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SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

0-49813
(Commission file number)

MARINER HEALTH CARE, INC.

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

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

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

     There were 20,000,000 shares of Common Stock of the registrant outstanding as of May 12, 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

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PART I

ITEM 1.          CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

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

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

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

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

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

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MARINER HEALTH CARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

NOTE 1          NATURE OF BUSINESS

Reporting Entity

Mariner Health Care, Inc. and its subsidiaries (collectively, the “Company”) provide post-acute healthcare services, primarily through the operation of 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 March 31, 2003, 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. Included in the total SNFs are nine managed SNFs with 1,245 licensed beds. At March 31, 2003, the Company also operated 13 owned, leased or managed long-term acute care hospitals (“LTACs”) in four states with 683 licensed beds.

Nursing home services represents the Company’s only reportable operating segment (see Note 9 for financial information about the Company’s reportable segments).

Emergence from Bankruptcy

On March 25, 2002, the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”) approved the Company’s second amended and restated joint plan of reorganization filed on February 1, 2002 (including all modifications thereof and schedules and exhibits thereto, the “Joint Plan”). On May 13, 2002 (the “Effective Date”), the Company and substantially all of its subsidiaries emerged from proceedings under chapter 11 of title 11 (“Chapter 11”) of the United States Code (the “Bankruptcy Code”) pursuant to the terms of the Joint Plan. In connection with its emergence from bankruptcy, the Company changed its name to Mariner Health Care, Inc.

Discontinued Operations

In October 2001, the Company received the approval of the Bankruptcy Court to sell its institutional pharmacy services business (the “APS Division”). The Company consummated the sale of the APS Division on January 6, 2002. Accordingly, the results of the APS Division have been treated as a discontinued operation in accordance with accounting principles generally accepted in the United States (see Note 5).

NOTE 2          BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. Accordingly, these financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2002 included in the Company’s Annual Report on Form 10-K filed with the SEC. In the opinion of management, the financial information included herein reflects all adjustments considered necessary for a fair presentation of interim results and, except for the items described in Note 3, all such adjustments are of a normal and recurring nature. Operating results for interim periods are not necessarily indicative of the results that may be expected for the entire year.

The 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. In adopting the requirements of fresh-start reporting as of May 1, 2002, the provisions of the Company’s Joint Plan were implemented, assets and liabilities were adjusted to their estimated fair values and the accumulated deficit for the Company’s subsidiaries that were part of the Chapter 11 cases was eliminated. The financial statements for all periods prior to May 1, 2002 reflect the financial position, results of operations and cash flows of

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MARINER HEALTH CARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

the Company’s predecessor entity (the “Predecessor Company”). The financial statements for the three months ended March 31, 2003, reflect the consolidated 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 include the operations of both the Predecessor Company and Reorganized Company.

Since fresh-start reporting materially changed the amounts previously recorded in the consolidated financial statements of the Predecessor Company, a black line signifying the difference in presentation 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.

Between filing for protection under the Bankruptcy Code on January 18, 2000 (the “Petition Date”) and the Effective Date, the Company operated its business as a debtor-in-possession subject to the jurisdiction of the Bankruptcy Court. Accordingly, the Predecessor Company’s consolidated financial statements presented herein for periods prior to its emergence from bankruptcy are 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.

The Reorganized Company adopted the accounting policies of the Predecessor Company. In accordance with the fresh-start reporting provisions of SOP 90-7, the Reorganized 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.

Comparability of Financial Information

The adoption of fresh-start reporting as of May 1, 2002 materially changed the amounts previously recorded in the consolidated financial statements of the Predecessor Company. With respect to reported operating results, management believes that business segment operating income of the Predecessor Company is generally comparable to that of the Reorganized Company, excluding divested facilities. However, capital costs, such as interest, depreciation and amortization, of the Predecessor Company generally are not comparable to those of the Reorganized Company. In addition, the reported financial position and cash flows of the Predecessor Company generally are not comparable to those of the Reorganized Company.

In connection with the implementation of fresh-start reporting, the Company recorded a gain of approximately $1.2 billion from the restructuring of its debt in accordance with the provisions of the Joint Plan. Other significant adjustments also were 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 are reflected in the operating results of the Predecessor Company for the four months ended April 30, 2002.

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 not less than the fair market value of the shares at the date of grant. The Reorganized Company has stock option plans authorizing the grant of stock options to purchase up to 2,153,022 shares of common stock, par value $0.01 per share (the “New Common Stock”). At March 31, 2003, there were options to purchase 2,060,560 shares of common stock outstanding at exercise prices ranging from $3.00 to $20.12, all of which were equal to the fair market value of the common stock on the date of the grant. There were options to purchase 190,210 shares of New Common Stock exercisable at March 31, 2003.

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.

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MARINER HEALTH CARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

The Company accounts for stock options in accordance with Accounting Principles Board (“APB”) Opinion 25, “Accounting for Stock Issued to Employees,” and related interpretations. Accordingly, the Company recognizes no compensation expense for stock option grants. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure, an Amendment of SFAS No. 123” (“SFAS 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):

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:

Recent Accounting Pronouncements

In April 2003, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (“SFAS 149”), which is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The guideline should be applied prospectively. The Company believes the adoption of SFAS 149 will not have a material impact on its consolidated financial position, results of operations or cash flows.

In January 2003, 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 did not have a material impact on the consolidated financial position, results of operations or cash flows of the Company.

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MARINER HEALTH CARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

In December 2002, FASB issued SFAS 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 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 APB Opinion 25 “Accounting for Stock Issued to Employees,” and related interpretations. For this reason, the transition guidance of SFAS 148 did not have a material impact on the consolidated financial position, results of operations or cash flows. SFAS 148 does amend existing guidance with respect to required disclosures, regardless of the method of accounting used.

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 were 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 were effective beginning January 1, 2003. This interpretation did not have a material impact on the consolidated financial position, results of operations or cash flows.

Reclassifications

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

Reorganization Items

In accordance with SOP 90-7, the Predecessor Company recorded all expenses incurred as a result of the bankruptcy filings as reorganization items. A summary of the principal categories of reorganization items for the three months ended March 31, 2002 follows (in thousands of dollars):

NOTE 3          FRESH-START REPORTING

In accordance with SOP 90-7, the Company adopted fresh-start reporting because holders of 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):

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

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MARINER HEALTH CARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

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):

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 stockholders’ 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.

The adjustments entitled “Fresh-Start Adjustments” reflect the adoption of fresh-start reporting, including the adjustments to record property and equipment and identifiable intangible assets at their fair values. The assets and liabilities have been recorded at their estimated fair values. Management estimated the fair value of the Company’s assets and liabilities by using both independent appraisals and commonly used discounted cash flow valuation methods. The reorganization value on the Effective Date included in the Joint Plan 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.

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

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MARINER HEALTH CARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

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

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MARINER HEALTH CARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

(a)		To record the payment of cash in connection with the discharge of indebtedness and settlement of prepetition liabilities according to the terms of the Joint Plan.
(b)

(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 (as defined herein).
(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:

(h)		To record the issuance of the Term Loans (as defined herein) under the Senior Credit Facility, to record the issuance of the Second Priority Notes (as defined herein), and to record various mortgages and capital leases entered into or renegotiated pursuant to the terms of the Joint Plan.
(i)		To record estimated settlement of prepetition insurance claims previously accrued for as liabilities subject to compromise.
(j)		To record issuance of New Common Stock and warrants to purchase New Common Stock.
(k)		To eliminate the common stock of the Predecessor Company.
(l)

(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 over-market 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 certain subsidiaries that were not part of the Company’s bankruptcy proceedings).

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MARINER HEALTH CARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Pro Forma Information

The condensed consolidated pro forma effect of the Joint Plan assuming that the Effective Date occurred on January 1, 2002 follows (in thousands of dollars, except per share amounts):

The condensed consolidated pro forma results exclude reorganization items recorded prior to May 1, 2002. The 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 condensed consolidated 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 January 1, 2002.

NOTE 4          REVENUE

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

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

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MARINER HEALTH CARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

NOTE 5          DIVESTITURES

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 received the approval of the Bankruptcy Court to sell the APS Division, subject to an auction and overbidding process under the supervision of the Bankruptcy Court. As a result, an auction of the assets comprising the APS Division was held on December 4, 2001, at which time, following competitive bidding at the auction, Omnicare was determined to have made the highest and best bid for the assets of the APS Division. On December 5, 2001, the Bankruptcy Court approved the sale of the APS Division to Omnicare for a cash closing price of $97.0 million and up to $18.0 million in future payments, depending upon certain post-closing operating results of the APS Division. These payments, if earned, would be received in each of 2003, 2004 and 2005. During the three months ended March 31, 2003, the Company earned and received the first payment of $6.0 million. During the three months ended March 31, 2002, the Company realized a gain on the sale of the APS Division of $21.4 million. In April 2002, the Company recognized an additional gain of $7.7 million on the sale of the APS Division.

Other Divestitures

During the three months ended March 31, 2002, the Company completed the sale or divestiture of approximately ten owned or leased facilities and certain other assets, which resulted in a net loss of approximately $2.5 million and is included in net loss on divestitures within reorganization items. In addition, effective April 3, 2002, the Company divested itself of six facilities, which resulted in a net loss of approximately $10.3 million and is included in net loss on divestitures within reorganization items for the three months ended March 31, 2002 (see Note 2). These 16 facilities reported net revenue of approximately $10.6 million for the three months ended March 31, 2002.

NOTE 6          COMPREHENSIVE INCOME

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

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MARINER HEALTH CARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

NOTE 7          EARNINGS PER SHARE

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