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SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549


______________


FORM 10-K

______________


x
        
        ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended December 31, 2002ORo
        
        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For 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. Employerincorporation or organization)
        
        Identification No.)One Ravinia Drive, Suite 1500Atlanta, Georgia
        
        30346(Address of principal executive offices)
        
        (Zip code)


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

______________


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

_____________


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 28, 2002 (the last business day of the registrants most recently
completed second fiscal quarter) was $154,814,550, based on the last sale price
for the Common Stock of $13.25 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 20,000,000 shares of Common Stock issued and outstanding as of
March 26, 2003.

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 OPERATION   
|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
|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.   CONTROLS AND PROCEDURES                                                            
|                                                                     | ITEM  15.   EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K                    
|SIGNATURES                                                          
|EX-10.21 SECOND AMENDMENT AND LIMITED WAIVER                        
|EX-21 SUBSIDIARIES OF THE COMPANY                                   
|EX-23 CONSENT ERNST & YOUNG LLP                                     
|EX-99.1 SECTION 906 CERTIFICATION OF THE CEO                        
|EX-99.2 SECTION 906 CERTIFICATION OF THE CFO                        



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MARINER HEALTH CARE, INC.

TABLE OF CONTENTS

PagePart IItem 1
        
        Business
        
        
        1Item 2
        
        Properties
        
        
        21Item 3
        
        Legal Proceedings
        
        
        23Item 4
        
        Submission of Matters to a Vote of Security Holders
        
        
        24Part IIItem 5
        
        Market for Registrants Common Equity and Related Stockholder Matters
        
        
        24Item 6
        
        Selected Financial Information
        
        
        26Item 7
        

Managements Discussion and Analysis of
Financial Condition and Results of Operations
        
        
        29Item 7A
        
        Quantitative and Qualitative Disclosures About Market Risk
        
        
        46Item 8
        
        Financial Statements and Supplementary Data
        
        
        47Item 9
        
        Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
        
        
        47Part IIIItem 10
        
        Directors and Executive Officers of the Registrant
        
        
        47Item 11
        
        Executive Compensation
        
        
        50Item 12
        
        Security Ownership of Certain Beneficial Owners and Management
        
        
        55Item 13
        
        Certain Relationships and Related Transactions
        
        
        57Item 14
        
        Controls and Procedures
        
        
        58Item 15
        
        Exhibits, Financial Statement Schedules and Reports on Form 8-K
        
        
        58


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PART I




ITEM 1.       BUSINESS

General

Mariner Health Care, Inc., through its operating subsidiaries, is one of the
largest providers of long-term healthcare services in the United States, based
on net revenue and the number of nursing homes owned and leased. We provide
these services primarily through the operation of skilled nursing facilities,
or SNFs, and long-term acute care hospitals, or LTACs. As of December 31,
2002, we operated 297 owned, leased or managed facilities in 23 states,
including 289 SNFs and eight stand alone assisted living facilities and
apartments, or ALFs, with 35,419 licensed beds, as well as 13 LTACs in four
states with 683 licensed beds. Included in the total number of SNFs are nine
managed SNFs with 1,245 licensed beds. As of December 31, 2002, we owned 192
of our facilities, and 13 of our facilities were leased under capital leases.
We have significant facility concentrations in five states and several
metropolitan markets. As used in this report, references to we, us, our,
Mariner or similar terms include Mariner Health Care, Inc. and its operating
subsidiaries.

Inpatient services provided at our nursing facilities are our primary service
offering and, during the twelve months ended December 31, 2002, accounted for
93.7% of our revenue. Through our SNFs, we provide 24-hour care to patients
requiring skilled nursing services, including assistance with activities of
daily living, or ADL, therapy and rehabilitation services. Our LTACs
accommodate the relatively high acuity needs of patients discharged from
short-term, acute-care hospitals when a patients condition warrants more
intensive care than can be provided in a typical nursing facility.

The long-term care industry is highly regulated and industry participants,
including Mariner, derive a significant portion of their revenue from
reimbursement under the Medicare and Medicaid programs. For the twelve months
ended December 31, 2002, we derived 81.8% of our revenue from Medicare and
Medicaid payments. In the past, the industry as a whole has been materially
and adversely impacted by changes in Medicare and Medicaid reimbursement.
Future changes in Medicare and Medicaid policy will continue to materially
impact industry participants.

Congress has twice passed legislation intended to mitigate the impact of
legislation that changed Medicare reimbursement from a cost based system to a
system based on a fixed per diem rate. The mitigating legislation consisted of
two parts and materially lessened the impact this prospective payment system,
or PPS, had on our results of operations in the past two years. However,
certain portions of the mitigating legislation expired on September 30, 2002,
commonly referred to as the Medicare Reimbursement Cliff. The impact of the
Medicare Reimbursement Cliff resulted in our loss of $8.8 million in revenue
and operating income for the three months ended December 31, 2002. Unless
there is further legislation providing for reimbursement relief passed by
Congress, and assuming our patient census remains stable, we expect the impact
of the Medicare Reimbursement Cliff to result in a loss of approximately $37.0
million in revenue and operating income in 2003 and annually thereafter.

Effective March 31, 2003 we amended our Senior Credit Facility. The amendment,
among other things, adjusts the terms of our financial covenants for the two
year period beginning March 31, 2003. In addition, this amendment also
provided us with a waiver to a violation of one of our financial covenants for
the period ended December 31, 2002. This amendment is more fully described in
Managements Discussion and Analysis of Financial Condition and Results of
Operation.

In addition to the Medicare
Reimbursement Cliff,
other parts of this mitigating legislation will expire when the Centers for
Medicare & Medicaid Services, or CMS, publishes a refined reimbursement system
for the Medicare program. This second part of the mitigating legislation
provides for certain add ons to reimbursement payments for higher acuity
patients. Recently, CMS announced a delay in the implementation of further
refinements in reimbursement rates until October 1, 2004, at the earliest.
Because the revised reimbursement rates have not yet been published, it is
unclear what effect they will have on us, or if the add on payments included in
the second part of the mitigating legislation will be included in these new
rates. Additionally, many states have adopted or are proposing cuts in their
Medicaid programs, the effects of which could be significant. At this time,
however, it is impossible for us to determine the likelihood or magnitude of
any proposed cuts.

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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., or Grancare.
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, 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 filed with the Bankruptcy
Court and as amended, was confirmed on April 3, 2002. This is referred to as
our Joint Plan. The effective date of our Joint Plan was May 13, 2002, or the
Effective Date. 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.

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. Our reports on Form
10-K, Form 10-Q and Form 8-K, as well as amendments to those reports, are
available free of charge on our website as soon as reasonably practicable after
we file the reports with the SEC.

Industry Overview

We compete in the long-term care industry. The long-term care industry
includes companies that offer post-acute, sub-acute or general healthcare
services such as skilled nursing care, long-term home care services and other
support services, primarily to elderly patients. Post-acute care refers to
care rendered to a patient following discharge from a hospital or following a
serious medical event. Sub-acute care refers to the type of care rendered at
SNFs and encompasses all care other than that rendered by acute care facilities
such as hospitals. Within the long-term care industry, we specifically focus
on the United States nursing home market through the operation of our SNF and
LTAC facilities. We primarily target elderly individuals in need of long-term
medical care or requiring assistance to function on a daily basis.

The primary difference between a SNF, a LTAC and other senior healthcare
facilities, such as ALFs, is the level of care each is capable or licensed to
provide. ALFs do not provide skilled nursing care and do not participate in
the Medicare or Medicaid programs. SNFs provide room, board and a variety of
other skilled nursing and rehabilitation services to their residents and are
required to be licensed by the state in which they operate. They are certified
to participate in the Medicare and Medicaid programs. LTACs function as
hospitals, are subject to more stringent licensure and certification processes
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. ALFs 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
cleaning, which ordinarily would be done by the individuals, are performed for
them by the facility.

We believe the demand for the services provided by long-term care facilities
will increase during the next decade due primarily to: (i) demographic trends;
(ii) advances in medical technology prolonging the average life expectancy; and
(iii) the impact of cost containment measures by government and private-pay
sources resulting in higher acuity patients being transferred more quickly to
settings such as SNFs, where care can generally be provided at a lower cost.

Long-Term Care Services

Inpatient services provided through our nursing facilities constitute our
primary service offering and during the twelve months ended December 31, 2002
accounted for 93.7% of our revenue. For the three months ended December 31,
2001, inpatient services accounted for 93.7% of our revenue, and for the fiscal
year ended September 30, 2001, they accounted for 94.0% of our revenue. Over
98.0% of our long-term care facilities are certified for participation in the
Medicare and Medicaid programs.

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Our SNFs provide 24-hour care to patients requiring access to skilled nursing
or rehabilitation services. Substantially all patients in our inpatient
facilities receive assistance with one or more ADL services, including feeding,
bathing, dressing, eating, toileting, transportation and related services. 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 licensed
physician to serve as its medical director.

Our inpatient facilities provide a broad range of case management services over
the course of treatment, including, as appropriate, ongoing medical evaluation,
social service needs, specialty equipment requirements, outcomes measurement,
discharge planning and arrangement for home care. These basic services are
supplemented, in our Medicare-certified facilities, by rehabilitation services,
including physical, occupational and speech therapies.

In addition, we operate specialized units in a number of our SNFs that provide
sub-acute, or intensive, institutional type medical care to patients with
medically complex conditions. Within these specialty units, trained staff
members offer care for patients as an alternative to treatment in a more
expensive acute-care hospital setting. In addition to basic therapy services,
these specialty units offer, among other things, enteral therapy, intravenous
therapy, specialized wound management and ventilator, tracheotomy, cancer and
HIV care. Through our nursing home services division, we also offer
specialized services in some of our facilities for residents with Alzheimers
disease.

Included in the nursing home services division are our eight freestanding ALFs
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 SNFs
also include assisted living operations and apartment units located on the same
campus as the SNF.

Long-Term Acute Care Hospitals

We own one and lease or manage 12 other LTACs, encompassing 683 licensed beds
in four states. 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.

Marketing

In marketing our 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 healthcare 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
healthcare 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 healthcare providers such as health maintenance
organizations, or HMOs, and other managed care providers, which we believe may
increase our sub-acute care business. Typically, patients referred by managed
care providers, 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.

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Suppliers

We purchase our supplies from a variety of independent suppliers. 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 our supplies can
be provided by several alternative suppliers if the relationship with a
national supplier is terminated. We recently established a company-wide
internet-based purchasing solution designed to ensure best product and pricing
for our facilities on an aggregate basis.

Competition

The long-term care industry is segmented into a variety of competitive areas
that market similar services. These competitors include nursing homes,
hospitals, extended care centers, ALFs, 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. SNFs 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 SNFs and, in the case of
private pay residents, charges for services. Since there is little price
competition with respect to Medicaid and Medicare residents, the range of
services provided by the SNFs 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.

Within some of our SNFs, 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.

Customers

We receive payments for services rendered to patients 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, HMOs, 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.

We have historically received, and expect to continue to receive, a majority of
our revenue from federal and state governments and governmental entities.
However, there are no individual customers or related groups of customers that
account for a significant portion of our revenue. 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 facilities, we do not expect that the
loss of a single customer or group of related customers would have a material
adverse effect on our business or revenue.

Our revenue and profitability are affected by ongoing efforts of third-party
payors to contain healthcare 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,

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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. Also, we have historically derived higher revenue from
providing specialized medical services than from providing routine inpatient
care.

Employees

We employ approximately 39,500 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 northern California, Michigan, Wisconsin,
Maryland, Ohio, West Virginia and Florida. We have collective bargaining
agreements with unions representing employees at 28 facilities. In addition, a
union represents employees at another of our facilities without a collective
bargaining agreement.

Of our 12 unionized facilities in northern California, 11 are represented by
the Service Employees International Union, or SEIU, and are subject to a
regional master collective bargaining agreement. The other unionized facility
in northern 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 twelve facilities, licensed nurses also are
represented by the relevant union. The agreement with the SEIU expires on
April 30, 2004, with a wage and benefit re-opener for the third year of the
contract, which means that the agreement may be subject to renegotiation in
2003. The Teamsters agreement expired on December 31, 2002 and negotiations
are ongoing.

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 expires on September 30,
2003 and the 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.
At another of our facilities in Maryland, the employees are represented by the
United Food and Commercial Workers Union. This agreement will expire on April
30, 2004.

In Wisconsin, there is one facility where the workers are represented by the
SEIU. The SEIU agreement relating to that facility will expire on May 1, 2004.
The SEIU also represents employees at one of our facilities in West Virginia
and another in Florida. The SEIU agreement for the West Virginia facility will
expire on March 1, 2005, and there is no agreement for the Florida facility.
We are currently negotiating a collective bargaining agreement for the Florida
facility. 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.

Insurance

Insurance related costs in the long-term care industry continue to rise at a
dramatic rate. This primarily includes professional/general liability, or
PL/GL, workers compensation and directors and officers liability programs.
Costs for PL/GL programs are of particular concern in Florida and Texas where
we maintain significant operations. Our PL/GL insurance related costs for our
inpatient facilities in Florida represented approximately 31.8%, and in Texas
represented approximately 41.7%, of our total PL/GL related costs for the
fiscal year ended December 31, 2002. Significant increases in the frequency
and severity of PL/GL claims also continues. Insurance markets have responded
to this

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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.

Due to the rising cost and limited availability of PL/GL insurance, we
currently purchase excess PL/GL liability insurance only, and maintain, in all
states except Colorado, an unaggregated $1.0 million self-insured retention per
claim. In Colorado, we maintain first dollar coverage. Additionally, in the
second quarter of 2002, due to changes in the workers compensation insurance
market, we moved from a guaranteed cost program for our employee injury losses
to a program where we self insure the first $500,000 of each employee injury
claim. Because we are 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 we can be liable in any policy period. Although we base our
loss estimates on independent actuarial analyses 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.

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 the Petition Date, 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.

On the Effective Date, and in connection with the consummation of the Joint
Plan, we entered into our Senior Credit Facility, which provided us funds to
satisfy specified obligations to our creditors under the Joint Plan, for
general working capital purposes and for permitted acquisitions.

As part of our Joint Plan, the senior lenders under our prepetition credit
facility received, among other things:



| |  |  | $216.5 million, representing 79.6% of the available cash, after
giving effect to certain adequate protection payments paid to senior
lenders in connection with our disposition of assets;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | $119.4 million in principal amount of second priority secured notes
due 2009, or our Second Priority Notes, representing 79.6% of those
notes; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 15,290,428 shares of our common stock, representing 76.4% of our
common stock issued as of the Effective Date.
| | - |  | --------------------------------------------------------------------------------------------------------------

The senior lenders under the prepetition senior credit facility of Mariner
Health Group, Inc., or MHG, a former wholly-owned subsidiary, received, among
other things:



| |  |  | $58.5 million, representing 20.4% of the available cash, after
giving effect to certain adequate protection payments paid to senior
lenders in connection with our disposition of assets;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | $30.6 million in principal amount of our Second Priority Notes,
representing 20.4% of those notes;
| | - |  | --------------------------------------------------------------------------------------------------

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| |  |  | 3,911,416 shares of our common stock, representing 19.6% of our
common stock issued as of the Effective Date; and
| | - |  | -----------------------------------------------------------------------------------------------------------------



| |  |  | $525,000 in cash on account of professional fees.
| | - |  | -------------------------------------------------

Holders of general unsecured allowed claims against us, other than holders of
claims against MHG, will receive, upon resolution of outstanding claims, pro
rata distributions of:



| |  |  | 399,078 shares of our common stock, representing 2% of our common
stock issued as of the Effective Date; and
| | - |  | ------------------------------------------------------------------------------------------------------------



| |  |  | warrants to purchase an additional 376,893 shares of our common
stock, which have a per share exercise price of $28.04 and are
exercisable for two years after the Effective Date.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The holders of general unsecured allowed claims against MHG are entitled to
receive, along with the holders of senior subordinated notes issued by MHG
prior to bankruptcy, pro rata distributions of a $7.5 million cash fund.

Holders of senior subordinated notes issued by us prior to our bankruptcy
received pro rata distributions of:



| |  |  | 399,078 shares of our common stock, representing 2% of the shares
of our common stock issued as of the Effective Date; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------



| |  |  | warrants exercisable for 376,893 shares of our common stock, which
have a per share exercise price of $28.04 and are exercisable for two
years after the Effective Date.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

As part of the Joint Plan, we completed an internal restructuring of our
corporate subsidiaries, or Corporate Restructuring Program, in order to realize
certain expected operational benefits described below. The Corporate
Restructuring Program also resulted in the creation of a new wholly owned
subsidiary of ours, or the Management Company, that currently provides
management services to each of our operating subsidiaries pursuant to
management agreements with each such subsidiary.

Under each management agreement, the Management Company agrees to provide the
following services:



| |  |  | those required to meet the personnel requirements of each operating subsidiary;
| | - |  | -------------------------------------------------------------------------------



| |  |  | accounting, cash management and back office support;
| | - |  | ----------------------------------------------------



| |  |  | central purchasing and vendor support;
| | - |  | --------------------------------------



| |  |  | preparation of Medicare and Medicaid cost reports;
| | - |  | --------------------------------------------------



| |  |  | development of operational policies and procedures;
| | - |  | ---------------------------------------------------



| |  |  | regulatory compliance support;
| | - |  | ------------------------------



| |  |  | risk management; and
| | - |  | --------------------



| |  |  | legal assistance.
| | - |  | -----------------

In exchange for providing these services, the Management Company is paid a fee
of 5% of each operating subsidiarys net revenue.

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Expected benefits of the Corporate Restructuring Program include:



| |  |  | improved tracking and documentation of revenue, expenses and intercompany transactions;
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | enhanced ability to engage in acquisition and financing activities;
| | - |  | -------------------------------------------------------------------



| |  |  | enhanced ability to evaluate internal policies and procedures;
| | - |  | --------------------------------------------------------------



| |  |  | enhanced ability to meet operating subsidiarys staffing needs;
| | - |  | ---------------------------------------------------------------



| |  |  | improved understanding of the corporate entity and/or employees
responsible for SNF operations and adherence to corporate structure;
and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------



| |  |  | clarification of the appropriate contracting authority of different
employees.
| | - |  | ------------------------------------------------------------------------------

Global Settlement.We have reached a settlement with the United States to
resolve certain United States Claims (as defined below) 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, and
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
wholly owned by us at anytime 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;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  |  | we agreed to enter into the Corporate Integrity Agreement with the Office of Inspector General;
| | - |  | -----------------------------------------------------------------------------------------------



| |  |  | 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 accounting principles generally accepted in the United
States, 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.

Corporate Integrity Agreement.On April 3, 2002, as a condition of the Global
Settlement Agreement we entered into with the United States government, we
entered into a Corporate Integrity Agreement with the Office of Inspector
General of the U.S. Department of Health and Human Services to promote our
compliance with the requirements of Medicare, Medicaid and all other federal
healthcare 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 healthcare program
requirements relating to financial and quality of care issues;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------



| |  |  | conduct training each year for all employees to promote compliance
with federal healthcare 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, regional 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;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | enhance our current system of internal financial controls to
promote compliance with federal healthcare 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 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 healthcare 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 healthcare 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.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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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 healthcare programs.

Regulation

The healthcare 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. The industry 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 healthcare programs.

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

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  Medicare Certified Skilled Nursing
Facilities.The Balanced Budget Act of 1997 amended the Medicare program by
revising the payment system for skilled nursing facilities. Specifically, it
required the establishment of a prospective payment system 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, SNFs
receive a fixed per diem rate for each of their Medicare Part A patients.
Included in this per diem rate are ancillary services, such as pharmacy and
rehabilitation therapy services, that historically were provided to many of our
SNFs by our pharmacy and therapy subsidiaries.

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 SNFs under PPS. As of October 1, 2002, certain of the
temporary payment increases provided for in the Medicare, Medicaid, and SCHIP
Balanced Budget Refinement Act of 1999 and the Medicare, Medicaid, and SCHIP
Benefits Improvement and Protection Act of 2000, have expired. Under these
Acts, Congress also directed CMS to refine the payment system for certain
medically complex, rehabilitation and high acuity patients and provided
additional funding for those patients until the payment system is refined.
Congress mandated that these refinements be budget neutral. For this reason,
the PPS per diem rates were temporarily increased for some patient categories.
While we do not know when CMS will refine the payment system, CMS recently
announced a delay in the implementation of further refinements in reimbursement
rates until October 1, 2004, at the earliest. Although the refinements in the
payment system are intended to result in a PPS that more appropriately
reimburses providers for the services needed by certain payment categories, it
is unclear at this time what effect the refined reimbursement system will have
on us, or if the add on payments will be included in the new rates.

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Fee for Service Reimbursement  Medicare Certified Skilled Nursing Facilities.
We are also reimbursed for specified services, such as rehabilitation therapy
services, provided to Medicare SNF patients under the Medicare Part B benefit.
The Balanced Budget Act also set a maximum per beneficiary amount, or limit,
per provider for physical therapy and speech pathology, and another limit for
occupational therapy. A moratorium on the therapy limitation expired at the
end of calendar year 2002, and CMS has instructed fiscal intermediaries (i.e.,
the companies that process Medicare claims) that claims for outpatient therapy
services provided on or after July 1, 2003 will be subject to the financial
limitation, which is $1,590 in 2003. Because we cannot prospectively determine
the number of our patients who will require therapy or the amount of therapy
they will require, we are unable to quantify the effect this will have on our
results of operations.

The Balanced Budget Refinement Act also excluded certain items and services
from the formerly all-inclusive SNF 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 SNF 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.

Nursing Home Reimbursement  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 as a means of balancing
their state budgets. Existing and future initiatives affecting Medicaid
reimbursement may reduce utilization of (and reimbursement for) nursing
facility services. 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 healthcare
services for Medicaid beneficiaries. Although the rule will be phased in over
eight years to reduce the adverse impact on certain states, the rule eventually
could result in decreased federal funding to state Medicaid programs, which
have used these accounting techniques to enhance their federal funding, which,
in turn, could prompt certain 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.

Nurse Staffing Issues.We could experience significant increases in our
operating costs due to shortages in qualified nurses, healthcare professionals
and other key personnel. The market for these key personnel is highly
competitive. We, like other healthcare providers, have experienced
difficulties in attracting and retaining qualified personnel such as nursing
facility administrators, nurses, certified nurses aides and other important
healthcare providers. Our LTACs are particularly dependent on nurses for
patient care. There is currently a shortage of

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nurses, and trends indicate
this shortage will worsen in the future. The difficulty our SNFs 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 healthcare personnel. Our ability to control labor costs will
significantly affect our future operating results.

We operate a number of SNFs in Florida and California, which have enacted
legislation establishing minimum staffing requirements for SNFs operating in
those states. Each SNF in Florida and California must satisfy established
minimum nursing hours of direct care per resident per day. Certain other
states in which we operate SNFs 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. 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.

Medicare Reimbursement  Long-Term Acute Care Hospitals.CMS has replaced the
reasonable cost-based payment system for LTACs with a PPS. As of October 1,
2002, and subject to a five-year phase-in period during which reimbursement
will be 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 PPS. We have elected to adopt the
full federal rates immediately. This 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 will be calculated for each diagnosis related group.
Because the LTAC PPS has only recently gone into effect, we cannot predict the
ultimate impact the new system will have on us. To date, however, this payment
system has not had a material adverse impact on our financial condition or
results of operations.

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 of 1996, or 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 healthcare
industry. Among the standards that the Department of Health and Human Services
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 healthcare industry, we believe that the law will require
significant and costly changes to current practices. The Department of Health
and Human Services 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 healthcare transactions
and seek to protect the privacy and security of health information. The first
rule requires the use of uniform standards for common healthcare transactions,
including healthcare claims information, plan eligibility, referral
certification and authorization, claims status, plan enrollment and
disenrollment, payment and remittance advice, plan premium payments and
coordination of benefits.

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 third and final rule governing the security of health information was
issued February 20, 2003. This rule specifies a series of administrative,
technical and physical security procedures we must implement to assure the
confidentiality of electronic protected health information.

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The Department of Health and Human Services 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 Department of Health
and Human Services. We submitted a compliance plan and were granted the
deadline extension. On February 20, 2003, the Department of Health and Human
Services 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. Sanctions for failing to comply with HIPAA include criminal
penalties and civil sanctions. We are in the process of quantifying the costs
associated with HIPAA compliance and, although not currently quantifiable,
believe they may be material.

Survey and Certification.Long-term care facilities must comply with certain
requirements to participate either as a SNF under Medicare or a nursing
facility under Medicaid. Failure to substantially comply with these
requirements may result in 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. 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.

Nursing Home Quality Initiative.In April 2002, the Department of Health and
Human Services 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 SNF 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, the Department of Health and Human Services announced
that the program is being launched nationwide. For the national project, minor
modifications have been made to the list of quality measures. The Department
of Health and Human Services 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.

Referral Restrictions and Fraud and Abuse.The federal anti-kickback statute
prohibits 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 healthcare 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 healthcare 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 healthcare 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 healthcare 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 under the anti-kickback statute 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.

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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.

HIPAA also created two new federal crimes: healthcare fraud and false
statements relating to healthcare matters. The healthcare fraud statute
prohibits knowingly and willfully executing a scheme to defraud any healthcare
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 healthcare benefits, items or services. A violation of this
statute is a felony and may result in fines or imprisonment.

Additionally, HIPAA granted expanded enforcement authority to the Department of
Health and Human Services 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 healthcare
delivery and payment. The Balanced Budget Act also includes numerous
healthcare 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 healthcare 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 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 FCA.

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.

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Certificates of Need.Certificate of Need statutes and regulations control the
development and expansion of healthcare services and facilities in some states.
This process is intended to promote quality healthcare 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.

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 healthcare 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. Also, 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
healthcare programs.

The purpose of our compliance program is to address compliance issues,
communicate issues to our chief executive officer and 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 SNFs 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.

Risk Factors

We depend heavily on reimbursement from Medicare, Medicaid and other
third-party payors and reimbursement rates from these 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, 2002 and the three-month transition period ended December 31,
2001, we derived approximately 81.7% and 81.8% 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 rates 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,
could result in a substantial reduction in our revenue and operating margins.

The Balanced Budget Act made numerous changes to the Medicare and Medicaid
programs which affected us. Under the Medicare program, the new law required
the establishment of a PPS for Medicare Part A SNF services, under which
facilities are paid a flat federal per diem rate for virtually all covered
services, including pharmacy and therapy. The PPS was phased in over four cost
reporting periods, and started with cost reporting periods beginning on or
after July 1, 1998. As a result of our significant dependence on Medicare and
Medicaid reimbursement, the introduction of PPS significantly reduced our
per-patient reimbursement rate, resulting in lower per patient revenue and
making it difficult for us to service our then-existing debt obligations. The
exact revenue impact of PPS is not determinable due to other changes that were
made in our operations at about the same time. PPS comparable data by
payor source cannot be reliably determined because cost reports that were

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filed for
reimbursement with Medicare prior to PPS were more complex and included
additional allocations that were not included on the reports filed after PPS
was implemented. Without comparable cost reports, it is not possible to
directly calculate the impact of PPS on our revenue.

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. A
moratorium on the limitation expired at the end of calendar year 2002, and CMS
has instructed Medicare contractors that claims for outpatient therapy services
provided on or after July 1, 2003, will be subject to the financial limitation,
which is $1,590 in 2003. Because Medicare contractors have not yet begun to
apply the limitation, and we are unable to quantify what our patient mix will
be in the future, we are unable to quantify the effect this will have on our
results of operations.

Likewise, the Balanced Budget Act required the Secretary of the Department of
Health and Human Services to establish a PPS for home health services, which
was implemented beginning October 1, 2000. With regard to hospices, the
Balanced Budget Act limited reimbursement by setting the payment rate increase
at a market basket minus 1.0% for fiscal years 1998 through 2002. The law also
instituted a number of reforms of the hospice benefit, including a provision
that hospices could be reimbursed based on the location where care is furnished
(rather than the location of the hospice), effective for cost reporting periods
beginning on or after October 1, 1997. Other provisions limited Medicare
payments for certain drugs and biologicals, durable medical equipment and
parenteral and enteral nutrients and supplies. The Balanced Budget Act led to
a significant reduction in the reimbursement received by our SNFs as well as
the closure of some of our operations. The reduction in per-patient payments
to us resulting from this Act was one of the primary causes leading to the
filing of our bankruptcy. Future changes to Medicare and Medicaid
reimbursement may result in similar difficulties.

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 SNFs under PPS. These bills were the Balanced Budget
Refinement Act and the Benefits Improvement and Protection Act of 2000. As of
October 1, 2002, some of the temporary payment increases provided for in these
Acts expired. Under these Acts, Congress also directed CMS to refine the
payment system for certain medically complex, rehabilitation and high acuity
patients and provided additional funding for those patients until the payment
system is refined. Congress mandated that these refinements be budget
neutral. For this reason, the PPS per diem rates were temporarily increased
for some patient categories. While we do not know when CMS will refine the
payment system, CMS recently delayed its implementation, and indicated that no
further refinements will be implemented before October 1, 2004, at the
earliest. At such time, the per diem increases are expected to be eliminated
or incorporated into the refined reimbursement system. Although the
refinements in the payment system are intended to result in a PPS that more
appropriately reimburses providers for the services needed by certain payment
categories, we are unable to predict whether or how our revenue will be
affected by this portion of the refined payment system.

The Balanced Budget Act also repealed the federal payment standard for Medicaid
reimbursement levels, often referred to as the Boren Amendment, for hospitals
and nursing facilities. By repealing the Boren Amendment, the Balanced Budget
Act removed existing impediments on the ability of states to reduce their
Medicaid reimbursement levels. Since that repeal, many states have sought to
lower their nursing home payment rates, and several have succeeded.
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. Proposed
Medicaid cuts could have a significant impact on our financial conditions.

Additionally, net revenue realizable under third-party payor agreements can
change after examination and retroactive adjustment by payors during the claims
settlement processes. Payors may disallow requests for reimbursement based on
determinations that certain costs are not reimbursable or reasonable, or
because additional documentation is necessary. There also continue to be new
legislative and regulatory proposals that could impose further limitations on
government and private payments to healthcare providers. In some cases, states
have enacted or are considering enacting measures designed to reduce their
Medicaid expenditures and to make changes to private healthcare insurance. We
cannot assure you that adequate reimbursement levels will continue to be
available for the services provided by us, which are currently

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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 combination of the effects of the Medicare
Reimbursement Cliff, further refinements to the PPS Medicare reimbursement
system that results in lower payments to us, increased staffing costs and cuts
in state Medicaid funding could have a material adverse effect on our results
of operations.

Our substantial leverage could adversely affect our financial condition.As a
result of the Medicare Reimbursement Cliff and its impact and expected
continued impact on our revenue and operating income, we are very highly
leveraged. Our Senior Credit Facility consists of $212.0 million in term
loans, or the Term Loans, and an $85.0 million revolving line of credit, or the
Revolving Credit Facility. On December 31, 2002, we had total debt of
approximately $484.8 million, of which $210.4 million consisted of borrowings
under our Senior Credit Facility. Additionally, $22.5 million in letters of
credit were outstanding under the Senior Credit Facility as of December 31,
2002 and $150.0 million of our debt consisted of the Second Priority Notes. We
also had stockholders equity of approximately $268.4 million.

Our substantial indebtedness and the provisions in the Senior Credit Facility
could also have other important consequences. For example:



| |  |  | they could increase our vulnerability to general adverse economic
and industry conditions, including material adverse regulatory changes
such as reductions in reimbursement;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | they could increase the cost or limit the availability of
additional financing, if needed or desired, to fund future working
capital, capital expenditures and other general corporate requirements,
or to carry out other aspects of our business plan;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | they could require us to dedicate a substantial portion of our cash
flow from operations to the payment of principal of, and interest on,
our indebtedness, reducing our cash flow available for working capital,
capital expenditures or other general corporate purposes, or to carry
out other aspects of our business plan;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | they could require us to maintain debt coverage and financial
ratios at specified levels, reducing our financial flexibility;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------



| |  |  | they could limit our ability to make material acquisitions or take
advantage of business opportunities that may arise;
| | - |  | ----------------------------------------------------------------------------------------------------------------------



| |  |  | they could limit our flexibility in planning for, or reacting to, changes in our business and the industry;
| | - |  | -----------------------------------------------------------------------------------------------------------



| |  |  | they could place us at a competitive disadvantage compared to our competitors that have less debt; and
| | - |  | ------------------------------------------------------------------------------------------------------



| |  |  | our lenders under the Senior Credit
Facility can sweep our cash collections on
a daily basis, apply those funds against any outstanding Revolving
Credit Facility loans of Senior Credit Facility obligations then
overdue, before
making it available for general working
capital purposes.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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. This implementation
should enable us to better meet both the changing standards of industry
technology and the needs of our customer base. 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 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.

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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, SNFs 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 healthcare services reimbursable under federal
and/or state healthcare 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 government programs such
as Medicare and Medicaid.

In addition, the Ethics in Patient Referral Act of 1989, commonly referred to
as the federal physician self-referral prohibition or Stark Law, broadly
defines the scope of prohibited physician referrals under federal healthcare
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 healthcare
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 large for-profit, multi-facility providers like
us. In the State of Florida for example, a new statute could be interpreted to
require the state to revoke, absent sufficient mitigating factors, all licenses
held by an entity even if only one facility has perceived regulatory
deficiencies. The federal government has imposed extensive enforcement
policies resulting in a significant increase in the number 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, suffer civil or criminal penalties or be
required to make significant changes to our operations. 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 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.

Private third-party payors continue to try to reduce healthcare costs, which
could reduce our revenue.Private third-party payors, which are parties
responsible for the payment for medical services received by others, other than
the Medicare and Medicaid programs, are continuing their efforts to control
healthcare costs through direct contracts with healthcare providers, increased
utilization reviews, or reviews of the propriety of, and charges for, services
provided, and greater enrollment in managed care programs and preferred
provider organizations. Preferred provider organizations are entities through
which employer health plans and insurers can contract to purchase healthcare
services from selected providers for their beneficiaries. These private payors
increasingly are demanding discounted fee structures and the assumption by
healthcare providers of all or a portion of the financial risk associated with
the provision of care. We could be adversely affected by the continuing
efforts of private third-party payors to contain the amount of reimbursement we
receive for healthcare 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 under these programs. Future changes in
the reimbursement rates or methods of private third-party payors or the
implementation of other measures to reduce reimbursement for our services could
result in a substantial reduction in our revenue and a material adverse effect
on our operations and financial condition.

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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 results of operations, liquidity and financial condition.
As is typical in the healthcare 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 liability insurance only, and maintain, in all
states except Colorado, an unaggregated $1.0 million self-insured retention per
claim. In Colorado, we maintain first dollar coverage. Additionally, in the
second quarter of 2002, due to changes in the workers compensation insurance
market, we moved from a guaranteed cost program for our employee injury losses
to a program where we self insure the first $500,000 of each employee injury
claim. Because we are 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 we can be liable in any policy period. Although we base our
loss estimates on independent actuarial analyses, which determine expected
liabilities on an undiscounted basis, including incurred but not reported
losses, based upon the available information to date, the ultimate amount of the losses
could exceed our estimates and our insurance limits. 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.

Provisions for losses on our financial statements may not be adequate.Loss
provisions in our financial statements 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 a certified 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 our
management 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.

LTACS have recently become subject to a PPS, which could negatively impact our
revenue. CMS has also replaced the reasonable cost-based payment system for
LTACs with a prospective payment system. As of October 1, 2002, and subject to
a five year phase-in period during which reimbursement will be based on a blend
of federal rates and a cost-reimbursement system (although some facilities can
elect to adopt the full federal rates immediately). We have elected to adopt
the full federal rates immediately. The prospective payment system 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. Because the LTAC prospective payment system has only
recently gone into effect, we are currently unable to determine the ultimate
impact the new system will have on us. To date, however, this payment system
has not had a material adverse impact on our financial condition or results of
operations.

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If we fail to comply with our Corporate Integrity Agreement, we could be
subject to severe sanctions.On April 3, 2002, as a condition of the Global
Settlement Agreement we entered into with the United States government, we
entered into a Corporate Integrity Agreement with the Office of Inspector
General of the U.S. Department of Health and Human Services to promote our
compliance with the requirements of Medicare, Medicaid and all other federal
healthcare programs. Under the Corporate Integrity Agreement, we are reviewing
our current 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 healthcare programs. Any of these sanctions
would have a material adverse effect on our financial condition and results of
operations.

The cost to replace or retain qualified nurses, healthcare 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, healthcare professionals and other key personnel. The market
for these key personnel is highly competitive. We, like other healthcare
providers, have experienced difficulties in attracting and retaining qualified
personnel, especially facility administrators, nurses, certified nurses aides
and other important healthcare 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
SNFs 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 healthcare personnel. Our ability to control labor costs
will significantly affect our future operating results.

We operate a number of SNFs in Florida and California, which have enacted
legislation establishing minimum staffing requirements for SNFs operating in
those states. Each SNF in Florida and California must satisfy established
minimum nursing hours of direct care per resident per day. Certain other
states in which we operate SNFs 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.

Effective May 1, 2002, we adopted fresh-start reporting and our financial
statements reflect fresh-start accounting adjustments in connection with our
emergence from bankruptcy; therefore, financial information reflecting our
recent results of operations and financial condition is not comparable to prior
periods.In connection with our emergence from bankruptcy, we adopted the
provisions 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, or SOP
90-7, effective May 1, 2002. As a result, the book value of our fixed assets
and amortization schedules have changed. As a result 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.

Denial of pending change of ownership applications may have an adverse impact
on our business.In connection with our emergence from bankruptcy, we
completed a corporate restructuring program that required us to file change of
ownership applications with state governmental entities in connection with
moving certain of our SNFs within our corporate structure. If a sufficient
number of change of ownership applications are rejected by any of these
entities, it could have a material adverse impact on our financial condition
and results of operations.

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Forward-Looking Statements

Statements contained in this annual report on Form 10-K that are not historical
facts may be forward looking statements as defined in the Private Securities
Litigation Reform Act of 1995. These statements reflect our beliefs and
assumptions and are based on information currently available to us. 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. Forward-looking statements are only predictions and involve
known and unknown risks, uncertainties and other factors that may cause our
actual results, performance or achievements or industry results to be
materially different from any future results, performance or achievements
expressed or implied by the forward-looking statements.

Factors that may cause our actual results to differ materially from those
described in forward-looking statements include, but are not limited to,
changes in general economic and industry-specific business conditions or
changes in laws and regulations, tax or reimbursement rates or accounting
standards in any of our markets, as well as those described under Risk
Factors and elsewhere in this report.

Except as required by law, we disclaim any obligation to update any
forward-looking statements or to publicly announce the result of any revisions
to any of the forward-looking statements contained in this report or any
amendment to this report. We caution you not to place undue reliance on any
forward-looking statements, which speak only as of the date of this report or,
if applicable, as of the date of any amendment to this report.




ITEM 2.       PROPERTIES

As of December 31, 2002, we operated an aggregate of 297 owned, leased or
managed nursing facilities and ALFs, of which 205 were owned, mortgaged or
leased under capital leases, as indicated in the columns below. We had 83
facilities under operating leases and managed nine additional SNFs. As of
December 31, 2002, we operated an aggregate of 13 LTACs of which one was owned,
nine were subject to leases and three were managed for third parties. 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.

As of December 31, 2002 we had 14 properties whose leases were set to expire
within the next twelve months, seven of which contain renewal options.
Additionally we lease four locations for corporate and regional offices. This
includes our headquarters in Atlanta, Georgia, whose two leases are set to
expire during 2003. We are currently in negotiations with the landlord
regarding renewing a lease for our corporate headquarters. We consider our
properties to be well maintained and in suitable condition for the conduct of
our business.

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The following table provides information concerning the nursing facilities
operated by us as of December 31, 2002.

Number of FacilitiesNumber ofCapital
        
        
        
        
        
        LicensedState
        
        Owned
        
        Leased
        
        Mortgaged
        
        Leases
        
        Managed
        
        Total
        
        Beds (1)Alabama
        
        
        6
        
        
        
        
        
        
        
        
        
        
        
        1
        
        
        
        
        
        
        
        7
        
        
        
        748California
        
        
        8
        
        
        
        22
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        30
        
        
        
        3,384Colorado
        
        
        26
        
        
        
        2
        
        
        
        
        
        
        
        2
        
        
        
        
        
        
        
        30
        
        
        
        3,229Connecticut
        
        
        1
        
        
        
        
        
        
        
        1
        
        
        
        
        
        
        
        
        
        
        
        2
        
        
        
        250Florida
        
        
        16
        
        
        
        2
        
        
        
        2
        
        
        
        7
        
        
        
        
        
        
        
        27
        
        
        
        3,342Georgia
        
        
        3
        
        
        
        6
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        9
        
        
        
        1,175Illinois
        
        
        3
        
        
        
        2
        
        
        
        1
        
        
        
        
        
        
        
        2
        
        
        
        8
        
        
        
        835Louisiana
        
        
        1
        
        
        
        2
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        3
        
        
        
        683Maryland
        
        
        7
        
        
        
        1
        
        
        
        
        
        
        
        
        
        
        
        3
        
        
        
        11
        
        
        
        1,699Massachusetts
        
        
        2
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        2
        
        
        
        227Michigan
        
        
        1
        
        
        
        
        
        
        
        9
        
        
        
        
        
        
        
        
        
        
        
        10
        
        
        
        1,326Mississippi
        
        
        1
        
        
        
        9
        
        
        
        
        
        
        
        
        
        
        
        1
        
        
        
        11
        
        
        
        1,235Nebraska
        
        
        7
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        7
        
        
        
        538North Carolina
        
        
        25
        
        
        
        2
        
        
        
        3
        
        
        
        
        
        
        
        1
        
        
        
        31
        
        
        
        3,964Ohio
        
        
        1
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        1
        
        
        
        93Pennsylvania
        
        
        2
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        2
        
        
        
        205South Carolina
        
        
        3
        
        
        
        9
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        12
        
        
        
        1,521Tennessee
        
        
        2
        
        
        
        4
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        6
        
        
        
        689Texas
        
        
        51
        
        
        
        20
        
        
        
        
        
        
        
        3
        
        
        
        2
        
        
        
        76
        
        
        
        8,963Virginia
        
        
        
        
        
        
        2
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        2
        
        
        
        137West Virginia
        
        
        1
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        1
        
        
        
        186Wisconsin
        
        
        5
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        5
        
        
        
        637Wyoming
        
        
        4
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        4
        
        
        
        353Total
        
        
        176
        
        
        
        83
        
        
        
        16
        
        
        
        13
        
        
        
        9
        
        
        
        297
        
        
        
        35,419


---

(1) Managed facilities account for 1,245 licensed beds


The following table provides information concerning the LTACs operated by us as
of December 31, 2002.

Number of FacilitiesNumber ofState
        
        Owned
        
        Leased
        
        Managed
        
        Total
        
        Licensed BedsArizona
        
        
        
        
        
        
        1
        
        
        
        
        
        
        
        1
        
        
        
        34Louisiana
        
        
        1
        
        
        
        2
        
        
        
        
        
        
        
        3
        
        
        
        172Ohio
        
        
        
        
        
        
        
        
        
        
        2
        
        
        
        2
        
        
        
        75Texas
        
        
        
        
        
        
        6
        
        
        
        1
        
        
        
        7
        
        
        
        402Total
        
        
        1
        
        
        
        9
        
        
        
        3
        
        
        
        13
        
        
        
        683


22



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##### Table of Contents






ITEM 3.       LEGAL PROCEEDINGS

From time to time, we have been party to various legal proceedings in the
ordinary course of business. As is typical in the healthcare 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
healthcare industry and we in general continue to experience an increasing
trend in the frequency and severity of litigation and claims. While we believe
that we provide quality care to patients in our facilities and materially
comply with all applicable regulatory requirements, an adverse determination in
a legal proceeding or governmental investigation, whether currently asserted or
arising in the future, could have a material adverse effect on our financial
condition.

On June 11, 2001, one of our prior liability insurance carriers, 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 of the
claims falling under two PL/GL policies issued to one of our subsidiaries by
Royal. One of our prior liability insurance carriers, Northfield Insurance
Company, moved to intervene in the Royal adversary proceeding on July 25, 2001.
We did not oppose the motion to intervene, and it was subsequently 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.

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.
Other claims arise from duties that we believe the Individual Defendants
breached as officers of MHG and MPAN, Paragons successor following the MHG
acquisition. In the Fulton County action, we are seeking actual damages,
including compensatory, consequential and punitive damages in an amount to be
determined at trial. Discovery is in the early stages.

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., United States Bankruptcy
Court for the District of Delaware, Chapter 11 Case Nos. 00-00113 (MFW) and
00-00215 (MFW), Adversary Nos. 02-5604 and 02-5606. 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 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. 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, 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 No.
02-05598 (consolidated with Adversary No. 02-05599). In this enforcement
action, we generally alleged that we do not have any obligation to indemnify
the Individual Defendants. 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 moved to dismiss the Individual Defendants estoppel
counterclaim. The Individual Defendants opposed the motion, which is pending.
Discovery is in the early stages.

After we filed the Fulton County action, former members of MHGs board of
directors 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 Convalesant 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 $200.0 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. The Cobb County action is in the early stages of discovery.

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.

23



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##### Table of Contents






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

Not applicable.




PART II




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

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 shares of our 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 forCommon StockHigh
        
        Low2003First Quarter
        
        $
        6.25
        
        
        $
        2.85


High
        
        Low2002Second Quarter (from May 13, 2002)
        
        $
        14.00
        
        
        $
        12.75Third Quarter
        
        $
        13.25
        
        
        $
        7.00Fourth Quarter
        
        $
        7.75
        
        
        $
        4.10


As of March 26, 2003, there were ten 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.

24



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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, 2002.

Equity Compensation Plan Information

Number of securitiesNumber of securities
        
        
        
        remaining available forto be issued
        
        Weighted-average
        
        future issuance underupon exercise of
        
        exercise price of
        
        equity compensation plansoutstanding options,
        
        outstanding options,
        
        (excluding securitiesPlan Category
        
        warrants and rights
        
        warrants and rights
        
        reflected in column (a))Equity compensation plans approved by
security holders
        
        
        1,673,060
        
        
        $
        20.12
        
        
        
        304,962Equity compensation plans not approved by
security holders
        
        
        175,000
        
        
        
        20.12
        
        
        
        Total
        
        
        1,848,060
        
        
        $
        20.12
        
        
        
        304,962


2002 Outside Directors Stock Option Plan

On May 16, 2002, the board of directors adopted the Mariner Health Care, Inc.
2002 Outside Directors Stock Option Plan, or 2002 outside directors plan.
This plan has not been approved by our stockholders. The 2002 outside
directors plan provides us with the ability to grant each non-employee
director non-qualified stock options to purchase shares of Mariner common
stock. This plan is administered by the compensation committee of the board of
directors, and the compensation committee has the authority in its sole
discretion to interpret, grant options under, make all other determinations and
take all other actions it deems necessary or advisable for the implementation
and administration of the 2002 outside directors plan or any agreements
thereunder. The terms and conditions of each award made under the 2002 outside
directors plan are set forth in individual non-qualified stock option
agreements.

Directors who are not employees are eligible to receive options under the 2002
outside directors plan. The exercise price per share of any stock option must
be equal to the fair market value of a share of common stock at the time of
grant, provided that within the first 90 days following the consummation of the
Joint Plan, options could be granted with an exercise price equal to the
reorganization price per share even if that was less than fair market value. A
total of 175,000 shares of our common stock are reserved for issuance under the
2002 outside directors plan. Shares subject to options that expire or are
terminated are again available for grant under the plan. At December 31, 2002,
all of these options had been granted and were outstanding. Options expire at
the earlier of ten years after the date of grant or one year after the director
ceases to be a director. Options granted to outside directors were 25% vested
on the date of 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 is 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 adjust
options, as it deems appropriate, including accelerating or cutting out
options.

Recent Sales of Unregistered Securities

In connection with the effectiveness of the Joint Plan we issued the equity
securities described below in reliance on the exemption from registration
provided by Section 1145(b) of Chapter 11 of title 11 of the United States
Code. In all cases, the securities were issued in consideration of the claims
held by creditors in connection with our Chapter 11 cases.

Common Stock.An aggregate of 20.0 million shares of our common stock were
issued to the classes of creditors described in our Current Report on Form 8-K
filed with the SEC on April 17, 2002.

Warrants.Warrants to purchase an aggregate of 753,786 shares of our common
stock were issued to the classes of creditors described in our Current Report
on Form 8-K filed with the SEC on April 17, 2002. The initial exercise price
of the warrants was $28.04. The exercise period for the warrants began on May
13, 2002 and expires on the second anniversary of the issuance of the warrants.
The terms governing the warrants are set forth in a Warrant Agreement, dated
as of May 13, 2002, between us and American Stock Transfer and Trust Company,
as Warrant Agent, filed as Exhibit 4.1 to our Quarterly Report on From 10-Q for
the quarterly period ended March 31, 2002.

25



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##### Table of Contents









ITEM 6.       SELECTED FINANCIAL DATA

Upon emergence from Chapter 11 proceedings, we adopted fresh-start reporting in
accordance with SOP 90-7. In connection with our adoption of fresh-start
reporting, our reorganization value has been 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 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, 2002 is
labeled Reorganized Company and reflects the effect of our Joint Plan and the
associated adjustments. Additionally, the consolidated statement of operations
data appearing for the eight months ended December 31, 2002 relates to a period
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 generally
accepted accounting principles and is presented solely for convenience
purposes, as certain items are compared and discussed in the section entitled
Managements Discussion and Analysis of Financial Condition and Results of
Operations.

You should read the following selected financial data in conjunction with the
section entitled Managements Discussion and Analysis of Financial Condition
and Results of Operations, and the financial statements and the notes to those
statements appearing elsewhere in this report. The following selected
financial data for the Reorganized Company for the eight months ended December
31, 2002 and for the Predecessor Company for the four months ended April 30,
2002 and the three-months ended December 31, 2001 was prepared using the
consolidated financial statements that appear elsewhere in this report. The
selected financial data for the three months ended December 31, 2000 was
prepared using our consolidated financial statements included in the
Predecessor Companys publicly filed documents.

A black line has been drawn between the accompanying 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.

26



---



##### Table of Contents



CombinedPredecessorCompany andReorganized
        
        ReorganizedCompany
        
        Company
        

        
        Predecessor CompanyTwelve Months
        
        Eight Months
        

        
        Four Months
        
        Three Months
        
        Three MonthsEnded
        
        Ended
        

        
        Ended
        
        Ended
        
        EndedDecember 31,
        
        December 31,
        

        
        April 30,
        
        December 31,
        
        December 31,2002
        
        2002
        

        
        2002
        
        2001
        
        2000Statement of Operations DataNet revenue
        
        $
        1,785,094
        
        
        $
        1,183,657
        
        

        
        $
        601,437
        
        
        $
        458,151
        
        
        $
        470,348Total costs and expenses
        
        
        1,809,449
        
        
        
        1,218,944
        
        

        
        
        590,505
        
        
        
        440,615
        
        
        
        450,687Operating (loss) income
        
        
        (24,355
        )
        
        
        (35,287
        )
        

        
        
        10,932
        
        
        
        17,536
        
        
        
        19,661Other income (expenses)
        
        
        1,371,924
        
        
        
        (22,017
        )
        

        
        
        1,393,941
        
        
        
        (14,039
        )
        
        
        (10,133
        )Income (loss) from continuing operations
before income taxes
        
        
        1,347,569
        
        
        
        (57,304
        )
        

        
        
        1,404,873
        
        
        
        3,497
        
        
        
        9,528Provision for income taxes
        
        
        1,010
        
        
        
        1,010
        
        

        
        
        
        
        
        
        
        
        
        
        Income (loss) from continuing operations
        
        
        1,346,559
        
        
        
        (58,314
        )
        

        
        
        1,404,873
        
        
        
        3,497
        
        
        
        9,528Discontinued operations
        
        
        29,082
        
        
        
        
        
        

        
        
        29,082
        
        
        
        898
        
        
        
        382Net income (loss)
        
        $
        1,375,641
        
        
        $
        (58,314
        )
        

        
        $
        1,433,955
        
        
        $
        4,395
        
        
        $
        9,910Earnings (loss) per shareBasic and dilutedIncome (loss) from continuing operations
        
        $
        67.33
        
        
        $
        (2.92
        )
        

        
        $
        19.07
        
        
        $
        0.05
        
        
        $
        0.13Discontinued operations
        
        
        1.45
        
        
        
        
        
        

        
        
        0.39
        
        
        
        0.01
        
        
        
        Net income (loss) per share
        
        $
        68.78
        
        
        $
        (2.92
        )
        

        
        $
        19.46
        
        
        $
        0.06
        
        
        $
        0.13Shares used in computing earnings (loss) per shareBasic and diluted
        
        
        20,000
        
        
        
        20,000
        
        

        
        
        73,688
        
        
        
        73,688
        
        
        
        73,688Operating StatisticsNumber of facilities (end of period)
        
        
        297
        
        
        
        297
        
        

        
        
        304
        
        
        
        317
        
        
        
        364Average occupancy rate
        
        
        86.1
        %
        
        
        86.1
        %
        

        
        
        86.2
        %
        
        
        88.5
        %
        
        
        86.6
        %Revenue by payor sourceMedicaid
        
        
        48.3
        %
        
        
        48.5
        %
        

        
        
        47.7
        %
        
        
        48.9
        %
        
        
        50.7
        %Medicare
        
        
        33.5
        %
        
        
        33.0
        %
        

        
        
        34.5
        %
        
        
        33.0
        %
        
        
        27.7
        %Private and other
        
        
        18.2
        %
        
        
        18.5
        %
        

        
        
        17.8
        %
        
        
        18.1
        %
        
        
        21.6
        %


27



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##### Table of Contents



The following selected financial data
for the fiscal years ended September 30, 2001 and 2000 and the
balance sheet data as of December 31, 2002, December 31, 2001 and September 30, 2001
were derived from our consolidated financial statements and the related notes
included elsewhere in this report. The selected financial data for the
remaining periods was prepared using our consolidated financial statements
included in the Predecessor Companys publicly filed documents. The 1998
financial information gives effect to the mergers involving LCA and GranCare
effective November 1, 1997 and the merger between the resulting entity and MHG
effective July 31, 1998.

Predecessor CompanyFiscal Year Ended September 30,2001
        
        2000
        
        1999
        
        1998Statement of Operations DataNet revenue
        
        $
        1,872,135
        
        
        $
        1,879,307
        
        
        $
        1,990,863
        
        
        $
        1,802,203Total costs and expenses
        
        
        1,863,657
        
        
        
        1,885,867
        
        
        
        3,414,448
        
        
        
        1,921,464Operating income (loss)
        
        
        8,478
        
        
        
        (6,560
        )
        
        
        (1,423,585
        )
        
        
        (119,261
        )Other income (expenses)
        
        
        (47,347
        )
        
        
        (69,094
        )
        
        
        (194,401
        )
        
        
        (114,609
        )Loss from continuing operations
before income taxes
        
        
        (38,869
        )
        
        
        (75,654
        )
        
        
        (1,617,986
        )
        
        
        (233,870
        )Benefit for income taxes
        
        
        (4,807
        )
        
        
        (19,374
        )
        
        
        
        
        
        
        (10,686
        )Loss from continuing operations
        
        
        (34,062
        )
        
        
        (56,280
        )
        
        
        (1,617,986
        )
        
        
        (223,184
        )Discontinued operations
        
        
        667
        
        
        
        (2,705
        )
        
        
        (160,296
        )
        
        
        24,807Loss before extraordinary loss
        
        
        (33,395
        )
        
        
        (58,985
        )
        
        
        (1,778,282
        )
        
        
        (198,377
        )Extraordinary loss on early extinguishment of
debt, net of $6,034 income tax benefit
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        (11,275
        )Net loss
        
        $
        (33,395
        )
        
        $
        (58,985
        )
        
        $
        (1,778,282
        )
        
        $
        (209,652
        )Earnings (loss) per shareBasic and dilutedLoss from continuing operations
        
        $
        (0.46
        )
        
        $
        (0.76
        )
        
        $
        (22.03
        )
        
        $
        (4.59
        )Discontinued operations
        
        
        0.01
        
        
        
        (0.04
        )
        
        
        (2.18
        )
        
        
        0.51Extraordinary loss
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        (0.23
        )Net loss
        
        $
        (0.45
        )
        
        $
        (0.80
        )
        
        $
        (24.21
        )
        
        $
        (4.31
        )Shares used in computing loss per shareBasic and diluted
        
        
        73,688
        
        
        
        73,688
        
        
        
        73,459
        
        
        
        48,601Operating StatisticsNumber of facilities (end of period)
        
        
        326
        
        
        
        364
        
        
        
        413
        
        
        
        428Average occupancy rate
        
        
        87.4
        %
        
        
        86.1
        %
        
        
        85.4
        %
        
        
        84.1
        %Revenue by payor sourceMedicaid
        
        
        49.3
        %
        
        
        50.9
        %
        
        
        46.9
        %
        
        
        42.1
        %Medicare
        
        
        30.2
        %
        
        
        27.4
        %
        
        
        27.5
        %
        
        
        30.7
        %Private and other
        
        
        20.5
        %
        
        
        21.7
        %
        
        
        25.6
        %
        
        
        27.2
        %


Reorganized
        

        
        
        Predecessor CompanyCompanySeptember 30,December 31,
        


        
        December 31,2002
        


        
        2001
        
        2001
        
        2000
        
        1999
        
        1998Balance Sheet DataCash and cash equivalents
        
        $
        38,618
        
        

        
        $
        213,740
        
        
        $
        209,050
        
        
        $
        170,468
        
        
        $
        71,817
        
        
        $
        3,314Receivables
        
        
        264,092
        
        

        
        
        238,736
        
        
        
        241,860
        
        
        
        246,695
        
        
        
        307,571
        
        
        
        617,380Property and equipment, net
        
        
        567,260
        
        

        
        
        412,965
        
        
        
        416,026
        
        
        
        439,044
        
        
        
        459,553
        
        
        
        927,153Working capital
        
        
        116,566
        
        

        
        
        347,641
        
        
        
        334,444
        
        
        
        331,711
        
        
        
        (1,829,065
        )
        
        
        484,879Total assets
        
        
        1,178,738
        
        

        
        
        1,222,355
        
        
        
        1,230,978
        
        
        
        1,247,635
        
        
        
        977,728
        
        
        
        3,033,915Long-term debt,
including current
portion (1)
        
        
        484,762
        
        

        
        
        2,112,418
        
        
        
        2,116,755
        
        
        
        2,147,756
        
        
        
        2,146,434
        
        
        
        2,022,480Stockholders equity
(deficit)
        
        
        268,395
        
        

        
        
        (1,467,260
        )
        
        
        (1,471,509
        )
        
        
        (1,440,177
        )
        
        
        (1,386,019
        )
        
        
        397,014Total capitalization
        
        
        753,157
        
        

        
        
        645,158
        
        
        
        645,246
        
        
        
        707,579
        
        
        
        760,415
        
        
        
        2,419,494




---

|(1) |  | Long-term debt, including current portion, included approximately
$2,052,730 and $2,057,067 classified 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.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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


Overview

We are one of the largest providers of long-term healthcare services in the
United States. As of December 31, 2002, we operated 297 owned, leased or
managed facilities in 23 states, including 289 SNFs and eight stand alone ALFs
and apartments, with 35,419 licensed beds, as well as 13 LTACs in four states
with 683 licensed beds. Included in the total number of SNFs are nine managed
SNFs with 1,245 licensed beds. As of December 31, 2002, we owned 192 of our
facilities, and 13 of our facilities were leased under capital leases.

Inpatient services provided at our SNFs, ALFs and rehabilitation hospitals are
our primary service offering and have historically accounted for over 90% of
our revenue and cash flows. Through our SNFs, 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.

On January 6, 2002, we completed the sale of our institutional pharmacy
services business, or the APS Division, to Omnicare, Inc. During the quarter
ended December 31, 2001, we 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. 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, subject to adjustments as provided in the purchase agreement, and up
to $18.0 million in future payments, depending upon post-closing operating
results of the APS Division. For this reason, the APS Division has been
reflected as a discontinued operation.

Reorganization

On the Petition Date, we filed voluntary petitions for relief in the Bankruptcy
Court under Chapter 11 of the Bankruptcy Code, thus commencing our Chapter 11
cases. On the Effective Date, we emerged from proceedings under the Bankruptcy
Code under the terms of our Joint Plan. In connection with our emergence from
bankruptcy, we changed our name to Mariner Health Care, Inc.

On the Effective Date, and in connection with the consummation of our Joint
Plan, we entered into the Senior Credit Facility, which provided funds to
satisfy specified obligations to our creditors under the Joint Plan and
provides funds for general working capital purposes and permitted acquisitions.
We also issued the Second Priority Notes to our senior secured creditors in
the Chapter 11 cases.

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. These financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of financial statements in conformity with
accounting principles generally accepted in the United States 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.

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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. 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. The statement requires a segregation of
liabilities subject to compromise by the Bankruptcy Court as of the Petition
Date and identification of all transactions and events that are directly
associated with our reorganization. Pursuant to SOP 90-7, prepetition
liabilities are reported on the basis of the expected amounts of such allowed
claims, as opposed to the amounts for which those claims may be settled. Under
our Joint Plan, we settled those claims at amounts substantially less than
their allowed amounts.

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. For accounting purposes,
the adjustments for fresh-start reporting have been recorded in the
accompanying consolidated financial statements as of May 1, 2002. 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 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.

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
prepetition contractual agreements and historical costs are 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 prepetition 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 SFAS 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 statement 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 approximately $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.

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Critical Accounting Policies and Estimates

General.We believe the following critical accounting policies affect the more
significant judgments and estimates used in the preparation of our consolidated
financial statements.

Revenue Recognition.We have agreements with third-party payors that provide
for payments to our SNFs. 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 at least a
possibility that recorded estimates may change by a material amount.
Consistent with healthcare 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.

Collectibility of Accounts Receivable.Accounts receivable consist primarily
of amounts due from the Medicare and Medicaid programs, other government
programs, managed care health plans, commercial insurance companies and
individual patients. Estimated provisions for doubtful accounts are recorded
to the extent it is probable that a portion or all of a particular account will
not be collected. In evaluating the collectibility of accounts receivable, we
consider a number of factors, including the age of the accounts, changes in
collection patterns, the composition of patient accounts by payor type, the
status of ongoing disputes with third-party payors and general industry
conditions. Changes in these estimates are charged or credited to the results
of operations in the period of the change. If circumstances change (including,
but not limited to: economic downturn; higher than expected defaults or
denials; reduced collections; and change in our payor mix), our estimates of
the recoverability of our receivables could be reduced by a material amount.
Our provision for bad debts represented 1.7%, 1.7%, 1.5% and 1.6% of net
revenue for the twelve months ended December 31, 2002, the three months ended
December 31, 2001 and the fiscal years ended September 30, 2001 and 2000,
respectively. Our allowance for doubtful accounts represented 21.7%, 20.4% and
18.1% of accounts receivable at December 31, 2002, December 31, 2001 and
September 30, 2001, respectively.

Insurance and Professional Liability Risks.We currently purchase PL/GL
insurance through a third-party insurance company, maintaining an unaggregated
$1.0 million self-insured retention per claim, except in Colorado, where we
maintain first dollar coverage. Loss provisions for professional liability
risks, including incurred but not reported losses, are provided on an
undiscounted basis in the period of the related coverage. These provisions are
based on internal and external evaluations of the merits of individual claims,
analysis of claim history and independent actuarially determined estimates.
The methods of making these estimates and establishing the resulting accrued
liabilities are reviewed frequently by management with any material adjustments
resulting from that review reflected in current earnings. Although management
believes that the current provision for loss is adequate, the ultimate
liability may be in excess of or less than the amounts recorded.

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 bases 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 SNFs 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 reliazability of the deferred tax assets is
uncertain.

If all or a portion of the pre-reorganization 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.

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Impairment of Property and Equipment.We review the carrying value of property
and equipment 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. We also review the
carrying value of property and equipment when the carrying value of related
long-lived intangible assets are reviewed. If the estimated future
undiscounted cash flows exceed the carrying value of the assets, the carrying
value is reduced to the fair value.

In 2002 we retained an independent expert 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. Accordingly, we recognized an impairment
charge relating to our long-lived assets in the fourth quarter of the twelve
months ended December 31, 2002.

Impairment of Reorganization Value in Excess of Amounts Allocable to
Identifiable Assets.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 for impairment at least annually or more frequently if events or changes
in circumstances indicate the asset might be impaired. We performed the test
for impairment in the fourth quarter of the twelve months ended December 31,
2002 and engaged an independent expert to assist in the analysis to determine
if there was any impairment related to excess reorganization value. This
analysis indicated that the excess reorganization value was impaired by $57.3
million. Accordingly, we recorded an impairment charge of $57.3 million
relating to its excess reorganization value during the fourth quarter of the
twelve months ended December 31, 2002.

Derivative Market Value.We have non-recourse indebtedness of a subsidiary
that includes an option to allow us to extend the term on the loan. This
term-extending option meets the definition of an embedded derivative instrument
according to the provisions of SFAS No.133, Accounting for Derivative
Instruments and Hedging Activities. Therefore, this derivative is accounted
for as a purchased option, or more specifically a payer swaption. Fair value
of the payer swaption should increase if interest rates rise because the
probability of exercising this option at a future date increases. The payer
swaption has been bifurcated from the related debt and recorded as an asset at
its estimated fair market value of $3.2 million as of December 31, 2002.

An estimate of the fair value was determined using the Black model. The Black
model is similar to the Black-Scholes model used for valuing stock options.
This market value calculation is very sensitive to changes in interest rates
and the estimate of the volatility of interest rates. An increase in these
variables, with other variables held constant, will cause the value of the
payer swaption to increase. Prior to maturity of the debt, at the option of
Professional Health Care Management, Inc, or PHCMI, the debtor and a
wholly-owned subsidiary of the Company, between February 1, 2005 and July 31,
2005, the debt can be prepaid. In the event the debt is prepaid, the payer
swaption will become worthless and we will recognize an expense for the current
market value.

Recent Accounting Pronouncements

In January 2003, the Financial Accounting Standards Board, or FASB, issued FASB
Interpretation No. 46, Consolidation of Variable Interest Entities. This
Interpretation provides guidance with respect to the identification of variable
interest entities and when the assets, liabilities, noncontrolling interests
and results of operations of a variable interest entity need to be included in
a companys consolidated financial statements. This Interpretation is not
expected to have a significant impact our financial position, results of
operations or cash flows.

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In December 2002, FASB issued Statement of Financial Accounting Standards, or
SFAS, No. 148, Accounting for Stock-Based Compensation  Transition and
Disclosure, an Amendment of SFAS No. 123, or SFAS No. 148. SFAS No. 148
provides alternative methods of transition for an entity that voluntarily
changes to the fair value based method of accounting for stock-based employee
compensation. The provisions of this Statement were effective December 31,
2002. Management currently intends to continue to account for stock-based
compensation under the intrinsic value method set forth in Accounting
Principles Board, or APB, Opinion 25 Accounting for Stock Issued to
Employees, or APB 25, and related interpretations. For this reason, the
transition guidance of SFAS No. 148 does not have an impact on our financial
position or results of operations. This Statement does amend existing guidance
with respect to required disclosures, regardless of the method of accounting
used. The revised disclosure requirements are presented in the notes to our
financial statements included elsewhere in this report.

In November 2002, FASB issued FASB Interpretation No. 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others. This Interpretation 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. The disclosure
requirements of this Interpretation are effective and were adopted by us as of
December 31, 2002, and require disclosure of the nature of any guarantee, the
maximum potential amount of future payments that the guarantor could be
required o make under the guarantee and the current amount of the liability, if
any, for the guarantors obligations under the guarantee. The recognition
requirements of this Interpretation were effective beginning January 1, 2003.
This Interpretation is not expected to have a significant impact on our
financial position, results of operations or cash flows.

In July 2002, FASB issued SFAS No. 146 Accounting for Costs Associated with
Exit or Disposal Activities, or SFAS No. 146. This statement replaces
Emerging Issues Task Force Issue No. 94-3 Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity. This
Statement requires the recognition of costs associated with exit or disposal
activities when they are incurred rather than at the date of a commitment to an
exit or disposal plan. SFAS No. 146 is to be applied prospectively to exit or
disposal activities initiated after December 31, 2002 with early adoption
encouraged. We adopted SFAS No. 146 on May 1, 2002 in connection with our
adoption of fresh-start reporting and its adoption did not have a significant
material impact on our consolidated financial position, results of operations
or cash flows.

In April 2002, FASB issued SFAS No. 145, Rescission of FASB Statements No. 4,
44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections, or
SFAS No. 145. This Statement rescinds SFAS No. 4 Reporting Gains and Losses
from Extinguishment of Debt, or SFAS No. 4, resulting in the criteria in APB
Opinion No. 30 being used to classify gains and losses from extinguishment of
debt. SFAS No. 64, Extinguishment of Debt Made to Satisfy Sinking-Fund
Requirements, or SFAS No. 64, amended SFAS No. 4, which is, therefore, no
longer necessary. SFAS No. 44, Accounting for Intangible Assets of Motor
Carriers, or SFAS No. 44, was issued to establish accounting requirements for
the effects of transition to the provisions of the Motor Carrier Act of 1980.
Because the transition has been completed, this Statement is no longer
necessary. SFAS No. 145 amended SFAS No. 13, Accounting for Leases, or SFAS
No. 13, to require that certain lease modifications that have economic effects
similar to sale-leaseback transactions be accounted for in the same manner as
sale-leaseback transactions. The provisions of SFAS No. 145 related to SFAS
No. 13 are effective for transactions occurring after May 15, 2002. All other
provisions of SFAS No. 145 are effective for financial statements issued on or
after May 15, 2002 with early adoption encouraged. We adopted SFAS No. 145 on
May 1, 2002 in connection with our adoption of fresh-start reporting and,
accordingly, have presented the reorganization and restructuring of our debt in
connection with the terms of our Joint Plan as a reorganization item.

In July 2001, FASB issued SFAS No. 142, Goodwill and Other Intangible Assets,
or SFAS No. 142, which established new rules on the accounting for goodwill and
other intangible assets. Under SFAS No. 142, goodwill and intangible assets
with indefinite lives will no longer be amortized; however, they will be
subject to annual impairment tests as prescribed by the Statement. The
impairment test for the excess reorganization value recorded in connection with
our fresh-start reporting was performed during the quarter ending December 31,
2002. Intangible assets with definite lives will continue to be amortized over
their estimated useful lives. The amortization provisions of SFAS No. 142
apply immediately to goodwill and intangible assets acquired after June 30,
2001. With respect to goodwill and intangible assets acquired prior to July 1,
2001, companies are required to adopt SFAS No. 142 for fiscal years beginning
after December 15, 2001.

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##### Table of Contents



In accordance with our adoption of SFAS No. 142, we discontinued amortizing
goodwill effective January 1, 2002. The following table illustrates the impact
on our earnings 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
        )


In June 2001, FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations, which addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and
the associated asset retirement costs. We will adopt this accounting standard
on January 1, 2003 and it is not expected to have a material impact
on our financial position, results of operations or cash flows.

In October 2001, FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long Lived Assets, or SFAS No. 144. Companies are required to
adopt SFAS No. 144 in their fiscal year beginning after December 15, 2001. SFAS
No. 144 changes the criteria that would have to be met to classify an asset as
held-for-sale, revises the rules regarding reporting the effects of a disposal
of a segment of a business and requires expected future operating losses from
discontinued operations to be displayed in discontinued operations in the
period(s) in which the losses were incurred. We adopted this accounting
standard as required on January 1, 2002 and it did not have a material impact on our financial position, results of operations or cash flows.

Occupancy Data

We calculate aggregate occupancy percentages for all of our nursing facilities
by dividing the total number of beds occupied by the total number of licensed
beds available for use during the periods indicated. Licensed beds refer to
the number of beds for which a license has been issued, which may vary in some
instances from licensed beds available for use. The average occupancy rate for
our SNFs was 86.1% for the twelve months ended December 31, 2002, 88.5% for the
three months ended December 31, 2001 and 87.4% and 86.1% for the fiscal years
ended September 30, 2001 and 2000, respectively. We do not believe there is a
consistent industry standard as to how occupancy is measured; for this reason,
the information presented may not be comparable to other long-term care
providers. Occupancy percentages should not be relied upon alone to determine
the profitability of a facility. Other factors affecting profitability include
the sources of payment, terms of reimbursement and the acuity levels for the
patients in the facilities. The following table provides certain occupancy
data for our nursing facilities as of the dates indicated.

Reorganized Company
        

        
        Predecessor CompanyTwelve Months
        
        Eight Months
        

        
        Four Months
        
        Three Months
        
        Fiscal Year EndedEnded
        
        Ended
        

        
        Ended
        
        Ended
        
        September 30,December 31,
        
        December 31,
        

        
        April 30,
        
        December 30,2002
        
        2002
        

        
        2002
        
        2001
        
        2001
        
        2000Total average residents
        
        
        30,514
        
        
        
        30,149
        
        

        
        
        31,243
        
        
        
        32,638
        
        
        
        35,047
        
        
        
        39,099Weighted average licensed beds
available for use
        
        
        35,434
        
        
        
        35,032
        
        

        
        
        36,239
        
        
        
        36,876
        
        
        
        40,105
        
        
        
        45,389Weighted average occupancy
        
        
        86.1
        %
        
        
        86.1
        %
        

        
        
        86.2
        %
        
        
        88.5
        %
        
        
        87.4
        %
        
        
        86.1
        %


The average occupancy rate for our LTACs was 80.1% for the year ended December 31, 2002, 78.2% for the three months ended December 31, 2001 and 82.0% for the fiscal year ended September 30, 2001.

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Sources of Revenue

Reimbursement rates from government sponsored programs, such as Medicare and Medicaid, are strictly regulated and subject to funding appropriations from federal and state governments. Ongoing efforts of third-party payors to contain healthcare costs by limiting reimbursement rates, increasing case management review and negotiating reduced contract pricing continue to affect our revenue and profitability. Changes in reimbursement rates, including the implementation of PPS, have
 adversely affected us, resulting in significantly lower Medicare revenue than we would have received under the previous cost-based payment methodology.

Revenue from nursing home services is a function of occupancy rates, payor mix, and acuity levels for the patients in the facilities. The following table provides the approximate percentage of our net patient revenue derived from the various sources of payment for the periods indicated.

Reorganized Company
        

        
        Predecessor CompanyTwelve Months
        
        Eight Months
        

        
        Four Months
        
        Three Months
        
        Fiscal Year EndedEnded
        
        Ended
        

        
        Ended
        
        Ended
        
        September 30,December 31,
        
        December 31,
        

        
        April 30,
        
        December 30,2002
        
        2002
        

        
        2002
        
        2001
        
        2001
        
        2000Medicaid
        
        
        48.3
        %
        
        
        48.5
        %
        

        
        
        47.7
        %
        
        
        48.9
        %
        
        
        49.3
        %
        
        
        50.9
        %Medicare
        
        
        33.5
        %
        
        
        33.0
        %
        

        
        
        34.5
        %
        
        
        33.0
        %
        
        
        30.2
        %
        
        
        27.4
        %Private and other
        
        
        18.2
        %
        
        
        18.5
        %
        

        
        
        17.8
        %
        
        
        18.1
        %
        
        
        20.5
        %
        
        
        21.7
        %


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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 table below.

|                                                             |  |                                                                   |           |               |           |              |           |   |           |                     |  |              |           |              |           |                                 |         |      |         |   |         |  |         |   |           |   |           |   |           |   |           |  
|------------------------------------------------------------ |  | ----------------------------------------------------------------- | --------- | ------------- | --------- | ------------ | --------- | - | --------- | ------------------- |  | ------------ | --------- | ------------ | --------- | ------------------------------- | ------- | ---- | ------- | - | ------- |  | ------- | - | --------- | - | --------- | - | --------- | - | --------- | -
|                                                             |  |                                                                   |           | Combined      |           |              |           |   |           |                     |  |              |           |              |           |                                 |         |      |         |   |         |  |         |   |           |   |           |   |           |  
|                                                             |  |                                                                   |           | Predecessor   |           |              |           |   |           |                     |  |              |           |              |           |                                 |         |      |         |   |         |  |         |   |           |   |           |   |           |  
|                                                             |  |                                                                   |           | Company and   |           |              |           |   |           |                     |  |              |           |              |           |                                 |         |      |         |   |         |  |         |   |           |   |           |   |           |  
|                                                             |  |                                                                   |           | Reorganized   |           | Reorganized  |           |   |           |                     |  |              |           |              |           |                                 |         |      |         |   |         |  |         |   |           |   |           |  
|                                                             |  |                                                                   |           | Company       |           | Company      |           |   |           | Predecessor Company
|                                                             |  |                                                                   |           |               |           |              |           |   |           |                    
|                                                             |  |                                                                   |           | Twelve Months |           | Eight Months |           |   |           | Four Months         |  | Three Months |           | Three Months |           |                                 |         |      |         |   |         | 
|                                                             |  |                                                                   |           | Ended         |           | Ended        |           |   |           | Ended               |  | Ended        |           | Ended        |           | Fiscal Year Ended September 30,
|                                                             |  |                                                                   |           | December 31,  |           | December 31, |           |   |           | April 30,           |  | December 31, |           | December 31, |           |                                
|                                                             |  |                                                                   |           | 2002          |           | 2002         |           |   |           | 2002                |  | 2001         |           | 2000         |           | 2001                            |         | 2000
|                                                             |  |                                                                   |           |               |           |              |           |   |           |                     |  |              |           |              |           |                                 |         |     
|Net revenue                                                  |  | $                                                                 | 1,785,094 |               |           | $            | 1,183,657 |   |           |                     |  | $            | 601,437   |              |           | $                               | 458,151 |      |         | $ | 470,348 |  |         | $ | 1,872,135 |   |           | $ | 1,879,307 |  
|Costs and expenses                                           |  |                                                                   |           |               |           |              |           |   |           |                     |  |              |           |              |           |                                 |         |      |         |   |         |  |         |   |           |   |           |   |           |  
|                                                             |  | Operating expenses                                                |           |               | 1,512,802 |              |           |   | 990,027   |                     |  |              |           |              | 522,775   |                                 |         |      | 386,848 |   |         |  | 391,477 |   |           |   | 1,587,892 |   |           |   | 1,596,710 |  
|                                                             |  | General and administrative                                        |           |               | 177,162   |              |           |   | 121,165   |                     |  |              |           |              | 55,997    |                                 |         |      | 42,721  |   |         |  | 47,846  |   |           |   | 192,956   |   |           |   | 220,509   |  
|                                                             |  | Depreciation and amortization                                     |           |               | 34,885    |              |           |   | 23,152    |                     |  |              |           |              | 11,733    |                                 |         |      | 11,046  |   |         |  | 11,364  |   |           |   | 49,399    |   |           |   | 49,235    |  
|                                                             |  | Impairment of long-lived assets                                   |           |               | 84,600    |              |           |   | 84,600    |                     |  |              |           |              |          |                                 |         |      |        |   |         |  |        |   |           |   |          |   |           |   | 19,413    |  
|                                                             |  | Loss on settlement with government                                |           |               |          |              |           |   |          |                     |  |              |           |              |          |                                 |         |      |        |   |         |  |        |   |           |   | 33,410    |   |           |   |          |  
|                                                             |  |                                                                   |           |               |           |              |           |   |           |                     |  |              |           |              |           |                                 |         |      |         |   |         |  |         |   |           |   |           |   |           |  
|                                                             |  | Total costs and expenses                                          |           |               | 1,809,449 |              |           |   | 1,218,944 |                     |  |              |           |              | 590,505   |                                 |         |      | 440,615 |   |         |  | 450,687 |   |           |   | 1,863,657 |   |           |   | 1,885,867 |  
|                                                             |  |                                                                   |           |               |           |              |           |   |           |                     |  |              |           |              |           |                                 |         |      |         |   |         |  |         |   |           |   |           |   |           |  
|Operating (loss) income                                      |  |                                                                   | (24,355   | )             |           |              | (35,287   | ) |           |                     |  |              | 10,932    |              |           |                                 | 17,536  |      |         |   | 19,661  |  |         |   | 8,478     |   |           |   | (6,560    | )
|Other income (expenses)                                      |  |                                                                   |           |               |           |              |           |   |           |                     |  |              |           |              |           |                                 |         |      |         |   |         |  |         |   |           |   |           |   |           |  
|                                                             |  | Interest expense                                                  |           |               | (30,183   | )            |           |   | (27,166   | )                   |  |              |           |              | (3,017    | )                               |         |      | (3,474  | ) |         |  | (3,209  | ) |           |   | (5,171    | ) |           |   | (71,905   | )
|                                                             |  | Interest income                                                   |           |               | 6,639     |              |           |   | 5,485     |                     |  |              |           |              | 1,154     |                                 |         |      | 2,603   |   |         |  | 2,465   |   |           |   | 6,007     |   |           |   | 11,366    |  
|                                                             |  | Reorganization items                                              |           |               | 1,394,309 |              |           |   |          |                     |  |              |           |              | 1,394,309 |                                 |         |      | (13,153 | ) |         |  | (8,102  | ) |           |   | (47,721   | ) |           |   | (10,816   | )
|                                                             |  | Other                                                             |           |               | 1,159     |              |           |   | (336      | )                   |  |              |           |              | 1,495     |                                 |         |      | (15     | ) |         |  | (1,287  | ) |           |   | (462      | ) |           |   | 2,261     |  
|                                                             |  |                                                                   |           |               |           |              |           |   |           |                     |  |              |           |              |           |                                 |         |      |         |   |         |  |         |   |           |   |           |   |           |  
|(Loss) income from continuing operations before income
taxes |  |                                                                   | 1,347,569 |               |           |              | (57,304   | ) |           |                     |  |              | 1,404,873 |              |           |                                 | 3,497   |      |         |   | 9,528   |  |         |   | (38,869   | ) |           |   | (75,654   | )
|Provision (benefit) for income taxes                         |  |                                                                   | 1,010     |               |           |              | 1,010     |   |           |                     |  |              |          |              |           |                                 |        |      |         |   |        |  |         |   | (4,807    | ) |           |   | (19,374   | )
|                                                             |  |                                                                   |           |               |           |              |           |   |           |                     |  |              |           |              |           |                                 |         |      |         |   |         |  |         |   |           |   |           |   |           |  
|(Loss) income from continuing operations                     |  |                                                                   | 1,346,559 |               |           |              | (58,314   | ) |           |                     |  |              | 1,404,873 |              |           |                                 | 3,497   |      |         |   | 9,528   |  |         |   | (34,062   | ) |           |   | (56,280   | )
|Discontinued operations                                      |  |                                                                   |           |               |           |              |           |   |           |                     |  |              |           |              |           |                                 |         |      |         |   |         |  |         |   |           |   |           |   |           |  
|                                                             |  | Income (loss) from operations of discontinued
pharmacy operations |           |               |          |              |           |   |          |                     |  |              |           |              |          |                                 |         |      | 898     |   |         |  | 382     |   |           |   | 667       |   |           |   | (2,705    | )
|                                                             |  | Gain on sale of discontinued
pharmacy operations                  |           |               | 29,082    |              |           |   |          |                     |  |              |           |              | 29,082    |                                 |         |      |        |   |         |  |        |   |           |   |          |   |           |   |          |  
|                                                             |  |                                                                   |           |               |           |              |           |   |           |                     |  |              |           |              |           |                                 |         |      |         |   |         |  |         |   |           |   |           |   |           |  
|Net (loss) income                                            |  | $                                                                 | 1,375,641 |               |           | $            | (58,314   | ) |           |                     |  | $            | 1,433,955 |              |           | $                               | 4,395   |      |         | $ | 9,910   |  |         | $ | (33,395   | ) |           | $ | (58,985   | )
|                                                             |  |                                                                   |           |               |           |              |           |   |           |                     |  |              |           |              |           |                                 |         |      |         |   |         |  |         |   |           |   |           |   |           |  

Combined Reorganized Company and Predecessor Company Fiscal Year Ended December 31, 2002
Compared to the Predecessor Company Fiscal Year Ended September 30, 2001

Net Revenue.Net revenue totaled $1,785.1 million for the twelve months ended
December 31, 2002, a decrease of $87.0 million, or 4.6%, compared to the fiscal
year ended September 30, 2001. After adjusting for the effect of the 77
facilities that were divested from October 1, 2000 until December 31, 2002, net
revenue increased $107.3 million, or 6.6%, in the twelve months ended December
31, 2002 compared to the fiscal year ended September 30, 2001.

Net revenue from nursing home services accounted
for $1,671.6 million, or
93.6%, of total net revenue for the twelve months ended December 31, 2002
compared to $1,759.9 million, or 94.0%, of total net revenue for the fiscal
year ended September 30, 2001. Revenue from nursing home services was derived
from the provision of routine and ancillary services and is a function of
occupancy rates and payor mix.

Net revenue from nursing home services provided by our nursing facilities
decreased $88.3 million, or 5.0%, however, net revenue of our nursing homes,
excluding facilities that were divested, increased by $106.1 million, or 7.0%,
to $1,614.1 million for the twelve months ended December 31, 2002 compared to
$1,508.0 million for the fiscal year ended September 30, 2001. This increase
was the result of an average increase in revenue per patient day of $10.66, or
7.75%, partially offset by a slight decrease in the total number of patient
days.

Medicare reimbursement as a percentage of our total revenue increased by 10.9%
and comprised 33.5% of the total payor mix in the twelve months ended December
31, 2002. Medicare reimbursement accounted for 30.2% of our total revenue in
the fiscal year ended September 30, 2001.

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Increases in the Medicaid reimbursement rate of approximately 6% in the twelve
months ended December 31, 2002 and semiannual revenue increases of
approximately 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 to several state Medicaid programs for the final
settlement of the amount to be reimbursed to these payors in the three months
ended December 31, 2002.

These increases in revenue were partially offset by a $8.8 million decrease in
revenue in the fourth quarter of the twelve months ended December 31, 2002 due
to the impact of the Medicare Reimbursement Cliff. We estimate that the impact
of the Medicare Reimbursement Cliff could result in a loss of revenue and
operating income of up to approximately $37.0 million in 2003 and annually
thereafter, assuming no further legislative relief and a consistent patient
census.

Costs and Expenses.Costs and expenses for the twelve months ended December
31, 2002 were $1,809.4 million, a decrease of $54.3 million, or 2.9%, compared
to $1,863.7 million of costs and expenses for the fiscal year ended September
30, 2001. After adjusting for the costs and expenses of facilities that have
been divested, costs and expenses for the twelve months ended December 31, 2002
were $1,730.7 million, an increase of $152.5 million, or 9.7%, compared to
$1,578.2 million of costs and expenses for the fiscal year ended September 30,
2001. The increase after adjusting for divested facilities was attributable to
an increase in operating expenses and the impairment of long-lived assets,
which were partially offset by a decrease in depreciation and amortization.

Operating expenses for the twelve months ended December 31, 2002 were $1,512.8
million, a decrease of $75.1 million, or 4.7%, compared to $1,587.9 million for
the fiscal year ended September 30, 2001. After adjusting for the operating
expenses of facilities that have been divested, operating expenses for the
twelve months ended December 31, 2002 were $1,443.0 million, an increase of
$110.4 million, or 8.3%, compared to $1,332.6 million of operating expenses for
the fiscal year ended September 30, 2001.

Depreciation and amortization expense, excluding facilities that were divested,
decreased 27.3%, to $34.1 million, from $46.9 million in the previous fiscal
year due to the discontinuation of goodwill amortization on January 1, 2002,
upon the adoption of SFAS No. 142. The financial results for the fiscal year
ended September 30, 2001 included $11.3 million for amortization of goodwill.

Our financial results for the twelve months ended December 31, 2002 included a
charge of $84.6 million for the impairment of long-lived assets. The
impairment charge 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 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. During the three months ended
December 31, 2002, we recorded $4.0 million as a reduction of the
expense for bad debts related to recoveries of accounts previously sent to a collection
agency. The fiscal year ended
September 30, 2001 financial results included a loss of $33.4 million for the
settlement with the government of certain qui tam actions as part of our Global
Settlement.

Operating Income (Loss).Operating loss for the twelve months ended December
31, 2002 was $24.4 million, while operating income was $8.5 million for the
twelve months ended September 30, 2001, a net decrease of $32.9 million. After
adjusting for divested facilities and the $84.6 million charge for the
impairment of long-lived assets, operating income was $81.5 million and $42.1
million, respectively, an increase of $39.4 million, or 93.6%, for the twelve
months ended December 31, 2002 and fiscal year ended September 30, 2001,
respectively. The increase in operating income was due to the continued
reduction of corporate overhead expenses and the divestiture of facilities,
most of which we deemed to be under-performing.

Interest Expense.Interest expense for the twelve months ended December 31,
2002 was $30.2 million. Interest expense for the fiscal year ended September
30, 2001 was $5.2 million, an increase of $25.0 million. The increase in
interest expense was due to the new capital structure upon emergence from
bankruptcy.

Reorganization Items.Reorganization items, which consisted of income,
expenses and other gains and losses incurred as a result of the bankruptcy
filings, resulted in a $1,394.3 million gain for the twelve months ended
December 31, 2002 compared to a $47.7 million loss for the fiscal year ended
September 30, 2001. During the twelve months ended
December 31, 2002, we recorded a gain of $1,229.6 million
from the

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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.

Discontinued Operation.The results of the APS Division have been classified
as a discontinued operation in accordance with accounting principles generally
accepted in the United States. During the twelve months ended December 31,
2002, we recorded a gain on the sale of the APS Division of approximately $29.1
million. Income from the operation of discontinued pharmacy operations was
approximately $0.7 million for the fiscal year ended September 30, 2001.

As a condition of the sale of the APS Division to Omnicare, we may receive a
total of up to $18.0 million in future payments. These payments, if earned,
would be received in each of 2003, 2004 and 2005. The amount of
the payments is dependent upon certain post-closing operating results of the
APS Division. Subsequent to December 31, 2002, we earned and received the first payment of $6.0 million, which
will be reflected in our financial results for the first quarter of 2003.

Income Taxes.Provision for income taxes was $1.0 million for the twelve
months ended December 31, 2002. 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. The benefit for income taxes was $4.8 million for
the fiscal 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.

Three Months Ended December 31, 2001 Compared to the Three Months Ended December 31, 2000

Net Revenue.Net revenue totaled $458.2 million for the three months ended
December 31, 2001, a decrease of $12.2 million, or 2.6%, compared to three
months ended December 31, 2000. Although net revenue from nursing home
services decreased by $13.7 million, or 3.1%, net revenue of our facilities,
excluding divested facilities, increased by 7.2%, or $28.6 million. The
increase resulted from numerous factors, including 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% in the three
months ended December 31, 2001 as compared to the three months
ended December 31, 2000. These increases were offset by a decrease in revenue of $34.7
million due to the impact of the divestiture of facilities during the three
months ended December 31, 2001 as well as during fiscal year
ended September 30, 2001.

Costs and Expenses.Costs and expenses for the three months ended December 31,
2001 were $440.6 million, a decrease of $10.1 million, or 2.2%, compared to
$450.7 million of costs and expenses for the three months ended December 31,
2000. After adjusting for the costs and expenses of facilities that have been
divested, costs and expenses for the three months ended December 31, 2001 were
$438.0 million, an increase of $39.0 million, or 9.8%, compared to $399.0
million of costs and expenses for the three months ended December 31, 2000.

Operating expense for the three months ended
December 31, 2001 was $386.8
million, a decrease of $4.7 million, or 1.2%, compared to $391.5 million for
the three months ended December 31, 2000. After adjusting for the operating
expense of facilities that were divested, operating expense for the three
months ended December 31, 2001 was $384.5 million, an increase of $39.1
million, or 11.3%, compared to $345.4 million of operating expense for the
three months ended December 31, 2000.

The increase in operating expense was due to the increase in salaries, wages
and benefits in the three months ended December 31, 2001 resulting from changes
in certain federal, state and local 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 in the three months ended December 31, 2001.
Additional increases in the three months ended December 31, 2001 were due to
the increased reliance on employment agencies in some local areas as a result
of shortage of qualified labor.

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Operating Income.Operating income decreased to $17.5 million in the three
months ended December 31, 2001 from $19.7 million in the three months ended
December 31, 2000. The $2.2 million decrease was attributable to decreases in
total revenue of $12.2 million described above and a decrease in total costs
and expenses of $10.1 million for the three months ended December 31, 2001
compared to the three months ended December 31, 2000.

Interest Expense.Interest expense for the three months ended December 31,
2001 was $3.5 million. Interest expense for the three months ended December
31, 2000 was $3.2 million, an increase of $0.3 million. In
connection with our adoption of SOP 90-7 on January 18,
2000 as a debtor-in-possession, we discontinued
accruing interest for our debt facilities classified as liabilities subject to
compromise.
Contractual interest for the three months ended December 31, 2001 was $43.5
million, which was $40.0 million in excess of interest expense included in our
consolidated financial statements for this period.

Reorganization Items.Reorganization items, which consisted of income,
expenses and other costs directly related to our reorganization since the
Petition Date, increased $5.1 million from $8.1 million for the three months
ended December 31, 2000 to $13.2 million for the three months ended December
31, 2001. The increase was primarily attributable to an increase of $8.5
million for professional fees incurred in connection with the various aspects
of the Chapter 11 cases, including filing of the disclosure statement and Joint
Plan. The increase in reorganization items resulted from an increase in
professional fees for the three months ended December 31, 2001 as compared to
the three months ended December 31, 2000 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.

Discontinued Operation.The results of the APS Division have been classified
as a discontinued operation in accordance with accounting principles generally
accepted in the United States. Income from operations of our APS Division
increased from $0.4 million for the three months ended December 31, 2000 to
$0.9 million for the three months ended December 31, 2001. Revenue from the
APS Division increased by $9.1 million from $53.8 million for the three months
ended December 31, 2000 to $62.9 million for the three months ended December
31, 2001, which was primarily attributable to an increase in the number of beds
served as well as increased sales to new and existing customers. Total costs
and expenses increased $8.3 million from $53.3 million for the three months
ended December 31, 2000 to $61.6 million for the three months ended December
31, 2001, primarily as a result of an increase of $7.6 million in ancillary
service expense, which was affected by the level of service provided and
patient acuity.

Income Taxes.No provision for income taxes was recorded in the three month
period ended December 31, 2001 and 2000. We had sufficient net operating tax
loss carryforwards to offset any income in these periods. No provision for
income tax benefit was reflected as the tax loss carryforwards had a valuation
allowance recorded against them.

Fiscal Year Ended September 30, 2001 Compared to the Fiscal Year Ended September 30, 2000

Net Revenue.Net revenue totaled $1,872.1 million for the fiscal year ended
September 30, 2001, a decrease of $7.2 million, or 0.4%, compared to net
revenue of $1,879.3 million for the fiscal year ended September 30, 2000.
Although net revenue from nursing home services decreased by $8.8
million, or 0.5%, net revenue of the our SNFs, excluding 44 facilities
that were divested during the fiscal year ended September 30, 2001 and 28 facilities that were divested
during the fiscal year ended September 30, 2000, increased by
9.2%, or approximately $139.9
million. The increase resulted from numerous factors, including a 4.8% 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 7.4% in the fiscal year ended
September 30, 2001 compared to the fiscal year ended
September 30, 2000.

Costs and Expenses.Costs and expenses for the fiscal year ended September 30,
2001 were $1,863.7 million, a decrease of $22.2 million, or 1.2%, compared to
$1,885.9 million of costs and expenses for the fiscal year ended September 30, 2000. After adjusting for the costs and

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expenses of facilities that were divested, costs and expenses for the fiscal year ended September 30,
2001 were $1,725.4 million, an increase of $139.5 million, or 8.8%, compared to
$1,585.9 million of costs and expenses for the fiscal year ended September 30,
2000. The increase after adjusting for divested facilities was attributed to
an increase in operational and general and administrative expenses.

Operating expenses for the fiscal year ended September 30, 2001 were $1,587.9
million, a decrease of $8.8 million, or 0.6%, compared to $1,596.7 million for
the fiscal year ended September 30, 2000. After adjusting for the operating
expenses of facilities that were divested, operating expenses for the
fiscal year ended September 30, 2001 were $1,462.7 million, an increase of
$85.6 million, or 6.2%, compared to $1,377.1 million of operating expenses for
the fiscal year ended September 30, 2000.

General and administrative expenses for the fiscal year ended September 30,
2001 were $193.0 million, a decrease of $27.5 million, or 12.5%, compared to
$220.5 million for the fiscal year ended September 30, 2000. After adjusting
for the facilities that were divested, general and administrative expenses
for the fiscal year ended September 30, 2001 were $180.4 million, an increase
of $19.9 million, or 12.4%, compared to $160.5 million for the twelve months
ended September 30, 2000.

Operating Income (Loss).Operating income for the fiscal year ended September 30,
2001 was $8.5 million, compared to an operating loss of $6.6 million for the
fiscal year ended September 30, 2000, a net increase of $15.1 million. The
operating loss for the fiscal year ended September 30, 2000 included reductions
for an impairment of long-lived assets of $19.4 million and a loss on disposal
of assets of $3.7 million. After adjusting for divested facilities, operating
income was $36.1 million for the fiscal year ended September 30, 2001. After
adjusting for divested facilities, operating income for the fiscal year ended
September 30, 2000 was $28.6 million, an increase of $7.5 million, or 26.2%.

Interest Expense.Interest expense for the
fiscal year ended September 30,
2001 was $5.2 million. Interest expense for the fiscal year ended September
30, 2000 was $71.9 million, a decrease of $66.7 million. The decrease was due
to the fact that since the Petition Date, we discontinued accruing interest
relating to our debt facilities then classified as liabilities subject to
compromise in accordance with SOP 90-7. Contractual interest for the
fiscal year ended September 30, 2001 and 2000 was $201.1 million and $238.8 million,
respectively, which was $195.9 million and $167.0 million, respectively, in
excess of interest expense included in our consolidated financial statements
for those periods.

Reorganization Items.Reorganization items, consisting of income, expenses and
other costs directly related to our reorganization since the Petition Date,
increased $36.9 million from $10.8 million in fiscal year ended September 30,
2000 to $47.7 million in fiscal year ended September 30, 2001. The increase
was attributable to an increase of $14.1 million for professional fees incurred
in connection with our Chapter 11 cases and an increase of $9.6 million for
other reorganization costs, which primarily related to employee retention and
severance. In addition, net gain on divestiture included in reorganization
items decreased from $14.7 million to a net loss on divestiture of $1.5 million
for fiscal years ended September 30, 2000 and 2001, respectively. During the
fiscal year ended September 30, 2000, we realized a net gain of $11.1 million
due to a settlement agreement reached with Senior Housing Properties Trust
primarily related to the leasing of twenty-two of our facilities.

Discontinued Operation.The results of the APS Division have been classified
as a discontinued operation in accordance with accounting principles generally
accepted in the United States. Income from the operation of discontinued
pharmacy operations increased from a loss of $2.7 million for fiscal year 2000
to income of $0.7 million for fiscal year 2001. Revenue of the APS Division
decreased by $22.7 million in fiscal year 2001 compared to fiscal year 2000.
The decrease was primarily attributable to a reduction in the number of beds
served as well as decreased sales to new and existing customers. Total costs
and expenses decreased $28.4 million, primarily as a result of an decrease of
$15.9 million in ancillary service expense, which was affected by the level of
service provided and patient acuity, as well as a decrease in salaries, wages
and benefits of $15.9 million.

Income Taxes.The benefit for income taxes was $4.8 million and $19.4 million
for the twelve months ended September 30, 2001 and 2000, respectively. Losses
were incurred in each of the two periods. A valuation allowance was
established to completely offset the income tax benefit of the current losses
because we believed the deferred asset may not be recognizable under the more likely than not standard.
The income tax benefit recorded in each period resulted from the
receipt of income tax refunds due to carryback of prior year losses and amended
income tax returns.

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Liquidity and Capital Resources of the Company

|                              |                  |                                         |         |                        |         |                  |        |           |       |           |        |               |        |   |        |        |       |   |         |        |         | 
|----------------------------- | ---------------- | --------------------------------------- | ------- | ---------------------- | ------- | ---------------- | ------ | --------- | ----- | --------- | ------ | ------------- | ------ | - | ------ | ------ | ----- | - | ------- | ------ | ------- | 
|                              |                  |                                         |         | Payments due by Period
|                              |                  |                                         |         |                       
|                              |                  |                                         |         | Total                  |         | Less Than 1 Year |        | 1-3 Years |       | 4-5 Years |        | After 5 Years
|                              |                  |                                         |         |                        |         |                  |        |           |       |           |        |              
|Contractual obligations       |                  |                                         |         |                        |         |                  |        |           |       |           |        |               |        |   |        |        |       |   |         |       
|                              | Long-term debt   |                                         |         |                        |         |                  |        |           |       |           |        |               |        |   |        |        |       |   |         |        |        
|                              |                  | Term loans                              |         | $                      | 210,410 |                  |        | $         | 2,120 |           |        | $             | 4,240  |   |        | $      | 4,240 |   |         | $      | 199,810 | 
|                              |                  | Second priority notes                   |         |                        | 150,000 |                  |        |           |      |           |        |               |       |   |        |        |      |   |         |        | 150,000 | 
|                              |                  | Non-recourse indebtedness of
subsidiary |         |                        | 59,688  |                  |        |           |      |           |        |               |       |   |        |        |      |   |         |        | 59,688  | 
|                              |                  | Mortgage notes payable                  |         |                        | 11,420  |                  |        |           | 151   |           |        |               | 344    |   |        |        | 409   |   |         |        | 10,516  | 
|                              |                  | Capital leases                          |         |                        | 53,244  |                  |        |           | 7,522 |           |        |               | 25,389 |   |        |        | 9,059 |   |         |        | 11,274  | 
|                              | Operating leases |                                         |         | 188,149                |         |                  |        | 33,443    |       |           |        | 55,446        |        |   |        | 36,749 |       |   |         | 62,511 |        
|                              | Other            |                                         |         | 1,879                  |         |                  |        | 135       |       |           |        | 238           |        |   |        | 140    |       |   |         | 1,366  |        
|                              |                  |                                         |         |                        |         |                  |        |           |       |           |        |               |        |   |        |        |       |   |         |        |         | 
|Total Contractual obligations |                  | $                                       | 674,790 |                        |         | $                | 43,371 |           |       | $         | 85,657 |               |        | $ | 50,597 |        |       | $ | 495,165 |       
|                              |                  |                                         |         |                        |         |                  |        |           |       |           |        |               |        |   |        |        |       |   |         |        |         | 

|                             |                       |   |                                            |        |                  |   |           |        |           |   |               |   |  |   |   |   |  |   |   |   | 
|---------------------------- | --------------------- | - | ------------------------------------------ | ------ | ---------------- | - | --------- | ------ | --------- | - | ------------- | - |  | - | - | - |  | - | - | - | 
|                             |                       |   | 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 (1) |   | $                                          | 25,563 |                  |   | $         | 25,563 |           |   | $             |  |  |   | $ |  |  |   | $ |  | 
|                             |                       |   |                                            |        |                  |   |           |        |           |   |               |   |  |   |   |   |  |   |   |   | 
|Total Commercial commitments |                       | $ | 25,563                                     |        |                  | $ | 25,563    |        |           | $ |              |   |  | $ |  |   |  | $ |  |  
|                             |                       |   |                                            |        |                  |   |           |        |           |   |               |   |  |   |   |   |  |   |   |   | 



---

|    |  |                                                                                   
|--- |  | ----------------------------------------------------------------------------------
|(1) |  | Includes letters of credit collateralized with approximately $3.1 million
in cash.

Working Capital and Cash Flows

At December 31, 2002, we had working capital of $116.6 million and cash and
cash equivalents of $38.6 million, compared to working capital of $347.6
million and cash and cash equivalents of $213.7 million at December 30, 2001.
As of February 28, 2003, we had $40.9 million in cash and cash equivalents with
which to fund our working capital needs. For the eight months ended December
31, 2002, net cash provided by operating activities of continuing operations
before reorganization items was $10.0 million. Net cash provided by operating
activities of continuing operations before reorganization items was $38.5
million for the four months ended April 30, 2002. For the fiscal year ended
September 30, 2001, net cash provided by operating activities of continuing
operations before reorganization items was approximately $139.6 million.

Purchases of property and equipment were $33.6 million for the eight months
ended December 31, 2002 and $27.6 million for the four months ended April 30,
2002, both of which were financed through internally generated funds. Capital
expenditures for the four months ended April 30, 2002 included $15.2 million
related to certain facilities that were damaged by floods for which insurance
proceeds of $13.4 million were received in the twelve months ended December 31,
2002. 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 also anticipate
spending a portion of our planned capital expenditures for the twelve months
ending December 31, 2003 to complete additions to our information systems,
which include a new centralized clinical billing function and enhancements to
other accounting and human resource systems. Some of the costs associated with
these enhancements may qualify as capital expenditures in accordance with
American Institute of Certified Public Accountants Statement of Position 98-1,
Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use.

During the eight months ended December 31, 2002, we received net proceeds from
the disposition of assets of approximately $4.0 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. During the fiscal year ended September 30, 2001, we received net proceeds from the disposition of
assets of $7.9 million. The majority of the cash from the disposition of
assets prior to the eight month period ended December 31, 2002 was used for
repayments against our prepetition senior credit facilities as adequate
protection payments.

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During the eight months ended December 31, 2002, we made aggregate principal
repayments to long-term debt of $5.9 million. During the four months ended
April 30, 2002, we made aggregate principal repayments to long-term debt of
$386.9 million, of which $287.4 million was paid to the principal lenders under
our prepetition senior credit facilities in connection with the consummation of
the Joint Plan. In connection with our emergence from bankruptcy, we borrowed
$212.0 million under our Senior Credit Facility.

Capital Resources

Senior Credit Facility.Effective March 31, 2003, we amended our Senior Credit
Facility. This amendment, among other things, adjusts the terms of the
financial covenants in the Senior Credit Facility for the two year period
beginning March 31, 2003 and adjusted our interest rate. In addition, this
amendment also provided us with a waiver to a violation of one of our financial
covenants for the period ended December 31, 2002. Outstanding loans under the
Senior Credit Facility bear interest, at our election, using either a base rate
or eurodollar rate, plus an applicable margin which ranges from 2.25%-3.25% for
base rate loans and 3.25%-4.25% for eurodollar rate loans. These margins are
subject to quarterly adjustment depending upon our total debt leverage ratio.
Within the range indicated above, adjustments may increase or reduce the
applicable margins, as the case may be. Prior to the amendment of the Senior
Credit Facility, the applicable margin ranged from 1.25%  2.25% for base rate
loans and 2.25% to 3.25% for eurodollar rate loans.

Borrowings under the Term Loans were used to fund our obligations under the
Joint Plan and to pay in cash all or a portion of certain claims of prepetition
senior credit facility lenders and mortgage lenders. At March 15, 2003, the
interest rate was 4.63% and $210.4 million in borrowings were outstanding on
the Term Loans. Additional amounts cannot be borrowed under the Term Loans.
The Term Loans amortize 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 mature on May 13, 2008. The Term Loans
can be prepaid at our option without penalty or premium. In addition, the Term
Loans are subject to mandatory prepayment in certain events such as some asset
or securities sales or our receipt of certain insurance proceeds. The Term
Loans are also subject to annual mandatory prepayment to the extent of 75% of
our consolidated excess cash flow. Any mandatory prepayment of our Term Loans
will reduce our remaining financial flexibility by reducing our available cash
balance. While we are currently unable to quantify the extent to which this
will affect our future operations, it is possible that it will make it more
difficult or impossible for us to fund future operations, which could impair
our operating results.

Borrowings under the Revolving Credit Facility may be used for general
corporate purposes, including working capital and permitted acquisitions.
Usage under the Revolving Credit Facility, which matures on May 13, 2007, is
subject to a borrowing base based upon both a percentage of our eligible
accounts receivable and a percentage of the real property collateral value of
substantially all of our SNFs. No borrowings were outstanding under the
Revolving Credit Facility as of March 15, 2003; however, approximately $22.6
million of letters of credit issued under the Revolving Credit Facility were
outstanding on that date. Also as of March 15, 2003, $62.4 million remained
available for future borrowings.

The Senior Credit Facility is guaranteed by substantially all of our
subsidiaries and is secured by liens and security interests on substantially
all of our real property and personal property assets. In addition to those
described above, covenants negotiated in the Senior Credit Facility restrict
our ability to borrow funds in the event we maintain a cash book balance in
excess of $25.0 million and also require us to maintain compliance with certain
financial and non-financial covenants, including minimum fixed charge coverage
ratios, minimum consolidated adjusted EBITDA (as defined in the Senior Credit
Facility), maximum total leverage and senior leverage ratios, as well as
maximum capital expenditures.

Second Priority Notes.The Second Priority Notes bear interest at a 3-month
LIBOR, adjusted quarterly, plus 550 basis points. At March 15, 2003, the
interest rate payable under the Second Priority Notes was 6.9%. The Second
Priority Notes mature on May 13, 2009, and are subject to redemption without
premium or penalty at any time, at our option. The Indenture covering these
notes includes 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. Liens and security
interests in the same collateral as that pledged to secure the Senior Credit
Facility secure these obligations. However, the liens and security interests
benefiting the Second Priority Note holders and trustee rank immediately junior
in priority behind the liens and security interests securing the Senior Credit
Facility.

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Other Letters of Credit.As of December 31, 2002 and March 31, 2003 we had
outstanding approximately $3.0 million in letters of credit issued under our
pre-Effective Date credit facilities and secured by approximately $3.1 million
of cash collateral.

Non-Recourse Indebtedness of Unrestricted Subsidiary.One of our wholly owned
subsidiaries, PHCMI, is the borrower under an approximately $59.7 million
mortgage loan from Omega Healthcare Investors, Inc., or Omega, that was
restructured as part of the Chapter 11 cases. The loan, or the Omega Loan,
bears interest at a rate of 11.57% per annum, is guaranteed by all the
subsidiaries of PHCMI and is secured by liens and security interests on all or
substantially all of the real property and personal property of PHCMI and its
subsidiaries, or the PHCMI Entities, including nine SNFs located in Michigan
and three others in North Carolina, or the Omega Facilities. Omega is also
entitled to receive an annual amendment fee equal to 25% of the free cash flow
from the Omega Facilities.

The Omega Loan 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. Prior to maturity, the Omega Loan is not
subject to prepayment without the consent of PHCMI except (a) between February
1, 2005 and July 31, 2005, at 103% of par, and (b) within six months prior to
the scheduled maturity date, at par, in each case plus accrued and unpaid
interest.

The Omega Loan constitutes non-recourse indebtedness to the rest of the legal
entities of Mariner excluding PHCMI, or the MHC Entities. None of the MHC
Entities 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, none of the PHCMI Entities have guaranteed either the Senior
Credit Facility or the Senior Secured Notes, nor have they pledged their assets
for that indebtedness. The Omega Loan restricts the extent to which PHCMI can
incur other indebtedness, including intercompany indebtedness from PHCMIs
shareholders.

Other Factors Affecting Liquidity and Capital Resources.Due to the impact of
the Medicare Reimbursement Cliff, we are currently receiving a lower rate of
Medicare reimbursement for services provided on or after October 1, 2002 than
we did before that date. The remaining increases in Medicare reimbursement for
high-acuity patients provided for under the Balanced Budget Refinement Act and
Benefits Improvement and Protection Act are expected to terminate when CMS
implements a resource utilization group refinement. CMS recently announced
that it was delaying the implementation of any further refinements to the
reimbursement rates until October 1, 2004, at the earliest. Based solely on
the impact of the existing cuts caused by the Medicare Reimbursement Cliff, and
not accounting for other factors, such as pending refinements to the Medicare
reimbursement system, potential Medicaid cuts and increased labor costs more
fully described above, and assuming that additional mitigating legislation is
not enacted by Congress and our patient census remains stable, the Medicare
Reimbursement Cliff is expected to result in a loss of revenue and operating
income of up to approximately $37.0 million annually beginning in 2003. The
impact, and expected continued impact, of the Medicare Reimbursement Cliff is
expected to materially adversely affect our cash flows for the indefinite
future. A more complete discussion of the expected impact of the Medicare
Reimbursement Cliff is contained in Risk Factors and Capital Resources
above.

We are also reimbursed for services, such as rehabilitation therapy services,
provided to Medicare SNF patients under the Medicare Part B benefit. The
Balanced Budget Refinement Act also revised the reimbursement methodology for
therapy services under Medicare Part B and set a maximum per beneficiary
amount, or limit, per provider for physical therapy and speech pathology
combined, and another limit for occupational therapy. A subsequent moratorium
on the therapy limitation expired at the end of calendar year 2002, and CMS has
instructed Medicare contractors that claims for outpatient therapy services
provided on or after July 1, 2003 will be subject to the therapy limitation,
which is $1,590 in 2003. We are unable to quantify whether and to what extent
the reinstatement of limits on reimbursement for therapy is expected to have on
our business, as this is a function of the number of patients receiving therapy
and the level of therapy they require.

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Upon our emergence from bankruptcy, we 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, we requested that
all of our facilities be converted to Mutual of Omaha, or Mutual, as our 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. Due to reasons beyond our control, such as the disparity
between the Mutual billing system and those of the other fiscal intermediaries,
delays in Mutual receiving Tie-In Notices from CMS approving them as the fiscal
intermediary for some facilities and issues with respect to paying for patients
who were at a facility prior to its conversion to Mutual, the October 1, 2002
and January 1, 2003 conversions have resulted in a slow-down in cash
collections for services to Medicare patients. We estimate that we are
currently owed approximately $10.0 million from Mutual for Medicare services
previously rendered. We are working closely with Mutual and have requested an
accelerated payment to resolve the slow-down in collections. Failure to reach
a satisfactory resolution of the slow down in cash collections from Mutual
could have an adverse effect on our liquidity.

The Balanced Budget Act also repealed the federal payment standard for Medicaid
reimbursement levels for hospitals and nursing facilities. By repealing this
standard, the Balanced Budget Act removed previously existing impediments on
the ability of states to reduce their Medicaid reimbursement levels. Many
states in which we maintain significant operations are proposing and/or have
implemented reductions in their Medicaid reimbursement levels, and these
reductions would be expected to materially adversely affect our revenue.

Due to a decrease in the number of people entering the nursing profession and
an increased demand for nurses in the healthcare industry, we have experienced
a significant increase in our labor costs over the course of the last year in
certain markets in which we plan to continue operations. While this has not
yet had a material adverse effect on our operations, there can be no assurance
that further increases in nursing staff wages will not have such an effect in
the future. We have also experienced increased staffing requirements in order
to maintain compliance with various Medicare and Medicaid programs. We
anticipate that the nursing staff shortage will accelerate, especially in light
of a demographic review indicating that a significant percentage of people
engaged in the nursing profession are nearing retirement age with no
significant group of younger nursing staff candidates to fill anticipated
vacancies.

Insurance related costs in the long-term care industry continue to rise at a
dramatic rate. This primarily includes PL/GL, workers compensation and
directors and officers liability programs. Significant increases in the
frequency and severity of PL/GL claims also continues. 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. 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.

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, and 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 liability insurance only, and maintain, in all
states except Colorado, an unaggregated $1.0 million self-insured retention per
claim. In Colorado, we maintain first dollar coverage. Additionally, in the
second quarter of the twelve months ended December 31, 2002, due to changes in
the workers compensation insurance market, we moved from a guaranteed cost
program for our employee injury losses, to a program where we 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
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.

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Loss provisions in our financial statements 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. The external analysis is completed by a certified
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 our management with any material
adjustments resulting therefrom, being reflected in current earnings. Although
we believe our provisions for self-insured losses in our financial statements
are adequate, the ultimate liability may be more or less than the amounts
recorded. In the event the provisions for loss reflected in our financial
statements is inadequate, our financial condition and results of operations may
be materially affected.

We maintain two captive insurance subsidiaries to provide for reinsurance
obligations under workers compensation, PL/GL and automobile liability for
losses that occurred prior to April 1, 1998. These obligations are funded with
long-term, fixed income investments, which are not available to satisfy other
obligations.

We anticipate an increase in employee benefits expenses during the fiscal year
2003 due to the rising cost of employee health insurance. The higher cost of
insurance is due to an increase in the participation rate among employees, the
increase in the cost of insurance per employee and an increase in the total
number of employees.

We also have significant rent obligations relating to our leased facilities.
Total rent expense was approximately $29.7 million, $15.6 million and $62.8
million for the eight months ended December 31, 2002, four months ended April
30, 2002 and fiscal year September 30, 2001, respectively.

The HIPAA privacy regulations regarding electronic transactions and code sets
require that key data exchanges, including claims information, plan
eligibility, referral certification and authorization, claims status, plan
enrollment and disenrollment and payment and remittance advice, be transmitted
electronically and uniformly. This new method of submitting information,
including payment information, to our fiscal intermediaries is required under
HIPAA to be implemented on October 16, 2003. While we believe that we and the
Medicare program will be HIPAA compliant by such date, there is a significant
risk that many of the state Medicaid programs from which we receive Medicaid
reimbursement will not, particularly in light of the budget deficits many of
them are facing. In the event that a state is unable to process our HIPAA
compliant requests for payment, our liquidity could be adversely affected. We
are in the process of evaluating the extent of the problem, and program testing
of the new data submission requirements is to begin on April 16, 2003.
Following October 16, 2003, it will be a violation of HIPAA to submit data in
any format other than that prescribed by HIPAA. We are in the process of
developing contingency plans to address this potential issue, but no assurance
can be given that our liquidity will not be adversely affected following the
October 16, 2003 implementation of the new HIPAA electronic transactions and
code sets standards if the state Medicaid programs are not compliant.

Impact of Inflation

The healthcare industry is labor intensive. Wages and other labor-related
costs are especially sensitive to inflation. Increases in wages and other
labor-related costs as a result of inflation or the increase in minimum wage
requirements without a corresponding increase in Medicaid and Medicare
reimbursement rates would, 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.

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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 and interest
payments on our Second Priority Notes, each of which bear interest based on
variable rates. If market interest rates rise, so will our required interest
payments on these borrowings.

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, 2002, we had exposure to interest rate risk related to changes
in LIBOR, which affects the interest paid on our variable rate borrowings and
the fair value of our fixed rate borrowings. The following table provides
information about our financial instruments that are sensitive to changes in
interest rates, including principal cash flows and related weighted average
interest rates by expected maturity for the periods indicated (dollars in
thousands):

|                                                  |                       |  |                     |       |        |  |        |       |               |  |        |        |            |  |       |       |                   |  |   |       |   |  |   |         |   |  |   |         |  |  |   |         | 
|------------------------------------------------- | --------------------- |  | ------------------- | ----- | ------ |  | ------ | ----- | ------------- |  | ------ | ------ | ---------- |  | ----- | ----- | ----------------- |  | - | ----- | - |  | - | ------- | - |  | - | ------- |  |  | - | ------- | 
|                                                  |                       |  | Expected Maturities |       |        |  |        |       |               |  |       
|                                                  |                       |  |                     |       |        |  |        |       | Fair Value at
|                                                  |                       |  | Year 1              |       | Year 2 |  | Year 3 |       | Year 4        |  | Year 5 |        | Thereafter |  | Total |       | December 31, 2002
|                                                  |                       |  |                     |       |        |  |        |       |               |  |        |        |            |  |       |       |                  
|Liabilities                                       |                       |  |                     |       |        |  |        |       |               |  |        |        |            |  |       |       |                   |  |   |       |   |  |   |         |   |  |   |         |  |  |   |        
|Long-term debt,
including amounts
due in one year |                       |  |                     |       |        |  |        |       |               |  |        |        |            |  |       |       |                   |  |   |       |   |  |   |         |   |  |   |         |  |  |   |        
|                                                  | Fixed rate            |  | $                   | 7,673 |        |  | $      | 6,819 |               |  | $      | 18,914 |            |  | $     | 8,243 |                   |  | $ | 1,225 |   |  | $ | 81,478  |   |  | $ | 124,352 |  |  | $ | 127,148 | 
|                                                  | Average interest
rate |  |                     | 9.3   | %      |  |        | 9.4   | %             |  |        | 9.6    | %          |  |       | 10.2  | %                 |  |   | 10.5  | % |  |   | 10.6    | % |  |   |         |  |  |   |         | 
|                                                  | Variable rate         |  | $                   | 2,120 |        |  | $      | 2,120 |               |  | $      | 2,120  |            |  | $     | 2,120 |                   |  | $ | 2,120 |   |  | $ | 349,810 |   |  | $ | 360,410 |  |  | $ | 360,410 | 

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 a eurodollar rate, plus a margin that ranges from 2.25%-3.25% for base
rate loans and 3.25%-4.25% for eurodollar rate loans. The Second Priority
Notes bear interest at 3-month LIBOR, reset quarterly, plus 550 basis points.
While we do not currently employ interest rate hedges, we are in the process of
evaluating alternatives for the conversion of some or all of our indebtedness
from variable rate to fixed rate, as required by our Senior Credit Facility.
These alternatives may include entering 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 you
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
approximately $59.7 million mortgage loan from Omega Healthcare Investors,
Inc., or Omega, that was restructured as part of the Chapter 11 cases. The
loan, or 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, or more specifically a payer swaption. The fair market
value of the payer swaption was bifurcated from the Omega Loan and recorded as
an asset with a current market value of $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 payer swaption will become worthless and we will recognize an
expense for the current market value.

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The current market value was determined using the Black 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, 2002 were as follows: 11.57% strike price, 7.7 years until the
swap begins, 11.0 year term of the swap, notional $59.7 million, standard
deviation of the forward rate 15.5%, 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 payer swaption 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-2 through F-49 of
this annual report on Form 10-K.




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

Not applicable.




PART III




ITEM  10.   DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Directors and Executive Officers

|                        |  |     |    |                      |  |                                                                                           |  | 
|----------------------- |  | --- | -- | -------------------- |  | ----------------------------------------------------------------------------------------- |  | 
|Name                    |  | Age |    | Principal Occupation
|                        |  |     |    |                     
|C. Christian Winkle     |  |     | 40 |                      |  | President and Chief Executive Officer                                                    
|Victor L. Lund          |  |     | 55 |                      |  | Chairman of the Board of Directors                                                       
|Patrick H. Daugherty    |  |     | 36 |                      |  | General Counsel and Senior Portfolio Manager of
Highland Capital Management, L.P.        
|Earl P. Holland         |  |     | 58 |                      |  | Retired Vice Chairman and Chief Operating Officer
of Health Management Associates, Inc.  
|Philip L. Maslowe       |  |     | 55 |                      |  | Retired Executive Vice President and Chief
Financial Officer of The Wackenhut Corporation
|Mohsin Y. Meghji        |  |     | 38 |                      |  | Principal of Loughlin, Meghji + Company                                                  
|M. Edward Stearns       |  |     | 42 |                      |  | Senior Vice President of Foothill Capital
Corporation                                    
|Michael E. Boxer        |  |     | 41 |                      |  | Executive Vice President and Chief Financial Officer                                     
|Boyd P. Gentry          |  |     | 44 |                      |  | Senior Vice President and Treasurer                                                      
|Stefano M. Miele        |  |     | 36 |                      |  | Senior Vice President, General Counsel and Secretary                                     
|Terry OMalley          |  |     | 54 |                      |  | Senior Vice President, Human Resources                                                   
|David F. Polakoff, M.D. |  |     | 48 |                      |  | Senior Vice President, Medical Affairs and Chief Medical Officer                         
|William C. Straub       |  |     | 56 |                      |  | Senior Vice President and Chief Accounting Officer                                       

There are no family relationships between any of the directors, or any of
Mariners executive officers. Mariners executive officers serve at the
discretion of the board of directors. Detailed information about Mariners
directors is provided below.

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C. Christian Winklehas served as Mariners President, Chief Executive Officer
and a director since March 2000. From January 1999 through March 2000, he
served as our Executive Vice President. Prior to that, Mr. Winkle served as
Executive Vice President and Chief Operating Officer of Integrated Health
Services, Inc., or IHS, a long-term healthcare service provider, from May 1997
to December 1998. From May 1997 through April 1998, he served as Executive
Vice President-Field Operations of IHS owned and leased facilities, and from
May 1995 to May 1997, he served as Senior Vice President-Operations of IHS.
Prior to that, Mr. Winkle served as Regional Vice President of Operations and
President-MSU Product Development of IHS from September 1992 through March
1994.

Victor L. Lundhas served as our non-executive Chairman of the Board 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. 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.

Patrick H. Daughertyhas served as a director since May 2002. He is General
Counsel and a Senior Portfolio Manager at Highland Capital Management, L.P., or
Highland. Highland is an institutional money management firm. Mr. Daugherty
has been employed at Highland since 1998 and manages a portfolio primarily
consisting of stressed and distressed credits with a focus on healthcare
related investments. Prior to joining Highland, Mr. Daugherty served as Vice
President in the Corporate Finance Group at NationsBanc Capital Markets, Inc.
(now Bank of America), a commercial bank, from 1993 to 1998, where he
originated and structured leveraged transactions in the healthcare sector. He
received a B.B.A. in Finance from the University of Texas at Austin and a Juris
Doctorate from the University of Houston School of Law.

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 health benefits 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 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 also currently serves as the Chairman of the
Board of AMF Bowling Worldwide, Inc.

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 Senior Manager
and then 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 healthcare. 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.

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M. Edward Stearnshas served as a director since May 2002. He is Senior Vice
President of Foothill Capital Corporation, or Foothill, a capital management
company and a subsidiary of Wells Fargo & Co., and a Managing General Partner
of five partnerships in the Foothill family of funds. He has been employed at
Foothill since 1991 and manages a portfolio primarily consisting of distressed
credits with a focus on healthcare related investments. He served on the
official committee of unsecured creditors in the Sun Healthcare Group, Inc.
bankruptcy case and currently serves on the official committee of unsecured
creditors in the Coram Healthcare Corporation bankruptcy, as well as on
numerous lender steering committees. Mr. Stearns served on the steering
committee for the lenders under our prepetition senior credit facility during
our bankruptcy proceedings. Mr. Stearns has also served as nonexecutive
Chairman of the Board of Healthcare America (now The Brown Schools) from 1996
to 1997, a director of William Lyon Homes from 1998 to 1999 and director of
Quantegy, Inc. since 1999. Mr. Stearns earned a B.A. in Economics from
Wesleyan University in 1982 and an M.B.A. from The University of California at
Los Angeles in 1987.

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
NYSE listed specialty pharmaceuticals company. Before Joining Watson in July
1998, Mr. Boxer was President of The Enterprise Group, a financial advisory
firm, which provided consulting services to Watson Pharmaceuticals from July
1998 to December 2002. 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. Mr. Gentry joined us in June 1996 as Vice
President, Investor Relations and Treasurer. Prior to his time with our
predecessor companies, and us Mr. Gentry held various commercial lending and
corporate finance positions with Bank of America (formerly NationsBank), a
commercial bank, where his last position was Senior Vice President, Corporate
Finance.

Stefano M. Mielehas served as our Senior Vice President, General Counsel and
Secretary since May 2002. Prior to May 2002, Mr. Miele served as our Senior
Vice President, Associate General Counsel and Assistant Secretary. He joined
GranCare, a long-term healthcare service provider acquired by our predecessor,
in April 1995 as Associate General Counsel. Mr. Miele joined GranCare from the
international law firm of Jones, Day, Reavis & 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).

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.

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Appointment of Directors/Emergence from Bankruptcy

We emerged from bankruptcy protection effective May 13, 2002 pursuant to the
terms of our Joint Plan of Reorganization, as amended and approved by the
Bankruptcy Court. 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. Mr. Maslowe was elected
to a vacant board of directors position by the remaining directors in August
2002.

Section 16(A) Beneficial Ownership Reporting Compliance

Pursuant to Section 16(a) of the Securities Exchange Act of 1934, as amended,
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 2002 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 inadvertent late
filing of two Forms 4 relating to three transactions by Patrick H. Daugherty,
one of our directors.




ITEM 11. EXECUTIVE COMPENSATION

The following table presents information concerning compensation earned by our
chief executive officer during the fiscal year ended December 31, 2002 and
our four other most highly compensated executive officers serving at December
31, 2002 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. After that date, Ms. Whittle, Mr.
Gentry, Mr. Miele and Dr. Polakoff were employed by Mariner Health Care
Management Company, or the Management Company, a wholly owned subsidiary of
ours.

Summary Compensation Table

|                            |                                   |                 |      |                     |  |              |         |         |       |   |           |         |     |   |           |        |    
|--------------------------- | --------------------------------- | --------------- | ---- | ------------------- |  | ------------ | ------- | ------- | ----- | - | --------- | ------- | --- | - | --------- | ------ | ---
|                            |                                   |                 |      |                     |  |              |         |         |       |   |           |         |     |   | All Other
|Name and Principal Position |                                   | Fiscal Year (1) |      | Annual Compensation |  | Compensation
|                            |                                   |                 |      |                     |  |             
|                            |                                   |                 |      |                     |  |              | Salary  |         | Bonus |   |           |         |    
|                            |                                   |                 |      |                     |  |              |         |         |       |   |           |         |    
|C. Christian Winkle         |                                   |                 | 2002 |                     |  | $            | 737,308 |         |       | $ | 1,500,000 | (2)     |     | $ | 18,000    | (4)   
|                            | President, Chief Executive        |                 |      | 2001-12/31          |  |              |         | 652,550 |       |   |           | 585,000 | (3) |   |           | 15,450 | (4)
|                            | Officer and Director              |                 |      | 2001                |  |              |         | 652,550 |       |   |           | 780,000 |     |   |           | 12,900 | (4)
|                            |                                   |                 | 2000 |                     |  |              | 570,962 |         |       |   | 600,000   |         |     |   | 15,453    | (5)   
|Susan Thomas Whittle        |                                   |                 | 2002 |                     |  | $            | 346,327 |         |       | $ | 350,000   | (2)     |     | $ | 7,800     | (7)   
|                            | Former Executive Vice President,  |                 |      | 2001-12/31          |  |              |         | 333,500 |       |   |           | 187,500 | (3) |   |           | 10,350 | (7)
|                            | General Counsel and Secretary (6) |                 |      | 2001                |  |              |         | 333,500 |       |   |           | 250,000 |     |   |           | 10,350 | (7)
|                            |                                   |                 | 2000 |                     |  |              | 328,482 |         |       |   | 175,000   |         |     |   |          |       
|Boyd P. Gentry              |                                   |                 | 2002 |                     |  | $            | 314,423 |         |       | $ | 325,000   | (2)     |     | $ | 7,800     | (7)   
|                            | Senior Vice President             |                 |      | 2001-12/31          |  |              |         | 272,077 |       |   |           | 112,500 | (3) |   |           | 8,342  | (7)
|                            | and Treasurer                     |                 |      | 2001                |  |              |         | 262,846 |       |   |           | 150,000 |     |   |           | 8,342  | (7)
|                            |                                   |                 | 2000 |                     |  |              | 235,000 |         |       |   | 85,000    |         |     |   |          |       
|David F. Polakoff, M.D      |                                   |                 | 2002 |                     |  | $            | 363,462 |         |       | $ | 150,000   | (2)     |     | $ | 7,800     | (7)   
|                            | Senior Vice President,            |                 |      | 2001-12/31          |  |              |         | 350,000 |       |   |           | 67,500  | (3) |   |           | 11,562 | (7)
|                            | Medical Affairs and               |                 |      | 2001                |  |              |         | 350,000 |       |   |           | 90,000  |     |   |           | 11,562 | (7)
|                            | Chief Medical Officer             |                 |      | 2000                |  |              |         | 354,039 |       |   |           | 50,000  |     |   |           |       |    
|Stefano M. Miele            |                                   |                 | 2002 |                     |  | $            | 246,741 |         |       | $ | 150,000   | (2)     |     | $ | 7,800     | (7)   
|                            | Senior Vice President,            |                 |      | 2001-12/31          |  |              |         | 196,154 |       |   |           | 75,000  | (3) |   |           | 7,800  | (7)
|                            | General Counsel and               |                 |      | 2001                |  |              |         | 193,558 |       |   |           | 75,000  |     |   |           | 7,800  | (7)
|                            | Secretary                         |                 |      | 2000                |  |              |         | 170,192 |       |   |           | 49,300  |     |   |           |       |    



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---

|(1) |  | The row 2001  12/31 represents the 12-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 12-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) |  | Consists of amounts paid in connection with our bankruptcy proceedings
and approved by the Bankruptcy Court.                                                                                                                                                                                                                                                                                                                                                           
|   
|(3) |  | Represents prorated portion of bonus (9/12) earned during the 12-month
period ended December 31, 2001.                                                                                                                                                                                                                                                                                                                                                                 
|   
|(4) |  | Represents automobile allowance.                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   
|(5) |  | Represents temporary living expenses.                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   
|(6) |  | Ms. Whittles employment terminated on December 31, 2002.                                                                                                                                                                                                                                                                                                                                                                                                              
|   
|(7) |  | Represents automobile allowance of $7,800 and matching contributions
under our 401(k) Plan.                                                                                                                                                                                                                                                                                                                                                                            

Option Grants in Last Fiscal Year

The following table presents stock option grants made to each of the named
executive officers during the fiscal year ended December 31, 2002. Except for
Mr. Winkles, these option grants vest ratably over four years commencing on
the first anniversary of the date of grant. Mr. Winkles option grant vests
8.33% per quarter, with the remaining shares vesting on the third anniversary
of May 15, 2002, 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

|                    |  |                   |         |                 |  |          |      |            |  |     |       |     |  |  |         |  |  |                       |           |  |  |   |            | 
|------------------- |  | ----------------- | ------- | --------------- |  | -------- | ---- | ---------- |  | --- | ----- | --- |  |  | ------- |  |  | --------------------- | --------- |  |  | - | ---------- | 
|                    |  |                   |         |                 |  |          |      |            |  |     |       |     |  |  |         |  |  | Potential Realizable 
|                    |  |                   |         |                 |  |          |      |            |  |     |       |     |  |  |         |  |  | Value at Assumed     
|                    |  |                   |         |                 |  |          |      |            |  |     |       |     |  |  |         |  |  | Annual Rates of Stock
|                    |  |                   |         |                 |  |          |      |            |  |     |       |     |  |  |         |  |  | Price Appreciation   
|                    |  | Individual Grants |         | for Option Term
|                    |  |                   |         |                
|                    |  | Number of         |         | Percent of      |  |          |      |            |  |     |       |     |  |  |         |  |  |                       |           | 
|                    |  | Securities        |         | Total Options   |  | Exercise |      |            |  |     |       |     |  |  |         |  |  |                      
|                    |  | Underlying        |         | Granted to      |  | or Base  |      |            |  |     |       |     |  |  |         |  |  |                      
|                    |  | Options           |         | Employees in    |  | Price    |      | Expiration |  | 5%  |       | 10%
|Name                |  | Granted (#)       |         | Fiscal Year     |  | ($/Sh)   |      | Date       |  | ($) |       | ($)
|                    |  |                   |         |                 |  |          |      |            |  |     |       |    
|C. Christian Winkle |  |                   | 439,560 |                 |  |          | 25.7 | %          |  | $   | 20.12 |     |  |  | 5/15/12 |  |  | $                     | 5,560,434 |  |  | $ | 14,096,689 | 
|Susan Thomas Wittle |  |                   |        |                 |  |          |     |            |  |     |      |     |  |  |        |  |  |                       |          |  |  |   |           | 
|Boyd P. Gentry      |  |                   | 65,000  |                 |  |          | 3.8  |            |  |     | 20.12 |     |  |  | 5/15/12 |  |  |                       | 822,250   |  |  |   | 2,084,550  | 
|David F. Polakoff   |  |                   | 40,000  |                 |  |          | 2.3  |            |  |     | 20.12 |     |  |  | 5/15/12 |  |  |                       | 506,000   |  |  |   | 1,282,800  | 
|Stefano M. Miele    |  |                   | 40,000  |                 |  |          | 2.3  |            |  |     | 20.12 |     |  |  | 5/15/12 |  |  |                       | 506,000   |  |  |   | 1,282,800  | 

Option Exercises and Year End Option Values

No value was realized from the exercise of stock
options during the fiscal year ended December 31, 2002 because no options were exercised. The
following table presents unexercised options that were held at the end of our
2002 fiscal year by each named executive officer. Value of in-the-money
options would represent the aggregate

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market value of the underlying securities at December 31, 2002 minus the
aggregate exercise price payable for those shares.

Aggregated Option Exercises in Last Fiscal Year and FY-End Option Values

|                    |  |          |   |          |  |             |   |               |  |                            |         |                      |  |  |         |  |  |  |   |  |  |  |   | 
|------------------- |  | -------- | - | -------- |  | ----------- | - | ------------- |  | -------------------------- | ------- | -------------------- |  |  | ------- |  |  |  | - |  |  |  | - | 
|                    |  |          |   |          |  |             |   |               |  | Number of Securities       |         | Value of Unexercised
|                    |  |          |   |          |  |             |   |               |  | Underlying Unexercised     |         | In-the-Money Options
|                    |  |          |   |          |  |             |   |               |  | Options at Fiscal Year-End |         | at Fiscal Year-End  
|                    |  |          |   |          |  |             |   |               |  | (#)                        |         | ($)                 
|                    |  |          |   |          |  |             |   |               |  |                            |         |                     
|                    |  | Shares   |   |          |  |             |   |               |  |                            |         |                      |  |  |         |  |  |  |   |  |  | 
|                    |  | Acquired |   |          |  |             |   |               |  |                            |         |                      |  |  |         |  |  |  |   |  |  | 
|                    |  | on       |   | Value    |  |             |   |               |  |                            |         |                      |  |  |         |  |  |  |   | 
|                    |  | Exercise |   | Realized |  |             |   |               |  |                            |         |                      |  |  |         |  |  |  |   | 
|Name                |  | (#)      |   | ($)      |  | Exercisable |   | Unexercisable |  | Exercisable                |         | Unexercisable       
|                    |  |          |   |          |  |             |   |               |  |                            |         |                     
|C. Christian Winkle |  |          |  |          |  |             |  |               |  |                            | 109,845 |                      |  |  | 329,715 |  |  |  |  |  |  |  |  | 
|Susan Thomas Wittle |  |          |  |          |  |             |  |               |  |                            |        |                      |  |  |        |  |  |  |  |  |  |  |  | 
|Boyd P. Gentry      |  |          |  |          |  |             |  |               |  |                            |        |                      |  |  | 65,000  |  |  |  |  |  |  |  |  | 
|David F. Polakoff   |  |          |  |          |  |             |  |               |  |                            |        |                      |  |  | 40,000  |  |  |  |  |  |  |  |  | 
|Stefano M. Miele    |  |          |  |          |  |             |  |               |  |                            |        |                      |  |  | 40,000  |  |  |  |  |  |  |  |  | 

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.

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.

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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.

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, 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, 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.

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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.

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, 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.

Susan Thomas Whittle.We have entered into a separation agreement and general
release with Susan Thomas Whittle pursuant to which her employment with us
terminated as of December 31, 2002. We have agreed to pay Ms. Whittle
$330,500, less legal deductions, over a 52-week period during which Ms. Whittle
has agreed to remain available to provide consulting services to us as may be
requested by our Chief Executive Officer and our General Counsel.

Pursuant to the terms of the agreement, Ms. Whittle has agreed not to disclose
any confidential information for a period of two years following the execution
of the agreement and any trade secrets for as long as the trade secrets remain
confidential under applicable law. Ms. Whittle has agreed not to solicit any
client or prospective client of ours or solicit or hire our employees for one
year following the end of her employment.

Compensation Committee Interlocks and Insider Participation

Our compensation committee currently consists of Messrs. Lund, Daugherty and
Stearns. None of the members of our compensation committee was at any time
during our 2002 fiscal year, or any other time, an officer or employee of
Mariner. None of the members of the compensation committee serves as a member
of the board of directors 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.

54



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Mr. Daugherty is general counsel and a senior portfolio manager of Highland
Capital Management, L.P. Highland Capital is the general partner of Highland
Crusader Offshore Partners, L.P. and the investment advisor for Prospect Street
High Income Portfolio, Inc. Highland Crusader and Prospect Street beneficially
own over 5% of our common stock and are affiliated with Highland Loan Funding V
Ltd., which is a member of the syndicate of financial institutions serving as
lenders under our Senior Credit Facility. In connection with its participation
in this syndicate, Highland Loan Funding V is entitled to receive its pro rata
share of interest payments and any other customary fees under our Senior Credit
Facility.




ITEM  12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth, as of March 18, 2003, 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 executive officer named in the Summary Compensation Table above; 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 18, 2003. 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,
One Ravinia Drive, Suite 1500, Atlanta, Georgia 30346.

|                                                         |  |                  |           |            |  |  |      |  
|-------------------------------------------------------- |  | ---------------- | --------- | ---------- |  |  | ---- | -
|                                                         |  | Number of Shares |           | Percentage
|Beneficial Owner                                         |  | Owned            |           | Owned(1)  
|                                                         |  |                  |           |           
|Directors and Executive Officers:                        |  |                  |           |            |  |  |      |  
|C. Christian Winkle                                      |  |                  | 146,461   | (2)        |  |  | *    |  
|Susan Thomas Whittle                                     |  |                  |          |            |  |  |     |  
|Boyd P. Gentry                                           |  |                  | 16,250    | (3)        |  |  | *    |  
|David F. Polakoff, M.D.                                  |  |                  | 10,000    | (4)        |  |  | *    |  
|Stefano M. Miele                                         |  |                  | 10,000    | (4)        |  |  | *    |  
|Victor L. Lund                                           |  |                  | 25,000    | (5)        |  |  | *    |  
|Patrick H. Daugherty                                     |  |                  | 1,602,563 | (6)        |  |  | 8.0  | %
|Earl P. Holland                                          |  |                  | 12,500    | (7)        |  |  | *    |  
|Philip L. Maslowe                                        |  |                  | 12,500    | (7)        |  |  | *    |  
|Mohsin Y. Meghji                                         |  |                  | 17,500    | (7)(8)     |  |  | *    |  
|M. Edward Stearns                                        |  |                  | 1,756,096 | (9)        |  |  | 8.8  | %
|Directors and executive officers as a group (23 persons) |  |                  | 3,701,280 | (10)       |  |  | 18.5 | %
|5% Beneficial Owners:                                    |  |                  |           |            |  |  |      |  
|Oaktree Capital Management, LLC and affiliates           |  |                  | 4,809,419 | (11)       |  |  | 24.0 | %
|Foothill Capital Corporation and affiliates              |  |                  | 1,756,096 | (9)(12)    |  |  | 8.8  | %
|Highland Capital Management, L.P. and affiliates         |  |                  | 1,599,763 | (6)(13)    |  |  | 8.0  | %
|Halcyon Restructuring Fund, L.P.                         |  |                  | 1,574,967 | (14)       |  |  | 7.9  | %
|Greenlight Capital, L.L.C                                |  |                  | 1,562,929 | (15)       |  |  | 7.8  | %



---

|*   |  | Represents less than one percent of the outstanding shares of our common
stock at March 18, 2003.                                                                                                                                                                                                                                                                                                                   
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(1) |  | Based on 20,000,000 shares of our common stock outstanding as of March
18, 2003. Shares issuable under stock options or warrants exercisable
within 60 days of March 18, 2003 are treated as if outstanding for
purposes of computing the percentage ownership of the person holding these
securities but are not treated as outstanding for the purposes of
computing the percentage ownership of any other person.
|   
|(2) |  | Consists of options that are exercisable within 60 days of March 18, 2003
to acquire 146,461 shares of common stock.                                                                                                                                                                                                                                                                                                

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|(3)  |  | Consists of options that are exercisable within 60 days of March 18, 2003
to acquire 16,250 shares of common stock.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    
|(4)  |  | Consists of options that are exercisable within 60 days of March 18, 2003
to acquire 10,000 shares of common stock.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|    
|(5)  |  | Consists of options that are exercisable within 60 days of March 18, 2003
to acquire 25,000 shares of common stock.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|    
|(6)  |  | Based upon a Form 4 filed with the SEC on December 9, 2002 and the
Schedule 13D filed with the SEC on May 23, 2002 by Highland Capital
Management, L.P., Highland Crusader Offshore Partners, L.P., Prospect
Street High Income Portfolio, Inc. and Mr. Daugherty. Includes 1,437,010,
77,673 and 72,580 shares of common stock held by Highland Crusader,
Prospect Street and Highland Capital, respectively. Also includes options
held by Mr. Daugherty that are exercisable within 60 days of March 18,
2003 to acquire 12,500 shares of common stock. Mr. Daugherty is an
employee of Highland Capital, which is the general partner of Highland
Crusader and the investment advisor for Prospect Street. Under an
arrangement between Mr. Daugherty and Highland Capital, Mr. Daugherty is
required to assign or remit all compensation, including stock options,
received as a director of Mariner to his employer. Accordingly, Mr.
Daugherty disclaims beneficial ownership of these securities, except to
the extent of his pecuniary interest therein.                                                                                                                                                                                                                                                                                                                                                                    
|    
|(7)  |  | Includes options that are exercisable within 60 days of March 18, 2003 to
acquire 12,500 shares of common stock.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|    
|(8)  |  | Pursuant to an arrangement between Mr. Meghji and LM + Co., Mr. Meghji is
required to assign or remit all compensation, including stock options,
received as a director of Mariner to his employer. Accordingly, Mr.
Meghji disclaims beneficial ownership of these securities.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|    
|(9)  |  | Based upon a Form 4 filed with the SEC on November 21, 2002 by Mr.
Stearns and Amendment No. 1 to Schedule 13G filed with the SEC on February
14, 2003 by Foothill Partners III, L.P., Foothill Partners IV, L.P., FP IV
GP, LLC, and the following managing partners/members: The Foothill Group,
Inc., Stearns Family Trust 2001, Dennis R. Ascher, Jeffery T. Nikora
Living Trust and John F. Nickoll Living Trust. FP IV GP is the general
partner of Foothill Partners IV and the managing partners/members named
above are the managing members of Foothill Partners IV. The managing
partners/members are the general partners of Foothill Partners III. Mr.
Stearns is the trustee of the Stearns Family Trust 2001. Foothill
Partners III beneficially owns 933,386 shares of common stock and its
affiliate, Foothill Partners IV, beneficially owns 810,210 shares of
common stock. Includes options held by Mr. Stearns that are exercisable
within 60 days of March 18, 2003 to acquire 12,500 shares of common stock.
Mr. Stearns is the managing general partner of Foothill Partners III and
Foothill Partners IV. Pursuant to an arrangement between Mr. Stearns and
Foothill Capital Corporation, Mr. Stearns is required to assign or remit
all compensation, including stock options, received as a director of
Mariner to Foothill. Accordingly, Mr. Stearns disclaims beneficial
ownership of these securities.
|    
|(10) |  | See notes (1)  (9).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|    
|(11) |  | Based upon Amendment No.1 to Schedule 13D filed with the SEC on November
12, 2002 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 2,497,589 shares of our common stock, Opportunities
III has sole power to vote and dispose of 2,083,536 shares of our common
stock and certain other affiliates of Oaktree Capital Management
beneficially own, in the aggregate, 228,294 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                                                                                                                                                                                                                         

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|     |  | of the Oaktree Funds and Accounts is 333 South Grand Avenue,
28th Floor, Los Angeles, CA 90071.                                                                                                                         
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    
|(12) |  | The address of Foothill Capital is 2450 Colorado Avenue, Suite 3000,
Santa Clara, CA 90404.                                                                                                                             
|    
|(13) |  | The address of Highland Capital, Highland Crusader and Prospect Street is
Two Galleria Tower, 13455 Noel Road, Suite 1300, Dallas, TX 75240.                                                                            
|    
|(14) |  | The address of Halcyon is 477 Madison Avenue, 8th Floor, New York, NY 10002.                                                                                                                                            
|    
|(15) |  | Based upon Amendment
No. 1 to Schedule 13G filed with the SEC on March
18, 2003 by Greenlight Capital, L.L.C., David Einhorn and Jeffrey A.
Kerwin. Their address is 420 Lexington Ave., Suite 1740, New York, NY
10170.




ITEM  13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Transactions with Management

In December 2002, in connection with C. Christian Winkles agreement to
relocate his personal residence to Atlanta, Georgia, the site of our corporate
headquarters, we purchased Mr. Winkle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 $1.4 million.
Additionally, we 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 our corporate relocation policy.

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.

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

Each of the entities named as five percent beneficial owners in our principal
stockholders table above held prepetition claims in our bankruptcy cases and,
as a consequence, received pro rata distributions made pursuant to our Joint
Plan. These distributions are more fully described elsewhere in our filings
with the SEC.

Loughlin Meghji + Company

Mohsin Y. Meghji, one of our directors, is a principal in LM+Co., the financial
advisor to the senior lenders steering committee in our bankruptcy
proceedings. This committee represented the interests of lenders under our
prepetition senior credit facility during our bankruptcy proceedings. During
these proceedings, we paid LM+Co. $526,996 in fees in
connection with its representation of this committee.

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

Foothill Group and Foothill Income Trust, affiliates of Foothill Capital
Corporation, which, together with its affiliates, beneficially owns over 5% of
our common stock, are members of the syndicate of financial institutions
serving as lenders under the revolving and term loan facilities of our Senior
Credit Facility. In connection with their participation in this syndicate,
Foothill Group and Foothill Income Trust are entitled to receive their 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 serving as lenders under our
Senior Secured Notes. In connection with their participation in this
syndicate, they are entitled to receive their pro rata share of interest
payments and any other customary fees under the Senior Secured Notes. M.
Edward Stearns, one of our 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 Senior Credit Facility. This represented their pro
rata share of commitment fees, paid to all lenders, related to our
Senior Credit Facility.

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Highland Capital Management

Highland Capital Management, together with certain
of its affiliates, beneficially owns over 5% of our common
stock. Certain affiliates of Highland Capital are members of the syndicate of
financial institutions serving as
lenders under our Senior Credit Facility. In connection with their participation
in this syndicate, these affiliates are entitled to receive their pro rata
share of interest payments and any other customary fees under the Senior Credit
Facility. Patrick Daugherty, one of our directors, is general counsel and a
senior portfolio manager of Highland Capital, the general partner of Highland
Crusader and the investment advisor for Prospect Street High Income Portfolio,
affiliates of Highland Capital and stockholders of ours. In May 2002, Highland Capital
and its affiliates received $0.8 million as lenders under our Senior Credit
Facility. This represented their pro rata share of commitment fees,
paid to all lenders, related to our Senior Credit Facility.




ITEM  14.   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
Exchange Act reports. We periodically review and evaluate these disclosure
controls and procedures systems to ensure this information is accumulated and
communicated to management, including our Chief Executive Officer and Chief
Financial Officer, as appropriate, to allow timely decisions about required
disclosure. In completing our review and evaluation 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.

Also, in connection with the annual audit of our financial statements, our
independent auditor reported to senior management and the audit committee that
they concluded we currently have an insufficient number of corporate accounting
personnel with the appropriate experience for their responsibilities and the
accurate assessment and application of accounting principles. Since our
emergence from bankruptcy, we have been addressing and continue to address this
issue through the hiring of additional qualified accounting and finance
personnel. Notwithstanding the foregoing, 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 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.




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:

|                                                                                                                                                                                                                                                                              |  |      |     | 
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | --- | 
|                                                                                                                                                                                                                                                                              |  | Page
|                                                                                                                                                                                                                                                                              |  |     
|Report of Independent Auditors                                                                                                                                                                                                                                                |  |      | F-2 | 
|Consolidated Balance Sheets for the Reorganized Company as of
December 31, 2002 and for the Predecessor Company as of December 31,
2001 and September 30, 2001                                                                                                                |  |      | F-3 | 
|Consolidated Statements of Operations for the Reorganized Company 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 years ended September 30, 2001 and 2000 |  |      | F-4 | 

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|                                                                                                                                                                                                                                                                                                  |  |  |     | 
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  |  | --- | 
|Consolidated Statements of Stockholders Equity (Deficit) for the
Reorganized Company for the eight months ended December 31, 2002 and
for the Predecessor Company for the four months ended April 30, 2002,
three months ended December 31, 2001 and the years ended September
30, 2001 and 2000 |  |  | F-5 | 
|Consolidated Statements of Cash Flows for the Reorganized Company 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 years ended September 30, 2001and
2000                  |  |  | F-6 | 
|Notes to Consolidated Financial Statements                                                                                                                                                                                                                                                        |  |  | F-7 | 



|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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|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).                                                                                    
|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 & 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).                                                                                                                                                                                                                                                                                                                                                                                                                                    
|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).                                                                                                                                                     

60



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|      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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).                                                                                                                                                                                                                                        
|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.                                                                                                                                                                                                                                                                
|21    |  | Subsidiaries of the Company.                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|23    |  | Consent of Ernst & Young LLP.                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|99.1  |  | Confirmation Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                          

61



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|     |  |                                                                                                                       
|---- |  | ----------------------------------------------------------------------------------------------------------------------
|99.2 |  | Confirmation Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.



---

|+ |  | Management contract or compensatory plan or arrangement.
|- |  | --------------------------------------------------------



|(b) |  | Reports on Form 8-K
|--- |  | -------------------
|   
|    |  | Not applicable.    

62



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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: April 10, 2003

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 WinkleC. Christian Winkle   |  | President, Chief Executive Officer and
Director (Principal Executive Officer)              |  | April 10, 2003
|                                            
|                                             |  |                                                                                            |  |               
|                                            
|/s/ Michael E. BoxerMichael E. Boxer         |  | Executive Vice President and
Chief Financial Officer (Principal
Financial Officer)         |  | April 10, 2003
|                                            
|                                             |  |                                                                                            |  |               
|                                            
|/s/ William C. StraubWilliam C. Straub       |  | Senior Vice President, Controller,
Chief Accounting Officer (Principal
Accounting Officer) |  | April 10, 2003
|                                            
|                                             |  |                                                                                            |  |               
|                                            
|/s/ Victor L. LundVictor L. Lund             |  | Chairman of the Board                                                                      |  | April 10, 2003
|                                            
|                                             |  |                                                                                            |  |               
|                                            
|/s/ Patrick H. DaughertyPatrick H. Daugherty |  | Director                                                                                   |  | April 10, 2003
|                                            
|                                             |  |                                                                                            |  |               
|                                            
|/s/ Earl P. HollandEarl P. Holland           |  | Director                                                                                   |  | April 10, 2003
|                                            
|                                             |  |                                                                                            |  |               
|                                            
|/s/ Philip L. MaslowePhilip L. Maslowe       |  | Director                                                                                   |  | April 10, 2003
|                                            
|                                             |  |                                                                                            |  |               
|                                            
|/s/ Mohsin Y. MeghjiMohsin Y. Meghji         |  | Director                                                                                   |  | April 10, 2003
|                                            
|                                             |  |                                                                                            |  |               
|                                            
|/s/ M. Edward StearnsM. Edward Stearns       |  | Director                                                                                   |  | April 10, 2003

63



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##### Table of Contents



CERTIFICATION

I, C. Christian Winkle, certify that:



|1. |  | I have reviewed this annual report on Form 10-K of Mariner Health Care,
Inc.;                                                                                                                                                                                                                                           
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|2. |  | Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
|  
|3. |  | Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual
report;                   
|  
|4. |  | The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:                                                                                               



| | a) |  | designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | evaluated the effectiveness of the registrants disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the Evaluation Date); and                                                                                                  
|
| | c) |  | presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;                                                                                                                        



|5. |  | The registrants other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the
equivalent function):
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrants ability to
record, process, summarize and report financial data and have
identified for the registrants auditors any material weaknesses in
internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrants
internal controls; and                                                                                                                                        



|6. |  | The registrants other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |  |                                                                                                                                                                                                                                                                                                                                                                                       
|   |  | Date:   April 10, 2003                                                                                                                                                                                                                                                                                                                                                                



| | /s/ C. Christian Winkle
C. Christian Winkle
President and
Chief Executive Officer (Principal
Executive Officer)
| | ---------------------------------------------------------------------------------------------------------------

64



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CERTIFICATION

I, Michael E. Boxer, certify that:



|1. |  | I have reviewed this annual report on Form 10-K of Mariner Health Care,
Inc.;                                                                                                                                                                                                                                           
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|2. |  | Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
|  
|3. |  | Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual
report;                   
|  
|4. |  | The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:                                                                                               



| | a) |  | designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | evaluated the effectiveness of the registrants disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the Evaluation Date); and                                                                                                  
|
| | c) |  | presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;                                                                                                                        



|5. |  | The registrants other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the
equivalent function):
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrants ability to
record, process, summarize and report financial data and have
identified for the registrants auditors any material weaknesses in
internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrants
internal controls; and                                                                                                                                        



|6. |  | The registrants other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |  |                                                                                                                                                                                                                                                                                                                                                                                       
|   |  | Date:   April 10, 2003                                                                                                                                                                                                                                                                                                                                                                



| | /s/ Michael E. Boxer
Michael E. Boxer
Executive Vice President and
Chief Financial Officer (Principal
Financial Officer)
| | ------------------------------------------------------------------------------------------------------------------------

65



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##### Table of Contents



MARINER HEALTH CARE, INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2002

|                                                                                                                                                                                                                                                                                                      |  |      |     | 
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | --- | 
|                                                                                                                                                                                                                                                                                                      |  | Page
|                                                                                                                                                                                                                                                                                                      |  |     
|Report of Independent Auditors                                                                                                                                                                                                                                                                        |  |      | F-2 | 
|                                                                                                                                                                                                                                                                                                      |  |      |     | 
|Consolidated Balance Sheets for the Reorganized Company as of December 31, 2002 and for
the Predecessor Company as of December 31, 2001 and September 30, 2001                                                                                                                                        |  |      | F-3 | 
|                                                                                                                                                                                                                                                                                                      |  |      |     | 
|Consolidated Statements of Operations for the Reorganized Company 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 years ended September 30, 2001, and 2000                    |  |      | F-4 | 
|                                                                                                                                                                                                                                                                                                      |  |      |     | 
|Consolidated Statements of Stockholders Equity (Deficit) for the Reorganized Company 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 years ended September 30, 2001
and 2000 |  |      | F-5 | 
|                                                                                                                                                                                                                                                                                                      |  |      |     | 
|Consolidated Statements of Cash Flows for the Reorganized Company 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 years ended September 30, 2001 and 2000                     |  |      | F-6 | 
|                                                                                                                                                                                                                                                                                                      |  |      |     | 
|Notes to Consolidated Financial Statements                                                                                                                                                                                                                                                            |  |      | F-7 | 

F-1



---



##### 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, 2002, December 31, 2001 and
September 30, 2001, and the related consolidated statements of operations,
stockholders equity (deficit) and cash flows for the eight months ended
December 31, 2002, the four months ended April 30, 2002, the three months ended
December 31, 2001 and the years ended September 30, 2001 and 2000. Our audits
also included the financial statement schedule listed in the index at Item 15.
These consolidated financial statements and schedule are 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, 2002 and 2001 and
September 30, 2001, and the consolidated results of their operations and their
cash flows for the eight months ended December 31, 2002, the four months ended
April 30, 2002, the three months ended December 31, 2001 and the years ended
September 30, 2001 and 2000, 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 1, 2 and 4 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
April 7, 2003

F-2



---



##### Table of Contents



MARINER HEALTH CARE, INC.
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share amounts)

|                                                                           |                                                                                                                           |                                                      |                                                |         |           |              |  |  |           |                     |            |               |           |            |            |   |  | 
|-------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------- | ---------------------------------------------- | ------- | --------- | ------------ |  |  | --------- | ------------------- | ---------- | ------------- | --------- | ---------- | ---------- | - |  | 
|                                                                           |                                                                                                                           |                                                      |                                                |         |           | Reorganized  |  |  |           |                     |            |               |           |            |            |  
|                                                                           |                                                                                                                           |                                                      |                                                |         |           | Company      |  |  |           | Predecessor Company
|                                                                           |                                                                                                                           |                                                      |                                                |         |           |              |  |  |           |                    
|                                                                           |                                                                                                                           |                                                      |                                                |         |           | December 31, |  |  |           | December 31,        |            | September 30,
|                                                                           |                                                                                                                           |                                                      |                                                |         |           | 2002         |  |  |           | 2001                |            | 2001         
|                                                                           |                                                                                                                           |                                                      |                                                |         |           |              |  |  |           |                     |            |              
|                                                                           |                                                                                                                           |                                                      |                                                | ASSETS  |           |              |  |  |           |                     |            |               |           |            |            |   |  | 
|                                                                           |                                                                                                                           |                                                      |                                                |         |           |              |  |  |           |                     |            |               |          
|Current assets                                                             |                                                                                                                           |                                                      |                                                |         |           |              |  |  |           |                     |            |               |           |           
|                                                                           | Cash and cash equivalents                                                                                                 |                                                      | $                                              | 38,618  |           |              |  |  | $         | 213,740             |            |               | $         | 209,050    |           
|                                                                           | Receivables, net of allowance for doubtful accounts of $72,996,
$61,049 and $53,286                                       |                                                      |                                                | 264,092 |           |              |  |  |           | 238,736             |            |               |           | 241,860    |           
|                                                                           | Inventories                                                                                                               |                                                      |                                                | 7,405   |           |              |  |  |           | 6,720               |            |               |           | 6,769      |           
|                                                                           | Net assets of discontinued operations                                                                                     |                                                      |                                                |        |           |              |  |  |           | 59,053              |            |               |           | 60,360     |           
|                                                                           | Prepaid expenses and other current assets                                                                                 |                                                      |                                                | 27,542  |           |              |  |  |           | 34,628              |            |               |           | 42,164     |           
|                                                                           |                                                                                                                           |                                                      |                                                |         |           |              |  |  |           |                     |            |               |           |            |           
|                                                                           |                                                                                                                           | Total current assets                                 |                                                |         | 337,657   |              |  |  |           |                     | 552,877    |               |           |            | 560,203    |  
|                                                                           |                                                                                                                           |                                                      |                                                |         |           |              |  |  |           |                     |            |               |          
|Property and equipment, net                                                |                                                                                                                           |                                                      | 567,260                                        |         |           |              |  |  | 412,965   |                     |            |               | 416,026   |           
|Reorganization value in excess of amounts allocable to identifiable assets |                                                                                                                           |                                                      | 201,388                                        |         |           |              |  |  |          |                     |            |               |          |           
|Goodwill, net                                                              |                                                                                                                           |                                                      | 6,797                                          |         |           |              |  |  | 193,651   |                     |            |               | 196,223   |           
|Restricted investments                                                     |                                                                                                                           |                                                      | 38,693                                         |         |           |              |  |  | 37,767    |                     |            |               | 32,831    |           
|Other assets                                                               |                                                                                                                           |                                                      | 26,943                                         |         |           |              |  |  | 25,095    |                     |            |               | 25,695    |           
|                                                                           |                                                                                                                           |                                                      |                                                |         |           |              |  |  |           |                     |            |               |           |            |           
|                                                                           |                                                                                                                           | Total assets                                         |                                                | $       | 1,178,738 |              |  |  |           | $                   | 1,222,355  |               |           | $          | 1,230,978  |  
|                                                                           |                                                                                                                           |                                                      |                                                |         |           |              |  |  |           |                     |            |               |           |            |           
|                                                                           |                                                                                                                           |                                                      | LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIT) |         |           |              |  |  |           |                     |            |               |           |            |            |   | 
|                                                                           |                                                                                                                           |                                                      |                                                |         |           |              |  |  |           |                     |            |               |          
|Current liabilities                                                        |                                                                                                                           |                                                      |                                                |         |           |              |  |  |           |                     |            |               |           |           
|                                                                           | Current maturities of long-term debt                                                                                      |                                                      | $                                              | 9,793   |           |              |  |  | $         |                    |            |               | $         |           |           
|                                                                           | Accounts payable                                                                                                          |                                                      |                                                | 48,417  |           |              |  |  |           | 66,217              |            |               |           | 72,608     |           
|                                                                           | Accrued compensation and benefits                                                                                         |                                                      |                                                | 68,444  |           |              |  |  |           | 91,368              |            |               |           | 100,488    |           
|                                                                           | Accrued insurance obligations                                                                                             |                                                      |                                                | 28,650  |           |              |  |  |           | 24,725              |            |               |           | 24,764     |           
|                                                                           | Other current liabilities                                                                                                 |                                                      |                                                | 65,787  |           |              |  |  |           | 22,926              |            |               |           | 27,899     |           
|                                                                           |                                                                                                                           |                                                      |                                                |         |           |              |  |  |           |                     |            |               |           |            |           
|                                                                           |                                                                                                                           | Total current liabilities                            |                                                |         | 221,091   |              |  |  |           |                     | 205,236    |               |           |            | 225,759    |  
|                                                                           |                                                                                                                          
|Liabilities subject to compromise                                          |                                                                                                                           |                                                      |                                               |         |           |              |  |  | 2,289,600 |                     |            |               | 2,293,820 |           
|                                                                           |                                                                                                                          
|Long-term debt, net of current maturities                                  |                                                                                                                           |                                                      | 474,969                                        |         |           |              |  |  | 59,688    |                     |            |               | 59,688    |           
|Long-term insurance reserves                                               |                                                                                                                           |                                                      | 195,562                                        |         |           |              |  |  | 107,734   |                     |            |               | 92,769    |           
|Other liabilities                                                          |                                                                                                                           |                                                      | 14,044                                         |         |           |              |  |  | 22,785    |                     |            |               | 25,827    |           
|Minority interest                                                          |                                                                                                                           |                                                      | 4,677                                          |         |           |              |  |  | 4,572     |                     |            |               | 4,624     |           
|                                                                           |                                                                                                                           |                                                      |                                                |         |           |              |  |  |           |                     |            |               |           |            |           
|                                                                           |                                                                                                                           | Total liabilities                                    |                                                |         | 910,343   |              |  |  |           |                     | 2,689,615  |               |           |            | 2,702,487  |  
|                                                                           |                                                                                                                          
|Commitments and contingencies                                              |                                                                                                                           |                                                      |                                                |         |           |              |  |  |           |                     |            |               |           |           
|                                                                           |                                                                                                                          
|Stockholders equity (deficit)                                             |                                                                                                                           |                                                      |                                                |         |           |              |  |  |           |                     |            |               |           |           
|                                                                           | Reorganized Company preferred stock, $.01 par value; 10,000,000 shares
authorized; none issued or outstanding             |                                                      |                                                |        |           |              |  |  |           |                    |            |               |           |           |           
|                                                                           | Predecessor Company preferred stock, $.01 par value; 5,000,000 shares
authorized; none issued or outstanding              |                                                      |                                                |        |           |              |  |  |           |                    |            |               |           |           |           
|                                                                           | Reorganized Company common stock, $.01 par value; 80,000,000 shares
authorized; 20,000,000 shares issued and outstanding  |                                                      |                                                | 200     |           |              |  |  |           |                    |            |               |           |           |           
|                                                                           | Predecessor Company common stock, $.01 par value; 500,000,000 shares
authorized; 73,688,379 shares issued and outstanding |                                                      |                                                |        |           |              |  |  |           | 737                 |            |               |           | 737        |           
|                                                                           | Reorganized Company warrants to purchase common stock                                                                     |                                                      |                                                | 935     |           |              |  |  |           |                    |            |               |           |           |           
|                                                                           | Capital surplus                                                                                                           |                                                      |                                                | 358,977 |           |              |  |  |           | 980,952             |            |               |           | 980,952    |           
|                                                                           | Accumulated deficit                                                                                                       |                                                      |                                                | (92,048 | )         |              |  |  |           | (2,449,378          | )          |               |           | (2,453,773 | )         
|                                                                           | Accumulated other comprehensive income                                                                                    |                                                      |                                                | 331     |           |              |  |  |           | 429                 |            |               |           | 575        |           
|                                                                           |                                                                                                                           |                                                      |                                                |         |           |              |  |  |           |                     |            |               |           |            |           
|                                                                           |                                                                                                                           | Total stockholders equity (deficit)                 |                                                |         | 268,395   |              |  |  |           |                     | (1,467,260 | )             |           |            | (1,471,509 | )
|                                                                           |                                                                                                                           |                                                      |                                                |         |           |              |  |  |           |                     |            |               |           |            |           
|                                                                           |                                                                                                                           | Total liabilities and stockholders equity (deficit) |                                                | $       | 1,178,738 |              |  |  |           | $                   | 1,222,355  |               |           | $          | 1,230,978  |  
|                                                                           |                                                                                                                           |                                                      |                                                |         |           |              |  |  |           |                     |            |               |           |            |           

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

F-3



---



##### Table of Contents



MARINER HEALTH CARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except per share amounts)

|                                                             |                                                                                                                                                                                                                                                       |                          |           |              |           |  |  |                     |           |              |         |                                 |         |         |         |   |           |           |           |   |           |           |           | 
|------------------------------------------------------------ | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------ | --------- | ------------ | --------- |  |  | ------------------- | --------- | ------------ | ------- | ------------------------------- | ------- | ------- | ------- | - | --------- | --------- | --------- | - | --------- | --------- | --------- | 
|                                                             |                                                                                                                                                                                                                                                       |                          |           | Reorganized  |           |  |  |                     |          
|                                                             |                                                                                                                                                                                                                                                       |                          |           | Company      |           |  |  | Predecessor Company
|                                                             |                                                                                                                                                                                                                                                       |                          |           |              |           |  |  |                    
|                                                             |                                                                                                                                                                                                                                                       |                          |           | Eight Months |           |  |  | Four Months         |           | Three Months |         |                                 |         |         |         |   |           |          
|                                                             |                                                                                                                                                                                                                                                       |                          |           | Ended        |           |  |  | Ended               |           | Ended        |         | Fiscal Year Ended September 30,
|                                                             |                                                                                                                                                                                                                                                       |                          |           | December 31, |           |  |  | April 30,           |           | December 31, |         |                                
|                                                             |                                                                                                                                                                                                                                                       |                          |           | 2002         |           |  |  | 2002                |           | 2001         |         | 2001                            |         | 2000   
|                                                             |                                                                                                                                                                                                                                                       |                          |           |              |           |  |  |                     |           |              |         |                                 |         |        
|Net revenue                                                  |                                                                                                                                                                                                                                                       | $                        | 1,183,657 |              |           |  |  | $                   | 601,437   |              |         | $                               | 458,151 |         |         | $ | 1,872,135 |           |           | $ | 1,879,307 |          
|Costs and expenses                                           |                                                                                                                                                                                                                                                       |                          |           |              |           |  |  |                     |           |              |         |                                 |         |         |         |   |           |           |           |   |           |          
|                                                             | Operating expense                                                                                                                                                                                                                                     |                          |           | 990,027      |           |  |  |                     |           | 522,775      |         |                                 |         | 386,848 |         |   |           | 1,587,892 |           |   |           | 1,596,710 |          
|                                                             | General and administrative                                                                                                                                                                                                                            |                          |           | 121,165      |           |  |  |                     |           | 55,997       |         |                                 |         | 42,721  |         |   |           | 192,956   |           |   |           | 220,509   |          
|                                                             | Depreciation and amortization                                                                                                                                                                                                                         |                          |           | 23,152       |           |  |  |                     |           | 11,733       |         |                                 |         | 11,046  |         |   |           | 49,399    |           |   |           | 49,235    |          
|                                                             | Impairment of long-lived assets                                                                                                                                                                                                                       |                          |           | 84,600       |           |  |  |                     |           |             |         |                                 |         |        |         |   |           |          |           |   |           | 19,413    |          
|                                                             | Loss on settlement with government                                                                                                                                                                                                                    |                          |           |             |           |  |  |                     |           |             |         |                                 |         |        |         |   |           | 33,410    |           |   |           |          |          
|                                                             |                                                                                                                                                                                                                                                       |                          |           |              |           |  |  |                     |           |              |         |                                 |         |         |         |   |           |           |           |   |           |          
|                                                             |                                                                                                                                                                                                                                                       | Total costs and expenses |           |              | 1,218,944 |  |  |                     |           |              | 590,505 |                                 |         |         | 440,615 |   |           |           | 1,863,657 |   |           |           | 1,885,867 | 
|                                                             |                                                                                                                                                                                                                                                       |                          |           |              |           |  |  |                     |           |              |         |                                 |         |         |         |   |           |           |           |   |           |          
|Operating (loss) income                                      |                                                                                                                                                                                                                                                       |                          | (35,287   | )            |           |  |  |                     | 10,932    |              |         |                                 | 17,536  |         |         |   | 8,478     |           |           |   | (6,560    | )        
|                                                             |                                                                                                                                                                                                                                                       |                          |           |              |           |  |  |                     |           |              |         |                                 |         |        
|Other income (expenses)                                      |                                                                                                                                                                                                                                                       |                          |           |              |           |  |  |                     |           |              |         |                                 |         |         |         |   |           |           |           |   |           |          
|                                                             | Interest expense (Contractual interest for the four
months ended April 30, 2002 was $45,697, the three
months ended December 31, 2001 was $43,487 and
for the fiscal years ended September 30, 2001 and
2000 was $201,066 and $238,911, respectively) |                          |           | (27,166      | )         |  |  |                     |           | (3,017       | )       |                                 |         | (3,474  | )       |   |           | (5,171    | )         |   |           | (71,905   | )        
|                                                             | Interest income                                                                                                                                                                                                                                       |                          |           | 5,485        |           |  |  |                     |           | 1,154        |         |                                 |         | 2,603   |         |   |           | 6,007     |           |   |           | 11,366    |          
|                                                             | Reorganization items                                                                                                                                                                                                                                  |                          |           |             |           |  |  |                     |           | 1,394,309    |         |                                 |         | (13,153 | )       |   |           | (47,721   | )         |   |           | (10,816   | )        
|                                                             | Other                                                                                                                                                                                                                                                 |                          |           | (336         | )         |  |  |                     |           | 1,495        |         |                                 |         | (15     | )       |   |           | (462      | )         |   |           | 2,261     |          
|                                                             |                                                                                                                                                                                                                                                       |                          |           |              |           |  |  |                     |           |              |         |                                 |         |         |         |   |           |           |           |   |           |          
|(Loss) income from continuing operations before income
taxes |                                                                                                                                                                                                                                                       |                          | (57,304   | )            |           |  |  |                     | 1,404,873 |              |         |                                 | 3,497   |         |         |   | (38,869   | )         |           |   | (75,654   | )        
|Provision (benefit) for income taxes                         |                                                                                                                                                                                                                                                       |                          | 1,010     |              |           |  |  |                     |          |              |         |                                 |        |         |         |   | (4,807    | )         |           |   | (19,374   | )        
|                                                             |                                                                                                                                                                                                                                                       |                          |           |              |           |  |  |                     |           |              |         |                                 |         |         |         |   |           |           |           |   |           |          
|(Loss) income from continuing operations                     |                                                                                                                                                                                                                                                       |                          | (58,314   | )            |           |  |  |                     | 1,404,873 |              |         |                                 | 3,497   |         |         |   | (34,062   | )         |           |   | (56,280   | )        
|                                                             |                                                                                                                                                                                                                                                       |                          |           |              |           |  |  |                     |           |              |         |                                 |         |        
|Discontinued operations                                      |                                                                                                                                                                                                                                                       |                          |           |              |           |  |  |                     |           |              |         |                                 |         |         |         |   |           |           |           |   |           |          
|                                                             | Income (loss) from operations of discontinued
pharmacy operations                                                                                                                                                                                     |                          |           |             |           |  |  |                     |           |             |         |                                 |         | 898     |         |   |           | 667       |           |   |           | (2,705    | )        
|                                                             | Gain on sale of discontinued
pharmacy operations                                                                                                                                                                                                      |                          |           |             |           |  |  |                     |           | 29,082       |         |                                 |         |        |         |   |           |          |           |   |           |          |          
|                                                             |                                                                                                                                                                                                                                                       |                          |           |              |           |  |  |                     |           |              |         |                                 |         |         |         |   |           |           |           |   |           |          
|Net (loss) income                                            |                                                                                                                                                                                                                                                       | $                        | (58,314   | )            |           |  |  | $                   | 1,433,955 |              |         | $                               | 4,395   |         |         | $ | (33,395   | )         |           | $ | (58,985   | )        
|                                                             |                                                                                                                                                                                                                                                       |                          |           |              |           |  |  |                     |           |              |         |                                 |         |         |         |   |           |           |           |   |           |          
|Earnings (loss) per share  basic and diluted                |                                                                                                                                                                                                                                                       |                          |           |              |           |  |  |                     |           |              |         |                                 |         |         |         |   |           |           |           |   |           |          
|                                                             | (Loss) income from continuing operations                                                                                                                                                                                                              |                          | $         | (2.92        | )         |  |  |                     | $         | 19.07        |         |                                 | $       | 0.05    |         |   | $         | (0.46     | )         |   | $         | (0.76     | )        
|                                                             | Earnings (loss) from discontinued operations                                                                                                                                                                                                          |                          |           |             |           |  |  |                     |           | 0.39         |         |                                 |         | 0.01    |         |   |           | 0.01      |           |   |           | (0.04     | )        
|                                                             |                                                                                                                                                                                                                                                       |                          |           |              |           |  |  |                     |           |              |         |                                 |         |         |         |   |           |           |           |   |           |          
|                                                             | Net (loss) income per share                                                                                                                                                                                                                           |                          | $         | (2.92        | )         |  |  |                     | $         | 19.46        |         |                                 | $       | 0.06    |         |   | $         | (0.45     | )         |   | $         | (0.80     | )        
|                                                             |                                                                                                                                                                                                                                                       |                          |           |              |           |  |  |                     |           |              |         |                                 |         |         |         |   |           |           |           |   |           |          

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

F-4



---



##### Table of Contents



MARINER HEALTH CARE, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT)
(dollars and shares in thousands)

|                                              |                                                              |        |              |           |          |       |         |         |             |         |          |        |  |       |               |   |  |   |            |           |             |   |        |       |   |   |            |           |  
|--------------------------------------------- | ------------------------------------------------------------ | ------ | ------------ | --------- | -------- | ----- | ------- | ------- | ----------- | ------- | -------- | ------ |  | ----- | ------------- | - |  | - | ---------- | --------- | ----------- | - | ------ | ----- | - | - | ---------- | --------- | -
|                                              |                                                              |        |              |           |          |       |         |         |             |         | Warrants |        |  |       |               |   |  |   |            |           | Accumulated |   |        |       |  
|                                              |                                                              |        |              |           |          |       |         |         |             |         | to       |        |  |       |               |   |  |   |            |           | Other       |   |        |       |  
|                                              |                                                              |        | Common Stock |           | Purchase |       |         |         |             |         |          |        |  |       | Comprehensive |   |  |   |           
|                                              |                                                              |        |              |           | Common   |       | Capital |         | Accumulated |         | Income   |        |  |       |              
|Predecessor Company                           |                                                              | Shares |              | Par Value |          | Stock |         | Surplus |             | Deficit |          | (Loss) |  | Total
|                                              |                                                              |        |              |           |          |       |         |         |             |         |          |        |  |      
|Balance, September 30, 1999                   |                                                              |        | 73,695       |           |          | $     | 737     |         |             | $       |         |        |  | $     | 980,952       |   |  | $ | (2,361,393 | )         |             | $ | (6,315 | )     |   | $ | (1,386,019 | )        
|                                             
|Comprehensive loss                            |                                                              |        |              |           |          |       |         |         |             |         |          |        |  |       |               |   |  |   |            |           |             |   |        |       |   |   |            |          
|                                              | Net loss                                                     |        |              |          |          |       |         |        |             |         |          |       |  |       |               |  |  |   |            | (58,985   | )           |   |        |      |   |   |            | (58,985   | )
|                                              | Unrealized gain on securities
available-for-sale, net of tax |        |              |          |          |       |         |        |             |         |          |       |  |       |               |  |  |   |            |          |             |   |        | 4,827 |   |   |            | 4,827     |  
|                                              |                                                             
|Comprehensive loss                            |                                                              |        |              |           |          |       |         |         |             |         |          |        |  |       |               |   |  |   |            |           |             |   |        |       |   |   | (54,158    | )        
|Retirement of stock                           |                                                              |        | (7           | )         |          |       |        |         |             |         |         |        |  |       |              |   |  |   |           |           |             |   |       |       |   |   |           |          
|                                              |                                                              |        |              |           |          |       |         |         |             |         |          |        |  |       |               |   |  |   |            |           |             |   |        |       |   |   |            |          
|Balance, September 30, 2000                   |                                                              |        | 73,688       |           |          |       | 737     |         |             |         |         |        |  |       | 980,952       |   |  |   | (2,420,378 | )         |             |   | (1,488 | )     |   |   | (1,440,177 | )        
|                                             
|Comprehensive loss                            |                                                              |        |              |           |          |       |         |         |             |         |          |        |  |       |               |   |  |   |            |           |             |   |        |       |   |   |            |          
|                                              | Net loss                                                     |        |              |          |          |       |         |        |             |         |          |       |  |       |               |  |  |   |            | (33,395   | )           |   |        |      |   |   |            | (33,395   | )
|                                              | Unrealized gain on securities
available-for-sale, net of tax |        |              |          |          |       |         |        |             |         |          |       |  |       |               |  |  |   |            |          |             |   |        | 2,063 |   |   |            | 2,063     |  
|                                              |                                                             
|Comprehensive loss                            |                                                              |        |              |           |          |       |         |         |             |         |          |        |  |       |               |   |  |   |            |           |             |   |        |       |   |   | (31,332    | )        
|                                              |                                                              |        |              |           |          |       |         |         |             |         |          |        |  |       |               |   |  |   |            |           |             |   |        |       |   |   |            |          
|Balance, September 30, 2001                   |                                                              |        | 73,688       |           |          |       | 737     |         |             |         |         |        |  |       | 980,952       |   |  |   | (2,453,773 | )         |             |   | 575    |       |   |   | (1,471,509 | )        
|                                             
|Comprehensive income                          |                                                              |        |              |           |          |       |         |         |             |         |          |        |  |       |               |   |  |   |            |           |             |   |        |       |   |   |            |          
|                                              | Net income                                                   |        |              |          |          |       |         |        |             |         |          |       |  |       |               |  |  |   |            | 4,395     |             |   |        |      |   |   |            | 4,395     |  
|                                              | Unrealized loss on securities
available-for-sale, net of tax |        |              |          |          |       |         |        |             |         |          |       |  |       |               |  |  |   |            |          |             |   |        | (146  | ) |   |            | (146      | )
|                                              |                                                             
|Comprehensive income                          |                                                              |        |              |           |          |       |         |         |             |         |          |        |  |       |               |   |  |   |            |           |             |   |        |       |   |   | 4,249      |          
|                                              |                                                              |        |              |           |          |       |         |         |             |         |          |        |  |       |               |   |  |   |            |           |             |   |        |       |   |   |            |          
|Balance, December 31, 2001                    |                                                              |        | 73,688       |           |          |       | 737     |         |             |         |         |        |  |       | 980,952       |   |  |   | (2,449,378 | )         |             |   | 429    |       |   |   | (1,467,260 | )        
|                                             
|Comprehensive income                          |                                                              |        |              |           |          |       |         |         |             |         |          |        |  |       |               |   |  |   |            |           |             |   |        |       |   |   |            |          
|                                              | Net income                                                   |        |              |          |          |       |         |        |             |         |          |       |  |       |               |  |  |   |            | 1,433,955 |             |   |        |      |   |   |            | 1,433,955 |  
|                                              | Unrealized loss on securities
available-for-sale, net of tax |        |              |          |          |       |         |        |             |         |          |       |  |       |               |  |  |   |            |          |             |   |        | (603  | ) |   |            | (603      | )
|                                              |                                                             
|Comprehensive income                          |                                                              |        |              |           |          |       |         |         |             |         |          |        |  |       |               |   |  |   |            |           |             |   |        |       |   |   | 1,433,352  |          
|                                              |                                                              |        |              |           |          |       |         |         |             |         |          |        |  |       |               |   |  |   |            |           |             |   |        |       |   |   |            |          
|Balance, 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       |   |  |   |           |           |             |   |       |       |   |   | 359,177    |          
|Issuance of warrants to purchase
common stock |                                                              |        |             |           |          |       |        |         |             |         | 935      |        |  |       |              |   |  |   |           |           |             |   |       |       |   |   | 935        |          
|                                             
|Reorganized Company                           |                                                              |        |              |           |          |       |         |         |             |         |          |        |  |       |               |   |  |   |            |           |             |   |        |       |   |   |            |          
|Balance, May 1, 2002                          |                                                              |        | 20,000       |           |          |       | 200     |         |             |         | 935      |        |  |       | 358,977       |   |  |   | (33,734    | )         |             |   | (174   | )     |   |   | 326,204    |          
|Comprehensive loss                            |                                                              |        |              |           |          |       |         |         |             |         |          |        |  |       |               |   |  |   |            |           |             |   |        |       |   |   |            |          
|                                              | Net loss                                                     |        |              |          |          |       |         |        |             |         |          |       |  |       |               |  |  |   |            | (58,314   | )           |   |        |      |   |   |            | (58,314   | )
|                                              | Unrealized gain on securities
available-for-sale, net of tax |        |              |          |          |       |         |        |             |         |          |       |  |       |               |  |  |   |            |          |             |   |        | 505   |   |   |            | 505       |  
|                                              |                                                             
|Comprehensive loss                            |                                                              |        |              |           |          |       |         |         |             |         |          |        |  |       |               |   |  |   |            |           |             |   |        |       |   |   | (57,809    | )        
|                                              |                                                              |        |              |           |          |       |         |         |             |         |          |        |  |       |               |   |  |   |            |           |             |   |        |       |   |   |            |          
|Balance, December 31, 2002                    |                                                              |        | 20,000       |           |          | $     | 200     |         |             | $       | 935      |        |  | $     | 358,977       |   |  | $ | (92,048    | )         |             | $ | 331    |       |   | $ | 268,395    |          
|                                              |                                                              |        |              |           |          |       |         |         |             |         |          |        |  |       |               |   |  |   |            |           |             |   |        |       |   |   |            |          

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

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##### Table of Contents



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

|                                                                                               |                                                                                         |                                      |                                                            |         |              |         |   |   |                     |           |              |            |                                 |        |         |         |         |         |         |         |         |         |         |         |  
|---------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------- | ------------------------------------ | ---------------------------------------------------------- | ------- | ------------ | ------- | - | - | ------------------- | --------- | ------------ | ---------- | ------------------------------- | ------ | ------- | ------- | ------- | ------- | ------- | ------- | ------- | ------- | ------- | ------- | -
|                                                                                               |                                                                                         |                                      |                                                            |         | Reorganized  |         |   |   |                    
|                                                                                               |                                                                                         |                                      |                                                            |         | Company      |         |   |   | Predecessor Company
|                                                                                               |                                                                                         |                                      |                                                            |         |              |         |   |   |                     |          
|                                                                                               |                                                                                         |                                      |                                                            |         | Eight Months |         |   |   | Four Months         |           | Three Months |            |                                 |        |         |         |         |         |        
|                                                                                               |                                                                                         |                                      |                                                            |         | Ended        |         |   |   | Ended               |           | Ended        |            | Fiscal Year Ended September 30,
|                                                                                               |                                                                                         |                                      |                                                            |         | December 31, |         |   |   | April 30,           |           | December 31, |            |                                
|                                                                                               |                                                                                         |                                      |                                                            |         | 2002         |         |   |   | 2002                |           | 2001         |            | 2001                            |        | 2000   
|                                                                                               |                                                                                         |                                      |                                                            |         |              |         |   |   |                     |           |              |            |                                 |        |        
|Cash flows from operating activities                                                           |                                                                                         |                                      |                                                            |         |              |         |   |   |                     |           |              |            |                                 |        |         |         |         |         |         |         |         |        
|                                                                                               | Net (loss) income                                                                       |                                      | $                                                          | (58,314 | )            |         |   |   | $                   | 1,433,955 |              |            | $                               | 4,395  |         |         | $       | (33,395 | )       |         | $       | (58,985 | )      
|                                                                                               | Adjustments to reconcile net (loss) income to net cash
provided by operating activities |                                      |                                                            |         |              |         |   |   |                     |           |              |            |                                 |        |         |         |         |         |         |         |         |         |        
|                                                                                               |                                                                                         |                                      | Provision for bad debts                                    |         |              | 4,924   |   |   |                     |           |              | 25,344     |                                 |        |         | 7,763   |         |         |         | 28,140  |         |         |         | 30,166  |  
|                                                                                               |                                                                                         |                                      | Loss on disposition of assets                              |         |              | 2,279   |   |   |                     |           |              |           |                                 |        |         |        |         |         |         |        |         |         |         | 3,673   |  
|                                                                                               |                                                                                         |                                      | Depreciation and amortization                              |         |              | 23,152  |   |   |                     |           |              | 11,733     |                                 |        |         | 11,046  |         |         |         | 49,399  |         |         |         | 49,235  |  
|                                                                                               |                                                                                         |                                      | Impairment of long-lived assets                            |         |              | 84,600  |   |   |                     |           |              |           |                                 |        |         |        |         |         |         |        |         |         |         | 19,413  |  
|                                                                                               |                                                                                         |                                      | Loss on settlement with government                         |         |              |        |   |   |                     |           |              |           |                                 |        |         |        |         |         |         | 33,410  |         |         |         |        |  
|                                                                                               |                                                                                         |                                      | Casualty gain                                              |         |              |        |   |   |                     |           |              | (1,527     | )                               |        |         |        |         |         |         |        |         |         |         |        |  
|                                                                                               |                                                                                         |                                      | Reorganization items                                       |         |              |        |   |   |                     |           |              | (1,394,309 | )                               |        |         | 13,153  |         |         |         | 47,721  |         |         |         | 10,816  |  
|                                                                                               |                                                                                         |                                      | Equity earnings/minority interest                          |         |              | 336     |   |   |                     |           |              | 33         |                                 |        |         | 15      |         |         |         | 462     |         |         |         | (2,261  | )
|                                                                                               |                                                                                         |                                      | Provision for income taxes                                 |         |              | 1,010   |   |   |                     |           |              |           |                                 |        |         |        |         |         |         | (4,807  | )       |         |         | (19,374 | )
|                                                                                               |                                                                                         |                                      | (Income) loss from discontinued pharmacy
operations        |         |              |        |   |   |                     |           |              |           |                                 |        |         | (898    | )       |         |         | (667    | )       |         |         | 2,705   |  
|                                                                                               |                                                                                         |                                      | Gain on sale of discontinued pharmacy
operations           |         |              |        |   |   |                     |           |              | (29,082    | )                               |        |         |        |         |         |         |        |         |         |         |        |  
|                                                                                               |                                                                                         |                                      | Interest accretion on discounted debt                      |         |              |        |   |   |                     |           |              |           |                                 |        |         |        |         |         |         |        |         |         |         | 15,540  |  
|                                                                                               | Changes in operating assets and liabilities                                             |                                      |                                                            |         |              |         |   |   |                     |           |              |            |                                 |        |         |         |         |         |         |         |         |         |        
|                                                                                               |                                                                                         |                                      | Receivables                                                |         |              | (40,628 | ) |   |                     |           |              | (13,090    | )                               |        |         | (4,545  | )       |         |         | (57,972 | )       |         |         | (27,594 | )
|                                                                                               |                                                                                         |                                      | Inventories                                                |         |              | 226     |   |   |                     |           |              | (1,218     | )                               |        |         | (113    | )       |         |         | 395     |         |         |         | (884    | )
|                                                                                               |                                                                                         |                                      | Prepaid expenses and other current assets                  |         |              | 1,318   |   |   |                     |           |              | 4,410      |                                 |        |         | 6,903   |         |         |         | 20,949  |         |         |         | 459     |  
|                                                                                               |                                                                                         |                                      | Accounts payable                                           |         |              | (5,683  | ) |   |                     |           |              | (27,211    | )                               |        |         | (6,273  | )       |         |         | 22,382  |         |         |         | 40,969  |  
|                                                                                               |                                                                                         |                                      | Accrued liabilities and other current liabilities          |         |              | (19,662 | ) |   |                     |           |              | 25,323     |                                 |        |         | (13,582 | )       |         |         | (16,068 | )       |         |         | 110,088 |  
|                                                                                               | Changes in long-term insurance reserves                                                 |                                      |                                                            | 18,292  |              |         |   |   |                     | 11,369    |              |            |                                 | 14,926 |         |         |         | 53,903  |         |         |         | (19,181 | )      
|                                                                                               | Other                                                                                   |                                      |                                                            | (1,824  | )            |         |   |   |                     | (7,185    | )            |            |                                 | (460   | )       |         |         | (4,208  | )       |         |         | (27,922 | )      
|                                                                                               |                                                                                         |                                      |                                                            |         |              |         |   |   |                     |           |              |            |                                 |        |         |         |         |         |         |         |         |         |        
|Net cash provided by operating activities of
continuing operations before reorganization items |                                                                                         |                                      | 10,026                                                     |         |              |         |   |   | 38,545              |           |              |            | 32,330                          |        |         |         | 139,644 |         |         |         | 126,863 |        
|                                                                                               |                                                                                         |                                      |                                                            |         |              |         |   |   |                     |           |              |            |                                 |        |         |         |         |         |         |         |         |         |        
|Net cash provided by discontinued pharmacy operations                                          |                                                                                         |                                      |                                                           |         |              |         |   |   |                    |           |              |            | 2,205                           |        |         |         | 4,235   |         |         |         | 5,384   |        
|                                                                                               |                                                                                         |                                      |                                                            |         |              |         |   |   |                     |           |              |            |                                 |        |         |         |         |         |         |         |         |         |        
|                                                                                               |                                                                                         | Payment of reorganization items, net |                                                            |         | (38,178      | )       |   |   |                     |           | (35,813      | )          |                                 |        | (14,824 | )       |         |         | (46,191 | )       |         |         | (25,503 | )      
|                                                                                               |                                                                                         |                                      |                                                            |         |              |         |   |   |                     |           |              |            |                                 |        |         |         |         |         |         |         |         |         |        
|Cash flows from investing activities                                                           |                                                                                         |                                      |                                                            |         |              |         |   |   |                     |           |              |            |                                 |        |         |         |         |         |         |         |         |        
|                                                                                               |                                                                                         |                                      | Purchases of property and equipment                        |         |              | (33,565 | ) |   |                     |           |              | (27,553    | )                               |        |         | (6,229  | )       |         |         | (31,902 | )       |         |         | (30,563 | )
|                                                                                               |                                                                                         |                                      | Acquisition of a skilled nursing facility                  |         |              | (8,900  | ) |   |                     |           |              |           |                                 |        |         |        |         |         |         |        |         |         |         |        |  
|                                                                                               |                                                                                         |                                      | Proceeds from sale of property, equipment and
other assets |         |              | 4,065   |   |   |                     |           |              | 92,446     |                                 |        |         | 32      |         |         |         | 7,900   |         |         |         | 11,337  |  
|                                                                                               |                                                                                         |                                      | Restricted investments                                     |         |              | 12,319  |   |   |                     |           |              | (14,975    | )                               |        |         | (5,082  | )       |         |         | 3,393   |         |         |         | 22,405  |  
|                                                                                               |                                                                                         |                                      | Net collections on notes receivable                        |         |              | 58      |   |   |                     |           |              | 146        |                                 |        |         | 595     |         |         |         | 1,171   |         |         |         | 1,405   |  
|                                                                                               |                                                                                         |                                      | Insurance Proceeds                                         |         |              | 7,414   |   |   |                     |           |              | 6,020      |                                 |        |         |        |         |         |         |        |         |         |         |        |  
|                                                                                               |                                                                                         |                                      | Other                                                      |         |              |        |   |   |                     |           |              |           |                                 |        |         |        |         |         |         |        |         |         |         | (2,360  | )
|                                                                                               |                                                                                         |                                      |                                                            |         |              |         |   |   |                     |           |              |            |                                 |        |         |         |         |         |         |         |         |         |        
|Net cash (utilized) provided by investing activities                                           |                                                                                         |                                      | (18,609                                                    | )       |              |         |   |   | 56,084              |           |              |            | (10,684                         | )      |         |         | (19,438 | )       |         |         | 2,224   |        
|                                                                                               |                                                                                         |                                      |                                                            |         |              |         |   |   |                     |           |              |            |                                 |        |         |         |         |         |         |         |         |         |        
|Cash flows from financing activities                                                           |                                                                                         |                                      |                                                            |         |              |         |   |   |                     |           |              |            |                                 |        |         |         |         |         |         |         |         |        
|                                                                                               |                                                                                         |                                      | Repayment of long-term debt                                |         |              | (5,881  | ) |   |                     |           |              | (386,872   | )                               |        |         | (4,337  | )       |         |         | (39,668 | )       |         |         | (10,317 | )
|                                                                                               |                                                                                         |                                      | Proceeds from issuance of long-term debt                   |         |              |        |   |   |                     |           |              | 212,000    |                                 |        |         |        |         |         |         |        |         |         |         |        |  
|                                                                                               |                                                                                         |                                      | Payment of deferred financing fees                         |         |              |        |   |   |                     |           |              | (6,424     | )                               |        |         |        |         |         |         |        |         |         |         |        |  
|                                                                                               |                                                                                         |                                      |                                                            |         |              |         |   |   |                     |           |              |            |                                 |        |         |         |         |         |         |         |         |         |        
|Net cash utilized by financing activities                                                      |                                                                                         |                                      | (5,881                                                     | )       |              |         |   |   | (181,296            | )         |              |            | (4,337                          | )      |         |         | (39,668 | )       |         |         | (10,317 | )      
|                                                                                               |                                                                                         |                                      |                                                            |         |              |         |   |   |                     |           |              |            |                                 |        |         |         |         |         |         |         |         |         |        
|(Decrease) increase in cash and cash equivalents                                               |                                                                                         |                                      | (52,642                                                    | )       |              |         |   |   | (122,480            | )         |              |            | 4,690                           |        |         |         | 38,582  |         |         |         | 98,651  |        
|                                                                                               |                                                                                         |                                      |                                                            |         |              |         |   |   |                     |           |              |            |                                 |        |         |         |         |         |         |         |         |         |         |         |  
|Cash and cash equivalents, beginning of period                                                 |                                                                                         |                                      | 91,260                                                     |         |              |         |   |   | 213,740             |           |              |            | 209,050                         |        |         |         | 170,468 |         |         |         | 71,817  |        
|                                                                                               |                                                                                         |                                      |                                                            |         |              |         |   |   |                     |           |              |            |                                 |        |         |         |         |         |         |         |         |         |        
|Cash and cash equivalents, end of period                                                       |                                                                                         | $                                    | 38,618                                                     |         |              |         |   | $ | 91,260              |           |              | $          | 213,740                         |        |         | $       | 209,050 |         |         | $       | 170,468 |        
|                                                                                               |                                                                                         |                                      |                                                            |         |              |         |   |   |                     |           |              |            |                                 |        |         |         |         |         |         |         |         |         |        

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

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NOTE  1   NATURE OF BUSINESS

Reporting Entity

Mariner Health Care, Inc. and its subsidiaries (collectively the Company)
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. The Company and
its operating subsidiaries provide post-acute healthcare services, primarily
through the operation of their skilled nursing facilities (SNFs). All
references to the Company herein are intended to include the operating
subsidiaries through which the services described herein are directly provided.
At December 31, 2002, the Companys significant operations consisted of 297
nursing facilities, including 289 SNFs and eight stand-alone assisted living
facilities and apartments (ALFs), in 23 states with 35,419 licensed beds and
significant concentrations of facilities and beds in five states and several
metropolitan markets. Nursing facilities represent the Companys only reportable operating
segment. Included in the total SNFs are nine managed SNFs with 1,245 licensed
beds. The Company also operates 13 owned, leased or managed long-term acute
care hospitals (LTACs) in four states with 683 licensed beds (see Note 21 for
financial information about the Companys segments).

In October 2001, the Company and certain of its subsidiaries 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 5).

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.

NOTE  2   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States.

The Company emerged from bankruptcy effective May 1, 2002 for financial
reporting purposes, at which time it adopted the provisions 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). 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 previously recorded in the Companys consolidated financial
statements, a black line separates the financial data pertaining to periods
after the adoption of fresh-start reporting from the financial data pertaining
to periods prior to the adoption of fresh-start reporting to signify the
difference in the basis of preparation of financial information for each
respective entity.

The financial statements for all periods prior to May 1, 2002 reflect the
financial position, results of operations and cash flows of the Companys
predecessor entity (the Predecessor Company). The financial statements for
the eight months ended December 31, 2002 reflect the financial position,
results of operations and cash flows of the reorganized entity (the
Reorganized Company). Unless stated otherwise as the Predecessor Company or
the Reorganized Company, all references to the Company includes the operations
of both the Predecessor Company and Reorganized Company.

Between the date the Company filed for protection under chapter 11 of title 11
(Chapter 11) of the United States Code (the Bankruptcy Code) on January 18,
2000 (the Petition Date) and its emergence from bankruptcy on the Effective
Date, the Company operated its business as a debtor-in-possession subject to
the jurisdiction of the Bankruptcy Court. Accordingly, the
Companys consolidated financial statements for periods prior to its
emergence from bankruptcy were presented in conformity
with SOP 90-7 and were prepared on a going concern basis which assumes
continuity of operations and realization of assets and settlement of
liabilities and commitments in the normal course of business.

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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 (see Recent Accounting Pronouncements).

The accompanying consolidated financial statements include the accounts of the
Company. All significant intercompany accounts and transactions have been
eliminated in consolidation.

Comparable Transition Period

The following table presents summarized statements of operations information
for the three months ended December 31, 2001 and 2000 (in thousands of
dollars):

|                                                      |                                                            |   |                                 |     |      |   |             |     | 
|----------------------------------------------------- | ---------------------------------------------------------- | - | ------------------------------- | --- | ---- | - | ----------- | --- | 
|                                                      |                                                            |   | Predecessor Company            
|                                                      |                                                            |   | Three Months Ended December 31,
|                                                      |                                                            |   |                                
|                                                      |                                                            |   | 2001                            |     | 2000
|                                                      |                                                            |   |                                 |     |     
|                                                      |                                                            |   |                                 |     |      |   | (Unaudited)
|                                                      |                                                            |   |                                 |     |      |   |             |     | 
|Net revenue                                           |                                                            | $ | 458,151                         |     |      | $ | 470,348     |    
|Costs and expenses                                    |                                                            |   | 440,615                         |     |      |   | 450,687     |    
|                                                      |                                                            |   |                                 |     |      |   |             |    
|Operating income                                      |                                                            |   | 17,536                          |     |      |   | 19,661      |    
|Other expenses                                        |                                                            |   | (14,039                         | )   |      |   | (10,133     | )  
|                                                      |                                                            |   |                                 |     |      |   |             |    
|Income from continuing operations
before income taxes |                                                            |   | 3,497                           |     |      |   | 9,528       |    
|Provision for income taxes                            |                                                            |   |                                |     |      |   |            |    
|                                                      |                                                            |   |                                 |     |      |   |             |    
|Income from continuing operations                     |                                                            |   | 3,497                           |     |      |   | 9,528       |    
|Discontinued operations                               |                                                            |   |                                 |     |      |   |             |    
|                                                      | Income from operations of discontinued
pharmacy operations |   |                                 | 898 |      |   |             | 382 | 
|                                                      |                                                            |   |                                 |     |      |   |             |    
|Net income                                            |                                                            | $ | 4,395                           |     |      | $ | 9,910       |    
|                                                      |                                                            |   |                                 |     |      |   |             |    

Use of Estimates

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States 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.

Cash and Cash Equivalents

The Company considers all highly liquid, unrestricted investments with
remaining maturities of three months or less to be cash equivalents.

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Inventories

Inventories, consisting principally of medical supplies, are valued at the
lower of cost or market using the first-in, first-out method of accounting.

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 are stated at
cost less accumulated depreciation.

Major replacements and significant improvements are capitalized, whereas
ordinary maintenance and repairs are expensed as incurred. Interest costs
related to funds borrowed to finance construction are capitalized but were not
significant for any period presented.

Depreciation and amortization expense is recorded using the straight-line basis
over the estimated useful lives of the assets as follows:

|                                  |  |             |  | 
|--------------------------------- |  | ----------- |  | 
|Buildings                         |  | 2540 years
|Building improvements             |  | 1025 years
|Furniture, fixtures and equipment |  | 320 years 

Goodwill

Beginning January 1, 2002, goodwill is no longer amortized but is subject to
periodic impairment testing. On the Effective Date, the Company wrote off its
goodwill for the Company and its subsidiaries that were part of the bankruptcy
proceedings and recorded reorganization value in excess of amounts allowable to
identifiable assets. Amortization of goodwill charged to expense was $2.6
million for the three months ended December 31, 2001 and $11.3 million and
$12.6 million for the fiscal years ended September 30, 2001 and 2000,
respectively. Accumulated amortization at December 31, 2002, December 31, 2001
and September 30, 2001 and 2000 was $1.0 million, $37.4 million, $34.9 million
and $24.0 million, respectively. During the fiscal year ended September 30,
2000, the Company revised its estimate of the useful life of existing goodwill
from 30 and 40 years to 20 years. The net effect of such change was a charge
of $4.4 million, or $0.06 per share, for the fiscal year ended September 30,
2000.

Reorganization Value in Excess of Amounts Allocable to Identifiable Assets

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 4). The Company performed an analysis
under the Statement of Financial Accounting Standards (SFAS), No. 142,
Goodwill and Other Intangible Assets (SFAS No. 142), and recognized an
impairment charge of $57.3 million during the three months ended December 31,
2002 (see Note 15).

Assessment of Long-Lived Assets

The carrying value of long-lived assets is reviewed periodically to determine
if facts and circumstances suggest 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 healthcare trends and other publicly available
information. If these factors and the projected undiscounted cash flows of the
Company over the remaining useful life indicate the asset will not be
recoverable, the carrying value will be adjusted to the estimated fair value.
The Company reviewed its long-lived assets in accordance with SFAS No. 144,
Accounting for the Impairment or Disposal of Long Lived Assets (SFAS No.
144) and recognized an impairment charge of $27.3 million during the three
months ended December 31, 2002 (see Note 15).

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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. This term-extending option 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, or more specifically a payer swaption.
The payer swaption was bifurcated from the related debt and recorded in other
assets at its estimated fair market value of $3.2 million as of December 31,
2002.

Restricted Investments

Restricted investments 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. Restricted investments also
include amounts restricted for collateral under the terms of certain letters of
credit and mortgage agreements. 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 (see Note
9).

Insurance

Due to the rising cost and limited availability of professional/general
liability (PL/GL) insurance, the Company currently purchases excess PL/GL
liability 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. Additionally, in the second quarter
of 2002 due to changes in the workers compensation insurance market, the
Company moved from a guaranteed cost program for employee injury losses to a
program where 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 seven years. Although the Company bases its loss estimates
on independent actuarial analyses, among other things, which determine expected
liabilities on an undiscounted basis including incurred but not reported
losses, the Companys loss estimates are based on its best information to date.
The amount of the losses could exceed recorded estimates. In the event the
Companys actual liability exceeds the estimates and insurance limits for any
given period, results of operations and financial condition could be materially
adversely impacted.

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.
Although the Company believes that the provisions for self-insured losses in
its financial statements are adequate, the ultimate liability may be in excess
of the amounts recorded. In the event the provisions for loss reflected in
the Companys financial statements are inadequate, the financial condition and
results of operations could be materially affected.

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 17).

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Net Revenue

Revenue is derived from services rendered to patients for routine long-term
care, including daily dietary, social and recreational services, and a full
range of pharmacy, rehabilitation and medical services. Revenue is recorded
based upon established rates and adjusted for differences between such rates
and estimated amounts reimbursable by third-party payors when applicable.
Estimated settlements under third-party payor retrospective rate setting
programs (primarily Medicare and Medicaid) are accrued in the period the
related services are rendered.

Historically, the Medicare program utilized a cost-based retrospective
reimbursement system for SNFs based on reasonable direct and indirect allowable
costs, as well as capital costs and ancillary costs, primarily therapy and
pharmacy costs. Under this system, each SNF received an interim payment during
the year then submitted an annual cost report prepared in accordance with
federal and state regulations, subject to audit and retroactive adjustment in
future periods. 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. In the opinion of management, adequate
provision has been made for such adjustments and final settlements should not
have a material effect on the Companys financial position or results of
operations. The Balanced Budget Act of 1997 (the Balanced Budget Act) made
numerous changes to the Medicare program through the implementation of a
prospective payment system (PPS) whereby reimbursement for skilled nursing
facilities became based on an all-inclusive per diem rate, which varies
depending on the level of acuity of the patient (see Note 7).

Change in Accounting Estimates

During the three months ended December 31, 2002, the Company recorded $3.5
million of revenue from adjustments to the estimated amount due to several
state Medicaid programs for the final settlement of the amount to be reimbursed
to these payors. In addition, during the three months ended December 31, 2002,
the Company recorded approximately $4.0 million as a reduction of provision for
bad debts for recoveries of accounts previously sent to a collection agency.

Comprehensive Income

The Company accounts for comprehensive income according to the provisions of
SFAS No. 130, Reporting Comprehensive Income, 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
(deficit), which are excluded from net income (loss). The Company has
presented comprehensive income in the consolidated statements of stockholders
equity (deficit).

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 (see Note
21).

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 stock option
plans for key employees and non-employee directors that authorize the granting
of stock options to purchase up to 2,153,022 shares of common stock in the
aggregate. At December 31, 2002, there were options to purchase 1,848,060
shares of common stock outstanding. All options granted through December 31,
2002 have an exercise price of $20.12, which was equal to
the fair market value of the common stock on the date of the grant. There were
options to purchase 153,595 shares of common stock exercisable at December 31,
2002. The Mariner Health Care, Inc. 2002 Stock Incentive Plan (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
(see Note 13).

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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 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. 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s pro forma net
income (loss) and earnings (loss) 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
|                            |                                                                                                                              |   |              |        |   |  |                    
|                            |                                                                                                                              |   | Eight Months |        |   |  | Four Months         |   | Three Months |       |                                 |   |       |      |   |   |        
|                            |                                                                                                                              |   | Ended        |        |   |  | Ended               |   | Ended        |       | Fiscal Year Ended September 30,
|                            |                                                                                                                              |   | December 31, |        |   |  | April 30,           |   | December 31, |       |                                
|                            |                                                                                                                              |   | 2002         |        |   |  | 2002                |   | 2001         |       | 2001                            |   | 2000 
|                            |                                                                                                                              |   |              |        |   |  |                     |   |              |       |                                 |   |      
|Net (loss) income           |                                                                                                                              | $ | (58,314      | )      |   |  |                     | $ | 1,433,955    |       |                                 | $ | 4,395 |      |   | $ | (33,395 | )     |   | $ | (58,985 | )    
|                            | Deduct: total stock-based employee
compensation expense determined
under fair value based methods
for all awards, net of tax |   |              | (2,519 | ) |  |                     |   |              | (123  | )                               |   |       | (92  | ) |   |         | (98   | ) |   |         | (185  | )
|                            |                                                                                                                              |   |              |        |   |  |                     |   |              |       |                                 |   |       |      |   |   |         |       |   |   |         |      
|Pro forma net (loss) income |                                                                                                                              | $ | (60,833      | )      |   |  |                     | $ | 1,433,832    |       |                                 | $ | 4,303 |      |   | $ | (33,493 | )     |   | $ | (59,170 | )    
|                            |                                                                                                                              |   |              |        |   |  |                     |   |              |       |                                 |   |       |      |   |   |         |       |   |   |         |      
|Basic and diluted EPS       |                                                                                                                              |   |              |        |   |  |                     |   |              |       |                                 |   |       |      |   |   |         |       |   |   |         |      
|                            | As reported                                                                                                                  |   | $            | (2.92  | ) |  |                     |   | $            | 19.46 |                                 |   | $     | 0.06 |   |   | $       | (0.45 | ) |   | $       | (0.80 | )
|                            | Pro forma                                                                                                                    |   |              | (3.04  | ) |  |                     |   |              | 19.46 |                                 |   |       | 0.06 |   |   |         | (0.45 | ) |   |         | (0.80 | )

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
|                            |  |              |              |   |  |                    
|                            |  | Eight Months |              |   |  | Four Months         |  | Three Months |              |                                 |  |      |              |   |  | 
|                            |  | Ended        |              |   |  | Ended               |  | Ended        |              | Fiscal Year Ended September 30,
|                            |  | December 31, |              |   |  | April 30,           |  | December 31, |              |                                
|                            |  | 2002         |              |   |  | 2002                |  | 2001         |              | 2001                            |  | 2000
|                            |  |              |              |   |  |                     |  |              |              |                                 |  |     
|Dividend yield              |  |              | 0.0          | % |  |                     |  |              | 0.0          | %                               |  |      | 0.0          | % |  |  | 0.0          | % |  |  | 0.0          | %
|Expected volatility         |  |              | 0.51         |   |  |                     |  |              | 0.42 - 1.21  |                                 |  |      | 0.42 - 1.21  |   |  |  | 0.42 - 1.21  |   |  |  | 0.42 - 1.21  |  
|Risk-free interest rate     |  |              | 3.63% - 4.70 | % |  |                     |  |              | 4.61% - 6.11 | %                               |  |      | 4.61% - 6.11 | % |  |  | 4.61% - 6.11 | % |  |  | 4.61% - 6.11 | %
|Expected life in years      |  |              | 6            |   |  |                     |  |              | 3 - 8        |                                 |  |      | 3 - 8        |   |  |  | 3 - 8        |   |  |  | 3 - 8        |  
|Weighted-average fair value |  | $            | 10.80        |   |  |                     |  |              |             |                                 |  |      |             |   |  |  |             |   |  |  |             |  

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Recent Accounting Pronouncements

In January 2003, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 46, Consolidation of Variable Interest Entities. This
Interpretation provides guidance with respect to the identification of variable
interest entities and when the assets, liabilities, noncontrolling interests
and results of operations of a variable interest entity need to be included in
a companys consolidated financial statements. This Interpretation is not
expected to have a significant impact on the consolidated financial position,
results of operations or cash flows of the Company.

In December 2002, FASB issued SFAS No. 148, which provides alternative methods
of transition for an entity that voluntarily changes to the fair value based
method of accounting for stock-based employee compensation. The provisions of
the Statement were effective December 31, 2002. Management currently intends
to continue to account for stock-based compensation under the intrinsic value
method set forth in APB 25 and related interpretations. For this reason, the
transition guidance of SFAS No. 148 does not have an impact on the Companys
consolidated financial position, results of operations or cash flows. SFAS No.
148 does amend existing guidance with respect to required disclosures,
regardless of the method of accounting used. The revised disclosure
requirements are presented above.

In November 2002, FASB issued FASB Interpretation No. 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others. This Interpretation 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. The disclosure
requirements of this Interpretation are effective as of December 31, 2002 and
require 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 recognition requirements of this
Interpretation are effective beginning January 1, 2003. This interpretation is
not expected to have a significant impact on the Companys financial position,
results of operations or cash flows.

In July 2002, FASB issued SFAS No. 146 Accounting for Costs Associated with
Exit or Disposal Activities (SFAS No. 146). This statement replaces
Emerging Issues Task Force Issue No. 94-3 Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity. This
Statement requires the recognition of costs associated with exit or disposal
activities when they are incurred rather than at the date of a commitment to an
exit or disposal plan. SFAS No. 146 is to be applied prospectively to exit or
disposal activities initiated after December 31, 2002 with early adoption
encouraged. The Company adopted SFAS No. 146 on May 1, 2002 in connection with
the adoption of fresh-start reporting, and its adoption did not have a
material impact on its consolidated financial position, results of
operations or cash flows.

In April 2002, FASB issued SFAS No. 145, Rescission of FASB Statements No. 4,
44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections
(SFAS No. 145). This Statement rescinds SFAS No. 4, Reporting Gains and
Losses from Extinguishment of Debt (SFAS No. 4) resulting in the criteria in
APB Opinion No. 30 being used to classify gains and losses from extinguishment
of debt. SFAS No. 64, Extinguishment of Debt Made to Satisfy Sinking-Fund
Requirements, amended SFAS No. 4, which is, therefore, no longer necessary.
SFAS No. 44, Accounting for Intangible Assets of Motor Carriers, was issued
to establish accounting requirements for the effects of transition to the
provisions of the Motor Carrier Act of 1980. Because the transition has been
completed, this Statement is no longer necessary. SFAS No. 145 amended SFAS
No. 13, Accounting for Leases (SFAS No. 13), to require that certain lease
modifications that have economic effects similar to sale-leaseback transactions
be accounted for in the same manner as sale-leaseback transactions. The
provisions of SFAS No. 145 related to SFAS No. 13 are effective for
transactions occurring after May 15, 2002. All other provisions of SFAS No.
145 are effective for financial statements issued on or after May 15, 2002 with
early adoption encouraged. The Company adopted SFAS No. 145 on May 1, 2002 in
connection with its adoption of fresh-start reporting and, accordingly, has
presented the reorganization and restructuring of the debt in connection with
the terms of the Joint Plan as a reorganization item.

In July 2001, FASB issued SFAS No. 142, which established new rules on the
accounting for goodwill and other intangible assets. Under SFAS No. 142,
goodwill and intangible assets with indefinite lives will no longer be
amortized; however, they will be subject to annual impairment tests as
prescribed by the statement. The impairment test for the excess reorganization value recorded in connection with the

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Companys fresh-start reporting was performed during the quarter ended December
31, 2002. Intangible assets with definite lives will continue to be amortized
over their estimated useful lives. The amortization provisions of SFAS No. 142
apply immediately to goodwill and intangible assets acquired after June 30,
2001. With respect to goodwill and intangible assets acquired prior to July 1,
2001, companies are required to adopt SFAS No. 142 for fiscal years beginning
after December 15, 2001.

In accordance with the adoption of SFAS No. 142, the Company discontinued
amortizing goodwill effective January 1, 2002. 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 Company
|                                      |  |                    
|                                      |  | Three Months        |       |               |  |  
|                                      |  | Ended               |       | Year Ended   
|                                      |  | December 31,        |       | September 30,
|                                      |  | 2001                |       | 2001         
|                                      |  |                     |       |              
|Reported net income (loss)            |  | $                   | 4,395 |               |  | $ | (33,395 | )
|Add back goodwill amortization        |  |                     | 2,572 |               |  |   | 11,340  |  
|                                      |  |                     |       |               |  |   |         |  
|Adjusted net income (loss)            |  | $                   | 6,967 |               |  | $ | (22,055 | )
|                                      |  |                     |       |               |  |   |         |  
|Earnings per share-basic and diluted: |  |                     |       |               |  |   |         |  
|Reported net income (loss)            |  | $                   | 0.06  |               |  | $ | (0.45   | )
|Goodwill amortization                 |  |                     | 0.03  |               |  |   | 0.15    |  
|                                      |  |                     |       |               |  |   |         |  
|Adjusted net income (loss)            |  | $                   | 0.09  |               |  | $ | (0.30   | )
|                                      |  |                     |       |               |  |   |         |  

In June 2001, FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations, which addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and
the associated asset retirement costs. The Company adopted this accounting
standard on May 1, 2002 and it did not have a material impact on the Companys
consolidated financial position, results of operations or cash flows.

In October 2001, FASB issued SFAS No. 144. Companies are required to adopt SFAS
No. 144 in their fiscal year beginning after December 15, 2001. SFAS No. 144
changes the criteria that would have to be met to classify an asset as
held-for-sale, revises the rules regarding reporting the effects of a disposal
of a segment of a business and requires expected future operating losses from
discontinued operations to be displayed in discontinued operations in the
period(s) in which the losses were incurred. The Company adopted this
accounting standard as required on January 1, 2002 and it did not have a
material impact on its consolidated financial position, results of
operations or cash flows.

NOTE 3      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

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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. 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 Second Priority 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 11).

Certain of the Debtors SNFs 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 SNFs; (ii) a cash payment of approximately $0.5 million and the
restructuring of mortgages on two SNFs; and (iii) an agreement to surrender
certain SNFs and other collateral in satisfaction of mortgages on certain other
SNFs.

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.

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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
a $297.0 million Senior Credit Facility with a syndicate of lenders (the
Senior Credit Facility), 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 New Common Stock and 10,000,000 shares reserved for issuance as
preferred stock, par value $.01 per share (the New Preferred Stock)(see Note
11).

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):

|                                        |                                                      |                                      |           |           |           | 
|--------------------------------------- | ---------------------------------------------------- | ------------------------------------ | --------- | --------- | --------- | 
|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

Liabilities subject to compromise refers to liabilities incurred prior to the
commencement of the Chapter 11 Cases. These liabilities consisted primarily of
long-term debt and certain accounts payable and accrued liabilities, which
represented the Companys estimate of known or potential prepetition claims to
be resolved in connection with the Chapter 11 Cases. Such claims were
ultimately settled based on negotiations, actions of the Bankruptcy
Court, resolution with respect to disputed claims, rejection of executory contracts or
unexpired leases, determination

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as to the value of any collateral securing
claims, treatment under the Joint Plan and other events. Payment terms for
these amounts were established in connection with the Joint Plan. A summary of
the principal categories of claims classified as liabilities subject to
compromise at December 31, 2001, and September 30, 2001 is as follows (in
thousands of dollars):

|                              |  |              |           |               |  |   |           |  
|----------------------------- |  | ------------ | --------- | ------------- |  | - | --------- | -
|                              |  | December 31, |           | September 30,
|                              |  | 2001         |           | 2001         
|                              |  |              |           |              
|Long-term debt                |  | $            | 2,052,730 |               |  | $ | 2,057,067 |  
|Accounts payable              |  |              | 95,911    |               |  |   | 95,794    |  
|Accrued interest              |  |              | 79,959    |               |  |   | 79,959    |  
|Accrued insurance obligations |  |              | 86,268    |               |  |   | 86,268    |  
|Other accrued liabilities     |  |              | 7,706     |               |  |   | 7,706     |  
|Deferred loan costs           |  |              | (32,974   | )             |  |   | (32,974   | )
|                              |  |              |           |               |  |   |           |  
|                              |  | $            | 2,289,600 |               |  | $ | 2,293,820 |  
|                              |  |              |           |               |  |   |           |  

Primarily all liabilities subject to compromise would have been classified as
current liabilities at December 31, 2001 and September 30, 2001 if the Chapter
11 Filings had not been filed.

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. Interest expense for the four months ended April 30, 2002,
the transition period ended December 31, 2001 and the fiscal years ended
September 30, 2001 and 2000 represents interest paid on certain capital leases
and other miscellaneous indebtedness. Interest paid on prepetition
indebtedness was $3.5 million during the transition period ended December 31,
2001. Interest paid on prepetition indebtedness in fiscal year 2001 was $5.2
million. Interest paid on prepetition indebtedness was $20.5 million during
fiscal year 2000, of which $15.6 million was paid prior to the Petition Date.

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        |  | Fiscal 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  |  
|                                                                      |  |                     |            |              |  |                                 |        |      |  |   |        |   |  |   |         |  

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NOTE
4           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
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 15).

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

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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 identifiable assets was impaired. Accordingly,
the Company recorded an impairment charge of $57.3 million relating to its
reorganization value in excess of amounts allocable to identifiable assets (see
Note 15).

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.

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 | (q)     |          |      |             | 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 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 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.                                                                                                        
|(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).

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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                                                    |  | $             | 1,785,094 |                     |  | $             | 458,151 |  |  | $ | 1,872,135 |  
|                                                           |  |               |           |                     |  |               |         |  |  |   |           |  
|(Loss) income from continuing operations                   |  | $             | (56,357   | )                   |  | $             | 10,265  |  |  | $ | (25,762   | )
|Income from operations of discontinued
pharmacy operations |  |               |          |                     |  |               | 898     |  |  |   | 667       |  
|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                   |  | $             | (2.82     | )                   |  | $             | 0.51    |  |  | $ | (1.29     | )
|Income from operations of discontinued
pharmacy operations |  |               |          |                     |  |               | 0.05    |  |  |   | 0.03      |  
|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 5      DISCONTINUED 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, including certain of its subsidiaries, 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.
As a condition of the sale of the
APS Division to Omnicare, the Company may receive a total of up to $18.0
million in future payments. These payments, if earned, would be received in
each of 2003, 2004 and 2005. The amount of the payments is
dependent upon certain post-closing operating results of the APS Division.
Subsequent to December 31, 2002, the Company earned and received the first payment of $6.0
million, which will be reflected in the financial results for the
first quarter of 2003. During the four months ended April 30,
2002, the Company realized a gain on the sale of the APS Division of
approximately $29.1 million. Income (loss) from the operation of discontinued
pharmacy operations was approximately $0.9 million, $0.7 million and $(2.7)
million for the three months ended December 31, 2001 and the fiscal years ended
September 30, 2001 and 2000, respectively.

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The Company has reclassified its prior consolidated financial statements to
present the operating results of the APS Division as a discontinued operation.
Operating results for the APS Division were as follows for the periods
indicated (in thousands of dollars):

|                                                                  |  |                     |        |                                 |  |      |         |   |  |   |         |  
|----------------------------------------------------------------- |  | ------------------- | ------ | ------------------------------- |  | ---- | ------- | - |  | - | ------- | -
|                                                                  |  | Predecessor Company
|                                                                  |  |                    
|                                                                  |  | Three Months        |        |                                 |  |      |         |   |  |  
|                                                                  |  | Ended               |        | Fiscal Year Ended September 30,
|                                                                  |  | December 31,        |        |                                
|                                                                  |  | 2001                |        | 2001                            |  | 2000
|                                                                  |  |                     |        |                                 |  |     
|Net revenue                                                       |  | $                   | 62,855 |                                 |  | $    | 214,633 |   |  | $ | 238,372 |  
|Total costs and expenses                                          |  |                     | 61,669 |                                 |  |      | 213,225 |   |  |   | 241,669 |  
|                                                                  |  |                     |        |                                 |  |      |         |   |  |   |         |  
|Operating income (loss)                                           |  |                     | 1,186  |                                 |  |      | 1,408   |   |  |   | (3,297  | )
|Other (expenses) income                                           |  |                     | (288   | )                               |  |      | (741    | ) |  |   | 592     |  
|                                                                  |  |                     |        |                                 |  |      |         |   |  |   |         |  
|Income (loss) from operations of
discontinued pharmacy operations |  | $                   | 898    |                                 |  | $    | 667     |   |  | $ | (2,705  | )
|                                                                  |  |                     |        |                                 |  |      |         |   |  |   |         |  

The assets and liabilities of the Companys discontinued pharmacy operations
consisted of the following (in thousands of dollars):

|                                          |  |                     |        |               |  |   |        |  
|----------------------------------------- |  | ------------------- | ------ | ------------- |  | - | ------ | -
|                                          |  | Predecessor Company
|                                          |  |                    
|                                          |  | December 31,        |        | September 30,
|                                          |  | 2001                |        | 2001         
|                                          |  |                     |        |              
|Receivables                               |  | $                   | 26,792 |               |  | $ | 28,386 |  
|Inventories                               |  |                     | 13,007 |               |  |   | 13,368 |  
|Prepaid expenses and other current assets |  |                     | 749    |               |  |   | 550    |  
|Property and equipment, net               |  |                     | 11,315 |               |  |   | 10,778 |  
|Goodwill, net                             |  |                     | 8,966  |               |  |   | 8,966  |  
|Other assets                              |  |                     | 1,526  |               |  |   | 1,637  |  
|Liabilities subject to compromise         |  |                     | (1,458 | )             |  |   | (1,575 | )
|Other liabilities                         |  |                     | (1,844 | )             |  |   | (1,750 | )
|                                          |  |                     |        |               |  |   |        |  
|Net assets of discontinued operations     |  | $                   | 59,053 |               |  | $ | 60,360 |  
|                                          |  |                     |        |               |  |   |        |  

NOTE 6      DIVESTITURES

Eight Months Ended December 31, 2002

Reorganized Company.During the eight months ended December 31, 2002, the
Reorganized Company completed the sale or divestiture of seven owned or leased
facilities and certain other assets, resulting in a net loss of approximately
$2.3 million. These facilities reported net revenue of approximately $15.6
million and $17.7 million for the eight months ended December 31, 2002 and the
four months ended April 30, 2002, respectively. For the three months ended
December 31, 2001, these facilities reported net revenue of approximately $13.4
million. In addition, these facilities reported net revenue of approximately
$53.2 million and $48.7 million for the fiscal years ended September 30, 2001
and 2000, respectively.

Four Months Ended April 30, 2002

Predecessor Company.During the four months ended April 30, 2002, the
Predecessor Company completed the sale or divestiture of
approximately twenty owned
or leased facilities and certain assets, which resulted in a net loss of

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approximately $10.8 million and is included in net loss (gain) on divestitures
within reorganization items. These facilities reported net revenue of
approximately $13.0 million for the four months ended April 30, 2002. In
addition, these facilities reported net revenue of approximately $18.0 million,
$70.5 million and $66.7 million for the three months ended December 31, 2001
and the fiscal years ended September 30, 2001 and 2000, respectively.

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, which resulted in a net gain of approximately $1.7
million. These facilities reported net revenue of approximately $2.0 million
for the three months ended December 31, 2001 and $17.5 million and $16.7
million for the fiscal years ended September 30, 2001 and 2000, respectively.

Fiscal Year Ended September 30, 2001

During the fiscal year ended September 30, 2001, the Company completed the sale
or divestiture of approximately forty-four owned, leased or managed facilities and
certain other assets, which resulted in a net gain of approximately $3.7
million. These facilities reported net revenue of approximately $110.7 million
and $173.0 million for the fiscal years ended September 30, 2001 and 2000,
respectively.

Fiscal Year Ended September 30, 2000

During the period from the Petition Date through September 30, 2000, the
Company completed the sale or divestiture of certain owned, leased or managed
facilities and certain other assets, which resulted in a net gain of
approximately $3.6 million.

In addition, the Company, through its GranCare subsidiaries, also settled
certain lease arrangements with twenty-two facilities from Senior Housing
Properties Trust and its wholly-owned subsidiary SPTMNR Properties Trust
(SPTMNR), which succeeded to the interests of Health and Retirement
Properties Trust (collectively, the SNH Entities), which resulted in the
Companys realization of a net gain of $11.1 million. On June 30, 2000, the
Company and the SNH Entities executed a settlement agreement, which was
approved by the Bankruptcy Court on May 10, 2000, whereby: (a) the Company
obtained fee simple ownership of five of the previously leased facilities from
the SNH Entities; (b) seventeen facilities leased by the Company and related
personal property leased by the Company were assigned to affiliates of the SNH
Entities; (c) a cash collateral deposit of $15.0 million and shares of the SNH
Entities' stock, with a market value of $7.2 million, were retained by the SNH
Entities; and (d) the Company agreed to manage the seventeen facilities
transferred to the SNH Entities during a transition period, which ended
December 31, 2000. Upon termination of the agreement relating to the
management of these facilities, the Company had no further relationship with or
obligations to the SNH Entities.

During the quarter ended December 31, 1999, the Company completed the sale of
certain facilities and other assets, which resulted in a net gain on sale
of assets of approximately $1.4 million. The Company also disposed of its
remaining home health operations and recorded a net loss on disposal of assets
of approximately $2.7 million during the fiscal year ended September 30, 2000.

Twenty-eight facilities were divested during the fiscal year ended September 30, 2000
reporting net revenue of approximately $87.1 million for the fiscal year ended
September 30, 2000.

NOTE 7      REVENUE

Net revenue includes amounts payable for services rendered to patients from the
federal government under Medicare, from the various states where the Company
operates under Medicaid, and from private insurers and the patients themselves.

The sources and amounts of the Companys patient revenue are determined by a
number of factors, including licensed bed capacity of its facilities, occupancy
rate, payor mix, type of services rendered to the patient, and rates of
reimbursement among payor categories (private/other, Medicare and Medicaid).
Changes in the mix of the

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Companys patients among the private pay, Medicare and Medicaid categories, as
well as changes in the quality mix, significantly affect the profitability of
the Companys operations.

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

|                  |             |   |              |           |  |  |                     |   |              |         |                                 |   |         |         |  |   |         |           |  |   |         |           | 
|----------------- | ----------- | - | ------------ | --------- |  |  | ------------------- | - | ------------ | ------- | ------------------------------- | - | ------- | ------- |  | - | ------- | --------- |  | - | ------- | --------- | 
|                  |             |   | Reorganized  |           |  |  |                     |   |              |         |                                 |   |         |         |  |   |         |           |  |   |        
|                  |             |   | Company      |           |  |  | Predecessor Company
|                  |             |   |              |           |  |  |                    
|                  |             |   | Eight Months |           |  |  | Four Months         |   | Three Months |         |                                 |   |         |         |  |   |        
|                  |             |   | Ended        |           |  |  | Ended               |   | Ended        |         | Fiscal Year Ended September 30,
|                  |             |   | December 31, |           |  |  | April 30,           |   | December 31, |         |                                
|                  |             |   | 2002         |           |  |  | 2002                |   | 2001         |         | 2001                            |   | 2000   
|                  |             |   |              |           |  |  |                     |   |              |         |                                 |   |        
|Medicaid          |             | $ | 574,283      |           |  |  |                     | $ | 287,073      |         |                                 | $ | 223,834 |         |  | $ | 923,576 |           |  | $ | 956,290 |          
|Medicare          |             |   | 390,611      |           |  |  |                     |   | 207,286      |         |                                 |   | 151,034 |         |  |   | 565,230 |           |  |   | 514,881 |          
|Private and other |             |   | 218,763      |           |  |  |                     |   | 107,078      |         |                                 |   | 83,283  |         |  |   | 383,329 |           |  |   | 408,136 |          
|                  |             |   |              |           |  |  |                     |   |              |         |                                 |   |         |         |  |   |         |           |  |   |         |          
|                  | Net revenue |   | $            | 1,183,657 |  |  |                     |   | $            | 601,437 |                                 |   | $       | 458,151 |  |   | $       | 1,872,135 |  |   | $       | 1,879,307 | 
|                  |             |   |              |           |  |  |                     |   |              |         |                                 |   |         |         |  |   |         |           |  |   |         |          

Balanced Budget Act and the Prospective Payment System

The Company derives a substantial portion of revenue from third-party payors,
including the Medicare and Medicaid programs. Third-party payor programs are
highly regulated and are subject to frequent and substantial changes. Changes
in the reimbursement rates or methods of payment from third-party payors,
including the Medicare and Medicaid programs, or the implementation of other
measures to reduce reimbursements, could result in a substantial reduction in
revenue and operating margins.

Prior to July 1, 1998, the Medicare program utilized a cost-based retrospective
reimbursement system for SNFs, 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 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 PPS for Medicare Part A SNF services, under which facilities are paid a
flat federal per diem rate for virtually all covered services, including
pharmacy and therapy.

PPS was phased in over four cost reporting periods, and started with cost
reporting periods beginning on or after July 1, 1998. As a result of the
Companys significant dependence on Medicare and Medicaid reimbursement, the
introduction of PPS significantly reduced the per-patient reimbursement rate,
resulting in lower per patient revenue.

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 then applicable to
independent therapists to all outpatient rehabilitation services beginning in
1999. Specifically, the Balanced Budget Act imposed a per beneficiary cap of
$1,500 per provider per therapy service provided, indexed for inflation. A
moratorium on the therapy limitation expired at the end of calendar year 2002.

Likewise, the Balanced Budget Act required the Secretary of the Department of
Health and Human Services to establish a PPS for home health services, to be
implemented beginning October 1, 1999, but which was delayed until October 1,
2000. With regard to hospices, the Balanced Budget Act limited reimbursement
by setting the payment rate increase at a market basket minus 1.0% for fiscal
years 1998 through 2002.

The law also instituted a number of reforms of the hospice benefit, including a
provision that hospices could be reimbursed based on the location where care is
furnished (rather than the location of the hospice), effective for cost
reporting periods beginning on or after October 1, 1997. Other provisions
limited Medicare payments for certain drugs and biologicals, durable medical
equipment and parenteral and enteral nutrients and supplies. The Balanced
Budget Act led to the divestiture or closure of the Predecessor Companys
pharmacy, therapy, home health and hospice operations as well as a significant
reduction in the reimbursement received by the Companys SNFs.

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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 SNFs under PPS. These bills were the Medicare,
Medicaid, and SCHIP Balanced Budget Refinement Act of 1999 and the Medicare,
Medicaid, and SCHIP Benefits Improvement and Protection Act of 2000. As of
October 1, 2002, some of the temporary payment increases provided for in these
Acts expired, which resulted in a loss of revenue and operating income for the
Company of $8.8 million during the three months ended December 31, 2002 and is
anticipated to result in a loss of an additional approximately $37.0 million in
fiscal year 2003 and annually thereafter, assuming there is no further
litigation providing for reimbursements relief and our patient census
remains stable. This is referred to as the Medicare Reimbursement Cliff. Under these
Acts, Congress also directed Centers for Medicare & Medicaid Services (CMS),
to refine the payment system for certain medically complex, rehabilitation and
high acuity patients and provided additional funding for those patients until
the payment system is refined. Congress mandated that these refinements be
budget neutral. For this reason, the PPS per diem rates have been
temporarily increased for some patient categories. CMS recently announced that
it was delaying the implementation of any further refinements to reimbursement
rates until October 1, 2004, at the earliest. At such time, the per diem
increases are expected to be eliminated. Although the refinements in the
payment system are intended to result in a PPS that more appropriately
reimburses providers for the services needed by certain payment categories, the
Company is unable to predict whether or how revenue will be affected by this
portion of the refined payment system. Additionally, it is not clear if the
temporary increases for higher acuity patients will be included in the refined
payment system.

The Balanced Budget Act also repealed the federal payment standard for Medicaid
reimbursement levels, often referred to as the Boren Amendment, for hospitals
and nursing facilities. By repealing the Boren Amendment, the Balanced Budget
Act removed existing impediments on the ability of states to reduce their
Medicaid reimbursement levels. Since that repeal, many states have sought to
lower their nursing home payment rates, and several have succeeded.
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.

Additionally, net revenue realizable under third-party payor agreements can
change after examination and retroactive adjustment by payors during the claims
settlement processes. Payors may disallow requests for reimbursement based on
determinations that certain costs are not reimbursable or reasonable, or
because additional documentation is necessary. There also continue to be new
legislative and regulatory proposals that could impose further limitations on
government and private payments to healthcare providers. In some cases, states
have enacted or are considering enacting measures designed to reduce their
Medicaid expenditures and to make changes to private healthcare insurance.

There is no assurance that adequate reimbursement levels will continue to be
available for the services provided by the Company, 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 the Companys liquidity, financial condition and
results of operations. It is possible that the combination of the effects of
the Medicare Reimbursement Cliff, further refinements to the PPS Medicare
reimbursement system that results in lower payments to the Company, increased
staffing costs and cuts in state Medicaid funding could have a material adverse
effect on the Companys results of operations.

Regulation

In the ordinary course of business, the Company is regularly subject to
inquiries, investigations and audits by federal and state agencies to determine
if the Company is in compliance with regulations governing the operation of,
and reimbursement for, SNFs 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 healthcare services reimbursable under federal and/or state healthcare
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 government programs such as Medicare and Medicaid.

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In addition, the Ethics in Patient Referral Act of 1989, commonly referred to
as the federal physician self-referral prohibition or Stark Law, broadly
defines the scope of prohibited physician referrals under federal healthcare
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 healthcare
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. There is no assurance that governmental
officials charged with responsibility for enforcing the provisions of these
laws and regulations will not assert that one or more of the Companys
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 large for-profit, multi-facility providers like
the Company. In the State of Florida, for example, a new statute could be
interpreted to require the state to revoke, absent sufficient mitigating
factors, all licenses held by an entity even if only one facility has perceived
regulatory deficiencies. The federal government has imposed extensive
enforcement policies resulting in a significant increase in the number 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 the Company fails to comply, or is perceived as failing to
comply, with the extensive laws and regulations applicable to its business, the
Company could become ineligible to receive government program reimbursement,
suffer civil or criminal penalties or be required to make significant changes
to operations. In addition, the Company could be forced to expend considerable
resources responding to an investigation or other enforcement action under
these laws or regulations. Furthermore, should the Company lose licenses or
certifications for a number of facilities as a result of regulatory action or
otherwise, the Company could be deemed to be in default under certain
agreements, including agreements governing outstanding indebtedness.

The Company is 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. The
failure to obtain or renew required regulatory approvals or licenses or to
comply with applicable regulatory requirements, the suspension or revocation of
licenses or 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 the operations and financial
condition of the Company.

Private Third-Party Payors

Private third-party payors, which are parties responsible for the payment for
medical services received by others, other than the Medicare and Medicaid
programs, are continuing their efforts to control healthcare costs through
direct contracts with healthcare providers, increased utilization reviews, or
reviews of the propriety of, and charges for, services provided, and greater
enrollment in managed care programs and preferred provider organizations.
Preferred provider organizations are entities through which employer health
plans and insurers can contract to purchase healthcare services from selected
providers for their beneficiaries. These private payors increasingly are
demanding discounted fee structures and the assumption by healthcare providers
of all or a portion of the financial risk associated with the provision of
care.

The Company could be adversely affected by the continuing efforts of private
third-party payors to contain the amount of reimbursement the company receives
for healthcare services. There is no assurance 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 under these programs. Future changes in the
reimbursement rates or methods of private third-party payors or the
implementation of other measures to reduce reimbursement for services could
result in a substantial reduction in the Companys revenue and a material
adverse effect on the operations and financial condition of the Company.

Significant legal actions, which are commonplace in the healthcare service
industry, could subject the Company to increased operating costs and
substantial uninsured liabilities, which would materially and adversely affect
the Companys liquidity and financial condition.

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NOTE 8      PROPERTY AND EQUIPMENT

Property and equipment at December 31, 2002, December 31, 2001 and September
30, 2001 consisted of the following (in thousands of dollars):

|                                     |       |   |              |         |  |  |                     |   |               |         |  |   |          |         | 
|------------------------------------ | ----- | - | ------------ | ------- |  |  | ------------------- | - | ------------- | ------- |  | - | -------- | ------- | 
|                                     |       |   | Reorganized  |         |  |  |                     |   |               |         |  |   |         
|                                     |       |   | Company      |         |  |  | Predecessor Company
|                                     |       |   |              |         |  |  |                    
|                                     |       |   | December 31, |         |  |  | December 31,        |   | September 30,
|                                     |       |   | 2002         |         |  |  | 2001                |   | 2001         
|                                     |       |   |              |         |  |  |                     |   |              
|Land                                 |       | $ | 82,796       |         |  |  |                     | $ | 65,258        |         |  | $ | 65,665   |        
|Buildings and improvements           |       |   | 376,252      |         |  |  |                     |   | 445,432       |         |  |   | 443,119  |        
|Leasehold improvements               |       |   | 22,646       |         |  |  |                     |   | 53,878        |         |  |   | 53,600   |        
|Furniture, fixtures and equipment    |       |   | 80,260       |         |  |  |                     |   | 164,133       |         |  |   | 163,435  |        
|Leased property under capital leases |       |   | 31,733       |         |  |  |                     |   | 41,190        |         |  |   | 41,152   |        
|                                     |       |   |              |         |  |  |                     |   |               |         |  |   |          |        
|                                     | Total |   |              | 593,687 |  |  |                     |   |               | 769,891 |  |   |          | 766,971 | 
|Less: Accumulated depreciation       |       |   | (26,427      | )       |  |  |                     |   | (356,926      | )       |  |   | (350,945 | )      
|                                     |       |   |              |         |  |  |                     |   |               |         |  |   |          |        
|                                     |       | $ | 567,260      |         |  |  |                     | $ | 412,965       |         |  | $ | 416,026  |        
|                                     |       |   |              |         |  |  |                     |   |               |         |  |   |          |        

The Company is developing and implementing a new information technology
infrastructure to improve customer service, enhance operating efficiencies and
provide more effective management of business operations. In June 2002 the
Company established technological feasibility and the Company has capitalized
$13.7 million of software development costs as of December 31, 2002. The costs
are reported at the lower of unamortized cost or net realizable value and are
included in furniture, fixtures and equipment above. Prior to June 2002,
software development costs were expensed and are included in operating expenses
in the accompanying consolidated statement of operations.

Depreciation expense, including amortization of assets under capital leases,
related to property and equipment was $23.2 million for the eight months ended
December 31, 2002, $11.7 million for the four months ended April 30, 2002, $8.3
million for the three months ended December 31, 2001 and $37.4 million and
$32.3 million for the fiscal years ended September 30, 2001 and 2000,
respectively. The carrying value of buildings and improvements has been
reduced by $27.3 million in the three months ended December 31, 2002 related to
the tangible asset impairment that was recorded according to the provisions of
SFAS No. 144 (see Note 15).

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NOTE 9      RESTRICTED INVESTMENTS

Restricted investments at December 31, 2002, December 31, 2001 and September
30, 2001 consisted of the following (in thousands of dollars):

|                                      |                            |   |           |        |                  |   |                  |     |                |   |   |   |  |   |        |        | 
|------------------------------------- | -------------------------- | - | --------- | ------ | ---------------- | - | ---------------- | --- | -------------- | - | - | - |  | - | ------ | ------ | 
|                                      |                            |   | Amortized |        | Gross Unrealized |   | Gross Unrealized |     | Estimated Fair
|                                      |                            |   | Cost      |        | Gains            |   | Losses           |     | Value         
|                                      |                            |   |           |        |                  |   |                  |     |               
|Reorganized Company                   |                            |   |           |        |                  |   |                  |     |                |   |   |   |  |   |        |       
|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                       |   |           | 707    |                  |   |                  |    |                |   |   |  |  |   |        | 707    | 
|                                      | Other                      |   |           | 214    |                  |   |                  |    |                |   |   |  |  |   |        | 214    | 
|                                      |                            |   |           |        |                  |   |                  |     |                |   |   |   |  |   |        |        | 
|                                      |                            |   | 11,494    |        |                  |   | 623              |     |                |   |  |   |  |   | 12,117 |       
|Restricted by bank agreements         |                            |   |           |        |                  |   |                  |     |                |   |   |   |  |   |        |       
|                                      | Cash collateral accounts   |   |           | 26,576 |                  |   |                  |    |                |   |   |  |  |   |        | 26,576 | 
|                                      |                            |   |           |        |                  |   |                  |     |                |   |   |   |  |   |        |        | 
|                                      |                            | $ | 38,070    |        |                  | $ | 623              |     |                | $ |  |   |  | $ | 38,693 |       
|                                      |                            |   |           |        |                  |   |                  |     |                |   |   |   |  |   |        |        | 
|                                     
|Predecessor Company                   |                            |   |           |        |                  |   |                  |     |                |   |   |   |  |   |        |       
|December 31, 2001                     |                            |   |           |        |                  |   |                  |     |                |   |   |   |  |   |        |       
|Restricted by self insurance programs |                            |   |           |        |                  |   |                  |     |                |   |   |   |  |   |        |       
|                                      | U.S. Treasury Notes        |   | $         | 3,291  |                  |   | $                | 48  |                |   | $ |  |  |   | $      | 3,339  | 
|                                      | Corporate debt securities  |   |           | 9,365  |                  |   |                  | 170 |                |   |   |  |  |   |        | 9,535  | 
|                                      | Mortgage-backed securities |   |           | 5,022  |                  |   |                  | 74  |                |   |   |  |  |   |        | 5,096  | 
|                                      | Cash                       |   |           | 1,164  |                  |   |                  |    |                |   |   |  |  |   |        | 1,164  | 
|                                      | Other                      |   |           | 683    |                  |   |                  |    |                |   |   |  |  |   |        | 683    | 
|                                      |                            |   |           |        |                  |   |                  |     |                |   |   |   |  |   |        |        | 
|                                      |                            |   | 19,525    |        |                  |   | 292              |     |                |   |  |   |  |   | 19,817 |       
|Restricted by bank agreements         |                            |   |           |        |                  |   |                  |     |                |   |   |   |  |   |        |       
|                                      | Cash collateral accounts   |   |           | 17,950 |                  |   |                  |    |                |   |   |  |  |   |        | 17,950 | 
|                                      |                            |   |           |        |                  |   |                  |     |                |   |   |   |  |   |        |        | 
|                                      |                            | $ | 37,475    |        |                  | $ | 292              |     |                | $ |  |   |  | $ | 37,767 |       
|                                      |                            |   |           |        |                  |   |                  |     |                |   |   |   |  |   |        |        | 
|September 30, 2001                    |                            |   |           |        |                  |   |                  |     |                |   |   |   |  |   |        |       
|Restricted by self insurance programs |                            |   |           |        |                  |   |                  |     |                |   |   |   |  |   |        |       
|                                      | U.S. Treasury Notes        |   | $         | 3,293  |                  |   | $                | 47  |                |   | $ |  |  |   | $      | 3,340  | 
|                                      | Corporate debt securities  |   |           | 9,975  |                  |   |                  | 399 |                |   |   |  |  |   |        | 10,374 | 
|                                      | Mortgage-backed securities |   |           | 4,440  |                  |   |                  | 129 |                |   |   |  |  |   |        | 4,569  | 
|                                      | Cash                       |   |           | 1,137  |                  |   |                  |    |                |   |   |  |  |   |        | 1,137  | 
|                                      | Other                      |   |           | 749    |                  |   |                  |    |                |   |   |  |  |   |        | 749    | 
|                                      |                            |   |           |        |                  |   |                  |     |                |   |   |   |  |   |        |        | 
|                                      |                            |   | 19,594    |        |                  |   | 575              |     |                |   |  |   |  |   | 20,169 |       
|Restricted by bank agreements         |                            |   |           |        |                  |   |                  |     |                |   |   |   |  |   |        |       
|                                      | Cash collateral accounts   |   |           | 12,662 |                  |   |                  |    |                |   |   |  |  |   |        | 12,662 | 
|                                      |                            |   |           |        |                  |   |                  |     |                |   |   |   |  |   |        |        | 
|                                      |                            | $ | 32,256    |        |                  | $ | 575              |     |                | $ |  |   |  | $ | 32,831 |       
|                                      |                            |   |           |        |                  |   |                  |     |                |   |   |   |  |   |        |        | 

Proceeds from the sales and maturities of investments were $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 and $16.8 million for the fiscal years ended September 30,
2001 and 2000, respectively.

The amortized cost and estimated fair value of debt securities and other
investments at December 31, 2002, by contractual maturity, are shown below (in
thousands of dollars). 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.

F-28



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|                                      |                            |        |           |        |        |       |         |       |          |      |           |       |  |   |     |     |  |   |        |        | 
|------------------------------------- | -------------------------- | ------ | --------- | ------ | ------ | ----- | ------- | ----- | -------- | ---- | --------- | ----- |  | - | --- | --- |  | - | ------ | ------ | 
|                                      |                            |        |           |        |        |       |         |       |          |      |           |       |  |   |     |     |  |   | Total 
|                                      |                            |        | Less than |        | 1 to 5 |       | 5 to 10 |       | After 10 |      | Amortized
|Amortized Cost                        |                            | 1 year |           | years  |        | years |         | years |          | Cost
|                                      |                            |        |           |        |        |       |         |       |          |     
|December 31, 2002                     |                            |        |           |        |        |       |         |       |          |      |           |       |  |   |     |     |  |   |        |       
|Restricted by self insurance programs |                            |        |           |        |        |       |         |       |          |      |           |       |  |   |     |     |  |   |        |       
|                                      | U.S. Treasury Notes        |        | $         | 334    |        |       | $       | 250   |          |      | $         | 551   |  |   | $   |    |  |   | $      | 1,135  | 
|                                      | Corporate debt securities  |        |           | 1,070  |        |       |         | 3,972 |          |      |           | 388   |  |   |     |    |  |   |        | 5,430  | 
|                                      | Mortgage-backed securities |        |           | 231    |        |       |         | 2,470 |          |      |           | 1,036 |  |   |     | 271 |  |   |        | 4,008  | 
|                                      | Cash                       |        |           | 707    |        |       |         |      |          |      |           |      |  |   |     |    |  |   |        | 707    | 
|                                      | Other                      |        |           | 214    |        |       |         |      |          |      |           |      |  |   |     |    |  |   |        | 214    | 
|                                      |                            |        |           |        |        |       |         |       |          |      |           |       |  |   |     |     |  |   |        |        | 
|                                      |                            |        | 2,556     |        |        |       | 6,692   |       |          |      | 1,975     |       |  |   | 271 |     |  |   | 11,494 |       
|Restricted by bank agreements         |                            |        |           |        |        |       |         |       |          |      |           |       |  |   |     |     |  |   |        |       
|                                      | Cash collateral accounts   |        |           | 26,576 |        |       |         |      |          |      |           |      |  |   |     |    |  |   |        | 26,576 | 
|                                      |                            |        |           |        |        |       |         |       |          |      |           |       |  |   |     |     |  |   |        |        | 
|                                      |                            | $      | 29,132    |        |        | $     | 6,692   |       |          | $    | 1,975     |       |  | $ | 271 |     |  | $ | 38,070 |       
|                                      |                            |        |           |        |        |       |         |       |          |      |           |       |  |   |     |     |  |   |        |        | 

|                                      |                            |        |           |        |        |       |         |       |          |            |           |       |  |   |     |     |  |   |        |        | 
|------------------------------------- | -------------------------- | ------ | --------- | ------ | ------ | ----- | ------- | ----- | -------- | ---------- | --------- | ----- |  | - | --- | --- |  | - | ------ | ------ | 
|                                      |                            |        |           |        |        |       |         |       |          |            |           |       |  |   |     |     |  |   | Total 
|                                      |                            |        | Less than |        | 1 to 5 |       | 5 to 10 |       | After 10 |            | Estimated
|Estimated Fair Value                  |                            | 1 year |           | years  |        | years |         | years |          | Fair Value
|                                      |                            |        |           |        |        |       |         |       |          |           
|December 31, 2002                     |                            |        |           |        |        |       |         |       |          |            |           |       |  |   |     |     |  |   |        |       
|Restricted by self insurance programs |                            |        |           |        |        |       |         |       |          |            |           |       |  |   |     |     |  |   |        |       
|                                      | U.S. Treasury Notes        |        | $         | 334    |        |       | $       | 254   |          |            | $         | 597   |  |   | $   |    |  |   | $      | 1,185  | 
|                                      | Corporate debt securities  |        |           | 1,090  |        |       |         | 4,251 |          |            |           | 421   |  |   |     |    |  |   |        | 5,762  | 
|                                      | Mortgage-backed securities |        |           | 236    |        |       |         | 2,576 |          |            |           | 1,164 |  |   |     | 273 |  |   |        | 4,249  | 
|                                      | Cash                       |        |           | 707    |        |       |         |      |          |            |           |      |  |   |     |    |  |   |        | 707    | 
|                                      | Other                      |        |           | 214    |        |       |         |      |          |            |           |      |  |   |     |    |  |   |        | 214    | 
|                                      |                            |        |           |        |        |       |         |       |          |            |           |       |  |   |     |     |  |   |        |        | 
|                                      |                            |        | 2,581     |        |        |       | 7,081   |       |          |            | 2,182     |       |  |   | 273 |     |  |   | 12,117 |       
|Restricted by bank agreements         |                            |        |           |        |        |       |         |       |          |            |           |       |  |   |     |     |  |   |        |       
|                                      | Cash collateral accounts   |        |           | 26,576 |        |       |         |      |          |            |           |      |  |   |     |    |  |   |        | 26,576 | 
|                                      |                            |        |           |        |        |       |         |       |          |            |           |       |  |   |     |     |  |   |        |        | 
|                                      |                            | $      | 29,157    |        |        | $     | 7,081   |       |          | $          | 2,182     |       |  | $ | 273 |     |  | $ | 38,693 |       
|                                      |                            |        |           |        |        |       |         |       |          |            |           |       |  |   |     |     |  |   |        |        | 

NOTE 10      DEBT

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

|                                    |                                                                    |                |         |                    |         |  |  |                     |            |               |        |  |            |           |        | 
|----------------------------------- | ------------------------------------------------------------------ | -------------- | ------- | ------------------ | ------- |  |  | ------------------- | ---------- | ------------- | ------ |  | ---------- | --------- | ------ | 
|                                    |                                                                    |                |         | ReorganizedCompany |         |  |  | Predecessor Company
|                                    |                                                                    |                |         |                    |         |  |  |                    
|                                    |                                                                    |                |         | December 31,       |         |  |  | December 31,        |            | September 30,
|                                    |                                                                    |                |         | 2002               |         |  |  | 2001                |            | 2001         
|                                    |                                                                    |                |         |                    |         |  |  |                     |            |              
|Secured debt:                       |                                                                    |                |         |                    |         |  |  |                     |            |               |        |  |            |          
|                                    | Senior Credit Facility:                                            |                |         |                    |         |  |  |                     |            |               |        |  |            |           |       
|                                    |                                                                    | Term Loans     |         | $                  | 210,410 |  |  |                     |            | $             |       |  |            | $         |       | 
|                                    | Second Priority Notes                                              |                |         | 150,000            |         |  |  |                     |            |              |        |  |            |          |       
|                                    | Prepetition senior credit facilities                               |                |         |                   |         |  |  |                     |            | 1,301,982     |        |  |            | 1,305,283 |       
|                                    | Non-recourse indebtedness of subsidiary                            |                |         | 59,688             |         |  |  |                     |            | 59,688        |        |  |            | 59,688    |       
|                                    | Mortgage notes payable and capital leases                          |                |         | 64,664             |         |  |  |                     |            | 127,442       |        |  |            | 128,478   |       
|Unsecured debt:                     |                                                                    |                |         |                    |         |  |  |                     |            |               |        |  |            |          
|                                    | Prepetition senior subordinated debt, net of unamortized discounts |                |         |                   |         |  |  |                     |            | 597,328       |        |  |            | 597,328   |       
|                                    | Prepetition notes payable and other unsecured debt                 |                |         |                   |         |  |  |                     |            | 25,978        |        |  |            | 25,978    |       
|                                    |                                                                    |                |         |                    |         |  |  |                     |            |               |        |  |            |           |        | 
|                                    |                                                                    |                | 484,762 |                    |         |  |  |                     | 2,112,418  |               |        |  | 2,116,755  |          
|Less: current maturities            |                                                                    |                | (9,793  | )                  |         |  |  |                     |           |               |        |  |           |          
|Less: amounts subject to compromise |                                                                    |                |        |                    |         |  |  |                     | (2,052,730 | )             |        |  | (2,057,067 | )        
|                                    |                                                                    |                |         |                    |         |  |  |                     |            |               |        |  |            |           |        | 
|                                    |                                                                    | Long-term debt |         | $                  | 474,969 |  |  |                     |            | $             | 59,688 |  |            | $         | 59,688 | 
|                                    |                                                                    |                |         |                    |         |  |  |                     |            |               |        |  |            |           |        | 

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Interest paid by the Reorganized Company during the eight months ended December
31, 2002 was $23.9 million. Interest paid by the Predecessor Company 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. Interest paid by the Predecessor Company on prepetition
indebtedness was $20.5 million during the year ended September 30, 2000, of
which $15.6 million was paid prior to the Petition Date.

Senior Credit Facility

As previously noted, on the Effective Date and in connection with the
consummation of the Joint Plan, the Company entered into the Senior Credit
Facility with a syndicate of lenders consisting of: (i) an $85.0 million
revolving credit facility (the Revolving Credit Facility); and (ii) a $212.0
million six-year term loan facility (the Term Loans). Outstanding amounts
under the Senior Credit Facility bear interest, at the Companys election, at a
eurodollar rate or an alternate base rate, in each case, plus an applicable
margin, which ranges from 1.25%-2.25% for base rate loans and 2.25%-3.25% for
eurodollar loans. The interest rate on the Term Loans was 4.69% at December
31, 2002. The applicable margin for loans under the Revolving Credit Facility
is subject to adjustment in the future based upon a performance related grid.

The Senior Credit Facility is guaranteed by substantially all of the Companys
direct and indirect wholly owned subsidiaries and is 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 Senior
Credit Facility limits, 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 Senior Credit Facility, which contains customary representations
and warranties, restricts the Companys ability to borrow funds thereunder in
the event the Company maintains in excess of a $25.0 million cash balance and
requires the Company to maintain compliance with certain financial covenants,
including minimum consolidated adjusted EBITDA (as defined in the Senior Credit
Facility), maximum leverage ratios, minimum fixed charge coverage ratios and
maximum capital expenditures.

The Revolving Credit Facility is available for general corporate purposes,
including working capital and permitted acquisitions. Usage under the
Revolving Credit Facility, which matures on May 13, 2007, is 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 SNFs. No borrowings were
outstanding under the Revolving Credit Facility 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 Term Loans 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 Term
Loans amortize 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 mature on May 13, 2008. The Term Loans can be
prepaid at the Companys option without penalty or premium. In addition, the
Term Loans are subject to mandatory prepayment: (i) from the proceeds of
certain asset sales which are 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 are 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 Term Loans are also subject to annual
mandatory prepayment to the extent of 75% of the Companys consolidated excess
cash flow (as defined in the Senior Credit Facility).

The Senior Credit Facility has been 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 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 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 Senior Credit
Facility.

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The Company incurred deferred financing costs of approximately $6.4 million
related to the Senior Credit Facility. For the eight months ended December 31,
2002, $0.7 million of these costs were amortized as an increase in interest
expense using the straight-line method.

Second Priority Notes

As previously noted, on the Effective Date, and in connection with the
consummation of the Joint Plan, the Company entered into an indenture (the
Indenture) with The Bank of New York, as Trustee, pursuant to which the
Company issued the Second Priority Notes in the aggregate principal amount of
$150.0 million. The Second Priority Notes bear interest at the
three month
London Interbank Offered Rate (LIBOR) plus 550 basis points (6.90% at
December 31, 2002) and mature on May 13, 2009. The Second Priority Notes are
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
Senior Credit Facility, liens granted to secure certain third-party mortgage
loans and other permitted liens. The Second Priority Notes may be prepaid at
any time without penalty, subject to restrictions in place under the Senior
Credit Facility. The Indenture includes 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

One of the Companys wholly owned subsidiaries, Professional Health Care
Management, Inc. (PHCMI), is the borrower under an approximately $59.7
million mortgage loan from Omega Healthcare Investors, Inc. (Omega) that was
restructured as part of the Chapter 11 Cases. The 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. 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, or more
specifically a payer swaption. The fair market value of the payer swaption
has been separated from the Omega Loan and recorded as an asset at current
market value. 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. Omega is also entitled to receive an
annual amendment fee equal to 25% of the annual free cash flow from the Omega
Facilities (as defined below).

The Omega Loan is guaranteed by all of PHCMIs subsidiaries (together with
PHCMI, the PHCMI Entities), 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 SNFs located in Michigan and three in North
Carolina (collectively, the Omega Facilities). The Omega Loan constitutes
non-recourse indebtedness to all of the other subsidiaries of the Company, none
of which 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 other PHCMI Entities has guaranteed
either the Senior Credit Facility or the Second Priority 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.

Other Indebtedness

All of the Companys mortgages are secured by the underlying property. These
loans bear 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).

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Scheduled Maturities of Long-Term Debt

The scheduled maturities of long-term debt are as follows (in thousands of
dollars):

|           |  |              |         | 
|---------- |  | ------------ | ------- | 
|           |  | Reorganized 
|           |  | Company     
|           |  | December 31,
|           |  | 2002        
|           |  |             
|Year 1     |  | $            | 9,793   | 
|Year 2     |  |              | 8,939   | 
|Year 3     |  |              | 21,034  | 
|Year 4     |  |              | 10,363  | 
|Year 5     |  |              | 3,345   | 
|Thereafter |  |              | 431,288 | 
|           |  |              |         | 
|           |  | $            | 484,762 | 
|           |  |              |         | 

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. The remaining $22.6 million
in letters of credit were issued after the Effective Date pursuant to the
Senior Credit Facility and are not cash collateralized or drawn upon as of
December 31, 2002.

Prepetition Debt  Predecessor Company

In connection with the Chapter 11 Cases, no principal or interest payments were
made on the Companys prepetition indebtedness with the exception of repayments
made against the Companys prepetition senior credit facilities primarily as a
result of the application of a portion of the cash proceeds received from the
sale of certain facilities and other assets and adequate protection payments
with regard to certain mortgaged facilities and capital leases.

Debtor-in-Possession Financing Agreements  Predecessor Company

On the Petition Date, the Bankruptcy Court entered orders approving: (i) a
$100.0 million debtor-in-possession financing facility for the MPAN Debtors
(the MPAN DIP Financing) from a syndicate of lenders led by JP Morgan Chase
Bank (f/k/a The Chase Manhattan Bank, Chase), which was subsequently replaced
by Foothill Capital Corporation as administrative agent; and (ii) a $50.0
million debtor-in-possession financing facility for the MHG Debtors (the MHG
DIP Financing and, together with the MPAN DIP Financing, the DIP Financings)
from a syndicate of lenders led by PNC Bank, National Association (PNC). In
January 2001, the commitment under the MPAN DIP Financing was reduced from
$100.0 million to $50.0 million, and the commitment under the MHG DIP Financing
was reduced from $50.0 million to $25.0 million. The DIP Financings, and their
related liens, were terminated on the Effective Date, at which time there were
no outstanding borrowings. Approximately $12.6 million in outstanding letters
of credit issued for the account of the Debtors under the DIP Financings prior
to the Effective Date remained outstanding, and were cash collateralized in
accordance with the Joint Plan. As of December 31, 2002, all such letters of
credit (except for one $3.0 million letter of credit) had been replaced by
non-cash collateralized letters of credit issued under the Revolving Credit
Facility. After receiving notice of non-renewal, the beneficiary of the $3.0
million letter of credit drew that letter of credit on or about January 8,
2003; accordingly, this letter of credit is no longer outstanding.

Interest was payable on the principal amount outstanding under the MPAN DIP
Financing at the per annum rate equal to the Alternative Base Rate of Chase
plus three percent (3%) payable monthly in arrears. Interest was payable on
the principal amount outstanding under the MHG DIP Financing at a per annum
rate equal to the base rate of PNC (i.e., the higher of the PNC prime rate or a
rate equal to the federal funds rate plus 50 basis points) plus the applicable
spread, which was 250 basis points. The obligations of the MPAN Debtors under
the MPAN DIP Financing were jointly and severally guaranteed by each of the
MPAN Debtors and were secured by liens and security interests on substantially
all of the real property and personal property assets of the MPAN Debtors; the
obligations of the MHG Debtors under the MHG DIP Financing were jointly and
severally guaranteed by each of the MHG Debtors and were secured by liens and
security interests on all or substantially all of the real property and

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personal property assets of the MHG Debtors. The DIP Financings contained
customary representations, warranties and other affirmative and restrictive
covenants.

NOTE
11           STOCKHOLDERS EQUITY

As of the consummation of the Joint Plan on the Effective Date, the authorized
capital stock of the Reorganized Company consisted of 90,0000,000 shares, with
80,000,000 shares reserved for issuance as New Common Stock and 10,000,000
million shares reserved for issuance as 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 has 80,000,000 shares of New Common Stock that are authorized to be
issued, of which 20,000,000 were issued and outstanding following the initial
distribution of New Common Stock in accordance with the Joint Plan. Up to
2,153,022 additional shares of New 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 13). The issued and
outstanding shares of New Common Stock are validly issued, fully paid and
nonassessable. New 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 Reorganized Companys
Senior Credit Facility and the Indenture contain negative covenants that impose
restrictions on, among other things, the Companys ability to pay dividends.
The Reorganized Company does not plan to pay dividends on the New Common Stock
for the foreseeable future. In the event of a liquidation, dissolution or
winding up of the Company, holders of New 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 New Common Stock holders have no preemptive rights and
no rights to require the redemption of the New 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 New
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 12           INSURANCE RISKS

Insurance related costs in the long-term care industry, including PL/GL,
workers compensation and directors and officers liability programs, continue
to rise at a dramatic rate. Costs for PL/GL programs are of particular concern
in Florida and Texas where the Company maintains significant operations.
Significant increases in the frequency and severity of PL/GL claims also
continues. 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. These increases have already had an adverse effect on the
Companys operations. No assurance can be given that the Companys PL/GL costs
will not continue to rise, or that PL/GL coverage will be available to the
Company in the future. In the event that PL/GL insurance coverage becomes cost
prohibitive to maintain, or unavailable in some markets, the Company may be
forced to re-evaluate its continued operations in these markets.

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, PL/GL and automobile liability for losses that occurred prior to
April 1, 1998. Pursuant to

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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 $12.1 million, $19.8 million and $20.2
million at December 31, 2002, December 31, 2001 and September 30, 2001,
respectively (see Note 9).

Total insurance reserves at December 31, 2002 included in the accompanying
consolidated balance sheet are: (i) short-term reserves of $28.7 million, which
are included in accrued insurance obligations; and (ii) long-term reserves of
$195.6 million, which are included in long-term insurance reserves. Provisions
for such risks were approximately $74.3 million for the eight months ended
December 31, 2002, $39.9 million for the four months ended April 30, 2002,
$31.1 million for the three months ended December 31, 2001, and $118.4 million
and $104.4 million for the fiscal years ended September 30, 2001 and 2000,
respectively. In the three months ended December 31, 2002, the Company
deposited $10.0 million into an escrow account to pay future costs associated
with PL/GL.

NOTE 13           STOCK OPTION PLANS

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 the Companys stockholders.

A total of 1,978,022 shares of common stock are reserved for issuance under the
2002 Stock Incentive Plan. At December 31, 2002, there were options to
purchase 1,673,060 shares of New Common Stock outstanding under this plan. The
number of shares of New 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 except that options to
purchase 439,560 shares of New Common Stock granted to the Reorganized
Companys Chief Executive Officer vest 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 administers the 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 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 and its affiliates are eligible
to participate in the 2002 Stock Incentive Plan. Currently, approximately 100
individuals participate in this plan. The 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 New 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.

2002 Outside Directors Stock Option Plan

On May 16, 2002, the Board of Directors adopted the Mariner Health Care, Inc.
2002 Outside Directors Stock Option Plan (the 2002 Outside Directors Plan).
The 2002 Outside Directors Plan provides the Company with the ability to
grant each non-employee director non-qualified stock options to purchase shares
of New Common Stock with an option exercise price less than or equal to the
fair market value of these shares at the date of grant. This plan is
administered by the Compensation Committee of the Board of Directors which has
the authority in its sole discretion to interpret, grant options under, make
all other determinations and take all other actions it deems

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necessary or advisable for the implementation and administration of the 2002
Outside Directors Plan or any agreements thereunder. The terms and conditions
of each award made under the 2002 Outside Directors Plan are set forth in
individual non-qualified stock option agreements.

A total of 175,000 shares of New Common Stock are reserved for issuance under
the 2002 Outside Directors Plan. At December 31, 2002, all of these options
had been granted and were outstanding. Options granted to non-employee
directors were 25% vested on the date of grant, with the remaining options
vesting in equal annual installments over three years. The number of shares of
New Common Stock reserved is subject to adjustment in the event of stock
dividends, stock splits, recapitalizations or similar events.

The table below presents the stock option plans for the Reorganized Company.

|                                                               |  |                    |           |       |  |           |       | 
|-------------------------------------------------------------- |  | ------------------ | --------- | ----- |  | --------- | ----- | 
|                                                               |  | Eight Months Ended
|                                                               |  | December 31, 2002 
|                                                               |  |                   
|                                                               |  |                    |           |       |  | Weighted 
|                                                               |  |                    |           |       |  | Average  
|                                                               |  |                    |           |       |  | Exercise 
|                                                               |  | Options            |           | Price
|                                                               |  |                    |           |      
|Outstanding at the Effective Date                              |  |                    |          |       |  | $         |      | 
|Granted                                                        |  |                    | 1,885,560 |       |  |           | 20.12 | 
|Exercised                                                      |  |                    |          |       |  |           |      | 
|Forfeited                                                      |  |                    | (37,500   | )     |  |           | 20.12 | 
|                                                               |  |                    |           |       |  |           |       | 
|Outstanding at end of year                                     |  |                    | 1,848,060 |       |  | $         | 20.12 | 
|                                                               |  |                    |           |       |  |           |       | 
|Exercisable at end of year                                     |  |                    | 153,595   |       |  | $         | 20.12 | 
|                                                               |  |                    |           |       |  |           |       | 
|Weighted average fair value of options
granted during the year |  |                    |           |       |  | $         | 10.80 | 
|                                                               |  |                    |           |       |  |           |       | 
|Weighted average contractual life
at December 31, 2002         |  |                    |           |       |  | 9.4 years

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 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.

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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 |  |                                 |      |       |  |         |           |          |  |         |      |       |  |          |            |  
|                                                                 |  | Ended       |           | Ended        |  | Fiscal Year Ended September 30,
|                                                                 |  | April 30,   |           | December 31, |  |                                
|                                                                 |  | 2002        |           | 2001         |  | 2001                            |      | 2000 
|                                                                 |  |             |           |              |  |                                 |      |      
|                                                                 |  |             |           |              |  | Weighted                        |      |       |  |         |           | Weighted |  |         |      |       |  | Weighted |            |   |  |   |       | Weighted
|                                                                 |  |             |           |              |  | Average                         |      |       |  |         |           | Average  |  |         |      |       |  | Average  |            |   |  |   |       | Average 
|                                                                 |  |             |           |              |  | Exercise                        |      |       |  |         |           | Exercise |  |         |      |       |  | Exercise |            |   |  |   |       | Exercise
|                                                                 |  | Options     |           | Price        |  | 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  |          |  |   | 4,624,264 |   |  | $ | 9.14  | 
|Granted                                                          |  |             |          |              |  |                                 |     |       |  |         |          |          |  |         |     |       |  |          |           |   |  |   |      |          |  |   |          |   |  |   |      | 
|Exercised                                                        |  |             |          |              |  |                                 |     |       |  |         |          |          |  |         |     |       |  |          |           |   |  |   |      |          |  |   |          |   |  |   |      | 
|Forfeited                                                        |  |             |          |              |  |                                 |     |       |  |         | (112,500  | )        |  |         | 7.60 |       |  |          | (1,888,190 | ) |  |   | 16.35 |          |  |   | (624,328  | ) |  |   | 5.74  | 
|                                                                 |  |             |           |              |  |                                 |      |       |  |         |           |          |  |         |      |       |  |          |            |   |  |   |       |          |  |   |           |   |  |   |       | 
|Outstanding at end
of period                                     |  |             | 1,999,246 |              |  | $                               | 7.57 |       |  |         | 1,999,246 |          |  | $       | 7.57 |       |  |          | 2,111,746  |   |  | $ | 7.57  |          |  |   | 3,999,936 |   |  | $ | 9.67  | 
|                                                                 |  |             |           |              |  |                                 |      |       |  |         |           |          |  |         |      |       |  |          |            |   |  |   |       |          |  |   |           |   |  |   |       | 
|Exercisable at end
of period                                     |  |             | 1,489,204 |              |  | $                               | 8.88 |       |  |         | 1,461,871 |          |  | $       | 8.88 |       |  |          | 1,441,371  |   |  | $ | 8.39  |          |  |   | 2,691,311 |   |  | $ | 11.33 | 
|                                                                 |  |             |           |              |  |                                 |      |       |  |         |           |          |  |         |      |       |  |          |            |   |  |   |       |          |  |   |           |   |  |   |       | 
|                                                                 |  | $           | 0.75 -    |              |  |                                 |      |       |  | $       | 0.75 -    |          |  |         |      |       |  | $        | 0.75 -     |   |  |   |       |          |  | $ | 0.75 -    |   |  |   |       | 
|Price range                                                      |  | $           | 46.45     |              |  |                                 |      |       |  | $       | 46.45     |          |  |         |      |       |  | $        | 46.45      |   |  |   |       |          |  | $ | 46.45     |   |  |   |       | 
|                                                                 |  |             |           |              |  |                                 |      |       |  |         |           |          |  |         |      |       |  |          |            |   |  |   |       |          |  |   |           |   |  |   |       | 
|Weighted average fair
value of options
granted during the period |  |             |           |              |  |                                 |     |       |  |         |           |          |  |         |     |       |  |          |            |   |  |   |      |          |  |   |           |   |  |   |      | 
|                                                                 |  |             |           |              |  |                                 |      |       |  |         |           |          |  |         |      |       |  |          |            |   |  |   |       |          |  |   |           |   |  |   |       | 

NOTE 14           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 $2.0 million for the eight months
ended December 31, 2002, $0.9 million for the four months ended April 30, 2002,
$0.8 for the three months ended December 31, 2001 and $3.1 million and $3.6
million for the fiscal years ended September 30, 2001 and 2000, respectively.

NOTE
15           IMPAIRMENT OF LONG-LIVED ASSETS

The Companys 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 upon emergence from bankruptcy (see Note 4).

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 the related tangible assets to
comply with the annual impairment requirements of SFAS No. 142 and SFAS No. 144.

SFAS No. 142 requires testing of the intangible assets for impairment on an
annual basis and more frequently in certain circumstances. When impairment is
indicated, the intangible asset must be written down, rather than amortized, as
required before January 1, 2002. Prior to testing intangible assets for
impairment, the tangible assets must be tested for impairment under SFAS No.
144.

The impairment test under SFAS No. 144 was a two-step process. It required
developing cash flow projections for each of the Companys SNFs and LTACs. In
the first step, these undiscounted cash flows were compared to the

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carrying value of the tangible assets. Impairment was indicated at certain
SNFs and LTACs based on the 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.
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. This required the second step of the test to be
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.
After the impaired tangible assets were reduced to their fair values, the
impairment test of the intangible assets was performed.

The impairment test under SFAS No. 142 was a two-step process that required
intangible assets to be evaluated at the reporting unit level. In the first
step, the fair value of the reporting unit was determined based on the market
value, local market conditions and lower than expected future cash flows. This
fair value was then compared with the carrying value of the reporting unit. If
the fair value of the reporting unit was less than the carrying value of the
reporting unit, an impairment of the intangible asset was possible, and the
second step of the test was performed. In the second step, the implied fair
value of the intangible asset was compared with 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.

The total impairment for the eight months ended December 31, 2002 was $84.6
million and was recorded in the three months ended December 31, 2002. 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 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.

Prior to January 1, 2002, SFAS No. 121 Accounting for the Impairment of
Long-Lived Assets and for Long Lived Assets to be Disposed Of (SFAS No.121),
was the authoritative guidance for the impairment of long-lived assets. SFAS
No. 121 required impairment losses to be recognized for long-lived assets when
indicators of impairment were present and the undiscounted cash flows were not
sufficient to recover the assets carrying amount.

The revenue recorded by the Company in its nursing facilities under PPS is
substantially less than the cost-based reimbursement that was previously
received. The implementation of PPS resulted in a greater than expected
decline in reimbursement for nursing home services and in the demand and market
rates for the Companys pharmacy services. Management determined these revenue
declines were other than temporary and were expected to have a material adverse
effect on future revenue and cash flow.

In the fourth quarter of the fiscal year ended September 30, 2000, the Company
recorded an impairment charge based on a detailed analysis of the Companys
long-lived assets and their estimated cash flows. This analysis resulted in
the identification and measurement of an impairment loss of approximately $19.4
million relating principally to several nursing facilities with cash flow
losses or where projected cash flows were not sufficient to recover the
carrying amount of the long-lived assets. The impairment loss was comprised of
$12.1 million of goodwill and $7.3 million of property and equipment.

Each analysis included managements estimate of the undiscounted future cash
flows to be generated by these assets with a comparison to their carrying
values. If the undiscounted future cash flow estimates were less than the
carrying value of the asset, then the carrying value was written down to the
estimated fair value. Goodwill associated with an impaired asset was included
with the carrying value of that asset in performing both the impairment test
and in measuring the amount of impairment loss related to the asset. Fair
value was estimated based on either managements estimate of fair value,
present value of future cash flows or market value less estimated cost to sell
for certain facilities to be disposed.

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NOTE 16      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):

|                                                                                                           |                                                                         |                                                                   |         |              |   |  |  |                     |           |              |        |                                 |        |        |      |   |         |         |      |   |         |         |        |  
|---------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------- | ----------------------------------------------------------------- | ------- | ------------ | - |  |  | ------------------- | --------- | ------------ | ------ | ------------------------------- | ------ | ------ | ---- | - | ------- | ------- | ---- | - | ------- | ------- | ------ | -
|                                                                                                           |                                                                         |                                                                   |         | Reorganized  |   |  |  |                     |           |              |        |                                 |        |        |      |   |         |         |      |   |         |        
|                                                                                                           |                                                                         |                                                                   |         | Company      |   |  |  | Predecessor Company
|                                                                                                           |                                                                         |                                                                   |         |              |   |  |  |                    
|                                                                                                           |                                                                         |                                                                   |         | Eight Months |   |  |  | Four Months         |           | Three Months |        |                                 |        |        |      |   |         |        
|                                                                                                           |                                                                         |                                                                   |         | Ended        |   |  |  | Ended               |           | Ended        |        | Fiscal Year Ended September 30,
|                                                                                                           |                                                                         |                                                                   |         | December 31, |   |  |  | April 30,           |           | December 31, |        |                                
|                                                                                                           |                                                                         |                                                                   |         | 2002         |   |  |  | 2002                |           | 2001         |        | 2001                            |        | 2000  
|                                                                                                           |                                                                         |                                                                   |         |              |   |  |  |                     |           |              |        |                                 |        |       
|Numerator for basic and diluted
income (loss) per share:                                                   |                                                                         |                                                                   |         |              |   |  |  |                     |           |              |        |                                 |        |        |      |   |         |         |      |   |         |        
|                                                                                                           | (Loss) income from continuing
operations                                |                                                                   | $       | (58,314      | ) |  |  |                     | $         | 1,404,873    |        |                                 | $      | 3,497  |      |   | $       | (34,062 | )    |   | $       | (56,280 | )     
|                                                                                                           | Discontinued operations:                                                |                                                                   |         |              |   |  |  |                     |           |              |        |                                 |        |        |      |   |         |         |      |   |         |         |       
|                                                                                                           |                                                                         | Income (loss) from operations of
discontinued pharmacy
operations |         |              |  |  |  |                     |           |              |       |                                 |        |        | 898  |   |         |         | 667  |   |         |         | (2,705 | )
|                                                                                                           |                                                                         | Gain on sale of discontinued
pharmacy operations                  |         |              |  |  |  |                     |           |              | 29,082 |                                 |        |        |     |   |         |         |     |   |         |         |       |  
|                                                                                                           |                                                                         |                                                                   |         |              |   |  |  |                     |           |              |        |                                 |        |        |      |   |         |         |      |   |         |         |       
|Net (loss) income                                                                                          |                                                                         | $                                                                 | (58,314 | )            |   |  |  | $                   | 1,433,955 |              |        | $                               | 4,395  |        |      | $ | (33,395 | )       |      | $ | (58,985 | )      
|                                                                                                           |                                                                         |                                                                   |         |              |   |  |  |                     |           |              |        |                                 |        |        |      |   |         |         |      |   |         |         |       
|Denominator:                                                                                               |                                                                         |                                                                   |         |              |   |  |  |                     |           |              |        |                                 |        |        |      |   |         |         |      |   |         |        
|                                                                                                           | Denominator for basic income
(loss) per share  weighted
average shares |                                                                   |         | 20,000       |   |  |  |                     |           | 73,688       |        |                                 |        | 73,688 |      |   |         | 73,688  |      |   |         | 73,688  |       
|                                                                                                           | Effect of dilutive
securities  stock options                           |                                                                   |         |             |   |  |  |                     |           |             |        |                                 |        |       |      |   |         |        |      |   |         |        |       
|                                                                                                           |                                                                         |                                                                   |         |              |   |  |  |                     |           |              |        |                                 |        |        |      |   |         |         |      |   |         |         |       
|Denominator for diluted income
(loss) per share  adjusted
weighted average shares and
assumed conversions |                                                                         |                                                                   | 20,000  |              |   |  |  |                     | 73,688    |              |        |                                 | 73,688 |        |      |   | 73,688  |         |      |   | 73,688  |        
|                                                                                                           |                                                                         |                                                                   |         |              |   |  |  |                     |           |              |        |                                 |        |        |      |   |         |         |      |   |         |         |       
|Earnings (loss) per share  basic
and diluted:                                                             |                                                                         |                                                                   |         |              |   |  |  |                     |           |              |        |                                 |        |        |      |   |         |         |      |   |         |        
|                                                                                                           | (Loss) income from continuing
operations                                |                                                                   | $       | (2.92        | ) |  |  |                     | $         | 19.07        |        |                                 | $      | 0.05   |      |   | $       | (0.46   | )    |   | $       | (0.76   | )     
|                                                                                                           | Discontinued operations:                                                |                                                                   |         |              |   |  |  |                     |           |              |        |                                 |        |        |      |   |         |         |      |   |         |         |       
|                                                                                                           |                                                                         | Income (loss) from operations of
discontinued pharmacy
operations |         |              |  |  |  |                     |           |              |       |                                 |        |        | 0.01 |   |         |         | 0.01 |   |         |         | (0.04  | )
|                                                                                                           |                                                                         | Gain on sale of discontinued
pharmacy operations                  |         |              |  |  |  |                     |           |              | 0.39   |                                 |        |        |     |   |         |         |     |   |         |         |       |  
|                                                                                                           |                                                                         |                                                                   |         |              |   |  |  |                     |           |              |        |                                 |        |        |      |   |         |         |      |   |         |         |       
|Net (loss) income per share                                                                                |                                                                         | $                                                                 | (2.92   | )            |   |  |  | $                   | 19.46     |              |        | $                               | 0.06   |        |      | $ | (0.45   | )       |      | $ | (0.80   | )      
|                                                                                                           |                                                                         |                                                                   |         |              |   |  |  |                     |           |              |        |                                 |        |        |      |   |         |         |      |   |         |         |       

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

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NOTE 17      INCOME TAXES

The provision (benefit) for income taxes is presented in the table below (in
thousands of dollars):

|          |                 |   |              |      |   |  |                     |   |              |   |                                 |   |      |   |  |   |        |        |   |   |         |         |  
|--------- | --------------- | - | ------------ | ---- | - |  | ------------------- | - | ------------ | - | ------------------------------- | - | ---- | - |  | - | ------ | ------ | - | - | ------- | ------- | -
|          |                 |   | Reorganized  |      |   |  |                     |   |              |   |                                 |   |      |   |  |   |        |        |   |   |        
|          |                 |   | Company      |      |   |  | Predecessor Company
|          |                 |   |              |      |   |  |                    
|          |                 |   | Eight Months |      |   |  | Four Months         |   | Three Months |   |                                 |   |      |   |  |   |       
|          |                 |   | Ended        |      |   |  | Ended               |   | Ended        |   | Fiscal Year Ended September 30,
|          |                 |   | December 31, |      |   |  | April 30,           |   | December 31, |   |                                
|          |                 |   | 2002         |      |   |  | 2002                |   | 2001         |   | 2001                            |   | 2000
|Current:  |                 |   |              |      |   |  |                     |   |              |   |                                 |   |      |   |  |   |        |        |   |   |         |        
|          | Federal         |   | $            |     |   |  |                     |   | $            |  |                                 |   | $    |  |  |   | $      | (7,607 | ) |   | $       | (19,374 | )
|          | State and local |   |              | 450  |   |  |                     |   |              |  |                                 |   |      |  |  |   |        | 2,800  |   |   |         |        |  
|          |                 |   |              |      |   |  |                     |   |              |   |                                 |   |      |   |  |   |        |        |   |   |         |         |  
|          |                 |   | 450          |      |   |  |                     |   |             |   |                                 |   |     |   |  |   | (4,807 | )      |   |   | (19,374 | )      
|Deferred: |                 |   |              |      |   |  |                     |   |              |   |                                 |   |      |   |  |   |        |        |   |   |         |        
|          | Federal         |   |              | 884  |   |  |                     |   |              |  |                                 |   |      |  |  |   |        |       |   |   |         |        |  
|          | State and local |   |              | (324 | ) |  |                     |   |              |  |                                 |   |      |  |  |   |        |       |   |   |         |        |  
|          |                 |   |              |      |   |  |                     |   |              |   |                                 |   |      |   |  |   |        |        |   |   |         |         |  
|          |                 |   | 560          |      |   |  |                     |   |             |   |                                 |   |     |   |  |   |       |        |   |   |        |        
|          |                 |   |              |      |   |  |                     |   |              |   |                                 |   |      |   |  |   |        |        |   |   |         |         |  
|Total     |                 | $ | 1,010        |      |   |  |                     | $ |             |   |                                 | $ |     |   |  | $ | (4,807 | )      |   | $ | (19,374 | )      
|          |                 |   |              |      |   |  |                     |   |              |   |                                 |   |      |   |  |   |        |        |   |   |         |         |  

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
|                                            |                                                    |  |              |      |  |  |                    
|                                            |                                                    |  | Eight Months |      |  |  | Four Months         |  | Three Months |       |                                 |  |       |      |  |  |      
|                                            |                                                    |  | Ended        |      |  |  | Ended               |  | Ended        |       | Fiscal Year Ended September 30,
|                                            |                                                    |  | December 31, |      |  |  | April 30,           |  | December 31, |       |                                
|                                            |                                                    |  | 2002         |      |  |  | 2002                |  | 2001         |       | 2001                            |  | 2000 
|                                            |                                                    |  |              |      |  |  |                     |  |              |       |                                 |  |      
|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 |  |              | 0.2  |  |  |                     |  |              | 1.0   |                                 |  |       | 2.8  |  |  |       | 5.9 |  |  |       | (1.6 | )
|                                            | Permanent book/tax differences                     |  |              |      |  |  |                     |  |              |       |                                 |  |       |      |  |  |       |     |  |  |       |      |  
|                                            | Goodwill amortization                              |  |              |     |  |  |                     |  |              |      |                                 |  |       | 13.1 |  |  |       | 7.7 |  |  |       |     |  
|                                            | Cancellation of indebtedness                       |  |              |     |  |  |                     |  |              | (25.5 | )                               |  |       |     |  |  |       |    |  |  |       |     |  
|                                            | Impairment of long-lived assets                    |  |              | 35.0 |  |  |                     |  |              |      |                                 |  |       |     |  |  |       |    |  |  |       | 5.5  |  
|                                            | Fresh start                                        |  |              |     |  |  |                     |  |              | (2.6  | )                               |  |       |     |  |  |       |    |  |  |       |     |  
|                                            | Other permanent items                              |  |              | 1.6  |  |  |                     |  |              | (0.1  | )                               |  |       | 1.1  |  |  |       | 2.0 |  |  |       | 1.6  |  
|Realization of benefit of carryback         |                                                    |  |             |      |  |  |                     |  |             |       |                                 |  |      |      |  |  | (19.9 | )   |  |  | (24.8 | )   
|Change in valuation allowance               |                                                    |  |             |      |  |  |                     |  | (7.8         | )     |                                 |  | (52.0 | )    |  |  | 26.8  |     |  |  | 29.5  |     
|                                            |                                                    |  |              |      |  |  |                     |  |              |       |                                 |  |       |      |  |  |       |     |  |  |       |     
|Effective tax rate                          |                                                    |  | 1.8          | %    |  |  |                     |  | 0.0          | %     |                                 |  | 0.0   | %    |  |  | (12.5 | )%  |  |  | (24.8 | )%  
|                                            |                                                    |  |              |      |  |  |                     |  |              |       |                                 |  |       |      |  |  |       |     |  |  |       |     

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

|                                    |                                                           |   |              |         |   |  |                     |   |               |         |  |   |          |         | 
|----------------------------------- | --------------------------------------------------------- | - | ------------ | ------- | - |  | ------------------- | - | ------------- | ------- |  | - | -------- | ------- | 
|                                    |                                                           |   | Reorganized  |         |   |  |                     |   |               |         |  |   |         
|                                    |                                                           |   | Company      |         |   |  | Predecessor Company
|                                    |                                                           |   |              |         |   |  |                    
|                                    |                                                           |   | December 31, |         |   |  | December 31,        |   | September 30,
|                                    |                                                           |   | 2002         |         |   |  | 2001                |   | 2001         
|                                    |                                                           |   |              |         |   |  |                     |   |              
|Deferred tax liabilities:           |                                                           |   |              |         |   |  |                     |   |               |         |  |   |          |        
|                                    | Amounts relating to property and equipment                |   | $            | (3,717  | ) |  |                     |   | $             |        |  |   | $        |        | 
|Deferred tax assets:                |                                                           |   |              |         |   |  |                     |   |               |         |  |   |          |        
|                                    | Allowance for bad debts and other
current asset valuation |   |              | 29,043  |   |  |                     |   |               | 36,174  |  |   |          | 44,375  | 
|                                    | Amounts relating to property and equipment                |   |              |        |   |  |                     |   |               | 69,887  |  |   |          | 71,995  | 
|                                    | Payroll benefits                                          |   |              | 11,397  |   |  |                     |   |               | 13,356  |  |   |          | 16,045  | 
|                                    | Restructuring reserves                                    |   |              | 1,457   |   |  |                     |   |               |        |  |   |          |        | 
|                                    | Intangibles                                               |   |              | 46,560  |   |  |                     |   |               | 16,743  |  |   |          | 16,743  | 
|                                    | NOL carryforwards                                         |   |              | 414,203 |   |  |                     |   |               | 320,461 |  |   |          | 316,610 | 
|                                    | Accrued expenses                                          |   |              | 505     |   |  |                     |   |               | 8,033   |  |   |          | 7,542   | 
|                                    | Tax credits                                               |   |              | 212     |   |  |                     |   |               | 14,280  |  |   |          | 14,013  | 
|                                    | Insurance                                                 |   |              | 87,420  |   |  |                     |   |               | 31,206  |  |   |          | 24,852  | 
|                                    | Medicare timing differences                               |   |              | 1,937   |   |  |                     |   |               | 8,790   |  |   |          | 8,272   | 
|                                    | Other miscellaneous                                       |   |              | 7,051   |   |  |                     |   |               | 4,137   |  |   |          | 4,629   | 
|                                    |                                                           |   |              |         |   |  |                     |   |               |         |  |   |          |         | 
|Total deferred tax assets           |                                                           |   | 599,785      |         |   |  |                     |   | 523,067       |         |  |   | 525,076  |        
|                                    |                                                           |   |              |         |   |  |                     |   |               |         |  |   |          |         | 
|Net deferred tax assets/liabilities |                                                           |   | 596,068      |         |   |  |                     |   | 523,067       |         |  |   | 525,076  |        
|Less: valuation allowance           |                                                           |   | (596,068     | )       |   |  |                     |   | (523,067      | )       |  |   | (525,076 | )      
|                                    |                                                           |   |              |         |   |  |                     |   |               |         |  |   |          |         | 
|Net deferred tax assets             |                                                           | $ |             |         |   |  |                     | $ |              |         |  | $ |         |        
|                                    |                                                           |   |              |         |   |  |                     |   |               |         |  |   |          |         | 

Federal and state income tax payments made for the eight months ended December
31, 2002 and four months ended April 30, 2002
were $0.4 million and $0.1 million, respectively. Additionally, payments were $2.1 million, $0.8 million
and $0.6 million for the three months ended December 31, 2001 and the fiscal
years ended September 30, 2001 and 2000, 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, $4.0 million and $21.9 million for the three months
ended December 31, 2001 and fiscal years ended September 30, 2001 and 2000,
respectively.

The reorganization of the Company on the Effective Date constituted an
ownership change under Section 382 of the Internal Revenue Code (Section
382), which imposes annual limitations on the utilization of loss
carryforwards after certain ownership changes. However, if certain historical
creditor tests are met, the annual limitation imposed by Section 382 resulting
from the reorganization will not apply. The Company believes it meets the
required tests but is currently in the process of a more complete analysis. If
the tests are met, 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.

In connection with the bankruptcy reorganization, the Company realized a gain
from the extinguishment of certain indebtedness. This gain will not be taxable
since the gain resulted from the reorganization of the Company under the
Bankruptcy Code. However, the Company will be required pursuant to Section 108
of the Internal Revenue Code 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. The Company currently estimates that the NOLs will be reduced
by approximately $606.2 million pursuant to the provisions of Sections 382 and
108 as discussed above if the Company meets the requirements of Section
382(l)(5). If those requirements are not met, the provisions of Section 382
(l)(6) would impose an annual limitation on the future utilization of NOLs
equal to approximately $20.2 million per year. The
Company has approximately $641.5 million of NOL carryforwards after the
aforementioned reductions as of December 31, 2002, which will expire at various
dates through 2022.

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The Company has established a valuation allowance to completely offset its net
deferred tax assets because the Company believes the deferred tax assets will
not be recognized under the more likely than not standard. 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. As of December 31, 2002, the Company had reduced the valuation
allowance established in fresh-start reporting by approximately $0.6 million,
which resulted in a corresponding reduction to reorganization value in excess
of amounts allocable to identifiable assets.

NOTE 18 COMMITMENTS AND CONTINGENCIES

Leases

At December 31, 2002, 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):

|                                          |  |              |        |   |  |                     |               |      |         |   |  |   |         |  
|----------------------------------------- |  | ------------ | ------ | - |  | ------------------- | ------------- | ---- | ------- | - |  | - | ------- | -
|                                          |  | Reorganized  |        |   |  |                     |               |      |         |   |  |  
|                                          |  | Company      |        |   |  | Predecessor Company
|                                          |  |              |        |   |  |                    
|                                          |  | December 31, |        |   |  | December 31,        | September 30,
|                                          |  | 2002         |        |   |  | 2001                |               | 2001
|                                          |  |              |        |   |  |                     |               |     
|Facilities operating under capital leases |  | $            | 31,733 |   |  |                     |               | $    | 41,190  |   |  | $ | 41,152  |  
|Less: Accumulated amortization            |  |              | (861   | ) |  |                     |               |      | (13,729 | ) |  |   | (12,996 | )
|                                          |  |              |        |   |  |                     |               |      |         |   |  |   |         |  
|                                          |  | $            | 30,872 |   |  |                     |               | $    | 27,461  |   |  | $ | 28,156  |  
|                                          |  |              |        |   |  |                     |               |      |         |   |  |   |         |  

The Predecessor Company previously entered into a $100.0 million leasing
program (the Synthetic Lease) to be used as a funding mechanism for future
assisted living and skilled nursing facility construction, lease conversions,
and other facility acquisitions. Upon the Companys emergence from bankruptcy,
the Company purchased the facilities under the Synthetic Lease.

The Synthetic Lease was an unconditional triple net lease for a period of
seven years (beginning in September 1996) with the annual lease obligation a
function of the amount spent by the lessor to acquire or construct the project,
a variable interest rate, and commitment and other fees. The Predecessor
Company guaranteed a minimum of approximately 83% of the residual value of the
leased property and also had an option to purchase the properties at any time
prior to the maturity date at a price sufficient to pay the entire amount
financed, accrued interest, and certain expenses. The Synthetic Lease was
accounted for as an operating lease. The Synthetic Lease was amended on
December 23, 1998 to mirror certain changes made to the Companys prepetition
senior credit facility and subsequently amended in May 1999 to reduce the
commitment from $100.0 million to $80.0 million. The Synthetic Lease contained
customary covenants that, among other things, required maintenance of certain
financial ratios and limited amounts of additional debt and repurchases of
common stock.

Beginning on September 30, 1999, the Predecessor Company was in violation of
certain of these financial covenants and, as a result, could not make
additional borrowings under the Synthetic Lease. The Predecessor Company
ceased making rent payments under the Synthetic Lease in November 1999. The
automatic stay protection afforded by the Chapter 11 Filings prevented any
action from being taken outside the Chapter 11 Cases with respect to any
defaults that existed under the Synthetic Lease unless otherwise determined by
the Bankruptcy Court. One consequence of the defaults under the Synthetic
Lease was that the lessor under the Synthetic Lease, FBTC Leasing Corp., had
been

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unable to make additional borrowings under the related credit facility and make
such proceeds available for the completion of the five facilities then
currently under construction. Under the terms of the DIP Financing, the
Company was permitted to borrow and spend up to $8.8 million to complete such
facilities. As part of the Joint Plan, the Synthetic Lease was unwound and the
Synthetic Lease facilities were conveyed to the Companys subsidiaries
operating those facilities.

Rental expense, net of sublease rental income for all operating leases was
$29.7 million for the eight months ended December 31, 2002, $15.6 million for
the four months ended April 30, 2002, $12.1 million for the three months ended
December 31, 2001 and $62.8 million and $80.6 million for the fiscal years
ended September 30, 2001 and 2000, respectively. 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 $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 and $6.1
million for the fiscal years ended September 30, 2001 and 2000, respectively.
Contingent rent, based primarily on revenue, was $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 and $3.4 million for the fiscal years ended September 30, 2001 and
2000, respectively.

The table below presents a schedule of future minimum rental commitments and
sublease income under noncancelable leases as of December 31, 2002 (in
thousands of dollars):

|                                  |  |           |         |        |  |          |         |   |  |   |         |  
|--------------------------------- |  | --------- | ------- | ------ |  | -------- | ------- | - |  | - | ------- | -
|                                  |  |           |         |        |  | Sublease |         |   |  |  
|                                  |  | Operating |         | Income |  | Capital 
|                                  |  |           |         |        |  |         
|2003                              |  | $         | 33,578  |        |  | $        | (1,930  | ) |  | $ | 10,837  |  
|2004                              |  |           | 30,361  |        |  |          | (1,930  | ) |  |   | 9,507   |  
|2005                              |  |           | 25,323  |        |  |          | (1,844  | ) |  |   | 20,577  |  
|2006                              |  |           | 19,884  |        |  |          | (1,586  | ) |  |   | 9,084   |  
|2007                              |  |           | 17,006  |        |  |          | (1,586  | ) |  |   | 1,821   |  
|Subsequent years                  |  |           | 63,877  |        |  |          | (8,039  | ) |  |   | 12,722  |  
|                                  |  |           |         |        |  |          |         |   |  |   |         |  
|Total minimum rental obligations  |  | $         | 190,029 |        |  | $        | (16,915 | ) |  |   | 64,548  |  
|                                  |  |           |         |        |  |          |         |   |  |   |         |  
|Less amount representing interest |  |           |         |        |  |          |         |   |  |   | (11,304 | )
|                                  |  |           |         |        |  |          |         |   |  |   |         |  
|Present value of capital leases   |  |           |         |        |  |          |         |   |  |   | 53,244  |  
|Less: Current portion             |  |           |         |        |  |          |         |   |  |   | (7,522  | )
|                                  |  |           |         |        |  |          |         |   |  |   |         |  
|Long-term portion                 |  |           |         |        |  |          |         |   |  | $ | 45,722  |  
|                                  |  |           |         |        |  |          |         |   |  |   |         |  

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 $13.4 million of insurance proceeds have been received as of
December 31, 2002.

Litigation

From time to time, the Company has been party to various legal proceedings in
the ordinary course of business. As is typical in the healthcare industry, the
Company is and 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 healthcare industry in general continues to experience an
increasing trend in the frequency and severity of litigation and claims.

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In some states in which the Company has significant operations, insurance
coverage for the risk of punitive and certain other damages arising from
general and professional liability litigation may not be available in some
circumstances. There can be no assurance that it will not be liable for
punitive or other damages awarded in litigation for which insurance coverage is
not available. The Company 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. While the
Company believes that it provides quality care to patients in the Companys
facilities and materially complies with all applicable regulatory requirements,
an adverse determination in a legal proceeding or governmental investigation,
whether currently asserted or arising in the future, could have a material
adverse effect on the Companys financial condition.

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 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
subsequently 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.

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 (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 Health Network, Inc. Other claims arise from duties that the Company believes the Individual
Defendants breached as officers of MHG and MPAN, Paragons successor following
the MHG acquisition. In the Fulton County action, the Company is seeking
actual damages, including compensatory, consequential and punitive damages in
an amount to be determined at trial. Discovery is in the early stages.

In response to the action the Company 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., United
States Bankruptcy Court for the District of Delaware. Chapter 11 Case Nos.
00-00113 (MFW) and 00-00215 (MFW), Adversary Nos 02-5604 and 02-5606. In the
Chancery Court action, the Individual Defendants generally claim they are not
liable for the claims asserted in the Fulton County action and that the Company
is contractually and statutorily obligated to indemnify them against the claims
in the Fulton County action. The Company removed the Chancery Court action to
the Bankruptcy Court. 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, 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 No. 02-05598 (consolidated with Adversary No. 02-05599). In this
enforcement action, the Company generally allege that it does not have any
obligation to indemnify the Individual Defendants. 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 the
Company is estopped from asserting those claims. The Company moved to dismiss
the Individual Defendants estoppel counterclaim. The Individual Defendants
opposed the motion, which is pending. Discovery is in the early stages.

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After the Company filed the Fulton County action, former members of MHGs board
of directors filed an action in the Superior Court of Cobb County, Georgia (the
Cobb County action) against PWC and the Individual Defendants based on claims
arising out of MHGs acquisition of Convalesant 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. The Cobb County action is in the
early stages of discovery.

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

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 False
Claims Act, the Civil Monetary Penalties Law, and 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 the 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 accounting principles generally accepted in the United
States, 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.

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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.

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. Due to the commencement of
the Chapter 11 Cases, fair values at December 31, 2001 and September 30, 2001
for the Predecessor Companys outstanding debt instruments were unable to be
estimated.

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

|                          |  |                     |         |            |  |                     |         |               |  |            |  |        |           |            |  |          |         |  |  |   |           |  |  |   |         | 
|------------------------- |  | ------------------- | ------- | ---------- |  | ------------------- | ------- | ------------- |  | ---------- |  | ------ | --------- | ---------- |  | -------- | ------- |  |  | - | --------- |  |  | - | ------- | 
|                          |  | Reorganized Company |         |            |  | Predecessor Company
|                          |  |                     |         |            |  |                    
|                          |  | December 31,        |         |            |  | December 31,        |         | September 30,
|                          |  | 2002                |         |            |  | 2001                |         | 2001         
|                          |  |                     |         |            |  |                     |         |              
|                          |  | Carrying            |         |            |  |                     |         |               |  | Carrying   |  |        |           |            |  | Carrying |         |  |  |  
|                          |  | Amount              |         | Fair Value |  |                     |         | Amount        |  | Fair Value |  | Amount |           | Fair Value
|                          |  |                     |         |            |  |                     |         |               |  |            |  |        |           |           
|Cash and cash
equivalents |  | $                   | 38,618  |            |  | $                   | 38,618  |               |  |            |  | $      | 213,740   |            |  | $        | 213,740 |  |  | $ | 209,050   |  |  | $ | 209,050 | 
|Restricted
investments    |  | $                   | 38,693  |            |  | $                   | 38,693  |               |  |            |  | $      | 37,767    |            |  | $        | 37,767  |  |  | $ | 32,831    |  |  | $ | 32,831  | 
|Total long-term debt      |  | $                   | 484,762 |            |  | $                   | 487,558 |               |  |            |  | $      | 2,112,418 |            |  |          | N/A     |  |  | $ | 2,116,755 |  |  |   | N/A     | 

NOTE 20      CONCENTRATIONS OF RISK

A significant portion of the Companys revenue is received from the Medicare
and Medicaid programs. The healthcare industry is experiencing the effects of
the federal and state governments trend toward cost containment as government
and other third-party payors seek to impose lower reimbursement and utilization
rates as well as negotiate reduced payment schedules with providers. These
cost containment measures, combined with the increasing influence of managed
care and competition for patients, generally have resulted in reduced rates of
reimbursement for services to be provided by the Company.

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 SNFs under PPS. These bills were the Medicare,
Medicaid, and SCHIP Balanced Budget Refinement Act of 1999 and the Medicare,
Medicaid, and SCHIP Benefits Improvement and Protection Act of 2000. As of
October 1, 2002, some of the temporary payment increases provided for in these
Acts expired, which resulted in a loss of revenue and operating income of $8.8
million during the three months ended December 31, 2002 and is anticipated to result
in a loss of an additional approximately $37.0 million in fiscal year 2003 and
annually thereafter, assuming there is no further mitigating legislation
providing for reimbursement relief and patient census remains stable. Under these Acts, Congress
also directed CMS to refine the payment system for certain medically complex,
rehabilitation and high acuity patients and provided additional funding for
those patients until the payment system is refined. Congress mandated that
these refinements be budget neutral. For this reason, the PPS per diem rates
have been temporarily increased for some patient categories. CMS recently
announced that it was delaying the implementation of any further refinements to reimbursement
rates until October 1, 2004, at the earliest. At such time, the per diem
increases are expected to be eliminated. Although the refinements in the
payment system are intended to result in a PPS that more appropriately
reimburses providers for the services needed by certain payment categories, the
company is unable to predict whether or how the Companys revenue will be
affected by this portion of the refined payment system. Additionally, it is
not clear if the temporary increases for higher acuity patients will be
included in the refined payment system.

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In recent years, several significant actions have been taken with respect to
Medicare and Medicaid reimbursement, including the adoption of PPS
reimbursement pursuant to the Balanced Budget Act, as modified by the Balanced
Budget Refinement Act and Benefits Improvement and Protection Act, and the
repeal of the Boren Amendment federal payment standard for Medicaid payments
to nursing facilities (see Note 7).

In addition to the above actions, there have been, and the Company expects that
there will continue to be, a number of additional proposals to limit
reimbursements to long-term care facilities under the Medicare and Medicaid
programs. The Company cannot predict whether any of these additional proposals
will be adopted, or if adopted and implemented, what effect such proposals
would have on the Company.

Approximately 81.5% and 82.2% of the Companys total revenue for the eight
months ended December 31, 2002 and four months ended April 30, 2002,
respectively, was derived from the Medicare and Medicaid programs.
Approximately 81.8%, 79.5%, and 78.3% of the Companys total revenue for the
three months ended December 31, 2001 and for the fiscal years ended September
30, 2001 and 2000, respectively, was derived from reimbursement under the
Medicare and Medicaid programs. In addition, the Company has significant
accounts receivable whose collectibility is dependent upon the performance of
these governmental programs. The Company also operates long-term care
facilities in 23 states, 194 of which are located in Texas, Florida, North
Carolina, California and Colorado. The Company does not believe there are
significant credit risks associated with these governmental programs and that
an adequate provision has been made for the possibility of these receivables
proving uncollectible, which is continually monitored and adjusted as
necessary.

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. Due to reasons beyond the Companys control, such as the disparity
between the Mutual billing system and those of the other fiscal intermediaries,
delays in Mutual receiving Tie-In Notices from CMS approving them as the fiscal
intermediary for some facilities, and issues with respect to paying for
patients who were at a facility prior to its conversion to Mutual, the October
1, 2002 and January 1, 2003 conversions have resulted in a slow-down in cash
collections for the Company relating to services rendered to Medicare patients.
The Company is working closely with Mutual and expects to request an
accelerated payment to resolve the slow-down in collections. Failure to reach
a satisfactory resolution of the slow down in cash collections from Mutual
could have an adverse affect on the Companys liquidity.

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.

NOTE 21      SEGMENT INFORMATION

Description of the Types of Products and Services from Which Each Operating
Segment Derives its Revenue

As previously disclosed, the Company has one reportable segment, nursing home
services, which provides long-term healthcare through the operation of skilled
nursing facilities in the United States. The Other category includes the
Companys non-reportable segments, primarily its LTAC hospitals, corporate
items not considered to be an operating segment, and eliminations.

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Measurement of Segment Profit or Loss and Segment Assets

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 margin that basically represents revenue less operating expenses.
The operating margin does not include regional and corporate overhead,
depreciation and amortization, interest income, interest expense,
reorganization items, income taxes or extraordinary items. Gains or losses
on sales of assets and certain items, including impairment of assets, legal and
regulatory matters and restructuring costs, are also excluded from operating
margin and not considered in the evaluation of segment performance. The
Company does not have any intersegment revenue. Asset information by segment,
including capital expenditures, and net income (loss) beyond operating margins
are not provided to the Companys chief operating decision maker.

Total impairment for the eight months ended December 31, 2002 was $84.6 million
and was recorded in the three months ended December 31, 2002 (see Note 15).
The impairment charge 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 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.

Factors Management Used to Identify the Enterprises Reportable Segments

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 of the APS Division, for the Reorganized Company for the eight
months ended December 31, 2002, for the Predecessor Company for the four months
ended April 30, 2002, the three months ended December 31, 2001 and the fiscal
years ended September 30, 2001 and 2000 (in thousands of dollars):

|                                     |  |              |           |       |  |       |          |   |  |   |           | 
|------------------------------------ |  | ------------ | --------- | ----- |  | ----- | -------- | - |  | - | --------- | 
|                                     |  | Nursing Home |           |       |  |       |          |   |  |  
|                                     |  | Services     |           | Other |  | Total
|                                     |  |              |           |       |  |      
|Reorganized Company                  |  |              |           |       |  |       |          |   |  |   |           | 
|Eight Months Ended December 31, 2002 |  |              |           |       |  |       |          |   |  |   |           | 
|Revenue from external customers      |  | $            | 1,107,229 |       |  | $     | 76,428   |   |  | $ | 1,183,657 | 
|Operating margin (loss)              |  |              | 113,583   |       |  |       | (41,118  | ) |  |   | 72,465    | 
|Depreciation and amortization        |  |              | 20,851    |       |  |       | 2,301    |   |  |   | 23,152    | 
|                                    
|                                    
|Predecessor Company                  |  |              |           |       |  |       |          |   |  |   |           | 
|Four Months Ended April 30, 2002     |  |              |           |       |  |       |          |   |  |   |           | 
|Revenue from external customers      |  | $            | 564,350   |       |  | $     | 37,087   |   |  | $ | 601,437   | 
|Operating margin (loss)              |  |              | 44,405    |       |  |       | (21,740  | ) |  |   | 22,665    | 
|Depreciation and amortization        |  |              | 10,839    |       |  |       | 894      |   |  |   | 11,733    | 
|                                    
|Three Months Ended December 31, 2001 |  |              |           |       |  |       |          |   |  |   |           | 
|Revenue from external customers      |  | $            | 429,461   |       |  | $     | 28,690   |   |  | $ | 458,151   | 
|Operating margin (loss)              |  |              | 44,445    |       |  |       | (15,863  | ) |  |   | 28,582    | 
|Depreciation and amortization        |  |              | 9,089     |       |  |       | 1,957    |   |  |   | 11,046    | 
|                                    
|Fiscal Year 2001                     |  |              |           |       |  |       |          |   |  |   |           | 
|Revenue from external customers      |  | $            | 1,759,865 |       |  | $     | 112,270  |   |  | $ | 1,872,135 | 
|Operating margin (loss)              |  |              | 153,706   |       |  |       | (95,829  | ) |  |   | 57,877    | 
|Depreciation and amortization        |  |              | 37,454    |       |  |       | 11,945   |   |  |   | 49,399    | 
|                                    
|Fiscal Year 2000                     |  |              |           |       |  |       |          |   |  |   |           | 
|Revenue from external customers      |  | $            | 1,768,688 |       |  | $     | 110,619  |   |  | $ | 1,879,307 | 
|Operating margin (loss)              |  |              | 221,648   |       |  |       | (147,277 | ) |  |   | 74,371    | 
|Depreciation and amortization        |  |              | 39,552    |       |  |       | 9,683    |   |  |   | 49,235    | 

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NOTE
22       RELATED PARTY TRANSACTIONS

The Company, through a wholly owned-subsidiary, currently leases 12 SNFs under
operating and capital leases from a certain organization in which a former
board member of the Predecessor Company, who resigned effective August 31,
2000, has a significant interest. The Company originally entered into leases
for 14 facilities and on March 30, 2000 and September 11, 2000, the Bankruptcy
Court approved the rejection and termination of two of the leases. The Company
made cash payments on such lease obligations of approximately $4.6 million for
the eight months ended December 31, 2002, $2.3 million for the four months
ended April 30, 2002, $1.7 million for the three months ended December 31,
2001, and $7.0 million and $6.9 million for the fiscal years ended September
30, 2001 and 2000, respectively.

Transactions with Management

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 market value
was determined based upon the average of two 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.

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.

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

Each of the five percent or greater beneficial owners of our 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.

Loughlin Meghji + Company

Mohsin Y. Meghji, one of the Companys directors, is a principal in LM + Co.,
the financial advisor to the senior lenders steering committee in the
Companys bankruptcy proceedings. This committee represented the interests of
lenders under the Companys prepetition senior credit facility during
bankruptcy proceedings. During these proceedings, LM + Co. received $0.2
million for the eight months ended December 31, 2002, and $0.3 million for the
four months ended April 30, 2002 in fees in connection with its representation
of this committee.

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

Foothill Group and Foothill Income Trust, affiliates of Foothill Partners III
and Foothill Partners IV, which beneficially own over 5% of the Reorganized
Companys common stock, 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 Senior
Credit Facility. This represented their pro rata share of commitment
fees, paid to all lenders, related to our Senior Credit Facility.

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Highland Capital Management

Highland Capital Management, together with certain
of its affiliates, beneficially owns over
5% of New Common Stock. Certain affiliates of Highland Capital 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, these
affiliates are entitled to receive their pro rata share of interest payments and any other
customary fees under the Senior Credit Facility. Patrick Daugherty, one of
Mariners directors, is general counsel and a senior portfolio manager at
Highland Capital, the general partner of Highland Crusader Offshore Partners
and the investment advisor for Prospect Street High Income Portfolio,
both of whom are stockholders of ours.
In May 2002, Highland Capital and its affiliates received
$0.8 million as lenders
under our Senior Credit Facility. This represented their pro rata
share of commitment fees, paid to all lenders, related to our Senior Credit Facility.

NOTE 23      QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

The following tables summarize unaudited quarterly financial data for the
Reorganized Company for the eight months ended December 31, 2002, the
Predecessor Company for the four months ended April 30, 2002, three months
ended December 31, 2001 and fiscal year ended September 30, 2001 (in thousands,
except per share amounts):

|                                                                       |  |                     |         |                                      |  |         |         |         |  |         |         |   |  |   |         |   |  |   |         |  
|---------------------------------------------------------------------- |  | ------------------- | ------- | ------------------------------------ |  | ------- | ------- | ------- |  | ------- | ------- | - |  | - | ------- | - |  | - | ------- | -
|                                                                       |  | Predecessor Company
|                                                                       |  |                    
|                                                                       |  | Three Months        |         | Fiscal Year Ended September 30, 2001
|                                                                       |  | Ended               |         |                                     
|                                                                       |  | December 31,        |         | Fourth                               |  | Third   |         | Second  |  | First  
|                                                                       |  | 2001                |         | Quarter                              |  | Quarter |         | Quarter |  | Quarter
|                                                                       |  |                     |         |                                      |  |         |         |         |  |        
|Net revenue                                                            |  | $                   | 458,151 |                                      |  | $       | 539,677 |         |  | $       | 394,439 |   |  | $ | 467,671 |   |  | $ | 470,348 |  
|Total costs and expenses                                               |  |                     | 440,615 |                                      |  |         | 580,327 |         |  |         | 377,944 |   |  |   | 454,699 |   |  |   | 450,687 |  
|                                                                       |  |                     |         |                                      |  |         |         |         |  |         |         |   |  |   |         |   |  |   |         |  
|Operating income (loss)                                                |  |                     | 17,536  |                                      |  |         | (40,650 | )       |  |         | 16,495  |   |  |   | 12,972  |   |  |   | 19,661  |  
|Other (expenses) income                                                |  |                     | (14,039 | )                                    |  |         | (16,573 | )       |  |         | (21,843 | ) |  |   | 1,202   |   |  |   | (10,133 | )
|                                                                       |  |                     |         |                                      |  |         |         |         |  |         |         |   |  |   |         |   |  |   |         |  
|Income (loss) from continuing operations
before income taxes           |  |                     | 3,497   |                                      |  |         | (57,223 | )       |  |         | (5,348  | ) |  |   | 14,174  |   |  |   | 9,528   |  
|Provision (benefit) for income taxes                                   |  |                     |        |                                      |  |         | (4,807  | )       |  |         |        |   |  |   |        |   |  |   |        |  
|                                                                       |  |                     |         |                                      |  |         |         |         |  |         |         |   |  |   |         |   |  |   |         |  
|Income (loss) from continuing operations                               |  |                     | 3,497   |                                      |  |         | (52,416 | )       |  |         | (5,348  | ) |  |   | 14,174  |   |  |   | 9,528   |  
|Discontinued operations                                                |  |                     |         |                                      |  |         |         |         |  |         |         |   |  |   |         |   |  |   |         |  
|Income (loss) from operations of
discontinued pharmacy operations      |  |                     | 898     |                                      |  |         | 308     |         |  |         | 494     |   |  |   | (517    | ) |  |   | 382     |  
|                                                                       |  |                     |         |                                      |  |         |         |         |  |         |         |   |  |   |         |   |  |   |         |  
|Net income (loss)                                                      |  | $                   | 4,395   |                                      |  | $       | (52,108 | )       |  | $       | (4,854  | ) |  | $ | 13,657  |   |  | $ | 9,910   |  
|                                                                       |  |                     |         |                                      |  |         |         |         |  |         |         |   |  |   |         |   |  |   |         |  
|Earnings (loss) per share  basic and diluted                          |  |                     |         |                                      |  |         |         |         |  |         |         |   |  |   |         |   |  |   |         |  
|Income (loss) from continuing operations                               |  | $                   | 0.05    |                                      |  | $       | (0.71   | )       |  | $       | (0.07   | ) |  | $ | 0.19    |   |  | $ | 0.13    |  
|Income (loss) from discontinued operations                             |  |                     | 0.01    |                                      |  |         |        |         |  |         | 0.01    |   |  |   | (0.01   | ) |  |   | 0.01    |  
|                                                                       |  |                     |         |                                      |  |         |         |         |  |         |         |   |  |   |         |   |  |   |         |  
|Net income (loss) per share                                            |  | $                   | 0.06    |                                      |  | $       | (0.71   | )       |  | $       | (0.07   | ) |  | $ | 0.19    |   |  | $ | 0.13    |  
|                                                                       |  |                     |         |                                      |  |         |         |         |  |         |         |   |  |   |         |   |  |   |         |  
|Shares used in computing earnings
(loss) per share  basic and diluted |  |                     | 73,688  |                                      |  |         | 73,688  |         |  |         | 73,688  |   |  |   | 73,688  |   |  |   | 73,688  |  
|                                                                       |  |                     |         |                                      |  |         |         |         |  |         |         |   |  |   |         |   |  |   |         |  

|                                                                       |  |                     |         |         |  |                     |         |   |  |                |         |         |  |  |  |   |           |   |  |   |         |  
|---------------------------------------------------------------------- |  | ------------------- | ------- | ------- |  | ------------------- | ------- | - |  | -------------- | ------- | ------- |  |  |  | - | --------- | - |  | - | ------- | -
|                                                                       |  | Reorganized Company |         |         |  | Predecessor Company
|                                                                       |  |                     |         |         |  |                    
|                                                                       |  |                     |         |         |  |                     |         |   |  | Second
Quarter |         |         |  | 
|                                                                       |  | Fourth              |         | Third   |  | Last Two            |         |   |  | First          |         | First  
|                                                                       |  | Quarter             |         | Quarter |  | Months              |         |   |  | Month          |         | Quarter
|                                                                       |  |                     |         |         |  |                     |         |   |  |                |         |        
|Net revenue                                                            |  | $                   | 442,703 |         |  | $                   | 445,866 |   |  | $              | 295,088 |         |  |  |  | $ | 146,818   |   |  | $ | 454,619 |  
|Total costs and expenses                                               |  |                     | 513,412 |         |  |                     | 427,010 |   |  |                | 278,522 |         |  |  |  |   | 148,569   |   |  |   | 441,936 |  
|                                                                       |  |                     |         |         |  |                     |         |   |  |                |         |         |  |  |  |   |           |   |  |   |         |  
|Operating (loss) income                                                |  |                     | (70,709 | )       |  |                     | 18,856  |   |  |                | 16,566  |         |  |  |  |   | (1,751    | ) |  |   | 12,683  |  
|Other (expenses) income                                                |  |                     | (9,802  | )       |  |                     | (8,806  | ) |  |                | (3,409  | )       |  |  |  |   | 1,442,591 |   |  |   | (48,650 | )
|                                                                       |  |                     |         |         |  |                     |         |   |  |                |         |         |  |  |  |   |           |   |  |   |         |  
|(Loss) income from continuing operations
before income taxes           |  |                     | (80,511 | )       |  |                     | 10,050  |   |  |                | 13,157  |         |  |  |  |   | 1,440,840 |   |  |   | (35,967 | )
|(Benefit) provision for income taxes                                   |  |                     | (8,353  | )       |  |                     | 4,100   |   |  |                | 5,263   |         |  |  |  |   |          |   |  |   |        |  
|                                                                       |  |                     |         |         |  |                     |         |   |  |                |         |         |  |  |  |   |           |   |  |   |         |  
|(Loss) income from continuing operations                               |  |                     | (72,158 | )       |  |                     | 5,950   |   |  |                | 7,894   |         |  |  |  |   | 1,440,840 |   |  |   | (35,967 | )
|Discontinued operations                                                |  |                     |         |         |  |                     |         |   |  |                |         |         |  |  |  |   |           |   |  |   |         |  
|Gain on sale of discontinued pharmacy operations                       |  |                     |        |         |  |                     |        |   |  |                |        |         |  |  |  |   | 7,696     |   |  |   | 21,386  |  
|                                                                       |  |                     |         |         |  |                     |         |   |  |                |         |         |  |  |  |   |           |   |  |   |         |  
|Net (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                               |  |                     | (3.61   | )       |  |                     | 0.30    |   |  |                | 0.39    |         |  |  |  |   | 19.55     |   |  |   | (0.49   | )
|Gain in sale of discontinued operations                                |  |                     |        |         |  |                     |        |   |  |                |        |         |  |  |  |   | 0.10      |   |  |   | 0.29    |  
|                                                                       |  |                     |         |         |  |                     |         |   |  |                |         |         |  |  |  |   |           |   |  |   |         |  
|Net (loss) income per share                                            |  | $                   | (3.61   | )       |  | $                   | 0.30    |   |  | $              | 0.39    |         |  |  |  | $ | 19.65     |   |  | $ | (0.20   | )
|                                                                       |  |                     |         |         |  |                     |         |   |  |                |         |         |  |  |  |   |           |   |  |   |         |  
|Shares used in computing (loss) earnings
per share  basic and diluted |  |                     | 20,000  |         |  |                     | 20,000  |   |  |                | 20,000  |         |  |  |  |   | 73,688    |   |  |   | 73,688  |  
|                                                                       |  |                     |         |         |  |                     |         |   |  |                |         |         |  |  |  |   |           |   |  |   |         |  

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##### Table of Contents



SCHEDULE II

VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
MARINER HEALTH CARE, INC.
(dollars in thousands)

|                                     |  |              |         |            |  |                |        |              |  |        |         |                 |  |         |   |  |  |   |         | 
|------------------------------------ |  | ------------ | ------- | ---------- |  | -------------- | ------ | ------------ |  | ------ | ------- | --------------- |  | ------- | - |  |  | - | ------- | 
|                                     |  | Balance      |         |            |  |                |        |              |  |        |         | Other Additions |  | Balance
|                                     |  | Beginning of |         | Charged to |  | Deduction From |        | From         |  | End of
|                                     |  | Period       |         | Income     |  | Reserve        |        | Acquisitions |  | Period
|                                     |  |              |         |            |  |                |        |              |  |       
|Eight Months Ended December 31, 2002 |  |              |         |            |  |                |        |              |  |        |         |                 |  |         |   |  |  |   |         | 
|Allowance for doubtful accounts      |  | $            | 84,629  |            |  |                | 4,924  |              |  |        | (16,557 | )               |  |         |  |  |  | $ | 72,996  | 
|                                     |  |              |         |            |  |                |        |              |  |        |         |                 |  |         |   |  |  |   |         | 
|Valuation allowance                  |  | $            | 597,078 |            |  |                | (1,010 | )            |  |        |        |                 |  |         |  |  |  | $ | 596,068 | 
|                                     |  |              |         |            |  |                |        |              |  |        |         |                 |  |         |   |  |  |   |         | 
|                                    
|Four Months Ended April 30, 2002     |  |              |         |            |  |                |        |              |  |        |         |                 |  |         |   |  |  |   |         | 
|Allowance for doubtful accounts      |  | $            | 61,049  |            |  |                | 25,344 |              |  |        | (1,764  | )               |  |         |  |  |  | $ | 84,629  | 
|                                     |  |              |         |            |  |                |        |              |  |        |         |                 |  |         |   |  |  |   |         | 
|Valuation allowance                  |  | $            | 523,067 |            |  |                | 74,011 |              |  |        |        |                 |  |         |  |  |  | $ | 597,078 | 
|                                     |  |              |         |            |  |                |        |              |  |        |         |                 |  |         |   |  |  |   |         | 
|Three Months Ended December 31, 2001 |  |              |         |            |  |                |        |              |  |        |         |                 |  |         |   |  |  |   |         | 
|Allowance for doubtful accounts      |  | $            | 53,286  |            |  |                | 7,763  |              |  |        |        |                 |  |         |  |  |  | $ | 61,049  | 
|                                     |  |              |         |            |  |                |        |              |  |        |         |                 |  |         |   |  |  |   |         | 
|Valuation allowance                  |  | $            | 525,076 |            |  |                | (2,009 | )            |  |        |        |                 |  |         |  |  |  | $ | 523,067 | 
|                                     |  |              |         |            |  |                |        |              |  |        |         |                 |  |         |   |  |  |   |         | 
|Fiscal Year 2001                     |  |              |         |            |  |                |        |              |  |        |         |                 |  |         |   |  |  |   |         | 
|Allowance for doubtful accounts      |  | $            | 44,624  |            |  |                | 28,140 |              |  |        | (19,478 | )               |  |         |  |  |  | $ | 53,286  | 
|                                     |  |              |         |            |  |                |        |              |  |        |         |                 |  |         |   |  |  |   |         | 
|Valuation allowance                  |  | $            | 521,639 |            |  |                | 3,437  |              |  |        |        |                 |  |         |  |  |  | $ | 525,076 | 
|                                     |  |              |         |            |  |                |        |              |  |        |         |                 |  |         |   |  |  |   |         | 
|Fiscal Year 2000                     |  |              |         |            |  |                |        |              |  |        |         |                 |  |         |   |  |  |   |         | 
|Allowance for doubtful accounts      |  | $            | 65,274  |            |  |                | 30,166 |              |  |        | (50,816 | )               |  |         |  |  |  | $ | 44,624  | 
|                                     |  |              |         |            |  |                |        |              |  |        |         |                 |  |         |   |  |  |   |         | 
|Valuation allowance                  |  | $            | 470,557 |            |  |                | 51,082 |              |  |        |        |                 |  |         |  |  |  | $ | 521,639 | 
|                                     |  |              |         |            |  |                |        |              |  |        |         |                 |  |         |   |  |  |   |         |