to allow the entity to finance its own
activities or (b) do not possess certain characteristics of a controlling
financial interest. FIN 46 sets forth a model to evaluate potential
consolidation of these entities, known as variable interest entities,
or VIEs,
based on an assessment of which party to the VIE, if any, absorbs a majority of
the exposure to its expected losses, receives a majority of its expected
residual returns, or both, which is referred to for purposes of
FIN 46 as the primary beneficiary. FIN 46 also requires
disclosures about VIEs that a company is not required to consolidate but in
which it has a significant variable interest. FIN 46 is effective for all new
VIEs created or acquired after January 31, 2003. For VIEs created or acquired
prior to February 1, 2003, the provisions of FIN 46 must be applied for the
first interim or annual period beginning after March 15, 2004 except for
companies with special purpose entities which must apply the provisions of FIN
46 to those special purpose entities no later than the first reporting period
ending after December 15, 2003. We have evaluated the impact of FIN 46 on our consolidated financial statements
and identified three joint venture subsidiaries as VIEs for which we have
determined that we are the primary beneficiary. These joint venture
subsidiaries, which operate skilled nursing facilities that are managed by us,
are fifty percent owned by us and have historically been consolidated due to
control. We have historically provided funds for working capital and have
other long-term notes from these joint ventures which are eliminated in
consolidation. The joint venture subsidiaries have revenues which are included
in our consolidated financial statements of $36.7 million, $22.8 million, $10.7
million, $8.2 million, and $30.4 million, for the year ended December 31, 2003,
for the eight months ended December 31, 2002, for the four months ended April
30, 2002, for the three month transition period ended December 31, 2001, and
for the fiscal year ended September 30, 2001, respectively. These joint venture
subsidiaries have net liabilities that are included in the accompanying
consolidated financial statements of approximately $39.9 million
and $31.8
million at December 31, 2003 and 2002, respectively. 41




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##### Table of Contents



Results of Operations The following table represents our operating results for the periods presented.
Since the adoption of fresh-start reporting did not have a material effect on
the comparability of our operating income, we have combined the respective
operating results of the Reorganized Company and the Predecessor Company for
twelve months ended December 31, 2002 and compared these results as summarized
in the tables below (in thousands of dollars), however, this is not a
presentation in accordance with GAAP and is presented solely for
convenience purposes, as certain items within in this time frame
are required to be discussed in the period to period comparisons below. CombinedPredecessorCompany andReorganized
    
    Reorganized
    
    ReorganizedCompany
    
    Company
    
    Company
    

    Predecessor CompanyYear
    
    Twelve Months
    
    Eight Months
    

    Four Months
    
    Three Months
    
    Three Months
    
    YearEnded
    
    Ended
    
    Ended
    

    Ended
    
    Ended
    
    Ended
    
    EndedDecember 31,
    
    December 31,
    
    December 31,
    

    April 30,
    
    December 31,
    
    December 31,
    
    September 30,2003
    
    2002
    
    2002
    

    2002
    
    2001
    
    2000
    
    2001(unaudited)
    
    
    

    
    
    
    
    (unaudited)Net revenue
    
    $
    1,715,367
    
    
    $
    1,754,073
    
    
    $
    1,163,006
    
    

    $
    591,067
    
    
    $
    450,542
    
    
    $
    462,779
    
    
    $
    1,840,654Costs and expensesOperating expensesWage and related costs
    
    
    1,015,007
    
    
    
    1,021,978
    
    
    
    679,938
    
    

    
    342,040
    
    
    
    261,114
    
    
    
    274,780
    
    
    
    1,043,133Supplies
    
    
    100,490
    
    
    
    107,751
    
    
    
    71,285
    
    

    
    36,466
    
    
    
    28,901
    
    
    
    30,333
    
    
    
    120,768Insurance
    
    
    78,871
    
    
    
    85,942
    
    
    
    55,392
    
    

    
    30,550
    
    
    
    24,172
    
    
    
    22,175
    
    
    
    94,837Divestiture related charges
    
    
    49,564
    
    
    
    
    
    
    
    
    
    

    
    
    
    
    
    
    
    
    
    
    
    
    
    Provision for bad debt
    
    
    20,345
    
    
    
    32,105
    
    
    
    8,347
    
    

    
    23,758
    
    
    
    7,080
    
    
    
    9,476
    
    
    
    26,523Rent expense
    
    
    35,650
    
    
    
    38,454
    
    
    
    25,463
    
    

    
    12,991
    
    
    
    10,393
    
    
    
    14,770
    
    
    
    49,767Other
    
    
    294,779
    
    
    
    298,741
    
    
    
    200,721
    
    

    
    98,020
    
    
    
    71,613
    
    
    
    62,435
    
    
    
    343,898Total operating expenses
    
    
    1,594,706
    
    
    
    1,584,971
    
    
    
    1,041,146
    
    

    
    543,825
    
    
    
    403,273
    
    
    
    413,969
    
    
    
    1,678,926General and administrative expenses
    
    
    99,103
    
    
    
    72,285
    
    
    
    47,072
    
    

    
    25,213
    
    
    
    18,943
    
    
    
    18,473
    
    
    
    73,957Depreciation and amortization
    
    
    37,082
    
    
    
    34,320
    
    
    
    22,764
    
    

    
    11,556
    
    
    
    10,928
    
    
    
    11,251
    
    
    
    48,687(Gain) loss on sale of divested facilities
    
    
    (25,197
    )
    
    
    2,122
    
    
    
    2,122
    
    

    
    
    
    
    
    
    
    
    
    
    
    
    
    Impairment of long-lived assets
    
    
    
    
    
    
    84,600
    
    
    
    84,600
    
    

    
    
    
    
    
    
    
    
    
    
    
    
    
    Loss on settlement with government
    
    
    
    
    
    
    
    
    
    
    
    
    

    
    
    
    
    
    
    
    
    
    
    
    
    
    33,410Total costs and expenses
    
    
    1,705,694
    
    
    
    1,778,298
    
    
    
    1,197,704
    
    

    
    580,594
    
    
    
    433,144
    
    
    
    443,693
    
    
    
    1,834,980Operating income (loss)
    
    
    9,673
    
    
    
    (24,225
    )
    
    
    (34,698
    )
    

    
    10,473
    
    
    
    17,398
    
    
    
    19,086
    
    
    
    5,674Other (expenses) incomeInterest expense
    
    
    (36,493
    )
    
    
    (29,890
    )
    
    
    (26,972
    )
    

    
    (2,918
    )
    
    
    (3,398
    )
    
    
    (3,125
    )
    
    
    (4,613
    )Loss on write-off of deferred financing costs
    
    
    (5,941
    )
    
    
    
    
    
    
    
    
    

    
    
    
    
    
    
    
    
    
    
    
    
    
    Interest income
    
    
    2,747
    
    
    
    6,639
    
    
    
    5,485
    
    

    
    1,154
    
    
    
    2,602
    
    
    
    2,464
    
    
    
    6,005Reorganization items
    
    
    
    
    
    
    1,394,309
    
    
    
    
    
    

    
    1,394,309
    
    
    
    (13,153
    )
    
    
    (8,102
    )
    
    
    (47,721
    )Other
    
    
    1,345
    
    
    
    1,159
    
    
    
    (336
    )
    

    
    1,495
    
    
    
    (15
    )
    
    
    (1,287
    )
    
    
    (462
    )(Loss) income from continuing operations
before income taxes
    
    
    (28,669
    )
    
    
    1,347,992
    
    
    
    (56,521
    )
    

    
    1,404,513
    
    
    
    3,434
    
    
    
    9,036
    
    
    
    (41,117
    )(Benefit) provision for income taxes
    
    
    (6,142
    )
    
    
    1,179
    
    
    
    1,323
    
    

    
    (144
    )
    
    
    (25
    )
    
    
    (197
    )
    
    
    (5,706
    )(Loss) income from continuing operations
    
    
    (22,527
    )
    
    
    1,346,813
    
    
    
    (57,844
    )
    

    
    1,404,657
    
    
    
    3,459
    
    
    
    9,233
    
    
    
    (35,411
    )Discontinued operations(Loss) income from discontinued
operations, net of tax
    
    
    (1,583
    )
    
    
    (254
    )
    
    
    (470
    )
    

    
    216
    
    
    
    936
    
    
    
    677
    
    
    
    2,016Gain on sale of discontinued
operations, net of tax
    
    
    11,314
    
    
    
    29,082
    
    
    
    
    
    

    
    29,082
    
    
    
    
    
    
    
    
    
    
    
    Net (loss) income
    
    $
    (12,796
    )
    
    $
    1,375,641
    
    
    $
    (58,314
    )
    

    $
    1,433,955
    
    
    $
    4,395
    
    
    $
    9,910
    
    
    $
    (33,395
    )
 42




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##### Table of Contents



Reconciliation of EBITDA to net (loss) income CombinedPredecessorCompany andReorganized
    
    Reorganized
    
    ReorganizedCompany
    
    Company
    
    Company
    

    Predecessor CompanyThree MonthsYear
    
    Twelve Months
    
    Eight Months
    

    Four Months
    
    Three Months
    
    Ended
    
    YearEnded
    
    Ended
    
    Ended
    

    Ended
    
    Ended
    
    December 31,
    
    EndedDecember 31,
    
    December 31,
    
    December 31,
    

    April 30,
    
    December 31,
    
    2000
    
    September 30,2003
    
    2002
    
    2002
    

    2002
    
    2001
    
    (unaudited)
    
    2001Net (loss) income
    
    $
    (12,796
    )
    
    $
    1,375,641
    
    
    $
    (58,314
    )
    

    $
    1,433,955
    
    
    $
    4,395
    
    
    $
    9,910
    
    
    $
    (33,395
    )Add back:(Benefit) provision for income taxes
    
    
    (6,142
    )
    
    
    1,179
    
    
    
    1,323
    
    

    
    (144
    )
    
    
    (25
    )
    
    
    (197
    )
    
    
    (5,706
    )Interest expense
    
    
    36,493
    
    
    
    29,890
    
    
    
    26,972
    
    

    
    2,918
    
    
    
    3,398
    
    
    
    3,125
    
    
    
    4,613Loss on write-off of deferred financing costs
    
    
    5,941
    
    
    
    
    
    
    
    
    
    

    
    
    
    
    
    
    
    
    
    
    
    
    
    Interest income
    
    
    (2,747
    )
    
    
    (6,639
    )
    
    
    (5,485
    )
    

    
    (1,154
    )
    
    
    (2,602
    )
    
    
    (2,464
    )
    
    
    (6,005
    )Depreciation and amortization
    
    
    37,082
    
    
    
    34,320
    
    
    
    22,764
    
    

    
    11,556
    
    
    
    10,928
    
    
    
    11,251
    
    
    
    48,687EBITDA (1)
    
    $
    57,831
    
    
    $
    1,434,391
    
    
    $
    (12,740
    )
    

    $
    1,447,131
    
    
    $
    16,094
    
    
    $
    21,625
    
    
    $
    8,194
  (1)
    
    The table presented below contains items that are excluded
when calculating EBITDA for the purpose of determining our compliance
with certain ratios contained in our Senior Credit Facility and the
indenture pertaining to our Notes, or Debt Financing EBITDA. These
ratios determine our compliance with certain covenants contained in
the documents relevant to both debt obligations as well as our
ability to draw on our Revolving Credit Facility, issue additional
Notes and undertake certain desired corporate actions. If these items
were excluded from EBITDA as presented in the table above, Debt
Financing EBITDA would be $73,938 for the year ended
December 31, 2003 and $119,743 for the twelve months ended
December 31, 2002. Year Ended
    
    Twelve MonthsDecember 31,
    
    Ended December2003
    
    31, 2002Impairment of long-lived assets
    
    $
    
    
    
    $
    84,600Gain on sale of discontinued
operations, net of tax
    
    
    (11,314
    )
    
    
    (29,082
    )Reorganization items
    
    
    
    
    
    
    (1,394,309
    )(Gain) loss on sale of divested facilities
    
    
    (25,197
    )
    
    
    2,122Divestiture related charges
    
    
    49,564
    
    
    
    Loss from operations of divested facilities
    
    
    3,054
    
    
    
    22,021Increase (decrease) to EBITDA
    
    $
    16,107
    
    
    $
    (1,314,648
    )
 For additional information
regarding the manner in which Debt Financing EBITDA may impact our
liquidity see Liquidity and Capital
Resources  Cash Flows from
Financing Activities in this Item 7 below. Year Ended December 31, 2003 (Reorganized Company) Compared to the Twelve
Months Ended December 31, 2002 (Combined Reorganized Company and Predecessor
Company) Net Revenue We reported net revenues of $1,715.4 million during the year ended December 31,
2003, compared to $1,754.1 million for the twelve months ended December 31,
2002. The decrease of $38.7 million, or 2.2%, consists primarily of the
following:  
    
    A decrease of $91.8 million related to divested facilities that do
not qualify for discontinued operations presentation.  
    
    An increase of $47.6 million in skilled nursing facilities we operated as of
December 31, 2003, or same facility operations. This increase is due
primarily to:  
    
    A net increase of $23.1 million in Medicare
revenues due primarily to an increase in patient days of 86,486
resulting in a $26.9 million increase. The increase in patient days was a
direct result of our focus on attracting a higher acuity patient population.
The increase was partially offset by a $3.8 million decrease in Medicare
revenues due to a $2.97 rate per patient day decrease. The
change in rates represents a blend of three quarters of the
Medicare Reimbursement Cliff and one quarter of the Medicare
Administrative fix and market basket increase.
    
    A net increase of $20.5 million in Medicaid
revenues due primarily to a rate increase of $3.96 per patient
day resulting in a $25.7 million increase, which was partially
offset by the rate decrease discussed below. This increase was
driven by increases in provider tax based 43




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##### Table of Contents



rate increases in
Georgia, Massachusetts, North Carolina and Wisconsin as well as
other general increases in our other states. This increase was
partially offset by a revenue decrease due to a decrease in patient days of
47,841, or less than 1%.  
    
    An increase of $2.1 million in insurance
revenues received from health maintenance organizations due to increases in both census and rates.
    
    An increase of $7.0 million in revenues received from
the veterans administration in connection with hospice services due to an increase in patient days of 56,169, or an
increase of 26.9%. This increase is due to expanding our presence in
new markets.
    
    A net overall decrease of $5.4 million in private
revenues due to a decrease in patient days of 134,484 that
resulted in a $16.3 million reduction of revenues. The
reduction is due primarily to the market for private payors
shifting to assisted living facilities. The decrease was partially offset
by an overall rate increase of $7.61 per patient day that resulted in a $9.9
million increase in revenues. This increase was attributable to
two rate increases we made in March 2003 and July 2003.  
    
    An increase of $5.9 million related to LTAC revenues primarily
related to an increase of 2,638 commercial patient days resulting
from new managed care contracts. Operating Expenses We reported operating expenses of $1,594.7 million during the year ended
December 31, 2003, compared to $1,585.0 million during the twelve months ended
December 31, 2002, or an increase of $9.7 million, or 0.6%.
This change is primarily due to:  
    
    Wage and related costs decreased $7.0 million due primarily to:  
    
    A decrease of $48.4 million related to divested facilities that do
not qualify for discontinued operations presentation.  
    
    A partially offsetting increase in same facility operations of $41.0
million, primarily related to annual salary and benefit cost increases, hiring of
additional personnel and an increase of $0.4 million related to
increases in LTAC expenses due primarily to an increase in benefits
resulting from a shift from contract labor to employees.  
    
    Supplies decreased $7.3 million due primarily to:  
    
    A decrease of $5.9 million related to divested facilities that do
not qualify for discontinued operations presentation.  
    
    A decrease of $1.0 million in same facility operations.  
    
    Insurance, which consists primarily of professional and general liability
insurance costs, decreased $7.1 million due primarily to:  
    
    A decrease of $8.1 million related to divested facilities that do
not qualify for discontinued operations presentation.  
    
    An overall increase of $1.1 million in same facility operations due
primarily to rising litigation and claims.  
    
    In connection with exiting the operations of our divested
facilities in Florida and Louisiana,
we recorded divestiture related charges of $49.6 million during the year ended
December 31, 2003. These charges consisted of $24.0 million for bad debt
expense, $21.0 million of insurance expense for professional liability
claims, of which $6.0 million related
to the purchase of tail insurance coverage, and $4.6
million of exit and other related costs.  
    
    Provision for bad debt decreased $11.8 million primarily
due to a $21.1 million
decrease of bad debt expense related to divested facilities that do not qualify
for discontinued operations presentation. This decrease was partially offset
by a $6.2 million increase in same store facility operations and a $3.2 million
increase in LTAC bad debt expense.  
    
    Rent decreased $2.8 million due in part to successfully
renegotiating contracts and divested facilities.  
    
    Other operating expenses decreased $4.0 million primarily due
to a $5.4 million decrease in contracted services expenses related to
divested facilities that did not qualify for discontinued operations
presentation, partially offset by decreases in various other expenses. 44




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##### Table of Contents



General and Administrative Expenses We reported general and administrative expenses of $99.1 million during the
year ended December 31, 2003, compared to $72.3 million during the twelve
months ended December 31, 2002. The increase of $26.8 million, or 37.1%,
relates to the following:  
    
    An increase of $7.0 million in legal costs related to
our claim against an insurance company for certain owned
and leased facilities that were damaged by floods, costs
associated with the PWC litigation and an increase in litigation
matters due to the lifting of the automatic stay imposed during our
bankruptcy proceedings that prevented certain matters from being
litigated during such proceedings.
    
    An increase of $7.3 million in costs associated with the
implementation of new information technology infrastructure and
systems and a new centralized back office support services center
business model.
    
    An increase of $6.9 million primarily related to increases in wage
and related costs. This increase was due primarily to incentive
compensation expenses, employee benefit cost increases, annual salary
increases, and the hiring of additional corporate personnel.
    
    The remaining increase of $5.6 million relates to increases in
professional fees and other insurance costs of $2.8 million, $0.5
million related to compensation expense for a restricted stock grant
and $2.3 million primarily related to contracted services. Gain On Sale of Divested Facilities We reported a gain on sale of divested facilities of $25.2 million during the
year ended December 31, 2003, compared to a loss on sale of divested facilities
of $2.1 million during the twelve months ended December 31, 2002. The increase
of $27.3 million relates to the divestitures of the facilities in Florida and
Louisiana during the fourth quarter ended December 31, 2003 that did not
qualify for discontinued operations presentation. Depreciation and Amortization We reported depreciation and amortization of $37.1 million during the year
ended December 31, 2003, compared to $34.3 million during the twelve months
ended December 31, 2002. The increase of $2.8 million, or 8.2%, primarily
relates to the following:  
    
    An increase of $4.3 million related to incremental depreciation
expense on capital expenditures in same facility operations and at
corporate locations.
    
    A decrease of $2.1 million due to the divested facilities that do
not qualify for discontinued operations presentation.
    
    An increase of $0.6 million related to the LTAC operations. Interest Expense We reported interest expense of $36.5 million during the year ended December
31, 2003, compared to $29.9 million during the twelve months ended December 31,
2002. The increase of $6.6 million, or 22.1%, primarily relates to interest
expense being lower in the twelve months ended December 31, 2002 as we did not
accrue interest relating to our debt facilities then classified as liabilities
subject to compromise through April 30, 2002. Loss on Write-off of Deferred Financing Costs We reported a loss of $5.9 million related to the write-off of deferred
financing fees as a result of the debt refinancing during the fourth quarter
ended December 31, 2003. 45




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##### Table of Contents



Income Taxes

We reported an income tax benefit of $6.1 million on the loss from continuing
operations before income taxes during the year ended December 31, 2003,
compared to a provision for income taxes of $1.2 million during the twelve
months ended December 31, 2002. The $6.1 million benefit offsets income taxes
on gains from sales of discontinued operations. We had sufficient tax loss
carryforwards to offset the income from continuing operations before income
taxes for the twelve months ended December 31, 2002, however, the income tax
benefit of utilizing pre-emergence deferred tax assets is first applied to
reduce reorganization value recorded in connection with fresh-start reporting
pursuant to SOP 90-7 as the tax loss deferred tax asset had a valuation
allowance recorded against it at the date of emergence.

Discontinued Operations

(Loss) income from Discontinued Operations

The results of operations of any disposed facilities that qualify for
discontinued operations under SFAS No. 144 (see Note 4 to the consolidated
financial statements) and the discontinued pharmacy operations have been
reported as discontinued operations for all periods presented in the
accompanying consolidated statements of operations. A summary of the discontinued operations for the periods
presented is as follows (in thousands of dollars):

|                                                       |  |                     |        |              |                     |   |             |   |              |  |               |        |   |  |   |        |   |  |   |         |  
|------------------------------------------------------ |  | ------------------- | ------ | ------------ | ------------------- | - | ----------- | - | ------------ |  | ------------- | ------ | - |  | - | ------ | - |  | - | ------- | -
|                                                       |  | Reorganized Company |        |              | Predecessor Company
|                                                       |  |                     |        |              |                    
|                                                       |  | Year                |        | Eight Months |                     |   | Four Months |   | Three Months |  | Year         
|                                                       |  | Ended               |        | Ended        |                     |   | Ended       |   | Ended        |  | Ended        
|                                                       |  | December 31,        |        | December 31, |                     |   | April 30,   |   | December 31, |  | September 30,
|                                                       |  | 2003                |        | 2002         |                     |   | 2002        |   | 2001         |  | 2001         
|                                                       |  |                     |        |              |                     |   |             |   |              |  |              
|Net revenue                                            |  | $                   | 27,832 |              |                     | $ | 20,651      |   |              |  | $             | 10,370 |   |  | $ | 70,464 |   |  | $ | 246,114 |  
|Total costs and expenses                               |  |                     | 30,225 |              |                     |   | 21,240      |   |              |  |               | 9,911  |   |  |   | 69,140 |   |  |   | 241,902 |  
|                                                       |  |                     |        |              |                     |   |             |   |              |  |               |        |   |  |   |        |   |  |   |         |  
|Operating (loss) income                                |  |                     | (2,393 | )            |                     |   | (589        | ) |              |  |               | 459    |   |  |   | 1,324  |   |  |   | 4,212   |  
|                                                       |  |                     |        |              |                     |   |             |   |              |  |               |        |   |  |   |        |   |  |   |         |  
|Other income (expenses)                                |  |                     | 810    |              |                     |   | 119         |   |              |  |               | (243   | ) |  |   | (388   | ) |  |   | (2,196  | )
|                                                       |  |                     |        |              |                     |   |             |   |              |  |               |        |   |  |   |        |   |  |   |         |  
|(Loss) income from discontinued
operations, net of tax |  | $                   | (1,583 | )            |                     | $ | (470        | ) |              |  | $             | 216    |   |  | $ | 936    |   |  | $ | 2,016   |  
|                                                       |  |                     |        |              |                     |   |             |   |              |  |               |        |   |  |   |        |   |  |   |         |  

Gain on Sale of Discontinued Operations

We reported a net gain on the sale of the
discontinued operations, net of tax, of $11.3 million
during the year ended December 31, 2003, compared to $29.1 million during the
twelve months ended December 31, 2002, a decrease of $17.8
million or 6.1%. The gain of $29.1 million recorded
during the twelve months ended December 31, 2002 includes the gain on sale of
the APS division. The $11.3 million gain on sale of discontinued operations
for the year ended December 31, 2003 includes the recognition and receipt of
remaining Earnout Payments related to the sale of the APS division, as well as
net gains on the sale of certain facilities that qualified for discontinued
operations presentation.

Three Months Ended December 31, 2001 (Predecessor Company) Compared to the
Three Months Ended December 31, 2000 (Predecessor Company)

Net Revenue

We reported net revenue of $450.5 million for the three months ended December
31, 2001, compared to $462.8 million during the three months ended December 31,
2000. The decrease of $12.3 million, or 2.7%, relates to the following:



| |  |  | A decrease of $43.6 million related to divested facilities that do
not qualify for discontinued operations presentation.
| | - |  | ------------------------------------------------------------------------------------------------------------------------

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| |  |  | An increase of $28.6 million in same facility operations. This
increase is due primarily to a 5.2% increase in Medicare reimbursement
rates in connection with the legislative relief provided by the Balanced
Budget Refinement Act and Benefits Improvement and Protection Act, which
mitigated the year over year phase-in effect of PPS. In addition,
average per diem rates for Medicaid reimbursement increased 5.3%.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | An increase of $2.7 million related to LTAC revenues.                                                                                                                                                                                                                                                                                                                                                                      

Operating Expenses

We reported operating expenses of $403.3 million during the three months ended
December 31, 2001 compared to $414.0 million during the three months ended
December 31, 2000. The decrease of $10.7 million, or 2.6%, consists of the
following:



| |  |  | A decrease of $46.2 million due primarily to the divested facilities
that do not qualify for discontinued operations presentation.                                                                                                                                                                                                                                                                                                                       
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | An increase of $32.8 million for same facility operations primarily
related to changes in federal, state and local staffing regulations. These regulatory standards mandated an increase in
the type, quality and level of personnel employed at our facilities and,
therefore impacted operating expenses. Additional increases were due to
an increased reliance on employment agencies in some local areas as a
result of shortage of qualified labor.
|
| |  |  | An increase of $2.7 million related to increases in LTAC expenses.                                                                                                                                                                                                                                                                                                                                                                                       

Reorganization Items

We reported reorganization losses of $13.2 million during the three months
ended December 31, 2001, compared to $8.1 million during the three months ended
December 31, 2000. The increased loss of $5.1 million, or 63.0% primarily relates to
the following:



| |  |  | Reorganization items, which consisted of income, expenses and other
costs directly related to our reorganization since the Petition Date
increased due primarily to an increase of $8.5 million for
professional fees incurred in connection with the various aspects of
our bankruptcy proceedings, including filing of the disclosure statement and Joint
Plan and was partially offset by net gains realized on divestitures
during the three months ended December 31, 2001 of $1.7 million as
compared to net losses realized on divestitures during the three months
ended December 31, 2000 of $2.8 million.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Twelve Months Ended December 31, 2002(Combined Predecessor Company and
Reorganized Company) Compared to Year Ended September 30, 2001 (Predecessor
Company)

Net Revenue

We reported net revenues of $1,754.1 million during the twelve months ended
December 31, 2002, compared to $1,840.7 million for the year ended September
30, 2001. The decrease of $86.6 million, or 4.7%, consists primarily of the
following:



| |  |  | A decrease of $185.0 million related to divested facilities that do
not qualify for discontinued operations presentation.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | An increase of $97.7 million in same facility operations due
primarily to a shift from Medicaid reimbursement and other payor sources
to Medicare reimbursement as a percentage of total revenue by 10.9%. In
addition, increases in the Medicaid reimbursement rate of 6% in the
twelve months ended December 31, 2002 and semiannual revenue increases
of 3% from private payor sources accounted for the remainder of the
increase in net revenue for the twelve months ended December 31, 2002.
We recorded $3.5 million as an addition to revenue relating to
adjustments to the estimated amount due from several state Medicaid
programs for the final settlement of the amount to be reimbursed to
these payors in the year ended December 31, 2002. These increases in
revenue were partially offset by an $8.8 million decrease in revenue in
the fourth quarter of the twelve months ended December 31, 2002 due
primarily to the impact of the Medicare Reimbursement Cliff.
|
| |  |  | An increase of $1.7 million related to LTAC revenues.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

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Operating Expenses

We reported operating expenses of $1,585.0 million during the twelve months
ended December 31, 2002, compared to $1,678.9 million during the year ended
September 30, 2001. The decrease of $93.9 million, or 5.6% is primarily due to:



| |  | Wage and related costs decreased $21.2 million primarily due to:
|- |  | ----------------------------------------------------------------



| |  |  | A decrease of $118.6 million related to divested facilities that do
not qualify for discontinued operations presentation.                                                                                                                                                                                                                                                                                                                                                     
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | An overall increase in same facility operations of $92.6 million
related to changes in federal, state and local staffing regulations that
were imposed on us. These regulatory standards mandated an increase in
the type, quality and level of personnel employed at our facilities and,
therefore impacted operating expenses. Additional increases were due to
the increase reliance on employment agencies in some local areas as a
result of shortage of qualified labor.
|
| |  |  | An increase of $5.4 million
related to the LTAC operations.                                                                                                                                                                                                                                                                                                                                                                                                                   



| |  | Supplies decreased $13.0 million primarily due to divested facilities that do
not qualify for discontinued operations presentation.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Insurance, which consists primarily of professional and general liability
insurance costs, decreased $8.9 million due primarily to:



| |  |  | A decrease of $12.7 million related to divested facilities that do
not qualify for discontinued operations presentation.
| | - |  | ------------------------------------------------------------------------------------------------------------------------
|
| |  |  | An overall increase of $3.8 million in same facility operations due
primarily to rising litigation and claims.          



| |  | Provision for bad debt increased $5.6 million due primarily to $10.8 million of
bad debt expense recorded during the twelve months ended December 31, 2002
related to receivables of divested facilities sent to a collection
agency.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Rent decreased $11.3 million due primarily to:                                                                                                                                                                                       



| |  |  | A decrease of $15.3 million related to divested facilities that do
not qualify for discontinued operations presentation.
| | - |  | ------------------------------------------------------------------------------------------------------------------------
|
| |  |  | A decrease of $0.5 million
related to LTAC rent expense.                                                                
|
| |  |  | An increase of $4.9 million in same facility operations.                                                                



| |  | Other operating expenses decreased
$45.2 million primarily as a result of divested
facilities that do not qualify for discontinued operations presentation.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------

Impairment of Long-lived Assets

We recorded an impairment charge of $84.6 million during the twelve months
ended December 31, 2002. The impairment charge relates to the following:



| |  |  | $57.3 million for the reorganization value in excess of amounts
allocable to identifiable assets according to the provisions of SFAS No.
142 and $27.3 million for property and equipment according to the
provisions of SFAS No. 144. We performed our annual impairment analysis
in the fourth quarter of the twelve months ended December 31, 2002 to
comply with the requirements of SFAS No. 142.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Depreciation and Amortization

We reported depreciation and amortization of $34.3 million during the twelve
months ended December 31, 2002, compared to $48.7 million during the year ended
September 30, 2001. The decrease of $14.4 million, or 29.6% primarily relates
to the discontinuation of goodwill amortization on January 1, 2002, upon the
adoption of SFAS No. 142.

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Loss on Settlement with Government

We reported a loss of $33.4 million during the year ended September 30, 2001
for the settlement with the government of certain qui tam actions as part of
our Global Settlement.

Interest Expense

We reported interest expense of $29.9 million during the twelve months ended
December 31, 2002, compared to $4.6 million during the year ended September 30,
2001. The increase of $25.3 million was due to the new capital
structure upon emergence from bankruptcy.

Reorganization Items

We reported a reorganization gain of $1,394.3 million during the twelve months
ended December 31, 2002, compared to a reorganization loss of $47.7 million
during the year ended September 30, 2001. The increase of $1,442.0 million
relates primarily to the following:



| |  |  | During the twelve months ended December 31, 2002, we recorded a gain
of $1,229.6 million from the restructuring of our debt in accordance
with the provisions of the Joint Plan. In addition, we recorded a gain
on fresh-start valuation adjustments of $253.9 million for adjustments
to record property and equipment and identifiable intangible assets at
their fair values in accordance with our adoption of fresh-start
reporting.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Income Taxes

We reported provision for income taxes of $1.2 million for the twelve months
ended December 31, 2002, compared to a benefit of $5.7 million during the year
ended September 30, 2001. The change of $6.9 million relates primarily to the
following:



| |  |  | The provision that was recorded for the twelve months ended December
31, 2002 resulted from permanent differences between GAAP book income
and taxable income for federal and state income tax purposes arising
from our emergence from bankruptcy. We had sufficient tax loss
carryforwards to offset current year income. However, the income tax
benefit of utilizing pre-emergence deferred tax assets is first applied
to reduce reorganization value recorded in connection with fresh-start
reporting pursuant to SOP 90-7 as the tax loss deferred tax asset had a
valuation allowance recorded against it at the date of emergence. A
benefit for income taxes of $5.7 million was recorded for the year ended
September 30, 2001. The income tax benefit recorded resulted from the
receipt of income tax refunds due to the carryback of prior years
losses and amended income tax returns. A loss was incurred during this
period, however a valuation allowance was recorded to completely offset
the income tax benefit of the loss in the twelve months ended December
31, 2002 because we believed the deferred tax asset would not be
recognizable under the more likely than not standard.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Discontinued Operations

We reported a gain on the sale of
discontinued operations of $29.1 million during the
twelve months ended December 31, 2002, compared to no gain for the year ended
September 30, 2001. The increase relates primarily to the following:



| |  |  | The results of the APS Division have been classified as a
discontinued operation in accordance with GAAP. During the twelve months ended
December 31, 2002, we recorded a gain on the sale of the APS Division of
$29.1 million.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Liquidity and Capital Resources

The following table represents our future cash requirements for the next five
years and thereafter for our long-term debt obligations and operating lease
payments (in thousands of dollars):

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|                              |                  |                                         |         |                        |         |                  |        |           |       |           |        |               |       |   |        |        |       |   |         |        |         | 
|----------------------------- | ---------------- | --------------------------------------- | ------- | ---------------------- | ------- | ---------------- | ------ | --------- | ----- | --------- | ------ | ------------- | ----- | - | ------ | ------ | ----- | - | ------- | ------ | ------- | 
|                              |                  |                                         |         | Payments due by Period
|                              |                  |                                         |         |                       
|                              |                  |                                         |         | Total                  |         | Less Than 1 Year |        | 1-3 Years |       | 4-5 Years |        | After 5 Years
|                              |                  |                                         |         |                        |         |                  |        |           |       |           |        |              
|Contractual obligations       |                  |                                         |         |                        |         |                  |        |           |       |           |        |               |       |   |        |        |       |   |         |       
|                              | Long-term debt   |                                         |         |                        |         |                  |        |           |       |           |        |               |       |   |        |        |       |   |         |        |        
|                              |                  | Term loan facility                      |         | $                      | 135,000 |                  |        | $         | 1,350 |           |        | $             | 2,700 |   |        | $      | 2,700 |   |         | $      | 128,250 | 
|                              |                  | Senior subordinated notes               |         |                        | 175,000 |                  |        |           |      |           |        |               |      |   |        |        |      |   |         |        | 175,000 | 
|                              |                  | Non-recourse indebtedness of
subsidiary |         |                        | 59,688  |                  |        |           |      |           |        |               |      |   |        |        |      |   |         |        | 59,688  | 
|                              |                  | Capital leases                          |         |                        | 19,948  |                  |        |           | 8,313 |           |        |               | 9,305 |   |        |        | 2,286 |   |         |        | 44      | 
|                              | Operating leases |                                         |         | 181,621                |         |                  |        | 31,642    |       |           |        | 49,453        |       |   |        | 35,218 |       |   |         | 65,308 |        
|                              | Other            |                                         |         | 1,951                  |         |                  |        | 128       |       |           |        | 209           |       |   |        | 144    |       |   |         | 1,470  |        
|                              |                  |                                         |         |                        |         |                  |        |           |       |           |        |               |       |   |        |        |       |   |         |        |        
|Total contractual obligations |                  | $                                       | 573,208 |                        |         | $                | 41,433 |           |       | $         | 61,667 |               |       | $ | 40,348 |        |       | $ | 429,760 |       
|                              |                  |                                         |         |                        |         |                  |        |           |       |           |        |               |       |   |        |        |       |   |         |        |        

|                             |                   |   |                                            |        |                  |   |           |        |           |   |               |   |  |   |   |   |  |   |   |   | 
|---------------------------- | ----------------- | - | ------------------------------------------ | ------ | ---------------- | - | --------- | ------ | --------- | - | ------------- | - |  | - | - | - |  | - | - | - | 
|                             |                   |   | Amount of Commitment Expiration per Period
|                             |                   |   |                                           
|                             |                   |   | Total                                      |        | Less Than 1 Year |   | 1-3 Years |        | 4-5 Years |   | After 5 Years
|                             |                   |   |                                            |        |                  |   |           |        |           |   |              
|Commercial commitments       |                   |   |                                            |        |                  |   |           |        |           |   |               |   |  |   |   |   |  |   |   |  
|                             | Letters of credit |   | $                                          | 34,630 |                  |   | $         | 34,630 |           |   | $             |  |  |   | $ |  |  |   | $ |  | 
|                             |                   |   |                                            |        |                  |   |           |        |           |   |               |   |  |   |   |   |  |   |   |   | 
|Total commercial commitments |                   | $ | 34,630                                     |        |                  | $ | 34,630    |        |           | $ |              |   |  | $ |  |   |  | $ |  |  
|                             |                   |   |                                            |        |                  |   |           |        |           |   |               |   |  |   |   |   |  |   |   |   | 

Cash Requirements

At December 31, 2003, we had working capital of $56.0 million and cash and cash
equivalents of $41.9 million, compared to working capital of $116.6 million and
cash and cash equivalents of $38.6 million at December 31, 2002. The decrease
in working capital is primarily a result of the charges recorded by us
during the year ended December 31, 2003 related to our divestitures of
facilities in Florida and Louisiana. Based upon our existing cash levels,
expected operating cash flows and capital spending, and the availability of
borrowings under our Revolving Credit Facility, we believe we have the
necessary financial resources to satisfy our liquidity
needs for the foreseeable future.

There were no borrowings under our
Revolving Credit Facility at December 31, 2003, although we had total outstanding letters of credit aggregating
$34.6 million (which counts against the amount available to us under our
Revolving Credit Facility). The outstanding letters of
credit were issued as security for letters of credit issued under the revolving
credit facility of our previous senior credit facility. The
$34.6 million figure referred to above represents 105% of the
outstanding letters of credit issued under the previous
revolving credit facility. The letters of credit issued as security
under our Senior Credit Facility will remain outstanding until the beneficiaries of the underlying letters of
credit accept a new replacement letter of credit under the Revolving Credit
Facility. Therefore, the maximum net exposure under all letters of credit at
December 31, 2003 is $34.6 million.

Cash Flows from Operating Activities

Net cash provided by operating activities of continuing operations before
reorganization items was $58.2 million, $11.6 million and $38.6 million for the
year ended December 31, 2003, for the eight months ended December 31, 2002, and
for the four months ended April 30, 2002, respectively. Our cash flows from
operations increased $8.0 million during the year ended December 31, 2003 as
compared to the twelve months ended December 31, 2002. This increase was
primarily due to an incremental increase in our cash collections on
receivables and an increase in cash related to the timing of payments on
accounts payable during the year ended December 31, 2003 as
compared to the twelve months ended December 31, 2002, partially offset by
the negative impact of the Medicare Reimbursement Cliff and an
increase in PL/GL insurance claim settlement payments during the year ended
December 31, 2003 as compared to the twelve months ended
December 31, 2002.

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Cash Flows from Investing Activities

Purchases of property and equipment were $74.1 million for the year ended
December 31, 2003, which were financed through internally generated funds. Our
operations require capital expenditures for renovations of existing facilities
in order to continue to meet regulatory requirements, to upgrade facilities for
the treatment of sub-acute patients, to accommodate the addition of specialty
medical services and to improve the physical appearance of facilities for
marketing purposes. In addition, capital expenditures are required for
completion of certain facility expansions, new construction projects and
supporting non-nursing home operations.

We are in the process of developing and implementing a new information
technology infrastructure to improve customer service, enhance operating
efficiencies and provide for more effective management of business operations.
This will include a new centralized clinical billing function and enhancements
to other accounting and human resource systems. Implementation of the new
systems and software carries risks such as cost overruns, project delays and
business interruption delays. If we experience a material business interruption
as a result of the implementation of our future information technology
infrastructure or are unable to obtain the projected benefits of this new
infrastructure, it could have a material impact to our liquidity and cash
flows, as well as potentially result in an impairment of the related
information technology assets. Our unamortized capitalized software
costs at December 31, 2003 were $42.5 million.

Total purchases of property and equipment, including expenditures related to
our information technology infrastructure, are projected to be approximately
$66.0 million during the year ended December 31, 2004. We expect to fund these
purchases through internally generated funds.

Seven of our skilled nursing facilities and one of our LTACs were damaged
during tropical storm Allison in June 2001. We have made in the past and
expect to continue to make substantial expenditures necessary to repair or
replace these facilities as a result of the damage caused by the storm. Over
the next several years we estimate that we may spend approximately $28.0
million to complete all work necessary to complete this project. As described
in more detail in Item 3, Legal Proceedings included elsewhere in this report, we are
currently in litigation regarding our property insurance coverage for this
loss. At this time we cannot guarantee any particular result in this
litigation, and this could result in a negative impact on our future operations
and cash flows.

In the normal course of business, we evaluate the performance of operating
units in order to make a determination of whether to sell or otherwise dispose
of under-performing or non-strategic assets.

During the year ended December 31, 2003, we received net proceeds from the
divestiture of assets of $91.3 million. This consists primarily of proceeds from the
sale of assets primarily in Florida and Louisiana of $73.1 million that were
used to repay $56.9 million of debt outstanding under our
previous senior credit facility and the
retirement of $11.4
million of facility specific mortgage indebtedness. In addition, we received
$18.0 million related to the Earnout Payments from the sale of the APS
division in January 2002.

During the eight months ended December 31, 2002, we received net proceeds from
the disposition of assets of $4.1 million. During the four months ended April
30, 2002, we received net proceeds from the disposition of assets of $92.4
million, which primarily related to the sale of the APS Division. The majority
of the cash from the disposition of assets prior to our emergence from
bankruptcy was used for repayments against our pre-petition senior credit
facilities as adequate protection payments.

Cash Flows from Financing Activities

On December 19, 2003, we entered
into the Senior Credit Facility with a syndicate of lenders. The Senior Credit Facility
provides for a $135.0 million term loan facility and a $90.0
million revolving credit facility. The Term
Loan was drawn in full on December 19, 2003. As of December 31, 2003, there
were no borrowings under the Revolving Credit Facility, although we utilized
$34.6 million of borrowing capacity under the Revolving Credit Facility to
issue letters of credit on the closing date to replace or support letters of credit issued
under our previous senior credit facility and other loan arrangements.

The Term Loan matures on January 2, 2010 and the Revolving Credit Facility
matures on January 8, 2008. The interest rates per annum applicable to the
Senior Credit Facility will be the London InterBank Offering Rate, or LIBOR,
or, at the our option, the base rate, which will be the higher of (x) the rate
of interest publicly announced by the administrative agent of the Senior Credit
Facility as its prime rate in effect, or (y) the federal funds effective rate
from time to time plus 0.50%, in each case, plus the applicable margin (as
defined below). The applicable margin with respect to the Revolving Credit
Facility will be

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determined in accordance with a performance grid based on our consolidated
lease-adjusted leverage ratio. We expect the applicable margin will range from
2.00% to 2.75% in the case of LIBOR advances, and from 1.00% to 1.75% in the
case of base rate advances. For purposes of the Term Loan, the applicable
margin will range from 2.50% to 2.75% in the case of LIBOR advances, and from
1.50% to 1.75% in the case of base rate advances, based on our consolidated lease-adjusted leverage ratios. The default rate on the
Senior Credit Facility will be 2.00% above the interest rate otherwise
applicable to base rate loans. We are also obligated to pay a commitment fee
ranging, depending on usage, from 0.50% to 0.75% on the unused portion of the
Revolving Credit Facility. At December 31, 2003, the interest rate on the Term
Loan was 5.75%.

We are permitted to incur additional indebtedness of up to $65.0 million under
the Senior Credit Facility, or by the issuance of additional notes under the
indenture governing Notes or through a
mortgage loan transaction with one or more other lenders in order to optionally
refinance the $59.7 million mortgage loan or the Omega Loan from Omega
Healthcare Investors, Inc., or Omega. Any refinancing of the Omega Loan might
cause Professional Health Care Management, Inc., or PHCMI, a wholly subsidiary
of ours, and its subsidiaries, or the PHCMI Entities to become guarantor
subsidiaries under the Senior Credit Facility. If additional borrowings under
the Senior Credit Facility were used to refinance the Omega Loan pursuant to
this arrangement, they would rank senior to the Notes and the subsidiary
guarantees of the Notes.

In addition, on December 19, 2003, we issued $175.0 million aggregate principal
amount of 8.25% Notes under an indenture, or Indenture among ourself,
certain guarantor subsidiaries, or the Guarantors, and U.S. Bank National
Association, as trustee, or the Trustee. The Notes are general unsecured
obligations and are subordinated in right of payment to all of our existing and future
senior indebtedness, are senior in right of payment to any
of our future subordinated indebtedness and are unconditionally
guaranteed by the Guarantors.

Proceeds from the Senior Credit Facility and the Notes were used to repay
the second priority notes previously issued by us in full, as well as borrowings under our previous
senior credit facility and pay fees and expenses associated with the Senior Credit Facility
and Note transactions. During the year ended December 31, 2003, we paid $13.2 million
in financing costs consisting of $1.5 million paid related to the second
amendment of our previous senior credit facility and $11.7 million paid in
connection with the refinancing of such senior credit facility as well as the
second priority notes previously issued by us.

We expect to pay approximately $41.4 million in the year ended December 31, 2004 related to
long-term debt and operating leases. During the year ended December 31, 2003,
we made aggregate principal repayments of long-term debt of $375.4 million.
During the eight months ended December 31, 2002, we made aggregate principal
repayments of long-term debt of $5.9 million. During the four months ended
April 30, 2002, we made aggregate principal repayments of long-term debt of
$386.9 million, of which $287.4 million was paid to the principal lenders under
our pre-petition senior credit facilities in connection with the consummation
of the Joint Plan.

Our obligations under the Senior Credit Facility are guaranteed by each of our
direct and indirect wholly owned domestic subsidiaries, excluding the PHCMI
Entities, certain joint ventures and our captive insurance subsidiaries.

All obligations under the Senior Credit Facility and the related guarantees are
secured by a perfected first priority lien or security interest (junior only to
liens securing the Omega Loan and other permitted liens) in substantially all
of our tangible and intangible assets, including intellectual property, real
property and all of the capital stock or other equity interests of each of our
direct and indirect wholly-owned domestic subsidiaries, excluding the PHCMI
Entities and other specified immaterial subsidiaries.

Our ability to make payments on and to refinance our indebtedness, including
the Senior Credit Facility and the Notes, and to fund planned capital
expenditures, will depend on our ability to generate cash in the future. This,
to a certain extent, is subject to general economic, financial, competitive,
legislative, regulatory and other factors that are beyond our
control. Furthermore, our ability to access available capacity under
our Revolving Credit Facility and to issue additional Notes under the
Indenture, as well as to engage in certain desired corporate
activities, depends, among other things, upon our ability to comply
with lease-adjusted leverage ratios, senior leverage ratios and
minimum fixed charge coverage ratios, all of which are calculated
using Debt Financing EBITDA. As a result, failure to comply with the
ratios mentioned above may have an adverse effect on our liquidity.

Other Factors Affecting Liquidity and Capital Resources

Revenue Sources

We derive a substantial portion of our revenue from third-party payors,
including the Medicare and Medicaid programs. For the year ended December 31,
2003, we derived 81.2% of our total revenue from the Medicare and Medicaid
programs. Third-party payor programs are highly regulated and are subject to
frequent and substantial changes. Changes in the reimbursement rate or methods
of payment from third-party payors, including the Medicare and Medicaid
programs, or the implementation of other measures to reduce reimbursements for
our services has in the past, and could in the future, result in a substantial
reduction in our revenues and operating margins. Additionally, net revenue
realizable under third-party payor agreements can change after

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examination and retroactive adjustment by payors during the claims settlement
processes or as a result of post-payment audits. Payors may disallow requests
for reimbursement based on determinations that certain costs are not
reimbursable or reasonable because additional documentation is necessary or
because certain services were not covered or were not reasonable and medically
necessary. There also continue to be new legislative and regulatory proposals
that could impose further limitations on government and private payments to
health care providers. In some cases, states have enacted or are considering
enacting measures designed to reduce their Medicaid expenditures and to make
changes to private health care insurance. We cannot assure you that adequate
reimbursement levels will continue to be available for the services provided by
us, which are currently being reimbursed by Medicare, Medicaid or private
third-party payors. Further limits on the scope of services reimbursed and on
reimbursement rates could have a material adverse effect on our liquidity,
financial condition and results of operations. It is possible that the effects
of any of the Medicare Reimbursement Cliff, further refinements to Medicare
 or PPS that result in lower
payments to us or cuts in state Medicaid funding could have a material adverse
effect on our results of operations. See Item 1, Business  Reimbursement.

Professional and General Liability

As is typical in the health care industry, we are and will continue to be
subject to claims that our services have resulted in resident injury or other
adverse effects. We, like our industry peers, have experienced an increasing
trend in the frequency and severity of PL/GL claims and litigation asserted against us. In
some states in which we have significant operations, insurance coverage for the
risk of punitive damages arising from PL/GL claims and/or litigation may not,
in certain cases, be available due to state law prohibitions or limitations of
availability. We cannot assure you that we will not be liable for punitive
damage awards that are either not covered or are in excess of our insurance
policy limits. We also believe that there has been, and will continue to be, an
increase in governmental investigations of long-term care providers,
particularly in the area of Medicare/Medicaid false claims, as well as an
increase in enforcement actions resulting from these investigations. Insurance
is not available to cover such losses. Any adverse determination in a legal
proceeding or governmental investigation, whether currently asserted or arising
in the future, could have a material adverse effect on our financial condition.
In spite of the fact that we recently exited the State of Florida, we will
continue to be subject to claims arising from our prior operations for some
time. Additionally, the enactment of Texas tort reform resulted in a
significant increase in the number of cases being filed prior to the effective
date of the new legislation. These two factors could result in significant
PL/GL costs in future years although such costs
are related to prior periods. Also, the large increase in the number of claims
filed in these states, together with rising costs in other states, could
subject us to costs in excess of the reserves we have set aside for these periods.
While our actuarial analysis indicates that we currently have
sufficient insurance and reserves set aside to address these matters, as these
claims mature no assurance can be given that we will not be required to expend
additional funds in future periods for claims related to prior periods.

Labor Costs

We could experience significant increases in our operating costs due to
shortages in qualified nurses, health care professionals and other key
personnel. The market for these key personnel is highly competitive. We, like
other health care providers, have experienced difficulties in attracting and
retaining qualified personnel, especially facility administrators, nurses,
certified nurses aides and other important health care providers. Our LTACs
are particularly dependent on nurses for patient care. There is currently a
shortage of nurses, and trends indicate this shortage will worsen in the
future. The difficulty our skilled nursing facilities are experiencing in
hiring and retaining qualified personnel has increased our average wage rate.
We may continue to experience increases in our labor costs primarily due to
higher wages and greater benefits required to attract and retain qualified
health care personnel. Our ability to control labor costs will significantly
affect our future operating results.

In addition, wages and other labor-related costs are especially sensitive to
inflation. Increases in wages and other labor-related costs as a result of
inflation or the increase in minimum wage requirements without a corresponding
increase in Medicaid and Medicare reimbursement rates would, and have,
adversely impacted us. In some of our markets there is a labor shortage that
could have an adverse effect upon our ability to attract or retain sufficient
numbers of skilled and unskilled personnel at reasonable wages. Accordingly,
rising wage rates have had an adverse effect on us in some of our markets.

Rent

We also have significant rent obligations relating to our leased facilities.
Total rent expense for leased facilities including rent expense for
discontinued operations, and corporate locations was $38.3 million, $41.6 million,
$15.5 million, and $62.8 million for the year ended December 31, 2003, the
twelve months ended December 31, 2002, the four months ended April 30, 2002,
and fiscal year ended September 30, 2001, respectively.

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk is the risk of loss arising from adverse changes in market rates
and prices, such as interest rates, foreign currency exchange rates and
commodity prices. Our primary exposure to market risk is interest rate risk
associated with borrowings under our Senior Credit Facility which bears interest based on
variable rates. If market interest rates rise, so will our required interest
payments on borrowings under our Senior Credit Facility.

General Interest Rate Risk

The following discussion of our exposure to interest rate risk has been
prepared using assumptions considered reasonable in light of information
currently available to us. Given the unpredictability of interest rates as well
as other factors, actual results could differ materially from those projected.

At December 31, 2003, we had exposure to interest rate risk related to changes
in LIBOR, which affects the interest paid on our variable rate borrowings under our Senior Credit Facility and
the fair value of our fixed rate borrowings under the Omega Loan and the Notes. The following table provides
information about our Senior Credit Facility which is sensitive to changes in
interest rates, including principal cash flows and related weighted average
interest rates by expected maturity for the periods indicated (in thousands of
dollars):

|                                                  |                       |  |                     |       |        |  |        |       |               |  |        |       |            |  |       |       |                   |  |   |       |   |  |   |         |   |  |   |         |  |  |   |         | 
|------------------------------------------------- | --------------------- |  | ------------------- | ----- | ------ |  | ------ | ----- | ------------- |  | ------ | ----- | ---------- |  | ----- | ----- | ----------------- |  | - | ----- | - |  | - | ------- | - |  | - | ------- |  |  | - | ------- | 
|                                                  |                       |  | Expected Maturities |       |        |  |        |       |               |  |       
|                                                  |                       |  |                     |       |        |  |        |       | Fair Value at
|                                                  |                       |  | Year 1              |       | Year 2 |  | Year 3 |       | Year 4        |  | Year 5 |       | Thereafter |  | Total |       | December 31, 2003
|                                                  |                       |  |                     |       |        |  |        |       |               |  |        |       |            |  |       |       |                  
|Liabilities                                       |                       |  |                     |       |        |  |        |       |               |  |        |       |            |  |       |       |                   |  |   |       |   |  |   |         |   |  |   |         |  |  |   |        
|Long-term debt,
including amounts
due in one year |                       |  |                     |       |        |  |        |       |               |  |        |       |            |  |       |       |                   |  |   |       |   |  |   |         |   |  |   |         |  |  |   |        
|                                                  | Fixed rate            |  | $                   | 8,313 |        |  | $      | 8,807 |               |  | $      | 498   |            |  | $     | 523   |                   |  | $ | 1,763 |   |  | $ | 234,732 |   |  | $ | 254,636 |  |  | $ | 256,493 | 
|                                                  | Average interest
rate |  |                     | 9.0   | %      |  |        | 9.1   | %             |  |        | 9.1   | %          |  |       | 9.1   | %                 |  |   | 9.1   | % |  |   | 9.1     | % |  |   |         |  |  |   |         | 
|                                                  | Variable rate         |  | $                   | 1,350 |        |  | $      | 1,350 |               |  | $      | 1,350 |            |  | $     | 1,350 |                   |  | $ | 1,350 |   |  | $ | 128,250 |   |  | $ | 135,000 |  |  | $ | 135,000 | 

The interest rates on the variable rate portions of our long-term debt vary.
Loans under the Senior Credit Facility bear interest, at our election,
using LIBOR or the base rate, which will be the higher of (x) the rate of
interest publicly announced by the administrative agent of the Senior Credit
Facility as its prime rate in effect, or (y) the federal funds effective rate
from time to time plus 0.50%, in each case, plus an applicable margin ranging
from 2.00% to 2.75% for LIBOR advances, and from 1.00% to 1.75% for base rate
advances, based on our consolidated lease-adjusted leverage ratio.
While we do not currently employ interest rate hedges, we may in the
future be required to convert some or all of our indebtedness from variable
rate to fixed rate, and as a result, may enter into interest rate
swap arrangements, refinancing existing variable rate debt with fixed rate debt
or managing the mix of our long-term variable and fixed rate borrowings. We
cannot assure that any of these alternatives will successfully hedge our
interest rate risk, and adverse changes in market interest rates could have a
material adverse effect on our financial condition.

Derivative Instrument

One of our wholly-owned subsidiaries, PHCMI, is the borrower under an $59.7
million mortgage loan from Omega, that was
restructured as part of our bankruptcy proceeding. The Omega Loan,
bears interest at a rate of 11.57% per annum, and provides for interest-only
payments until its scheduled maturity on August 31, 2010. The maturity date of
the Omega Loan may be extended at PHCMIs option until August 31, 2021. This
term-extending option meets the definition of an embedded derivative
instrument. This derivative is accounted for as a purchased option. The fair
market value of purchased option was bifurcated from the Omega Loan and
recorded as an asset and had a market value of $3.3 million on December 31,
2003 and $3.2 million on December 31, 2002. Prior to maturity, the Omega Loan
is subject to prepayment at the option of PHCMI between February 1, 2005 and
July 31, 2005, at 103% of par (notice of which prepayment must be given by
December 31, 2004). In the event the debt is prepaid, the purchased option will
become worthless and we will recognize an expense for the current market value.

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The market value for both periods was determined using the Black-Scholes model.
The selection of this model is subjective and we believe it gives an accurate
estimate of the fair value for this derivative. Like all models used to
estimate the fair value of a transaction of this nature, the resulting market
value is very sensitive to changes in the assumptions. The assumptions used in
the model as of December 31, 2003 and 2002, respectively, were as follows:
11.57% strike price for both periods, 6.6 and 7.7 years until the swap begins,
respectively, 11.0 year term of the swap for both periods, notional of $59.7
million for both periods, standard deviation of the forward rate of 16.7% and
15.5%, respectively, market par yield plus 500 basis points. The market value
calculation is most sensitive to changes in the standard deviation of the
forward rate and the market par yield (both the change in the level of interest
rates and the shape of the interest rate curve). An increase in these
variables, with other variables held constant, will cause the value of the
purchased option to increase. We do not purchase or hold any derivative
financial instruments for trading purposes.




ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The information required by
Item 8 is contained in pages F-1 through F-55
of this Annual Report on Form 10-K.

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

Not applicable.




ITEM 9A. CONTROLS AND PROCEDURES

We currently have in place systems relating to disclosure controls and
procedures with respect to the accurate and timely recordation, processing,
summarization and reporting of information required to be disclosed in our
reports required to be filed under the Exchange Act. We periodically review and evaluate these
disclosure controls and procedures systems to ensure this information is
accumulated and communicated to management, including our Chief Executive
Officer and Chief Financial Officer, as appropriate, to allow timely decisions
about required disclosure. In completing our review and evaluation in
connection with the preparation of this annual report within 90 days prior to
the date of the report, management necessarily applied its judgment in
assessing the costs and benefits of these controls and procedures which, by
their nature, can provide only reasonable assurance regarding managements
control objectives.

The Chief Executive Officer and Chief Financial Officer believe our internal
controls and procedures are effective, in all material respects. There have
been no significant changes in our internal controls or in other factors that
could significantly affect our internal controls, other than the hiring of
additional accounting personnel, which we will continue to do. We understand
the SEC may be promulgating additional rules relating to internal controls. We
cannot provide assurance that our current internal controls will not change in
the future to reflect potential new rules of the SEC.

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PART III




ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Directors and Executive Officers

|                        |  |     |    |                      |  |                                                                                                    
|----------------------- |  | --- | -- | -------------------- |  | ---------------------------------------------------------------------------------------------------
|Name                    |  | Age |    | Principal Occupation
|                        |  |     |    |                     
|C. Christian Winkle     |  |     | 41 |                      |  | President, Chief Executive Officer and Director                                                    
|Victor L. Lund          |  |     | 56 |                      |  | Chairman of the Board of Directors                                                                 
|Earl P. Holland         |  |     | 58 |                      |  | Director, Retired Vice Chairman and Chief Operating
Officer of Health Management Associates, Inc.  
|Philip L. Maslowe       |  |     | 57 |                      |  | Director, Retired Executive Vice President and Chief
Financial Officer of The Wackenhut Corporation
|Mohsin Y. Meghji        |  |     | 39 |                      |  | Director, Principal of Loughlin, Meghji + Company                                                  
|Michael E. Boxer        |  |     | 42 |                      |  | Executive Vice President and Chief Financial Officer                                               
|Boyd P. Gentry          |  |     | 45 |                      |  | Senior Vice President and Treasurer                                                                
|Stefano M. Miele        |  |     | 37 |                      |  | Senior Vice President, General Counsel and Secretary                                               
|Terry OMalley          |  |     | 55 |                      |  | Senior Vice President, Human Resources                                                             
|David F. Polakoff, M.D. |  |     | 49 |                      |  | Senior Vice President, Medical Affairs and Chief
Medical Officer                                   
|William C. Straub       |  |     | 57 |                      |  | Senior Vice President and Chief Accounting Officer                                                 

There are no family relationships between any of the directors, or any of our
executive officers. Our executive officers serve at the discretion of the Board
of Directors. Detailed information about our directors and executive officers
is provided below. Effective March 10, 2004, Patrick H.
Daugherty and M. Edward Stearns resigned from our Board of Directors.
Accordingly, they are not included in the table above and their
biographical information is not presented below.

Directors

C. Christian Winklehas served as our President, Chief Executive Officer and a
director since March 2000. From January 1999 through March 2000, he served as
our Executive Vice President and Chief Operating Officer. Prior to that, Mr.
Winkle served as Executive Vice President and Chief Operating Officer of
Integrated Health Services, Inc., or IHS, a long-term health care service
provider, from May 1997 to December 1998. From May 1997 through April 1998, he
served as Executive Vice President, Field Operations for owned and leased IHS
facilities, and from May 1995 to May 1997, he served as Senior Vice President,
Operations of IHS. Prior to that, Mr. Winkle served in various capacities at
IHS, including Regional Vice President of Operations and President, MSU Product
Development, from September 1992.

Victor L. Lundhas served as our non-executive Chairman of the Board of
Directors and as a director since May 2002. From June 1999 through June 2002,
he served as Vice Chairman of the Board of Albertsons, Inc., a food and drug
retailer. He is also a member of the board of directors of The Steiner
Corporation, Borders Group, Inc., NCR Corporation and Service Corporation
International. From May 1995 through June 1999, Mr. Lund served as Chairman of
the Board and Chief Executive Officer of American Stores Company, a food and
drug retailer. His previous position consisted of serving as President and
Chief Executive Officer of American Stores.

Earl P. Hollandhas served as a director since May 2002. He is the former Vice
Chairman and Chief Operating Officer for Health Management Associates, Inc., or
HMA, an owner and operator of acute-care hospitals. Prior to joining HMA, he
worked at Humana, Inc., a hospital management company, from 1971 to 1981,
ultimately serving as Chief Executive Officer for a hospital in Overland Park,
Kansas. He joined HMA in 1981 and held several operations positions until being
promoted to Vice Chairman and Head of the Acquisitions Group in 1997. He became
Chief Operating Officer of HMA in 1999. He currently serves on the board of
directors of

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Cornerstone Management Partners, Inc., Essent Healthcare Company,
First Bancorp, Inc., Team Health, Inc. and Ultrawatt Energy Systems, Inc. Mr.
Holland earned a B.S. degree in Business Administration from Southeast Missouri
State University in 1968.

Philip L. Maslowehas served as a director since August 2002. Most recently he
served as the Executive Vice President and Chief Financial Officer of The
Wackenhut Corporation, a security, staffing and privatized prisons corporation,
where he was employed since August 1997. From July 1993 until May 1997, he
served in various executive positions at KinderCare Learning Centers, Inc., a
childcare company, most recently as Executive Vice President and Chief
Financial Officer. Mr. Maslowe was formerly Chairman of the Board of AMF
Bowling Worldwide, Inc. Mr. Maslowe received a B.B.A. from Loyola University
of Chicago and a Masters Degree in Management from Northwestern University.

Mohsin Y. Meghjihas served as a director since May 2002. He is a principal of
Loughlin Meghji + Company, or LM+Co., a New York based restructuring advisory
firm. Prior to forming LM+Co. in January 2002, Mr. Meghji was a partner in the Restructuring Group of Andersen LLP, a business
advisory firm where he was employed since January 1994. For the majority of his
career, Mr. Meghji has specialized in advising management, investors and
creditors in relation to business restructurings in a variety of industries,
including health care. He served as the financial advisor to the lenders under
our prepetition senior credit facility during our bankruptcy proceedings. Mr.
Meghji received an honors B.B.A. from the Schulich School of Business of York
University, Canada in 1987 and has also attended the INSEAD Business School in
France for executive courses. He is a U.K. and Canadian Chartered Accountant.

Officers

Michael E. Boxerhas served as our Executive Vice President and Chief Financial
Officer since January 2003. Prior to joining us, Mr. Boxer served as Senior
Vice President and Chief Financial Officer of Watson Pharmaceuticals, Inc., a
New York Stock Exchange listed specialty pharmaceuticals company. Before joining Watson in July
1998, Mr. Boxer was President of The Enterprise Group, a financial advisory
firm. Prior to that, Mr. Boxer was Vice President of the Health Care Group at
Furman Selz, LLC, a New York based investment bank.

Boyd P. Gentryhas served as our Senior Vice President and Treasurer since
November 1997. Mr. Gentry has also served as President and Chief Operating
Officer of our APS Division prior to its disposition in January 2002. Mr.
Gentry joined us in July 1995 as Vice President, Investor Relations and
Treasurer. Prior to his time with us, Mr. Gentry held various commercial
lending and corporate finance positions with Bank of America (formerly
NationsBank) where his last position was Senior Vice President, Corporate
Finance.

Stefano M. Mielehas served as our Senior Vice President, General Counsel and
Secretary since January 2002. Prior to January 2002, Mr. Miele served as our
Senior Vice President, Associate General Counsel and Assistant Secretary. He
joined one of our predecessor companies in April 1995 as Associate General
Counsel. Mr. Miele joined us from the international law firm of Jones, Day,
Reavis and Pogue, where he worked in the corporate group.

Terry OMalleyhas served as our Senior Vice President of Human Resources since
February 2002. He joined one of our predecessor companies in 1995 as Vice
President of Human Resources and Chief Administration Officer. Prior to joining
us, Mr. OMalley held the position of Senior Vice President of Human Resources
at Helix Health System Services, a community-based health system.

David F. Polakoff, M.D.has served as our Senior Vice President, Medical
Affairs and Chief Medical Officer since August 1998. From December 1997 through
July 1998 Dr. Polakoff was the Chief Medical Officer of one of our predecessor
companies. Prior to joining us, Dr. Polakoff served on the full time faculty of
Harvard Medical School, where he taught Geriatric Medicine from 1988 through
1997. He retains an adjunct faculty appointment at this time. Contemporaneous
with his Harvard tenure, Dr. Polakoff served in various positions, culminating
as Director of the Geriatric Research, Education and Clinical Center of the
West Roxbury VA Medical Center (a Harvard teaching hospital).

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William C. Straubhas served as our Senior Vice President and Chief Accounting
Officer since September 1999. Prior to joining us, Mr. Straub served as Chief
Financial Officer of EmCare, Inc., an integrated service provider for hospital
emergency department staffing and management from 1998 through September 1999.
Prior to this, Mr. Straub served as Chief Financial Officer of UNARCO, a
manufacturer and distributor of shopping carts, during 1997 and Chief Financial
Officer of Geonex Corporation, a geographical information systems provider
during 1996.

Audit Committee Financial Expert

We have a standing audit committee, or the Audit Committee, in accordance with
Section 3(a)(58)(A) of the Exchange Act. The Audit Committee is comprised of
Messrs. Holland (Chairman), Maslowe and Meghji. The Board of Directors has
determined that Messrs. Holland and Maslowe are independent as defined under
Item 7(d)(3)(iv) of Schedule 14A of the Exchange Act (since we are not listed
on the New York Stock Exchange or American Stock Exchange or quoted on Nasdaq,
we have elected to use the definition of independence in Rule 4200(a)(15) of
the National Association of Securities Dealers listing standards as required
by Item 7(d)(3)(iv)(B) of Schedule 14A of the Exchange Act). The Board of
Directors has also determined that Messrs. Holland and Maslowe each qualify as
an audit committee financial expert as defined under Item 401 of Regulation
S-K.

Appointment of Directors/Emergence from Bankruptcy

We emerged from bankruptcy protection effective May 13, 2002 pursuant to the
terms of our Joint Plan. Each of the directors currently serving on our Board of
Directors, other than Mr. Maslowe, received their initial appointment pursuant
to the terms of our Joint Plan. There is no agreement or term of the Joint Plan
that governs the future selection of directors. The Board of Directors elected
Mr. Maslowe to a vacant director position in August 2002.

Section 16(A) Beneficial Ownership Reporting Compliance

Pursuant to Section 16(a) of the
Exchange Act, our directors and officers, and any persons who beneficially own more than 10%
of our Common Stock, are required to file initial reports of ownership and
reports of changes in ownership with the SEC. Based solely upon our review of
copies of such reports from the time of our emergence from bankruptcy, when we
issued our Common Stock, until the end of our 2003 fiscal year, and written
representations from our directors and officers, we believe that all filing
requirements applicable to directors, officers and more than 10% beneficial
owners for this period have been complied with, except for the following
matters: Messrs. Gentry, Miele, OMalley, Straub and Winkle each filed a late
Form 4 on February 17, 2004 in connection with the options received by them
pursuant to the employee stock option exchange discussed in
Item 5 above. Messrs. Daugherty (January 14, 2004), Holland (January 12, 2004), Lund (January
12, 2004), Maslowe (January 12, 2004), Meghji (January 13, 2004) and Stearns
(January 12, 2004) each filed a late Form 4 on the date listed in the
parenthetical next to their names in connection with the director stock option
exchange discussed in Item 5 above. Mr. Stearns also filed a late Form 4 on
February 13, 2004 relating to a disposition of stock by a company in which he
is a beneficial owner.

Code of Ethics

We have adopted a code of ethics, or
the Code of Ethics, that applies to all of
our directors, employees and officers, including our principal executive
officer, principal financial officer, principal accounting officer, controller
and persons performing similar functions. The Code of Ethics is posted on our
website at www.marinerhealthcare.com. Any waivers of or changes to the Code of
Ethics will be posted on our website. We also have a company-wide code of
conduct, or the Code of Conduct, applicable to all of our employees, including
our senior executives. The Code of Conduct is also posted on our website.

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ITEM 11. EXECUTIVE COMPENSATION

The following table presents information concerning compensation earned by our
Chief Executive Officer during the year ended December 31, 2003 and our
four other most highly compensated executive officers serving at December 31,
2003 who earned over $100,000 in salary and bonus. They are collectively
referred to as the named executive officers. Until May 13, 2002, the named
executive officers were employed by Mariner Post-Acute Network, Inc. (a
predecessor to Mariner Health Care, Inc.). After that date, Mariner Health Care
Management Company, or the Management Company, a wholly-owned subsidiary of
ours, employed Dr. Polakoff and Messrs. Gentry and Miele.

Summary Compensation Table

|                            |                                     |                 |                     |            |  |       |         |              |  |   |         |           |     |   |           |         |    
|--------------------------- | ----------------------------------- | --------------- | ------------------- | ---------- |  | ----- | ------- | ------------ |  | - | ------- | --------- | --- | - | --------- | ------- | ---
|                            |                                     |                 | Annual Compensation
|                            |                                     |                 |                     |            |  |       |         |              |  |  
|                            |                                     |                 |                     |            |  |       |         |              |  |   |         |           |     |   | All Other
|Name and Principal Position |                                     | Fiscal Year (1) |                     | Salary     |  | Bonus |         | Compensation
|                            |                                     |                 |                     |            |  |       |         |             
|C. Christian Winkle         |                                     |                 | 2003                |            |  | $     | 750,000 |              |  | $ | 455,560 |           |     | $ | 18,000    | (4)    
|                            | President, Chief Executive          |                 |                     | 2002       |  |       |         | 737,308      |  |   |         | 2,197,500 | (2) |   |           | 107,554 | (4)
|                            | Officer and Director                |                 |                     | 2001-12/31 |  |       |         | 652,550      |  |   |         | 585,000   | (3) |   |           | 15,450  | (4)
|                            |                                     |                 | 2001                |            |  |       | 652,550 |              |  |   | 780,000 |           |     |   | 12,900    | (4)    
|
|Michael
E. Boxer(5)         |                                     |                 | 2003                |            |  | $     | 427,500 |              |  | $ | 210,859 |           |     | $ | 70,645    | (6)    
|                            | Executive
Vice President and Chief  |                 |                     |            |  |       |         |              |  |   |         |           |     |   |           |         |    
|                            | Financial
Officer                   |                 |                     |            |  |       |         |              |  |   |         |           |     |   |           |         |    
|David F. Polakoff, M.D.     |                                     |                 | 2003                |            |  | $     | 390,386 |              |  | $ | 136,668 |           |     | $ | 8,680     | (6)    
|                            | Senior Vice President,              |                 |                     | 2002       |  |       |         | 363,462      |  |   | $       | 260,000   | (2) |   |           | 10,066  | (6)
|                            | Medical Affairs and Chief   Medical |                 |                     | 2001-12/31 |  |       |         | 350,000      |  |   |         | 67,500    | (3) |   |           | 10,350  | (6)
|                            | Officer                             |                 |                     | 2001       |  |       |         | 350,000      |  |   |         | 90,000    |     |   |           | 10,350  | (6)
|Boyd P. Gentry              |                                     |                 | 2003                |            |  | $     | 325,000 |              |  | $ | 102,375 |           |     | $ | 10,800    | (6)    
|                            | Senior Vice President               |                 |                     | 2002       |  |       |         | 314,423      |  |   |         | 465,000   | (2) |   |           | 10,483  | (6)
|                            | and Treasurer                       |                 |                     | 2001-12/31 |  |       |         | 272,077      |  |   |         | 112,500   | (3) |   |           | 8,342   | (6)
|                            |                                     |                 | 2001                |            |  |       | 262,846 |              |  |   | 150,000 |           |     |   | 8,342     | (6)    
|Stefano M. Miele            |                                     |                 | 2003                |            |  | $     | 250,000 |              |  | $ | 75,926  |           |     | $ | 10,800    | (6)    
|                            | Senior Vice President,              |                 |                     | 2002       |  |       |         | 246,741      |  |   |         | 250,000   | (2) |   |           | 9,377   | (6)
|                            | General Counsel and Secretary       |                 |                     | 2001-12/31 |  |       |         | 196,154      |  |   |         | 56,250    | (3) |   |           | 10,350  | (6)
|                            |                                     |                 | 2001                |            |  |       | 193,558 |              |  |   | 75,000  |           |     |   | 10,350    | (6)    



---

|(1) |  | The row 2001 
12/31 represents the twelve-month period ended December 31,
2001, including the three month transition period from October 1, 2001 to
December 31, 2001 in connection with a change in our fiscal year end from
September 30 to December 31. The row 2001
represents the twelve-month period
ended September 30, 2001. Consequently, the compensation paid during the
nine-month period from January 1, 2001 to September 30, 2001 is reported
in both rows.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | Includes, for Mr. Winkle,
Dr. Polakoff, Mr. Gentry and Mr. Miele, respectively,
$697,500, $160,000, $140,000 and $100,000 as bonuses earned for
2002 but paid in 2003 and $1,500,000, $100,000, $325,000 and $150,000 as payments
made in 2002 pursuant to a key employee retention plan approved by the
Bankruptcy Court and paid in connection with our emergence from
bankruptcy.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   
|(3) |  | Represents prorated portion of
bonus (9/12) earned during the twelve-month
period ended December 31, 2001.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   
|(4) |  | Represents automobile allowances
only for all periods reported, except 2002 which includes $89,554 in
relocation expenses reimbursed to Mr. Winkle pursuant to our
relocation plan when he relocated his residence from Maryland to our
corporate headquarters in Atlanta, Georgia and $18,000 in automobile
allowance.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|   
|(5) |  | Mr. Boxers employment commenced January 14, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   
|(6) |  | For 2003, includes automobile
allowances of $7,800 paid to Dr. Polakoff and Messrs. Gentry
and Miele, respectively, and matching contributions of $880, $3,000 and $3,000
made to Dr. Polakoff and Messrs. Gentry and Miele, respectively, under our 401(k)
Plan. For Mr. Boxer, includes an automobile allowance of $7,600 paid in 2003 and
$63,045 in relocation expenses reimbursed to Mr. Boxer pursuant to our
relocation plan when he relocated his residence from California to our
corporate headquarters in Atlanta, Georgia. For 2002, includes automobile allowances of $7,800 paid to
Dr. Polakoff and Messrs. Gentry and Miele, respectively,
and matching contributions of $2,266, $2,683 and $1,577 made to
Dr. Polakoff and Messrs. Gentry and Miele, respectively,
under our 401(K) Plan. For 2001, includes automobile allowances of
$7,800 paid to Dr. Polakoff and Messrs. Gentry and Miele,
respectively, and matching contributions of $2,550, $542 and $2,550
made to Dr. Polakoff and Messrs. Gentry and Miele,
respectively, under our 401(K) Plan.

60



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##### Table of Contents



Option Grants in Last Fiscal Year

The following table presents stock option grants made to each of the named
executive officers during the year ended December 31, 2003. Except for
Mr. Winkles, these option grants vest ratably over four years commencing on
the first anniversary of the date of grant, which was December 16,
2003. Mr. Winkles option grant vests
at the rate of 8.33% per quarter, with the remaining shares vesting on the third anniversary
of December 16, 2003, the date of grant. The exercise price per share of each
option granted was equal to the fair market value of our Common Stock on the
date of grant.

Potential realizable value is calculated assuming that the stock price on the
date of grant appreciates at the indicated rate compounded annually until the
option is exercised and sold on the last day of its term for the appreciated
stock price. The 5% and 10% assumed rates of appreciation are required by the
rules of the SEC and do not represent our estimate or projection of our future
Common Stock price.

Option Grants in Last Fiscal Year Table

|                    |  |                   |         |                       |  |          |      |            |  |     |       |                 |  |                    |          |  |  |                      |           |  |  |   |            | 
|------------------- |  | ----------------- | ------- | --------------------- |  | -------- | ---- | ---------- |  | --- | ----- | --------------- |  | ------------------ | -------- |  |  | -------------------- | --------- |  |  | - | ---------- | 
|                    |  |                   |         |                       |  |          |      |            |  |     |       |                 |  |                    |          |  |  | Potential Realizable
|                    |  | Individual Grants |         | Value at Assumed     
|                    |  |                   |         | Annual Rates of Stock
|                    |  | Number of         |         | Percent of            |  |          |      |            |  |     |       |                 |  | Price Appreciation
|                    |  | Securities        |         | Total Options         |  | Exercise |      |            |  |     |       | for Option Term
|                    |  | Underlying        |         | Granted to            |  | or Base  |      |            |  |     |       |                
|                    |  | Options           |         | Employees in          |  | Price    |      | Expiration |  | 5%  |       | 10%            
|Name                |  | Granted (#)       |         | Fiscal Year           |  | ($/Sh)   |      | Date       |  | ($) |       | ($)            
|                    |  |                   |         |                       |  |          |      |            |  |     |       |                
|C. Christian Winkle |  |                   | 439,560 |                       |  |          | 23.0 | %          |  | $   | 18.08 |                 |  |                    | 12/16/13 |  |  | $                    | 4,997,980 |  |  | $ | 12,665,861 | 
|Michael E. Boxer    |  |                   | 200,000 |                       |  |          | 10.4 |            |  |     | 6.30  |                 |  |                    | 1/14/13  |  |  |                      | 792,407   |  |  |   | 2,008,115  | 
|David F. Polakoff   |  |                   | 40,000  |                       |  |          | 2.1  |            |  |     | 18.08 |                 |  |                    | 12/16/13 |  |  |                      | 454,817   |  |  |   | 1,152,595  | 
|Boyd P. Gentry      |  |                   | 65,000  |                       |  |          | 3.4  |            |  |     | 18.08 |                 |  |                    | 12/16/13 |  |  |                      | 739,077   |  |  |   | 1,872,966  | 
|Stefano M. Miele    |  |                   | 40,000  |                       |  |          | 2.1  |            |  |     | 18.08 |                 |  |                    | 12/16/13 |  |  |                      | 454,817   |  |  |   | 1,152,595  | 

Option Exercises and Fiscal Year End Option Values

No options were exercised and no value was realized from any exercises during
our 2003 fiscal year. With the exception of Messrs. Winkle and Boxer, there
were no vested and unexercised options held at the end of our 2003 fiscal year
by our named executive officers. Value of in-the-money options represents the
aggregate market value of the underlying securities at our 2003 fiscal year end
minus the aggregate exercise price payable for those shares.

All options granted prior to our 2003 fiscal year to the named executive
officers, except for Mr. Boxers, were tendered to, accepted and cancelled by
us on June 14, 2003. Such tender, acceptance and cancellation
occurred in connection with our offer to exchange options held by
employees having an exercise price of $20.12 per share previously granted under
the 2002 Stock Incentive Plan for new options. Effective December 16, 2003,
the Compensation Committee granted new options pursuant to the 2002 Stock
Incentive Plan to the named executive officers to purchase shares of
Common Stock at a strike price of $18.08. These options will vest in
four equal annual installments beginning on the first anniversary of the date
of grant of the new options, with the exception of the options granted to
Mr. Winkle, which will vest in accordance with the terms set
forth in his employment agreement. We did not record any compensation expense with
respect to the named executive officers as a result of the exchange program
since the options were issued at the fair market value of our Common
Stock on the grant date.

Mr. Boxer did not tender his options to us, and as a result, the options remain
outstanding and are set forth in the table below. No value was realized from
the exercise of stock options during the fiscal year ended December 31, 2003
because no options were exercised. The following table presents unexercised
options that were held at the end of our 2003 fiscal year by each named
executive officer. Value of in-the-money options represents the aggregate
market value of the underlying securities at December 31, 2003 minus the
aggregate exercise price payable for those shares.

61



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##### Table of Contents



Aggregated Option Exercises in Last Fiscal Year and Fiscal Year End Option
Values Table

|                    |  |          |   |          |  |             |   |                            |  |                       |        |                      |  |  |         |  |  |   |         |  |  |   |           | 
|------------------- |  | -------- | - | -------- |  | ----------- | - | -------------------------- |  | --------------------- | ------ | -------------------- |  |  | ------- |  |  | - | ------- |  |  | - | --------- | 
|                    |  |          |   |          |  |             |   |                            |  | Number of Securities  |        | Value of Unexercised
|                    |  | Shares   |   |          |  |             |   | Underlying Unexercised     |  | In-the-Money Options 
|                    |  | Acquired |   |          |  |             |   | Options at Fiscal Year-End |  | at Fiscal
Year-End(1)
|                    |  | on       |   | Value    |  | (#)         |   | ($)                       
|                    |  | Exercise |   | Realized |  |             |   |                           
|Name                |  | (#)      |   | ($)      |  | Exercisable |   | Unexercisable              |  | Exercisable           |        | Unexercisable       
|                    |  |          |   |          |  |             |   |                            |  |                       |        |                     
|C. Christian Winkle |  |          |  |          |  |             |  |                            |  |                       | 36,615 |                      |  |  | 402,945 |  |  | $ | 154,515 |  |  | $ | 1,700,428 | 
|Michael E. Boxer    |  |          |  |          |  |             |  |                            |  |                       | 50,000 |                      |  |  | 150,000 |  |  | $ | 800,000 |  |  | $ | 2,400,000 | 
|David F. Polakoff   |  |          |  |          |  |             |  |                            |  |                       |       |                      |  |  | 40,000  |  |  |   |        |  |  | $ | 168,800   | 
|Boyd P. Gentry      |  |          |  |          |  |             |  |                            |  |                       |       |                      |  |  | 65,000  |  |  |   |        |  |  | $ | 274,300   | 
|Stefano M. Miele    |  |          |  |          |  |             |  |                            |  |                       |       |                      |  |  | 40,000  |  |  |   |        |  |  | $ | 168,800   | 

|    |  |                                                                                                                                                                                                                                   
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |  |                                                                                                                                                                                                                                   
|(1) |  | Value of exercised and
unexercised options at fiscal year-end represents the difference
between the exercise price of any outstanding in-the-money options
and $22.30, the closing price of our Common Stock on
December 31, 2003.

Employment Agreements

The following are summaries of the employment agreements with our named
executive officers. Although Messrs. Gentry and Miele are employed by the
Management Company, each is serving as an officer of both Mariner and the
Management Company. Dr. Polakoff is employed by and an officer
of the Management Company. Mr. Winkle and Mr. Boxer are
both employed by and officers of Mariner.

C. Christian Winkle

We entered into an employment agreement with Mr. Winkle as of April 4, 2002.
His agreement is for a continuous term during the period he remains employed by
us. Pursuant to this agreement, Mr. Winkle is entitled to receive:



| |  |  | a base salary, currently $750,000 per year, which is reviewed by our
Board of Directors annually, and may increase, but not decrease;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | an annual bonus of between 50% and 150% of his annual base salary if we achieve specified financial targets; and                     
|
| |  |  | fringe benefits, including stock options and pension and welfare benefits.                                                           

If Mr. Winkles employment is terminated without cause or he terminates his
employment for good reason prior to a change of control or following the second
anniversary of a change of control, he will continue to receive his
then-current salary for two years. He will also receive a lump sum payment
equal to the sum of: (i) his prorated target bonus for bonus amounts earned
during the year of termination; and (ii) two times the greater of (x) the
average annual bonuses paid to him over the two prior years and (y) his target
bonus amount. In addition, Mr. Winkle will be entitled (subject to mitigation)
to benefit continuation for a period of two years following his termination and
all equity-based awards will become fully vested.

If Mr. Winkles employment is terminated without cause or he terminates his
employment for good reason during the twenty-four month period following a
change of control, he will receive in a lump sum: (i) a prorated target bonus
for bonus amounts earned during the year of termination; and (ii) an amount
equal to 2.99 times the sum of (x) his then-current base salary plus (y) the
greater of the average bonus paid to him over the two prior years or his target
bonus. In addition, Mr. Winkle will be entitled (subject to mitigation) to
benefit continuation for a period of thirty-six months following his
termination, and all equity-based awards will become fully vested. Mr. Winkle
has agreed not to solicit any client or prospective client of ours or solicit
or hire our employees for two years following the end of his employment. In
addition, if Mr. Winkle terminates his employment without good reason, he is
restricted from competing against us for a period of one year.

-62-



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##### Table of Contents



Michael E. Boxer

We have entered into an employment agreement with Mr. Boxer as of December 4,
2002. Mr. Boxers agreement provides for a continuous term during the period
he remains employed by us. Pursuant to this agreement, Mr. Boxer is entitled
to receive:



| |  |  | a base salary, currently $450,000 per year, which is reviewed
by our Board of Directors annually, and may increase, but not
decrease;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | an annual bonus of between 50% and
100% of his annual base salary if we achieve specified financial targets; and                     
|
| |  |  | fringe benefits, including stock options and pension and welfare benefits.                                                           

If within one year following a change of control Mr. Boxers employment is
terminated without cause or he terminates his employment for good reason, then
he will receive in a lump sum: (i) a prorated target bonus for bonus amounts
earned during the year of termination; and (ii) an amount equal to 2.5 times
the sum of (x) his then-current base salary plus (y) the greater of the average
bonus paid to him over the two prior years or his target bonus. In addition,
Mr. Boxer will be entitled (subject to mitigation) to benefit continuation for
a period of thirty-six months following his termination and all equity-based
awards will become fully vested.

If Mr. Boxers employment is terminated without cause either prior to a change
in control or following the first anniversary of a change of control, he will
continue to receive his then-current salary for a period of two years
and he will also receive the minimum annual bonus permitted under his
employment agreement for the two fiscal years ending after the date of
his termination, payable at the time other executives of Mariner
receive their bonus payments. Finally, he will
receive in lump sum his prorated target bonus for bonus amounts
earned during the year of termination. In addition, he will be entitled (subject to mitigation)
to benefit continuation for a period not to exceed the period for which he
receives his then-current salary. In addition, all equity-based awards will
become fully vested.

Mr. Boxer has agreed not to solicit any client or prospective client of ours or
solicit or hire our employees for two years following the end of his
employment. In addition, if Mr. Boxer terminates his employment without good
reason, he is restricted from competing against us for a period of one year.

David F. Polakoff

The Management Company has entered into an employment agreement with Dr.
Polakoff as of May 13, 2002. Dr. Polakoffs agreement provides for a three-year
term, which extends automatically for successive one-year terms. Pursuant to
this agreement, Dr. Polakoff is entitled to receive:



| |  |  | a base salary, currently $350,000 per year, which is reviewed by the
Management Companys board of directors annually, and may increase, but
not decrease;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | an annual bonus equal to 50% of his annual base salary if we achieve specified financial targets; and                                                     
|
| |  |  | fringe benefits, including stock options and pension and welfare benefits.                                                                                

If within one year following a change of control Dr. Polakoffs employment is
terminated without cause or he terminates his employment for good reason, then
he will receive in a lump sum the following: (i) a prorated target bonus for
bonus amounts earned during the year of termination; and (ii) an amount equal
to 1.5 times the sum of (x) his then current base salary plus (y) the greater
of the average bonus paid to him over the two prior years or his target bonus.
In addition, he will be entitled (subject to mitigation) to benefit
continuation for a period of twenty-four months following his termination, and
all equity-based awards will become fully vested.

If Dr. Polakoffs employment is terminated without cause either prior to a
change in control or following the first anniversary of a change of control, he
will continue to receive his then-current salary for a period of one and
one-half years. He will also receive a lump sum payment equal to his prorated
target bonus for bonus amounts earned during the year of termination. In
addition, he will be entitled (subject to mitigation) to benefit continuation
for a period not to exceed the period for which he receives his then-current
salary.

Dr. Polakoff has agreed not to solicit any client or prospective client of ours
or solicit or hire our employees for two years following the end of his
employment. In addition, if Dr. Polakoff terminates his employment without good
reason, we have the option to cause him to comply with certain covenants in
which he is restricted from competing against us for a period of one year,
provided that we continue to pay his then-current base salary for a period of
one year following termination.

63



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##### Table of Contents



Boyd P. Gentry

The Management Company has entered into an employment agreement with Mr. Gentry
as of May 13, 2002. Mr. Gentrys agreement provides for a continuous term
during the period he remains employed by us. Pursuant to this agreement, Mr.
Gentry is entitled to receive:



| |  |  | a base salary, currently $325,000 per year, which is reviewed by the
Management Companys board of directors annually, and may increase, but
not decrease;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | an annual bonus of 60% of his annual base salary if we achieve specified financial targets; and                                                           
|
| |  |  | fringe benefits, including stock options and pension and welfare benefits.                                                                                

If within one year following a change of control Mr. Gentrys employment is
terminated without cause or he terminates his employment for good reason, then
he will receive in a lump sum: (i) a prorated target bonus for bonus amounts
earned during the year of termination; and (ii) an amount equal to 2.5 times
the sum of (x) his then current base salary plus (y) the greater of the average
bonus paid to him over the two prior years or his target bonus. In addition,
Mr. Gentry will be entitled (subject to mitigation) to benefit continuation for
a period of thirty-six months following his termination and all equity-based
awards will become fully vested.

If Mr. Gentrys employment is terminated without cause either prior to a change
in control or following the first anniversary of a change of control, he will
continue to receive his then current salary for a period of two and one-half
years. He will also receive a lump sum payment equal to his prorated target
bonus for bonus amounts earned during the year of termination. In addition, he
will be entitled (subject to mitigation) to benefit continuation for a period
not to exceed the period for which he receives his then current salary. In
addition, all equity-based awards will become fully vested.

Mr. Gentry has agreed not to solicit any client or prospective client of ours
or solicit or hire our employees for two years following the end of his
employment. In addition, if Mr. Gentry terminates his employment without good
reason, he is restricted from competing against us for a period of one year.

Stefano M. Miele

The Management Company has entered into an employment agreement with Mr. Miele
as of May 13, 2002. This agreement provides for a three-year term that extends
automatically for successive one-year terms. Mr. Miele is entitled to receive:



| |  |  | a base salary of at least $250,000 per year which is reviewed by the
Management Companys board of directors annually, and may increase, but
not decrease;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | an annual bonus of 50% of his annual base salary if we achieve specified financial targets; and                                                           
|
| |  |  | fringe benefits, including stock options and pension and welfare benefits.                                                                                

If within one year following a change of control Mr. Mieles employment is
terminated without cause or he terminates his employment for good reason, then
he will receive in a lump sum: (i) a prorated target bonus for bonus amounts
earned during the year of termination; and (ii) an amount equal to 1.5 times
the sum of (x) his then current base salary plus (y) the greater of the average
bonus paid to him over the two prior years or his target bonus. In addition, he
will be entitled (subject to mitigation) to benefit continuation for a period
of twenty-four months following his termination and all equity-based awards
will become fully vested.

If Mr. Mieles employment is terminated without cause either prior to a change
in control or following the first anniversary of a change of control, he will
continue to receive his then-current salary for a period of one and one-half
years. He will also receive a lump sum payment equal to his prorated target
bonus for bonus amounts earned during the year of termination. In addition, he
will be entitled (subject to mitigation) to benefit continuation for a period
not to exceed the period for which he receives his then-current salary. In
addition, all equity-based awards will become fully vested.

Mr. Miele has agreed not to solicit any client or prospective client of ours or
solicit or hire our employees for two years following the termination of his
employment. In addition, if he terminates his employment without good reason,
we have the option to cause him to comply with certain covenants in which he is
restricted from competing against us for a period of one year, provided that we
continue to pay his then-current base salary for a period of one year following
termination.

-64-



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##### Table of Contents



Compensation Committee Interlocks and Insider Participation

Our Compensation Committee currently
consists of Messrs. Lund (Chairman), Holland and Maslowe. None of the members of our Compensation Committee was at any time
during our 2003 fiscal year, or any other time, an officer or employee of any
Mariner entity. None of the members of the Compensation Committee serves as a
member of the board of  or compensation committee of any entity that
has one or more executive officers serving as a member of our Board of
Directors or Compensation Committee.

Compensation of Outside Directors

Directors who are executive officers
receive no additional compensation from us for their services as a
director or as a member of any committee of the Board of Directors.
Each outside director, other than the Chairman of the Board of
Directors, received a grant of 7,500 restricted shares of Common
Stock (which a director may elect to defer the right to receive) on
July 30, 2003, which replaced earlier granted and subsequently
cancelled options (see Item 5, Market for Registrants
Common Equity and Related Stockholder Matters, Director Stock Option
Exchange) under our 2003 Outside Directors Plan. The restricted
shares granted were 50% vested as of the date of
grant, and the remaining shares vest in equal increments over the next
two years on May 16, 2004 and May 16, 2005. With the
exception of the Chairman of the Board of Directors, each outside
director also receives an annual retainer of $35,000 and $2,000 for each
board meeting he attends in person or via telephone. Members of the
Audit Committee, other than the Chairman, receive a $5,000 annual retainer and each member is
paid $1,500 per meeting of the Audit Committee.
The Chairman of the Audit Committee receives an annual retainer of
$7,500. Members of each of the Compensation Committee and the Nominating and Corporate
Governance Committee, other than the Chairman of such committees, receive a $3,000 annual retainer and each
member of both committees is paid
$1,000 for each committee meeting. The Chairman of both of such
committees receive an annual retainer of $5,000 per year.
We also reimburse each director
for reasonable expenses incurred in connection with attendance at any
board or committee meetings. The Chairman of our Board of Directors
received 15,000 restricted shares of Common Stock on July 30,
2003. These shares were 50% vested on the date of grant, and the
remaining shares vest in equal increments over the next two years on
May 16, 2004 and May 16, 2005. Our Chairman receives an
annual retainer of $120,000 and the standard fee for each
board or committee meeting he attends in person or via telephone.




ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth, as of
March 12, 2004, the number and
percentage of shares of our Common Stock beneficially owned (as defined in Rule
13d-3 under the Securities Exchange Act of 1934) by: (i) all persons known to
us to beneficially own more than 5% of our Common Stock; (ii) each of our
directors; (iii) each named executive officer; and (iv) all directors and executive officers as a group. The number of
shares owned by a person includes shares of Common Stock subject to options or
warrants held by that person that are currently exercisable or exercisable
within 60 days of March 12, 2004. The number of shares owned by 5% beneficial
owners is based on the most recent information available to us, and, except as
noted below, the address of each beneficial owner is c/o Mariner Health Care,
Inc., One Ravinia Drive, Suite 1500, Atlanta, Georgia 30346.

|                                               |  |                  |           |            |  |  |      |  
|---------------------------------------------- |  | ---------------- | --------- | ---------- |  |  | ---- | -
|                                               |  | Number of Shares |           | Percentage
|Beneficial Owner                               |  | Owned            |           | Owned(1)  
|                                               |  |                  |           |           
|Directors and Executive Officers:              |  |                  |           |            |  |  |      |  
|C. Christian Winkle                            |  |                  | 36,615    | (2)        |  |  | *    |  
|Michael E. Boxer                               |  |                  | 55,000    | (3)        |  |  | *    |  
|Boyd P. Gentry                                 |  |                  |          |            |  |  |     |  
|Stefano M. Miele                               |  |                  |          |            |  |  |     |  
|David F. Polakoff, M.D.                        |  |                  |          |            |  |  |     |  
|Victor L. Lund                                 |  |                  | 11,250    | (4)        |  |  | *    |  
|Earl P. Holland                                |  |                  | 5,625     | (5)        |  |  | *    |  
|Philip L. Maslowe                              |  |                  | 5,625     | (5)        |  |  | *    |  
|Mohsin Y. Meghji                               |  |                  | 10,625    | (5)(6)     |  |  | *    |  
|and executive officers as a group (11 persons) |  |                  | 128,740   | (7)        |  |  | *    |  
|5% Beneficial Owners:                          |  |                  |           |            |  |  |      |  
|Oaktree Capital Management, LLC and affiliates |  |                  | 5,747,092 | (8)        |  |  | 28.7 | %



---

|*   |  | Represents less than one percent of the outstanding shares of our Common
Stock at March 12, 2004.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(1) |  | Based on 20,007,500 shares of our
Common Stock outstanding as of March 12, 2004. Shares issuable under stock options or warrants exercisable
within 60 days of March 12, 2004 are treated as if outstanding for
the purpose of computing the percentage ownership of the person holding these
securities but are not treated as outstanding for the purpose of
computing the percentage ownership of any other person. Similarly
shares of restricted Common Stock that (x) are vested, but whose
issuance has been deferred at the election of the relevant person and
(y) vest within 60 days of March 12,
2004 are treated as if outstanding for the purpose of computing the
percentage ownership of the person holding these securities but are
not treated as outstanding for computing the percentage ownership of
any other person.
|   
|(2) |  | Consists of options that are
exercisable within 60 days of March 12,
2004 to acquire 36,615 shares of Common Stock.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   
|(3) |  | Consists of 5,000 shares of Common
Stock and options that are
exercisable within 60 days of March 12,
2004 to acquire 50,000 shares of Common Stock.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   
|(4) |  | Consists of 11,250 shares of
restricted Common Stock that are vested or
vest within 60 days of March 12, 2004.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   

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##### Table of Contents



|(5) |  | Consists of 5,000 shares of Common
Stock and 5,625 shares of restricted stock that are vested or vest within
60 days of March 12, 2004.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(6) |  | Pursuant to an arrangement between Mr. Meghji and LM + Co., Mr. Meghji is
required to assign or remit all compensation, including stock options and
restricted stock, received as a director of Mariner to his employer.
Accordingly, Mr. Meghji disclaims beneficial ownership of these
securities.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   
|   
|(7) |  | See notes (1)  (6). Also
includes 4,000 shares owned by one of our executive officers who is not a named
executive officer.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   
|(8) |  | Based upon Amendment No. 7 to
Schedule 13D filed with the SEC on March 12, 2004 by Oaktree Capital Management, LLC, OCM Opportunities Fund II,
L.P., or Opportunities II, and OCM Opportunities Fund III, L.P., or
Opportunities III, collectively, the Oaktree Funds and Accounts. Oaktree
Capital Management is the general partner and/or investment advisor of
Opportunities II and Opportunities III. Opportunities II has sole power to
vote and dispose of 2,985,290 shares of our Common Stock, Opportunities
III has sole power to vote and dispose of 2,486,215 shares of our Common
Stock and certain other affiliates of Oaktree Capital Management
beneficially own, in the aggregate, 275,587 shares of our Common Stock.
Although Oaktree Capital Management may be deemed to beneficially own the
shares of Common Stock held by the Oaktree Funds and Accounts by virtue of
its status as general partner or investment manager of those funds and
accounts, Oaktree Capital Management, a registered investment advisor
under the Investment Advisors Act of 1940, disclaims any beneficial
interest in those shares except to the extent of its pecuniary interest
therein. The address of the Oaktree Funds and Accounts is 333 South Grand
Avenue, 28th Floor, Los Angeles, CA 90071.




ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Transactions with Management

In January 2003, in connection with Michael E. Boxers agreement to relocate
his personal residence to Atlanta, Georgia, the site of our corporate
headquarters, we purchased Mr. Boxers primary residence for its fair market
value in accordance with our corporate relocation policy. The fair market value
was determined based upon the average of two appraisals conducted by
independent appraisal services, and was determined to be $876,000.




ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The table below shows the aggregate
fees for the last two fiscal years we paid to Ernst & Young LLP for
audit and other services:



|                   |  |   | 2003       |  |  |   | 2002       | 
|------------------ |  | - | ---------- |  |  | - | ---------- | 
|Audit fees         |  | $ | 1,730,000  |  |  | $ | 2,510,000  | 
|Audit-related fees |  |   | 73,000     |  |  |   | 120,000    | 
|Tax fees           |  |   | 304,000    |  |  |   | 640,000    | 
|All other fees     |  |   | 201,000    |  |  |   | 270,000    | 
|                   |  |   |            |  |  |   |            | 
|Total              |  |   | $2,308,000 |  |  |   | $3,540,000 | 
|                   |  |   |            |  |  |   |            | 

All audit and permitted non-audit
services require pre-approval by the Audit Committee. The Audit
Committee approves proposed services and fee estimates for these
services. In the event any audit or non-audit services require
approval prior to a scheduled Audit Committee meeting, the Audit
Committee Chairman or his designee is authorized to approve any such
services, which approval is subsequently communicated to
the full Audit Committee at its next regular meeting. During 2003 all services performed by the auditors
were pre-approved by our Audit Committee.




ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a)  Documents filed as part of this report:

1.     Consolidated Financial Statements

The following reports and financial statements are filed herewith on the pages
indicated:

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|                                                                                                                                                                                                                                                                                                                                                           |  |      |     | 
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | --- | 
|                                                                                                                                                                                                                                                                                                                                                           |  | Page
|                                                                                                                                                                                                                                                                                                                                                           |  |     
|Report of Independent Auditors                                                                                                                                                                                                                                                                                                                             |  |      | F-1 | 
|Consolidated Balance Sheets as of
December 31, 2003 and 2002                                                                                                                                                                                                                                                                                               |  |      | F-2 | 
|Consolidated
Statements of Operations for the Reorganized Company for
the year ended
December 31, 2003 and for the eight months ended December 31, 2002 and for the
Predecessor Company for the four months ended April 30, 2002, the
three months ended December 31, 2001 and the year ended
September 30, 2001                                           |  |      | F-3 | 
|Consolidated
Statements of Stockholders Equity and Comprehensive Income
(Loss) for the
Reorganized Company for the year ended December 31, 2003 and
for the eight months ended December
31, 2002 and for the Predecessor Company for the four months ended
April 30, 2002, the three months ended December 31, 2001
and the year ended September 30, 2001 |  |      | F-4 | 
|Consolidated
Statements of Cash Flows for the Reorganized Company for
the year ended December 31, 2003 and for the eight months ended December 31, 2002 and for
the Predecessor Company for the four months ended April 30, 2002,
the three months ended December 31, 2001 and the year
ended September 30, 2001                                           |  |      | F-5 | 
|Notes to Consolidated Financial Statements                                                                                                                                                                                                                                                                                                                 |  |      | F-6 | 

2. Financial Statement Schedule

The following schedule is filed herewith:

Schedule II  Valuation and Qualifying Accounts and Reserves

All other schedules for which provision is made in the applicable accounting
regulations of the SEC are not required under the related instructions or are
inapplicable, and, therefore, have been omitted.

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##### Table of Contents



3. Exhibits

|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Number  |  | Exhibit                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|2.1    |  | Second Amended Joint Plan of Reorganization for Mariner Post-Acute Network, Inc.,
Mariner Health Group, Inc. and Their Respective Debtor Affiliates dated February 1,
2002 (incorporated herein by reference to Exhibit 2.1 to the Companys Transition
Report on Form 10-K for the transition period from October 1, 2001 to December 31,
2001).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|2.2    |  | Findings of Fact, Conclusions of Law and Order Confirming Debtors Joint Plan of
Reorganization, as signed by the United States Bankruptcy Court for the District of
Delaware on April 3, 2002 and entered on the docket of the United States Bankruptcy
Court for the District of Delaware in the Chapter 11 cases of the Company and its
affiliates (other than MHG and its affiliates) on April 3, 2002 (incorporated herein
by reference to Exhibit 2.2 to the Companys Current Report on Form 8-K dated April
17, 2002).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|2.3    |  | Findings of Fact, Conclusions of Law and Order Confirming Debtors Joint Plan of
Reorganization, as signed by the United States Bankruptcy Court for the District of
Delaware on April 3, 2002 and entered on the docket of the United States Bankruptcy
Court for the District of Delaware in the Chapter 11 cases of MHG and its affiliates
(other than the Company and its affiliates) on April 3, 2002 (incorporated herein by
reference to Exhibit 2.3 to the Companys Current Report on Form 8-K dated April 17,
2002).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|2.4    |  | Asset Purchase Agreement dated as of August 19, 2003 by and
among Formation Properties III, LLC, certain affiliates of
Formation Properties III, LLC, Mariner Health Care, Inc. and
certain subsidiaries of Mariner Health Care, Inc. (incorporated
herein by reference to Exhibit 10.2 to the Report on
Form 10-Q for the quarterly period ended September 30,
2003 (the September 2003 10-Q)). Certain exhibits
and schedules referenced in this agreement have been omitted in
accordance with Item 601(b)(2) of Regulation S-K. A copy of
any omitted exhibit or schedule will be furnished supplementally to
the SEC upon request.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|2.5    |  | First Amendment to Asset Purchase Agreement dated as of
September 30, 2003 by and among Formation Properties III,
LLC, certain affiliates of Formation Properties III, LLC,
Mariner Health Care, Inc. and certain subsidiaries of Mariner Health
Care, Inc. (incorporated herein by reference to Exhibit 10.3 to
the September 2003 10-Q).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|2.6     |  | Master Transaction Agreement, dated October 27, 2003, by and
among: Mariner Health Care, Inc., individually and on behalf of each
of its subsidiaries and affiliates identified on Exhibit A; and
Belleair East Medical Investors, Ltd. (L.P.), Dallas Medical
Investors, Ltd. (L.P.), Denver Medical Investors, Ltd. (L.P.), Ft.
Bend Medical Investors, Ltd. (L.P.), Houston-Northwest Medical
Investors, Ltd. (L.P.), Melbourne Healthcare Associates, Ltd.,
Northwest Healthcare, L.P., Orange Healthcare, Ltd. (L.P.), Pinellas
III Healthcare, Ltd. (L.P.), Polk Healthcare, Ltd. (L.P.), Pt.
Charlotte Healthcare, Ltd. (L.P.), South Denver Healthcare
Associates, Ltd. (L.P.), and Tallahassee Healthcare Associates, Ltd.
(L.P.), and Belleair East HCC, LLC, Melbourne Terrace RCC, LLC,
Spring Lake NC, LLC, Conway Lakes NC, LLC, Deep Creek RNC, LLC,
East Bay NC, LLC; and Samuel B. Kellett, SBK LLC and SBK Capital,
LLC. Certain
exhibits and schedules referenced in this agreement have been omitted
in accordance with Item 601(b)(2) of Regulation S-K. A copy
of any omitted exhibit or schedule will be furnished supplementally
to the SEC upon request.
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|3.1    |  | Third Amended and Restated Certificate of Incorporation of Mariner Health Care, Inc.
dated as of May 13, 2002 (incorporated herein by reference to Exhibit 3.1 to the
Companys Registration Statement on Form 8-A dated May 13, 2002).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|3.2    |  | Amended and Restated Bylaws of Mariner Health Care, Inc. dated as of May 13, 2002
(incorporated herein by reference to Exhibit 3.2 to the Companys Registration
Statement on Form 8-A dated May 13, 2002).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|4.1    |  | Warrant Agreement, dated as of May 13, 2002, between Mariner Health Care, Inc. and
American Stock Transfer and Trust Company, as Warrant Agent (incorporated herein by
reference to Exhibit 4.1 to the Companys Quarterly Report on Form 10-Q for the
quarter ended March 31, 2002 (the March 2002 10-Q)).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|4.2    |  | Indenture, dated as of May 13, 2002, among Mariner Health Care, Inc., the Guarantors
listed on Schedule I thereto, and the Bank of New York with respect to the issuance
of $150,000,000 in Principal Amount of Second Priority Secured Notes due 2009
(incorporated herein by reference to Exhibit 4.2 to the March 2002 10-Q).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|4.3    |  | Note issued in connection with the Indenture dated as of May 13, 2002, among Mariner
Health Care, Inc., the Guarantors listed on Schedule I thereto and the Bank of New
York with respect to the issuance of $150,000,000 in Principal Amount of Second
Priority Secured Notes due 2009 (included in Exhibit 4.2 hereto).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|4.4    |  | Common Stock Certificate for the Common Stock of Mariner Health Care, Inc., par value
$.01 per share (incorporated herein by reference to Exhibit 4.4 to the March 2002
10-Q).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|4.5     |  | Form of Series A 8 1/4% Senior Subordinated Note Due 2013.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|4.6     |  | Form of Series B 8 1/4% Senior Subordinated Note Due 2013.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|4.7     |  | Indenture dated as of December 19, 2003, among Mariner Health
Care, Inc., each of the Guarantors as named therein, and
U.S. Bank National Association.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|4.8    |  | Promissory Note, in the principal amount of $13,086,957.00, dated as
of October 1, 2003 from FC Properties III, LLC in favor of
Mariner Health Care, Inc. (incorporated herein by reference to
Exhibit 10.4 to the September 2003 10-Q).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.1   |  | Equity Registration Rights Agreement, dated as of May 13, 2002 by and among Mariner
Health Care, Inc., and OCM Administrative Services II, L.L.C. (incorporated herein by
reference to Exhibit 10.1 to the March 2002 10-Q).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.2   |  | Debt Registration Rights Agreement, dated as of May 13, 2002 by and among Mariner
Health Care, Inc. and OCM Administrative Services II, L.L.C. (incorporated herein by
reference to Exhibit 10.2 to the March 2002 10-Q).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.3   |  | Credit and Guaranty Agreement dated as of May 13, 2002 among Mariner Health Care,
Inc., certain subsidiaries of Mariner Health Care, Inc., as Guarantors, various
Lenders, Goldman Sachs Credit Partners L.P., and UBS Warburg LLC, as Joint Lead
Arrangers, Goldman Sachs Credit Partners L.P., as Syndication Agent, General Electric
Capital Corporation, as Collateral Monitoring Agent and Documentation Agent, and UBS
AG Stamford Branch, as Administrative Agent, with respect to $297,000,000 Senior
Secured Credit Facilities (incorporated herein by reference to Exhibit 10.3 to the
March 2002 10-Q).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.4   |  | Pledge and Security Agreement dated as of May 13, 2002 between each of Mariner Health
Care, Inc., and the other Grantors party thereto, and Residential Funding Corporation
d/b/a GMAC-RFC Health Capital, as the Joint Collateral Agent (incorporated herein by
reference to Exhibit 10.4 to the March 2002 10-Q).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.5   |  | Intercreditor and Collateral Agency Agreement dated as of May 13, 2002 among (i)
Residential Funding Corporation d/b/a GMAC-RFC Health Capital, as Joint Collateral
Agent thereunder, (ii) UBS AG, Stamford Branch, in its capacity as Administrative
Agent, the Bank of New York, as trustee under the Rollover Note Indenture referred to
therein, and Mariner Health Care, Inc. (incorporated herein by reference to Exhibit
10.5 to the March 2002 10-Q).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|*10.6  |  | Employment Agreement dated April 4, 2002, between C. Christian Winkle, President and
Chief Executive Officer of Mariner Health Care, Inc., and Mariner Health Care, Inc.
(incorporated herein by reference to Exhibit 10.1 to the Companys Quarterly Report
on Form 10-Q for the quarter ended June 30, 2002 (the June 2002 10-Q)).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|*10.7  |  | Employment Agreement dated May 13, 2002, between Boyd P. Gentry, Senior Vice
President and Treasurer of Mariner Health Care, Inc., and Mariner Health Care
Management Company (incorporated herein by reference to Exhibit 10.2 to the June 2002
10-Q).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          





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|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Number  |  | Exhibit                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|*10.8  |  | Employment Agreement dated May 13, 2002, between Stefano Miele, Senior Vice
President, General Counsel and Secretary of Mariner Health Care, Inc., and Mariner
Health Care Management Company (incorporated herein by reference to Exhibit 10.3 to
the June 2002 10-Q).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|*10.9  |  | Employment Agreement dated May 13, 2002, between Terry P. OMalley, Senior Vice
President, Human Resources of Mariner Health Care, Inc., and Mariner Health Care
Management Company (incorporated herein by reference to Exhibit 10.4 to the June
2002 10-Q).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|*10.10 |  | Employment Agreement dated May 13, 2002, between William C. Straub, Senior Vice
President and Chief Accounting Officer of Mariner Health Care, Inc., and Mariner
Health Care Management Company (incorporated herein by reference to Exhibit 10.5 to
the June 2002 10-Q).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|*10.11 |  | Employment Agreement dated May 13, 2002, between John M. Notermann, Senior Vice
President, Corporate Development of Mariner Health Care, Inc., and Mariner Health
Care Management Company (incorporated herein by reference to Exhibit 10.6 to the
June 2002 10-Q).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|*10.12 |  | Employment Agreement dated May 13, 2002, between David F. Polakoff, M.D., Senior
Vice President, Chief Medical Officer of Mariner Health Care, Inc., and Mariner
Health Care Management Company (incorporated herein by reference to Exhibit 10.7 to
the June 2002 10-Q).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.13  |  | Civil and Administrative Settlement Agreement by and between the United States of
America, acting through the United States Department of Justice, and on behalf of
the Office of Inspector General of the Department of Health and Human Services and
Mariner Post-Acute Network, Inc. (the predecessor company to Mariner Health Care,
Inc.), Mariner Health Group, Inc. and Affiliated Debtors dated March 25, 2002
(incorporated herein by reference to Exhibit 10.8 to the June 2002 10-Q).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.14  |  | Corporate Integrity Agreement between the Office of Inspector General of the
Department of Health and Human Services and Mariner Health Care, Inc. effective as
of April 3, 2002 (incorporated herein by reference to Exhibit 10.9 to the June 2002
10-Q).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.15  |  | Form of Management Agreement dated as of May 13, 2002, by and between Mariner Health
Care Management Company and the subsidiaries of Mariner Health Care, Inc. operating
skilled nursing facilities (incorporated herein by reference to Exhibit 10.10 to the
June 2002 10-Q).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.16  |  | Mariner Health Care, Inc. 2002 Stock Incentive Plan (incorporated herein by
reference to Exhibit 10.11 to the June 2002 10-Q).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.17  |  | Mariner Health Care, Inc. 2002 Outside Directors Stock Option Plan (incorporated
herein by reference to Exhibit 10.12 to the June 2002 10-Q).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.18  |  | First Amendment to Credit and Guaranty Agreement dated as of August 9, 2002, by and
among Mariner Health Care, Inc., certain subsidiaries of Mariner Health Care, Inc.,
Goldman Sachs Credit Partners L.P., UBS Warburg LLC, UBS AG, Stamford Branch,
General Electric Capital Corporation, and Residential Funding Corporation dba
GMAC-RFC Health Capital (incorporated herein by reference to Exhibit 10.13 to the
June 2002 10-Q).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|*10.19 |  | Separation Agreement and General Release between Susan Thomas Whittle and Mariner
Post-Acute Network, Inc. (incorporated herein by reference to Exhibit 10.14 to the
June 2002 Form 10-Q).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|*10.20 |  | Employment Agreement dated as of December 4, 2002, between Michael Boxer and Mariner
Health Care, Inc. (incorporated herein by reference to Exhibit 10.20 to the
Companys Registration Statement on Form S-1 dated November 12, 2002).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.21  |  | Second Amendment and Limited Waiver to Credit and Guaranty Agreement dated as of
March 31, 2003 by and among Mariner Health Care, Inc., certain subsidiaries of
Mariner Health Care, Inc. and certain other signatories thereto (incorporated
herein by reference to Exhibit 10.21 to the
Companys Annual Report on Form 10-K for fiscal year ended
December 31, 2002).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.22  |  | Third Amendment to Credit and Guaranty Agreement dated as of
September 30, 2003 by and among Mariner Health Care, Inc.,
certain subsidiaries of Mariner Health Care, Inc. and certain other
signatories thereto (incorporated herein by reference to
Exhibit 10.1 to the September 2003 10-Q).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.23   |  | First Amendment to Settlement Agreement, made and entered into as of
October 27, 2003, by and among: Mariner Health Care, Inc.,
individually and on behalf of each of its subsidiaries and affiliates
identified on Exhibit A; and Belleair East Medical Investors, Ltd.
(L.P.), Dallas Medical Investors, Ltd. (L.P.), Denver Medical
Investors, Ltd. (L.P.), Ft. Bend Medical Investors, Ltd. (L.P.),
Houston-Northwest Medical Investors, Ltd. (L.P.), Melbourne
Healthcare Associates, Ltd., Northwest Healthcare, L.P., Orange
Healthcare, Ltd. (L.P.), Pinellas III Healthcare, Ltd. (L.P.), Polk
Healthcare, Ltd. (L.P.), Pt. Charlotte Healthcare, Ltd. (L.P.), South
Denver Healthcare Associates, Ltd. (L.P.), and Tallahassee Healthcare
Associates, Ltd. (L.P.); and Arlington Heights Medical Investors,
Ltd., Villa Medical Investors, Ltd., Kenansville Medical Investors,
Ltd., Creek Forest, Limited, Ft. Worth Medical Investors, Ltd.,
Samuel B. Kellett, Stiles A. Kellett, Jr., Sun City Center
Associates, Ltd. (L.P.), The Charlotte Rich Kellett Irrevocable Trust
dated November 1, 1991, acting through William R. Bassett, as
Trustee, Kellett Partners, L.P., and The Samuel B. Kellett, Jr.
Irrevocable Trust dated November 1, 1991, acting through William R.
Bassett, as Trustee.
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.24   |  | Registration Rights Agreement, dated as of
December 19, 2003 by and among Mariner Health Care, Inc.,
various Guarantors, CIBC World Markets Corp., J.P. Morgan Securities
Inc., Lehman Brothers Inc. and Citigroup Global Markets Inc.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.25   |  | Credit and Guaranty Agreement dated as of December 19, 2003 among
Mariner Health Care, Inc., certain subsidiaries of Mariner Health
Care, Inc. as Guarantors, various Lenders party thereto, CIBC World
Markets Corp., J.P. Morgan Securities, Inc. and Lehman Brothers Inc.
as Joint Lead Arrangers, JPMorgan Chase Bank and Lehman Commercial
Paper Inc. as Co-Syndication Agents, Citicorp North America, Inc. and
General Electric Capital Corporation as Co-Documentation Agents and
Canadian Imperial Bank of Commerce as Administrative Agent and
Collateral Agent.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.26   |  | Pledge and Security Agreement dated as of December 19, 2003 among
Mariner Health Care, Inc. and the other Grantors party thereto and
Canadian Imperial Bank of Commerce as Collateral Agent.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|       
|10.27   |  | Mariner Health Care,
Inc. 2003 Outside Directors Stock Incentive Plan (amending and
restating the Mariner Health Care, Inc. 2002 Outside Directors
Stock Incentive Plan).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|21      |  | Subsidiaries of the Company.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|23      |  | Consent of Ernst and Young LLP.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|31.1    |  | Certification of the Chief Executive Officer pursuant to 15 U.S.C.
Section 7241, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|31.2    |  | Certification of the Chief Financial Officer pursuant to 15 U.S.C.
Section 7241, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|32.1    |  | Confirmation Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|32.2    |  | Confirmation Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

    Not filed herewith. In accordance with Rule 12b-32
of the General Rules and Regulations under the Exchange Act, reference is made to the document previously filed with the SEC.

*    Management contract or compensatory plan or arrangement.

(b)  Reports on Form 8-K

The
Company filed Current Reports on Form 8-K on October 15, 2003
(divestiture of certain Florida facilities); October 30, 2003
(termination of certain Florida leases); December 2, 2003
(divestiture of Florida and Louisiana facilities and note offering);
December 16, 2003 (agreement to sell notes); and December 22, 2003 (closing of note offering and senior credit facility).





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##### Table of Contents






SIGNATURES

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

| |  |                           |  |                                      
| |  | ------------------------- |  | -------------------------------------
| |  | MARINER HEALTH CARE, INC.
| |  |                           |  |                                      
| |  | By:                       |  | /s/ C. Christian Winkle              
| |  |                           |  |                                      
| |  |                           |  | C. Christian Winkle                  
| |  |                           |  | President and Chief Executive Officer

Date: March 15, 2004

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

|                                             |  |                                                                                            |  |               
|-------------------------------------------- |  | ------------------------------------------------------------------------------------------ |  | --------------
|Signature                                    |  | Title                                                                                      |  | Date          
|                                             |  |                                                                                            |  |               
|/s/ C. Christian Winkle

C. Christian Winkle |  | President, Chief Executive Officer
and Director (Principal Executive Officer)              |  | March 15, 2004
|                                             |  |                                                                                            |  |               
|/s/ Michael E. Boxer

Michael E. Boxer       |  | Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)         |  | March 15, 2004
|                                             |  |                                                                                            |  |               
|/s/ William C. Straub

William C. Straub     |  | Senior Vice President,
Controller, Chief Accounting
Officer (Principal Accounting Officer) |  | March 15, 2004
|                                             |  |                                                                                            |  |               
|/s/ Victor L. Lund

Victor L. Lund           |  | Chairman of the Board                                                                      |  | March 15, 2004
|                                             |  |                                                                                            |  |               
|/s/ Earl P. Holland

Earl P. Holland         |  | Director                                                                                   |  | March 15, 2004
|                                             |  |                                                                                            |  |               
|/s/ Philip L. Maslowe

Philip L. Maslowe     |  | Director                                                                                   |  | March 15, 2004
|                                             |  |                                                                                            |  |               
|/s/ Mohsin Y. Meghji

Mohsin Y. Meghji       |  | Director                                                                                   |  | March 15, 2004
|                                             |  |                                                                                            |  |               

-68-



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##### Table of Contents



REPORT OF INDEPENDENT AUDITORS

To the Stockholders and Board of Directors of Mariner Health Care, Inc.

We have audited the accompanying consolidated balance sheets of Mariner Health
Care, Inc. and subsidiaries as of December 31, 2003 and 2002, and the related
consolidated statements of operations, stockholders equity (deficit) and cash
flows for the year ended December 31, 2003, the eight months ended December 31,
2002, the four months ended April 30, 2002, the three months ended December 31,
2001 and for the year ended September 30, 2001. Our audits also included the
financial statement schedule listed in the index at Item 15. These consolidated
financial statements and schedule is the responsibility of the Companys
management. Our responsibility is to express an opinion on these consolidated
financial statements and schedule based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Mariner Health Care, Inc. and subsidiaries at December 31, 2003 and 2002, and
the consolidated results of their operations and their cash flows for year
ended December 31, 2003, the eight months ended December 31, 2002, the four
months ended April 30, 2002, the three months ended December 31, 2001 and for
the year ended September 30, 2001, in conformity with accounting principles
generally accepted in the United States. Also, in our opinion, the related
financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein.

As discussed in Note 2 to the consolidated financial statements, the Company
changed its method of accounting for goodwill during 2002. Furthermore, as
discussed in Notes 2 and 17 to the consolidated financial statements, the
consolidated financial statements also reflect the application of fresh-start
reporting as of May 1, 2002 and, therefore, the consolidated financial
statements for periods after May 1, 2002 are not comparable in all respects to
the consolidated financial statements for periods prior to such date.

| |  |                  
| |  | -----------------
| |  | ERNST & YOUNG LLP

Atlanta, Georgia
February 20, 2004

F-1



---



##### Table of Contents



MARINER HEALTH CARE, INC.
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share amounts) December 31,
    
    December 31,2003
    
    2002ASSETSCurrent assetsCash and cash equivalents
    
    $
    41,934
    
    
    $
    38,618Receivables, net of allowance for doubtful accounts of $97,448 and
$72,996
    
    
    234,098
    
    
    
    264,092Prepaid expenses and other current assets
    
    
    25,396
    
    
    
    34,947Total current assets
    
    
    301,428
    
    
    
    337,657Property and equipment, net
    
    
    544,356
    
    
    
    567,260Reorganization value in excess of amounts allocable to identifiable assets
    
    
    192,771
    
    
    
    201,388Goodwill, net
    
    
    6,797
    
    
    
    6,797Restricted investments
    
    
    19,300
    
    
    
    38,693Other assets
    
    
    43,082
    
    
    
    26,943Total assets
    
    $
    1,107,734
    
    
    $
    1,178,738LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilitiesCurrent maturities of long-term debt
    
    $
    9,663
    
    
    $
    9,793Accounts payable
    
    
    69,914
    
    
    
    48,417Accrued compensation and benefits
    
    
    69,330
    
    
    
    68,444Accrued insurance obligations
    
    
    54,315
    
    
    
    28,650Other current liabilities
    
    
    42,202
    
    
    
    65,787Total current liabilities
    
    
    245,424
    
    
    
    221,091Long-term debt, net of current maturities
    
    
    379,973
    
    
    
    474,969Long-term insurance reserves
    
    
    191,124
    
    
    
    195,562Other liabilities
    
    
    31,741
    
    
    
    14,044Minority interest
    
    
    3,319
    
    
    
    4,677Total liabilities
    
    
    851,581
    
    
    
    910,343Stockholders equityPreferred stock, $.01 par value; 10,000,000 shares
authorized; none issued or outstanding
    
    
    
    
    
    
    Common stock, $.01 par value; 80,000,000 shares
authorized; 20,007,500 shares issued; 20,007,500 outstanding
    
    
    200
    
    
    
    200Warrants to purchase common stock
    
    
    935
    
    
    
    935Capital surplus
    
    
    360,141
    
    
    
    358,977Unearned compensation
    
    
    (616
    )
    
    
    Accumulated deficit
    
    
    (104,844
    )
    
    
    (92,048
    )Accumulated other comprehensive income
    
    
    337
    
    
    
    331Total stockholders equity
    
    
    256,153
    
    
    
    268,395Total liabilities and stockholders equity
    
    $
    1,107,734
    
    
    $
    1,178,738
 The accompanying notes are an integral part of these consolidated financial statements. F-2




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##### Table of Contents



MARINER HEALTH CARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS(dollars in thousands, except per share amounts) Reorganized Company
    
    
    Predecessor CompanyYear
    
    Eight Months
    

    Four Months
    
    Three Months
    
    YearEnded
    
    Ended
    

    Ended
    
    Ended
    
    EndedDecember 31,
    
    December 31,
    

    April 30,
    
    December 31,
    
    September 30,2003
    
    2002
    

    2002
    
    2001
    
    2001Net revenue
    
    $
    1,715,367
    
    
    $
    1,163,006
    
    

    $
    591,067
    
    
    $
    450,542
    
    
    $
    1,840,654Costs and expensesOperating expenseWage and related costs
    
    
    1,015,007
    
    
    
    679,938
    
    

    
    342,040
    
    
    
    261,114
    
    
    
    1,043,133Supplies
    
    
    100,490
    
    
    
    71,285
    
    

    
    36,466
    
    
    
    28,901
    
    
    
    120,768Insurance
    
    
    78,871
    
    
    
    55,392
    
    

    
    30,550
    
    
    
    24,172
    
    
    
    94,837Divestiture related charges
    
    
    49,564
    
    
    
    
    
    

    
    
    
    
    
    
    
    
    
    Provision for bad debt
    
    
    20,345
    
    
    
    8,347
    
    

    
    23,758
    
    
    
    7,080
    
    
    
    26,523Rent expense
    
    
    35,650
    
    
    
    25,463
    
    

    
    12,991
    
    
    
    10,393
    
    
    
    49,767Other
    
    
    294,779
    
    
    
    200,721
    
    

    
    98,020
    
    
    
    71,613
    
    
    
    343,898Total operating expenses
    
    
    1,594,706
    
    
    
    1,041,146
    
    

    
    543,825
    
    
    
    403,273
    
    
    
    1,678,926General and
administrative expenses
    
    
    99,103
    
    
    
    47,072
    
    

    
    25,213
    
    
    
    18,943
    
    
    
    73,957Depreciation and amortization
    
    
    37,082
    
    
    
    22,764
    
    

    
    11,556
    
    
    
    10,928
    
    
    
    48,687(Gain) loss on sale of divested facilities
    
    
    (25,197
    )
    
    
    2,122
    
    

    
    
    
    
    
    
    
    
    
    Impairment of long-lived assets
    
    
    
    
    
    
    84,600
    
    

    
    
    
    
    
    
    
    
    
    Loss on settlement with government
    
    
    
    
    
    
    
    
    

    
    
    
    
    
    
    
    
    
    33,410Total costs and expenses
    
    
    1,705,694
    
    
    
    1,197,704
    
    

    
    580,594
    
    
    
    433,144
    
    
    
    1,834,980Operating income (loss)
    
    
    9,673
    
    
    
    (34,698
    )
    

    
    10,473
    
    
    
    17,398
    
    
    
    5,674Other (expenses) incomeInterest expense (Contractual interest for the four
months ended April 30, 2002 was $45,697, for the
three
months ended December 31, 2001 was $43,487 and
for the fiscal year ended September 30, 2001
was $201,066)
    
    
    (36,493
    )
    
    
    (26,972
    )
    

    
    (2,918
    )
    
    
    (3,398
    )
    
    
    (4,613
    )Loss on write-off of deferred financing costs
    
    
    (5,941
    )
    
    
    
    
    

    
    
    
    
    
    
    
    
    
    Interest income
    
    
    2,747
    
    
    
    5,485
    
    

    
    1,154
    
    
    
    2,602
    
    
    
    6,005Reorganization items
    
    
    
    
    
    
    
    
    

    
    1,394,309
    
    
    
    (13,153
    )
    
    
    (47,721
    )Other
    
    
    1,345
    
    
    
    (336
    )
    

    
    1,495
    
    
    
    (15
    )
    
    
    (462
    )(Loss) income from continuing operations before income
taxes
    
    
    (28,669
    )
    
    
    (56,521
    )
    

    
    1,404,513
    
    
    
    3,434
    
    
    
    (41,117
    )(Benefit) provision for income taxes
    
    
    (6,142
    )
    
    
    1,323
    
    

    
    (144
    )
    
    
    (25
    )
    
    
    (5,706
    )(Loss) income from continuing operations
    
    
    (22,527
    )
    
    
    (57,844
    )
    

    
    1,404,657
    
    
    
    3,459
    
    
    
    (35,411
    )Discontinued operations(Loss) income from discontinued
operations, net of tax
    
    
    (1,583
    )
    
    
    (470
    )
    

    
    216
    
    
    
    936
    
    
    
    2,016Gain on sale of discontinued
operations, net of tax
    
    
    11,314
    
    
    
    
    
    

    
    29,082
    
    
    
    
    
    
    
    Net (loss) income
    
    $
    (12,796
    )
    
    $
    (58,314
    )
    

    $
    1,433,955
    
    
    $
    4,395
    
    
    $
    (33,395
    )(Loss)
earnings per share - basic and diluted(Loss) income from continuing operations
    
    $
    (1.13
    )
    
    $
    (2.89
    )
    

    $
    19.06
    
    
    $
    0.05
    
    
    $
    (0.48
    )(Loss) income from discontinued operations
    
    
    (0.08
    )
    
    
    (0.03
    )
    

    
    
    
    
    
    0.01
    
    
    
    0.03Gain on sale of discontinued operations
    
    
    0.57
    
    
    
    
    
    

    
    0.40
    
    
    
    
    
    
    
    Net (loss) income per share
    
    $
    (0.64
    )
    
    $
    (2.92
    )
    

    $
    19.46
    
    
    $
    0.06
    
    
    $
    (0.45
    )
 The accompanying notes are an integral part of these consolidated financial statements. F-3




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##### Table of Contents



MARINER HEALTH CARE, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
AND COMPREHENSIVE INCOME (LOSS)
(dollars and shares in thousands) Warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    Accumulatedto
    
    
    
    
    
    
    
    
    
    
    
    
    
    OtherCommon Stock
    
    Purchase
    
    
    
    
    
    
    
    
    
    
    
    
    
    ComprehensiveCommon
    
    Capital
    
    Unearned
    
    Accumulated
    
    IncomePredecessor Company
    
    Shares
    
    Par Value
    
    Stock
    
    Surplus
    
    Compensation
    
    Deficit
    
    (Loss)
    
    TotalBalance, September 30, 2000
    
    
    73,688
    
    
    $
    737
    
    
    
    
    
    
    $
    980,952
    
    
    $
    
    
    
    $
    (2,420,378
    )
    
    $
    (1,488
    )
    
    $
    (1,440,177
    )Components of comprehensive lossNet loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (33,395
    )
    
    
    
    
    
    
    (33,395
    )Unrealized gain on securities
available-for-sale, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,063
    
    
    
    2,063Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (31,332
    )Balance, September 30, 2001
    
    
    73,688
    
    
    
    737
    
    
    
    
    
    
    
    980,952
    
    
    
    
    
    
    
    (2,453,773
    )
    
    
    575
    
    
    
    (1,471,509
    )Components of comprehensive incomeNet income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,395
    
    
    
    
    
    
    
    4,395Unrealized loss on securities
available-for-sale, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (146
    )
    
    
    (146
    )Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,249Balance, December 31, 2001
    
    
    73,688
    
    
    
    737
    
    
    
    
    
    
    
    980,952
    
    
    
    
    
    
    
    (2,449,378
    )
    
    
    429
    
    
    
    (1,467,260
    )Components of comprehensive incomeNet income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,433,955
    
    
    
    
    
    
    
    1,433,955Unrealized loss on securities
available-for-sale, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (603
    )
    
    
    (603
    )Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,433,352Balance, April 30, 2002
    
    
    73,688
    
    
    
    737
    
    
    
    
    
    
    
    980,952
    
    
    
    
    
    
    
    (1,015,423
    )
    
    
    (174
    )
    
    
    (33,908
    )Fresh-start accounting adjustments
    
    
    (73,688
    )
    
    
    (737
    )
    
    
    
    
    
    
    (980,952
    )
    
    
    
    
    
    
    981,689
    
    
    
    
    
    
    
    Issuance of common stock
    
    
    20,000
    
    
    
    200
    
    
    
    
    
    
    
    358,977
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    359,177Issuance of warrants to purchase
common stock
    
    
    
    
    
    
    
    
    
    $
    935
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    935Reorganized CompanyBalance, May 1, 2002
    
    
    20,000
    
    
    
    200
    
    
    
    935
    
    
    
    358,977
    
    
    
    
    
    
    
    (33,734
    )
    
    
    (174
    )
    
    
    326,204Components of comprehensive lossNet loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (58,314
    )
    
    
    
    
    
    
    (58,314
    )Unrealized gain on securities
available-for-sale, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    505
    
    
    
    505Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (57,809
    )Balance, December 31, 2002
    
    
    20,000
    
    
    
    200
    
    
    
    935
    
    
    
    358,977
    
    
    
    
    
    
    
    (92,048
    )
    
    
    331
    
    
    
    268,395Grant of restricted stock to directors
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,164
    
    
    $
    (1,164
    )
    
    
    
    
    
    
    
    
    
    
    Amortization of unearned compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    548
    
    
    
    
    
    
    
    
    
    
    
    548Issuance of restricted stock to directors
    
    
    8
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Components of comprehensive lossNet loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (12,796
    )
    
    
    
    
    
    
    (12,796
    )Unrealized loss on securities
available-for-sale, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6
    
    
    
    6Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (12,790
    )Balance, December 31, 2003
    
    
    20,008
    
    
    $
    200
    
    
    $
    935
    
    
    $
    360,141
    
    
    $
    (616
    )
    
    $
    (104,844
    )
    
    $
    337
    
    
    $
    256,153
 The accompanying notes are an integral part of these consolidated financial statements. F-4




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##### Table of Contents



MARINER HEALTH CARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands) Reorganized Company
    

    Predecessor CompanyYear
    
    Eight Months
    

    Four Months
    
    Three Months
    
    YearEnded
    
    Ended
    

    Ended
    
    Ended
    
    EndedDecember 31,
    
    December 31,
    

    April 30,
    
    December 31,
    
    September 30,2003
    
    2002
    

    2002
    
    2001
    
    2001Cash flows from operating activitiesNet (loss) income
    
    $
    (12,796
    )
    
    $
    (58,314
    )
    

    $
    1,433,955
    
    
    $
    4,395
    
    
    $
    (33,395
    )Adjustments to reconcile net (loss) income to net cash
provided by operating activitiesProvision for bad debt
    
    
    42,391
    
    
    
    4,749
    
    

    
    25,240
    
    
    
    7,754
    
    
    
    27,790(Gain) loss on sale of divestitures
    
    
    (36,511
    )
    
    
    2,122
    
    

    
    (29,082
    )
    
    
    
    
    
    
    Depreciation and amortization
    
    
    37,082
    
    
    
    22,764
    
    

    
    11,556
    
    
    
    10,928
    
    
    
    48,686Amortization of deferred financing costs
    
    
    7,288
    
    
    
    669
    
    

    
    
    
    
    
    
    
    
    
    Stock compensation
    
    
    548
    
    
    
    
    
    

    
    
    
    
    
    
    
    
    
    Impairment of long-lived assets
    
    
    
    
    
    
    84,600
    
    

    
    
    
    
    
    
    
    
    
    Loss on settlement with government
    
    
    
    
    
    
    
    
    

    
    
    
    
    
    
    
    
    
    33,410Casualty gain
    
    
    
    
    
    
    
    
    

    
    (1,527
    )
    
    
    
    
    
    
    Reorganization items
    
    
    
    
    
    
    
    
    

    
    (1,394,309
    )
    
    
    13,153
    
    
    
    47,721Minority interest and other
    
    
    (712
    )
    
    
    336
    
    

    
    33
    
    
    
    15
    
    
    
    462(Benefit) provision for income taxes
    
    
    (6,142
    )
    
    
    1,323
    
    

    
    (144
    )
    
    
    (25
    )
    
    
    (5,706
    )Loss (income) loss from discontinued
operations
    
    
    1,583
    
    
    
    470
    
    

    
    (216
    )
    
    
    (936
    )
    
    
    (2,016
    )Changes in operating assets and liabilitiesReceivables
    
    
    (19,960
    )
    
    
    (39,816
    )
    

    
    (12,832
    )
    
    
    (4,630
    )
    
    
    (59,426
    )Prepaid expenses and other current assets
    
    
    5,134
    
    
    
    1,539
    
    

    
    3,128
    
    
    
    7,190
    
    
    
    21,327Accounts payable
    
    
    21,719
    
    
    
    (5,262
    )
    

    
    (25,512
    )
    
    
    (6,478
    )
    
    
    22,652Accrued and other current liabilities
    
    
    392
    
    
    
    (24,035
    )
    

    
    25,382
    
    
    
    (13,574
    )
    
    
    (15,262
    )Insurance reserves
    
    
    21,227
    
    
    
    22,116
    
    

    
    11,369
    
    
    
    14,926
    
    
    
    53,903Other
    
    
    (3,037
    )
    
    
    (1,672
    )
    

    
    (8,418
    )
    
    
    (468
    )
    
    
    (4,288
    )Net cash provided by operating activities of
continuing operations before reorganization items
    
    
    58,206
    
    
    
    11,589
    
    

    
    38,623
    
    
    
    32,250
    
    
    
    135,858Net cash (utilized) provided by discontinued operations
    
    
    (180
    )
    
    
    (1,563
    )
    

    
    (78
    )
    
    
    2,285
    
    
    
    8,021Payment of reorganization items, net
    
    
    (16,087
    )
    
    
    (38,178
    )
    

    
    (35,813
    )
    
    
    (14,824
    )
    
    
    (46,191
    )Cash flows from investing activitiesPurchases of property and equipment
    
    
    (74,102
    )

    
    
    (33,565
    )
    

    
    (27,553
    )
    
    
    (6,229
    )
    
    
    (31,902
    )Acquisition of a skilled nursing facility
    
    
    
    
    
    
    (8,900
    )
    

    
    
    
    
    
    
    
    
    
    Proceeds from divestitures and sales of property,
equipment and other assets
    
    
    91,269
    
    
    
    4,065
    
    

    
    92,446
    
    
    
    32
    
    
    
    7,900Restricted investments
    
    
    19,399
    
    
    
    12,319
    
    

    
    (14,975
    )
    
    
    (5,082
    )
    
    
    3,393Net collections on notes receivable
    
    
    471
    
    
    
    58
    
    

    
    146
    
    
    
    595
    
    
    
    1,171Insurance proceeds
    
    
    2,896
    
    
    
    7,414
    
    

    
    6,020
    
    
    
    
    
    
    
    Net cash provided (utilized) by investing activities
    
    
    39,933
    
    
    
    (18,609
    )
    

    
    56,084
    
    
    
    (10,684
    )
    
    
    (19,438
    )Cash flows from financing activitiesRepayment of long-term debt
    
    
    (375,364
    )
    
    
    (5,881
    )
    

    
    (386,872
    )
    
    
    (4,337
    )
    
    
    (39,668
    )Proceeds from issuance of long-term debt
    
    
    310,000
    
    
    
    
    
    

    
    212,000
    
    
    
    
    
    
    
    Payment of deferred financing fees
    
    
    (13,192
    )
    
    
    
    
    

    
    (6,424
    )
    
    
    
    
    
    
    Net cash utilized by financing activities
    
    
    (78,556
    )
    
    
    (5,881
    )
    

    
    (181,296
    )
    
    
    (4,337
    )
    
    
    (39,668
    )Increase (decrease) in cash and cash equivalents
    
    
    3,316
    
    
    
    (52,642
    )
    

    
    (122,480
    )
    
    
    4,690
    
    
    
    38,582Cash and cash equivalents, beginning of period
    
    
    38,618
    
    
    
    91,260
    
    

    
    213,740
    
    
    
    209,050
    
    
    
    170,468Cash and cash equivalents, end of period
    
    $
    41,934
    
    
    $
    38,618
    
    

    $
    91,260
    
    
    $
    213,740
    
    
    $
    209,050
 The accompanying notes are an integral part of these consolidated financial statements. F-5




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##### Table of Contents



NOTE 1 NATURE OF BUSINESS Reporting Entity Mariner Health Care, Inc. and its subsidiaries (collectively the Company)
provide post-acute health care services, primarily through the operation of
skilled nursing facilities. As of December 31, 2003, the Company operated 256
skilled nursing facilities and eight stand-alone assisted living facilities
with an aggregate of 31,489 licensed beds. The Company owns 70% of its
facilities. The Company also operates eleven long-term acute care hospitals
(LTACs) in four states, with 613 licensed beds. The Companys facilities are
located in 23 states with significant concentrations in Texas, North Carolina,
California, Colorado and Maryland and clusters in twelve geographic markets in
nine of the states in which the Company operates. Skilled nursing services and
LTACs represent the Companys two reportable segments (see Note 21). The Company and certain of its subsidiaries emerged from bankruptcy on May 13,
2002 (the Effective Date) pursuant to the terms of the Joint Plan of
Reorganization (the Joint Plan) filed by Mariner Post-Acute Network Inc.
(MPAN) and Mariner Health Group, Inc. (MHG) and certain of their respective
subsidiaries, as amended and approved by the United States Bankruptcy Court for
the District of Delaware (the Bankruptcy Court), and changed its name from
MPAN to Mariner Health Care, Inc. In October 2001, the Company received the approval of the Bankruptcy Court to
sell its institutional pharmacy services business (the APS Division). The
Company consummated the sale of the APS Division on January 6, 2002.
Accordingly, the results of the APS Division have been treated as a
discontinued operation in accordance with accounting principles generally
accepted in the United States (see Note 4). Change in Year-End On December 13, 2001, the Board of Directors of the Company elected to change
the Companys fiscal year end from September 30 to December 31. Recent Developments Refinancing On December 19, 2003, the Company entered into a senior
credit facility
(the Senior Credit Facility) with a syndicate of lenders, which provides for a
$135.0 million term loan
facility (the Term Loan) and a $90.0 million revolving credit
facility (the Revolving Credit Facility). The Term Loan was
drawn in full on December 19, 2003. As of December 31, 2003, there were no
borrowings under the Revolving Credit Facility, although the Company utilized
approximately $34.6 million of borrowing capacity under the
Revolving Credit
Facility to issue letters of credit on the closing date to replace or
support letters of
credit issued under the Companys previous senior credit facility and other
loan arrangements. Also on December 19, 2003, the Company consummated an
offering for $175.0 million aggregate principal amount of 8.25% senior
subordinated notes (the Notes) due December 15, 2013. The Notes are unsecured senior
subordinated obligations and will be subordinated in right of payment to the
Senior Credit Facility, other existing senior indebtedness and future
senior indebtedness. The Company used the net proceeds of the Senior
Credit Facility and notes to redeem the then existing senior subordinated
notes, repay borrowings under the previous senior credit facility, and pay fees
and expenses associated with the new financing transactions (see Note 10). Divestiture of Florida and Louisiana facilities During the quarter ended December 31, 2003, the Company
sold 19 skilled
nursing facilities and terminated operating and capital leases with respect to
an additional eleven skilled nursing facilities in Florida and Louisiana (the
Divested Facilities) for net cash proceeds of $73.1 million and a $13.1
million five-year subordinated promissory note with an annual interest rate of
8%. These divestitures resulted in a $56.9 million reduction
of our then existing senior
debt, an $11.4 million retirement of facility specific mortgage indebtedness
and a $29.8 million elimination of capital lease indebtedness. The Company
recognized a pre-tax gain on sale of assets of $25.2 million and $49.6 million
of pre-tax operating expenses as a result of the divestitures that did not
qualify for discontinued operations under Statement of Financial Accounting
Standards (SFAS) No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets (SFAS No. 144). For the facilities sold in Florida and
Louisiana that did qualify for discontinued operations, the Company recorded a
$1.1 million gain, net of tax, which is included in gain on sale of
discontinued operations in the accompanying consolidated statements of
operations (see Note 4). F-6




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##### Table of Contents



NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The accompanying consolidated
financial statements have been prepared in accordance with in
accordance with accounting principles generally
accepted in the United States of America (GAAP).
The preparation of financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities at the date of the
financial statements, and the reported amounts of revenue and expenses during
the reporting period. Although these estimates are based on managements
knowledge of current events, they may ultimately differ from actual results as
a result of a number of factors, including those discussed elsewhere in this
report and in our other public filings from time to time. In connection with our emergence from bankruptcy, we reflected the terms of the
Joint Plan in our consolidated financial statements by adopting the principles
of fresh-start reporting in accordance with the American Institute of
Certified Public Accountants Statement of Position 90-7,
Financial Reporting by Entities in Reorganization Under the
Bankruptcy Code (SOP 90-7). Although our Joint Plan
became effective on May 13, 2002, for financial reporting purposes the
effective date of our Joint Plan was May 1, 2002. Under fresh-start reporting,
a new entity is deemed to be created for financial reporting purposes and the
recorded amounts of assets and liabilities are adjusted to reflect their
estimated fair values. Since fresh-start reporting materially changed the
amounts recorded in our consolidated financial statements, a black line
separates the financial data pertaining to periods after our adoption of
fresh-start reporting from the financial data pertaining
to periods prior to our adoption of fresh-start reporting to signify the
difference in the basis of preparation of financial information for each
respective entity. As a result of the adoption of fresh-start
reporting, our consolidated financial statements show periods after
May 1, 2002 as Reorganized Company periods and
periods prior to May 1, 2002 as Predecessor Company
periods. Unless stated otherwise as the Predecessor Company or the
Reorganized Company, all references to the Company include the
operations of both the Predecessor Company and Reorganized Company.
The Reorganized Company adopted the accounting policies of
Predecessor Company upon emergence from bankruptcy. In accordance
with the fresh-start reporting provisions of SOP 90-7, the Company also
adopted changes in accounting principles that were required in the
consolidated financial statements of the Reorganized Company within
the twelve-month period subsequent to the Effective Date. Between the date the Company
filed for protection under chapter 11 of title 11
(Chapter 11) of the United States Bankruptcy Code
(the Bankruptcy Code) on January 18, 2000 (the
Petition Date) and the Effective Date, we operated our business as a
debtor-in-possession subject to the jurisdiction of the Bankruptcy Court.
Accordingly, our consolidated financial statements prior to the adoption of
fresh-start reporting on May 1, 2002 have been presented in conformity with SOP
90-7 and were prepared on a going concern basis which assumed continuity of
operations and realization of assets and settlement of liabilities and
commitments in the ordinary course of business. As a result of our adoption of fresh start reporting, the book value of our
fixed assets and amortization schedules have changed. Because of our adoption
of fresh-start reporting, you will not be able to compare certain financial
information reflecting our results of operations and financial condition to
those for periods prior to our adoption of fresh-start reporting. Transition Period The following table presents summarized statements of operations information
for the following periods (in thousands of dollars): Predecessor CompanyThree Months Ended December 31,2001
    
    2000Net revenue
    
    $
    450,542
    
    
    $
    462,779Costs and expenses
    
    
    433,144
    
    
    
    443,693Operating income
    
    
    17,398
    
    
    
    19,086Other expenses
    
    
    (13,964
    )
    
    
    (10,050
    )Income from continuing operations before
income taxes
    
    
    3,434
    
    
    
    9,036(Benefit) Provision for income taxes
    
    
    (25
    )
    
    
    (197
    )Income from continuing operations
    
    
    3,459
    
    
    
    9,233Discontinued operationsIncome from discontinued operations, net of tax
    
    
    936
    
    
    
    677Net income
    
    $
    4,395
    
    
    $
    9,910
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Use of Estimates The preparation of financial
statements in conformity with GAAP requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Although these estimates are based on
managements knowledge of current events, they may ultimately differ from
actual results. Reclassifications Certain prior year amounts have been reclassified to conform to the current
year financial statement presentation. Stock Compensation Expense The Company accounts for stock options in accordance with Accounting Principles
Board (APB) Opinion 25, Accounting for Stock Issued to Employees (APB
25), and related interpretations. Accordingly, the Company recognizes no
compensation expense for stock option grants unless the stock options are
granted at an exercise price lower than the trading price on the date of grant,
or the options require variable accounting treatment. In accordance with
SFAS No. 123, Accounting for
Stock-Based Compensation (SFAS No. 123) as amended by SFAS No. 148,
Accounting for Stock-Based Compensation  Transition and Disclosure, an
Amendment of SFAS No. 123, (SFAS No. 148). The Company presents the
required disclosures under SFAS No. 148 prominently and in tabular format for
all periods presented (see Note 3). Cash and Cash Equivalents The Company considers all highly liquid, unrestricted investments with
remaining maturities of three months or less to be cash equivalents. Receivables Receivables consist primarily of amounts due from the Medicare and Medicaid
programs (Medicare and Medicaid were established in 1965 by the
Medicare and Medicaid Bill, Title XVII and Title XIX of the
Social Security Act, and the terms Medicare and
Medicaid refer to the programs established under the
Medicare and Medicaid Bill, as amended), other government programs, managed care health plans, commercial
insurance companies and individual patients and are recorded based on
estimated amounts due from third party payors and patients for health
care services provided. Interest is not charged on past due
receivables. Allowances for doubtful accounts
are established to the extent
that a portion of these receivables may become uncollectible. In establishing
the allowance for doubtful accounts, the Company considers a number of factors,
including the age of the accounts, changes in collection patterns, the
composition of patient accounts by payor type, the status of ongoing disputes
with third-party payors and general industry conditions. Changes in these
estimates are charged or credited to the results of operations in the period of
the change. If circumstances occur, such as an economic downturn, higher than
expected defaults or denials, or reduced collections, the estimates of the
recoverability of the Companys receivables could be reduced by a material
amount. During the quarter ended December 31, 2003, the Company recorded
additional bad debt expense of $24.0 million primarily related to the Divested
Facilities and reported as divestiture related charges in the
statement of operations (see Note 5 and Note 20). Property and Equipment On the Effective Date, the Reorganized Company adjusted the carrying values of
property and equipment to their estimated fair values in accordance with SOP
90-7. Property and equipment purchased after the Effective Date is
recorded at cost and all property and equipment stated at
the lower of carrying value or fair value less accumulated depreciation. Major
replacements and significant improvements are capitalized, whereas ordinary
maintenance and repairs are expensed as incurred. The Company accounts for long-lived assets, other than goodwill with an
indefinite useful life, in accordance with the provisions of SFAS No. 144. The
carrying value of long-lived assets is reviewed periodically to determine if
events or circumstances have changed which may indicate that the assets may be
impaired or the useful life may need to be changed. The Company considers
internal and external factors relating to each asset, including cash flow,
contract changes, local market developments, national health care trends and
other publicly available information. SFAS No. 144 requires impairment losses
to be recognized for long-lived assets used in operations when indicators of
impairment are present and the estimated undiscounted cash flows are not
sufficient to recover the assets carrying amounts. The impairment loss is
measured by comparing the estimated fair value of the asset, usually based on
discounted cash flows, to its carrying amount (see Note 7). Depreciation and amortization expense is recorded using the straight-line basis
over the estimated useful lives of the assets as follows: Buildings
    
    2540 yearsBuilding improvements
    
    525 yearsFurniture, fixtures and equipment
    
    320 years
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Assets Held for Sale and Discontinued Operations

SFAS No. 144 also addresses the accounting for and disclosure of long-lived
assets to be disposed of by sale. Under SFAS No. 144, when a long-lived asset
or group of assets (disposal group) meets certain criteria set forth in SFAS
No. 144, including a commitment by the Company to a plan to sell the long-lived
asset (disposal group) within one-year, the long-lived asset (disposal group)
will be measured at the lower of its carrying value or fair value less costs to
sell, are reclassified as held for sale on the consolidated balance sheet and
are no longer depreciated. There were no assets held for sale at December 31,
2003 or December 31, 2002.

If additional criteria are met under SFAS No. 144, the related operations and
cash flows of the long-lived asset (disposal group) will be reported as
discontinued operations in the consolidated statement of operations, with all
comparable periods restated (see Note 4).

Reorganization Value in Excess of Amounts Allocable to Identifiable Assets and
Goodwill

The Company adopted the provisions of fresh-start reporting as of May 1, 2002.
On this date, the intangible assets of the Reorganized Company were restated to
their fair market value based upon, among other things, estimates provided by
an independent financial advisor. Reorganization value in excess of amounts
allocable to identifiable assets represents the portion of reorganization value
of the Reorganized Company that could not be attributed to specific tangible or
identified intangible assets (see Note 17).

The Company accounts for reorganization value in excess of amounts allocable to
identifiable assets and goodwill in accordance with the provisions of SFAS No.
142, Goodwill and Other Intangible Assets (SFAS No. 142), which was
effective January 1, 2002. Accordingly, reorganization value in excess of
amounts allocable to identifiable assets and goodwill are stated at the lower
of carrying value or fair value and are no longer amortized; however, they are
subject to annual impairment tests as prescribed by SFAS No. 142, or more often
if events or circumstances change between annual impairment tests that may
indicate impairment (see Note 8).

Restricted Investments

Restricted investments include amounts restricted for collateral under the
terms of certain letters of credit and mortgage agreements. Restricted
investments also represent cash, fixed interest securities and other
investments that have primarily been designated to pay insurance claims of the
Companys wholly-owned insurance subsidiaries. These restricted investments
have been classified as available-for-sale securities in accordance with SFAS
No. 115 Accounting for Certain Investments in Debt and Equity Securities
and, accordingly, are reported at their estimated fair value with unrealized
gains and losses, net of related tax effects, included with accumulated other
comprehensive income as a separate component of stockholders equity. A
decline in the market value of any security below cost that is deemed other
than temporary is charged to earnings, resulting in the establishment of a new
cost basis for the security (see Note 9).

Deferred Financing Costs

Financing costs are deferred and are amortized on a straight-line basis, which
approximates the effective interest method, over the terms of the related debt.
The amortization is included in interest expense in the accompanying
consolidated statements of operations (see Note 10).

Derivative Instrument

The Company has $59.7 million in long-term debt that is non-recourse
indebtedness of a subsidiary. This loan includes an option for the Company to
extend the term of the loan at a fixed rate of interest, which meets the
definition of an embedded derivative instrument according to SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. Therefore, this
derivative is accounted for as a purchased option. The fair market value of
the purchased option has been separated from the related debt and recorded in
other assets at its estimated fair market value of $3.3 million as of December
31, 2003. Changes in the fair value of the payer swaption are recorded in the
consolidated statement of operations (see Note 10).

Insurance

Due to the rising cost and limited availability of professional/general
liability (PL/GL) insurance, the Company currently purchases excess PL/GL
insurance only, and maintains, in all states except Colorado, an
unaggregated $1.0 million self-insured retention per claim. In Colorado, the
Company maintains first dollar coverage. For workers
compensation claims, the Company self insures the first $0.5 million of each
employee injury claim. Because the Company is largely self-insured on both the
PL/GL and workers compensation programs, there is no limit on the maximum
number of claims or amount for which the Company can be liable in any policy
period. Claims for PL/GL and employee injury self-insured retention are paid
over varying periods that generally range from one to nine years.

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Loss provisions, including provisions for incurred but not reported losses, for
self-insured programs are provided on an undiscounted basis in the relevant
period. These provisions are based on internal and external evaluations of the
merits of individual claims, analysis of claims history and independent
actuarially determined estimates. The external analysis is completed by an
independent actuary with extensive experience in the long-term care industry.
The methods of determining these estimates and establishing the resulting
accrued liabilities are reviewed frequently by the Companys management, with
any resulting material adjustments being reflected in current earnings. During
the fourth quarter of the year ended December 31, 2003, the Company recorded an
additional $21.0 million expense for insurance costs primarily
related to exiting the operations of the
Divested Facilities and reported as divestiture related charges in
the statement of operations (see Note 5). Although the Company believes that the accrued insurance
obligation in its financial statements is adequate, the ultimate liability may
be in excess of the amounts recorded. In the event the provisions for
self-insured loss reflected in the Companys financial statements are
inadequate, the financial condition and results of operations could be
materially affected (see Note 11).

Income Taxes

Income taxes are accounted for under the asset and liability method. Deferred
income taxes are recognized for the tax consequences of temporary differences
by applying enacted statutory tax rates applicable to future years to
differences between the financial statement carrying amounts and the tax bases
of existing assets and liabilities. The effect on deferred taxes of a change in
tax rates is recognized in income in the period that includes the enactment
date. Provision is made for deferred income taxes applicable to temporary
differences between financial statement and taxable income. In assessing the
realizability of deferred tax assets, the Company considers whether it is more
likely than not that some portion or all of the deferred tax assets will not be
realized. To the extent that the deferred tax assets existing as of the
Effective Date that were reserved with a valuation allowance are realized in
the future, the income tax benefit derived from their utilization would be
first applied to reduce reorganization value recorded in connection with
fresh-start reporting pursuant to SOP 90-7 (see Note 15).

At December 31, 2003,
the Company estimates that there remains $563.0 million of net
operating loss (NOL) carryforwards, utilization of which is
subject to limitations. The income tax benefit of any NOL
carryforward utilization, if any, will be applied first as a
reduction to reorganization value in excess of amounts allocable to
identifiable assets and, thereafter, as a direct addition to paid
capital, pursuant to SOP 90-7, at such time it is assured.

If there is a
cumulative ownership change involving shareholders who own 5% or more
of the Companys common stock, par value $.01 per share
(Common Stock) of more than 50% during the two year period
following our emergence from bankruptcy (May 13, 2002), the
remaining NOL carryforwards will be forgone with no net impact to the
Companys consolidated financial statements. This could result in higher future
tax payments if we are profitable.

Net Revenue

Revenue is recorded based on estimated
net realizable amounts due from patients and
third-party payors for health care services provided, including anticipated
settlements under reimbursement agreements with Medicare, Medicaid and other
third-party payors, and is recognized in the period in which the services are
provided. Revenue is recorded net of provisions for discount arrangements with
commercial payors and contractual allowances with third-party payors, primarily
Medicare and Medicaid. Revenue realizable under third-party
payor agreements are subject to change due to examination and retroactive
adjustment. Estimated third-party payor settlements are recorded in the period
the related services are rendered. The methods of making such estimates are
reviewed periodically, and differences between the net amounts accrued and
subsequent settlements or estimates of expected settlements are reflected in
the current period results of operations.

All providers participating in the Medicare and Medicaid programs are required
to meet certain financial cost reporting requirements. Federal and state
regulations generally require the submission of annual cost reports covering
revenues, costs and expenses associated with the services provided to Medicare
beneficiaries and Medicaid recipients. Annual cost reports are subject to
routine audits and retroactive adjustments. These audits often require several
years to reach the final determination of amounts due to, or by, the Company
under these programs (see Note 6).

Guarantees

The Company has implemented Financial
Accounting Standards Board (FASB) Interpretation No. 45, Guarantors Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others (FIN 45). FIN 45 elaborates on the disclosures to be
made by a guarantor in its financial statements under certain guarantees that
it has issued. It also clarifies that a guarantor is required to recognize, at
the inception of a guarantee, a liability for the fair value of the obligation
undertaken in issuing the guarantee. FIN 45 requires disclosure of the nature
of the guarantee, the maximum potential amount of future payments that the
guarantor could be required to make under the guarantee, and the current amount
of the liability, if any, for the guarantors obligations under the guarantee.
The Company implemented the disclosure requirements as of December 31, 2002 and
the recognition requirements were effective January 1, 2003. The Company
currently does not guarantee, either directly or indirectly, any indebtedness
of others, however, any future guarantees will be recorded and disclosed in
accordance with FIN 45.

Comprehensive Income

The Company accounts for comprehensive income according to the provisions of
SFAS No. 130, Reporting Comprehensive Income (SFAS No. 130) which
establishes standards for reporting and display of comprehensive income and its
components in a full set of general-purpose financial statements. Comprehensive
income includes net income (loss), as well as charges and credits directly to
stockholders equity, which are excluded from net income (loss). The Company
has presented comprehensive income in the consolidated statements of
stockholders equity and comprehensive income (loss).

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Segment Reporting

The Company provides segment information in accordance with SFAS No. 131
Disclosures About Segments of an Enterprise and Related Information (SFAS
No. 131), which establishes standards for the method that public business
enterprises report information about operating segments in financial
statements. SFAS No. 131 also establishes standards for related disclosures
about products and services, geographic areas and major customers. The Company
currently has two reportable segments; nursing home services and LTACs (see
Note 21).

Recent Accounting Pronouncements

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity (SFAS No.
150). SFAS No. 150 improves the accounting for certain financial instruments
that under the previous guidance, issuers could account for as equity. SFAS
No. 150 requires that those instruments be classified as liabilities in
statements of financial position. SFAS No. 150 is effective for financial
instruments entered into or modified after May 31, 2003. On October 29, 2003,
the FASB deferred for an indefinite period the application of the guidance in
SFAS No. 150 until it could consider some of the resulting implementation
issues associated with the measurement and recognition issues. The Company has
not determined the resulting impact of the adoption of this statement on its
consolidated financial position, results of operations or cash flows.

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities (SFAS No. 149), which is
effective for contracts entered into or modified after June 30, 2003 and for
hedging relationships designated after June 30, 2003. SFAS No. 149 amends and
clarifies accounting and reporting for derivative instruments. In particular,
this statement amends certain other pronouncements and clarifies the
circumstances under which a contract with an initial investment meets the
characteristics of a derivative and when a derivative contains a financial
component. The guideline should be applied prospectively. The adoption of
SFAS No. 149 did not have a material impact on the consolidated financial position,
results of operations or cash flows of the Company.

In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities, an Interpretation of ARB No. 51 (FIN 46), which
addresses the consolidation of entities whose equity holders have either (a)
not provided sufficient equity at risk to allow the entity to finance its own
activities or (b) do not possess certain characteristics of a controlling
financial interest. FIN 46 sets forth a model to evaluate potential
consolidation of these entities, known as variable interest entities (VIEs),
based on an
assessment of which party to the VIE, if any, absorbs a majority of the
exposure to its expected losses, receives a majority of its expected residual
returns, or both (the primary beneficiary). FIN 46 also requires disclosures
about VIEs that a company is not required to consolidate but in which it has a
significant variable interest. FIN 46 is effective for all new VIEs created or
acquired after January 31, 2003. For VIEs created or acquired prior to
February 1, 2003, the provisions of FIN 46 must be applied for the first
interim or annual period beginning after March 15, 2004 except for companies
with special purpose entities which must apply the provisions of FIN 46 to
those special purpose entities no later than the first reporting period ending
after December 15, 2003.

The Company has evaluated the impact of FIN 46 on its consolidated financial
statements and identified three joint venture subsidiaries as VIEs for which
the Company has determined that it is the primary beneficiary. These joint
venture subsidiaries, which operate skilled nursing facilities that are managed
by the Company, are fifty percent owned by the Company and have historically
been consolidated by the Company due to control. The Company has also
historically provided funds for working capital and has other long term notes
to these joint ventures which are eliminated in consolidation in the
accompanying consolidated financial statements of the Company. The joint
venture subsidiaries have revenue which are included in the Companys
consolidated financial statements of $36.7 million, $22.8 million, $10.7
million, $8.2 million, and $30.4 million, for the year ended December 31, 2003,
for the eight months ended December 31, 2002, for the four months ended April
30, 2002, for the three month transition period ended December 31, 2001, and
for the year ended September 30, 2001, respectively. These joint venture
subsidiaries have net liabilities which are included in the accompanying
consolidated financial statements of approximately $39.9 million and $31.8
million at December 31, 2003 and 2002, respectively.

NOTE 3 STOCK BASED COMPENSATION

The Reorganized Company maintains two stock-based compensation plans that
provide for the granting of stock options to the Companys employees and
outside directors with exercise prices less than or equal to the fair value of
the shares at the date of grant. The Reorganized Company has a stock option
plan for key employees (the Mariner Health Care, Inc. 2002 Stock
Incentive Plan or the 2002 Stock Incentive Plan) and a stock option/restricted stock plan for
non-employee directors (the 2003 Outside Directors Stock
Incentive Plan or the 2003 Outside Directors Plan) that authorize the granting of stock options to purchase
up to 1,978,022 shares of Common Stock to key employees and the granting of
stock options or restricted stock units to purchase up to 175,000 shares of
Common Stock to non-employee directors, for 2,153,022 shares of
Common Stock
subject to issuance under both plans. At December 31, 2003, there were options
to purchase 1,916,060 shares of Common Stock outstanding at a weighted average
exercise price of $15.74 under the 2002 Stock Incentive Plan and there were 52,500 shares
of restricted stock units granted under the 2003 Outside
Directors Plan, of which 37,500 of those grants were
deferred at the election of certain directors.

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##### Table of Contents



There were 86,615 options to
purchase Common Stock exercisable at December 31, 2003. There
were 26,250 shares of restricted Common Stock granted pursuant to
the 2003 Outside Directors Plan
not subject to any vesting restrictions at December 31, 2003,
however, receipt of a portion of these shares was deferred at the
election of certain directors. The 2002 Stock Incentive Plan
was approved by the Bankruptcy Court in connection with the Companys emergence
from bankruptcy pursuant to the terms of its Joint Plan.

The Predecessor Company had stock option plans for key employees and outside
directors which authorized the granting of incentive stock options and
nonqualified options. Upon the Companys emergence from bankruptcy, all the
Predecessor Company stock option plans and options granted were canceled.

The Companys pro forma net (loss) income and net (loss) income per share,
assuming the election had been made to recognize compensation expense on
stock-based awards, are as follows (in thousands of dollars, except per share
amounts):

|                            |                                                                                                                              |   |                     |        |              |                     |         |             |   |              |   |               |       |   |   |       |      |   |   |         |       |  
|--------------------------- | ---------------------------------------------------------------------------------------------------------------------------- | - | ------------------- | ------ | ------------ | ------------------- | ------- | ----------- | - | ------------ | - | ------------- | ----- | - | - | ----- | ---- | - | - | ------- | ----- | -
|                            |                                                                                                                              |   | Reorganized Company |        |              | Predecessor Company
|                            |                                                                                                                              |   |                     |        |              |                    
|                            |                                                                                                                              |   | Fiscal Year         |        | Eight Months |                     |         | Four Months |   | Three Months |   | Fiscal Year  
|                            |                                                                                                                              |   | Ended               |        | Ended        |                     |         | Ended       |   | Ended        |   | Ended        
|                            |                                                                                                                              |   | December 31,        |        | December 31, |                     |         | April 30,   |   | December 31, |   | September 30,
|                            |                                                                                                                              |   | 2003                |        | 2002         |                     |         | 2002        |   | 2001         |   | 2001         
|                            |                                                                                                                              |   |                     |        |              |                     |         |             |   |              |   |              
|Net (loss) income           |                                                                                                                              | $ | (12,796             | )      |              | $                   | (58,314 | )           |   |              | $ | 1,433,955     |       |   | $ | 4,395 |      |   | $ | (33,395 | )    
|                            | Deduct: total stock-based employee
compensation expense determined
under fair value based methods
for all awards, net of tax |   |                     | (3,082 | )            |                     |         | (2,519      | ) |              |   |               | (123  | ) |   |       | (92  | ) |   |         | (98   | )
|                            |                                                                                                                              |   |                     |        |              |                     |         |             |   |              |   |               |       |   |   |       |      |   |   |         |      
|Pro forma net (loss) income |                                                                                                                              | $ | (15,878             | )      |              | $                   | (60,833 | )           |   |              | $ | 1,433,832     |       |   | $ | 4,303 |      |   | $ | (33,493 | )    
|                            |                                                                                                                              |   |                     |        |              |                     |         |             |   |              |   |               |       |   |   |       |      |   |   |         |      
|Basic and diluted EPS       |                                                                                                                              |   |                     |        |              |                     |         |             |   |              |   |               |       |   |   |       |      |   |   |         |      
|                            | As reported                                                                                                                  |   | $                   | (0.64  | )            |                     | $       | (2.92       | ) |              |   | $             | 19.46 |   |   | $     | 0.06 |   |   | $       | (0.45 | )
|                            | Pro forma                                                                                                                    |   |                     | (0.79  | )            |                     |         | (3.04       | ) |              |   |               | 19.46 |   |   |       | 0.06 |   |   |         | (0.45 | )

The Company uses the Black-Scholes model to determine the fair value of options
on the date of the grant. The Black-Scholes model was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferable. In addition, option-pricing models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Companys stock options have characteristics
significantly different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value estimate,
in managements opinion, the existing models do not necessarily provide a
reliable single measure of the fair value of its stock options.

For purposes of pro forma disclosures of net income (loss) and earnings per
share, the estimated fair value of the options is amortized to expense over the
options vesting period. The following weighted-average assumptions were used:

|                            |  |                     |            |              |                     |   |               |   |              |  |               |               |   |  |  |               |   |  |  |               |  
|--------------------------- |  | ------------------- | ---------- | ------------ | ------------------- | - | ------------- | - | ------------ |  | ------------- | ------------- | - |  |  | ------------- | - |  |  | ------------- | -
|                            |  | Reorganized Company |            |              | Predecessor Company
|                            |  |                     |            |              |                    
|                            |  | Fiscal Year         |            | Eight Months |                     |   | Four Months   |   | Three Months |  | Fiscal Year  
|                            |  | Ended               |            | Ended        |                     |   | Ended         |   | Ended        |  | Ended        
|                            |  | December 31,        |            | December 31, |                     |   | April 30,     |   | December 31, |  | September 30,
|                            |  | 2003                |            | 2002         |                     |   | 2002          |   | 2001         |  | 2001         
|                            |  |                     |            |              |                     |   |               |   |              |  |              
|Dividend yield              |  |                     | 0.0        | %            |                     |   | 0.0           | % |              |  |               | 0.0           | % |  |  | 0.0           | % |  |  | 0.0           | %
|Expected volatility         |  |                     | 0.64-0.68  |              |                     |   | 0.51          |   |              |  |               | 0.42 - 1.21   |   |  |  | 0.42 - 1.21   |   |  |  | 0.42 - 1.21   |  
|Risk-free interest rate     |  |                     | 3.11%-3.58 | %            |                     |   | 3.63 % - 4.70 | % |              |  |               | 4.61 % - 6.11 | % |  |  | 4.61 % - 6.11 | % |  |  | 4.61 % - 6.11 | %
|Expected life in years      |  |                     | 6          |              |                     |   | 6             |   |              |  |               | 3 - 8         |   |  |  | 3 - 8         |   |  |  | 3 - 8         |  
|Weighted-average fair value |  | $                   | 9.80       |              |                     | $ | 10.80         |   |              |  |               |              |   |  |  |              |   |  |  |              |  

2002 Stock Incentive Plan

On May 16, 2002, the Board of
Directors adopted the 2002 Stock Incentive Plan. This plan is
intended to meet the requirements of the federal tax provisions contained in
Section 162(m) of the Internal Revenue Code. The purpose of the 2002 Stock
Incentive Plan is to allow the Company to attract and retain qualified officers and key
employees and to provide these individuals with an additional incentive to
devote themselves to the Companys future success. Additionally,
the Company believes that awards
under the 2002 Stock Incentive Plan will more closely align the interests of
the Companys personnel with the interests of its stockholders.

A total of 1,978,022 shares of Common Stock are reserved for issuance under the
2002 Stock Incentive Plan. At December 31, 2003, there were options to purchase
1,916,060 shares of Common Stock outstanding under the 2002 Stock
Incentive Plan. The number of
shares of Common Stock reserved is subject to adjustment in the event of stock
dividends, stock splits, recapitalizations or similar events. Each option
granted has a term of ten years. Options granted to key employees vest in equal
annual installments over four years, with the exception of the
options granted to the Companys Chief Executive Officer, which will vest in accordance with the
terms set forth in his employment agreement at the rate of 8.33% per calendar
quarter, with any remaining options vesting at the end of three years. The
Compensation Committee of the Board of Directors (the Compensation
Committee) administers the 2002 Stock
Incentive Plan and determines the persons to whom, and the
times at which, awards will be granted, the types of awards to be granted and
all other related terms and conditions of the awards, subject to any
limitations in the 2002 Stock
Incentive Plan. The terms and conditions of each award are set forth
in written agreements with each participant.

All officers and key employees of the
Company are eligible to participate in the 2002
Stock Incentive Plan. Currently, approximately 114 individuals participate in
the 2002 Stock Incentive Plan. The 2002 Stock Incentive Plan provides for awards in the form of qualified and
non-qualified stock options, stock appreciation rights, shares of restricted
stock, stock grants and performance share awards.

The exercise price per share of any stock option must be less than or equal to
the fair market value of a share of Common Stock at the time of grant. No
participant may receive stock options or stock appreciation rights under the
2002 Stock Incentive Plan in any calendar year for more than 439,560 shares.

Employee Stock Option Exchange

In the second quarter of 2003, the Board of Directors approved a voluntary
stock option exchange program whereby the Company offered employees the opportunity to
exchange options having an exercise price of $20.12 for an equal number of new
options. Non-employee members of the Board of Directors were not eligible to
participate in the exchange program.

Under the terms of the program, in order to participate, eligible employees
were required to tender all of their options that were granted with an exercise
price of $20.12 in exchange for a commitment by the Company to grant new options under
the program six-months and one day following the closing date of the offering
period (the date of legal cancellation of the tendered options), with an
exercise price

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per share equal to the greater of $8.00 or the fair market value
of the Companys Common Stock at that time, whichever was
higher. On June 14, 2003, the Company
canceled options to purchase 1,563,560 shares of Common Stock. Effective
December 16, 2003, the Compensation Committee granted new options pursuant to
the 2002 Stock Incentive Plan to purchase 1,441,060 shares of Common Stock
to the participating employees, for which the grant date fair market value was
determined to be $18.08. These options will vest in three equal annual
installments beginning on the first anniversary of the date of grant of the new
options, with the exception of the options to be granted to the
Companys Chief Executive
Officer, which will vest in accordance with the terms set forth in his
employment agreement at the rate of 8.33% per calendar quarter,
commencing from the December 16, 2003 grant date referred to
above with any
remaining options vesting at the end of three years.

2003 Outside Directors Stock Incentive Plan

The 2003 Outside Directors Plan
provides the Company with the ability to grant each
non-employee director restricted Common Stock (which a director may elect to
defer the right to receive) and/or non-qualified stock options to purchase
shares of Common Stock. The 2003 Outside Directors Plan replaced the Mariner Health Care, Inc.
2002 Outside Directors Stock Option Plan. The 2003 Outside Directors Plan is administered by the Compensation
Committee, and the Compensation Committee has the authority in its sole
discretion to interpret, make grants under, make all other determinations and
take all other actions it deems necessary or advisable for the implementation
and administration of the 2003 Outside Directors Plan or any agreements thereunder. The
terms and conditions of each award made under the 2003 Outside
Directors Plan are set
forth in individual agreements between the relevant director and the
Company.

Directors who are not employees are eligible to receive restricted Common Stock
or options under the 2003 Outside Directors Plan. The exercise price per share
of any stock option must be equal to the fair market value of a share
of the Companys Common Stock at the time of grant. A total of 175,000 shares of Common
Stock are reserved for issuance under the 2003 Outside Directors Plan. Shares
subject to restricted stock grants or options that expire or are terminated are
again available for grant under the 2003 Outside Directors Plan. At December 31, 2003, 52,500 shares
of restricted stock had been granted. At their option, four of the six
directors entitled to receive shares of restricted Common Stock elected to
defer receipt of such shares pursuant to the terms of deferred restricted stock
agreements entered into as of December 16, 2003. Although there are no current
outstanding option grants under the 2003 Outside Directors Plan, any
options granted in the future would expire at the earlier of ten years after
the date of grant or one year after the director ceases to be a director. Any
options that may be granted to outside directors in the future would vest 25%
on the date of the grant, with the remaining options vesting in equal annual
installments over three years. The number of shares of Common Stock and the
exercise price per share for the options would be subject to adjustment in the
event of stock dividends, stock splits, recapitalizations and similar events.
In the event of a merger, tender offer or similar event, the Compensation
Committee may also adjust any option grants, as it deems appropriate, including
accelerating the options or swapping them for cash consideration
of equivalent value.

Director Stock Option Exchange

On July 30, 2003, the Compensation Committee approved a program to allow
outside directors to surrender their options to purchase shares of Common Stock
with an exercise price per share of $20.12, which were granted on May 16, 2002,
in exchange for restricted shares of Common Stock (which a director may elect
to defer the right to receive) to be granted under the 2003 Outside Directors Plan. The
program allowed for a number of shares to be issued to participating directors
equal to 30% of the number of options surrendered. Pursuant to the program each
outside director, other than the Chairman of the Board of Directors, received
an offer to exchange his options in return for a grant of 7,500 restricted
shares of Common Stock and the Chairman of the Board of Directors received an
offer to exchange his options in return for a grant of 15,000 restricted shares
of Common Stock. The shares will vest according to the original vesting
schedule of the surrendered options, hence 50% of each directors restricted
shares have vested and the remaining 50% will vest over the next two years on
May 16, 2004 and May 16, 2005. The Company recorded stock
compensation expense of $0.5 million during the fourth quarter
of 2003 in connection with the restricted stock grant.

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The table below presents certain information regarding the stock option plans
for the Company.

|                                  |  |                     |            |                    |  |          |       |       |  |  |           |          |  |   |       | 
|--------------------------------- |  | ------------------- | ---------- | ------------------ |  | -------- | ----- | ----- |  |  | --------- | -------- |  | - | ----- | 
|                                  |  | Reorganized Company
|                                  |  |                    
|                                  |  | Fiscal Year Ended   |            | Eight Months Ended
|                                  |  | December 31, 2003   |            | December 31, 2002 
|                                  |  |                     |            |                   
|                                  |  |                     |            |                    |  | Weighted |       |       |  |  |           | Weighted
|                                  |  |                     |            |                    |  | Average  |       |       |  |  |           | Average 
|                                  |  |                     |            |                    |  | Exercise |       |       |  |  |           | Exercise
|                                  |  | Options             |            | Price              |  | Options  |       | Price
|                                  |  |                     |            |                    |  |          |       |      
|Outstanding at the Effective Date |  |                     | 1,848,060  |                    |  | $        | 20.12 |       |  |  |          |          |  | $ |      | 
|Granted                           |  |                     | 1,941,060  |                    |  |          | 15.57 |       |  |  | 1,885,560 |          |  |   | 20.12 | 
|Exercised                         |  |                     |           |                    |  |          |      |       |  |  |          |          |  |   |      | 
|Cancelled                         |  |                     | (1,563,560 | )                  |  |          | 20.12 |       |  |  |          |          |  |   |      | 
|Forfeited                         |  |                     | (309,500   | )                  |  |          | 18.73 |       |  |  | (37,500   | )        |  |   | 20.12 | 
|                                  |  |                     |            |                    |  |          |       |       |  |  |           |          |  |   |       | 
|Outstanding at end of year        |  |                     | 1,916,060  |                    |  | $        | 15.74 |       |  |  | 1,848,060 |          |  | $ | 20.12 | 
|                                  |  |                     |            |                    |  |          |       |       |  |  |           |          |  |   |       | 
|Exercisable at end of year        |  |                     |           |                    |  | $        |      |       |  |  | 153,595   |          |  | $ | 20.12 | 
|                                  |  |                     |            |                    |  |          |       |       |  |  |           |          |  |   |       | 

The following is additional information relating to options outstanding
and exercisable as of December 31, 2003:

|                |  |  |  |                     |           |                |  |                  |       |                  |  |  |      | 
|--------------- |  |  |  | ------------------- | --------- | -------------- |  | ---------------- | ----- | ---------------- |  |  | ---- | 
|                |  |  |  | Options Outstanding
|                |  |  |  |                    
|                |  |  |  |                     |           |                |  | Weighted         |       | Weighted Average
|Range of        |  |  |  |                     |           |                |  | Average          |       | Remaining       
|Exercise Prices |  |  |  | Number of Shares    |           | Exercise Price |  | Contractual Life
|                |  |  |  |                     |           |                |  |                 
|$ 2.65-$ 3.00   |  |  |  |                     | 107,500   |                |  | $                | 2.87  |                  |  |  | 3.31 | 
|$ 5.40-$ 6.30   |  |  |  |                     | 215,000   |                |  | $                | 6.24  |                  |  |  | 3.08 | 
|$13.00          |  |  |  |                     | 90,000    |                |  | $                | 13.00 |                  |  |  | 3.86 | 
|$20.50          |  |  |  |                     | 62,500    |                |  | $                | 20.50 |                  |  |  | 3.97 | 
|$18.08          |  |  |  |                     | 1,441,060 |                |  | $                | 18.08 |                  |  |  | 2.96 | 
|                |  |  |  |                     |           |                |  |                  |       |                  |  |  |      | 
|                |  |  |  |                     | 1,916,060 |                |  |                  |       |                  |  |  |      | 
|                |  |  |  |                     |           |                |  |                  |       |                  |  |  |      | 

|                    |  |                  |        |                |  |          |       | 
|------------------- |  | ---------------- | ------ | -------------- |  | -------- | ----- | 
|Options Exercisable
|                   
|                    |  |                  |        |                |  | Weighted
|Range of            |  |                  |        |                |  | Average 
|Exercise Prices     |  | Number of Shares |        | Exercise Price
|                    |  |                  |        |               
|$  6.30             |  |                  | 50,000 |                |  | $        | 6.30  | 
|$18.08              |  |                  | 36,615 |                |  | $        | 18.08 | 
|                    |  |                  |        |                |  |          |       | 
|                    |  |                  | 86,615 |                |  |          |       | 
|                    |  |                  |        |                |  |          |       | 

Predecessor Company

The Predecessor Company had stock options plans for key employees and
non-employee directors which authorized the granting of incentive stock option,
nonqualified options or a combination of the forgoing to purchase up to
approximately 10 million shares of the

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Predecessor Companys common stock.
Generally, the exercise price of each option equaled the fair market value of
the Companys Common Stock on the date of grant and an options maximum term
was ten years after the date of grant.

The table below presents the stock option plans for the Predecessor Company.
The Predecessor Companys stock option plans, and all options outstanding,
thereunder, were cancelled on May 13, 2002 upon emergence from bankruptcy.

Predecessor Company

|                                                                 |  |             |           |              |  |               |      |       |  |         |           |          |  |   |      |  |  |          |            |   |  |   |       | 
|---------------------------------------------------------------- |  | ----------- | --------- | ------------ |  | ------------- | ---- | ----- |  | ------- | --------- | -------- |  | - | ---- |  |  | -------- | ---------- | - |  | - | ----- | 
|                                                                 |  | Four Months |           | Three Months |  | Fiscal Year  
|                                                                 |  | Ended       |           | Ended        |  | Ended        
|                                                                 |  | April 30,   |           | December 31, |  | September 30,
|                                                                 |  | 2002        |           | 2001         |  | 2001         
|                                                                 |  |             |           |              |  |              
|                                                                 |  |             |           |              |  | Weighted      |      |       |  |         |           | Weighted |  |   |      |  |  | Weighted
|                                                                 |  |             |           |              |  | Average       |      |       |  |         |           | Average  |  |   |      |  |  | Average 
|                                                                 |  |             |           |              |  | Exercise      |      |       |  |         |           | Exercise |  |   |      |  |  | Exercise
|                                                                 |  | Options     |           | Price        |  | Options       |      | Price |  | Options |           | Price   
|                                                                 |  |             |           |              |  |               |      |       |  |         |           |         
|Outstanding at
beginning of
period                               |  |             | 1,999,246 |              |  | $             | 7.57 |       |  |         | 2,111,746 |          |  | $ | 7.57 |  |  |          | 3,999,936  |   |  | $ | 9.67  | 
|Granted                                                          |  |             |          |              |  |               |     |       |  |         |          |          |  |   |     |  |  |          |           |   |  |   |      | 
|Exercised                                                        |  |             |          |              |  |               |     |       |  |         |          |          |  |   |     |  |  |          |           |   |  |   |      | 
|Forfeited                                                        |  |             |          |              |  |               |     |       |  |         | (112,500  | )        |  |   | 7.60 |  |  |          | (1,888,190 | ) |  |   | 16.35 | 
|                                                                 |  |             |           |              |  |               |      |       |  |         |           |          |  |   |      |  |  |          |            |   |  |   |       | 
|Outstanding at end
of period                                     |  |             | 1,999,246 |              |  | $             | 7.57 |       |  |         | 1,999,246 |          |  | $ | 7.57 |  |  |          | 2,111,746  |   |  | $ | 7.57  | 
|                                                                 |  |             |           |              |  |               |      |       |  |         |           |          |  |   |      |  |  |          |            |   |  |   |       | 
|Exercisable at end
of period                                     |  |             | 1,489,204 |              |  | $             | 8.88 |       |  |         | 1,461,871 |          |  | $ | 8.88 |  |  |          | 1,441,371  |   |  | $ | 8.39  | 
|                                                                 |  |             |           |              |  |               |      |       |  |         |           |          |  |   |      |  |  |          |            |   |  |   |       | 
|                                                                 |  | $           | 0.75-     |              |  |               |      |       |  | $       | 0.75-     |          |  |   |      |  |  | $        | 0.75-      |   |  |   |       | 
|Price range                                                      |  | $           | 46.45     |              |  |               |      |       |  | $       | 46.45     |          |  |   |      |  |  | $        | 46.45      |   |  |   |       | 
|                                                                 |  |             |           |              |  |               |      |       |  |         |           |          |  |   |      |  |  |          |            |   |  |   |       | 
|Weighted average fair
value of options
granted during the period |  |             |           |              |  |               |     |       |  |         |           |          |  |   |     |  |  |          |            |   |  |   |      | 
|                                                                 |  |             |           |              |  |               |      |       |  |         |           |          |  |   |      |  |  |          |            |   |  |   |       | 

NOTE 4 DISCONTINUED OPERATIONS

In the normal course of business, the Company evaluates the performance of its
operating units in order to make a determination of whether to sell
under-performing or non-strategic assets. An increasing trend in malpractice
litigation claims, rising costs of litigation, and losses associated with these
lawsuits have caused many insurance carriers to raise the cost of insurance
premiums or refuse to write insurance policies. These problems are
particularly acute in the state of Florida where, because of higher claim
amounts, PL/GL costs have become
increasingly expensive.

Discontinued Pharmacy Operations

On January 6, 2002, the Company consummated the sale of its APS Division to
Omnicare, Inc. and its wholly owned affiliate, APS Acquisition LLC
(collectively, Omnicare). During the quarter ended December 31, 2001, the
Company received the approval of the Bankruptcy Court to sell the APS Division,
subject to an auction and overbidding process under the supervision of the
Bankruptcy Court. As a result, an auction of the assets comprising the APS
Division was held on December 4, 2001, at which time, following competitive
bidding at the auction, Omnicare was determined to have made the highest and
best bid for the assets of the APS Division. On December 5, 2001, the
Bankruptcy Court approved the sale of the APS Division to Omnicare for a cash
closing price of $97.0 million and up to $18.0 million in future payments,
depending upon certain post-closing operating results of the APS Division (the
Earnout Payments). During the four months ended April 30, 2002, the Company
realized a gain on the sale of the APS Division of $29.1 million. During the
three months ended March 31, 2003, the Company earned and received the first
Earnout Payment of $6.0 million, at which time it recorded a gain of $3.6
million, net of taxes of $2.4 million. On July 23, 2003, the Company and
Omnicare entered into an agreement whereby all conditions for the remaining
Earnout Payments were considered to have been met and the Company received the
remaining $12.0 million on August 5, 2003, at which time it recorded a gain of
$7.2 million, net of taxes of $4.8 million.

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Other Discontinued Operations

The results of operations and cash flows of any divested facilities, including
four of the Florida and Louisiana divested facilities, that qualify for
discontinued operations under SFAS No. 144 are reclassified to discontinued
operations for all periods presented. There were no assets held for sale at
December 31, 2003, however, there were certain facilities divested during the
year ended December 31,
2003 whose operations and cash flows have been reclassed to discontinued
operations (see Note 5). The net assets of these facilities that were sold
during the year ended December 31, 2003 were $7.6 million at December 31, 2002.
The Company recorded a gain of $0.5 million, net of taxes on discontinued
operations other than the APS Division. This includes a gain of $1.1 million
related to facilities sold in Florida and Louisiana and a loss of $0.6 million,
net of taxes, on the sale of other divestitures.

Operating results for the discontinued operations, including the APS division,
were as follows for the periods indicated (in thousands of dollars):

|                                                       |  |                     |        |              |                     |   |             |   |              |  |               |        |   |  |   |        |   |  |   |         |  
|------------------------------------------------------ |  | ------------------- | ------ | ------------ | ------------------- | - | ----------- | - | ------------ |  | ------------- | ------ | - |  | - | ------ | - |  | - | ------- | -
|                                                       |  | Reorganized Company |        |              | Predecessor Company
|                                                       |  |                     |        |              |                    
|                                                       |  | Year                |        | Eight Months |                     |   | Four Months |   | Three Months |  | Year         
|                                                       |  | Ended               |        | Ended        |                     |   | Ended       |   | Ended        |  | Ended        
|                                                       |  | December 31,        |        | December 31, |                     |   | April 30,   |   | December 31, |  | September 30,
|                                                       |  | 2003                |        | 2002         |                     |   | 2002        |   | 2001         |  | 2001         
|                                                       |  |                     |        |              |                     |   |             |   |              |  |              
|Net revenue                                            |  | $                   | 27,832 |              |                     | $ | 20,651      |   |              |  | $             | 10,370 |   |  | $ | 70,464 |   |  | $ | 246,114 |  
|Total costs and expenses                               |  |                     | 30,225 |              |                     |   | 21,240      |   |              |  |               | 9,911  |   |  |   | 69,140 |   |  |   | 241,902 |  
|                                                       |  |                     |        |              |                     |   |             |   |              |  |               |        |   |  |   |        |   |  |   |         |  
|Operating (loss) income                                |  |                     | (2,393 | )            |                     |   | (589        | ) |              |  |               | 459    |   |  |   | 1,324  |   |  |   | 4,212   |  
|                                                       |  |                     |        |              |                     |   |             |   |              |  |               |        |   |  |   |        |   |  |   |         |  
|Other income (expenses)                                |  |                     | 810    |              |                     |   | 119         |   |              |  |               | (243   | ) |  |   | (388   | ) |  |   | (2,196  | )
|                                                       |  |                     |        |              |                     |   |             |   |              |  |               |        |   |  |   |        |   |  |   |         |  
|(Loss) income from discontinued
operations, net of tax |  | $                   | (1,583 | )            |                     | $ | (470        | ) |              |  | $             | 216    |   |  | $ | 936    |   |  | $ | 2,016   |  
|                                                       |  |                     |        |              |                     |   |             |   |              |  |               |        |   |  |   |        |   |  |   |         |  

NOTE 5 DIVESTITURES

Fiscal Year Ended December 31, 2003

During the year ended
December 31, 2003, the Company sold 19 skilled
nursing facilities and terminated operating and capital leases with respect to
an additional eleven skilled nursing facilities in Florida and Louisiana for cash
proceeds of $73.1 million and a $13.1 million five-year subordinated promissory
note with an annual interest rate of 8%. These divestitures resulted in a
$56.9 million reduction of our then existing senior debt, an $11.4 million retirement of facility
specific mortgage indebtedness and a $29.8 million elimination of capital lease
indebtedness. The Company recognized pre-tax gains of $25.2 million as a
result of the divestitures that did not qualify for discontinued operations
under the provisions of SFAS No. 144. For the facilities that qualified for
discontinued operations, the Company recorded a $1.1 million gain, net of tax,
which is included in gain on sale of discontinued operations in the
accompanying consolidated statements of operations. Also in connection with exiting the operations
of the
divested facilities, the Company recorded pre-tax charges of $49.6 million consisting
of $24.0 million for bad debt expense, $21.0 million of
insurance expense for professional liability claims, of which
$6.0 million related to the purchase of tail
insurance coverage, and $4.6 million for exit and other
costs, which are included in operating expenses for the year ended December 31,
2003. In addition, the Company did not meet the accounting criteria for the
full accrual method under the provisions of SFAS No. 66, Accounting for
Sales of Real Estate. Therefore, the Company recorded deferred income of
$13.1 million in connection with the divestitures. The Company expects to
recognize the deferred income during September 2008 upon receipt of cash for
the $13.1 million promissory note.

The Company has entered into an administrative services agreement with the new
operator for twenty-six of the thirty divested skilled nursing facilities to
perform certain back office services. These back office services include
accounting support, procurement of business supplies, billing and collections,
and information technology services. The Company determined that the sale for
the twenty-six facilities did not meet the accounting criteria for
discontinued operations under SFAS No. 144 due to the existence of cash flows
generated by the administrative services agreement.

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Eight Months Ended December 31, 2002

During the eight months ended December 31, 2002, the Company completed the sale
or divestiture of seven owned or leased skilled nursing facilities and certain
other assets through individual transactions, resulting in net loss of
approximately $2.1 million.

Predecessor Company

Four Months Ended April 30, 2002

During the four months ended April 30, 2002, the Predecessor Company completed
the sale or divestiture of twenty owned or leased skilled nursing facilities
and certain other assets through individual transactions, which resulted in a
net loss of approximately $10.8 million and is included in reorganization items
in the accompanying consolidated statements of operations.

Three Month Transition Period Ended December 31, 2001

During the three months ended December 31, 2001, the Predecessor Company
completed the sale or divestiture of approximately nine owned or leased
facilities and certain other assets through individual transactions, which
resulted in a net gain of approximately $1.7 million and is included in
reorganization items in the accompanying consolidated statements of operations.

Fiscal Year Ended September 30, 2001

During the fiscal year ended September 30, 2001, the Predecessor Company
completed the sale or divestiture of approximately forty-five owned, leased or
managed facilities, and certain other assets through individual transactions,
which resulted in a net gain of approximately $3.7 million and is included in
reorganization items in the accompanying consolidated statements of operations.

NOTE 6 NET REVENUE

Revenue is recorded based on estimated amounts due from patients and
third-party payors for health care services provided, including anticipated
settlements under reimbursement agreements with Medicare, Medicaid and other
third-party payors, and is recognized in the period in which the services are
provided. Revenue is recorded net of provisions for discount arrangements with
commercial payors and contractual allowances with third-party payors, primarily
Medicare and Medicaid. Revenue realizable under third-party payor agreements
are subject to change due to examination and retroactive adjustment. Estimated
third-party payor settlements are recorded in the period the related services
are rendered. The methods of making such estimates are reviewed periodically,
and differences between the net amounts accrued and subsequent settlements or
estimates of expected settlements are reflected in the current period results
of operations.

All providers participating in the Medicare and Medicaid programs are required
to meet certain financial cost reporting requirements. Federal and state
regulations generally require the submission of annual cost reports covering
revenues, costs and expenses associated with the services provided to Medicare
beneficiaries and Medicaid recipients. Annual cost reports are subject to
routine audits and retroactive adjustments. These audits often require several
years to reach the final determination of amounts due to, or by, the Company
under these programs.

Retroactive adjustments are estimated in the recording of revenues in the
period the related services are rendered. These amounts are adjusted in future
periods as adjustments become known or as cost reporting years are no longer
subject to audits, reviews or investigations. Changes in estimates related to
third party receivables resulted in an increase in net operating revenues of
$5.7 million and $3.5 million during the year ended December 31, 2003 and the
eight months ended December 31, 2002, respectively. The Company believes
adequate provision has been made to reflect any adjustments that could result
from audit of cost reports. However, due to the complexity of the laws and
regulations governing the Medicare and Medicaid programs, there is a
possibility that recorded estimates will change by a material amount in future
periods.

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The following is a summary of net revenue by payor type for the periods
indicated (in thousands of dollars): Reorganized Company
    

    Predecessor CompanyFiscal Year
    
    Eight Months
    

    Four Months
    
    Three Months
    
    Fiscal YearEnded
    
    Ended
    

    Ended
    
    Ended
    
    EndedDecember 31,
    
    December 31,
    

    April 30,
    
    December 31,
    
    September 30,2003
    
    2002
    

    2002
    
    2001
    
    2001Medicaid
    
    $
    817,743
    
    
    $
    562,262
    
    

    $
    281,317
    
    
    $
    219,759
    
    
    $
    905,516Medicare
    
    
    575,193
    
    
    
    385,274
    
    

    
    204,277
    
    
    
    141,178
    
    
    
    556,704Private and other
    
    
    322,431
    
    
    
    215,470
    
    

    
    105,473
    
    
    
    89,605
    
    
    
    378,434Net revenue
    
    $
    1,715,367
    
    
    $
    1,163,006
    
    

    $
    591,067
    
    
    $
    450,542
    
    
    $
    1,840,654
 Reimbursement Issues The Medicaid and Medicare programs are highly regulated. Compliance with laws
and regulations governing the Medicare and Medicaid programs is subject to
government review and interpretation, as well as significant regulatory action
including fines, penalties and possible exclusion from the Medicare and
Medicaid programs. The failure of the Company or its customers to comply
with applicable reimbursement regulations could adversely affect the Companys
business. It is not possible to quantify fully the effect of potential
legislative or regulatory changes, the administration of such legislation or
any other governmental initiatives on the Companys business. Accordingly,
there can be no assurance that the impact of these changes or any future
health care legislation will not further adversely affect the Companys
business. There can be no assurance that payments under governmental and
private third party payor programs will be timely, will remain at levels
comparable to present levels or will, in the future, be sufficient to cover the
costs allocable to patients eligible for reimbursement pursuant to such
programs. The Companys financial condition and results of operations may be
materially and adversely affected by the reimbursement process, which in the
health care industry is complex and can involve lengthy delays between the time
that revenue is recognized and the time that reimbursement amounts are settled.
In addition, under the Medicare program, if the federal government makes a
formal demand for reimbursement, even related to contested items, payment must
be made for those items before the provider is given an opportunity to appeal
and resolve the case. Medicare Reimbursement Issues Prior to July 1, 1998, the Medicare program utilized a cost-based retrospective
reimbursement system for skilled nursing facilities, LTACs and home health
agencies for reasonable direct and indirect allowable costs incurred in
providing routine service, as well as capital costs and ancillary costs. For
the Company, ancillary costs consisted of services performed by its pharmacy
and therapy businesses, which were divested before the Company emerged from
bankruptcy. The Balanced Budget Act of 1997 (the Balanced
Budget Act) made numerous changes to the Medicare and
Medicaid programs, which affected the Company. Under the Medicare program, the
new law required the establishment of a prospective payment system
(PPS) for Medicare Part A skilled nursing
services, under which facilities are paid a flat federal per diem rate for
virtually all covered services, including pharmacy and therapy. As a result of the impact of PPS on the long-term care industry, Congress twice
passed legislation intended to mitigate temporarily the reduction in Medicare
reimbursement rates for skilled nursing facilities under PPS. As of October 1,
2002, a 4% across-the-board increase in resource utilization groups
reimbursement rates (RUGs) reimbursement rates and a 16.7%
increase in the nursing component provided for in a combination of the Balanced
Budget Refinement Act of 1999 and the Medicare, Medicaid, and SCHIP
Benefits Improvement and Protection Act of 2000 expired. The
expiration of these temporary measures is commonly referred to as the Medicare
Reimbursement Cliff. In addition to the Medicare Reimbursement Cliff
provisions, other add ons included in this mitigating legislation will expire
when the Centers for Medicare and Medicaid Services (CMS) publishes a refined Medicare skilled nursing facility reimbursement
system to account for higher acuity patients. On August 4, 2003, CMS issued the
final skilled nursing facility PPS rule for fiscal year 2004, which delays
implementation of the refinements until October 1, 2004 at the
earliest.  However, President
Bushs proposed fiscal year 2005 budget indicates that the refinements will not
be implemented before September 30, 2005. The August 4, 2003 rule also includes
an inflation update and a correction of past forecast errors that together
increase the fiscal year 2004 skilled nursing facility PPS base rates by a
total of 6.26%. CMS estimates that the rate update will increase reimbursement
by approximately $850 million in fiscal year 2004, raising Medicare payment
rates per patient day by approximately $19 (although the actual
increase will vary from facility to facility because of geographic
wage adjustments and variances in patient acuity). In 2002, CMS implemented rules that replaced the reasonable cost-based payment
system for LTACs with a prospective payment system for LTACs
(LTAC PPS). As
of October 1, 2002, and subject to a five-year phase-in period during which
reimbursement is based on a blend of federal rates and a cost-based reimbursement system
(although some facilities can elect to adopt the full federal rates
immediately), LTACs are paid under this new LTAC PPS. We have elected to adopt
the full federal rates immediately. LTAC PPS uses information from patient
records to classify patients into distinct long-term care diagnosis related
groups, based on clinical characteristics and expected resource needs. Separate
per-discharge payments are calculated for each diagnosis related group. Our
experience under LTAC PPS has been positive. On January 30, 2004, CMS
published a proposed rule that would increase Medicare LTAC PPS rates by 2.9
percent, effective July 1, 2004, and make certain policy changes affecting LTAC
payment and classification policy. F-18




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long-term care diagnosis related
groups, based on clinical characteristics and expected resource needs. Separate
per-discharge payments are calculated for each diagnosis related group. Medicaid Reimbursement Issues The Balanced Budget Act also contained a number of additional changes, which
affected the Medicaid program. Significantly, the law repealed the Boren
Amendment, which required state Medicaid programs to reimburse nursing
facilities for the costs that are incurred by efficiently and economically
operated nursing homes. Since that repeal, many states where the Company
maintains significant operations have sought to lower their nursing home
payment rates, and several have succeeded. It is unclear at this time the
extent to which additional state Medicaid programs will adopt changes in their
Medicaid reimbursement systems, or, if adopted and implemented, what effect
these initiatives would have on the Company. Additionally, rising Medicaid
costs and decreasing state revenue caused by current economic conditions have
prompted an increasing number of states to cut Medicaid funding as a means of
balancing their state budgets. The Company can offer no assurances that future
changes in Medicaid reimbursement rates to nursing facilities will not have a
material adverse effect on the Company. Further, the Balanced Budget Act allows
states to mandate enrollment in managed care systems without seeking approval
from the Secretary of Health and Human Services for waivers from specified
Medicaid requirements as long as certain standards are met. While these managed
care programs have historically exempted institutional care, some states use
managed care financing for at least a portion of their long-term care programs.
Effective for Medicaid services provided on or after October 1, 1997, states
have considerable flexibility in establishing payment rates. The Company cannot
predict whether any additional states will change the Medicaid reimbursement
systems for long-term care facilities from cost-based or fee-for-service to
managed care negotiated or capitated rates or otherwise affect the level of
payments to the Company. On January 12, 2001, the Secretary of Health and Human Services issued final
regulations to implement changes to the Medicaid upper payment limit
requirements, which became effective May 14, 2002. The purpose of the rule is
to stop states from using specified accounting techniques to obtain extra
federal Medicaid matching funds that are not necessarily spent on health care
services for Medicaid beneficiaries. Although the rule is being phased in over
eight years to reduce the adverse impact on certain states, the rule eventually
could result in decreased federal funding to those state Medicaid programs that
have used these accounting techniques to enhance their federal funding, which,
in turn, could prompt such states to reduce Medicaid reimbursements to
providers, including nursing facilities. CMS announced additional restrictions
on such funding in January 2002, and the agency could consider further
limitations in the future. Moreover, President Bushs proposed fiscal year
2005 budget, if adopted by Congress, would restrict the use of certain
intergovernmental transfers and limit federal reimbursement to a state to the
cost of the Medicaid services provided. Federal Privacy and Transaction Regulations Other federal legislation requires major changes in our transmission and
retention of health information. The Health Insurance Portability and
Accountability Act (HIPAA) mandates, among other things, the
adoption of standards for the electronic exchange of health information in an
effort to encourage overall administrative simplification and enhance the
effectiveness and efficiency of the health care industry. Among the standards
that the Department of Health and Human Services (DHHS) has adopted or is
expected to adopt pursuant to HIPAA are standards for the following: electronic
transactions and code sets; unique identifiers for providers, employers, health
plans, and individuals; security and electronic signatures; and privacy. Although HIPAA was intended ultimately to reduce administrative expenses and
burdens within the health care industry, the Company believes that the law will
require significant and costly changes to current practices. DHHS has released
several final rules to date to implement various HIPAA administrative
simplification requirements, the most significant of which mandate the use of
new standards for specified health care transactions and seek to protect the
privacy and security of health information. The first rule requires the use of
uniform standards for common health care transactions, including health care
claims information, plan eligibility, referral certification and authorization,
claims status, plan enrollment and disenrollment, payment and remittance
advice, plan premium payments and coordination of benefits. The second rule imposes new standards relating to the privacy of individually
identifiable health information. These standards not only require the Companys
compliance with rules governing the use and disclosure of protected health
information, but they also require the Company to obtain satisfactory
assurances that any business associate to whom such information is disclosed
will safeguard the information. The third rule governing the security of health information was issued February
20, 2003. This rule specifies a series of administrative, technical and
physical security procedures the Company must implement to assure the
confidentiality of electronic protected health information. DHHS finalized the new transaction standards on August 17, 2000. Congress
passed legislation that extended the transaction standards deadline to October
16, 2003 for those HIPAA-covered entities that submitted a timely compliance
plan to the DHHS. The Company submitted a compliance plan and was granted the
deadline extension. On February 20, 2003, DHHS issued modifications to the
transaction standards, but these changes do not affect the compliance deadline.
The privacy standards were issued on December 28, 2000, and became effective on
April 14, 2001, with a compliance date of April 14, 2003 for most covered
entities. These privacy requirements were further modified in an August 2002
final rule. The security standards are effective April 21, 2003, with a
compliance date of April 21, 2005 for most covered entities.
Most recently, DHHS published a rule in January 2004 announcing the
adoption of the National Provider Identifier as the standard unique
health identifier for healthcare providers to use in filing and
pricing health care claims and other transactions. This rule is
effective May 23, 2005, with a compliance date of May 23,
2007. Sanctions for
failing to comply with HIPAA include criminal penalties and civil sanctions. F-19




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On September 23, 2003, DHHS acknowledged that not all of the health care
providers and health plans, state Medicaid offices and third party payors are
capable of accepting claims transactions in a manner that is compliant with the
HIPAA Standard Transactions and Code Set specifications. Therefore, DHHS has
agreed to allow covered entities to accept both HIPAA-compliant and
non-compliant transactions until such time as DHHS determines that compliance
has been achieved. The Companys claims are submitted by paper claims, direct
data entry or through the use of a health care clearinghouse. The Companys
clearinghouse has advised us that it has been testing and is currently
compliant with the Standard Transactions and Code Set specification. The
Company is prepared to utilize its contingency plan if necessary. Although the
Company can make no assurances, management does not anticipate that the
Companys liquidity will be adversely affected during the transition. NOTE 7 PROPERTY AND EQUIPMENT Property and equipment at December 31, 2003 and 2002 consisted of the following
(in thousands of dollars): Reorganized CompanyDecember 31,
    
    December 31,2003
    
    2002Land
    
    $
    72,485
    
    
    $
    82,796Buildings and improvements
    
    
    370,318
    
    
    
    376,252Leasehold improvements
    
    
    25,727
    
    
    
    22,646Furniture, fixtures and equipment
    
    
    116,375
    
    
    
    80,260Leased property under capital leases
    
    
    18,706
    
    
    
    31,733Total
    
    
    603,611
    
    
    
    593,687Less: Accumulated depreciation
    
    
    (59,255
    )
    
    
    (26,427
    )$
    544,356
    
    
    $
    567,260
 Impairment During the year ended December 31, 2003, the Company periodically reviewed its
long-lived assets for potential impairment in accordance with SFAS No. 144. No
impairment charge was recognized during fiscal year 2003. During the eight months ended December 31, 2002, potential impairment was
indicated at certain skilled nursing facilities and LTACs based on lower than
expected future cash flows, due in part to the expected reduction in revenue
for 2003 that resulted from the October 1, 2002 expiration of the temporary
increase in the Medicare reimbursement rates (the triggering event). The
Company retained an independent expert to assist in the determination of
whether any of the long-lived assets were potentially impaired. The impairment
test under SFAS No. 144 was a two-step process. It required developing cash
flow projections for each of the Companys skilled nursing facilities and
LTACs. In the first step, these undiscounted cash flows were compared to the
carrying value of the tangible assets. When and if a facilitys undiscounted
cash flows were less than the carrying value of the tangible assets, an
impairment of the tangible assets at the facility was indicated. If impairment
was indicated, the second step was performed. In the second step, discounted
cash flows for the facilities were calculated and the carrying values of the
tangible assets were reduced to the fair value if the carrying value exceeded
fair value. As a result of the SFAS No. 144 impairment analysis during the eight months
ended December 31, 2002, the Company recognized an impairment charge of $27.3
million. As a result of the triggering event, the Company reviewed its
reorganization value in excess of amounts allocable to identifiable assets and
goodwill for potential impairment. The total impairment charge recognized by
the Company for the eight months ended December 31, 2002 was $84.6 million.
The impairment charges consisted of $57.3 million for the reorganization value
in excess of amounts allocable to identifiable assets according to the
provisions of SFAS No. 142 (see Note 8) and $27.3 million for property and
equipment according to the provisions of SFAS No. 144. Both impairment charges
were incurred by reporting units in the nursing home services reportable
segment as defined in SFAS No. 131. Software Developed For Internal Use The Company is developing and implementing a new information technology
infrastructure to improve customer service, enhance operating efficiencies and
provide for more effective management of business operations. The Company has
capitalized $43.2 million and $13.7 million of software development costs as of
December 31, 2003 and 2002, respectively. Of the $43.2 million of capitalized
software costs at December 31, 2003, $5.3 million has been placed into service
and is currently being amortized over useful lives ranging from five to seven
years. As of December 31, 2003, there was $0.7 million of accumulated
amortization associated with the $5.3 million of software placed into service.
These costs are reported at the lower of unamortized cost or net realizable
value and are included in furniture, fixtures and equipment. Prior to June 30,
2002, software development costs were expensed and were included in F-20




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operating
expenses in the accompanying consolidated statements of operations. If
development and implementation of the new information technology infrastructure
and systems is not completed successfully, the Company could experience
temporary
interruptions in its operations and an adverse impact on its business, as well
as a potential impairment of its unamortized capitalized costs associated with
these systems. Depreciation Depreciation expense, including amortization of assets under capital leases and
capitalized software costs, related to property and equipment was $37.1 million
for the year ended December 31, 2003, $22.8 million for the eight months ended
December 31, 2002, $11.6 million for the four months ended April 30, 2002,
$10.9 million for the three months ended December 31, 2001 and $48.7 million
for the fiscal year ended September 30, 2001. The carrying value of buildings
and improvements was reduced by $27.3 million in the quarter ended December 31,
2002 related to the tangible asset impairment that was recorded according to
the provisions of SFAS No. 144.  NOTE 8
  
  REORGANIZATION VALUE IN EXCESS OF AMOUNTS ALLOCABLE TO IDENTIFIABLE ASSETS AND GOODWILL Fresh-Start Reporting On May 1, 2002, the Company adopted the provisions of fresh-start reporting.
On this date, the intangible assets of the Reorganized Company were restated to
their fair market value based upon, among other things, estimates provided by
an independent financial advisor. At December 31, 2002 the reorganization
value in excess of amounts allocable to identifiable assets of $201.4 million
represented the portion of reorganization value of the Reorganized Company that
could not be attributed to specific tangible or identified intangible assets. Year Ended December 31, 2003 During the year ended December 31, 2003, the Company divested a significant
portion of an operating segment (see Note 5). In accordance with the
provisions of SFAS No. 142, a portion of the excess reorganization value in
excess of amounts allocable to identifiable assets was included in the carrying
amount of the divested facilities. The amount of the excess reorganization
value in excess of amounts allocable to identifiable assets was determined
based on the relative fair values of the facilities divested. The excess
reorganization value in excess of amounts allocable to identifiable assets that
was written off as part of the divestitures was approximately $8.6 million, a
portion of which was included in the pre-tax gain on sale of divestitures of
$25.2 million in the accompanying statements of operations and a portion of
which was included in the gain on sale of discontinued operations, net of tax,
for the year ended December 31, 2003. As a result of a significant portion of the operating segment being divested,
the Company tested the remaining excess reorganization value in excess of
amounts allocable to identifiable assets for potential impairment. In
addition, the Company periodically reviewed its reorganization value in excess
of amounts allocable to identifiable assets for all reporting units, and
goodwill for potential impairment in accordance with SFAS No. 142, and
performed the required annual impairment test as of October 1, 2003. As a
result, no impairment charge was recognized during the year ended December 31,
2003. Eight Months Ended December 31, 2002 During the eight months ended December 31, 2002, the Company retained an
independent expert to assist in the determination of the reasonableness of the
carrying value of the reorganization value in excess of amounts allocable to
identifiable assets and goodwill. The assessment was performed as a result of
the triggering event that occurred on October 1, 2002 (see Note 7). The
Companys annual impairment test date coincided with the triggering event. The
impairment test under SFAS No. 142 is a two-step process that required the
Company to evaluate its intangible assets at the reporting unit level. The
first step was to determine the fair value of the reporting unit based on the
market value, local market conditions and lower than expected future cash
flows. The fair value was then compared to the carrying value of the reporting
unit. If, under the first step, the fair value of the reporting unit was less
than the carrying value of the reporting unit, step two of the impairment test
was required for those reporting units. The second step required comparing the
implied fair value of the intangible asset to the carrying value of the
intangible asset and an impairment loss was recognized to the extent that the
carrying value exceeded the implied fair value. As a result of the SFAS No. 142 impairment analysis, the Company recognized an
impairment charge of $57.3 million during the fourth quarter of the year ended
December 31, 2002. The total impairment charge recognized by the Company for
the eight months ended December 31, 2002 was $84.6 million. The impairment
charges consisted of $57.3 million for the reorganization value in excess of
amounts allocable to identifiable assets according to the provisions of SFAS
No. 142 (see Note 7) and $27.3 million for F-21




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property and equipment according to
the provisions of SFAS No. 144. Both impairment charges were incurred by
reporting units in the nursing home services reportable segment as defined in
SFAS No. 131. Transition Disclosures The Company adopted SFAS No. 142 effective January 1, 2002 and as a result,
amortization of goodwill ceased. Amortization of goodwill charged to expense
was $2.6 million for the three months ended December 31, 2001 and $11.3 million
for the fiscal year ended September 30, 2001. Accumulated amortization at
December 31, 2003 and 2002 was $1.0 million. The following table illustrates the impact on the Companys earnings as a
result of the adoption of SFAS No. 142 for the periods indicated (dollars in
thousands, except earnings per share amounts): Predecessor CompanyThree MonthsEnded
    
    Year EndedDecember 31,
    
    September 30,2001
    
    2001Reported net income (loss)
    
    $
    4,395
    
    
    $
    (33,395
    )Add back goodwill amortization
    
    
    2,572
    
    
    
    11,340Adjusted net income (loss)
    
    $
    6,967
    
    
    $
    (22,055
    )Earnings per share-basic and dilutedReported net income (loss)
    
    $
    0.06
    
    
    $
    (0.45
    )Goodwill amortization
    
    
    0.03
    
    
    
    0.15Adjusted net income (loss)
    
    $
    0.09
    
    
    $
    (0.30
    )
 F-22




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NOTE 9 RESTRICTED INVESTMENTS

Restricted investments at December 31, 2003 and 2002 consisted of the following
(in thousands of dollars):

|                                                                      |                            |      |           |       |                  |        |                  |       |                |   |     |     |   |   |        |       | 
|--------------------------------------------------------------------- | -------------------------- | ---- | --------- | ----- | ---------------- | ------ | ---------------- | ----- | -------------- | - | --- | --- | - | - | ------ | ----- | 
|                                                                      |                            |      | Amortized |       | Gross Unrealized |        | Gross Unrealized |       | Estimated Fair
|Reorganized Company                                                   |                            | Cost |           | Gains |                  | Losses |                  | Value
|                                                                      |                            |      |           |       |                  |        |                  |      
|December 31, 2003                                                     |                            |      |           |       |                  |        |                  |       |                |   |     |     |   |   |        |      
|Restricted by self insurance programs                                 |                            |      |           |       |                  |        |                  |       |                |   |     |     |   |   |        |      
|                                                                      | U.S. Treasury Notes        |      | $         | 1,729 |                  |        | $                | 16    |                |   | $   | (19 | ) |   | $      | 1,726 | 
|                                                                      | Corporate debt securities  |      |           | 4,116 |                  |        |                  | 255   |                |   |     |    |   |   |        | 4,371 | 
|                                                                      | Mortgage-backed securities |      |           | 2,830 |                  |        |                  | 162   |                |   |     |    |   |   |        | 2,992 | 
|                                                                      | Cash                       |      |           | 1,546 |                  |        |                  |      |                |   |     |    |   |   |        | 1,546 | 
|                                                                      | Other                      |      |           | 261   |                  |        |                  |      |                |   |     |    |   |   |        | 261   | 
|                                                                      |                            |      |           |       |                  |        |                  |       |                |   |     |     |   |   |        |       | 
|                                                                      |                            |      | 10,482    |       |                  |        | 433              |       |                |   | (19 | )   |   |   | 10,896 |      
|Restricted by insurance and other agreements                          |                            |      |           |       |                  |        |                  |       |                |   |     |     |   |   |        |      
|                                                                      | Cash collateral accounts   |      |           | 8,404 |                  |        |                  |      |                |   |     |    |   |   |        | 8,404 | 
|                                                                      |                            |      |           |       |                  |        |                  |       |                |   |     |     |   |   |        |       | 
|                                                                      |                            | $    | 18,886    |       |                  | $      | 433              |       |                | $ | (19 | )   |   | $ | 19,300 |      
|                                                                      |                            |      |           |       |                  |        |                  |       |                |   |     |     |   |   |        |       | 
|December 31, 2002                                                     |                            |      |           |       |                  |        |                  |       |                |   |     |     |   |   |        |      
|Restricted by self insurance programs                                 |                            |      |           |       |                  |        |                  |       |                |   |     |     |   |   |        |      
|                                                                      | U.S. Treasury Notes        |      | $         | 1,135 |                  |        | $                | 50    |                |   | $   |    |   |   | $      | 1,185 | 
|                                                                      | Corporate debt securities  |      |           | 5,430 |                  |        |                  | 332   |                |   |     |    |   |   |        | 5,762 | 
|                                                                      | Mortgage-backed securities |      |           | 4,008 |                  |        |                  | 241   |                |   |     |    |   |   |        | 4,249 | 
|                                                                      | Cash                       |      |           | 1,280 |                  |        |                  |      |                |   |     |    |   |   |        | 1,280 | 
|                                                                      | Other                      |      |           | 214   |                  |        |                  |      |                |   |     |    |   |   |        | 214   | 
|                                                                      |                            |      |           |       |                  |        |                  |       |                |   |     |     |   |   |        |       | 
|                                                                      |                            |      | 12,067    |       |                  |        | 623              |       |                |   |    |     |   |   | 12,690 |      
|Restricted by insurance and other agreements
Cash collateral accounts |                            |      | 26,003    |       |                  |        |                 |       |                |   |    |     |   |   | 26,003 |      
|                                                                      |                            |      |           |       |                  |        |                  |       |                |   |     |     |   |   |        |       | 
|                                                                      |                            | $    | 38,070    |       |                  | $      | 623              |       |                | $ |    |     |   | $ | 38,693 |      
|                                                                      |                            |      |           |       |                  |        |                  |       |                |   |     |     |   |   |        |       | 

Proceeds from the sales and maturities of investments were $8.4 million for the
year ended December 31, 2003, $10.3 million for the eight months ended December
31, 2002, $2.9 million for the four months ended April 30 2002, $2.7 million
for the three months ended December 31, 2001, and $20.8 million for the fiscal
year ended September 30, 2001.

The amortized cost and estimated fair value of debt securities and other
investments at December 31, 2003, by contractual maturity, are as follows (in
thousands of dollars):

|                                             |                            |        |           |       |        |       |         |       |          |      |           |     |  |   |    |    |  |   |        |       |  |  |  |  | 
|-------------------------------------------- | -------------------------- | ------ | --------- | ----- | ------ | ----- | ------- | ----- | -------- | ---- | --------- | --- |  | - | -- | -- |  | - | ------ | ----- |  |  |  |  | 
|                                             |                            |        |           |       |        |       |         |       |          |      |           |     |  |   |    |    |  |   | Total  |       |  |  | 
|                                             |                            |        | Less than |       | 1 to 5 |       | 5 to 10 |       | After 10 |      | Amortized |     |  |   |   
|Amortized Cost                               |                            | 1 year |           | years |        | years |         | years |          | Cost |           |     |  |  
|                                             |                            |        |           |       |        |       |         |       |          |      |           |     |  |  
|December 31, 2003                            |                            |        |           |       |        |       |         |       |          |      |           |     |  |   |    |    |  |   |        |      
|Restricted by self insurance programs        |                            |        |           |       |        |       |         |       |          |      |           |     |  |   |    |    |  |   |        |      
|                                             | U.S. Treasury Notes        |        | $         | 160   |        |       | $       | 1,240 |          |      | $         | 329 |  |   | $  |   |  |   | $      | 1,729 | 
|                                             | Corporate debt securities  |        |           |      |        |       |         | 3,817 |          |      |           | 299 |  |   |    |   |  |   |        | 4,116 | 
|                                             | Mortgage-backed securities |        |           | 30    |        |       |         | 1,988 |          |      |           | 715 |  |   |    | 97 |  |   |        | 2,830 | 
|                                             | Cash                       |        |           | 1,546 |        |       |         |      |          |      |           |    |  |   |    |   |  |   |        | 1,546 | 
|                                             | Other                      |        |           | 261   |        |       |         |      |          |      |           |    |  |   |    |   |  |   |        | 261   | 
|                                             |                            |        |           |       |        |       |         |       |          |      |           |     |  |   |    |    |  |   |        |       | 
|                                             |                            |        | 1,997     |       |        |       | 7,045   |       |          |      | 1,343     |     |  |   | 97 |    |  |   | 10,482 |      
|Restricted by insurance and other agreements |                            |        |           |       |        |       |         |       |          |      |           |     |  |   |    |    |  |   |        |      
|                                             | Cash collateral accounts   |        |           | 8,404 |        |       |         |      |          |      |           |    |  |   |    |   |  |   |        | 8,404 | 
|                                             |                            |        |           |       |        |       |         |       |          |      |           |     |  |   |    |    |  |   |        |       | 
|                                             |                            | $      | 10,401    |       |        | $     | 7,045   |       |          | $    | 1,343     |     |  | $ | 97 |    |  | $ | 18,886 |      
|                                             |                            |        |           |       |        |       |         |       |          |      |           |     |  |   |    |    |  |   |        |       | 

F-23



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|                                                        |                            |        |           |       |        |       |         |       |          |            |           |     |  |   |    |    |  |   |        |       | 
|------------------------------------------------------- | -------------------------- | ------ | --------- | ----- | ------ | ----- | ------- | ----- | -------- | ---------- | --------- | --- |  | - | -- | -- |  | - | ------ | ----- | 
|                                                        |                            |        | Less than |       | 1 to 5 |       | 5 to 10 |       | After 10 |            | Estimated
|Estimated Fair Value                                    |                            | 1 year |           | years |        | years |         | years |          | Fair Value
|                                                        |                            |        |           |       |        |       |         |       |          |           
|December 31, 2003
Restricted by self insurance programs |                            |        |           |       |        |       |         |       |          |            |           |     |  |   |    |    |  |   |        |      
|                                                        | U.S. Treasury Notes        |        | $         | 161   |        |       | $       | 1,233 |          |            | $         | 332 |  |   | $  |   |  |   | $      | 1,726 | 
|                                                        | Corporate debt securities  |        |           |      |        |       |         | 4,042 |          |            |           | 329 |  |   |    |   |  |   |        | 4,371 | 
|                                                        | Mortgage-backed securities |        |           | 30    |        |       |         | 2,082 |          |            |           | 782 |  |   |    | 98 |  |   |        | 2,992 | 
|                                                        | Cash                       |        |           | 1,546 |        |       |         |      |          |            |           |    |  |   |    |   |  |   |        | 1,546 | 
|                                                        | Other                      |        |           | 261   |        |       |         |      |          |            |           |    |  |   |    |   |  |   |        | 261   | 
|                                                        |                            |        |           |       |        |       |         |       |          |            |           |     |  |   |    |    |  |   |        |       | 
|                                                        |                            |        | 1,998     |       |        |       | 7,357   |       |          |            | 1,443     |     |  |   | 98 |    |  |   | 10,896 |      
|Restricted by insurance and other agreements            |                            |        |           |       |        |       |         |       |          |            |           |     |  |   |    |    |  |   |        |      
|                                                        | Cash collateral accounts   |        |           | 8,404 |        |       |         |      |          |            |           |    |  |   |    |   |  |   |        | 8,404 | 
|                                                        |                            |        |           |       |        |       |         |       |          |            |           |     |  |   |    |    |  |   |        |       | 
|                                                        |                            | $      | 10,402    |       |        | $     | 7,357   |       |          | $          | 1,443     |     |  | $ | 98 |    |  | $ | 19,300 |      
|                                                        |                            |        |           |       |        |       |         |       |          |            |           |     |  |   |    |    |  |   |        |       | 

Expected maturities may differ from contractual maturities because borrowers
may have the right to call or repay obligations with or without call or
prepayment penalties.

Management continually reviews its investment portfolio and evaluates whether
declines in the fair value of securities should be considered
other-than-temporary. Factored into this evaluation are the general market
considerations, the issuers financial condition and near-term prospects,
conditions in the issuers industry, the recommendations of advisors and the
length of time and extent to which the market value has been less than cost.
During the years ended December 31, 2003 and December 31, 2002, the Company had
no unrealized losses that were considered other-than-temporary. The following
table illustrates the Companys investments gross unrealized losses and fair
value aggregated by investment category and length of time that individual
securities have been in a continuous unrealized loss position at December 31,
2003 (in thousands of dollars):

|                          |  |                     |     |                        |  |            |     |        |  |            |   |            |  |   |   |  |  |            |     |  |  |   |     |  
|------------------------- |  | ------------------- | --- | ---------------------- |  | ---------- | --- | ------ |  | ---------- | - | ---------- |  | - | - |  |  | ---------- | --- |  |  | - | --- | -
|                          |  | Less than 12 Months |     | Greater than 12 months |  | Total     
|                          |  |                     |     |                        |  |           
|                          |  |                     |     |                        |  | Unrealized |     |        |  |            |   | Unrealized |  |   |   |  |  | Unrealized
|Description of Securities |  | Fair Value          |     | Losses                 |  | Fair Value |     | Losses |  | Fair Value |   | Losses    
|                          |  |                     |     |                        |  |            |     |        |  |            |   |           
|U.S. Treasury Notes       |  | $                   | 893 |                        |  | $          | (19 | )      |  | $          |  |            |  | $ |  |  |  | $          | 893 |  |  | $ | (19 | )
|                          |  |                     |     |                        |  |            |     |        |  |            |   |            |  |   |   |  |  |            |     |  |  |   |     |  

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NOTE 10 DEBT

Long-term debt is summarized in the following table (in thousands of
dollars):

|                         |                                                                |                                         |         |                           |         |      |         |         |         | 
|------------------------ | -------------------------------------------------------------- | --------------------------------------- | ------- | ------------------------- | ------- | ---- | ------- | ------- | ------- | 
|                         |                                                                |                                         |         | December 31, December 31,
|                         |                                                                |                                         |         |                          
|                         |                                                                |                                         |         | 2003                      |         | 2002
|                         |                                                                |                                         |         |                           |         |     
|Secured debt             |                                                                |                                         |         |                           |         |      |         |        
|                         | Senior Credit Facility
$90.0 million revolving credit facility |                                         | $       |                          |         |      | $       |        |        
|                         |                                                                | $85.0 million revolving credit facility |         |                           |        |      |         |         |        | 
|                         |                                                                | Term loans                              |         |                           | 135,000 |      |         |         |        | 
|                         |                                                                | Term loans                              |         |                           |        |      |         |         | 210,410 | 
|                         | Senior Subordinated Notes                                      |                                         |         | 175,000                   |         |      |         |        |        
|                         | Second Priority Notes                                          |                                         |         |                          |         |      |         | 150,000 |        
|                         | Non-recourse indebtedness of subsidiary                        |                                         |         | 59,688                    |         |      |         | 59,688  |        
|                         | Mortgage notes payable and capital leases                      |                                         |         | 19,948                    |         |      |         | 64,664  |        
|                         |                                                                |                                         |         |                           |         |      |         |         |        
|                         |                                                                |                                         | 389,636 |                           |         |      | 484,762 |        
|Less: current maturities |                                                                |                                         | (9,663  | )                         |         |      | (9,793  | )      
|                         |                                                                |                                         |         |                           |         |      |         |         |        
|                         | Long-term debt                                                 |                                         | $       | 379,973                   |         |      | $       | 474,969 |        
|                         |                                                                |                                         |         |                           |         |      |         |         |        

New Senior Credit Facility

On December 19, 2003 the Company
entered into the Senior Credit Facility with a syndicate of lenders which provides for a
$135.0 million term loan and a $90.0 million
revolving credit facility. The Term Loan was
drawn in full on December 19, 2003. As of December 31, 2003, there were no
borrowings outstanding under the Revolving Credit Facility, although the
Company utilized $34.6 million of borrowing capacity under the
Revolving Credit Facility to issue letters of credit on the closing date to
replace or support letters of credit issued under our previous senior credit facility
which consisted of: (i) an $85.0 million
revolving credit facility (the Old Revolving Credit
Facility) and (ii) a $212.0 million six-year term
loan facility (the Old Term Loan, collectively, the
Old Senior Credit Facility) and other
loan arrangements.

The Company is permitted to incur additional indebtedness of up to $65.0
million under the Senior Credit Facility, or by the issuance of additional
notes under the indenture governing the Notes or through a mortgage loan transaction with one or more other lenders in order
to optionally refinance the $59.7 million mortgage loan (the Omega Loan) from
Omega Healthcare Investors, Inc. (Omega). Any refinancing of the Omega Loan
might cause Professional Health Care Management, Inc. (PHCMI), a wholly
subsidiary of the Company, and its subsidiaries (the PHCMI Entities) to
become guarantor subsidiaries under the Senior Credit Facility. If additional
borrowings under the Senior Credit Facility were used to refinance the Omega
Loan pursuant to this arrangement, they would rank senior to the Notes and the
subsidiary guarantees of the Notes.

Maturity and Interest Rates

The Term Loan matures on January 2, 2010 and the Revolving Credit Facility
matures on January 8, 2008. The per annum interest rates applicable to the
Senior Credit Facility are the London InterBank Offering Rate (LIBOR), or, at
the Companys option, the base rate, which will be the higher of (x) the rate
of interest publicly announced by the administrative agent of the Senior Credit
Facility as its prime rate in effect, or (y) the federal funds effective rate
from time to time plus 0.50%, in each case, plus the applicable margin (as
defined below). The applicable margin with respect to the Revolving Credit
Facility will be determined in accordance with a performance grid based on the
Companys consolidated lease-adjusted leverage ratio. The Company expects the
applicable margin will range from 2.00% to 2.75% in the case of LIBOR advances,
and from 1.00% to 1.75% in the case of base rate advances. For purposes of the
Term Loan, the applicable margin will range from 2.50% to 2.75% in the case of
LIBOR advances, and from 1.50% to 1.75% in the case of base rate
advances, based on our consolidated lease-adjusted leverage ratio. The
default rate on the Senior Credit Facility will be 2.00% above the interest
rate otherwise applicable to base rate loans. The Company is also obligated to
pay a commitment fee ranging, depending on usage, from 0.50% to 0.75% on the
unused portion of the Revolving Credit Facility. At December 31, 2003, the
interest rate on the Term Loan was 5.75%.

Prepayments

Subject to certain exceptions, loans under the Senior Credit Facility are
required to be prepaid with 50% of the net cash proceeds of any sale of equity,
100% of the net proceeds of the incurrence of certain indebtedness (not
including the Notes issued on December 19, 2003), 100% of the net cash proceeds
from the sale or other disposition of certain assets to the extent not
reinvested in assets

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useful in the business of the Company and its subsidiaries
within 270 days, 100% of certain net insurance proceeds or net condemnation
awards which are not issued to repair, restore or replace the affected assets
within 360 days of receipt, and 75% of
excess cash flow, provided that if the Companys consolidated total leverage
ratio is below an agreed threshold, then 50% of excess cash flow. Amounts
prepaid in respect of the Term Loan may not be reborrowed;
accordingly, such prepayments may adversely affect the Companys liquidity.

The Company may prepay the Senior Credit Facility at any time in whole or in
part without premium or penalty, except that any prepayment of LIBOR advances
other than at the end of the applicable interest periods therefore must be made
with reimbursement for any funding losses and redeployment costs of the lenders
resulting therefrom.

Covenants

The Senior Credit Facility contains customary affirmative and negative
covenants, including, without limitation, limitations on indebtedness,
limitations on liens, limitations on guarantee obligations, limitations on
mergers, consolidations, liquidations and dissolutions, limitations on sales of
assets, limitations on leases, limitations on dividends and other payments in
respect of capital stock, limitations on investments, loans and advances,
limitations on optional payments and modifications of subordinated and other
debt instruments, limitations on transactions with affiliates, limitations on
granting negative pledges and limitations on changes in lines of business. In
addition, the Senior Credit Facility contains financial covenants including,
without limitation, with respect to maximum total lease-adjusted
leverage ratio,
maximum senior leverage ratio, minimum fixed charge coverage ratio and maximum
capital expenditures. At December 31, 2003, the Company was in compliance with
all covenants.

Events of Default

Events of default under the Senior Credit Facility include, among others,
nonpayment of principal when due, nonpayment of interest, fees or other
amounts, a material inaccuracy of any of the representations and warranties,
covenant defaults, cross-defaults, bankruptcy events, certain ERISA events,
material unsatisfied or unstayed judgments, actual or asserted invalidity of
any material guarantee or security document or security interest or
subordination provisions, a change of control and other actions including
certain health care regulatory actions having a material adverse effect.

Security and Guarantees

The Companys obligations under the Senior Credit Facility are guaranteed by
each of the Companys direct and indirect wholly owned domestic subsidiaries,
excluding the PHCMI Entities, certain joint ventures and the Companys captive
insurance subsidiaries.

All obligations under the Senior Credit Facility and the related guarantees are
secured by a perfected first priority lien or security interest (junior only to
liens securing the Omega Loan and other permitted liens) in substantially all
of the Companys tangible and intangible assets, including intellectual
property, real property and all of the capital stock or other equity interests
of each of the Companys direct and indirect wholly owned subsidiaries,
excluding the PHCMI Entities and other specified immaterial subsidiaries.

New Senior Subordinated Notes

On December 19, 2003, the Company issued $175.0 million aggregate principal
amount of 8.25% Notes under an indenture (the Indenture) among itself,
certain guarantor subsidiaries (the Guarantors) and U.S. Bank National
Association, as trustee (the Trustee). The Notes are general unsecured
obligations of the Company, are subordinated in right of payment to all
existing and future senior indebtedness of the Company, are senior in right of
payment to any future subordinated indebtedness of the Company and are
unconditionally guaranteed by the Guarantors.

Proceeds

Proceeds from the Senior Credit Facility and the Notes were used to repay
the our then outstanding second priority notes in full, repay borrowings
under the Old Senior Credit Facility
and pay fees and expenses associated with the financing transactions.

Maturity and Interest Rates

The Notes accrue interest at the rate of 8.25% per annum and will mature on
December 15, 2013. The interest is payable semi-annually in arrears on each
June 15 and December 15, commencing on June 15, 2004. The interest rate on the
Notes is subject to increase under the certain circumstances, including some
change in control events and certain exchange offers. Subject to the Companys
compliance with an Indenture covenant that limits additional indebtedness under
certain circumstances, the Company is entitled to, without the consent of the
holders of the Notes, issue more Notes under the Indenture on the same terms
and conditions as the existing Notes in an unlimited aggregate principal amount
(the Additional Notes). The Notes and the Additional Notes, if any, will be
treated as a single class for all purposes of the Indenture, including waivers,
amendments, redemptions and offers to purchase.

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Optional Redemption

Before December 15, 2006, the Company may redeem up to 35% of the aggregate
principal amount of Notes originally issued at any time and from time to time
at a redemption price equal to 108.250% of the aggregate principal amount so
redeemed, plus accrued and unpaid interest, if any, to the redemption date out
of the net proceeds of one or more equity offerings; provided that at least 65%
of the aggregate principal amount of Notes originally issued remains
outstanding immediately after the occurrence of any such redemption; and any
such redemption occurs within 90 days following the closing of such equity
offering.

On and after December 15, 2008, the Company may redeem the Notes at its option,
in whole at any time or in part from time to time, at the following redemption
prices (expressed as percentages of the principal amount thereof), plus accrued
and unpaid interest, if any, to the redemption date, if redeemed during the
twelve-month period beginning on December 15 of each year listed below:

|                    |  |            |         |  
|------------------- |  | ---------- | ------- | -
|Year                |  | Percentage
|                    |  |           
|2008                |  |            | 104.125 | %
|2009                |  |            | 102.750 | %
|2010                |  |            | 101.375 | %
|2011 and thereafter |  |            | 100.000 | %

Covenants

The Notes contain customary affirmative and negative covenants, including,
without limitation, limitations on other senior subordinated indebtedness,
limitations on restricted payments, limitation on investments, limitations on
liens, limitations on transaction with affiliates, limitations on creating of
subsidiaries, limitations on asset sales, limitations on preferred and capital
stock of restricted subsidiaries, limitations on dividends, limitations on
conduct of business and limitations on sale-leaseback transactions. In
addition, the Senior Credit Facility contains financial covenants including,
without limitation, with respect to maximum total lease-adjusted leverage ratio
(net of up to $35.0 million of cash balances), maximum senior leverage ratio
(net of up to $35.0 million of cash balances), minimum fixed charge coverage
ratio and maximum capital expenditures.

Events of Default

Events of default under the Notes include, among others, nonpayment of
principal when due, nonpayment of interest, fees or other amounts, covenant
defaults, bankruptcy events, material unsatisfied or unstayed judgments and
actual or asserted invalidity of any material guarantee.

Old Senior Credit Facility

On the Effective Date (May 13, 2002) and in connection with the consummation of
the Joint Plan, the Company entered into the Old Senior
Credit Facility. Outstanding amounts under the Old Senior Credit Facility
bore interest, at the Companys election, at a eurodollar rate or an alternate
base rate, in each case, plus an applicable margin, which ranged from 1.25% to
2.25% for base rate loans and 2.25% to 3.25% for eurodollar loans. The interest
rate on the Old Term Loan was 4.69% at December 31, 2002. The applicable margin
for loans under the Old Revolving Credit Facility was subject to adjustment in
the future based upon a performance related grid.

The Old Senior Credit Facility was guaranteed by substantially all of the
Companys direct and indirect wholly owned subsidiaries and was secured by a
perfected first priority lien or security interest (junior only to liens in
connection with certain third-party mortgage loans and other permitted liens)
in substantially all of the Companys tangible and intangible assets. The Old
Senior Credit Facility limited, among other things, the Companys ability to
incur additional indebtedness or contingent obligations, permit additional
liens, make additional acquisitions, sell or dispose of assets, pay dividends
on common stock and merge or consolidate with any other person or entity. In
addition, the Old Senior Credit Facility, which contained customary
representations and warranties, restricted the Companys ability to borrow
funds thereunder in the event the Company maintained in excess of a $25.0
million cash balance and required the Company to maintain compliance with
certain financial covenants, including minimum consolidated adjusted EBITDA (as
defined in the Old Senior Credit Facility), maximum leverage ratios, minimum
fixed charge coverage ratios and maximum capital expenditures.

The Old Revolving Credit Facility was available for general corporate purposes,
including working capital and permitted acquisitions. Usage under the Old
Revolving Credit Facility, which was to mature on May 13, 2007, was subject to
a borrowing base calculation based upon both a percentage of the Companys
eligible accounts receivable and a percentage of the real property collateral
value of substantially all of the Companys skilled nursing facilities. No
borrowings were outstanding under the Old Revolving Credit Facility

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as of December 31, 2002, but approximately $22.6 million of letters of credit
were outstanding under the Revolving Credit Facility on that date.

Proceeds of the Old Term Loan were used to fund the Companys obligations under
the Joint Plan and to pay in cash all or a portion of certain claims of
pre-petition senior credit facility lenders and mortgage lenders. The Old Term
Loan amortized in quarterly installments at a rate of 0.25% of the original
principal balance, or $530,000, payable on the last day of each fiscal quarter
beginning June 30, 2002, and to mature on May 13, 2008. The Old Term Loan could
be prepaid at the Companys option without penalty or premium. In addition, the
Old Term Loan was subject to mandatory prepayment: (i) from the proceeds of
certain asset sales which were not used within 180 days of receipt to acquire
long-term useful assets of the general type used in the Companys business;
(ii) from the proceeds of certain casualty insurance and condemnation awards,
the proceeds of which were not used within 360 days of receipt for the repair,
restoration or replacement of the applicable assets or for the purchase of
other long-term useful assets of the general type used in the Companys
business; and (iii) from the proceeds of the issuance of certain equity
securities and certain debt. The Old Term Loan was also subject to annual
mandatory prepayment to the extent of 75% of the Companys consolidated excess
cash flow (as defined in the Old Senior Credit Facility).

The Old Senior Credit Facility was amended to, among other things, defer the
Companys obligation to hedge its variable rate interest exposure until the
earlier of October 15, 2003, or 10 business days after the Company receives
notice from the Administrative Agent for the Old Senior Credit Facility (the
Administrative Agent) that the three-month eurodollar rate is at least 3% per
annum.

The Company was in violation of its maximum capital expenditures covenant for
the eight months ended December 31, 2002. That event of default was waived by
the Old Senior Credit Facility lenders in the Second Amendment and Limited
Waiver to Credit and Guaranty Agreement, dated as of March 31, 2003 (the
Second Amendment). The Second Amendment also amended the terms of certain of
the financial covenants and the interest rate contained in the Old Senior
Credit Facility.

Old Second Priority Notes

On the Effective Date, and in connection with the consummation of the Joint
Plan, the Company entered into an indenture (the Old Indenture) with The Bank of
New York, as Trustee, pursuant to which the Company issued the second priority
notes (the Old Notes) in the aggregate principal amount of $150.0 million.
The Old Notes bore interest at the three month LIBOR plus 550 basis points (6.90% at December 31, 2002) and were to mature
on May 13, 2009. The Old Notes were secured by a junior lien on substantially
all of the Companys tangible and intangible assets, subject to liens granted
to the lenders interest in the Old Senior Credit Facility, liens granted to
secure certain third-party mortgage loans and other permitted liens. The Old
Notes would be prepaid at any time without penalty, subject to restrictions in
place under the Old Senior Credit Facility. The Old Indenture included affirmative
and negative covenants customary for similar financings, including, without
limitation, restrictions on additional indebtedness, liens, restricted
payments, investments, asset sales, affiliate transactions and the creation of
unrestricted subsidiaries.

Non-Recourse Indebtedness of Subsidiary

PHCMI is the borrower under the approximately $59.7 million Omega Loan. The
Omega Loan bears interest at a rate of 11.57% per annum, and provides for
interest-only payments until its scheduled maturity on August 31, 2010. Prior
to maturity, the Omega Loan is not subject to prepayment at the option of PHCMI
except (a) between February 1, 2005 and July 31, 2005, at 103% of par (notice
of which prepayment must be given by December 31, 2004), and (b) within six
months prior to the scheduled maturity date, at par, in each case plus accrued
and unpaid interest.

The Omega Loan maturity date may be extended at PHCMIs option until August 31,
2021. This term-extending option meets the definition of an embedded derivative
instrument. This derivative is accounted for as a purchased option. The fair
market value of the purchased option has been separated from the related debt
and recorded in other assets at its estimated fair market value of $3.3 million
and $3.2 million as of December 31, 2003 and 2002, respectively.

The Omega Loan is guaranteed by all remaining subsidiaries of PHCMI, and is
secured by liens and security interests on all or substantially all of the real
property and personal property of the PHCMI Entities, including nine skilled
nursing facilities located in Michigan and three others in North Carolina (the
Omega Facilities). The Omega Loan constitutes nonrecourse indebtedness to the
Company and its restricted subsidiaries. Neither the Company nor any of its
restricted subsidiaries have guaranteed the Omega Loan or pledged assets to
secure the Omega Loan, other than the pledge of PHCMIs issued and outstanding
capital stock. In addition, neither PHCMI nor any of the PHCMI Entities have
guaranteed either the Senior Credit Facility or the Notes, nor have they
pledged their assets for such indebtedness. The Omega Loan restricts the extent
to which the PHCMI Entities can incur other indebtedness, including
intercompany indebtedness from PHCMIs shareholders, and can make distributions
to the Company and its other subsidiaries.

The Omega Facilities are managed by one of the Companys restricted
subsidiaries under a management agreement (the PHCMI Management Agreement),
which pays the manager a monthly management fee equal to 5% of gross revenues,
plus an annual

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incentive management fee equal to 75% of free cash flow from the Omega
Facilities. The remaining 25% of free cash flow from the Omega Facilities is
paid annually to Omega as an amendment fee. The PHCMI Management Agreement
expires by its terms on August 31, 2005, subject to two successive extension
options unilaterally exercisable by the manager, the first being a three-year
extension term, and the second being a two-year extension term.

Mortgage Notes Payable and Capital Leases

As of December 31, 2003, the Company had no mortgages outstanding. As of
December 31, 2002, all of the Companys mortgages were secured by the
underlying property and the loans bore interest at rates ranging from 8.3% to
9.0% per annum, with terms expiring from March 2009 to November 2030.

In addition, the Company leases certain equipment, land, and buildings under
capital leases. Assets under capital leases are capitalized using interest
rates appropriate at the inception of each lease (see Note 18).

Scheduled Maturities of Long-Term Debt

The scheduled maturities of long-term debt at December 31, 2003 are as
follows (in thousands of dollars):

|           |  |   |         | 
|---------- |  | - | ------- | 
|Year 1     |  | $ | 9,663   | 
|Year 2     |  |   | 10,157  | 
|Year 3     |  |   | 1,848   | 
|Year 4     |  |   | 1,873   | 
|Year 5     |  |   | 3,113   | 
|Thereafter |  |   | 362,982 | 
|           |  |   |         | 
|           |  | $ | 389,636 | 
|           |  |   |         | 

Letters of Credit

At December 31, 2003, the Company had total outstanding letters of credit
aggregating $34.6 million. The outstanding
letters of credit were issued as security for letters of credit
issued under the Old
Revolving Credit Facility. The $34.6 million figure referred to
above represents 105% of the outstanding letters of credit issued under the
Old Revolving Credit Facility. The letters of credit issued under our
Senior Credit Facility will remain outstanding until the beneficiaries of the underlying
letters of credit accept a new replacement letter of credit under the Revolving
Credit Facility. Therefore, the maximum net exposure under all letters of
credit at December 31, 2003 is $34.6 million. At December 31, 2002, the
Company had total outstanding letters of credit aggregating approximately $25.6
million, of which $3.0 million were issued prior to the Effective Date and were
collateralized with approximately $3.2 million of cash in accordance with the
Joint Plan.

Deferred Financing Costs

Deferred financing costs included in other assets in the accompanying
consolidated balance sheets consisted of the following for the periods
presented (in thousands of dollars):

|                         |  |                     |        |              |  |   |       |  
|------------------------ |  | ------------------- | ------ | ------------ |  | - | ----- | -
|                         |  | Reorganized Company
|                         |  |                    
|                         |  | December 31,        |        | December 31,
|                         |  | 2003                |        | 2002        
|                         |  |                     |        |             
|Deferred financing costs |  | $                   | 11,718 |              |  | $ | 6,424 |  
|Accumulated amortization |  |                     | (60    | )            |  |   | (669  | )
|                         |  |                     |        |              |  |   |       |  
|                         |  | $                   | 11,658 |              |  | $ | 5,755 |  
|                         |  |                     |        |              |  |   |       |  

As a result of the repayment of the Old Senior Credit Facility and the Old
Notes, unamortized deferred financing costs of $5.9 million were written off
during the quarter ended December 31, 2003 and are included in interest expense
in the accompanying consolidated statements of operations. Included in the
$5.9 million of deferred financing costs written off was $1.3 million, net of
$0.2 million of amortization, of additional deferred financing costs incurred
in May of 2003 related to the Old Credit Facility and Old Notes. Costs

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related to the refinancing of the Senior Credit Facility and the Notes of $11.7 million were
capitalized and will be amortized using the effective interest rate method over
the life of the debt to which the costs relate.

Amortization of deferred financing costs, including the write off of $5.9
million of deferred financing costs, and $1.3 million included in interest
expense in the accompanying consolidated statements of operations, was $7.3
million for the year ended December 31, 2003 and $0.7 million for the eight
months ended December 31, 2002.

Interest Paid

Interest paid by the Company during the year ended December 31, 2003 and the
eight months ended December 31, 2002 was $37.8 million and $23.9 million,
respectively. Interest paid by the Predecessor Company on prepetition
indebtedness was $2.8 million for the four months ended April 30, 2002, $3.5
million for the three months ended December 31, 2001 and $5.2 million for the
fiscal year ended September 30, 2001.

NOTE 11 INSURANCE

Professional and Workers Compensation Liability

Professional liability

Professional liability expense, including both the self-insured provision and
the cost of coverage maintained with unaffiliated commercial insurance
carriers, was $98.6 million for the year ended December 31, 2003, $55.3 million
for the eight months ended December 31, 2002, $30.5 million for the four months
ended April 30, 2002, $24.0 million for the three months ended December 31,
2001 and $91.2 million for the year ended September 30, 2001. The expense for
the year ended December 31, 2003 includes $21.0 million related to the
facilities divested in Florida, of which $6.0 million relates to
the purchase of tail insurance coverage.

Workers Compensation

The provision for workers compensation, including both the self-insured expense
and the cost of coverage maintained with unaffiliated commercial insurance
carriers, aggregated $27.2 million for the year ended December 31, 2003, $14.8
million for the eight months ended December 31, 2002, $7.4 million for the four
months ended April 30, 2002, $5.5 million for the three months ended December
31, 2001 and $17.7 million for the year ended September 30, 2001.

A summary of the assets and liabilities related to
professional and workers
compensation liability included in the consolidated balance sheet for the
periods presented is as follows (in thousands of dollars):

|            |                              |                        |         |                   |         |              |       |           |       |       |        |   |        |   |         |   |         | 
|----------- | ---------------------------- | ---------------------- | ------- | ----------------- | ------- | ------------ | ----- | --------- | ----- | ----- | ------ | - | ------ | - | ------- | - | ------- | 
|            |                              |                        |         | December 31, 2003
|            |                              |                        |         |                  
|            |                              |                        |         | Professional      |         | Workers      |       | Captive   |       |       |        |  
|            |                              |                        |         | Liability         |         | Compensation |       | Insurance |       | Total
|            |                              |                        |         |                   |         |              |       |           |       |      
|Assets      |                              |                        |         |                   |         |              |       |           |       |       |        |   |        |   |         |  
|            | Non-current                  |                        |         |                   |         |              |       |           |       |       |        |   |        |   |         |   |        
|            |                              | Restricted investments |         | $                 |        |              |       | $         | 354   |       |        | $ | 10,542 |   |         | $ | 10,896  | 
|            |                              |                        |         |                   |         |              |       |           |       |       |        |   |        |   |         |  
|            |                              | $                      |        |                   |         | $            | 354   |           |       | $     | 10,542 |   |        | $ | 10,896  |  
|            |                              |                        |         |                   |         |              |       |           |       |       |        |   |        |   |         |  
|Liabilities |                              |                        |         |                   |         |              |       |           |       |       |        |   |        |   |         |  
|            | Accrued insurance obligation |                        |         |                   |         |              |       |           |       |       |        |   |        |   |         |   |        
|            |                              | Current                |         | $                 | 53,259  |              |       | $         |      |       |        | $ | 1,056  |   |         | $ | 54,315  | 
|            |                              | Non-current            |         |                   | 183,399 |              |       |           | 4,061 |       |        |   | 3,664  |   |         |   | 191,124 | 
|            |                              |                        |         |                   |         |              |       |           |       |       |        |   |        |   |         |  
|            |                              | $                      | 236,658 |                   |         | $            | 4,061 |           |       | $     | 4,720  |   |        | $ | 245,439 |  
|            |                              |                        |         |                   |         |              |       |           |       |       |        |   |        |   |         |  

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|            |                              |                        |         |              |         |              |       |                   |       |       |        |   |        |   |         |   |         | 
|----------- | ---------------------------- | ---------------------- | ------- | ------------ | ------- | ------------ | ----- | ----------------- | ----- | ----- | ------ | - | ------ | - | ------- | - | ------- | 
|            |                              |                        |         |              |         |              |       | December 31, 2002 |       |       |        |  
|            |                              |                        |         |              |         |              |       |                   |       |       |        |  
|            |                              |                        |         | Professional |         | Workers      |       | Captive           |       |       |        |  
|            |                              |                        |         | Liability    |         | Compensation |       | Insurance         |       | Total
|            |                              |                        |         |              |         |              |       |                   |       |      
|Assets      |                              |                        |         |              |         |              |       |                   |       |       |        |   |        |   |         |  
|            | Non-current                  |                        |         |              |         |              |       |                   |       |       |        |   |        |   |         |   |        
|            |                              | Restricted investments |         | $            |        |              |       | $                 | 573   |       |        | $ | 12,117 |   |         | $ | 12,690  | 
|            |                              |                        |         |              |         |              |       |                   |       |       |        |   |        |   |         |   |         | 
|            |                              | $                      |        |              |         | $            | 573   |                   |       | $     | 12,117 |   |        | $ | 12,690  |  
|            |                              |                        |         |              |         |              |       |                   |       |       |        |   |        |   |         |   |         | 
|Liabilities |                              |                        |         |              |         |              |       |                   |       |       |        |   |        |   |         |  
|            | Accrued insurance obligation |                        |         |              |         |              |       |                   |       |       |        |   |        |   |         |   |        
|            |                              | Current                |         | $            | 21,650  |              |       | $                 | 6,000 |       |        | $ | 1,000  |   |         | $ | 28,650  | 
|            |                              | Non-current            |         |              | 187,700 |              |       |                   | 3,127 |       |        |   | 4,735  |   |         |   | 195,562 | 
|            |                              |                        |         |              |         |              |       |                   |       |       |        |   |        |   |         |   |         | 
|            |                              | $                      | 209,350 |              |         | $            | 9,127 |                   |       | $     | 5,735  |   |        | $ | 224,212 |  
|            |                              |                        |         |              |         |              |       |                   |       |       |        |   |        |   |         |   |         | 

Captives

The Company currently maintains two wholly owned captive insurance
subsidiaries, MPN Insurance Company, Ltd. (MPN Insurance) and GCI Indemnity,
Inc. (GCI Indemnity) to provide for reinsurance obligations under workers
compensation, professional liability and automobile liability for losses that
occurred prior to April 1, 1998. Pursuant to the reinsurance agreements, MPN
Insurance and GCI Indemnity are responsible to pay all losses that were
incurred by the company issuing the policies. The maximum loss exposure for
both captives is fully funded. Under the reinsurance agreements, GCI Indemnity
is collateralized through a security trust account, which has been designated
as restricted investments to pay for claims during the applicable policy
periods. Restricted investments designated to pay such claims had an estimated
fair value of $10.9 million and $12.7 million at December 31, 2003 and 2002,
respectively (see Note 9).

Health Insurance

Other than coverage provided under a few Health Maintenance Organizations, the
Company is self-insured for all medical and dental claims. The accrued
insurance obligation for employee health benefit claims was $5.3 million and
$6.8 million at December 31, 2003 and 2002, respectively, and is included in
accrued compensation and benefits in the accompanying consolidated balance
sheets.

The provision for self-insured losses for employee health benefit claims was
$36.8 million the year ended December 31, 2003, $20.4 million for the eight
months ended December 31, 2002, $8.9 million for the four months ended April
30, 2002, $6.7 million for the three months ended December 31, 2001 and $18.1
million for the year ended September 30, 2001.

NOTE 12 STOCKHOLDERS EQUITY

The authorized capital stock of the Company consists of 90,000,000 shares,
with 80,000,000 shares reserved for issuance as Common Stock and 10,000,000
shares reserved for issuance as preferred stock, par value $.01 per
share (the New Preferred Stock). All shares of authorized
common stock and preferred stock of the Predecessor Company were cancelled as
of the Effective Date.

Common Stock

The Company currently has 80,000,000 shares of Common Stock that are authorized
to be issued, of which 20,000,000 were issued and outstanding following the
initial distribution in accordance with the Joint Plan. Up to 2,153,022
additional shares of Common Stock may be issued in the future upon the exercise
of options granted or to be granted according to the provisions of the
Companys stock option plans (see Note 3). The issued and outstanding shares of
Common Stock are validly issued, fully paid and nonassessable. Common Stock
holders are entitled to one vote per share for each share held of record on all
matters submitted to a vote of stockholders and are entitled to receive ratably
such dividends as may be declared by the Board of Directors out of funds
legally available therefore. There is no cumulative voting in the election of
directors. The Senior Credit Facility and the Indenture contain negative
covenants that impose restrictions on, among other things, the Companys
ability to pay dividends. The Company does not

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plan to pay dividends for the foreseeable future. In the event of a
liquidation, dissolution or winding up of the Company, holders of Common Stock
will have the right to receive all assets available for distribution to
stockholders (after payment of liabilities and subject to the prior rights of
any holders of preferred stock then outstanding). The Common Stock holders have
no preemptive rights and no rights to require the redemption of the common
stock.

Warrants

The Reorganized Company issued warrants in connection with the Joint Plan in
consideration of the claims held by creditors in connection with the Chapter 11
cases, representing the right to purchase an aggregate of 753,786 shares of
Common Stock, subject to adjustment under certain circumstances. The initial
per share exercise price of the warrants is $28.04. The exercise period for the
warrants began on the Effective Date and expires on May 13, 2004. Each warrant
unexercised at the expiration of this period will become void, and all rights
will terminate. An assumed exercise of all warrants would result in cash
proceeds to the Company of approximately $21.1 million. The warrants were
recorded at fair value as consideration exchanged on the extinguishment of
debt.

NOTE 13 EMPLOYEE RETIREMENT PLANS

The Company sponsors various defined contribution retirement plans for the
benefit of employees. Company contributions to these plans represent a matching
percentage of certain employee contributions, which for certain plans is
subject to managements discretion based upon consolidated financial
performance. Total combined expense recognized by the Company under all of its
defined contribution retirement plans was $2.7 million for the year ended
December 31, 2003, $2.0 million for the eight months ended December 31, 2002,
$0.9 million for the four months ended April 30, 2002, $0.8 million for the
three months ended December 31, 2001, and $3.1 million for the fiscal year
ended September 30, 2001.

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NOTE 14 EARNINGS PER SHARE

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

The effect of dilutive securities for all periods presented has been excluded
because the effect is antidilutive.

|                                             |                          |                                                                                                            |                                                                      |   |                     |        |              |                     |         |             |   |              |   |               |        |  |   |        |      |  |   |         |       | 
|-------------------------------------------- | ------------------------ | ---------------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------- | - | ------------------- | ------ | ------------ | ------------------- | ------- | ----------- | - | ------------ | - | ------------- | ------ |  | - | ------ | ---- |  | - | ------- | ----- | 
|                                             |                          |                                                                                                            |                                                                      |   | Reorganized Company |        |              | Predecessor Company
|                                             |                          |                                                                                                            |                                                                      |   |                     |        |              |                    
|                                             |                          |                                                                                                            |                                                                      |   | Year                |        | Eight Months |                     |         | Four Months |   | Three Months |   | Year         
|                                             |                          |                                                                                                            |                                                                      |   | Ended               |        | Ended        |                     |         | Ended       |   | Ended        |   | Ended        
|                                             |                          |                                                                                                            |                                                                      |   | December 31,        |        | December 31, |                     |         | April 30,   |   | December 31, |   | September 30,
|                                             |                          |                                                                                                            |                                                                      |   | 2003                |        | 2002         |                     |         | 2002        |   | 2001         |   | 2001         
|                                             |                          |                                                                                                            |                                                                      |   |                     |        |              |                     |         |             |   |              |   |              
|Numerator for basic and diluted              |                          |                                                                                                            |                                                                      |   |                     |        |              |                     |         |             |   |              |   |               |        |  |   |        |      |  |  
|                                             | (Loss) income per share: |                                                                                                            |                                                                      |   |                     |        |              |                     |         |             |   |              |   |               |        |  |   |        |      |  |   |        
|                                             |                          | (Loss) income from continuing
operations                                                                   |                                                                      | $ | (22,527             | )      |              | $                   | (57,844 | )           |   |              | $ | 1,404,657     |        |  | $ | 3,459  |      |  | $ | (35,411 | )    
|                                             |                          | Discontinued operations:                                                                                   |                                                                      |   |                     |        |              |                     |         |             |   |              |   |               |        |  |   |        |      |  |   |         |      
|                                             |                          |                                                                                                            | (Loss) income from operations of
discontinued operations, net of tax |   |                     | (1,583 | )            |                     |         | (470        | ) |              |   |               | 216    |  |   |        | 936  |  |   |         | 2,016 | 
|                                             |                          |                                                                                                            | Gain on sale of discontinued
operations,net of tax                   |   |                     | 11,314 |              |                     |         |            |   |              |   |               | 29,082 |  |   |        |     |  |   |         |      | 
|                                             |                          |                                                                                                            |                                                                      |   |                     |        |              |                     |         |             |   |              |   |               |        |  |   |        |      |  |   |         |      
|                                             |                          | Net (loss) income                                                                                          |                                                                      | $ | (12,796             | )      |              | $                   | (58,314 | )           |   |              | $ | 1,433,955     |        |  | $ | 4,395  |      |  | $ | (33,395 | )    
|                                             |                          |                                                                                                            |                                                                      |   |                     |        |              |                     |         |             |   |              |   |               |        |  |   |        |      |  |   |         |      
|Denominator:                                 |                          |                                                                                                            |                                                                      |   |                     |        |              |                     |         |             |   |              |   |               |        |  |   |        |      |  |  
|                                             |                          | Denominator for basic income
(loss) per share - weighted
average shares                                    |                                                                      |   | 20,001              |        |              |                     | 20,000  |             |   |              |   | 73,688        |        |  |   | 73,688 |      |  |   | 73,688  |      
|                                             |                          | Effect of dilutive
securities - stock options                                                              |                                                                      |   |                    |        |              |                     |        |             |   |              |   |              |        |  |   |       |      |  |   |        |      
|                                             |                          |                                                                                                            |                                                                      |   |                     |        |              |                     |         |             |   |              |   |               |        |  |   |        |      |  |   |         |      
|                                             |                          | Denominator for diluted income
(loss) per share - adjusted
weighted average shares and
assumed conversions |                                                                      |   | 20,001              |        |              |                     | 20,000  |             |   |              |   | 73,688        |        |  |   | 73,688 |      |  |   | 73,688  |      
|                                             |                          |                                                                                                            |                                                                      |   |                     |        |              |                     |         |             |   |              |   |               |        |  |   |        |      |  |   |         |      
|Income (loss) per share - basic
and diluted: |                          |                                                                                                            |                                                                      |   |                     |        |              |                     |         |             |   |              |   |               |        |  |   |        |      |  |  
|                                             |                          | (Loss) income from continuing
operations                                                                   |                                                                      | $ | (1.13               | )      |              | $                   | (2.89   | )           |   |              | $ | 19.06         |        |  | $ | 0.05   |      |  | $ | (0.48   | )    
|                                             |                          | Discontinued operations:                                                                                   |                                                                      |   |                     |        |              |                     |         |             |   |              |   |               |        |  |   |        |      |  |   |         |      
|                                             |                          |                                                                                                            | (Loss) income from discontinued
operations                           |   |                     | (0.08  | )            |                     |         | (0.03       | ) |              |   |               |       |  |   |        | 0.01 |  |   |         | 0.03  | 
|                                             |                          |                                                                                                            | Gain on sale of discontinued
operations                              |   |                     | 0.57   |              |                     |         |            |   |              |   |               | 0.40   |  |   |        |     |  |   |         |      | 
|                                             |                          |                                                                                                            |                                                                      |   |                     |        |              |                     |         |             |   |              |   |               |        |  |   |        |      |  |   |         |      
|                                             |                          | Net (loss) income per share                                                                                |                                                                      | $ | (0.64               | )      |              | $                   | (2.92   | )           |   |              | $ | 19.46         |        |  | $ | 0.06   |      |  | $ | (0.45   | )    
|                                             |                          |                                                                                                            |                                                                      |   |                     |        |              |                     |         |             |   |              |   |               |        |  |   |        |      |  |   |         |      

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NOTE 15 INCOME TAXES

The provision (benefit) for income taxes allocated to continuing
operations is presented in the table below (in thousands of dollars). Income
tax provision (benefit) is allocated between continuing operations,
discontinued operations, and extraordinary items in accordance with SFAS
No. 109:

|                |  |                     |        |              |                     |   |             |  |              |  |               |      |   |  |   |     |   |  |   |        |  
|--------------- |  | ------------------- | ------ | ------------ | ------------------- | - | ----------- |  | ------------ |  | ------------- | ---- | - |  | - | --- | - |  | - | ------ | -
|                |  | Reorganized Company |        |              | Predecessor Company
|                |  |                     |        |              |                    
|                |  | Year                |        | Eight Months |                     |   | Four Months |  | Three Months |  | Year         
|                |  | Ended               |        | Ended        |                     |   | Ended       |  | Ended        |  | Ended        
|                |  | December 31,        |        | December 31, |                     |   | April 30,   |  | December 31, |  | September 30,
|                |  | 2003                |        | 2002         |                     |   | 2002        |  | 2001         |  | 2001         
|                |  |                     |        |              |                     |   |             |  |              |  |              
|Current:        |  |                     |        |              |                     |   |             |  |              |  |               |      |   |  |   |     |   |  |   |        |  
|Federal         |  | $                   | (6,451 | )            |                     | $ |            |  |              |  | $             | (126 | ) |  | $ | (25 | ) |  | $ | (8,394 | )
|State and local |  |                     | 309    |              |                     |   | 165         |  |              |  |               | (18  | ) |  |   |    |   |  |   | 2,688  |  
|                |  |                     |        |              |                     |   |             |  |              |  |               |      |   |  |   |     |   |  |   |        |  
|                |  |                     | (6,142 | )            |                     |   | 165         |  |              |  |               | (144 | ) |  |   | (25 | ) |  |   | (5,706 | )
|Deferred taxes: |  |                     |        |              |                     |   |             |  |              |  |               |      |   |  |   |     |   |  |   |        |  
|Federal         |  |                     |       |              |                     |   | 1,158       |  |              |  |               |     |   |  |   |    |   |  |   |       |  
|State and local |  |                     |       |              |                     |   |             |  |              |  |               |     |   |  |   |    |   |  |   |       |  
|                |  |                     |        |              |                     |   |             |  |              |  |               |      |   |  |   |     |   |  |   |        |  
|                |  |                     |       |              |                     |   | 1,158       |  |              |  |               |     |   |  |   |    |   |  |   |       |  
|                |  |                     |        |              |                     |   |             |  |              |  |               |      |   |  |   |     |   |  |   |        |  
|Total           |  | $                   | (6,142 | )            |                     | $ | 1,323       |  |              |  | $             | (144 | ) |  | $ | (25 | ) |  | $ | (5,706 | )
|                |  |                     |        |              |                     |   |             |  |              |  |               |      |   |  |   |     |   |  |   |        |  

The provision (benefit) for income taxes varies from the amount determined
by applying the federal statutory rate to pre-tax income as a result of the
following:

|                                             |                                                    |  |                     |     |              |                     |       |             |  |              |  |               |       |   |  |       |      |  |  |       |     | 
|-------------------------------------------- | -------------------------------------------------- |  | ------------------- | --- | ------------ | ------------------- | ----- | ----------- |  | ------------ |  | ------------- | ----- | - |  | ----- | ---- |  |  | ----- | --- | 
|                                             |                                                    |  | Reorganized Company |     |              | Predecessor Company
|                                             |                                                    |  |                     |     |              |                    
|                                             |                                                    |  | Year                |     | Eight Months |                     |       | Four Months |  | Three Months |  | Year         
|                                             |                                                    |  | Ended               |     | Ended        |                     |       | Ended       |  | Ended        |  | Ended        
|                                             |                                                    |  | December 31,        |     | December 31, |                     |       | April 30,   |  | December 31, |  | September 30,
|                                             |                                                    |  | 2003                |     | 2002         |                     |       | 2002        |  | 2001         |  | 2001         
|                                             |                                                    |  |                     |     |              |                     |       |             |  |              |  |              
|Federal statutory income tax rate            |                                                    |  | (35.0               | )%  |              |                     | (35.0 | )%          |  |              |  | 35.0          | %     |   |  | 35.0  | %    |  |  | (35.0 | )% 
|Increase (decrease) in taxes resulting from: |                                                    |  |                     |     |              |                     |       |             |  |              |  |               |       |   |  |       |      |  |  |       |    
|                                             | State and local taxes, net of federal tax
benefits |  |                     | 0.7 |              |                     |       | 0.2         |  |              |  |               | 1.0   |   |  |       | 2.8  |  |  |       | 5.9 | 
|                                             | Permanent book/tax differences:                    |  |                     |     |              |                     |       |             |  |              |  |               |       |   |  |       |      |  |  |       |     | 
|                                             | Goodwill amortization                              |  |                     |    |              |                     |       |            |  |              |  |               |      |   |  |       | 13.1 |  |  |       | 7.7 | 
|                                             | Cancellation of indebtedness                       |  |                     |    |              |                     |       |            |  |              |  |               | (25.5 | ) |  |       |     |  |  |       |    | 
|                                             | Impairment of long-lived assets                    |  |                     |    |              |                     |       | 35.0        |  |              |  |               |      |   |  |       |     |  |  |       |    | 
|                                             | Fresh Start                                        |  |                     |    |              |                     |       |            |  |              |  |               | (2.6  | ) |  |       |     |  |  |       |    | 
|                                             | Other permanent items                              |  |                     | 4.0 |              |                     |       | 1.6         |  |              |  |               | (0.1  | ) |  |       | 1.1  |  |  |       | 2.0 | 
|Realization of benefit of carryback          |                                                    |  |                    |     |              |                     |      |             |  |              |  |              |       |   |  |      |      |  |  | (19.9 | )  
|Change in valuation allowance                |                                                    |  | 8.9                 |     |              |                     | 0.5   |             |  |              |  | (7.8          | )     |   |  | (52.7 | )    |  |  | 25.4  |    
|                                             |                                                    |  |                     |     |              |                     |       |             |  |              |  |               |       |   |  |       |      |  |  |       |    
|Effective tax rate                           |                                                    |  | (21.4               | )%  |              |                     | 2.3   | %           |  |              |  | 0.0           | %     |   |  | (0.7  | %)   |  |  | (13.9 | )% 
|                                             |                                                    |  |                     |     |              |                     |       |             |  |              |  |               |       |   |  |       |      |  |  |       |    

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The components of the net deferred tax assets are as follows (in thousands of
dollars):

|                                    |                                                           |   |              |         |              |   |          |         |  
|----------------------------------- | --------------------------------------------------------- | - | ------------ | ------- | ------------ | - | -------- | ------- | -
|                                    |                                                           |   | December 31, |         | December 31,
|                                    |                                                           |   | 2003         |         | 2002        
|                                    |                                                           |   |              |         |             
|Deferred tax liabilities:           |                                                           |   |              |         |              |   |          |        
|                                    | Amounts relating to property and equipment                |   | $            | (169    | )            |   | $        | (3,717  | )
|                                    | Tax amortization of excess reorganzation
value            |   |              | (8,281  | )            |   |          |        |  
|Deferred tax assets:                |                                                           |   |              |         |              |   |          |        
|                                    | Allowance for bad debts and other
current asset valuation |   |              | 38,838  |              |   |          | 29,043  |  
|                                    | Payroll benefits                                          |   |              | 9,906   |              |   |          | 11,397  |  
|                                    | Restructuring reserves                                    |   |              | 2,494   |              |   |          | 1,457   |  
|                                    | Intangibles                                               |   |              |        |              |   |          | 46,560  |  
|                                    | NOL carryforwards-Predecessor Company                     |   |              | 206,431 |              |   |          | 414,203 |  
|                                    | NOL carryforwards-Reorganized Company                     |   |              | 10,525  |              |   |          |        |  
|                                    | Accrued expenses                                          |   |              | 505     |              |   |          | 505     |  
|                                    | Tax credits                                               |   |              | 1,857   |              |   |          | 212     |  
|                                    | Insurance                                                 |   |              | 98,230  |              |   |          | 87,420  |  
|                                    | Medicare timing differences                               |   |              | 2,839   |              |   |          | 1,937   |  
|                                    | Other miscellaneous                                       |   |              | 6,754   |              |   |          | 7,051   |  
|                                    |                                                           |   |              |         |              |   |          |         |  
|Total deferred tax assets           |                                                           |   | 378,379      |         |              |   | 599,785  |        
|                                    |                                                           |   |              |         |              |   |          |         |  
|Net deferred tax assets/liabilities |                                                           |   | 369,929      |         |              |   | 596,068  |        
|                                    |                                                           |   |              |         |              |   |          |         |  
|Less: valuation allowance           |                                                           |   | (369,929     | )       |              |   | (596,068 | )      
|                                    |                                                           |   |              |         |              |   |          |         |  
|Net deferred tax assets             |                                                           | $ |             |         |              | $ |         |        
|                                    |                                                           |   |              |         |              |   |          |         |  

For the fiscal year ended December 31, 2003, a federal income tax benefit of
$6.5 million and state income tax provision of $0.3 million allocable to
continuing operations was recorded. During 2003, the Company also reported loss
from discontinued operations of $1.6 million and gain on sale of discontinued
operations of $11.3 million. The loss from discontinued operations was shown
net of a tax benefit of $1.1 million and the gain on sale of discontinued
operations was shown net of a provision of $0.3 million.

Federal and state income tax payments were $0.2 million for the year ended
December 31, 2003, and $0.4 million and $0.1 million for the eight months ended
December 31, 2002 and four months ended April 30, 2002, respectively.
Additionally, payments were $2.1 million and $0.8 million for the three months
ended December 31, 2001 and the fiscal year ended September 30, 2001,
respectively.

The Company received tax refunds of $10.3 million for the eight months ended
December 31, 2002, which were reflected as a reduction of reorganization value
in excess of amounts allocated to identifiable assets. Additionally, refunds
received were $5.1 million and $4.0 million for the three months ended December
31, 2001 and fiscal year ended September 30, 2001, respectively.

The reorganization of the Company on May 12, 2002 constituted an ownership
change under Section 382 of the Internal Revenue Code (Section 382), which
theoretically imposed annual limitations on the utilization of loss
carryforwards after certain ownership changes. However, the Company made an
election on the 2002 consolidated return filed in 2003 that enabled the Company
to avoid the annual Section 382 limitations. The consequences of that election
were that the NOLs must be reduced by interest
deducted for income tax purposes for the period from October 1, 1998 through
the emergence date on indebtedness that was converted into stock pursuant to
the Joint Plan. This reduction is reflected in the reduction of NOL
carryforwards by the Predecessor Company and offsetting reduction in the Companys
valuation allowance. A further consequence of the election is if there is a
cumulative ownership change involving shareholders who own 5% or more of the
Companys Common Stock of more than 50% during the two year period following
our emergence from bankruptcy (May 1, 2002), the remaining NOL carryforwards
will be foregone with no net impact to the condensed consolidated financial
statements. This could result in higher future tax payments if the Company is
profitable.

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In connection with the bankruptcy reorganization, the Company realized a gain
from the extinguishment of certain indebtedness. This gain was not taxable
because the gain resulted from the reorganization of the Company under the
Bankruptcy Code. However, the Company was required pursuant to Section 108 of
the Internal Revenue Code (Section 108) to reduce its tax attributes including: (a) NOLs; (b)
tax credits; and (c) tax bases in assets in an amount equal to such gain on
extinguishment. Per the 2002 consolidated return for the Company, the NOLs were
reduced by $687.9 million pursuant to the provisions of Sections 382 and 108 as
discussed above. The Company has approximately $563 million of NOL
carryforwards after the aforementioned reductions as of December 31, 2003,
which will expire at various dates through 2023. Of the total NOL carryforward,
$118.4 million is unencumbered by any Section 382 limitations.

SFAS No. 109, Accounting for Income Taxes, requires that a valuation
allowance be established when it is more likely than not that all or a portion
of a deferred tax asset will not be realized. The ultimate realization of
deferred tax assets is dependent upon the generation of future taxable income
during the periods in which those temporary differences are deductible. In
making this determination, management considers all available positive and
negative evidence affecting specific deferred tax assets, including the
Companys past and anticipated future performance, the reversal of deferred tax
liabilities, and the implementation of tax planning strategies.

Objective positive evidence is necessary to support a conclusion that a
valuation allowance is not needed for all or a portion of deferred tax assets
when significant negative evidence exists. Cumulative losses in recent years
are the most compelling form of negative evidence considered by management in
this determination. The Company has established a valuation allowance to
completely offset its net deferred tax assets. The Company believes the
deferred tax assets will not be recognized under the more likely than not
standard. During the year ended December 31, 2003, the valuation allowance
recognized was $369.9 million. As the pre-emergence net deferred tax assets are
realized, a reduction in the valuation allowance established in connection with
fresh-start reporting will be recorded. Pursuant to SOP 90-7, the reduction in
this valuation allowance will first reduce reorganization value in excess of
amount allocable to identified assets recorded in fresh-start reporting and
other intangible assets, with any excess being treated as an increase to
capital in excess of par value.

NOTE 16 REORGANIZATION UNDER CHAPTER 11 OF THE BANKRUPTCY CODE

As previously noted, on the Effective Date, the Company emerged from
proceedings under Chapter 11 of the Bankruptcy Code pursuant to the terms of
the Joint Plan. On the Petition Date, MPAN and certain of its direct and
indirect subsidiaries (other than its wholly owned subsidiary, MHG, and its
direct and indirect subsidiaries, the MPAN Debtors) filed voluntary petitions
with the Bankruptcy Court for protection under Chapter 11 of the Bankruptcy
Code. On the same date, MHG and certain of its direct and indirect subsidiaries
(the MHG Debtors) also filed for relief under Chapter 11 of the Bankruptcy
Code, thus commencing the Chapter 11 cases (the Chapter 11 Cases).

On November 30, 2001, the MPAN Debtors and the MHG Debtors (collectively, the
Debtors) filed an initial version of the Joint Plan with the Bankruptcy
Court. The Joint Plan was amended on December 14, 2001 and again on February 1,
2002, at which time the Bankruptcy Court approved the Disclosure Statement
related to the Joint Plan and authorized the Debtors to solicit votes in favor
of the Joint Plan. A hearing on confirmation of the Joint Plan by the
Bankruptcy Court was held on March 25, 2002, in connection with which the Joint
Plan was further amended. The Bankruptcy Court confirmed the Joint Plan, as
amended, in connection with confirmation in orders dated April 3, 2002. The
Joint Plan was consummated on May 13, 2002, at which time the automatic stay
imposed by the Bankruptcy Court was terminated. See below for a summary of the
Joint Plan, which is qualified in its entirety by reference to all of the
provisions of the Joint Plan, as filed with the SEC on April 17, 2002 as
Exhibit 2.1 to the Companys Current Report on Form 8-K.

Joint Plan of Reorganization

The Joint Plan resulted from many months of good faith and arms length
negotiations among representatives of the Debtors, the lenders under the
Debtors prepetition senior secured credit facilities and the committees of
unsecured creditors in the Debtors Chapter 11 Cases. The principal provisions
of the Joint Plan provided for, among other things, the substantive
consolidation of the MPAN Debtors estates, and the separate substantive
consolidation of the MHG Debtors estates. Accordingly, any claims against, and
assets of, a particular MPAN Debtor as of the Effective Date were deemed to be
claims against and assets of all of the MPAN Debtors, and any claims against,
and assets of, a particular MHG Debtor as of the Effective Date were deemed to
be claims against and assets of all of the MHG Debtors.

Notwithstanding the foregoing, substantive consolidation did not affect the
validity of any creditors perfected and unavoidable interest in property of
the Debtors estates (such as validly perfected liens). In addition, the
Bankruptcy Courts orders confirming the Joint Plan provided that the
determinations regarding substantive consolidation do not apply to claims
arising after the Effective Date.

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As a result of the consummation of the Joint Plan, the Company has one capital
structure, and the MPAN Debtors and the MHG Debtors no longer operate
separately, except with respect to the resolution of claims in their respective
Chapter 11 Cases. In addition, the principal lenders under the Debtors
prepetition senior credit facilities received the substantial majority of the
equity in the Reorganized Company in accordance with the provisions of the
Joint Plan (see below).

Pursuant to the Joint Plan, the principal lenders under the Debtors
prepetition senior credit facilities received, among other things: (i) $275.0
million of available cash, as defined in the Joint Plan, after giving effect to
certain adequate protection payments paid to senior lenders in connection with
the disposition of assets; (ii) $150.0 million in principal amount of newly
issued secured debt (the Senior Subordinated Notes) (see Note 10); and (iii)
19.2 million shares of the Reorganized Companys common stock, par value $.01
per share (the New Common Stock), representing approximately 96% of the New
Common Stock issued as of the Effective Date (see Note 12).

Certain of the Debtors skilled nursing facilities were also encumbered by
mortgage debt owing to third parties (the Project Lenders). Most Project
Lenders received consensual treatment as provided in the Joint Plan, which
included, among other things: (i) a cash payment of $11.5 million in
satisfaction of mortgages on three skilled nursing facilities; (ii) a cash
payment of approximately $0.5 million and the restructuring of mortgages on two
skilled nursing facilities; and (iii) an agreement to surrender certain skilled
nursing facilities and other collateral in satisfaction of mortgages on certain
other skilled nursing facilities.

Holders of general unsecured allowed claims (other than holders of general
unsecured allowed claims against the MHG Debtors) received pro rata
distributions of 399,078 shares of New Common Stock (approximately 2% of the
New Common Stock issued on the Effective Date) and warrants to purchase an
additional 376,893 shares of New Common Stock. Such warrants have a per share
exercise price of $28.04 and are exercisable for a period of two years beyond
the Effective Date.

The holders of general unsecured allowed claims against the MHG Debtors
received, along with the holders of senior subordinated notes issued by the MHG
Debtors prior to bankruptcy, pro rata distributions of a $7.5 million cash
fund. Holders of senior subordinated notes issued by the MPAN Debtors prior to
bankruptcy received pro rata distributions of 399,078 shares of New Common
Stock (approximately 2% of the New Common Stock issued on the Effective Date)
and warrants to purchase an additional 376,893 shares of the New Common Stock.
Such warrants have a per share exercise price of $28.04 and are exercisable for
a period of two years beyond the Effective Date. Holders of punitive damage
claims and securities damage claims received no distributions under the Joint
Plan on account of such claims.

Most other creditors holding allowed secured claims were unimpaired, paid in
full, or had their collateral returned to them in satisfaction of their allowed
secured claims. Holders of allowed priority tax claims and allowed other
priority claims were paid in full.

The holders of preferred stock, common stock, warrants and options to purchase
common stock of the Company prior to the Effective Date did not receive any
distributions under the Joint Plan. On the Effective Date, MHG was merged out
of existence and its direct and indirect subsidiaries remained direct or
indirect subsidiaries of the Reorganized Company, as set forth in a corporate
restructuring program implemented by the Company in connection with the Joint
Plan and as described in more detail in the Joint Plan. The Joint Plan contains
various other provisions relating to, among other things, executory contracts
and leases, plan implementation and other matters that affected the rights of
creditors and equity holders.

Matters Related to Emergence

In connection with the consummation of the Joint Plan, the Company entered into
the $297.0 million Old Senior Credit Facility with a syndicate of lenders, dated as of the Effective Date, which provided funds
to satisfy certain obligations of the Predecessor Company to its creditors
under the Joint Plan, for general working capital purposes and for permitted
acquisitions. In connection with the issuance of the Second Priority Notes, the
Company entered into an indenture pertaining to such notes (see Note 10).

On the Effective Date, the Company filed a registration statement on Form 8-A
(the Form 8-A) with the Securities and Exchange Commission (the SEC) to
register the New Common Stock and warrants to purchase the New Common Stock
issued in connection with the Joint Plan. In addition, the Form 8-A disclosed
that the Company had filed its Third Amended and Restated Certificate of
Incorporation, which, among other things, changed the number of authorized
shares of capital stock to 90,000,000, with 80,000,000 shares reserved for
issuance as Common Stock and 10,000,000 shares reserved for issuance as
New Preferred Stock (see Note
12).

In connection with the restructuring of its debt in accordance with the
provisions of the Joint Plan, the Company realized a gain of approximately $1.2
billion, which is included in reorganization items in the consolidated
statements of operations. For accounting purposes, this gain has been reflected
in the operating results of the Predecessor Company for the four months ended
April 30, 2002. A summary of the gain follows (in thousands of dollars):

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|                                        |                                                      |                                      |           |           |           | 
|--------------------------------------- | ---------------------------------------------------- | ------------------------------------ | --------- | --------- | --------- | 
|Liabilities subject to compromise       |                                                      |                                      |           |          
|                                        | Pre-petition senior credit facilities and term loans |                                      | $         | 1,217,638 |          
|                                        | Pre-petition senior subordinated debt                |                                      |           | 597,328   |          
|                                        | Other pre-petition debt                              |                                      |           | 134,708   |          
|                                        |                                                      |                                      |           |          
|                                        |                                                      | Long-term debt subject to compromise |           |           | 1,949,674 | 
|                                        | Accounts payable and other accrued liabilities       |                                      |           | 169,897   |          
|                                        | Accrued interest                                     |                                      |           | 79,959    |          
|                                        | Deferred loan costs                                  |                                      |           | (32,253   | )        
|                                        |                                                      |                                      |           |          
|Total liabilities subject to compromise |                                                      |                                      | 2,167,277 |          
|Less: Consideration exchanged           |                                                      |                                      |           |          
|Cash payments                           |                                                      |                                      | 287,376   |          
|                                        | Value of secured, priority and other claims assumed  |                                      |           | 140,232   |          
|                                        | Value of Second Priority Notes                       |                                      |           | 150,000   |          
|                                        | Value of Reorganized Companys New Common Stock      |                                      |           | 359,177   |          
|                                        | Value of Reorganized Companys warrants              |                                      |           | 935       |          
|                                        |                                                      |                                      |           |          
|Gain on debt discharge                  |                                                      | $                                    | 1,229,557 |          
|                                        |                                                      |                                      |           |           |          

Liabilities Subject to Compromise

In accordance with SOP 90-7, effective January 18, 2000, the Company
discontinued accruing interest relating to its debt facilities then classified
as liabilities subject to compromise. Contractual interest was $45.7 million
for the four months ended April 30, 2002, $43.5 million for the transition
period ended December 31, 2001 and $201.1 million and $238.9 million for the
fiscal years ended September 30, 2001 and 2000, respectively, which is $42.7
million, $40.0 million, $195.9 million and $167.0 million in excess of interest
expense included in the accompanying consolidated financial statements for the
respective periods.

Reorganization Items

In accordance with SOP 90-7, the Company has recorded all transactions directly
related to the reorganization of the Company since the filing of the Chapter 11
Cases as reorganization items. A summary of the principal categories of
reorganization items follows (in thousands of dollars):

|                                                                      |  |                     |            |              |  |                          |        |      |  |   |        |   |  |   |         |  
|--------------------------------------------------------------------- |  | ------------------- | ---------- | ------------ |  | ------------------------ | ------ | ---- |  | - | ------ | - |  | - | ------- | -
|                                                                      |  | Predecessor Company
|                                                                      |  |                    
|                                                                      |  | Four Months         |            | Three Months |  |                          |        |      |  |   |        |  
|                                                                      |  | Ended               |            | Ended        |  | Year Ended September 30,
|                                                                      |  | April 30,           |            | December 31, |  |                         
|                                                                      |  | 2002                |            | 2001         |  | 2001                     |        | 2000
|Professional fees                                                     |  | $                   | 67,976     |              |  | $                        | 14,172 |      |  | $ | 40,158 |   |  | $ | 25,770  |  
|Net loss (gain) on divestitures                                       |  |                     | 10,766     |              |  |                          | (1,671 | )    |  |   | 1,531  |   |  |   | (14,688 | )
|Interest earned on accumulated
cash resulting from Chapter 11
filings |  |                     | (648       | )            |  |                          | (798   | )    |  |   | (6,112 | ) |  |   | (2,463  | )
|Other reorganization costs                                            |  |                     | 11,031     |              |  |                          | 1,450  |      |  |   | 12,144 |   |  |   | 2,197   |  
|Gain on extinguishment of debt                                        |  |                     | (1,229,557 | )            |  |                          |       |      |  |   |       |   |  |   |        |  
|Fresh-start valuations adjustments                                    |  |                     | (253,877   | )            |  |                          |       |      |  |   |       |   |  |   |        |  
|                                                                      |  |                     |            |              |  |                          |        |      |  |   |        |   |  |   |         |  
|                                                                      |  | $                   | (1,394,309 | )            |  | $                        | 13,153 |      |  | $ | 47,721 |   |  | $ | 10,816  |  
|                                                                      |  |                     |            |              |  |                          |        |      |  |   |        |   |  |   |         |  

NOTE 17 FRESH  START REPORTING

In accordance with SOP 90-7, the Company adopted fresh-start reporting because
holders of existing voting shares immediately before filing and confirmation of
the Joint Plan received less than 50% of the voting shares of the emerging
entity and its reorganization value is less than its postpetition liabilities
and allowed claims, as shown below (in thousands of dollars):

|                                                        |  |   |           | 
|------------------------------------------------------- |  | - | --------- | 
|Postpetition liabilities                                |  | $ | 268,942   | 
|Liabilities deferred pursuant to Chapter 11 proceedings |  |   | 2,167,277 | 
|                                                        |  |   |           | 
|Total postpetition liabilities and allowed claims       |  |   | 2,436,219 | 
|Reorganization value                                    |  |   | 816,800   | 
|                                                        |  |   |           | 
|Excess of liabilities over reorganization value         |  | $ | 1,619,419 | 
|                                                        |  |   |           | 

As previously discussed, in accordance with SOP 90-7, the Company adopted the
provisions of fresh-start reporting as of May 1, 2002. In adopting the
requirements of fresh-start reporting, the Company engaged an independent
financial advisor to assist in the determination of the reorganization value or
fair value of the emerging entity. The independent financial advisor determined
an estimated reorganization value of approximately $816.8 million before
considering any long-term debt or other obligations assumed in

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connection with the Joint Plan. This estimate was based upon various valuation
methods, including discounted projected cash flow analysis, selected comparable
market multiples of publicly traded companies and other applicable ratios and
economic industry information relevant to the operations of the Company, as
well as through negotiations with the various creditor parties in interest. The
estimated total equity value of the Reorganized Company aggregating
approximately $326.2 million was determined after taking into account the
values of the obligations assumed in connection with the Joint Plan.

After consideration of the Companys debt capacity and other capital structure
considerations, such as industry norms, projected earnings to fixed charges,
earnings before interest and taxes to interest, free cash flow to interest,
free cash flow to debt service and other applicable ratios, and after extensive
negotiations among parties in interest, it was agreed that the Companys
reorganization capital structure would be as follows (in thousands of dollars):

|                                        |  |   |           |  
|--------------------------------------- |  | - | --------- | -
|Postpetition current liabilities        |  | $ | 268,942   |  
|Senior credit facility-term loan        |  |   | 212,000   |  
|Second priority notes                   |  |   | 150,000   |  
|Non-recourse indebtedness of subsidiary |  |   | 59,688    |  
|Mortgage note payable and capital lease |  |   | 68,955    |  
|Long-term insurance reserves            |  |   | 177,270   |  
|Other long-term liabilities             |  |   | 26,246    |  
|Common stock                            |  |   | 200       |  
|Warrants to purchase common stock       |  |   | 935       |  
|Capital in excess of par                |  |   | 358,977   |  
|Accumulated deficit                     |  |   | (33,734   | )
|Accumulated other comprehensive loss    |  |   | (174      | )
|                                        |  |   |           |  
|                                        |  | $ | 1,289,305 |  
|                                        |  |   |           |  

The following reconciliation of the Predecessor Companys consolidated balance
sheet as of April 30, 2002 to that of the Reorganized Company as of May 1, 2002
was prepared to present the adjustments that give effect to the reorganization
and fresh-start reporting.

The adjustments entitled Reorganization reflect the consummation of the Joint
Plan, including the elimination of existing liabilities subject to compromise
and consolidated shareholders deficit, and reflect the aforementioned $816.8
million reorganization value, which includes the establishment of $265.0
million of reorganization value in excess of amounts allocable to net
identifiable assets (see Note 8).

The adjustments entitled Fresh-Start Adjustments reflect the adoption of
fresh-start reporting, including the adjustments to record property and
equipment and identifiable intangible assets at their fair values. The assets
and liabilities have been recorded at their estimated fair values. Management
estimated the fair value of the Companys assets and liabilities by using both
independent appraisals and commonly used discounted cash flow valuation
methods. The reorganization value on the Effective Date included in the Joint
Plan approved by the Bankruptcy Court was based upon various valuation methods,
including discounted projected cash flows, and assumed continued increases in
the Medicare reimbursement rates that expired on October 1, 2002. The Companys
annual impairment analysis performed in the three months ended December 31,
2002 under SFAS No. 142 indicated that the reorganization value in excess of
amounts allocable to identify able assets was impaired. Accordingly, the
Company recorded an impairment charge of $57.3 million during the three months
ended December 31, 2002 relating to its reorganization value in excess of
amounts allocable to identifiable assets (see Note 8).

Certain of the Companys wholly owned subsidiaries and consolidated joint
ventures did not file for protection under Chapter 11. The non-filing
subsidiaries were not subject to the fresh-start reporting provisions under SOP
90-7 and, consequently, their balance sheets are reflected in the consolidated
balance sheet at historical carrying value.

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A reconciliation of fresh-start reporting recorded as of May 1, 2002 follows
(in thousands of dollars):

|                                                                           |                                                       |                           |           |             |         |                |            |             |          |                   |          |         |      |   |        |          |         |             |           |         |         | 
|-------------------------------------------------------------------------- | ----------------------------------------------------- | ------------------------- | --------- | ----------- | ------- | -------------- | ---------- | ----------- | -------- | ----------------- | -------- | ------- | ---- | - | ------ | -------- | ------- | ----------- | --------- | ------- | ------- | 
|                                                                           |                                                       |                           |           | Predecessor |         |                |            |             |          |                   |          |         |      |   |        |          |         | Reorganized
|                                                                           |                                                       |                           |           | Company     |         |                |            |             |          |                   |          |         |      |   |        |          |         | Company    
|                                                                           |                                                       |                           |           | April 30,   |         |                |            |             |          | Fresh-Start       |          |         |      |   |        | May 1,  
|                                                                           |                                                       |                           |           | 2002        |         | Reorganization |            | Adjustments |          | Reclassifications |          | 2002   
|                                                                           |                                                       |                           |           |             |         |                |            |             |          |                   |          |        
|Current assets                                                             |                                                       |                           |           |             |         |                |            |             |          |                   |          |         |      |   |        |          |         |             |           |        
|                                                                           | Cash and cash
equivalents                             |                           | $         | 202,338     |         |                | $          | (111,078    | )(a)     |                   | $        |        |      |   | $      |         |         |             | $         | 91,260  |        
|                                                                           | Receivables                                           |                           |           | 232,162     |         |                |            | 3,640       | (b)      |                   |          |        |      |   |        |         |         |             |           | 235,802 |        
|                                                                           | Inventories                                           |                           |           | 7,631       |         |                |            |            |          |                   |          |        |      |   |        |         |         |             |           | 7,631   |        
|                                                                           | Other current assets                                  |                           |           | 28,918      |         |                |            |            |          |                   |          |        |      |   |        |         |         |             |           | 28,918  |        
|                                                                           |                                                       |                           |           |             |         |                |            |             |          |                   |          |         |      |   |        |          |         |             |           |         |        
|                                                                           |                                                       | Total current assets      |           |             | 471,049 |                |            |             | (107,438 | )                 |          |         |     |   |        |          |        |             |           |         | 363,611 | 
|Property and equipment, net                                                |                                                       |                           | 416,369   |             |         |                |           |             |          |                   | 160,353  | (m)     |      |   |       |          |         |             | 576,722   |        
|Reorganization value in
excess of amounts
allocable to
identifiable assets |                                                       |                           |          |             |         |                | 264,954    | (c)         |          |                   |         |         |      |   |       |          |         |             | 264,954   |        
|Goodwill                                                                   |                                                       |                           | 186,543   |             |         |                |           |             |          |                   | (179,746 | )(n)    |      |   |       |          |         |             | 6,797     |        
|Restricted investments                                                     |                                                       |                           | 34,054    |             |         |                | 16,453     | (d)         |          |                   |         |         |      |   |       |          |         |             | 50,507    |        
|Other assets                                                               |                                                       |                           | 29,251    |             |         |                | 5,924      | (e)         |          |                   | (8,461   | )(o)    |      |   |       |          |         |             | 26,714    |        
|                                                                           |                                                       |                           |           |             |         |                |            |             |          |                   |          |         |      |   |        |          |         |             |           |         |        
|                                                                           |                                                       | $                         | 1,137,266 |             |         | $              | 179,893    |             |          | $                 | (27,854  | )       |      | $ |       |          |         | $           | 1,289,305 |        
|                                                                           |                                                       |                           |           |             |         |                |            |             |          |                   |          |         |      |   |        |          |         |             |           |         |        
|Current liabilities                                                        |                                                       |                           |           |             |         |                |            |             |          |                   |          |         |      |   |        |          |         |             |           |        
|                                                                           | Current maturities of
long-term debt                  |                           | $         |            |         |                | $          |            |          |                   | $        |        |      |   | $      | 6,220    | (q)     |             | $         | 6,220   |        
|                                                                           | Accounts payable                                      |                           |           | 54,100      |         |                |            |            |          |                   |          |        |      |   |        |         |         |             |           | 54,100  |        
|                                                                           | Accrued compensation
and benefits                     |                           |           | 90,776      |         |                |            |            |          |                   |          |        |      |   |        |         |         |             |           | 90,776  |        
|                                                                           | Accrued insurance obligations                         |                           |           | 24,826      |         |                |            |            |          |                   |          |        |      |   |        |         |         |             |           | 24,826  |        
|                                                                           | Other current liabilities                             |                           |           | 110,229     |         |                |            | 7,162       | (f)      |                   |          |        |      |   |        | (16,250  | )(q)    |             |           | 101,141 |        
|                                                                           |                                                       |                           |           |             |         |                |            |             |          |                   |          |         |      |   |        |          |         |             |           |         |        
|                                                                           |                                                       | Total current liabilities |           |             | 279,931 |                |            |             | 7,162    |                   |          |         |     |   |        |          | (10,030 | )           |           |         | 277,063 | 
|Liabilities subject to
compromise                                          |                                                       |                           | 2,167,277 |             |         |                | (2,167,277 | )(g)        |          |                   |         |         |      |   |       |          |         |             |          |        
|Long-term debt, net of
current maturities                                  |                                                       |                           | 59,688    |             |         |                | 430,955    | (h)         |          |                   |         |         |      |   | (6,220 | )(q)     |         |             | 484,423   |        
|Long-term insurance reserves                                               |                                                       |                           | 119,002   |             |         |                | 58,268     | (i)         |          |                   |         |         |      |   |       |          |         |             | 177,270   |        
|Other liabilities                                                          |                                                       |                           | 18,497    |             |         |                |           |             |          |                   | (10,402  | )(o)    |      |   | 16,250 |          |         |             | 24,345    |        
|                                                                           |                                                       |                           |           |             |         |                |            |             |          |                   |          |         |      |   |        |          |         |             |           |         |        
|                                                                           |                                                       |                           | 2,644,395 |             |         |                | (1,670,892 | )           |          |                   | (10,402  | )       |      |   |       |          |         |             | 963,101   |        
|Stockholders equity
(deficit)                                             |                                                       |                           |           |             |         |                |            |             |          |                   |          |         |      |   |        |          |         |             |           |        
|                                                                           | Reorganized Company
common stock                      |                           |           |            |         |                |            | 200         | (j)      |                   |          |        |      |   |        |         |         |             |           | 200     |        
|                                                                           | Predecessor Company
common stock                      |                           |           | 737         |         |                |            | (737        | )(k)     |                   |          |        |      |   |        |         |         |             |           |        |        
|                                                                           | Reorganized Company
warrants to purchase
common stock |                           |           |            |         |                |            | 935         | (j)      |                   |          |        |      |   |        |         |         |             |           | 935     |        
|                                                                           | Capital in excess of
par value                        |                           |           | 980,952     |         |                |            | 359,714     | (j,k)    |                   |          |        |      |   |        | (981,689 | )(r)    |             |           | 358,977 |        
|                                                                           | Retained earnings
(accumulated deficit)               |                           |           | (2,488,644  | )       |                |            | 1,490,673   | (l)      |                   |          | (17,452 | )(p) |   |        | 981,689  | (r)     |             |           | (33,734 | )      
|                                                                           | Accumulated other
comprehensive loss                  |                           |           | (174        | )       |                |            |            |          |                   |          |        |      |   |        |         |         |             |           | (174    | )      
|                                                                           |                                                       |                           |           |             |         |                |            |             |          |                   |          |         |      |   |        |          |         |             |           |         |        
|                                                                           |                                                       | $                         | 1,137,266 |             |         | $              | 179,893    |             |          | $                 | (27,854  | )       |      | $ |       |          |         | $           | 1,289,305 |        
|                                                                           |                                                       |                           |           |             |         |                |            |             |          |                   |          |         |      |   |        |          |         |             |           |         |        

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|(a) |  | To record the payment of cash in connection with the discharge of
indebtedness and settlement of pre-petition liabilities according to the
terms of the Joint Plan.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------

(b)

|                                               |  |   |        |  
|---------------------------------------------- |  | - | ------ | -
|Note (b1)                                      |  | $ | 5,376  |  
|Note (b2)                                      |  |   | (1,736 | )
|                                               |  |   |        |  
|Total receivables reorganization
adjustment(b) |  | $ | 3,640  |  
|                                               |  |   |        |  



|(b1) |  | To adjust the settlement receivable for Medicaid payors related to the
Companys settlement with various state Medicaid programs in connection
with the Joint Plan.                             
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    
|(b2) |  | To write-off management fee receivables related to the settlement of
certain contractual disputes with a leaseholder in connection with the
Joint Plan.                                         
|    
|(c)  |  | To record the reorganized value of the Company in excess of amounts
allocable to identified assets.                                                                                             
|    
|(d)  |  | To record cash collateralization of various letters of credit required by
the terms of the Joint Plan.                                                                                          
|    
|(e)  |  | To record deferred financing costs incurred in connection with the Old
Senior Credit Facility.                                                                                                  
|    
|(f)  |  | To record a liability for the settlement of unsecured claims according to
the terms of the Joint Plan, and to record payment of professional fees
including success fees to bankruptcy advisors.
|    
|(g)  |  | To record the discharge of liabilities subject to compromise according to
the terms of the Joint Plan as follows:                                                                               

|                                                    |  |   |           |  
|--------------------------------------------------- |  | - | --------- | -
|Prepetition senior credit facilities and term loans |  | $ | 1,217,638 |  
|Prepetition senior subordinated debt                |  |   | 597,328   |  
|Other pre-petition debt                             |  |   | 134,708   |  
|Accounts payable and other accrued liabilities      |  |   | 169,897   |  
|Accrued interest                                    |  |   | 79,959    |  
|Unamortized deferred financing costs                |  |   | (32,253   | )
|                                                    |  |   |           |  
|Total liabilities subject to compromise             |  | $ | 2,167,277 |  
|                                                    |  |   |           |  



|(h) |  | To record the issuance of the Term Loan under the Old Senior Credit
Facility, to record the issuance of the Second Priority Notes, and to
record various mortgages and capital leases entered into or renegotiated
as per the terms of the Joint Plan.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(i) |  | To record estimated settlement of pre-petition insurance claims
previously accrued for as liabilities subject to compromise.                                                                                                                          
|   
|(j) |  | To record issuance of common stock and warrants to purchase common stock
of the Reorganized Company.                                                                                                                                                  
|   
|(k) |  | To eliminate the common stock of the Predecessor Company.                                                                                                                                                                                             
|   
|(l) |  |                                                                                                                                                                                                                                                       

|                                                                        |  |   |           |  
|----------------------------------------------------------------------- |  | - | --------- | -
|Reorganization adjustment (a)                                           |  | $ | (111,078  | )
|Reorganization adjustment (b)                                           |  |   | 3,640     |  
|Reorganization adjustment (c)                                           |  |   | 264,954   |  
|Reorganization adjustment (d)                                           |  |   | 16,453    |  
|Reorganization adjustment (e)                                           |  |   | 5,924     |  
|Reorganization adjustment (f)                                           |  |   | (7,162    | )
|Reorganization adjustment (g)                                           |  |   | 2,167,277 |  
|Reorganization adjustment (h)                                           |  |   | (430,955  | )
|Reorganization adjustment (i)                                           |  |   | (58,268   | )
|Reorganization adjustments (j)(k)                                       |  |   | (360,112  | )
|                                                                        |  |   |           |  
|Total retained earnings (accumulated deficit)
reorganization adjustment |  | $ | 1,490,673 |  
|                                                                        |  |   |           |  



|(m) |  | To adjust property and equipment to fair value and to write-off
previously recorded accumulated depreciation.                                               
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(n) |  | To write off historical goodwill of the Predecessor Company, excluding
certain subsidiaries of the Company that were not part of the bankruptcy
proceedings.

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|(o) |  | To write-off the Companys leasehold rights and over-market lease
valuation accounts.                                                                                                                                                                               
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(p) |  | To adjust property, equipment, goodwill, leasehold rights and overmarket
lease liabilities to fair value.                                                                                                                                                           
|   
|(q) |  | Entries to record the current and long-term classification of long-term
debt and reorganization fees to be settled in subsequent periods.                                                                                                                           
|   
|(r) |  | Entry to close out Predecessor Companys retained earnings to additional
paid in capital according to the terms of the Joint Plan (the remaining
accumulated deficit is related to several subsidiaries that were not part
of the Companys bankruptcy proceedings).

Pro Forma Information

The unaudited condensed consolidated pro forma effect of the Joint Plan
assuming the Effective Date occurred on October 1, 2000 follows (in thousands,
except per share amounts):

|                                                 |  |               |           |                     |  |               |         |  |  |   |           |  
|------------------------------------------------ |  | ------------- | --------- | ------------------- |  | ------------- | ------- |  |  | - | --------- | -
|                                                 |  | Combined      |           |                     |  |               |         |  |  |  
|                                                 |  | Reorganized   |           |                     |  |               |         |  |  |  
|                                                 |  | Company and   |           |                     |  |               |         |  |  |  
|                                                 |  | Predecessor   |           |                     |  |               |         |  |  |  
|                                                 |  | Company       |           | Predecessor Company
|                                                 |  |               |           |                    
|                                                 |  | Twelve Months |           | Three Months        |  | Year         
|                                                 |  | Ended         |           | Ended               |  | Ended        
|                                                 |  | December 31,  |           | December 31,        |  | September 30,
|                                                 |  | 2002          |           | 2001                |  | 2001         
|                                                 |  |               |           |                     |  |              
|Revenue                                          |  | $             | 1,754,073 |                     |  | $             | 450,542 |  |  | $ | 1,840,654 |  
|                                                 |  |               |           |                     |  |               |         |  |  |   |           |  
|(Loss) income from continuing operations         |  | $             | (56,103   | )                   |  | $             | 10,227  |  |  | $ | (27,111   | )
|(Loss) income from discontinued operations       |  |               | (254      | )                   |  |               | 936     |  |  |   | 2,016     |  
|Gain on sale of discontinued pharmacy operations |  |               | 29,082    |                     |  |               |        |  |  |   |          |  
|                                                 |  |               |           |                     |  |               |         |  |  |   |           |  
|Net (loss) income                                |  | $             | (27,275   | )                   |  | $             | 11,163  |  |  | $ | (25,095   | )
|                                                 |  |               |           |                     |  |               |         |  |  |   |           |  
|Earnings per share                               |  |               |           |                     |  |               |         |  |  |   |           |  
|(Loss) Income from continuing operations         |  | $             | (2.81     | )                   |  | $             | 0.51    |  |  | $ | (1.36     | )
|(Loss) income from discontinued operations       |  |               | (0.01     | )                   |  |               | 0.05    |  |  |   | 0.10      |  
|Gain on sale of discontinued pharmacy operations |  |               | 1.45      |                     |  |               |        |  |  |   |          |  
|                                                 |  |               |           |                     |  |               |         |  |  |   |           |  
|Net (loss) income                                |  | $             | (1.37     | )                   |  | $             | 0.56    |  |  | $ | (1.26     | )
|                                                 |  |               |           |                     |  |               |         |  |  |   |           |  
|Shares used in computing earnings (loss)         |  |               | 20,000    |                     |  |               | 20,000  |  |  |   | 20,000    |  
|                                                 |  |               |           |                     |  |               |         |  |  |   |           |  

The unaudited condensed consolidated pro forma results exclude reorganization
items recorded prior to May 1, 2002. The unaudited condensed consolidated pro
forma results include estimates for depreciation expense, interest expense and
the related income tax effect prior to May 1, 2002. The number of shares
outstanding has also been adjusted. The pro forma results are not necessarily
indicative of the financial results that might have resulted had the effective
date of the Joint Plan actually occurred on October 1, 2000.

NOTE 18 COMMITMENTS AND CONTINGENCIES

Leases

At December 31, 2003, certain of the Companys facilities were held under
operating or capital leases. The capital leases expire at various times from
2004 through 2010 and certain of them have multiple five year renewal options.
Certain of these leases also contain provisions allowing the Company to
purchase the leased assets during the term or at the expiration of the lease,
at a predetermined option price within the respective lease agreement. The
carrying value of assets secured by capital leases are summarized as follows
(in thousands of dollars):

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|                                          |  |              |        |              |  |   |        |  
|----------------------------------------- |  | ------------ | ------ | ------------ |  | - | ------ | -
|                                          |  | December 31, |        | December 31,
|                                          |  | 2003         |        | 2002        
|                                          |  |              |        |             
|Facilities operating under capital leases |  | $            | 18,706 |              |  | $ | 31,733 |  
|Less: Accumulated amortization            |  |              | (1,577 | )            |  |   | (861   | )
|                                          |  |              |        |              |  |   |        |  
|                                          |  | $            | 17,129 |              |  | $ | 30,872 |  
|                                          |  |              |        |              |  |   |        |  

Rental expense, net of sublease rental income for all operating leases, was
$46.3 million for the fiscal year ended December 31, 2003,
$29.1 million for
the eight months ended December 31, 2002, $15.3 million for the four months
ended April 30, 2002, $11.9 million for the three months ended December 31,
2001 and $61.4 million for the fiscal year ended September 30, 2001. Certain of
the capital and operating leases contain at least one renewal option (which
could extend the term of the leases by five to twenty years), purchase options
and provisions for payments by the Company of real estate taxes, insurance and
maintenance costs. Certain leases also contain increases based on the Consumer
Price Index, Medicaid reimbursement rates or at amounts specified in the lease
agreement. Sublease rental income was $0.2 million for the fiscal year ended
December 31, 2003, $2.0 million for the eight months ended December 31, 2002,
$0.8 million for the four months ended April 30, 2002, $0.8 million for the
three months ended December 31, 2001 and $4.6 million for the fiscal year ended
September 30, 2001. Contingent rent, based primarily on revenue, was $0.9
million for the fiscal year ended December 31, 2003, $0.6 million for the eight
months ended December 31, 2002, $0.3 million for the four months ending April
30, 2002, $0.3 million for the three months ended December 31, 2001 and $2.1
million for the fiscal year ended September 30, 2001.

The table below presents a schedule of future minimum rental commitments under
noncancelable leases as of December 31, 2003 (in thousands of dollars):

|                                  |  |           |         |         |  |   |        |  
|--------------------------------- |  | --------- | ------- | ------- |  | - | ------ | -
|                                  |  | Operating |         | Capital
|                                  |  |           |         |        
|2004                              |  | $         | 31,770  |         |  | $ | 9,246  |  
|2005                              |  |           | 27,355  |         |  |   | 9,208  |  
|2006                              |  |           | 22,307  |         |  |   | 676    |  
|2007                              |  |           | 19,427  |         |  |   | 676    |  
|2008                              |  |           | 15,935  |         |  |   | 1,812  |  
|Subsequent years                  |  |           | 66,778  |         |  |   | 43     |  
|                                  |  |           |         |         |  |   |        |  
|Total minimum rental obligations  |  | $         | 183,572 |         |  |   | 21,661 |  
|                                  |  |           |         |         |  |   |        |  
|Less amount representing interest |  |           |         |         |  |   | (1,713 | )
|                                  |  |           |         |         |  |   |        |  
|Present value of capital leases   |  |           |         |         |  |   | 19,948 |  
|Less: Current portion             |  |           |         |         |  |   | (8,313 | )
|                                  |  |           |         |         |  |   |        |  
|Long-term portion                 |  |           |         |         |  | $ | 11,635 |  
|                                  |  |           |         |         |  |   |        |  

Casualty Gain

During the four months ended April 2002, the Predecessor Company recorded a net
gain of approximately $1.5 million relating to certain owned and leased
facilities that were damaged by floods. The net gain is included in other
income and is comprised of a gain of approximately $14.4 million relating to
owned and capital leased facilities, whose net carrying value was less than the
insurance proceeds expected to be received, offset by a loss of approximately
$12.9 million relating to operating leased facilities whose estimated costs to
repair are in excess of the expected insurance proceeds to be received.
Approximately $16.5 million of insurance proceeds have been received as of
December 31, 2003.

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Litigation

General

From time to time, the Company has
been party to various legal proceedings in the
ordinary course of business. As is typical in the health care
industry, the Company expects to remain subject to claims that its services have resulted in
resident injury or other adverse effects. In addition, resident, visitor and
employee injuries will also subject the Company to the risk of litigation. The health
care industry in general continues to experience an increasing trend in the
frequency and severity of litigation and claims. There are currently no
outstanding uninsured litigation matters against the Company that it believes could have
a material adverse effect on it. Below is a summary of the major
outstanding litigation to which the Company is a party.

Royal Surplus Lines Litigation

On June 11, 2001, one of the
Companys prior liability insurance carriers, Royal Surplus
Lines Insurance Company (Royal), commenced an adversary proceeding in the Bankruptcy
Court, styled Royal Surplus Lines Insurance Company v. Mariner Health Group et
al., Adversary Proceeding No. A-01-4626 (MFW). In its complaint, Royal sought
among other things, declaratory judgments that it would not be required to
insure some claims falling under two PL/GL policies issued to one of
the Companys
subsidiaries by Royal. One of the Companys prior excess liability insurance carriers,
Northfield Insurance Company (Northfield), moved to intervene in the Royal
adversary proceeding on July 25, 2001. The Company did not oppose the motion to
intervene, and it was granted.

Prior to the parties engaging in any significant discovery, they agreed to
mediate the issues arising out of the Royal adversary proceeding. After the
mediation, Royal agreed to dismiss its complaint without prejudice, the Company agreed
to dismiss its counterclaim without prejudice, and Royal and the Company agreed to work
together to resolve claims in an alternative dispute resolution procedure.
Northfield did not agree to dismiss its complaint in intervention. Accordingly,
Northfield and the Company are currently engaging in discovery. The
Company has also filed a bad
faith counterclaim against Northfield arising out of its claims handling and
litigation tactics.

In April 2003, Northfield filed an insurance coverage action against the Company in the
United States District Court for the Northern District of Georgia. Northfield
seeks a declaration that it is not obligated to provide insurance coverage to
us in connection with a personal injury and wrongful death lawsuit filed
against the Company styled Louise Sherry Fisher, Individually, as Representative of all
Wrongful Death Beneficiaries, and Legal Heir of the Estate of Vestal Grant
Fisher, deceased v. Mariner Post-Acute Network, Inc., et al., No. 2000-40818
(28th Judicial District, Harris County, Tex.), (the Fisher
Action). Northfield alleges that its coverage obligation was
discharged by the Companys
failure to accept a reasonable settlement demand in the Fisher Action, and by
the Companys conduct and alleged refusal to cooperate in the defense of that case. In
addition to seeking a declaratory judgment, Northfield asserts claims for
breach of contract and negligence. Northfield seeks unspecified damages,
including recovery of the amount it paid to settle the Fisher Action, as well
as attorneys fees and costs.

The Company has filed an answer to Northfields complaint on May 5, 2003, denying that
Northfield is entitled to the relief it seeks and raising certain affirmative
defenses to Northfields claims. On May 5, 2003, the Company also filed a motion to
transfer the case to the United States District Court for the District of
Delaware, where, on August 7, 2001, Northfield instituted an adversary
proceeding against the Company regarding insurance coverage issues arising out of the
Fisher Action. That adversary proceeding is styled Northfield Insurance
Company v. Mariner Post-Acute Network, Inc., et al., Adversary Case No.
A-01-4626. On October 6, 2003, the United States District Court for the
Northern District of Georgia granted the Companys motion to transfer and transferred
this case to the United States District Court for the District of Delaware. On
October 23, 2003, the case was referred to the Bankruptcy Court, where it is
now pending.

On October 16, 2003, the Company filed a motion for summary judgment and on November 11,
2003, Northfield filed a cross-motion for summary judgment. Both motions are
pending. Discovery is ongoing. While no trial date has been set, a
mediation is planned for the first quarter of 2004.

PricewaterhouseCoopers Litigation

In August 2002, the Company filed a complaint in the State Court of Fulton County,
Georgia against PricewaterhouseCoopers, LLP (PWC) and several former
officers of MHG referred to as the Individual Defendants. The Fulton County
action asserts claims for fraud and breach of fiduciary duty against the
Individual Defendants and claims for fraud, professional negligence, negligent
misrepresentation and aiding and abetting breach of fiduciary duty against PWC.
Many of these claims arise from the July 1998 acquisition of MHG by
Paragon, one of the Companys predecessors. Other claims arise
from duties that the Company believes the Individual Defendants breached as officers of
MHG and MPAN, the Companys successor following the MHG
acquisition. In the Fulton County action, the Company is seeking actual damages
(including compensatory and consequential damages) and punitive damages, in an
amount to be determined at trial. Discovery is ongoing.

In response to the action commenced by the Company in Fulton County, the Individual
Defendants filed an action in Chancery Court in Delaware in September 2002
styled Stratton et al. v. Mariner Health Care, Inc., Civil Action No. 19879-NC.
In the Chancery Court action, the Individual Defendants generally claim they
are not liable for the claims asserted in the Fulton County action
and that the Company is

F-44



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contractually and statutorily obligated to indemnify them against the
claims in the Fulton County action. The Company removed the Chancery Court action to the
Bankruptcy Court, at which time the
action was assigned Adversary Case Nos. 02-5604 and 02-5606 in Chapter 11 Case
Nos. 00-0113 (MFW) and 00-00215 (MFW). After removal, the Company answered the
complaint and filed counterclaims. The Individual Defendants moved to remand
the action back to the Chancery Court. The Company opposed the motion. On December 16,
2003, the Bankruptcy Court denied the Individual Defendants remand motion and
dismissed their claims holding, among other things, that the Individual
Defendants indemnification claims had been discharged by
confirmation of the Companys
Joint Plan. The Individual Defendants have filed a motion to alter or amend
judgment, which is pending.

After the Individual Defendants filed the Chancery Court action, the Company also filed
an adversary proceeding in the Bankruptcy Court styled Mariner Health Care,
Inc. v. Stratton et al., United States Bankruptcy Court for the District of
Delaware, Chapter 11 Case Nos. 00-00113 (MFW) and 00-00215 (MFW), Adversary
Case No. 02-05598 (consolidated with Adversary Case No. 02-05599). In this
enforcement action, the Company generally alleged that it does not have any obligation to
indemnify the Individual Defendants and the Individual Defendants pursuit of
their indemnification claims violated the Companys discharge in bankruptcy. The
Individual Defendants filed counterclaims generally alleging that the
Company has an
obligation to indemnify them against the claims in the Fulton County action and
that it is estopped from asserting those claims. The Company has moved to dismiss the
Individual Defendants estoppel counterclaim. The Individual Defendants opposed
the motion, and on April 10, 2003, the Bankruptcy Court granted the motion to
dismiss.

After the Company filed the Fulton County action, William R. Bassett as Trustee for the
Charlotte R. Kellett Irrevocable Trust, as Trustee for the Samuel B. Kellett,
Jr. Irrevocable Trust, as Trustee for the Stiles A. Kellett, III Irrevocable
Trust and as Trustee for the Barbara K. Kellett Irrevocable Trust, Kellett
Family Partners, L.P. f/k/a Kellett Partners, L.P., Samuel B. Kellett, Stiles
A. Kellett, Jr. and SSK Partners, L.P., filed an action in the Superior Court
of Cobb County, Georgia against PWC and the Individual Defendants based on
claims arising out of MHGs acquisition of Convalescent Services, Inc. in 1995
because of the Individual Defendants and PWCs alleged misrepresentations.
This action is William R. Bassett, et al. v. PricewaterhouseCoopers, LLP, et
al., Superior Court of Cobb County, Georgia, Case No. 02-1-8314-35. The
plaintiffs in the Cobb County action seek damages in excess of $200 million.
The Individual Defendants added the Company as a third-party defendant in the Cobb
County action seeking to recover on indemnification claims similar to those
made by them in the Chancery Court action, and which are now pending, and
subject to resolution before the Bankruptcy Court in the enforcement action.
In November 2003, the Individual Defendants dismissed the Company without prejudice from
the Cobb County action.

Indemnity Insurance Company of
North America Litigation

In May 2003, the Company filed a complaint in the United States District Court for the
Eastern District of Texas, Beaumont Division, entitled Mariner Health Care,
Inc. v. Indemnity Insurance Company of North America, Inc., Case No. 103 CV
0279. The Company is seeking a declaratory judgment determining its rights and the
obligations of Indemnity Insurance Company of North America, Inc.
(IINA),
under an IINA policy of insurance regarding property damage and related losses
at the Companys facilities in Beaumont and Houston, Texas caused by Tropical Storm
Allison in June 2001. The Company additionally asserts breach of contract and unfair
claims handling practices claims against IINA. The Company further
seeks statutory
damages, punitive damages and attorneys fees under Texas Insurance Code and
the Texas Civil Practice and Remedies Code. IINA has answered the
Companys complaint
and the parties are in the process of pretrial discovery, with an anticipated
trial date in the third quarter of 2004.

On January 30, 2004, the Company moved to amend its complaint to include, as
plaintiffs, the Companys affiliates Cornerstone Health Management Company, Mariner
Health Care of Nashville, Inc. and Living Centers of Texas, Inc., and to make
other conforming amendments. This motion is pending.

While the Company is not able to predict the outcome of any of these matters, based on
currently available facts it does not believe that the resolution of any of these
proceedings will have a material adverse effect on its financial position,
results of operations or cash flows.

Global Settlement

The Company has reached a settlement with the United States to resolve certain
United States Claims (as defined below) against the Company that arose prior to
the Petition Date. This settlement is referred to as the Global
Settlement.
United States Claims are those claims or causes of action asserted by or on
behalf of the United States seeking remedies of any kind:
(i) under the Federal False Claims Act, 31 U.S.C.
§§ 3729-3733 (the False
Claims Act), the Civil Monetary Penalties Law, 42 U.S.C.
§ 1320a-7a (the Civil Monetary Penalties Law),
and the Program Fraud Civil Remedies Act of 1986, 31 U.S.C.
§§ 3801-3812 (the Program Fraud Civil
Remedies Act) and/or other statutory or common law doctrines of payment by
mistake, unjust enrichment, breach of contract, or fraud; (ii) for
administrative overpayments, including claims or causes of action for services
rendered or products supplied under Medicare, the TRICARE Program, or any other
federal health program; (iii) for specified civil monetary penalties; (iv)
arising under any provider or similar agreement with the United States; and (v)
for permissive exclusion from Medicare, Medicaid and other federal health
programs. The Global Settlement was approved by the Bankruptcy Court and became
effective on April 3, 2002.

Under the Global Settlement: (i) all Medicare claims and debts arising prior to
the Petition Date were released as between CMS and the Company; (ii) the United
States approved a settlement of Medicare administrative appeals related to
disallowances under the prudent buyer principle (the Prudent Buyer
Settlement); (iii) the Company waived its rights to collect any amounts due
under the Prudent Buyer Settlement; (iv) CMS adjusted specified Medicare PPS
base year cost reports to accurately calculate PPS rates; (v) CMS agreed to pay
the Company $3.0 million; (vi) the Department of Justice released the Company
from certain covered conduct alleged within six qui tam lawsuits and other
disputes under the Federal False Claims Act; (vii) the Company agreed to be
responsible for any attorney fees sought by qui tam relators counsel; (viii)
the United States waived any claims for (a) Medicare reimbursement for two
voluntary disclosures made by the Company to the United States and (b) Medicare
reimbursement related to an Office of Inspector General (the OIG),
investigation; (ix) the Company agreed to enter into a corporate integrity
agreement with the OIG; (x) the Company rejected and terminated specified
provider agreements for discontinued operations; (xi) the Company agreed to a
list of facilities that are covered by the Global Settlement; (xii) all cost
years ending on or before the Petition Date were fully and finally resolved by
the Global Settlement; (xiii) for cost years that span the Petition Date, CMS
agreed to settle the cost reports for these years, and the Company retained its
rights to appeal or request the reopening of such years, but any relief awarded
relating to those years will be pro-rated so that the prepetition portion is
waived and the post petition portion is preserved; and (xiv) as part of the
cure for the assumption of Medicare provider agreements, or in the case of any
rejected and terminated provider agreements, the Company agreed to pay any
portion of a Medicare overpayment or civil monetary penalty that accrued after
the Petition Date.

In accordance with GAAP, the Company recorded a charge of approximately $33.4 million relating
to the Global Settlement in its consolidated statement of operations for the
fourth quarter of the fiscal year ended September 30, 2001.

NOTE 19  DISCLOSURES REGARDING FAIR VALUE OF FINANCIAL INSTRUMENTS

The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate
that value:

Cash and Cash Equivalents

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

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Restricted Investments

Fair values for the Companys restricted investments were based on quoted
market rates.

Long-Term Debt

The fair value of the Companys long-term debt is estimated based upon the
current level of interest rates for similar debt.

The estimated values of the Companys financial instruments are as follows (in
thousands of dollars):

|                          |  |                   |         |                   |  |        |         |            |  |   |         |  |  |   |         | 
|------------------------- |  | ----------------- | ------- | ----------------- |  | ------ | ------- | ---------- |  | - | ------- |  |  | - | ------- | 
|                          |  | December 31, 2003 |         | December 31, 2002
|                          |  |                   |         |                  
|                          |  | Carrying          |         |                   |  |        |         | Carrying   |  |   |         | 
|                          |  | Amount            |         | Fair Value        |  | Amount |         | Fair Value
|                          |  |                   |         |                   |  |        |         |           
|Cash and cash equivalents |  | $                 | 41,934  |                   |  | $      | 41,934  |            |  | $ | 38,618  |  |  | $ | 38,618  | 
|Restricted investments    |  | $                 | 19,300  |                   |  | $      | 19,300  |            |  | $ | 38,693  |  |  | $ | 38,693  | 
|Total long-term debt      |  | $                 | 389,636 |                   |  | $      | 391,493 |            |  | $ | 484,762 |  |  | $ | 487,558 | 

NOTE 20 CONCENTRATIONS OF CREDIT RISK

Governmental Programs

The Company has significant accounts whose collectibility or realizability is
dependent upon the performance of certain governmental programs, primarily
Medicare and Medicaid. The Company does not believe there are significant
credit risks associated with these governmental programs. The mix of
receivables from patients and third-party payors at December 31, 2003 and
December 31, 2002 was as follows:

|         |  |              |       |              |  |  |       |  
|-------- |  | ------------ | ----- | ------------ |  |  | ----- | -
|         |  | December 31, |       | December 31,
|         |  | 2003         |       | 2002        
|         |  |              |       |             
|Medicare |  |              | 31.1  | %            |  |  | 35.3  | %
|Medicaid |  |              | 37.2  | %            |  |  | 33.5  | %
|Other    |  |              | 31.7  | %            |  |  | 31.2  | %
|         |  |              |       |              |  |  |       |  
|         |  |              | 100.0 | %            |  |  | 100.0 | %
|         |  |              |       |              |  |  |       |  

At the time the Company emerged from bankruptcy, the Company had ten Medicare
fiscal intermediaries through which Medicare claims were paid and cost reports
were filed and settled. In order to streamline the cost reporting process, the
Company requested, and CMS approved, that all of the Companys facilities be
converted to Mutual of Omaha (Mutual), as its single Medicare fiscal
intermediary starting with Medicare years beginning October 1, 2002. The
primary dates for conversion were October 1, 2002, January 1, 2003 and April 1,
2003.

Notes Receivable

The Company has certain interest-bearing notes receivable that are reviewed
periodically to determine if the notes are adequately reserved and are recorded
at their net realizable value. The Company had notes receivable of $35.8
million and $22.0 million, net of allowances of $6.9 million and $4.2 million,
respectively, at December 31, 2003 and 2002, respectively. Approximately $19.2
million of these notes are collateralized by the underlying skilled nursing
facilities.

Cash

The Company maintains its cash in bank deposit accounts, which, at times, may
exceed federally insured limits. The Company has not experienced any losses in
such accounts and believes that it is not exposed to any significant credit
risk on cash and cash equivalents.

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NOTE 21 SEGMENT INFORMATION

As previously disclosed, the Company
has two reportable segments, skilled nursing services, which provides
long-term health care through the operation of skilled
nursing facilities and assisted living facilities in the United States, and
LTACs, which provide services for the relatively high sub-acute clinical needs
patients. The Other category includes corporate items not considered to be
an operating segment, and eliminations.

The accounting policies of the operating segments are the same as those
described in the summary of significant accounting policies (see Note 2). The
Company primarily evaluates segment performance and allocates resources based
on operating profit (loss) that basically represents revenue less operating expenses.
The operating profit (loss) is net revenues less operating and general and
administrative expenses. The Company does not have any intersegment revenue.
Asset information by segment, including capital expenditures, and net income
(loss) beyond operating profit (loss) are not provided to the Companys chief
operating decision maker.

The Companys reportable segments are strategic business units that offer
different products and services. They are each managed separately because each
business has different marketing strategies due to differences in types of
customers, different distribution channels and different capital resource
needs.

The following tables summarize operating results and other financial
information, by business segment, excluding the results of the discontinued
operations, for the Company for the year ended December 31, 2003, for the eight
months ended December 31, 2002, and for the Predecessor Company for the four
months ended April 30, 2002, the three months ended December 31, 2001 and the
year ended September 30, 2001 (in thousands of dollars):

|                                     |  |              |           |       |  |        |         |       |  |   |         |   |  |   |           | 
|------------------------------------ |  | ------------ | --------- | ----- |  | ------ | ------- | ----- |  | - | ------- | - |  | - | --------- | 
|                                     |  | Nursing Home |           |       |  |        |         |       |  |   |         |   |  |  
|                                     |  | Services     |           | LTACs |  | Other* |         | Total
|                                     |  |              |           |       |  |        |         |      
|Reorganized Company                  |  |              |           |       |  |        |         |       |  |   |         |   |  |   |           | 
|Year Ended December 31, 2003         |  |              |           |       |  |        |         |       |  |   |         |   |  |   |           | 
|Revenue from external customers      |  | $            | 1,594,693 |       |  | $      | 119,266 |       |  | $ | 1,408   |   |  | $ | 1,715,367 | 
|Operating profit (loss)              |  |              | 105,108   |       |  |        | 15,139  |       |  |   | (98,689 | ) |  |   | 21,558    | 
|Depreciation and amortization        |  |              | 32,015    |       |  |        | 1,571   |       |  |   | 3,496   |   |  |   | 37,082    | 
|Total
assets                         |  |              | 765,543   |       |  |        | 22,849  |       |  |   | 319,342 |   |  |   | 1,107,734 | 
|Eight Months Ended December 31, 2002 |  |              |           |       |  |        |         |       |  |   |         |   |  |   |           | 
|Revenue from external customers      |  | $            | 1,087,974 |       |  | $      | 76,294  |       |  | $ | (1,262  | ) |  | $ | 1,163,006 | 
|Operating profit (loss)              |  |              | 117,613   |       |  |        | 7,631   |       |  |   | (50,456 | ) |  |   | 74,788    | 
|Depreciation and amortization        |  |              | 20,463    |       |  |        | 724     |       |  |   | 1,577   |   |  |   | 22,764    | 
|Total
assets                         |  |              | 808,789   |       |  |        | 42,921  |       |  |   | 327,028 |   |  |   | 1,178,738 | 
|                                    
|Predecessor Company                  |  |              |           |       |  |        |         |       |  |   |         |   |  |   |           | 
|Four Months Ended April 30, 2002     |  |              |           |       |  |        |         |       |  |   |         |   |  |   |           | 
|Revenue from external customers      |  | $            | 550,919   |       |  | $      | 37,075  |       |  | $ | 3,073   |   |  | $ | 591,067   | 
|Operating profit (loss)              |  |              | 40,785    |       |  |        | 3,384   |       |  |   | (22,140 | ) |  |   | 22,029    | 
|Depreciation and amortization        |  |              | 10,722    |       |  |        | 277     |       |  |   | 557     |   |  |   | 11,556    | 
|Total
assets                         |  |              | 1,036,127 |       |  |        | 77,284  |       |  |   | 175,894 |   |  |   | 1,289,305 | 
|Three Months Ended December 31, 2001 |  |              |           |       |  |        |         |       |  |   |         |   |  |   |           | 
|Revenue from external customers      |  | $            | 421,140   |       |  | $      | 28,680  |       |  | $ | 722     |   |  | $ | 450,542   | 
|Operating profit (loss)              |  |              | 44,255    |       |  |        | 2,292   |       |  |   | (18,221 | ) |  |   | 28,326    | 
|Depreciation and amortization        |  |              | 9,019     |       |  |        | 388     |       |  |   | 1,521   |   |  |   | 10,928    | 
|Total
assets                         |  |              | 699,167   |       |  |        | 61,349  |       |  |   | 461,839 |   |  |   | 1,222,355 | 
|Fiscal Year Ended September 30, 2001 |  |              |           |       |  |        |         |       |  |   |         |   |  |   |           | 
|Revenue from external customers      |  | $            | 1,726,259 |       |  | $      | 111,638 |       |  | $ | 2,757   |   |  | $ | 1,840,654 | 
|Operating profit (loss)              |  |              | 151,948   |       |  |        | 7,023   |       |  |   | (71,200 | ) |  |   | 87,771    | 
|Depreciation and amortization        |  |              | 37,068    |       |  |        | 1,870   |       |  |   | 9,749   |   |  |   | 48,687    | 
|Total
assets                         |  |              | 897,309   |       |  |        | 64,254  |       |  |   | 269,415 |   |  |   | 1,230,978 | 



|* |  | Included in the amounts indicated in the
Other column are cash, property plant and equipment,
goodwill, restricted investments, notes receivable and deferred
financing costs.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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NOTE 22  RELATED PARTY TRANSACTIONS

Transactions with Management

In January 2003, in connection with Chief Financial Officer Michael E. Boxers
agreement to relocate his personal residence to Atlanta, Georgia, the site of
the Companys corporate headquarters, the Company purchased Mr. Boxers primary
residence for its fair market value. The fair market value was determined based
upon the average of two appraisals conducted by independent appraisal services,
and was determined to be $876,000.

In December 2002, in connection with the Chief Executive Officer C. Christian
Winkles agreement to relocate his personal residence to Atlanta, Georgia, the
site of the Companys corporate headquarters, the Company purchased Mr.
Winkles primary residence for its fair market value. The fair maker value was
determined based upon the average of two separate appraisals conducted by
independent appraisal services, and was determined to be $1.4 million.
Additionally, the Company reimbursed Mr. Winkle for reasonable and customary
closing costs actually incurred related to the sale in the amount of
approximately $58,000, also in accordance with the Companys corporate
relocation package.

Consideration Received by Five Percent Beneficial Owners in Connection with
Bankruptcy Proceedings

Each of the five percent or greater beneficial owners the Companys common
stock, Oaktree Capital Management, LLC and affiliates; Foothill Capital
Corporation and affiliates; Highland Capital Management, L.P. and affiliates;
Halcyon Restructuring Fund, L.P.; and Greenlight Capital, L.L.C., held
prepetition claims in the bankruptcy cases and, as a consequence, received pro
rata distributions made pursuant to the Joint Plan.

Foothill Group, Inc. and Foothill Income Trust, L.P.

Foothill Group and Foothill Income Trust (Foothill), affiliates of Foothill
Partners III and Foothill Partners IV, which beneficially own over 5% of the
Companys common stock as of December 31, 2003, are members of the syndicate of
financial institutions serving as lenders under the Companys Senior Credit
Facility. In connection with their participation in this syndicate, Foothill
Group and Foothill Income Trust are entitled to receive there pro rata share of
interest payments and any other customary fees under the Senior Credit
Facility. Additionally, Foothill Partners III and Foothill Partners IV are
members of the syndicate of financial institutions that hold the Companys
Second Priority Notes. In connection with their participation in this
syndicate, they are entitled to receive there pro rata share of interest
payments and any other customary fees under the Second Priority Notes. M.
Edward Stearns, one of the Companys directors, is Senior Vice President of
Foothill Capital Corporation and a managing general partner of five
partnerships in the Foothill family of funds, which are affiliates of Foothill
Group and Foothill Income Trust. In May 2002, Foothill Group and Foothill
Income Trust received $0.1 million and $0.4 million, respectively, as lenders
under our Old Senior Credit Facility. This represented their pro rata share of
commitment fees, paid to all lenders, related to our Senior Credit Facility.
Subsequent to December 31, 2003, Foothill sold shares of the Companys common
stock and is no longer a beneficial owner.

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NOTE 23 Supplemental Guarantor/Non-Guarantor Financial Information

Certain subsidiaries (the Guarantor Subsidiaries) guarantee repayment of the
debt under the Senior Credit Facility and the Notes. Separate complete
financial statements of the respective Guarantor Subsidiaries are not presented
because the Guarantor Subsidiaries are wholly owned (directly or indirectly) by
the Company and fully and unconditionally guarantee the debt under the Senior
Credit Facility and the Notes on a joint and several basis.

The following condensed consolidating financial data is presented for the
holders of the Notes and illustrates the composition of Mariner Health Care,
Inc. (the Parent Company), the Guarantor Subsidiaries, and the Companys
subsidiaries that do not guarantee the debt under the Senior Credit Facility
and the Notes (the Non-Guarantor Subsidiaries) for the periods indicated.

There are certain restrictions on the ability of PHCMI and its subsidiaries,
all of which are Non-Guarantor Subsidiaries, to pay dividends, make loans or
advances and transfer certain property and assets to the Company and its other
subsidiaries.

The Company does not have any subsidiaries that are accounted for by the Parent
Company on the equity method. As such, the principal elimination entries
eliminate intercompany balances and transactions. Information regarding the
Guarantor Subsidiaries and Non-Guarantor Subsidiaries is as follows (in
thousands of dollars):

Reorganized Company

CONDENSED SELECTED CONSOLIDATING BALANCE SHEET
December 31, 2003

|                               |  |        |         |              |  |              |         |               |  |              |         |   |  |   |          |   |  |   |           | 
|------------------------------ |  | ------ | ------- | ------------ |  | ------------ | ------- | ------------- |  | ------------ | ------- | - |  | - | -------- | - |  | - | --------- | 
|                               |  |        |         |              |  | Guarantor    |         | Non-Guarantor |  |              |         |   |  |   |          |  
|                               |  | Parent |         | Subsidiaries |  | Subsidiaries |         | Eliminations  |  | Consolidated
|                               |  |        |         |              |  |              |         |               |  |             
|Current assets                 |  | $      |        |              |  | $            | 330,562 |               |  | $            | 23,394  |   |  | $ | (52,528  | ) |  | $ | 301,428   | 
|Total assets                   |  |        | 636,064 |              |  |              | 982,313 |               |  |              | 101,997 |   |  |   | (612,640 | ) |  |   | 1,107,734 | 
|Current liabilities            |  |        | 2,881   |              |  |              | 234,674 |               |  |              | 60,396  |   |  |   | (52,527  | ) |  |   | 245,424   | 
|Total liabilities              |  |        | 324,618 |              |  |              | 449,299 |               |  |              | 130,191 |   |  |   | (52,527  | ) |  |   | 851,581   | 
|Stockholders equity (deficit) |  |        | 311,446 |              |  |              | 533,014 |               |  |              | (28,194 | ) |  |   | (560,113 | ) |  |   | 256,153   | 

CONDENSED SELECTED CONSOLIDATING BALANCE SHEET
December 31, 2002

|                               |  |        |         |              |  |              |         |               |  |              |         |   |  |   |          |   |  |   |           | 
|------------------------------ |  | ------ | ------- | ------------ |  | ------------ | ------- | ------------- |  | ------------ | ------- | - |  | - | -------- | - |  | - | --------- | 
|                               |  |        |         |              |  | Guarantor    |         | Non-Guarantor |  |              |         |   |  |   |          |  
|                               |  | Parent |         | Subsidiaries |  | Subsidiaries |         | Eliminations  |  | Consolidated
|                               |  |        |         |              |  |              |         |               |  |             
|Current assets                 |  | $      |        |              |  | $            | 337,257 |               |  | $            | 21,379  |   |  | $ | (20,979  | ) |  | $ | 337,657   | 
|Total assets                   |  |        | 706,873 |              |  |              | 978,582 |               |  |              | 101,862 |   |  |   | (608,579 | ) |  |   | 1,178,738 | 
|Current liabilities            |  |        | 4,977   |              |  |              | 220,202 |               |  |              | 50,932  |   |  |   | (55,020  | ) |  |   | 221,091   | 
|Total liabilities              |  |        | 362,967 |              |  |              | 478,963 |               |  |              | 123,432 |   |  |   | (55,019  | ) |  |   | 910,343   | 
|Stockholders equity (deficit) |  |        | 343,907 |              |  |              | 499,618 |               |  |              | (21,570 | ) |  |   | (553,560 | ) |  |   | 268,395   | 

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CONDENSED SELECTED CONSOLIDATING STATEMENT OF OPERATIONS
For the fiscal year ended December 31, 2003

|                                  |  |        |         |              |  |              |           |               |  |              |         |   |  |   |        |   |  |   |           |  
|--------------------------------- |  | ------ | ------- | ------------ |  | ------------ | --------- | ------------- |  | ------------ | ------- | - |  | - | ------ | - |  | - | --------- | -
|                                  |  |        |         |              |  | Guarantor    |           | Non-Guarantor |  |              |         |   |  |   |        |  
|                                  |  | Parent |         | Subsidiaries |  | Subsidiaries |           | Eliminations  |  | Consolidated
|                                  |  |        |         |              |  |              |           |               |  |             
|Net revenues                      |  | $      |        |              |  | $            | 1,563,871 |               |  | $            | 147,985 |   |  | $ | 3,511  |   |  | $ | 1,715,367 |  
|Operating (loss) income           |  |        | (1,679  | )            |  |              | (3,966    | )             |  |              | 15,318  |   |  |   |       |   |  |   | 9,673     |  
|(Loss) income before
income taxes |  |        | (32,461 | )            |  |              | 16,159    |               |  |              | (6,621  | ) |  |   | (5,746 | ) |  |   | (28,669   | )
|Net (loss) income                 |  |        | (32,461 | )            |  |              | 32,035    |               |  |              | (6,624  | ) |  |   | (5,746 | ) |  |   | (12,796   | )

CONDENSED SELECTED CONSOLIDATING STATEMENT OF OPERATIONS
For the eight months ended December 31, 2002

|                                  |  |        |         |              |  |              |           |               |  |              |        |  |  |   |        |   |  |   |           |  
|--------------------------------- |  | ------ | ------- | ------------ |  | ------------ | --------- | ------------- |  | ------------ | ------ |  |  | - | ------ | - |  | - | --------- | -
|                                  |  |        |         |              |  | Guarantor    |           | Non-Guarantor |  |              |        |  |  |   |        |  
|                                  |  | Parent |         | Subsidiaries |  | Subsidiaries |           | Eliminations  |  | Consolidated
|                                  |  |        |         |              |  |              |           |               |  |             
|Net revenues                      |  | $      |        |              |  | $            | 1,072,902 |               |  | $            | 98,798 |  |  | $ | (8,694 | ) |  | $ | 1,163,006 |  
|Operating (loss) income           |  |        | (798    | )            |  |              | (43,059   | )             |  |              | 9,083  |  |  |   | 76     |   |  |   | (34,698   | )
|Income (loss) before
income taxes |  |        | (16,505 | )            |  |              | (41,047   | )             |  |              | 1,774  |  |  |   | (743   | ) |  |   | (56,521   | )
|Net (loss) income                 |  |        | (16,505 | )            |  |              | (42,841   | )             |  |              | 1,775  |  |  |   | (743   | ) |  |   | (58,314   | )

CONDENSED SELECTED CONSOLIDATING STATEMENT OF CASH FLOWS
For the fiscal year ended December 31, 2003

|                                                         |  |        |         |              |  |              |         |               |  |              |        |   |  |   |   |  |  |   |         |  
|-------------------------------------------------------- |  | ------ | ------- | ------------ |  | ------------ | ------- | ------------- |  | ------------ | ------ | - |  | - | - |  |  | - | ------- | -
|                                                         |  |        |         |              |  | Guarantor    |         | Non-Guarantor |  |              |        |   |  |   |   | 
|                                                         |  | Parent |         | Subsidiaries |  | Subsidiaries |         | Eliminations  |  | Consolidated
|                                                         |  |        |         |              |  |              |         |               |  |             
|Net cash provided
(utilized) by
operating activities (2) |  | $      | 50,110  |              |  | $            | (6,293  | )             |  | $            | (1,878 | ) |  | $ |  |  |  | $ | 41,939  |  
|Net cash provided
(utilized) by
investing activities     |  |        |        |              |  |              | 38,621  |               |  |              | 1,312  |   |  |   |  |  |  |   | 39,933  |  
|Net cash (utilized)
provided by
financing activities     |  |        | (50,110 | )            |  |              | (30,598 | )             |  |              | 2,152  |   |  |   |  |  |  |   | (78,556 | )
|                                                         |  |        |         |              |  |              |         |               |  |              |        |   |  |   |   |  |  |   |         |  
|Increase in cash and
cash equivalents                    |  |        |        |              |  |              | 1,730   |               |  |              | 1,586  |   |  |   |  |  |  |   | 3,316   |  
|Cash and cash equivalents,
beginning of period           |  |        |        |              |  |              | 37,734  |               |  |              | 884    |   |  |   |  |  |  |   | 38,618  |  
|Cash and cash equivalents,
end of period                 |  |        |        |              |  |              | 39,464  |               |  |              | 2,470  |   |  |   |  |  |  |   | 41,934  |  

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CONDENSED SELECTED
CONSOLIDATING STATEMENT OF CASH FLOWS
For the eight months ended December 31, 2002 Guarantor
    
    Non-GuarantorParent
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedNet cash provided (utilized) by
operating activities(2)
    
    $
    1,890
    
    
    $
    (24,896
    )
    
    $
    (5,146
    )
    
    $
    
    
    
    $
    (28,152
    )Net cash (utilized) provided by
investing activities
    
    
    
    
    
    
    (24,458
    )
    
    
    5,849
    
    
    
    
    
    
    
    (18,609
    )Net cash (utilized) provided by
financing activities
    
    
    (1,890
    )
    
    
    (3,134
    )
    
    
    (857
    )
    
    
    
    
    
    
    (5,881
    )Increase in cash and
cash equivalents
    
    
    
    
    
    
    (52,488
    )
    
    
    (154
    )
    
    
    
    
    
    
    (52,642
    )Cash and cash equivalents,
beginning of period
    
    
    
    
    
    
    90,222
    
    
    
    1,038
    
    
    
    
    
    
    
    91,260Cash and cash equivalents,
end of period
    
    
    
    
    
    
    37,734
    
    
    
    884
    
    
    
    
    
    
    
    38,618
 F-51




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##### Table of Contents



Predecessor Company CONDENSED SELECTED CONSOLIDATING STATEMENT OF OPERATIONS
Four months ended April 30, 2002 Guarantor
    
    Non-GuarantorParent(1)
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedNet revenues
    
    $
    
    
    
    $
    549,003
    
    
    $
    47,013
    
    
    $
    (4,949
    )
    
    $
    591,067Operating income (loss)
    
    
    
    
    
    
    5,854
    
    
    
    4,581
    
    
    
    38
    
    
    
    10,473Income (loss) before
income taxes
    
    
    
    
    
    
    1,341,555
    
    
    
    48,908
    
    
    
    14,050
    
    
    
    1,404,513Net income (loss)
    
    
    
    
    
    
    1,399,829
    
    
    
    48,908
    
    
    
    (14,782
    )
    
    
    1,433,955
 CONDENSED SELECTED CONSOLIDATING STATEMENT OF OPERATIONS
Three Months ended December 31, 2001 Guarantor
    
    Non-GuarantorParent(1)
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedNet revenues
    
    $
    
    
    
    $
    420,626
    
    
    $
    34,751
    
    
    $
    (4,835
    )
    
    $
    450,542Operating (loss) income
    
    
    
    
    
    
    14,158
    
    
    
    3,324
    
    
    
    (84
    )
    
    
    17,398(Loss) income before
income taxes
    
    
    
    
    
    
    3,357
    
    
    
    138
    
    
    
    (61
    )
    
    
    3,434Net (loss) income
    
    
    
    
    
    
    4,865
    
    
    
    138
    
    
    
    (608
    )
    
    
    4,395
 CONDENSED SELECTED
CONSOLIDATING STATEMENT OF OPERATIONS
Fiscal year ended September 30, 2001 Guarantor
    
    Non-GuarantorParent(1)
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedNet revenues
    
    $
    
    
    
    $
    1,708,484
    
    
    $
    137,124
    
    
    
    (4,954
    )
    
    $
    1,840,654Operating (loss) income
    
    
    
    
    
    
    1,383
    
    
    
    4,132
    
    
    
    159
    
    
    
    5,674(Loss) income before
income taxes
    
    
    
    
    
    
    (44,300
    )
    
    
    1,359
    
    
    
    1,824
    
    
    
    (41,117
    )Net (loss) income
    
    
    
    
    
    
    (36,578
    )
    
    
    1,359
    
    
    
    1,824
    
    
    
    (33,395
    )
 F-52




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##### Table of Contents



CONDENSED SELECTED
CONSOLIDATING STATEMENT OF CASH FLOWS
Four months ended April 30, 2002 Guarantor
    
    Non-GuarantorParent(1)
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedNet cash provided (utilized) by
operating activities(2)
    
    $
    
    
    
    $
    (8,679
    )
    
    $
    11,411
    
    
    $
    
    
    
    $
    2,732Net cash provided (utilized) by
investing activities
    
    
    
    
    
    
    69,157
    
    
    
    (13,073
    )
    
    
    
    
    
    
    56,084Net cash provided (utilized) by
financing activities
    
    
    
    
    
    
    (180,869
    )
    
    
    (427
    )
    
    
    
    
    
    
    (181,296
    )Increase in cash and
cash equivalents
    
    
    
    
    
    
    (120,391
    )
    
    
    (2,089
    )
    
    
    
    
    
    
    (122,480
    )Cash and cash equivalents,
beginning of period
    
    
    
    
    
    
    210,612
    
    
    
    3,128
    
    
    
    
    
    
    
    213,740Cash and cash equivalents,
end of period
    
    
    
    
    
    
    90,221
    
    
    
    1,039
    
    
    
    
    
    
    
    91,260
 CONDENSED SELECTED
CONSOLIDATING STATEMENT OF CASH FLOWS
Three Months ended December 31, 2001 Guarantor
    
    Non-GuarantorParent (1)
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedNet cash provided (utilized) by
operating activities(2)
    
    $
    
    
    
    $
    22,153
    
    
    $
    (2,442
    )
    
    $
    
    
    
    $
    19,711Net cash (utilized) provided by
investing activities
    
    
    
    
    
    
    (9,829
    )
    
    
    (855
    )
    
    
    
    
    
    
    (10,684
    )Net cash (utilized) provided by
financing activities
    
    
    
    
    
    
    (4,020
    )
    
    
    (317
    )
    
    
    
    
    
    
    (4,337
    )Increase in cash and
cash equivalents
    
    
    
    
    
    
    8,304
    
    
    
    (3,614
    )
    
    
    
    
    
    
    4,690Cash and cash equivalents,
beginning of period
    
    
    
    
    
    
    207,839
    
    
    
    1,211
    
    
    
    
    
    
    
    209,050Cash and cash equivalents,
end of period
    
    
    
    
    
    
    216,143
    
    
    
    (2,403
    )
    
    
    
    
    
    
    213,740
 F-53




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##### Table of Contents



CONDENSED SELECTED
CONSOLIDATING STATEMENT OF CASH FLOWS
Fiscal year ended September 30, 2001 Guarantor
    
    Non-GuarantorParent (1)
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedNet cash provided (utilized) by
operating activities(2)
    
    $
    
    
    
    $
    109,634
    
    
    $
    (11,946
    )
    
    $
    
    
    
    $
    97,688Net cash (utilized) provided by
investing activities
    
    
    
    
    
    
    (30,278
    )
    
    
    10,840
    
    
    
    
    
    
    
    (19,438
    )Net cash (utilized) provided by
financing activities
    
    
    
    
    
    
    (39,256
    )
    
    
    (412
    )
    
    
    
    
    
    
    (39,668
    )Increase in cash and
cash equivalents
    
    
    
    
    
    
    40,100
    
    
    
    (1,518
    )
    
    
    
    
    
    
    38,582Cash and cash equivalents,
beginning of period
    
    
    
    
    
    
    167,739
    
    
    
    2,729
    
    
    
    
    
    
    
    170,468Cash and cash equivalents,
end of period
    
    
    
    
    
    
    207,839
    
    
    
    1,211
    
    
    
    
    
    
    
    209,050
  (1)
    
    For the four months end April 30, 2002 and for the three months ended December 31, 2001 and for the fiscal year
ended September 30, 2001, there were no significant assets and
liabilities of the Parent
other than the investments in subsidiaries.  (2)
    
    Net cash provided (utilized) by operating activities includes net cash
(utilized) provided by discontinued operations and
payment of reorganization items. F-54




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##### Table of Contents



NOTE 24 QUARTERLY FINANCIAL INFORMATION (UNAUDITED) The following tables summarize unaudited quarterly financial data for the
Reorganized Company for the year ended December 31, 2003 and for the eight
months ended December 31, 2002, and the Predecessor Company for the four months
ended April 30, 2002 (in thousands, except per share amounts): Fiscal Year Ended December 31, 2003Fourth
    
    Third
    
    Second
    
    FirstQuarter
    
    Quarter
    
    Quarter
    
    QuarterNet revenue
    
    $
    416,798
    
    
    $
    444,083
    
    
    $
    430,425
    
    
    $
    424,061Total costs and expenses
    
    
    427,003
    
    
    
    437,565
    
    
    
    423,920
    
    
    
    417,206Operating (loss) income
    
    
    (10,205
    )
    
    
    6,518
    
    
    
    6,505
    
    
    
    6,855Other (expenses) income
    
    
    (13,759
    )
    
    
    (8,264
    )
    
    
    (8,884
    )
    
    
    (7,435
    )(Loss) income from continuing operations
before income taxes
    
    
    (23,964
    )
    
    
    (1,746
    )
    
    
    (2,379
    )
    
    
    (580
    )Benefit for income taxes
    
    
    (4,261
    )
    
    
    (698
    )
    
    
    (950
    )
    
    
    (233
    )(Loss) income from continuing operations
    
    
    (19,703
    )
    
    
    (1,048
    )
    
    
    (1,429
    )
    
    
    (347
    )Discontinued operations(Loss) income from discontinued operations
    
    
    (760
    )
    
    
    (73
    )
    
    
    (265
    )
    
    
    (485
    )Gain on sale of discontinued operations
    
    
    514
    
    
    
    7,200
    
    
    
    
    
    
    
    3,600Net (loss) income
    
    $
    (19,949
    )
    
    $
    6,079
    
    
    $
    (1,694
    )
    
    $
    2,768Earnings (loss) per share  basic and diluted(Loss) income from continuing operations
    
    $
    (0.98
    )
    
    $
    (0.05
    )
    
    $
    (0.07
    )
    
    $
    (0.02
    )(Loss) income from discontinued operations
    
    
    (0.04
    )
    
    
    
    
    
    
    (0.01
    )
    
    
    (0.02
    )Gain on sale of discontinued operations
    
    
    0.02
    
    
    
    0.35
    
    
    
    
    
    
    
    0.18Net (loss) income per share
    
    $
    (1.00
    )
    
    $
    0.30
    
    
    $
    (0.08
    )
    
    $
    0.14Shares used in computing net (loss) income
per share  basic and diluted
    
    
    20,004
    
    
    
    20,000
    
    
    
    20,000
    
    
    
    20,000
 For the four quarters ended December 31, 2002Reorganized Company
    

    Predecessor CompanyFourth
    
    Third
    
    Second Quarter

    
    FirstQuarter
    
    Quarter
    
    Last Two Months
    

    First Month
    
    QuarterNet revenue
    
    $
    435,021
    
    
    $
    437,921
    
    
    $
    290,064
    
    

    $
    144,307
    
    
    $
    446,760Total costs and expenses
    
    
    505,137
    
    
    
    419,186
    
    
    
    273,380
    
    

    
    146,360
    
    
    
    434,235Operating (loss) income
    
    
    (70,116
    )
    
    
    18,735
    
    
    
    16,684
    
    

    
    (2,053
    )
    
    
    12,525Other (expenses) income
    
    
    (9,736
    )
    
    
    (8,733
    )
    
    
    (3,360
    )
    

    
    1,442,615
    
    
    
    (48,569
    )(Loss) income from continuing operations
before income taxes
    
    
    (79,852
    )
    
    
    10,002
    
    
    
    13,324
    
    

    
    1,440,562
    
    
    
    (36,044
    )(Benefit) provision for income taxes
    
    
    (8,090
    )
    
    
    4,081
    
    
    
    5,330
    
    

    
    (111
    )
    
    
    (31
    )(Loss) income from continuing operations
    
    
    (71,762
    )
    
    
    5,921
    
    
    
    7,994
    
    

    
    1,440,673
    
    
    
    (36,013
    )Discontinued operations(Loss) income from discontinued operations
    
    
    (396
    )
    
    
    29
    
    
    
    (100
    )
    

    
    167
    
    
    
    46Gain on sale of discontinued pharmacy operations
    
    
    
    
    
    
    
    
    
    
    
    
    

    
    7,696
    
    
    
    21,386Net (loss) income
    
    $
    (72,158
    )
    
    $
    5,950
    
    
    $
    7,894
    
    

    $
    1,448,536
    
    
    $
    (14,581
    )(Loss) earnings per share  basic and diluted(Loss) income from continuing operations
    
    $
    (3.59
    )
    
    $
    0.30
    
    
    $
    0.40
    
    

    $
    19.55
    
    
    $
    (0.49
    )(Loss) loss from discontinued operations
    
    
    (0.02
    )
    
    
    
    
    
    
    (0.01
    )
    

    
    
    
    
    
    Gain on sale of discontinued operations
    
    
    
    
    
    
    
    
    
    
    
    
    

    
    0.11
    
    
    
    0.29Net (loss) income per share
    
    $
    (3.61
    )
    
    $
    0.30
    
    
    $
    0.39
    
    

    $
    19.66
    
    
    $
    (0.20
    )Shares used in computing net (loss) income
per share  basic and diluted
    
    
    20,000
    
    
    
    20,000
    
    
    
    20,000
    
    

    
    73,688
    
    
    
    73,688
 F-55




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##### Table of Contents



SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
MARINER HEALTH CARE, INC.
(dollars in thousands) Balance
    
    
    
    
    
    
    
    
    
    BalanceBeginning of
    
    Charged to
    
    Deduction From
    
    End ofPeriod
    
    Income
    
    Reserve
    
    PeriodFiscal Year 2003Allowance for doubtful accounts
    
    $
    72,996
    
    
    
    42,590
    
    
    
    (18,138
    )(1)
    
    $
    97,448Valuation
allowance on deferred tax assets
    
    $
    596,068
    
    
    
    
    
    
    
    (224,606
    )(2)
    
    $
    371,462Eight Months Ended December 31, 2002Allowance for doubtful accounts
    
    $
    84,629
    
    
    
    4,924
    
    
    
    (16,557
    )(1)
    
    $
    72,996Valuation allowance on deferred tax assets
    
    $
    597,078
    
    
    
    (1,010
    )
    
    
    
    
    
    $
    596,068Four Months Ended April 30, 2002Allowance for doubtful accounts
    
    $
    61,049
    
    
    
    25,344
    
    
    
    (1,764
    )(1)
    
    $
    84,629Valuation allowance on deferred tax assets
    
    $
    523,067
    
    
    
    74,011
    
    
    
    
    
    
    $
    597,078Three Months Ended December 31, 2001Allowance for doubtful accounts
    
    $
    53,286
    
    
    
    7,763
    
    
    
    
    
    
    $
    61,049Valuation allowance on deferred tax assets
    
    $
    525,076
    
    
    
    (2,009
    )
    
    
    
    
    
    $
    523,067Fiscal Year 2001Allowance for doubtful accounts
    
    $
    44,624
    
    
    
    28,140
    
    
    
    (19,478
    )(1)
    
    $
    53,286Valuation allowance on deferred tax assets
    
    $
    521,639
    
    
    
    3,437
    
    
    
    
    
    
    $
    525,076
 (1)   Write-off of
uncollectible accounts. (2)   The reorganization of the Company on May 1, 2002 constituted an ownership
change under Section 382 of the Internal Revenue Code (Section 382), which
theoretically imposed annual limitations on the utilization of loss
carryforwards after certain ownership changes. However, the Company made an
election on the 2002 consolidated return filed in 2003 that enabled the Company
to avoid the annual Section 382 limitations. The consequences of that election
were that the net operating losses (NOLs) must be reduced by interest
deducted for income tax purposes for the period from October 1, 1998 through
the emergence date on indebtedness that was converted into stock pursuant to
the Joint Plan. This reduction is reflected in the reduction of NOL
carryforwards by the Predecessor Company and offsetting reduction in the Companys
valuation allowance.