AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON OCTOBER 7, 1997.

REGISTRATION NO. 333-35695
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

----------------

AMENDMENT NO. 1

to
FORM S-4
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933

----------------

VENCOR, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

----------------

DELAWARE 8069 61-1055020
(STATE OR OTHER (PRIMARY STANDARD (I.R.S. EMPLOYER
JURISDICTION OF INDUSTRIAL CLASSIFICATION IDENTIFICATION NO.)
INCORPORATION OR CODE NUMBER)
ORGANIZATION)

3300 PROVIDIAN CENTER
400 WEST MARKET STREET
LOUISVILLE, KENTUCKY 40202
(502) 596-7300
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)

----------------

JILL L. FORCE
SENIOR VICE PRESIDENT,
GENERAL COUNSEL AND SECRETARY
VENCOR, INC.
3300 PROVIDIAN CENTER
400 WEST MARKET STREET
LOUISVILLE, KENTUCKY 40202
(502) 596-7300
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)

COPIES TO:
IVAN M. DIAMOND, ESQ.
GREENEBAUM DOLL & MCDONALD PLLC
3300 NATIONAL CITY TOWER
LOUISVILLE, KENTUCKY 40202
(502) 589-4200

----------------

APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE OF THE SECURITIES TO THE
PUBLIC: As soon as practicable after this Registration Statement becomes
effective.

If the securities being registered on this Form are to be offered in connection
with the formation of a holding company and there is compliance with General
Instruction G, check the following box. [_]

----------------

THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES
AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE
A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT
SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE
SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

PROSPECTUS

LOGO

OFFER TO EXCHANGE ITS 8 5/8% SENIOR SUBORDINATED NOTES DUE 2007
WHICH HAVE BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933
FOR ANY AND ALL OF ITS OUTSTANDING 8 5/8% SENIOR SUBORDINATED NOTES DUE 2007

THE EXCHANGE OFFER AND WITHDRAWAL RIGHTS WILL EXPIRE AT 5:00 P.M., NEW YORK
CITY TIME, ON NOVEMBER 21, 1997, UNLESS EXTENDED.

Vencor, Inc., a Delaware corporation ("Vencor" or the "Company"), hereby
offers, upon the terms and subject to the conditions set forth in this
Prospectus (as the same may be amended or supplemented from time to time, the
"Prospectus") and the accompanying Letter of Transmittal (which together
constitute the "Exchange Offer"), to exchange up to $750 million aggregate
principal amount of its 8 5/8% Senior Subordinated Notes due 2007 (the "New
Notes"), pursuant to a registration statement (the "Registration Statement")
filed under the Securities Act of 1933, as amended ("Securities Act"), of
which this Prospectus constitutes a part, for a like principal amount of its
outstanding 8 5/8% Senior Subordinated Notes due 2007 (the "Old Notes"),
issued on July 21, 1997, of which $750 million aggregate principal amount is
outstanding.

The terms of the New Notes are identical in all material respects to the terms
of the Old Notes, except that (i) the New Notes have been registered under the
Securities Act and therefore will not be subject to certain restrictions on
transfer applicable to the Old Notes, will not contain certain legends
relating thereto and will not be entitled to registration rights, and (ii) the
New Notes will not provide for any increase in the interest rate thereon. In
that regard, the Old Notes provide that if (i) the Registration Statement is
not filed with the Securities and Exchange Commission (the "Commission") on or
prior to September 19, 1997, (ii) the Registration Statement is not declared
effective by the Commission on or prior to November 18, 1997, or (iii) the
Exchange Offer is not consummated or a shelf registration statement with
respect to resale of the Old Notes (the "Shelf Registration Statement") is not
declared effective on or prior to December 18, 1997, then additional interest
(in addition to the interest otherwise due on the Old Notes) will accrue on
the Old Notes. The New Notes are being offered for exchange in order to
satisfy certain obligations of the Company under the Registration Rights
Agreement dated as of July 21, 1997, (the "Registration Rights Agreement")
between the Company and the Initial Purchasers (as defined) of the Old Notes.
The New Notes will be issued under the same Indenture (as defined) as the Old
Notes, and the New Notes and the Old Notes will constitute a single series of
debt securities under the Indenture. If the Exchange Offer is consummated, any
Old Notes which remain outstanding after consummation of the Exchange Offer
and the New Notes issued in the Exchange Offer will vote together as a single
class for purposes of determining whether Holders (as defined) of the
requisite percentage in outstanding principal amount of Notes (as defined)
have taken certain actions or exercised certain rights under the

(Continued on Page 3)

SEE "RISK FACTORS" BEGINNING ON PAGE 22 FOR A DISCUSSION OF CERTAIN RISK
FACTORS THAT SHOULD BE CONSIDERED BY HOLDERS PRIOR TO TENDERING THEIR OLD
NOTES IN THE EXCHANGE OFFER.

--------------

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REP-
RESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.

--------------

The date of this Prospectus is October , 1997.

[VENCOR LOGO]

[UNITED STATES MAP SHOWING LOCATION OF VENCOR FACILITIES.]

(Continued from Page 1)
Indenture. Holder(s) of New Notes and holder(s) of Old Notes are referred to
herein as "Holder(s)." The New Notes and the Old Notes are collectively
referred to herein as the "Notes." See "Description of the New Notes" and
"Description of the Old Notes."

Interest on the New Notes is payable semi-annually on January 15 and July 15 of
each year, (each, an "Interest Payment Date"), commencing on January 15, 1998.
The New Notes will mature on July 15, 2007. The New Notes will be redeemable at
the option of the Company, in whole or in part, at any time on or after July
15, 2002, at the redemption prices set forth herein, plus accrued and unpaid
interest thereon to the applicable redemption date. The New Notes are not
subject to any sinking fund requirement. In addition, upon the occurrence of a
Change of Control (as defined), each Holder of the New Notes may require the
Company to repurchase such New Notes at 101% of the principal amount thereof,
plus accrued and unpaid interest to the date of repurchase. See "Description of
the New Notes."

The New Notes will be general unsecured obligations of the Company subordinated
in right of payment to all Senior Debt (as defined) including all of the
obligations under the Credit Agreement (as defined). As of June 30, 1997, on a
pro forma basis after giving effect to the private offering of the Old Notes
(the "Offering") and the repurchase of certain THY (as defined) debt, the
Company would have had outstanding an aggregate principal amount of
approximately $1.0 billion of Senior Debt, which would rank senior in right of
payment to the New Notes. In addition, the New Notes effectively will be
subordinated to all outstanding indebtedness and other liabilities and
commitments (including trade payables and operating lease obligations) of the
Company's subsidiaries. As of June 30, 1997, on a pro forma basis as described
above, the outstanding indebtedness of the Company's subsidiaries would have
been approximately $160 million, excluding trade payables and operating lease
obligations aggregating approximately $401 million. The Indenture and the
Credit Agreement permit the Company and its subsidiaries to incur additional
indebtedness, subject to certain limitations. See "Description of the New
Notes."

The Company is making the Exchange Offer in reliance on the position of the
staff of the Division of Corporation Finance of the Commission as set forth in
certain interpretive letters addressed to third parties in other transactions.
The Company, however, has not sought its own interpretive letter and there can
be no assurance that the staff of the Division of Corporation Finance of the
Commission would make a similar determination with respect to the Exchange
Offer as it has in such interpretive letters to third parties. Based on these
interpretations by the staff of the Division of Corporation Finance of the
Commission, and subject to the two immediately following sentences, the Company
believes that the New Notes issued pursuant to this Exchange Offer in exchange
for Old Notes may be offered for resale, resold and otherwise transferred by a
Holder thereof (other than a Holder who is a broker-dealer) without further
compliance with the registration and prospectus delivery requirements of the
Securities Act, provided that such New Notes are acquired in the ordinary
course of such Holder's business and that such Holder is not participating, and
has no arrangement or understanding with any person to participate, in a
distribution (within the meaning of the Securities Act) of such New Notes.
However, any Holder of Old Notes who is an "affiliate" of the Company or who
intends to participate in the Exchange Offer for the purpose of distributing
New Notes, or any broker-dealer who purchased Old Notes from the Company to
resell pursuant to Rule 144A under the Securities Act ("Rule 144A") or any
other available exemption under the Securities Act, (i) will not be able to
rely on the interpretations of the staff of the Division of Corporation Finance
of the Commission set forth in the above-mentioned interpretive letters, (ii)
will not be permitted or entitled to tender such Old Notes in the Exchange
Offer and (iii) must comply with the registration and prospectus delivery
requirements of the Securities Act in connection with any sale or other
transfer of such Old Notes unless such sale is made pursuant to an exemption
from such requirements. In addition, as described below, if any broker-dealer
holds Old Notes acquired for its own account as a result of market-making or
other trading activities and exchanges such Old Notes for New Notes, then such
broker-dealer must deliver a prospectus meeting the requirements of the
Securities Act in connection with any resales of such New Notes.

such Holder is not a broker-dealer, it is not engaged in, and does not intend
to engage in, a distribution (within the meaning of the Securities Act) of such
New Notes. Each broker-dealer that receives New Notes for its own account
pursuant to the Exchange Offer must acknowledge that it acquired the Old Notes
for its own account as the result of market-making or other trading activities
and must agree that it will deliver a prospectus meeting the requirements of
the Securities Act in connection with any resale of such New Notes. The Letter
of Transmittal states that by so acknowledging and by delivering a prospectus,
a broker-dealer will not be deemed to admit that it is an "underwriter" within
the meaning of the Securities Act. Based on the position taken by the staff of
the Division of Corporation Finance of the Commission in the interpretive
letters referred to above, the Company believes that broker-dealers who
acquired Old Notes for their own accounts as a result of market-making or other
trading activities ("Participating Broker-Dealers") may fulfill their
prospectus delivery requirements with respect to the New Notes received upon
exchange of such Old Notes (other than Old Notes which represent an unsold
allotment from the original sale of the Old Notes) with a prospectus meeting
the requirements of the Securities Act, which may be the prospectus prepared
for an exchange offer so long as it contains a description of the plan of
distribution with respect to the resale of such New Notes. Accordingly, this
Prospectus may be used by a Participating Broker-Dealer during the period
referred to below in connection with resales of New Notes received in exchange
for Old Notes where such Old Notes were acquired by such Participating Broker-
Dealer for its own account as a result of market-making or other trading
activities. Subject to certain provisions set forth in the Registration Rights
Agreement, the Company has agreed that this Prospectus may be used by a
Participating Broker-Dealer in connection with resales of such New Notes for a
period ending 180 days after the Expiration Date (as defined) (subject to
extension under certain limited circumstances) or, if earlier, when all such
New Notes have been disposed of by such Participating Broker-Dealer. Any
Participating Broker-Dealer who is an "affiliate" of the Company may not rely
on such interpretive letters and must comply with the registration and
prospectus delivery requirements of the Securities Act in connection with any
resale transaction. See "Plan of Distribution" and "The Exchange Offer--Resales
of New Notes."

In that regard, each Participating Broker-Dealer who surrenders Old Notes
pursuant to the Exchange Offer will be deemed to have agreed, by execution of
the Letter of Transmittal, that, upon receipt of notice from the Company of the
occurrence of any event or the discovery of any fact which makes any statement
contained or incorporated by reference in this Prospectus untrue in any
material respect or which causes this Prospectus to omit to state a material
fact necessary in order to make the statements contained or incorporated by
reference herein, in light of the circumstances under which they were made, not
misleading or of the occurrence of certain other events specified in the
Registration Rights Agreement, such Participating Broker-Dealer will suspend
the sale of New Notes pursuant to this Prospectus until the Company has amended
or supplemented this Prospectus to correct such misstatement or omission and
has furnished copies of the amended or supplemented Prospectus to such
Participating Broker-Dealer or the Company has given notice that the sale of
the New Notes may be resumed, as the case may be. If the Company gives such
notice to suspend the sale of the New Notes, it shall extend the 180-day period
referred to above during which Participating Broker-Dealers are entitled to use
this Prospectus in connection with the resale of New Notes by the number of
days during the period from and including the date of the giving of such notice
to and including the date when Participating Broker-Dealers shall have received
copies of the amended or supplemented Prospectus necessary to permit resales of
the New Notes or to and including the date on which the Company has given
notice that the sale of New Notes may be resumed, as the case may be.

The New Notes will be a new issue of securities for which there currently is no
market. Although the Initial Purchasers have informed the Company that they
currently intend to make a market in the New Notes, they are not obligated to
do so, and any such market making may be discontinued at any time without
notice. Accordingly, there can be no assurance as to the development or
liquidity of any market for the New Notes. The Company currently does not
intend to apply for listing of the New Notes on any securities exchange or for
quotation through the National Association of Securities Dealers Automated
Quotation System.

Any Old Notes not tendered and accepted in the Exchange Offer will remain
outstanding and will be entitled to all the same rights and will be subject to
the same limitations applicable thereto under the Indenture (except for those
rights which terminate upon consummation of the Exchange Offer). Following
consummation of the

Exchange Offer, the Holders of Old Notes will continue to be subject to the
existing restrictions upon transfer
thereof, and the Company will have no further obligation to such Holders to
provide for registration under the Securities Act of the Old Notes held by
them. To the extent that Old Notes are tendered and accepted in the Exchange
Offer, a Holder's ability to sell untendered Old Notes could be adversely
affected. See "Summary--Certain Consequences of a Failure to Exchange Old
Notes."

THIS PROSPECTUS AND THE RELATED LETTER OF TRANSMITTAL CONTAIN IMPORTANT
INFORMATION. HOLDERS OF OLD NOTES ARE URGED TO READ THIS PROSPECTUS AND THE
RELATED LETTER OF TRANSMITTAL CAREFULLY BEFORE DECIDING WHETHER TO TENDER THEIR
OLD NOTES PURSUANT TO THE EXCHANGE OFFER.

Old Notes may be tendered for exchange on or prior to 5:00 p.m., New York City
time, on November 21, 1997 (such time on such date being hereinafter called the
"Expiration Date"), unless the Exchange Offer is extended by the Company (in
which case the term "Expiration Date" shall mean the latest date and time to
which the Exchange Offer is extended). Tenders of Old Notes may be withdrawn at
any time on or prior to the Expiration Date. The Exchange Offer is not
conditioned upon any minimum principal amount of Old Notes being tendered for
exchange. The Exchange Offer, however, is subject to certain events and
conditions which may be waived by the Company and to the terms and provisions
of the Registration Rights Agreement. Old Notes may be tendered in whole or in
part in a principal amount of $1,000 and integral multiples thereof. The
Company has agreed to pay all expenses of the Exchange Offer. See "The Exchange
Offer--Fees and Expenses." Each New Note will bear interest from the most
recent date to which interest has been paid, or duly provided for, on the Old
Note surrendered in exchange for such New Note or, if no such interest has been
paid, or duly provided for, on such Old Note, from July 21, 1997. Holders of
Old Notes whose Old Notes are accepted for exchange will not receive accrued
interest on such Old Notes for any period from and after the last Interest
Payment Date to which interest has been paid or duly provided for on such Old
Notes prior to the original issue date of the New Notes or, if no such interest
has been paid or duly provided for, will not receive any accrued interest on
such Old Notes, and will be deemed to have waived the right to receive any
interest on such Old Notes accrued from and after such Interest Payment Date
or, if no such interest has been paid or duly provided for, from and after July
21, 1997.

Any waiver, extension or termination of the Exchange Offer will be publicly
announced by the Company through a release to the Dow Jones News Service and as
otherwise required by applicable law or regulations.

This Prospectus, together with the Letter of Transmittal, is being sent to all
registered Holders of Old Notes as of October , 1997.

The Company will not receive any cash proceeds from the issuance of the New
Notes offered hereby. No dealer-manager is being used in connection with this
Exchange Offer. See "Use of Proceeds" and "Plan of Distribution."

NO DEALER, SALESPERSON OR OTHER INDIVIDUAL HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS IN
CONNECTION WITH THE OFFER MADE BY THIS PROSPECTUS. IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY THE COMPANY. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER OR A
SOLICITATION IN ANY JURISDICTION WHERE, OR TO ANY PERSON TO WHOM, IT IS
UNLAWFUL TO MAKE SUCH AN OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE
AN IMPLICATION THAT THERE HAS NOT BEEN ANY CHANGE IN THE FACTS SET FORTH IN
THIS PROSPECTUS OR IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT
INFORMATION SET FORTH HEREIN IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE
HEREOF.

TABLE OF CONTENTS

Available Information.................... 6
Summary.................................. 8
Risk Factors............................. 22
Use of Proceeds.......................... 27
Capitalization........................... 28
Unaudited Pro Forma Condensed Combined
Financial Statements.................... 29
Selected Historical Financial Data....... 36
Management's Discussion and Analysis of
Financial Condition and Results of
Operations.............................. 38
Business................................. 45

Management............................... 64
Description of the Credit Agreement...... 66
The Exchange Offer....................... 68
Description of the New Notes............. 76
Description of the Old Notes............. 100
Certain United States Federal Income Tax
Considerations.......................... 101
Plan of Distribution..................... 103
Legal Matters............................ 103
Experts.................................. 103
Index to Financial Statements............ F-1

AVAILABLE INFORMATION

The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance
therewith files reports, proxy statements and other information with the
Commission. The reports, proxy statements and other information filed by the
Company with the Commission may be inspected and copied at the public reference
facilities maintained by the Commission at Room 1024, 450 Fifth Street, N.W.,
Washington, D.C. 20549, as well as at the Commission's Regional Offices,
including the following: Northwestern Atrium Center, 500 West Madison Street,
Suite 1400, Chicago, Illinois 60661 and 7 World Trade Center, Suite 1300, New
York, New York 10048. Copies of such information may be obtained by mail at
prescribed rates from the Public Reference Section of the Commission at 450
Fifth Street, N.W., Washington, D.C. 20549 and certain of such information may
be accessed electronically on the Commission's Web Site at
(http://www.sec.gov). The Company's Common Stock is listed on the NYSE under
the symbol "VC." Reports, proxy statements and other information filed by the
Company may be inspected at the offices of the NYSE at 20 Broad Street, New
York, New York 10005.

INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE

The following documents filed by the Company with the Commission pursuant to
the Exchange Act (File No. 1-10989) are incorporated in this Prospectus by
reference and are made a part hereof:

1. Annual Report on Form 10-K for the fiscal year ended December 31, 1996
(the "Vencor 10-K");

2. Current Report on Form 8-K dated March 18, 1997;

3. Current Report on Form 8-K/A dated March 18, 1997;

4. The portions of the Company's Proxy Statement for the Annual Meeting of
Stockholders held on May 15, 1997, that have been incorporated by reference
into the Vencor 10-K;

5. Annual Report on Form 11-K (relating to the Vencor, Inc. Retirement
Savings Plan) for the fiscal year ended December 31, 1996;

6. Current Report on Form 8-K dated June 19, 1997;

7. Current Report on Form 8-K/A dated June 19, 1997;

8. Quarterly Reports on Form 10-Q for the periods ended March 31, 1997 and
June 30, 1997; and

9. Current Report on Form 8-K dated July 21, 1997.

All documents filed by the Company with the Commission pursuant to Section
13(a), 13(c), 14 or 15(d) of the Exchange Act subsequent to the date of this
Prospectus and prior to the termination of the offering shall be deemed to be
incorporated by reference in this Prospectus and to be a part hereof from the
date of the filing of such documents. Any statement contained in a document
incorporated or deemed incorporated herein by reference shall be deemed to be
modified or superseded for purposes of this Prospectus to the extent that a
statement contained herein or in any other subsequently filed document which
also is incorporated or deemed to be incorporated by reference herein modifies
or supersedes such statement. Any such statement so modified or superseded
shall not be deemed, except as so modified or superseded, to constitute a part
of this Prospectus.

THIS PROSPECTUS INCORPORATES DOCUMENTS BY REFERENCE WHICH ARE NOT PRESENTED
HEREIN OR DELIVERED HEREWITH. THE COMPANY WILL PROVIDE WITHOUT A CHARGE TO EACH
PERSON TO WHOM THIS PROSPECTUS IS DELIVERED, UPON ORAL OR WRITTEN REQUEST, A
COPY OF ANY OR ALL OF SUCH DOCUMENTS (OTHER THAN EXHIBITS TO SUCH DOCUMENTS,
UNLESS SUCH EXHIBITS ARE SPECIFICALLY INCORPORATED BY REFERENCE IN SUCH
DOCUMENTS). WRITTEN OR TELEPHONE REQUESTS SHOULD BE DIRECTED TO VENCOR, INC.,
3300 PROVIDIAN CENTER, 400 WEST MARKET STREET, LOUISVILLE, KENTUCKY 40202,
ATTENTION: SECRETARY (TELEPHONE (502) 596-7300).

FORWARD LOOKING STATEMENTS

Certain statements in this Prospectus under the headings "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," and "Business," in certain documents incorporated herein by
reference and in a number of other places, constitute forward looking
statements within the meaning of the Private Securities Litigation Reform Act
of 1995. Those statements appear in a number of places in this Prospectus and
include statements regarding the intent, belief or current expectations of the
Company or its management. Prospective Holders of the New Notes are cautioned
that any such forward looking statements are not guarantees of future
performance and may involve risks and uncertainties, and that actual results
may differ from those in the forward looking statements as a result of various
factors. The information contained in this Prospectus, including without
limitation the information under the aforementioned headings, identifies
important factors that could cause such differences.

SUMMARY

The following summary is qualified in its entirety by the more detailed
information and financial statements appearing elsewhere in this Prospectus or
incorporated herein by reference. Capitalized terms in this summary under the
captions "The Exchange Offer" and "The New Notes" and not otherwise defined are
defined under the caption "Description of the New Notes--Certain Definitions."

THE COMPANY

GENERAL

The Company is one of the largest providers of long-term healthcare services in
the United States. At June 30, 1997, the Company's operations included 58 long-
term acute care hospitals containing 5,107 licensed beds, 311 nursing centers
containing 40,869 licensed beds, a contract services business ("Vencare") which
provides respiratory and rehabilitation therapies and medical and pharmacy
management services under approximately 4,500 contracts to nursing centers and
other healthcare providers, and through its affiliate, Atria Communities, Inc.
("Atria"), 40 assisted and independent living communities with 3,977 units. The
Company currently operates in 46 states. Healthcare services provided through
this network of facilities include long-term hospital care, nursing care,
contract respiratory therapy services, acute cardiopulmonary care, subacute and
post-operative care, occupational healthcare, inpatient and outpatient
rehabilitation therapy, specialized care for Alzheimer's disease, hospice care,
home healthcare, pharmacy services and assisted and independent living. The
Company also continues to develop VenTouch(TM), a comprehensive paperless
clinical information system designed to increase the operating efficiencies of
the Company's facilities.

On March 21, 1997, the Company completed its acquisition of TheraTx,
Incorporated ("TheraTx") (the "TheraTx Merger"), a provider of subacute
rehabilitation and respiratory therapy program management services to nursing
centers and an operator of 26 nursing centers that provide a broad range of
subacute, specialty and basic medical and other geriatric services. On June 24,
1997, the Company acquired approximately 95% of the outstanding common stock of
Transitional Hospitals Corporation ("THY") (the "THY Acquisition"), an operator
of 16 long-term acute care hospitals and three satellite facilities in 13
states, through a cash tender offer. The Company completed the merger with THY
on August 26, 1997. THY also owns a 44% voting equity interest (61% ownership
interest) in Behavioral Healthcare Corporation ("BHC"), an operator of
psychiatric and behavioral clinics. For additional information regarding the
TheraTx Merger and the THY Acquisition (hereafter referred to collectively as
the "Acquisitions"), see "--Recent Developments."

The combinations of the Company with TheraTx and THY advance the integrated
growth strategy of the Company and enhance its position as one of the largest
full-service long-term healthcare providers. The TheraTx Merger significantly
enhances the Company's ability to provide rehabilitation services throughout
its network. The combination with THY expands the network of long-term acute
care hospitals which provides the foundation for the Company's long-term
healthcare continuum. On a pro forma basis, adjusting for the Acquisitions, the
Company would have generated 1996 revenues of $3.5 billion and EBITDA of $453
million.

BUSINESS STRATEGY

The Company believes that the demand for long-term care is increasing. Improved
medical care and advances in medical technology continue to increase the
survival rates for victims of disease and trauma. Many of these patients never
fully recover and require long-term care. The incidence of chronic problems
increases with age, particularly in connection with certain degenerative
conditions. As the average age of the United States population increases, the
Company believes that there will be an increase in the demand for long-term
care at all levels of the continuum of care.

At the same time, the healthcare system of the United States is experiencing a
period of significant change. Factors affecting the healthcare system include
cost containment, the expansion of managed care, improved medical technology,
an increased focus on measurable clinical outcomes and a growing public
awareness of healthcare spending by governmental agencies at Federal and state
levels. Payors are increasingly requiring providers to move patients from high-
acuity care environments to lower-acuity care settings as quickly as is
medically appropriate.

The Company's strategy is to continue to develop its full-service integrated
network to meet the range of needs of patients requiring long-term care. The
Company is continuing to integrate and expand the operations of its long-term
acute care hospitals and nursing centers and is also developing related
healthcare services. The Company provides a full range of clinical expertise,
as well as advanced technologies for cost-efficiencies, to accommodate patients
at all levels of long-term care. Key elements of the Company's strategy for
providing full-service integrated networks for long-term care are set forth
below:

Focus on Long-Term Care Continuum. The factors which affect the selection of
long-term care vary by community and include the Company's local competitive
position as well as its relationships with local referral sources. Accordingly,
the Company focuses its resources on further broadening its array of services
as well as developing integrated networks within each of the local markets it
serves. The Company's history of strategic acquisitions and complementary
business development initiatives has served to enhance the Company's position
as a leader in local and regional markets. In addition, the Company benefits
from economies of scale through its strategic focus on the long-term care
continuum.

The Company intends to continue expanding its long-term care network and
evaluates each acquisition or new market opportunity based on (i) the need for
placement of long-term patients or residents, (ii) existing provider referral
patterns, (iii) the presence of competitors, (iv) payor mix and (v) the
political and regulatory climate. From time to time, the Company may also sell
all or a portion of its interest in a facility or business where such
disposition would be in the best interest of the Company.

Increase Penetration of Specialty Care and Ancillary Services. The Company
intends to continue to expand the specialty care programs and ancillary
services provided in its nursing centers through its Vencare operations. These
services generally produce higher revenues than do routine nursing care
services and serve to differentiate the Company's nursing centers from others
in a given market. The Company is focusing on the expansion of its subacute,
medical and rehabilitation services, including physical, occupational and
speech therapies, wound care, oncology treatment, brain injury care, stroke
therapy and orthopedic therapy at its facilities.

Vencare also provides respiratory therapy and subacute care services pursuant
to contracts with nursing centers and other healthcare facilities owned by
third parties. The Vencare program includes hospice care, management of
cardiopulmonary hospital departments, rehabilitation therapy services, pharmacy
management services and mobile radiology services. Vencare enables the Company
to provide its services to lower acuity patients in cost-efficient settings.

Expand Presence in Home Healthcare Arena. During the summer of 1996, the
Company consolidated its home health services business to establish Vencor Home
Health Services. The Company intends to expand its home health and infusion
services as an affordable and practical approach to many healthcare needs.
These services include home health nursing and home infusion products and
services. The expansion of home health services extends the Company's continuum
of care to the lowest cost setting.

installed VenTouch(TM) in all of its existing hospitals during 1995 and began
installing VenTouch(TM) in its nursing centers in 1996. In addition, the
Company intends to offer its VenTouch(TM) information system as part of the
menu of services offered by Vencare to nursing centers not owned by the
Company.

RECENT DEVELOPMENTS

On March 21, 1997, the Company consummated the TheraTx Merger. The TheraTx
Merger was structured as a cash tender offer followed by a second-step merger
in which the Company paid approximately $336 million ($17.10 per share) for all
of the outstanding common stock of TheraTx and assumed long-term debt
approximating $197 million. Following the completion of the tender offer, the
Company merged its acquisition subsidiary with and into TheraTx and TheraTx
became a wholly-owned subsidiary of the Company. Upon consummation of the
TheraTx Merger, each share of TheraTx common stock not purchased through the
tender offer was converted into the right to receive $17.10 in cash.

Prior to the TheraTx Merger, TheraTx provided subacute rehabilitation and
respiratory therapy program management services to nursing centers and operated
26 nursing centers that provide a broad range of subacute, specialty and basic
medical and other geriatric services. TheraTx's nursing center operations have
been integrated with the Company's nursing center operations. TheraTx also
provided occupational healthcare and other related services in outpatient
clinics. In addition to its primary practice areas, TheraTx operated two
outpatient surgery centers, one acute care specialty hospital and 16
occupational health facilities, provided respiratory therapy and related
services to hospitals and provided medical supply distribution and related
services to the long-term healthcare industry. These services have been
incorporated into the Company's Vencare operations.

As a result of the TheraTx Merger, the Company acquired the rights to
TheraSys(R), a proprietary clinical information system which measures clinical
outcomes and clinical efficiency of care for its rehabilitation services.
TheraSys(R) allows for direct entry of patient information into the system and
facilitates the accumulation and analysis of patient care data. Using the data
derived from TheraSys(R), clinical teams can better manage patient, family and
payor expectations about the likely length, cost and results of therapy.

On June 18, 1997, the Company entered into an agreement and plan of merger (the
"THY Agreement") to acquire all of the outstanding common stock (the "THY
Shares") of THY at $16.00 per THY Share. The THY Acquisition was structured as
a cash tender offer followed by a second-step merger pursuant to which a
wholly-owned subsidiary of the Company acquired all remaining THY Shares which
were not tendered. The Company's wholly-owned subsidiary acquired 37.2 million
THY Shares (approximately 95% of the THY Shares) in the tender offer which
expired on June 19, 1997. On June 24, 1997, the Company completed the tender
offer, after which time the operations of THY were consolidated with those of
the Company. The Company and THY completed the merger of the Company's wholly-
owned subsidiary with and into THY on August 26, 1997.

Prior to entering into the THY Agreement, THY had entered into an agreement and
plan of merger with Select Medical Corporation ("Select") (the "Select Merger
Agreement"). The Select Merger Agreement was terminated prior to the execution
of the THY Agreement. Pursuant to the terms of the Select Merger Agreement, THY
paid Select a $19.4 million break-up fee.

THY operated 16 long-term acute care hospitals and three satellite facilities
located in 13 states. THY also provided contract respiratory therapy services
to nursing centers and hospital facilities owned by third parties. In addition,
THY owned a 44% voting equity interest (61% ownership interest) in BHC, an
operator of psychiatric and behavioral clinics.

At June 30, 1997, the Company owned 60.7% of Atria's outstanding common stock.
In July 1997, Atria sold 6.9 million shares of its common stock in a public
offering (the "Atria Offering"). Atria intends to use the net proceeds from the
Atria Offering, approximately $91.5 million, to finance the development and
acquisition of

assisted living communities and for general corporate purposes. The Company now
owns 42.8% of the outstanding common stock of Atria. Accordingly, the
operations of Atria, which were consolidated with those of the Company prior to
the Atria Offering, have been accounted for under the equity method since July
1, 1997.

On June 11, 1997, the Company announced that it had entered into a strategic
alliance with CNA Financial Corporation ("CNA") to develop and market a long-
term care insurance product. Under this arrangement, CNA will offer a long-term
care insurance product which features as a benefit a 15% discount for services
provided by members of the Company's network of long-term care providers.
Members of this network will act as preferred providers of care to covered
insureds and in certain states will provide preferential access to the
network's nursing centers.

CNA will be responsible for underwriting, marketing and distributing the
product through its national distribution network and will provide
administrative insurance product support. The Company will reinsure 50% of the
risk through a newly formed wholly-owned insurance company and will provide
utilization review services. It is anticipated that sales of this product will
commence by the end of 1997, initially in the states of Florida and Kentucky.
Provisions for such risk arrangements will be based upon actuarially determined
estimates. To the extent that subsequent costs exceed these provisions, the
Company could be required to fund substantial underwriting losses. Management
believes that the alliance with CNA will not have a material impact on the
Company's liquidity, financial position or results of operations in 1997.

In August 1997, the Company acquired a 99 bed long-term care hospital located
in Burbank, California and a 90 bed long-term care hospital located in
Milwaukee, Wisconsin.

On August 28, 1997, the Company entered into a definitive agreement to sell
substantially all of its assets relating to the occupational medicine business
it acquired in the TheraTx Merger. This transaction was completed on September
30, 1997. Management believes that this transaction will not have a material
effect on the Company's liquidity, financial condition or results of operations
in 1997.

On September 15, 1997, BHC entered into a definitive agreement to merge with
Atlanta-based Charter Behavioral Health Systems, LLC ("CBHS"). Under the terms
of the agreement, CBHS will acquire all of the issued and outstanding capital
stock of BHC for cash. The Company owns a 44% voting equity interest (61%
ownership interest) in BHC as a result of the THY Acquisition. The Company's
proceeds from the transaction, expected to approximate $140 million, will be
used to reduce the Company's borrowings under the Credit Agreement. This
transaction, which is subject to acceptable financing, due diligence by CBHS
and certain regulatory approvals, is expected to close during the fourth
quarter of 1997.

THE EXCHANGE OFFER

Issuer........................... Vencor, Inc.

The Exchange Offer............... Up to $750 million aggregate principal
amount of New Notes are being offered in
exchange for a like aggregate principal
amount of Old Notes. The Company is making
the Exchange Offer in order to satisfy its
obligations under the Registration Rights
Agreement relating to the Old Notes. For a
description of the procedures for tendering
Old Notes, see "The Exchange Offer--
Procedures for Tendering Old Notes."

Expiration Date..................
5:00 p.m., New York City time, on November
21, 1997 (such time on such date being
hereinafter called the "Expiration Date")
unless the Exchange Offer is extended by
the Company (in which case the term
"Expiration Date" shall mean the latest
date and time to which the Exchange Offer
is extended). Any waiver, extension or
termination of the Exchange Offer will be
publicly announced by the Company through a
release to the Dow Jones News Service and
as otherwise required by applicable law or
regulations. See "The Exchange Offer--
Expiration Date; Extensions; Amendments."

Certain Conditions to the The Exchange Offer is subject to certain
Exchange Offer................... conditions. The Company reserves the right
in its sole and absolute discretion,
subject to applicable law, at any time and
from time to time, (i) to delay the
acceptance of the Old Notes for exchange,
(ii) to terminate the Exchange Offer if
certain specified conditions have not been
satisfied, (iii) to extend the Expiration
Date of the Exchange Offer and retain all
Old Notes tendered pursuant to the Exchange
Offer, subject, however, to the right of
Holders of Old Notes to withdraw their
tendered Old Notes, or (iv) to waive any
condition or otherwise amend the terms of
the Exchange Offer in any respect. See "The
Exchange Offer--Expiration Date;
Extensions; Amendments" and "--Certain
Conditions to the Exchange Offer."

Withdrawal Rights................ Tenders of Old Notes may be withdrawn at
any time on or prior to 5:00 p.m., New York
City time, on the Expiration Date by
delivering a written notice of such
withdrawal to the Exchange Agent (as
defined) in conformity with certain
procedures set forth below under "The
Exchange Offer--Withdrawal Rights."

Procedures for Tendering Old Tendering Holders of Old Notes must
Notes............................ complete and sign a Letter of Transmittal
in accordance with the instructions
contained therein and forward the same by
mail or hand delivery, together with any
other required documents, to the Exchange
Agent at the address set forth herein by
5:00 p.m., New York City time, on the
Expiration Date, either with the Old Notes
to be tendered or in compliance with the
specified procedures for guaranteed
delivery of Old Notes.

Certain brokers, dealers, commercial banks,
trust companies and other nominees may also
effect tenders by book-entry transfer.
Holders of Old Notes registered in the name
of a broker, dealer, commercial bank, trust
company or other nominee are urged to
contact such person promptly if they wish
to tender Old Notes pursuant to the
Exchange Offer. Letters of Transmittal and
certificates representing Old Notes should
not be sent to the Company. Such documents
should only be sent to the Exchange Agent.
Questions regarding how to tender and
requests for information should be directed
to the Exchange Agent. See "The Exchange
Offer--Procedures for Tendering Old Notes"
and "--Exchange Agent."

Guaranteed Delivery Procedures... Holders of Old Notes who wish to tender
their Old Notes and whose Old Notes are not
immediately available or who cannot deliver
their Old Notes, the Letter of Transmittal
or any other documents required by the
Letter of Transmittal to the Exchange Agent
prior to the Expiration Date must tender
their Old Notes according to the guaranteed
delivery procedures set forth in "The
Exchange Offer--Procedures for Tendering
Old Notes--Guaranteed Delivery."

Resales of New Notes............. The Company is making the Exchange Offer in
reliance on the position of the staff of
the Division of Corporation Finance of the
Commission as set forth in certain
interpretive letters addressed to third
parties in other transactions. The Company,
however, has not sought its own
interpretive letter and there can be no
assurance that the staff of the Division of
Corporation Finance of the Commission would
make a similar determination with respect
to the Exchange Offer as it has in such
interpretive letters to third parties.
Based on these interpretations by the staff
of the Division of Corporation Finance of
the Commission, and subject to the two
immediately following sentences, the
Company believes that New Notes issued
pursuant to the Exchange Offer in exchange
for Old Notes may be offered for resale,
resold and otherwise transferred by a
Holder thereof (other than a Holder who is
a broker-dealer) without further compliance
with the registration and prospectus
delivery requirements of the Securities
Act, provided that such New Notes are
acquired in the ordinary course of such
Holder's business and that such Holder is
not participating, and has no arrangement
or understanding with any person to
participate, in a distribution (within the
meaning of the Securities Act) of such New
Notes. However, any Holder of Old Notes who
is an "affiliate" of the Company or who
intends to participate in the Exchange
Offer for the purpose of distributing the
New Notes, or any broker-dealer who
purchased the Old Notes from the Company to
resell pursuant to Rule 144A or any other
available exemption under the Securities
Act, (i) will not be

able to rely on the interpretations of the
staff of the Division of Corporation
Finance of the Commission set forth in the
above-mentioned interpretive letters, (ii)
will not be permitted or entitled to tender
such Old Notes in the Exchange Offer and
(iii) must comply with the registration and
prospectus delivery requirements of the
Securities Act in connection with any sale
or other transfer of such Old Notes unless
such sale is made pursuant to an exemption
from such requirements. In addition, as
described below, if any broker-dealer holds
Old Notes acquired for its own account as a
result of market-making or other trading
activities and exchanges such Old Notes for
New Notes, then such broker-dealer must
deliver a prospectus meeting the
requirements of the Securities Act in
connection with any resales of such New
Notes.

Each Holder of Old Notes who wishes to
exchange Old Notes for New Notes in the
Exchange Offer will be required to
represent that (i) it is not an "affiliate"
of the Company within the meaning of Rule
405 under the Securities Act, (ii) any New
Notes to be received by it are being
acquired in the ordinary course of its
business, (iii) it has no arrangement or
understanding with any person to
participate in a distribution (within the
meaning of the Securities Act) of such New
Notes, and, (iv) if such Holder is not a
broker-dealer, it is not engaged in, and
does not intend to engage in, a
distribution (within the meaning of the
Securities Act) of such New Notes. Each
broker-dealer that receives New Notes for
its own account pursuant to the Exchange
Offer must acknowledge that it acquired the
Old Notes for its own account as the result
of market-making or other trading
activities and must agree that it will
deliver a prospectus meeting the
requirements of the Securities Act in
connection with any resale of such New
Notes. The Letter of Transmittal states
that by so acknowledging and by delivering
a prospectus, a broker-dealer will not be
deemed to admit that it is an "underwriter"
within the meaning of the Securities Act.
Based on the position taken by the staff of
the Division of Corporation Finance of the
Commission in the interpretive letters
referred to above, the Company believes
that broker-dealers who acquired Old Notes
for their own accounts as a result of
market-making or other trading activities
("Participating Broker-Dealers") may
fulfill their prospectus delivery
requirements with respect to the New Notes
received upon exchange of such Old Notes
with a prospectus meeting the requirements
of the Securities Act, which may be the
prospectus prepared for an exchange offer
so long as it contains a description of the
plan of distribution with respect to the
resale of such New Notes. Accordingly, this
Prospectus may be used by a Participating
Broker-Dealer in connection with resales of
New Notes received in exchange for Old
Notes where such Old Notes

were acquired by such Participating Broker-
Dealer for its own account as a result of
market-making or other trading activities.
Subject to certain provisions set forth in
the Registration Rights Agreement and to
the limitations described under "The
Exchange Offer--Resales of New Notes," the
Company has agreed that this Prospectus may
be used by a Participating Broker-Dealer in
connection with resales of such New Notes
for a period ending 180 days after the
Expiration Date (subject to extension under
certain limited circumstances) or, if
earlier, when all such New Notes have been
disposed of by such Participating Broker-
Dealer. Any Participating Broker-Dealer who
is an "affiliate" of the Company may not
rely on such interpretive letters and must
comply with the registration and prospectus
delivery requirements of the Securities Act
in connection with any resale transaction.
See "Plan of Distribution" and "The
Exchange Offer--Resales of New Notes."

Acceptance of Old Notes and
Delivery of New Notes...........
Subject to the terms and conditions of the
Exchange Offer, including the reservation
of certain rights by the Company, the
Company will accept for exchange any and
all Old Notes which are properly tendered
in the Exchange Offer, and not withdrawn,
prior to 5:00 p.m., New York City time, on
the Expiration Date. Subject to such terms
and conditions, the New Notes issued
pursuant to the Exchange Offer will be
delivered promptly following the Expiration
Date. See "The Exchange Offer--Acceptance
for Exchange and Issuance of New Notes."

Exchange Agent................... The exchange agent with respect to the
Exchange Offer is First Chicago Trust
Company of New York (the "Exchange Agent").
The addresses and telephone number of the
Exchange Agent are set forth in "The
Exchange Offer--Exchange Agent" and in the
Letter of Transmittal.

Use of Proceeds.................. The Company will not receive any cash
proceeds from the issuance of the New Notes
offered hereby. See "Use of Proceeds."

Certain United States Federal
Income Tax Considerations.......
Holders of Old Notes should review the
information set forth under "Certain United
States Federal Income Tax Considerations"
prior to tendering Old Notes in the
Exchange Offer.

THE NEW NOTES

Securities Offered............... Up to $750 million aggregate principal
amount of the Company's 8 5/8% Senior
Subordinated Notes due 2007. The New Notes
will be issued and the Old Notes were
issued under an Indenture dated as of July
21, 1997 (the "Indenture") between the
Company and The Bank of New York (the
"Trustee"). The New Notes and any Old Notes
which remain outstanding after consummation
of the Exchange Offer will constitute a
single series of debt securities under the
Indenture and, accordingly, will vote
together as a single class for purposes of
determining whether Holders of the
requisite percentage in outstanding
principal amount thereof have taken certain
actions or exercised certain rights under
the Indenture. See "Description of the New
Notes--General." The terms of the New Notes
are identical in all material respects to
the terms of the Old Notes, except that (i)
the offer and sale of the New Notes have
been registered under the Securities Act
and therefore the New Notes are not subject
to certain restrictions on transfer
applicable to the Old Notes, will not
contain legends relating thereto and will
not be entitled to registration rights or
other rights under the Registration Rights
Agreement, and (ii) the New Notes will not
provide for any increase in the interest
rate thereon. See "The Exchange Offer--
Purpose of the Exchange Offer,"
"Description of the New Notes" and
"Description of the Old Notes."

Maturity Date.................... July 15, 2007.

Interest Payment Dates........... January 15 and July 15, commencing on
January 15, 1998.

Optional Redemption.............. The New Notes will be redeemable at the
option of the Company, in whole or in part,
at any time on or after July 15, 2002, at
the redemption prices set forth herein,
plus accrued and unpaid interest to the
redemption date.

Ranking.......................... The New Notes will constitute general
unsecured obligations of the Company and
will rank subordinate in right of payment
to all existing and future Senior Debt,
including all of the obligations under the
Credit Agreement. As of June 30, 1997, on a
pro forma basis after giving effect to the
Offering and the repurchase of certain THY
debt, the Company would have had
outstanding an aggregate principal amount
of approximately $1.0 billion of Senior
Debt. In addition, the New Notes
effectively will be subordinated to all
outstanding indebtedness and other
liabilities and commitments (including
trade payables and
operating lease obligations) of the
Company's subsidiaries. As of June 30,
1997, on a pro forma basis as described
above, the outstanding indebtedness of the
Company's subsidiaries would have been
approximately $160 million, excluding trade
payables and operating lease obligations

aggregating approximately $401 million.
Subject to certain limitations, the Credit
Agreement and the Indenture will permit the
Company and its subsidiaries to incur
additional indebtedness, including Senior
Debt.

Change of Control................ Upon a Change of Control, each Holder of
New Notes will have the right to require
the Company to repurchase such Holder's New
Notes at 101% of the principal amount
thereof, plus accrued and unpaid interest
to the date of repurchase. However, the
Credit Agreement provides that a Change of
Control will constitute a default
thereunder, which would permit the lenders
to cause the indebtedness under the Credit
Agreement to become immediately due and
payable or to institute a payment blockage
with respect to the New Notes. In order to
repurchase New Notes upon a Change of
Control, the Company would have to repay
all of its obligations under the Credit
Agreement (and any other agreements
relating to Senior Debt that contain
similar Change of Control provisions) or
would have to obtain the consent of the
holders of such indebtedness. There can be
no assurance that the Company will have the
financial resources to repurchase the New
Notes in the event of a Change of Control,
particularly if such Change of Control
requires the Company to refinance, or
results in the acceleration of, other
indebtedness. See "Description of the
Credit Agreement" and "Description of the
New Notes--Repurchase at the Option of
Holders upon a Change of Control."

Certain Covenants................ The Indenture contains certain covenants,
including, but not limited to, covenants
limiting: (i) the incurrence by the Company
and its Restricted Subsidiaries (as
defined) of additional indebtedness; (ii)
the payment of dividends on and the
redemption of capital stock by the Company;
(iii) the creation of liens securing
indebtedness; (iv) restrictions on the
ability of Restricted Subsidiaries to pay
dividends; (v) transactions with
affiliates; (vi) the sale of assets; and
(vii) the Company's ability to consolidate
or merge with or into, or to transfer all
or substantially all of its assets to,
another person. See "Description of the New
Notes--Certain Covenants."

Absence of Market for the New The New Notes will be a new issue of
Notes............................ securities for which there currently is no
market. Although J.P. Morgan Securities
Inc., NationsBanc Capital Markets, Inc.,
Goldman Sachs & Co. and Merrill Lynch,
Pierce, Fenner and Smith Incorporated, the
initial purchasers of the Old Notes (the
"Initial Purchasers"), have informed the
Company that they currently intend to make
a market in the New Notes, they are not
obligated to do so, and any such market
making may be discontinued at any time
without notice. Accordingly, there can be
no assurance as to the

development or liquidity of any market for
the New Notes. The Company currently does
not intend to apply for listing of the New
Notes on any securities exchange or for
quotation through the National Association
of Securities Dealers Automated Quotation
System.

RISK FACTORS

See "Risk Factors" for a discussion of certain factors that should be
considered by Holders in connection with an investment in the New Notes.

CERTAIN CONSEQUENCES OF A FAILURE TO EXCHANGE OLD NOTES

The sale of the Old Notes was not registered under the Securities Act or any
state securities laws and therefore the Old Notes may not be offered, sold or
otherwise transferred except in compliance with the registration requirements
of the Securities Act and any other applicable securities laws, or pursuant to
an exemption therefrom or in a transaction not subject thereto, and in each
case in compliance with certain other conditions and restrictions, including
the Company's and the Trustee's right in certain cases to require the delivery
of opinions of counsel, certifications and other information prior to any such
transfer. Old Notes which remain outstanding after consummation of the Exchange
Offer will continue to bear a legend reflecting such restrictions on transfer.
In addition, upon consummation of the Exchange Offer, Holders of Old Notes
which remain outstanding will not be entitled to any rights to have the resale
of such Old Notes registered under the Securities Act or to any similar rights
under the Registration Rights Agreement. The Company currently does not intend
to register under the Securities Act the resale of any Old Notes which remain
outstanding after consummation of the Exchange Offer.

To the extent that Old Notes are tendered and accepted in the Exchange Offer, a
Holder's ability to sell Old Notes could be adversely affected. In addition,
although the Old Notes are eligible for trading in the "PORTAL" market, to the
extent that Old Notes are tendered and accepted in connection with the Exchange
Offer, any trading market for Old Notes which remain outstanding after the
Exchange Offer could be adversely affected.

The New Notes and any Old Notes which remain outstanding after consummation of
the Exchange Offer will constitute a single series of debt securities under the
Indenture and, accordingly, will vote together as a single class for purposes
of determining whether Holders of the requisite percentage in outstanding
principal amount thereof have taken certain actions or exercised certain rights
under the Indenture. See "Description of the New Notes--General."

The Old Notes provide that, if the Exchange Offer is not consummated or the
Shelf Registration Statement is not declared effective on or prior to December
18, 1997, the Company will pay additional interest (in addition to the interest
otherwise due on the Old Notes) to each Holder of the Old Notes during the
first 90-day period following December 18, 1997, in an amount equal to 0.25%
per annum. The amount of interest will increase by an additional 0.25% per
annum for each subsequent 90-day period until consummation of the Exchange
Offer or the effectiveness of the Shelf Registration Statement, up to a maximum
amount of additional interest of 1.00% per annum. Following consummation of the
Exchange Offer, however, the Old Notes will not be entitled to any increase in
the interest rate thereon. The New Notes will not be entitled to any such
increase in the interest rate thereon. See "Description of the Old Notes."

SUMMARY HISTORICAL AND PRO FORMA FINANCIAL DATA

The following table sets forth (i) summary historical financial data of the
Company for the years ended December 31, 1996, 1995 and 1994, and the six
months ended June 30, 1997 and June 30, 1996, and (ii) summary pro forma
financial data for the year ended December 31, 1996 and the six months ended
June 30, 1997. The summary historical financial data presented herein have been
derived from the audited consolidated financial statements of the Company for
the fiscal years ended December 31 and unaudited condensed consolidated
financial statements of the Company for the six month periods ended June 30,
both of which are included elsewhere in this Prospectus. The summary pro forma
statement of operations data and other financial data give effect to the
Acquisitions, the related increase in borrowings under the Credit Agreement,
the Offering, the application of the net proceeds thereof as described in "Use
of Proceeds" and the repurchase of certain TheraTx and THY debt, as if each had
occurred on January 1, 1996. The summary pro forma condensed combined balance
sheet data at June 30, 1997 give effect to these events as if each had occurred
as of such date. The pro forma financial data are for informational purposes
only and are not necessarily indicative of the results that would have been
obtained had these events occurred on the dates specified above.

For all periods presented, pro forma financial data have been derived by
combining the historical financial data of the Company and TheraTx (based upon
annual reporting periods ended December 31 and the six months ended June 30)
and THY (based upon annual reporting periods ended November 30 and the six
months ended May 31). The following table should be read in conjunction with:
"Unaudited Pro Forma Condensed Combined Financial Statements," "Selected
Historical Financial Data," "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the historical consolidated financial
statements of the Company, TheraTx and THY presented elsewhere in this
Prospectus.

---------------------------------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, YEAR ENDED DECEMBER 31,
Dollars in thousands, PRO FORMA PRO FORMA
except 1997 1997 1996 1996 1996 1995 1994
per share amounts ---------- ---------- ---------- ---------- ---------- ---------- ----------

STATEMENT OF OPERATIONS
DATA:
Revenues................ $1,707,261 $1,458,991 $1,260,891 $3,475,217 $2,577,783 $2,323,956(c) $2,032,827
---------- ---------- ---------- ---------- ---------- ---------- ----------
Operating expenses...... 1,476,495 1,259,192 1,098,427 3,022,090 2,236,151 2,045,217 1,775,226
Depreciation and
amortization........... 68,409 53,851 49,639 146,949 99,533 89,478 79,519
Interest expense........ 70,073 31,334 24,621 147,577 45,922 60,918 62,828
Investment income....... (6,147) (3,313) (6,878) (12,515) (12,203) (13,444) (13,126)
Non-recurring
transactions........... -- -- -- 158,724(a)(b) 125,200 (a) 109,423 (c) (4,540)(d)
---------- ---------- ---------- ---------- ---------- ---------- ----------
1,608,830 1,341,064 1,165,809 3,462,825 2,494,603 2,291,592 1,899,907
---------- ---------- ---------- ---------- ---------- ---------- ----------
Income from operations
before
income taxes........... 98,431 117,927 95,082 12,392 83,180 32,364 132,920
Provision for income
taxes.................. 39,176 46,935 36,607 7,917 35,175 24,001 46,781
---------- ---------- ---------- ---------- ---------- ---------- ----------
Income from operations.. $ 59,255 $ 70,992 $ 58,475 $ 4,475 $ 48,005 $ 8,363 $ 86,139
========== ========== ========== ========== ========== ========== ==========
Fully diluted earnings
per common and common
equivalent share from
operations............. $ 0.83 $ 1.00 $ 0.82 $ 0.06 $ 0.68 $ 0.29 $ 1.28
BALANCE SHEET DATA:
Working capital......... $ 465,537 $ 481,537 $ 235,154 n/a $ 320,123 $ 239,666 $ 129,079
Total assets............ 3,413,244 3,410,057 1,918,115 n/a 1,968,856 1,912,454 1,656,205
Long-term debt.......... 1,938,206 1,935,019 699,868 n/a 710,507 778,100 746,212
Stockholders' equity.... 877,587 877,587 837,656 n/a 797,091 772,064 596,454
OTHER FINANCIAL DATA:
EBITDA(e)............... $ 230,766 $ 199,799 $ 162,464 $ 453,127 $ 341,632 $ 278,739 $ 257,601
EBITDA margin........... 13.5% 13.7% 12.9% 13.0% 13.3% 12.0% 12.7%
Ratio of EBITDA to
interest expense....... 3.3x 6.4x 6.6x 3.1x 7.4x 4.6x 4.1x
Capital expenditures:
Existing facilities and
construction........... n/a $ 132,900 $ 61,454 n/a $ 135,027 $ 136,893 $ 111,486
Acquisitions........... n/a 954,648 5,182 n/a 26,236 59,343 36,391

- -------
(a) Includes pretax charges incurred to complete the integration of The
Hillhaven Corporation ("Hillhaven") resulting from the merger of Hillhaven
into the Company on September 28, 1995 (the "Hillhaven Merger"), which
included costs associated with the planned disposition of 34 nursing
centers, the reorganization of the institutional pharmacy business and the
planned replacement of one hospital and three nursing centers.
(b) Includes pretax charges of $33.5 million related to the sale and closure of
THY's psychiatric business.
(c) Includes pretax charges aggregating $103.9 million incurred primarily in
connection with the consummation of the Hillhaven Merger, which included
costs associated with direct transaction costs, employee benefit and
severance costs, the planned disposition of certain nursing center
properties and changes in estimates in accrued revenues of $24.5 million
recorded in connection with certain prior-year nursing center third-party
reimbursement issues (recorded as a reduction in revenues). Non-recurring
transactions in 1995 also include $5.5 million recorded in connection with
the merger of Hillhaven with Nationwide Care, Inc. (the "Nationwide
Merger").
(d) Includes a gain resulting from the sales of assets and nursing center
restructuring activities.
(e) EBITDA represents operating income before depreciation, amortization, net
interest, income taxes and non-recurring transactions. While EBITDA should
not be construed as a substitute for operating income or a better indicator
of liquidity than cash flows from operating activities, which are
determined in accordance with generally accepted accounting principles, it
is included herein to provide additional information with respect to the
ability of the Company to meet its future debt service, capital expenditure
and working capital requirements. EBITDA is not necessarily a measure of
the Company's ability to fund its cash needs. See the Consolidated
Statements of Cash Flows of the Company, TheraTx and THY and the related
notes thereto included elsewhere in this Prospectus. EBITDA is included
herein because management believes that certain investors find it to be a
useful tool for measuring the Company's ability to service debt.

RISK FACTORS

In addition to the other matters described or incorporated by reference in this
Prospectus, prospective Holders of the New Notes should consider the specific
factors set forth below.

LEVERAGE AND ABILITY TO MEET DEBT SERVICE REQUIREMENTS

The Company is highly leveraged and a substantial portion of the Company's cash
flow from operations is dedicated to the payment of principal and interest on
its indebtedness. As of June 30, 1997, after giving pro forma effect to the
Offering and the repurchase of certain THY debt, the Company's consolidated
long-term indebtedness would have been approximately $1.9 billion, which
represents approximately 69% of its total capitalization. Subject to certain
limitations, the Credit Agreement and the Indenture permit the Company and its
subsidiaries to incur additional indebtedness. On a pro forma basis as
described above, for the year ended December 31, 1996, and the six months ended
June 30, 1997, the Company's ratio of earnings to fixed charges (calculated in
accordance with the requirements of the Commission) would have been 1.0 to 1
and 2.0 to 1, respectively.

The ability of the Company to service its indebtedness, and to comply with the
financial and restrictive covenants contained in the Credit Agreement and the
Indenture, is dependent upon the Company's future performance and business
growth which are subject to financial, economic, competitive, regulatory and
other factors affecting the Company, many of which are beyond its control.
While the Company believes that it will be able to generate sufficient cash
flow to cover required debt service payments, no assurance can be given to that
effect. If the Company is unable to generate sufficient funds to meet its debt
service obligations, it may be required to refinance some or all of such debt,
sell assets or raise additional equity. No assurance can be given that such
refinancings, asset sales or equity sales could be accomplished or, if
accomplished, would raise sufficient funds to meet its debt service
obligations. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Liquidity and--Capital Resources" and "Description
of the Credit Agreement." The Company's high degree of leverage and related
financial covenants could have a material adverse effect on its ability to
withstand competitive pressures or adverse economic conditions, make material
acquisitions, obtain future financing or take advantage of business
opportunities that may arise. In addition, a downturn in general economic
conditions or in its business could have a material adverse effect on the
Company's ability to meet its debt service obligations or to conduct its
business in the ordinary course.

The Credit Agreement contains financial covenants which, among other things,
require the Company to maintain certain financial ratios and restrict the
ability of the Company and its subsidiaries to incur indebtedness, make
acquisitions or investments, create or permit liens and make capital
expenditures. The Indenture contains covenants which restrict the Company from
incurring additional indebtedness, creating liens on its assets, making certain
asset dispositions and entering into transactions with affiliates. If the
Company is unable to generate sufficient cash flow or otherwise obtain the
funds necessary to make required payments of principal and interest under, or
is unable to comply with the covenants of, the Credit Agreement or the
Indenture, the Company could be in default under the terms thereof, which would
permit the lenders pursuant to the Credit Agreement to accelerate the maturity
of the Senior Debt created pursuant thereto and receive payment in full prior
to the receipt by the Holders of Notes of any payment of principal of, premium,
if any, and interest on the Notes. See "Description of the Credit Agreement,"
"Description of the New Notes" and "Description of the Old Notes."

SUBORDINATION OF THE NOTES; DEPENDENCE ON SUBSIDIARIES

The Notes are subordinated to all Senior Debt including all obligations under
the Credit Agreement. In the event of a circumstance in which the contractual
subordination provisions apply, Holders of Notes will not be entitled to
receive and will have an obligation to pay over to holders of Senior Debt any
payments they may receive in respect of the Notes. As of June 30, 1997, on a
pro forma basis after giving effect to the Offering and the repurchase of
certain THY debt, the Company would have had outstanding an aggregate principal
amount of approximately $1.0 billion of Senior Debt, which would rank senior in
right of payment to the Notes.

Furthermore, subject to certain limitations, the Credit Agreement and the
Indenture will permit the Company and its subsidiaries to incur additional
indebtedness, including Senior Debt. The indebtedness under the Credit
Agreement will become due prior to the time the principal obligations under the
Notes become due. Certain subsidiaries of the Company have issued guarantees
under the Credit Agreement which are secured by a pledge of the equity
interests in other subsidiaries owned by them and the Company has pledged all
intercompany debt owed to it as well as the issued and outstanding capital
stock of certain of its subsidiaries to secure indebtedness under the Credit
Agreement. In the event of a bankruptcy, liquidation or reorganization of the
Company, the assets of the Company would be available to pay obligations on the
Notes only after all Senior Debt has been paid in full, and there may not be
sufficient assets remaining to pay amounts due on any or all of the Notes then
outstanding. See "Description of the Credit Agreement," "Description of the New
Notes" and "Description of the Old Notes."

In addition, the operations of the Company are conducted primarily through its
subsidiaries. Therefore, the Company's ability to make required principal and
interest payments with respect to the Company's indebtedness, including the
Notes, depends on the earnings of its subsidiaries and on its ability to
receive funds from such subsidiaries through dividends or other payments. Since
the Notes are obligations of the Company only, the Company's subsidiaries are
not obligated or required to pay any amounts due pursuant to the Notes or to
make funds available therefor in the form of dividends or advances to the
Company. Furthermore, the Notes effectively are subordinated to all outstanding
indebtedness and other liabilities and commitments (including trade payables
and operating lease obligations) of the Company's subsidiaries. Any right of
the Company to receive assets of any of its subsidiaries upon the latter's
liquidation or reorganization (and the consequent right of Holders of Notes to
participate in those assets) effectively are subordinated to the claims of that
subsidiary's creditors, except to the extent that the Company itself is
recognized as a creditor of such subsidiary, in which case the claims of the
Company would still be subordinate to any security interest in the assets of
such subsidiary and any indebtedness of such subsidiary senior to that held by
the Company. As of June 30, 1997, on a pro forma basis as described above, the
outstanding indebtedness of the Company's subsidiaries would have been
approximately $160 million, excluding trade payables and operating lease
obligations aggregating approximately $401 million.

LIMITS ON REIMBURSEMENT

The Company derives a substantial portion of its net operating revenues from
third-party payors, including the Medicare and Medicaid programs. In 1996 and
for the six months ended June 30, 1997, the Company derived approximately 62%
and 59% of its total revenues from the Medicare and Medicaid programs,
respectively. Such programs are highly regulated and subject to frequent and
substantial changes. The recently enacted Balanced Budget Act of 1997 (the
"Budget Act") is intended to reduce Medicare payments by $115 billion over the
next five years and makes extensive changes in the Medicare and Medicaid
programs. In addition, private payors, including managed care payors,
increasingly are demanding discounted fee structures and the assumption by
healthcare providers of all or a portion of the financial risk. Efforts to
impose greater discounts and more stringent cost controls by private payors are
expected to continue. There can be no assurances that adequate reimbursement
levels will continue to be available for services provided by the Company which
are currently being reimbursed by Medicare, Medicaid or private payors.
Significant limits on the scope of services reimbursed and on reimbursement
rates and fees could have a material adverse effect on the Company's liquidity,
financial condition and results of operations.

EXTENSIVE REGULATION

The healthcare industry is subject to extensive Federal, state and local
regulation including, but not limited to, regulations relating to licensure,
conduct of operations, ownership of facilities, addition of facilities,
services and prices for services. In particular, Medicare and Medicaid
antikickback, antifraud and abuse amendments codified under Section 1128(B)(b)
of the Social Security Act (the "Antikickback Amendments") prohibit certain
business practices and relationships that might affect the provisions and cost
of healthcare services reimbursable under Medicare and Medicaid, including the
payment or receipt of remuneration for the referral of patients whose care will
be paid by Medicare or other governmental programs. Sanctions for violating the
Antikickback Amendments

include criminal penalties and civil sanctions, including fines and possible
exclusion from government programs such as the Medicare and Medicaid programs.

Pursuant to the Medicare and Medicaid Patient and Program Protection Act of
1987, the Department of Health and Human Services ("HHS") has issued
regulations that describe some of the conduct and business relationships
permissible under the Antikickback Amendments ("Safe Harbors"). The fact that a
given business arrangement does not fall within a Safe Harbor does not render
the arrangement per se illegal. Business arrangements of healthcare service
providers that fail to satisfy the applicable Safe Harbors criteria, however,
risk increased scrutiny and possible sanctions by enforcement authorities.

The Health Insurance Portability and Accountability Act of 1997, which became
effective January 1, 1997, amends, among other things, Title XI (42 U.S.C. 1301
et seq.) to broaden the scope of current fraud and abuse laws to include all
health plans, whether or not they are reimbursed under Federal programs.

In addition, Section 1877 of the Social Security Act, which restricts referrals
by physicians of Medicare and other government-program patients to providers of
a broad range of designated health services with which they have ownership or
certain other financial arrangements, was amended effective January 1, 1995, to
significantly broaden the scope of prohibited physician referrals under the
Medicare and Medicaid programs to providers with which they have ownership or
certain other financial arrangements (the "Self-Referral Prohibitions"). Many
states have adopted or are considering similar legislative proposals, some of
which extend beyond the Medicaid program to prohibit the payment or receipt of
remuneration for the referral of patients and physician self-referrals
regardless of the source of the payment for the care. These laws and
regulations are extremely complex and the industry has the benefit of little
judicial or regulatory interpretation. The Company does not believe its
arrangements are in violation of the Self-Referral Prohibitions. There can be
no assurance, however, that governmental officials charged with responsibility
for enforcing the provisions of the Self-Referral Prohibitions will not assert
that one or more of the Company's arrangements is in violation of such
provisions.

The Budget Act also provides a number of new antifraud and abuse provisions.
The Budget Act contains new civil monetary penalties for violations of the
Antikickback Amendments and imposes an affirmative duty on providers to insure
that they do not employ or contract with persons excluded from the Medicare
program. The Budget Act also provides a minimum ten year period for exclusion
from participation in Federal healthcare programs for persons convicted of a
prior healthcare offense.

Some states require state approval for development and expansion of healthcare
facilities and services, including findings of need for additional or expanded
healthcare facilities or services. Certificates of Need ("CON"), which are
issued by governmental agencies with jurisdiction over healthcare facilities,
are at times required for expansion of existing facilities, construction of new
facilities, addition of beds, acquisition of major items of equipment or
introduction of new services. The Company operates hospitals in 14 states that
require state approval for the expansion of its facilities and services under
CON programs. There can be no assurance that the Company will be able to obtain
a CON for any or all future projects. If the Company is unable to obtain the
requisite CON, its growth and business could be adversely affected.

The Company is unable to predict the future course of Federal, state and local
regulation or legislation, including Medicare and Medicaid statutes and
regulations. Changes in the regulatory framework could have a material adverse
effect on the Company's financial condition and results of operations.

HEALTHCARE REFORM LEGISLATION

Healthcare is one of the largest industries in the United States and continues
to attract much legislative interest and public attention. The Budget Act,
enacted in August 1997, contains extensive changes to the Medicare and Medicaid
programs intended to reduce payments under those programs by $115 billion and
$13 billion, respectively, over the next five years. Under the Budget Act,
annual growth rates for Medicare were reduced from over 10% to approximately
7.5% for the next five years based on specific program baseline projections

from the last five years. Virtually all spending reductions will come from
providers and changes in program components. The Budget Act affects
reimbursement systems for each of the Company's operating units.

The Budget Act will reduce payments to many of the Company's facilities,
including, but not limited to, payments made to the Company's hospitals, by
reducing incentive payments pursuant to the Tax Equity and Fiscal
Responsibility Act of 1982 ("TEFRA"), reducing allowable costs for capital
expenditures and bad debts and reducing payments for services to patients
transferred from a prospective payment system hospital. The Budget Act also
requires the establishment of a prospective payment system for nursing centers
for cost reporting periods beginning on or after July 1, 1998. During the first
three years, the per diem rates for nursing centers will be based on a blend of
facility-specific costs and Federal costs. Thereafter, the per diem rates will
be based solely on Federal costs. The rates for such services have not been
established or published. The prospective payment system also will cover
ancillary services provided to nursing center patients under the Company's
Vencare contract services business. The Budget Act also requires the
establishment of an interim prospective payment system for home health services
for cost reporting periods beginning on or after October 1, 1997. The interim
system will establish per visit limits and per beneficiary annual limits. A
permanent prospective payment system for home health services will be
established by October 1, 1999.

The Company believes that the Budget Act may adversely impact its hospital
business but cannot yet determine whether the impact on nursing center, Vencare
and home health operations will be positive or negative. The Company is
actively developing strategies and operational modifications to address these
changes in the Federal reimbursement system.

In March 1997, the Health Care Financing Administration ("HCFA") issued a
proposed rule to change Medicare reimbursement guidelines for therapy services
provided by the Company (including the rehabilitation contract therapy business
acquired as part of the TheraTx Merger). Under the proposed rule, HCFA would
revise the current salary equivalency guidelines for speech and occupational
therapy services. The proposed guidelines are based on a blend of data from
wage rates for hospitals and nursing facilities, and include salary, fringe
benefit and expense factors. Rates are defined by specific geographic market
areas, based upon a modified version of the hospital wage index. HCFA is
considering comments but has not issued a final rule at this time. The Company
cannot predict when the final regulation will be issued or if changes will be
made to the proposed guidelines.

There also continue to be state legislative proposals that would impose more
limitations on government and private payments to providers of healthcare
services such as the Company. Many states have enacted or are considering
enacting measures that are designed to reduce their Medicaid expenditures and
to make certain changes to private healthcare insurance. Some states also are
considering regulatory changes that include a moratorium on the designation of
additional long-term care hospitals and changes in the Medicaid reimbursement
system for long-term care hospitals. There are also a number of legislative
proposals including cost caps and the establishment of Medicaid prospective
payment systems for nursing centers. Moreover, by repealing the Boren
Amendment, the Budget Act eases the restrictions on the states' ability to
reduce their Medicaid reimbursement levels.

There can be no assurance that the Budget Act, proposed salary equivalency
rates, future healthcare legislation or other changes in the administration or
interpretation of governmental healthcare programs will not have a material
adverse effect on the Company's financial condition, results of operations and
liquidity.

CERTAIN LEGAL ACTIONS

On June 6, 1997, THY announced that it had been advised that it is a target of
a Federal grand jury investigation being conducted by the United States
Attorney's Office for the District of Massachusetts arising from activities of
THY's formerly owned dialysis business. The investigation involves an alleged
illegal arrangement in the form of a partnership which existed from June 1987
to June 1992 between Damon Corporation and THY. THY spun off its dialysis
business, now called Vivra Incorporated, on September 1, 1989. THY is
cooperating fully in the investigation.

7, 1997. The United States Department of Justice intervened in the suit which
was brought under the Federal Civil False Claims Act. AXR provides portable X-
ray services to nursing facilities (including those operated by the Company)
and other healthcare providers. The Company acquired an interest in AXR when
Hillhaven was merged into the Company in September 1995 and purchased the
remaining interest in AXR in February 1996. The suit alleges that AXR submitted
false claims to the Medicare and Medicaid programs. In conjunction with the qui
tam action, the United States Attorney's office for the Eastern District of
Arkansas also is conducting a criminal investigation into the allegations
contained in the qui tam complaint. The Company is cooperating fully in the
investigation.

On June 19, 1997, a class action lawsuit was filed in the United States
District Court for the District of Nevada on behalf of a class (the "Class")
consisting of all persons who sold shares of THY during the period from
February 26, 1997 through May 4, 1997, inclusive. The complaint alleges that
THY purchased shares of its common stock from members of the investing public
after it had received a written offer to acquire all of THY's common stock and
without making the required disclosure that such an offer had been made. The
complaint further alleges that defendants disclosed that there were
"expressions of interest" in acquiring THY when, in fact, at that time, the
negotiations had reached an advanced stage with actual firm offers at
substantial premiums to the trading price of THY's stock having been made which
were actively being considered by THY's Board of Directors. The complaint
asserts claims pursuant to Sections 10(b) and 20(a) of the Exchange Act and
common law principles of negligent misrepresentation and names as defendants
THY as well as certain senior executives and directors of THY. The Company is
vigorously defending this action.

POSSIBLE INABILITY TO IMPLEMENT GROWTH STRATEGY

There can be no assurance that the Company will be able to continue its growth
or be able to successfully implement its strategy to develop long-term
healthcare networks, including through acquisitions. There can be no assurance
that suitable acquisitions, for which other healthcare companies (including
those with greater financial resources than the Company) may be competing, can
be accomplished on terms favorable to the Company or that financing, if
necessary, can be obtained for such acquisitions. The Company may not be able
to effectively and profitably integrate the operations of THY or future
acquisitions or otherwise achieve the intended benefits of such acquisitions.
In addition, unforeseen expenses, difficulties, complications or delays may be
encountered in connection with the expansion of operations, which could inhibit
the Company's growth.

HIGHLY COMPETITIVE INDUSTRY

The healthcare services industry is highly competitive. The Company faces
competition from general acute care hospitals and general long-term care
hospitals which provide services comparable to those offered by the Company's
hospitals. Many general acute care hospitals are larger and more established
than the Company's hospitals. Certain hospitals that compete with the Company's
hospitals are operated by not-for-profit, nontaxpaying or governmental
agencies, which can finance capital expenditures on a tax-exempt basis, and
which receive funds and charitable contributions unavailable to the Company's
hospitals. Management believes that the Company may experience increased
competition from existing hospitals as well as hospitals converted to
specialized care facilities. The Company's nursing centers compete on a local
and regional basis with other nursing centers, and competition also exists for
the Vencare health services program. Management also expects that the Company
will continue to compete with other healthcare companies for hospital and other
healthcare acquisitions.

POSSIBLE INABILITY TO REPURCHASE NOTES UPON A CHANGE OF CONTROL

Upon a Change of Control, each Holder of Notes will have the right to require
the Company to repurchase any or all of the outstanding Notes owned by such
Holder at a price equal to 101% of the principal amount thereof, together with
accrued and unpaid interest. However, the Company's ability to repurchase the
Notes upon a Change of Control may be limited by the terms of then existing
contractual obligations of the Company and its subsidiaries. The Indenture does
not prohibit the Company in the future from incurring indebtedness (including
Senior Debt) otherwise permitted by the Indenture that contains Change of
Control provisions. Furthermore, the Credit Agreement provides that a Change of
Control will constitute a default thereunder, which would permit

the lenders to cause the indebtedness under the Credit Agreement to become
immediately due and payable or to institute a payment blockage with respect to
the Notes. In order to repurchase Notes upon a Change of Control, the Company
would have to repay all of its obligations under the Credit Agreement (and any
other agreements relating to Senior Debt that contains similar Change of
Control provisions) or would have to obtain the consent of the holders of such
indebtedness. There can be no assurance that the Company will have adequate
financial resources to repurchase the Notes in the event of a Change of
Control, particularly if such Change of Control requires the Company to
refinance, or results in the acceleration of, other indebtedness. If the
Company fails to repurchase all of the Notes tendered for purchase upon the
occurrence of a Change of Control, such failure will constitute an Event of
Default (as defined) under the Indenture. See "--Leverage and Ability to Meet
Debt Service Requirements."

The Change of Control provision may not necessarily afford the Holders
protection in the event of a highly leveraged transaction, including a
reorganization, restructuring, merger or other similar transaction involving
the Company that may adversely affect the Holders, because such transactions
may not involve a shift in voting power, beneficial ownership or management
control or, even if they do, may not involve a shift of the magnitude required
under the definition of Change of Control to trigger such provisions. Except as
described under "Description of the New Notes--Repurchase at the Option of the
Holders Upon a Change of Control," the Indenture does not contain provisions
that permit Holders of Notes to require the Company to repurchase or redeem the
Notes in the event of a takeover, recapitalization or similar transaction.

LACK OF PUBLIC MARKET FOR THE NEW NOTES

The New Notes are a new issue of securities and the Company does not intend to
apply for listing of the New Notes on any securities exchange or for quotation
through the National Association of Securities Dealers Automated Quotation
System. If any of the New Notes are traded after their initial issuance, they
may trade at a discount from the initial offering price of the Old Notes,
depending upon prevailing interest rates, the market for similar securities and
other factors, including general economic conditions, and the financial
condition of, performance of and prospects for the Company.

Although the Initial Purchasers have advised the Company that they currently
intend to make a market in the New Notes, they are not obligated to do so and
may discontinue such market making at any time without notice. There can be no
assurance that an active trading market for the New Notes will develop. See
"Description of the New Notes."

USE OF PROCEEDS

The Company will not receive any cash proceeds from the issuance of the New
Notes. In consideration for issuing the New Notes as described in this
Prospectus, the Company will receive Old Notes in like principal amount. The
Old Notes surrendered in exchange for the New Notes will be retired and
cancelled. Accordingly, the issuance of the New Notes will not result in any
change in the indebtedness of the Company.

The net proceeds from the Offering were approximately $731.8 million. All of
the net proceeds from the Offering were used to reduce amounts outstanding
under the Credit Agreement. The amount of outstanding indebtedness under the
Credit Agreement, at a weighted average interest rate of 6.6%, was
approximately $1.79 billion at June 30, 1997, after giving effect to the THY
Acquisition. The indebtedness under the Credit Agreement to which the net
proceeds from the Offering were applied was incurred primarily to fund the THY
Acquisition. Approximately $100 million of such indebtedness was owed to Morgan
Guaranty Trust Company of New York ("Morgan Guaranty"), and approximately $100
million to NationsBank, N.A. ("NationsBank"), the agent banks under the Credit
Agreement. Morgan Guaranty, a wholly-owned subsidiary of J.P. Morgan & Co.
Incorporated, is an affiliate of J.P. Morgan Securities Inc., the lead manager
of the Offering. NationsBanc Capital Markets, Inc., a subsidiary of
NationsBank, was a co-manager of the Offering.

CAPITALIZATION

The following table sets forth the capitalization of the Company at June 30,
1997 on both an actual basis and an as adjusted basis, giving effect to the
Offering, the application of the net proceeds thereof as described in "Use of
Proceeds" and the repurchase of certain THY debt. The following table should be
read in conjunction with the Consolidated Financial Statements, including the
notes thereto, "Selected Historical Financial Data" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included elsewhere in this Prospectus.

-------------------

AS OF JUNE 30, 1997
AS
ACTUAL ADJUSTED
---------- ----------
Dollars in thousands

SHORT-TERM DEBT:
Current maturities of long-term debt.................. $ 24,747 $ 24,747
========== ==========
LONG-TERM DEBT:
Senior collateralized debt payable in periodic in-
stallments through 2019.............................. $ 123,653 $ 123,653
Non-interest bearing residential mortgage bonds, pay-
able in periodic
installments through 2040............................ 33,509 33,509
Credit Agreement (1).................................. 1,765,050 1,024,438
8 5/8% Senior Subordinated Notes due 2007............. -- 750,000
8% Convertible Subordinated Notes due 2002............ 211 211
5 3/4% Convertible Subordinated Debentures due 2012... 6,201 --
Other................................................. 6,395 6,395
---------- ----------
Total long-term debt................................. 1,935,019 1,938,206
---------- ----------
STOCKHOLDERS' EQUITY:
Common stock.......................................... 18,215 18,215
Capital in excess of par value........................ 724,294 724,294
Retained earnings..................................... 218,013 218,013
Common treasury stock................................. (82,935) (82,935)
---------- ----------
Stockholders' equity................................. 877,587 877,587
---------- ----------
Total capitalization............................... $2,812,606 $2,815,793
========== ==========

- -------
(1) On June 24, 1997, the Company increased the total amount of the Credit
Agreement to $2.0 billion from $1.75 billion.

UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS

The following unaudited pro forma condensed combined statements of operations
of the Company for the six months ended June 30, 1997, and the year ended
December 31, 1996, give effect to the Acquisitions, the related increase in
borrowings under the Credit Agreement, the Offering, the application of the net
proceeds thereof as described in "Use of Proceeds" and the repurchase of
certain TheraTx and THY debt as if such events had occurred on January 1, 1996.
The summary pro forma condensed combined balance sheet at June 30, 1997 gives
effect to these events as if each had occurred as of such date. The unaudited
pro forma condensed combined financial information should be read in
conjunction with the accompanying notes and with the historical consolidated
financial statements of the Company, TheraTx and THY, including the notes
thereto and the information set forth in "Summary Historical and Pro Forma
Financial Data," "Selected Historical Financial Data," and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included elsewhere herein.

The Acquisitions will be accounted for using the purchase method of accounting.
Under purchase accounting, the total purchase price and fair value of
liabilities assumed will be allocated to the tangible and intangible assets and
liabilities based on their respective fair values as of the closing of such
Acquisitions. The unaudited pro forma condensed combined balance sheet reflects
preliminary estimates, which are subject to final determinations of the
allocation of the purchase price. The pro forma adjustments represent
management's preliminary determination of purchase accounting adjustments and
are based upon available information and certain assumptions that the Company
considers reasonable under the circumstances. Consequently, the amounts
reflected in the unaudited pro forma condensed combined balance sheet are
subject to change. Management does not expect that differences between the
preliminary and final purchase price allocation will have a material impact on
the Company's financial position and results of operations. In addition, the
pro forma condensed combined financial statements do not reflect any cost
savings and other financial synergies which may be realized in the future as a
result of the Acquisitions.

The unaudited pro forma condensed combined financial statements do not purport
to be indicative of the results that would have been obtained had the above-
described transactions been completed on the indicated dates or that may be
obtained in the future.

VENCOR, INC., THERATX, INCORPORATED AND TRANSITIONAL HOSPITALS CORPORATION
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 1997

---------------------------------------------------------

THERATX MERGER THY ACQUISITION
---------------------- ----------------------
THERATX THY PRO FORMA
VENCOR THERATX PRO FORMA THY PRO FORMA COMBINED
In thousands, HISTORICAL HISTORICAL ADJUSTMENTS HISTORICAL ADJUSTMENTS OFFERING VENCOR
except per share amounts ---------- ---------- ----------- ---------- ----------- -------- ----------

Revenues................ $1,458,991 $ 94,028 $ -- $159,444 $ (5,202)(d) $ -- $1,707,261
---------- -------- -------- -------- -------- -------- ----------
Operating expenses...... 1,259,192 80,541 -- 141,535 (4,773)(d) -- 1,476,495
Depreciation and amorti-
zation................. 53,851 2,645 1,162 (a) 6,969 4,026 (a) -- 68,409
(244)(d)
Interest expense........ 31,334 3,108 4,461 (b) 606 23,271 (b) 7,912 (b) 70,073
(600)(b) (19)(d)
Investment income....... (3,313) -- -- (2,971) 137 (d) -- (6,147)
---------- -------- -------- -------- -------- -------- ----------
1,341,064 86,294 5,023 146,139 22,398 7,912 1,608,830
---------- -------- -------- -------- -------- -------- ----------
Income from operations
before income taxes.... 117,927 7,734 (5,023) 13,305 (27,600) (7,912) 98,431
Provision for income
taxes.................. 46,935 2,862 (1,915)(c) 5,189 (10,746)(c) (3,149)(c) 39,176
---------- -------- -------- -------- -------- -------- ----------
Income from operations.. $ 70,992 $ 4,872 $ (3,108) $ 8,116 $(16,854) $ (4,763) $ 59,255
========== ======== ======== ======== ======== ======== ==========
Fully diluted earnings
per common and common
equivalent share from
operations............. $ 1.00 $ 0.83
Shares used in computing
fully diluted earnings
per common and common
equivalent share....... 71,037 71,037
Ratio of earnings to
fixed charges.......... 3.3x 2.0x

See accompanying notes to the unaudited pro forma
condensed combined financial statements.

VENCOR, INC., THERATX, INCORPORATED AND TRANSITIONAL HOSPITALS CORPORATION
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1996

---------------------------------------------------------

THERATX MERGER THY ACQUISITION
----------------------- -----------------------
THERATX THY PRO FORMA
VENCOR THERATX PRO FORMA THY PRO FORMA COMBINED
In thousands, HISTORICAL HISTORICAL ADJUSTMENTS HISTORICAL ADJUSTMENTS OFFERING VENCOR
except per share amounts ---------- ---------- ----------- ---------- ----------- -------- ----------

Revenues................ $2,577,783 $391,155 $ (915)(e) $507,194 $ -- $ -- $3,475,217
---------- -------- -------- -------- -------- -------- ----------
Operating expenses...... 2,236,151 331,038 (915)(e) 455,816 -- -- 3,022,090
Depreciation and amorti-
zation................. 99,533 11,324 5,396 (a) 22,364 8,332 (a) -- 146,949
Interest expense........ 45,922 13,024 21,954 (b) 3,889 48,164 (b) 15,824 (b) 147,577
(1,200)(b)
Investment income....... (12,203) (312) -- -- -- -- (12,515)
Non-recurring transac-
tions.................. 125,200 -- -- 33,524 -- -- 158,724
---------- -------- -------- -------- -------- -------- ----------
2,494,603 355,074 25,235 515,593 56,496 15,824 3,462,825
---------- -------- -------- -------- -------- -------- ----------
Income (loss) from oper-
ations before income
taxes.................. 83,180 36,081 (26,150) (8,399) (56,496) (15,824) 12,392
Provisions for income
taxes.................. 35,175 13,364 (8,136)(c) (3,047) (23,141)(c) (6,298)(c) 7,917
---------- -------- -------- -------- -------- -------- ----------
Income (loss) from oper-
ations................. $ 48,005 $ 22,717 $(18,014) $ (5,352) $(33,355) $ (9,526) $ 4,475
========== ======== ======== ======== ======== ======== ==========
Fully diluted earnings
per common and common
equivalent share from
operations............. $ 0.68 $ 0.06
Shares used in computing
fully diluted earnings
per common and common
equivalent share....... 70,702 64 (f) 70,766
Ratio of earnings to
fixed charges.......... 2.1x 1.0x

See accompanying notes to the unaudited pro forma condensed combined financial
statements.

VENCOR, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET
JUNE 30, 1997

-----------------------------------
PRO FORMA
VENCOR COMBINED
HISTORICAL OFFERING VENCOR
Dollars in thousands ---------- -------- ----------

ASSETS
Current assets:
Cash and cash equivalents................ $ 106,476 $(16,000)(g) $ 90,476
Accounts and notes receivable............ 639,889 -- 639,889
Inventories.............................. 36,525 -- 36,525
Income taxes............................. 103,556 -- 103,556
Other.................................... 52,200 -- 52,200
---------- -------- ----------
938,646 (16,000) 922,646
Property and equipment, net of
accumulated depreciation................. 1,587,946 -- 1,587,946
Intangible assets......................... 699,671 16,000 (g) 718,858
3,187 (h)
Investments in affiliates................. 85,974 -- 85,974
Other..................................... 97,820 -- 97,820
---------- -------- ----------
$3,410,057 $ 3,187 $3,413,244
========== ======== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable......................... $ 146,427 $ -- $ 146,427
Salaries, wages and other compensation... 153,304 -- 153,304
Other accrued liabilities................ 132,631 -- 132,631
Long-term debt due within one year....... 24,747 -- 24,747
---------- -------- ----------
457,109 -- 457,109
Long-term debt............................ 1,935,019 750,000 (h) 1,938,206
(746,813)(h)
Deferred credits and other liabilities.... 97,503 -- 97,503
Minority interests in equity of consoli-
dated entities........................... 42,839 -- 42,839
Stockholders' equity: --
Common stock............................. 18,215 -- 18,215
Capital in excess of par value........... 724,294 -- 724,294
Retained earnings........................ 218,013 -- 218,013
---------- -------- ----------
960,522 -- 960,522
Common treasury stock.................... (82,935) -- (82,935)
---------- -------- ----------
877,587 -- 877,587
---------- -------- ----------
$3,410,057 $ 3,187 $3,413,244
========== ======== ==========

See accompanying notes to the unaudited pro forma condensed combined financial
statements.

VENCOR, INC., THERATX, INCORPORATED AND TRANSITIONAL HOSPITALS CORPORATION
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS

NOTE 1--BASIS OF PRESENTATION

The purchase method of accounting has been used in the preparation of the
unaudited pro forma condensed combined financial statements. Under this method
of accounting, the aggregate purchase price is allocated to assets acquired and
liabilities assumed based on their estimated fair values. Accordingly, the
excess of the purchase price over the fair value of net assets acquired has
been reflected as goodwill. The purchase price and estimated fair values of
assets and liabilities are preliminary and subject to change.

For purposes of the unaudited pro forma condensed combined financial
statements, the excess of the purchase price for the Acquisitions over fair
value of the net assets acquired is being amortized over 40 years using the
straight-line method.

Pro forma income from operations before income taxes for the six months ended
June 30, 1997 excludes $3.7 million of non-recurring transaction costs incurred
by TheraTx in connection with the TheraTx Merger. Pro forma income from
operations before income taxes for the six months ended June 30, 1997 excludes
$6.6 million of non-recurring transaction costs incurred by THY and a $19.4
million break-up fee paid by THY in connection with the THY Acquisition in June
1997.

For the periods presented, unaudited pro forma financial data have been derived
by combining the historical financial data of Vencor and TheraTx (based upon
annual reporting periods ended December 31 and the six months ended June 30)
and THY (based upon annual reporting periods ended November 30 and the six
months ended May 31).

NOTE 2--PRO FORMA ADJUSTMENTS

The adjustments included in the unaudited pro forma condensed combined
financial statements follow (dollars in thousands):

(a) To adjust amortization expense:

-------------------

SIX YEAR
MONTHS ENDED ENDED
JUNE 30, DECEMBER 31,
1997 1996
------------ ------------

THERATX MERGER:
Record amortization related to the excess of
the purchase price for TheraTx over net as-
sets acquired................................ $2,075 $ 8,300
Eliminate TheraTx historical amortization of
the excess of purchase price over net assets
acquired..................................... (738) (2,904)
Actual amortization recorded for the period
March 21 through March 31.................... (175) --
------ -------
$1,162 $ 5,396
====== =======
THY ACQUISITION:
Record amortization related to the excess of
the purchase price for THY over net assets
acquired..................................... $4,166 $ 8,332
Actual amortization recorded for the period
June 24 through June 30...................... (140) --
------ -------
$4,026 $ 8,332
====== =======

VENCOR, INC., THERATX, INCORPORATED AND TRANSITIONAL HOSPITALS CORPORATION
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
(CONTINUED)

NOTE 2--PRO FORMA ADJUSTMENTS (CONTINUED)

(b) To record additional interest expense related to the borrowings and
refinancings for the Acquisitions and the Offering:

--------------------

SIX YEAR
MONTHS ENDED ENDED
JUNE 30, DECEMBER 31,
1997 1996
------------ ------------

THERATX MERGER:
Interest expense related to acquisition debt.................. $ 5,632 $ 22,528
Eliminate interest expense related to TheraTx bank credit
facility..................................................... (1,497) (4,510)
Interest expense on Credit Agreement replacing TheraTx bank
credit facility.............................................. 1,352 3,936
Actual interest recorded for the period March 18 through March
31........................................................... (1,026) --
-------- --------
$ 4,461 $ 21,954
======== ========
Interest expense on refinanced convertible notes.............. $ 3,400 $ 6,800
Eliminate interest expense on convertible notes............... (4,000) (8,000)
-------- --------
$ (600) $ (1,200)
======== ========
THY ACQUISITION:
Interest expense related to acquisition debt.................. $ 21,816 $ 43,732
Interest expense on $2.0 billion Credit Agreement............. 35,012 65,066
Eliminate interest expense on $1.75 billion Credit Agreement.. (32,790) (60,634)
Actual interest recorded for the period June 24 through
June 30...................................................... (767) --
-------- --------
$ 23,271 $ 48,164
======== ========
OFFERING:
Interest expense on the Old Notes (at the stated interest rate
of 8 5/8%)................................................... $ 32,344 $ 64,688
Amortization of deferred financing costs...................... 800 1,600
Amortization of original issue discount....................... 160 319
Eliminate interest expense on $747 million borrowed under the
Credit Agreement............................................. (25,392) (50,783)
-------- --------
$ 7,912 $ 15,824
======== ========

(c) To adjust the provision for income taxes for the increase in the effective
tax rate of the Company as a result of the Acquisitions and to record the
tax provision on the pro forma adjustments.

(d) To eliminate historical THY operations consolidated with the Company for
the period of June 24 through June 30.

(e) To eliminate transactions between the Company and TheraTx.

(f) To adjust common equivalent shares to reflect the conversion of TheraTx
stock options into stock options of the Company.

(g) To record cash paid for the Initial Purchasers' discount and estimated
expenses related to the Offering.

(h) To record the proceeds and original issue discount from the Offering and
the application thereof as described under "Use of Proceeds."

VENCOR, INC., THERATX, INCORPORATED AND TRANSITIONAL HOSPITALS CORPORATION
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
(CONTINUED)

NOTE 3--THY PSYCHIATRIC BUSINESS

During 1996, THY disposed of its psychiatric business, the historical operating
results of which are included in these unaudited pro forma condensed combined
financial statements. Revenues of the disposed psychiatric business aggregated
$239.3 million in 1996. See Note 12 to the THY Consolidated Financial
Statements.

NOTE 4--ATRIA SECONDARY COMMON STOCK OFFERING

In July 1997, Atria completed the Atria Offering. The Company now owns 42.8% of
the outstanding common stock of Atria. Accordingly, the operations of Atria,
which were consolidated with those of the Company prior to the Atria Offering,
have been accounted for under the equity method since July 1, 1997.

SELECTED HISTORICAL FINANCIAL DATA

The following table sets forth selected historical financial information for
the Company for each of the years in the five-year period ended December 31,
1996 and for the six months ended June 30, 1997 and 1996. The selected
historical financial data as of and for the two years ended December 31, 1993
were derived from the audited consolidated financial statements of the Company.
The selected historical financial data as of and for each of the three years
ended December 31, 1996 were derived from the audited consolidated financial
statements of the Company included elsewhere in this Prospectus. The selected
historical financial data for the six month periods have been derived from
unaudited condensed consolidated financial statements of the Company and
reflect all adjustments (consisting of normal recurring adjustments) that, in
the opinion of the management of the Company, are necessary for a fair
presentation of such information. Operating results for the six months ended
June 30, 1997 are not necessarily indicative of the results that may be
expected for 1997.

All information included in the following table should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and with the consolidated financial statements and related notes
of the Company included herein. Certain amounts derived from the consolidated
statements of operations have been reclassified to conform with the
presentation below.

-------------------------------------------------------------------------------------------
SIX MONTHS
ENDED JUNE 30, YEAR ENDED DECEMBER 31,
Dollars in thousands, 1997 1996 1996 1995 1994 1993 1992
except per share amounts ---------- ---------- ---------- ---------- ---------- ---------- ----------

STATEMENT OF OPERATIONS DATA:
Revenues............................ $1,458,991 $1,260,891 $2,577,783 $2,323,956(b) $2,032,827 $1,727,436 $1,575,225
---------- ---------- ---------- ---------- ---------- ---------- ----------
Operating expenses.................. 1,259,192 1,098,427 2,236,151 2,045,217 1,775,226 1,515,973 1,425,203
Depreciation and amortization....... 53,851 49,639 99,533 89,478 79,519 69,126 56,408
Interest expense.................... 31,334 24,621 45,922 60,918 62,828 73,559 62,532
Investment income................... (3,313) (6,878) (12,203) (13,444) (13,126) (16,056) (12,820)
Non-recurring transactions.......... -- -- 125,200(a) 109,423(b) (4,540)(c) 5,769(d) 113,265(e)
---------- ---------- ---------- ---------- ---------- ---------- ----------
1,341,064 1,165,809 2,494,603 2,291,592 1,899,907 1,648,371 1,644,588
---------- ---------- ---------- ---------- ---------- ---------- ----------
Income (loss) from operations
before income taxes................ 117,927 95,082 83,180 32,364 132,920 79,065 (69,363)
Provision for income taxes.......... 46,935 36,607 35,175 24,001 46,781 10,089 12,051
---------- ---------- ---------- ---------- ---------- ---------- ----------
Income (loss) from operations....... 70,992 58,475 48,005 8,363 86,139 68,976 (81,414)
Reinstatement of discontinued
operations......................... -- -- -- -- -- -- 24,743
Extraordinary gain (loss) on
extinguishment of debt, net of
income taxes....................... (3,849) -- -- (23,252) (241) (2,217) 380
Cumulative effect on prior years
of a change in accounting for
income taxes....................... -- -- -- -- -- (1,103) --
---------- ---------- ---------- ---------- ---------- ---------- ----------
Net income (loss)................. $ 67,143 $ 58,475 $ 48,005 $ (14,889) $ 85,898 $ 65,656 $ (56,291)
========== ========== ========== ========== ========== ========== ==========
Fully diluted earnings (loss) per
common and common equivalent share:
Income (loss) from operations...... $ 1.00 $ 0.82 $ 0.68 $ 0.29 $ 1.28 $ 1.22 $ (1.57)
Reinstatement of discontinued
operations........................ -- -- -- -- -- -- 0.47
Extraordinary gain (loss) on
extinguishment of debt............ (0.05) -- -- (0.32) -- (0.04) 0.01
Cumulative effect on prior years of
a change in accounting for income
taxes............................. -- -- -- -- -- (0.02) --
---------- ---------- ---------- ---------- ---------- ---------- ----------
Net income (loss)................. $ 0.95 $ 0.82 $ 0.68 $ (0.03) $ 1.28 $ 1.16 $ (1.09)
========== ========== ========== ========== ========== ========== ==========
BALANCE SHEET DATA:
Working capital..................... $ 481,537 $ 235,154 $ 320,123 $ 239,666 $ 129,079 $ 114,339 $ 114,695
Total assets........................ 3,410,057 1,918,115 1,968,856 1,912,454 1,656,205 1,563,350 1,515,812
Long-term debt...................... 1,935,019 699,868 710,507 778,100 746,212 784,801 988,998
Stockholders' equity................ 877,587 837,656 797,091 772,064 596,454 485,550 283,791
OTHER FINANCIAL DATA:
EBITDA (f).......................... $ 199,799 $ 162,464 $ 341,632 $ 278,739 $ 257,601 $ 211,463 $ 150,022
EBITDA margin....................... 13.7% 12.9% 13.3% 12.0% 12.7% 12.2% 9.5%
Ratio of EBITDA to interest expense. 6.4x 6.6x 7.4x 4.6x 4.1x 2.9x 2.4x
Ratio of earnings to fixed
charges (g)........................ 3.3x 3.5x 2.1x 1.4x 2.5x 1.8x 0.2x
Capital expenditures:
Existing facilities and
construction....................... $ 132,900 $ 61,454 $ 135,027 $ 136,893 $ 111,486 $ 74,111 $ 63,021
Acquisitions....................... 954,648 5,182 26,236 59,343 36,391 44,055 63,283

- -------
(a) Includes pretax charges incurred to complete the integration of Hillhaven,
which included costs associated with the planned disposition of 34 nursing
centers, the reorganization of the institutional pharmacy business and the
planned replacement of one hospital and the three nursing centers.
(b) Includes pretax charges aggregating $103.9 million incurred primarily in
connection with the consummation of the Hillhaven Merger, which included
costs associated with direct transaction costs, employee benefit and
severance costs, the planned disposition of certain nursing center
properties and changes in estimates in accrued revenues of $24.5 million
recorded in connection with certain prior-year nursing center third-party
reimbursement issues (recorded as a reduction of revenues). Non-recurring
transactions in 1995 also include $5.5 million recorded in connection with
the Nationwide Merger.
(c) Includes a gain resulting from the sales of assets and nursing center
restructuring activities.
(d) Includes a charge related to the restructuring of certain nursing centers
held for sale.
(e) Includes a charge related to the disposal of certain nursing center
properties.
(f) EBITDA represents operating income before depreciation, amortization, net
interest, income taxes and non-recurring transactions. While EBITDA should
not be construed as a substitute for operating income or a better indicator
of liquidity than cash flows from operating activities, which are
determined in accordance with generally accepted accounting principles, it
is included herein to provide additional information with respect to the
ability of the Company to meet its future debt service, capital expenditure
and working capital requirements. EBITDA is not necessarily a measure of
the Company's ability to fund its cash needs. See the Consolidated
Statements of Cash Flows of the Company and the related notes thereto
included elsewhere in this Prospectus. EBITDA is included herein because
management believes that certain investors find it to be a useful tool for
measuring the Company's ability to service debt.
(g) The ratio of earnings to fixed charges is calculated by dividing income
from operations before income taxes plus fixed charges (excluding
capitalized interest) by fixed charges (including capitalized interest).
Fixed charges consist of interest expense, including amortization of
financing costs, and that portion of rental expense deemed to be
representative of the interest component of rental expense less any
applicable sublease income.

MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The Selected Historical Financial Data and the consolidated financial
statements included in this Prospectus set forth certain data with respect to
the financial position, results of operations and cash flows of the Company
which should be read in conjunction with the following discussion and analysis.

BACKGROUND INFORMATION

The Company is one of the largest providers of long-term healthcare services in
the United States. At June 30, 1997, the Company's operations included 58 long-
term acute care hospitals containing 5,107 licensed beds, 311 nursing centers
containing 40,869 licensed beds, the Vencare contract services business and the
assisted and independent living communities of Atria, its affiliate. Healthcare
services provided through this network of facilities include long-term hospital
care, nursing care, contract respiratory therapy services, acute
cardiopulmonary care, subacute and post-operative care, occupational
healthcare, inpatient and outpatient rehabilitation therapy, specialized care
for Alzheimer's disease, hospice care, home healthcare, pharmacy services and
assisted and independent living. The Company also continues to develop
VenTouch(TM), a comprehensive paperless clinical information system designed to
increase the operating efficiencies of the Company's facilities.

On June 18, 1997, the Company entered into the THY Agreement to acquire all of
the THY Shares at $16.00 per THY Share. The THY Acquisition was structured as a
cash tender offer followed by a second-step merger pursuant to which a wholly-
owned subsidiary of the Company acquired the remaining THY Shares which had not
been tendered. The Company's wholly-owned subsidiary acquired 37.2 million THY
Shares (approximately 95% of the THY Shares) in the tender offer which expired
on June 19, 1997. On June 24, 1997, the Company completed the tender offer,
after which time the operations of THY were consolidated with those of the
Company. The Company completed the merger with THY on August 26, 1997. See Note
6 of the Notes to Condensed Consolidated Financial Statements.

Prior to entering into the THY Agreement, THY had entered into the Select
Merger Agreement. The Select Merger Agreement was terminated prior to the
execution of the THY Agreement. Pursuant to the terms of the Select Merger
Agreement, THY paid Select a $19.4 million break-up fee.

THY operates 16 long-term acute care hospitals and three satellite facilities
located in 13 states. THY also provides contract respiratory therapy services
to nursing centers and hospital facilities owned by third parties. In addition,
THY owns a 44% voting equity interest (61% ownership interest) in BHC, an
operator of psychiatric and behavioral clinics.

On March 21, 1997, the TheraTx Merger was completed. Accordingly, the
accompanying condensed consolidated financial statements and financial and
operating data included herein include the operations of TheraTx since the date
of acquisition. See Note 5 of the Notes to Condensed Consolidated Financial
Statements.

The Hillhaven Merger was consummated on September 28, 1995. At the time of the
Hillhaven Merger, Hillhaven operated 311 nursing centers, 56 retail and
institutional pharmacies and 23 assisted and independent living communities
with 3,122 units. Annualized revenues approximated $1.7 billion. See Note 2 of
the Notes to Consolidated Financial Statements for a description of the
Hillhaven Merger.

Prior to its merger with the Company, Hillhaven completed the Nationwide Merger
on June 30, 1995. At the time of the Nationwide Merger, Nationwide operated 23
nursing centers containing 3,257 licensed beds and four assisted and
independent living communities with 442 units. Annualized revenues approximated
$125 million. See Note 3 of the Notes to Consolidated Financial Statements for
a description of the Nationwide Merger.

As discussed in the Notes to Consolidated Financial Statements, the Hillhaven
Merger and Nationwide Merger have been accounted for by the pooling-in-
interests method. Accordingly, the accompanying consolidated

financial statements and financial and operating data included herein give
retroactive effect to these transactions and include the combined operations of
the Company, Hillhaven and Nationwide for all periods presented.

In the third quarter of 1996, the Company completed the initial public offering
of 5.8 million shares of common stock of Atria (the "IPO"). At June 30, 1997,
the Company owned 10.0 million shares, or 60.7% of Atria's outstanding common
stock. For accounting purposes, the accounts of Atria have been consolidated
with those of the Company, and the Company has recorded minority interests in
the earnings and equity of Atria since consummation of the IPO. See Note 4 of
the Notes to Consolidated Financial Statements for a description of the IPO.

RESULTS OF OPERATIONS

A summary of revenues follows (dollars in thousands):

SIX MONTHS ENDED
JUNE 30, YEAR ENDED DECEMBER 31,
------------------------------ --------------------------------------------------
1996 1995 1994
------------------ ------------------ ---------------
1997 1996 CHANGE AMOUNT CHANGE AMOUNT CHANGE AMOUNT
---------- ---------- ------ ---------- ------ ---------- ------ ----------

Hospitals............... $ 320,694 $ 268,659 19.4% $ 551,268 20.8% $ 456,486 26.4% $ 361,111
---------- ---------- ---------- ---------- ----------
Nursing centers......... 836,578 786,625 6.4 1,615,141 5.1 1,537,179 10.8 1,387,856
Non-recurring transac-
tions.................. -- -- -- (24,500) --
---------- ---------- ---------- ---------- ----------
836,578 786,625 6.4 1,615,141 6.8 1,512,679 9.0 1,387,856
---------- ---------- ---------- ---------- ----------
Vencare................. 301,062 199,562 50.9 399,068 26.2 316,254 29.4 244,476
Atria................... 31,199 25,448 22.6 51,846 8.1 47,976 20.7 39,758
---------- ---------- ---------- ---------- ----------
1,489,533 1,280,294 16.3 2,617,323 12.2 2,333,395 14.8 2,033,201
Elimination............. (30,542) (19,403) (39,540) (9,439) (374)
---------- ---------- ---------- ---------- ----------
$1,458,991 $1,260,891 15.7 $2,577,783 10.9 $2,323,956 14.3 $2,032,827
========== ========== ========== ========== ==========

---------------------------------------------------------

Six Months Ended June 30, 1997 and 1996
Hospital revenue increases in the first six months of 1997 resulted primarily
from an increase in patient days and improved patient mix. Hospital patient
days rose 10% to 323,180 from 294,328 in the same period last year. Non-
Medicaid patient days (for which payment rates are generally higher than
Medicaid) increased 13% to 278,305 in the first six months of 1997, while
Medicaid patient days declined 7% to 44,875.

During the fourth quarter of 1996, the Company entered into an agreement to
sell 34 under-performing or non-strategic nursing centers. At June 30, 1997, 27
of these centers had been sold; the remainder are expected to be sold upon
receipt of certain regulatory approvals. In connection with the TheraTx Merger,
the Company acquired 26 nursing centers on March 21, 1997. Excluding the effect
of these sales and acquisitions, nursing center revenues increased 4%, while
patient days declined 2%. The increase in same-store nursing center revenues
resulted primarily from price increases.

Excluding the effect of sales and acquisitions, nursing center revenue growth
was adversely impacted by a 6% decline in private patient days in the first six
months of 1997. In an effort to attract increased volumes of Medicare and
private pay patients, the Company is implementing a plan to expend
approximately $200 million over the next two years to improve existing
facilities and expand the range of services provided to accommodate higher
acuity patients.

Vencare revenues include approximately $75.5 million related to contract
rehabilitation therapy and certain other ancillary services businesses acquired
as part of the TheraTx Merger. Excluding the TheraTx Merger, Vencare revenues
grew 16% in the first six months of 1997 primarily as a result of growth in
volumes. Vencare ancillary service contracts in effect at June 30, 1997 totaled
4,524 compared to 4,295 at June 30, 1996. During 1997, the Company terminated
approximately 700 contracts which did not meet certain growth criteria. These
terminations did not materially impact Vencare operating results.

Pharmacy revenues (included in Vencare operations) declined 3% to $84.7 million
in the first six months of 1997 from $87.4 million in the same period last
year. The decline was primarily attributable to the effects of the
restructuring of the institutional pharmacy business initiated in the fourth
quarter of 1996 and the sale of the retail pharmacy outlets in January 1997.

During the first six months of 1997, the number of Atria communities in
operation expanded from 21 to 40, primarily as a result of a $30.7 million
acquisition of 12 communities. Same store revenues rose 7% in the six month
period primarily due to price increases and growth in ancillary services.

For the six month period in 1997, income from operations totaled $71.0 million
($1.00 per fully diluted share), up 21% from $58.5 million ($0.82 per fully
diluted share) for the same period in 1996. The increase was primarily
attributable to growth in hospital and Vencare operations and the continuing
effect of merger synergies achieved in 1996 in connection with the Hillhaven
Merger. The operating results of THY since the date of acquisition had no
material effect on second quarter 1997 net income.

During 1997, the Company recorded an after-tax charge of $3.8 million in
connection with the refinancing of the bank credit agreements of both the
Company and TheraTx and the repurchase of substantially all of the outstanding
TheraTx $100 million 8% Convertible Subordinated Notes due 2002 assumed in
connection with the TheraTx Merger.

Years Ended December 31, 1996, 1995 and 1994
Hospital revenues increased in both 1996 and 1995 from the acquisition of
facilities and growth in same-store patient days. Hospital patient days rose
20% to 586,144 in 1996 and 21% to 489,612 in 1995. Price increases in both
years were not significant.

Excluding the effect of non-recurring transactions, nursing center revenue
increases resulted primarily from growth in the volume of Medicare patients,
who typically require high levels of medical care. Medicare patient days grew
3% to 1,562,600 in 1996 and 11% to 1,511,300 in 1995. Nursing center revenue
growth was adversely impacted by a decline in private pay patient days to
2,812,700 in 1996 from 2,911,500 in 1995 and 3,052,000 in 1994.

Growth in Vencare revenues in both 1996 and 1995 was primarily attributable to
the expansion of the Vencare contract services business. The number of Vencare
contracts grew from 2,648 at the end of 1994 to 4,072 and 4,346 at December 31,
1995 and 1996, respectively.

Atria revenues increased in both years as a result of price increases, growth
in occupancy, expansion of ancillary services and, in 1995, the purchase of
controlling interests in two communities previously accounted for under the
equity method and the effect of two newly constructed facilities.

In the fourth quarter of 1996, the Company recorded pretax charges aggregating
$125.2 million ($79.9 million net of tax) primarily to complete the integration
of Hillhaven. In November 1996, the Company executed a definitive agreement to
sell 34 under-performing or non-strategic nursing centers in early 1997. A
charge of $65.3 million was recorded in connection with the planned disposition
of these nursing centers. In addition, the Company's previously independent
institutional pharmacy business, acquired as part of the Hillhaven Merger, was
integrated into Vencare, resulting in a charge of $39.6 million related
primarily to costs associated with employee severance and benefit costs
(approximately 500 employees), facility close-down expenses and the write-off
of certain deferred costs for services to be discontinued. A provision for loss
totaling $20.3 million related to the planned replacement of one hospital and
three nursing centers was also recorded in the fourth quarter.

In the third quarter of 1995, the Company recorded pretax charges aggregating
$128.4 million ($89.9 million net of tax) primarily in connection with the
consummation of the Hillhaven Merger. The charges included (i) $23.2 million of
investment advisory and professional fees, (ii) $53.8 million of employee
benefit plan and
severance costs (approximately 500 employees), (iii) $26.9 million of losses
associated with the planned disposition of certain nursing center properties
and (iv) $24.5 million of charges to reflect the Company's change

in estimates of accrued revenues recorded in connection with certain prior-year
nursing center third-party reimbursement issues. During 1996, activities
related to the elimination of duplicative corporate and operational functions
were substantially completed, and management expects that the dispositions of
certain nursing center properties will be concluded in 1997. Operating results
for 1995 also include pretax charges of $5.5 million ($3.7 million net of tax)
recorded in the second quarter related primarily to the Nationwide Merger.

Non-recurring transactions related primarily to sales of assets and nursing
center restructuring activities increased pretax income by $4.5 million ($2.7
million net of tax) in 1994.

Income from operations for 1996 totaled $48.0 million, compared to $8.3 million
and $86.1 million for 1995 and 1994, respectively. Excluding the effect of non-
recurring transactions, 1996 income from operations increased 25% to $127.9
million ($1.81 per share--fully diluted) and 22% to $101.9 million ($1.45 per
share-- fully diluted) in 1995. The growth in both periods resulted primarily
from increased hospital volumes and growth in higher margin ancillary services
in both Vencare and the nursing center business and, in 1996, realization of
substantial synergies resulting from the Hillhaven Merger. Management believes
that additional revenues resulting from patient cross-referrals within the
healthcare network created by the Hillhaven Merger aggregated approximately $80
million in 1996. In addition, cost reductions from elimination of duplicative
functions, increased cost efficiencies and refinancing of long-term debt
increased 1996 pretax income by approximately $20 million.

For more information concerning the provision for income taxes as well as
information regarding differences between effective income tax rates and
statutory rates, see Note 7 of the Notes to Consolidated Financial Statements.

LIQUIDITY

Cash provided by operations totaled $123.7 million and $117.0 million for the
six months ended June 30, 1997 and 1996, respectively, and $183.5 million,
$113.6 million and $133.0 million for each of the three years ended December
31, 1996, 1995 and 1994, respectively. Cash payments in 1996 and 1995 related
to non-recurring transactions reduced cash flows from operations by
approximately $22 million and $32 million, respectively.

Days of revenues in accounts receivable increased to 65 at June 30, 1997,
compared to 54, 50 and 45 at December 31, 1996, 1995 and 1994, respectively.
Recent growth in accounts receivable was primarily related to the restructuring
of the Company's pharmacy operations (which began in the fourth quarter of
1996) and growth in rehabilitation contracts acquired in the TheraTx Merger.
The collection cycle for rehabilitation therapy contracts typically requires in
excess of three months. In addition, growth in accounts receivable over the
past three years has also been attributable to integration of acquired hospital
facilities and delays in payments from certain state Medicaid programs and
managed care plans.

On June 24, 1997, the Company increased the total amount of the Credit
Agreement to $2.0 billion from $1.75 billion. The Company used approximately
$575 million of the available borrowings under the Credit Agreement to complete
the THY Acquisition. At June 30, 1997, available borrowings under the Credit
Agreement approximated $170 million. On July 21, 1997, the Company completed a
$750 million private placement of long-term debt. The net proceeds of the
Offering were used to reduce outstanding borrowings under the Credit Agreement.
At September 12, 1997, available borrowings under the Credit Agreement
approximated $900 million.

Since the completion of the IPO, Atria has maintained a $200 million bank
credit facility (the "Atria Credit Facility") to finance its expansion and
development program. At June 30, 1997, amounts available under the Atria Credit
Facility aggregated $110 million.

Working capital totaled $481.5 million at June 30, 1997, compared to $320.1
million and $239.7 million at December 31, 1996 and 1995, respectively.
Management believes that cash flows from operations and amounts available under
the Credit Agreement are sufficient to meet the Company's future expected
liquidity needs.

During 1997, the Company refinanced substantially all of the TheraTx $100
million 8% Convertible Subordinated Notes due 2002 through borrowings under the
Credit Agreement. The after tax loss associated with this transaction
approximated $1.6 million.

At June 30, 1997, the Company's ratio of debt to debt and equity totaled 69.1%.
Management intends to reduce the Company's future leverage through, among other
things, the use of anticipated excess cash flows from operations and the sale
of certain non-strategic assets acquired from TheraTx and THY. See "--Other
Information."

CAPITAL RESOURCES

Excluding acquisitions, capital expenditures totaled $132.9 million and $61.5
million for the six months ended June 30, 1997 and 1996, respectively, and
$135.0 million, $136.9 million and $111.5 million for each of the three years
ended December 31, 1996, 1995 and 1994, respectively. Planned capital
expenditures in 1997 (excluding acquisitions) are expected to approximate $200
million and include significant expenditures related to nursing center
improvements.

Management believes that its capital expenditure program is adequate to expand,
improve and equip existing facilities. At June 30, 1997, the estimated cost to
complete and equip construction in progress approximated $70 million.

The net purchase price of the TheraTx Merger was approximately $355 million and
was financed primarily through borrowings under the Credit Agreement. See Note
5 of the Notes to Condensed Consolidated Financial Statements for a discussion
of the TheraTx Merger.

The net purchase price of the THY Acquisition was approximately $575 million
and was financed primarily through borrowings under the Credit Agreement. See
"Use of Proceeds." See Note 6 of the Notes to Condensed Consolidated Financial
Statements for a discussion of the THY Acquisition.

Capital expenditures for the acquisition of new facilities (and related
healthcare businesses) and previously leased facilities totaled $25.0 million
for the six months ended June 30, 1997, and $26.2 million, $59.3 million and
$36.4 million for each of the three years ended December 31, 1996, 1995 and
1994, respectively. Management intends to acquire additional hospitals, nursing
centers and ancillary service businesses in the future.

Capital expenditures were financed primarily through internally generated funds
and, in 1997, from borrowings under the Credit Agreement and proceeds from the
IPO. In addition, capital expenditures were also financed through the
collection of notes receivable in 1996 aggregating $78.2 million and $66.5
million of proceeds in 1995 from the public offering of common stock. The
Company intends to finance a substantial portion of its capital expenditures
with internally generated funds and long-term debt. Sources of capital include
available borrowings under the Credit Agreement, public or private debt and
equity.

In August 1997, the Company acquired a 99 bed long-term care hospital located
in Burbank, California and a 90 bed long-term care hospital located in
Milwaukee, Wisconsin.

During 1996, the Company repurchased 1,950,000 shares of common stock at an
aggregate cost of $55.3 million.

As discussed in Note 9 of the Notes to Consolidated Financial Statements, the
Company called for redemption of all its outstanding convertible debt
securities in the fourth quarter of 1995, resulting in the issuance of
approximately 7,259,000 shares of common stock. Approximately $34.4 million of
the convertible securities were redeemed in exchange for cash equal to 104.2%
of face value plus accrued interest. These transactions had no material effect
on earnings per common and common equivalent share.

As discussed in Note 9 of the Notes to Consolidated Financial Statements, the
Company entered into certain interest rate swap agreements in the fourth
quarter of 1995 to eliminate the impact of changes in interest rates on $400
million of floating rate debt outstanding. The agreements expire in varying
amounts through April 1998 and provide for fixed rates at 5.7% plus 3/8% to 1
1/8%. In addition, the Company entered into interest rate swap agreements in
May 1997 on $300 million of floating rate debt. These agreements expire in $100
million increments in May 1999, November 1999 and May 2000, and provide for
fixed rates at 6.4% plus 3/8% to 1 1/8%.

HEALTHCARE LEGISLATION

The Budget Act, enacted in August 1997, contains extensive changes to the
Medicare and Medicaid programs intended to reduce payments under those programs
by $115 billion and $13 billion, respectively, over the next five years. Under
the Budget Act, annual growth rates for Medicare were reduced from over 10% to
approximately 7.5% for the next five years based on specific program baseline
projections from the last five years. Virtually all spending reductions will
come from providers and changes in program components. The Budget Act affects
reimbursement systems for each of the Company's operating units.

The Budget Act will reduce payments to many of the Company's facilities,
including, but not limited to, payments made to the Company's hospitals, by
reducing TEFRA incentive payments, reducing allowable costs for capital
expenditures and bad debts and reducing payments for services to patients
transferred from a prospective payment system hospital. The Budget Act also
requires the establishment of a prospective payment system for nursing centers
for cost reporting periods beginning on or after July 1, 1998. During the first
three years, the per diem rates for nursing centers will be based on a blend of
facility-specific costs and Federal costs. Thereafter, the per diem rates will
be based solely on Federal costs. The rates for such services have not been
established or published. The prospective payments system also will cover
ancillary services provided to nursing center patients under the Company's
Vencare contract services business. The Budget Act requires the establishment
of an interim prospective payment system for home health services for cost
reporting periods beginning on or after October 1, 1997. The interim system
will establish per visit limits and per beneficiary annual limits. A permanent
prospective payment system for home health services will be established by
October 1, 1999.

In March 1997, the HCFA issued a proposed rule to change Medicare reimbursement
guidelines for therapy services provided by the Company (including the
rehabilitation contract therapy business acquired as part of the TheraTx
Merger). Under the proposed rule, HCFA would revise the current salary
equivalency guidelines for speech and occupational therapy services. The
proposed guidelines are based on a blend of data from wage rates for hospitals
and nursing facilities, and include salary, fringe benefits and expense
factors. Rates are defined by specific geographic market areas, based upon a
modified version of the hospital wage index. HCFA is considering comments but
has not issued a final rule at this time. While the Company cannot predict when
the final regulation will be issued, or if changes will be made to the proposed
guidelines, management believes that the imposition of salary equivalency
guidelines on speech and occupational therapy services, as proposed, would not
significantly decrease Vencare operating margins or have a material adverse
effect on the Company's contract services business.

There also continue to be state legislative proposals that would impose more
limitations on government and private payments to providers of healthcare
services such as the Company. Many states have enacted or are considering
enacting measures that are designed to reduce their Medicaid expenditures and
to make certain changes to private healthcare insurance. Some states also are
considering regulatory changes that include a moratorium on the designation of
additional long-term care hospitals and changes in the Medicaid reimbursement
system for long-term care hospitals. There are also a number of legislative
proposals including cost caps and the establishment of Medicaid prospective
payments systems for nursing centers. Moreover, by repealing the Boren
Amendment, the Budget Act eases the restrictions on the states' ability to
reduce their Medicaid reimbursement levels.

Medicare revenues as a percentage of total revenues were 32% and 31% for the
six months ended June 30, 1997 and 1996, respectively; and 31%, 30%, and 27%
for each of the three years ended December 31, 1996, 1995

and 1994, respectively. Medicaid revenues as a percentage of total revenues
were 27% and 31% for the six months ended June 30, 1997 and 1996, respectively;
and 31%, 33%, and 36% for each of the three years ended December 31, 1996, 1995
and 1994, respectively.

OTHER INFORMATION

On June 11, 1997, the Company announced that it had entered into a strategic
alliance with CNA to develop and market a long-term care insurance product.
Under this arrangement, CNA will offer a long-term care insurance product which
features as a benefit a 15% discount for services provided by members of the
Company's network of long-term care providers. Members of this network will act
as preferred providers of care to covered insureds and in certain states will
provide preferential access to the network's nursing centers.

On September 15, 1997, BHC entered into a definitive agreement to merge with
CBHS. Under the terms of the agreement, CBHS will acquire all of the issued and
outstanding capital stock of BHC for cash. The Company owns a 44% voting equity
interest (61% ownership interest) in BHC as a result of the THY Acquisition.
The Company's proceeds from the transaction, expected to approximate $140
million, will be used to reduce the Company's borrowings under the Credit
Agreement. For accounting purposes, no gain will be recorded as a result of the
sale of the Company's interest in BHC. The underlying valuation of the
Company's investment in BHC, which will be determined from the sale, will be
adjusted by the purchase method of accounting applied in connection with the
THY Acquisition. Accordingly, the preliminary amount of goodwill resulting from
THY Acquisition will be reduced. This transaction, which is subject to
acceptable financing, due diligence by CBHS and certain regulatory approvals,
is expected to close during the fourth quarter of 1997.

Various lawsuits and claims arising in the ordinary course of business are
pending against the Company. Resolution of litigation and other loss
contingencies is not expected to have a material adverse effect on the
Company's liquidity, financial position or result of operations.

The Credit Agreement and the Atria Credit Facility contain customary covenants
which require, among other things, maintenance of certain financial ratios and
limit amounts of additional debt and repurchases of common stock. The Company
was in compliance with all such covenants at June 30, 1997.

As discussed in Note 4 of the Notes to Condensed Consolidated Financial
Statements, on December 31, 1997 the Company will be required to change the
method of computing earnings per common share on a retroactive basis. The
change in calculation method is not expected to have a material impact on
previously reported earnings per common share.

During 1996, the Company adopted Financial Accounting Standards Board
Statements No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of" and No. 123, "Accounting for Stock Based
Compensation." See Notes 5 and 12 of the Notes to Consolidated Financial
Statements.

BUSINESS

GENERAL

The Company is one of the largest providers of long-term healthcare services in
the United States. At June 30, 1997, the Company's operations included 58 long-
term acute care hospitals containing 5,107 licensed beds, 311 nursing centers
containing 40,869 licensed beds, the Vencare contract services business which
provides respiratory and rehabilitation therapies and medical and pharmacy
management services under approximately 4,500 contracts to nursing centers and
other healthcare providers, and through Atria, 40 assisted and independent
living communities with 3,977 units. The Company currently operates in 46
states. Healthcare services provided through this network of facilities include
long-term hospital care, nursing care, contract respiratory therapy services,
acute cardiopulmonary care, subacute and post-operative care, occupational
healthcare, inpatient and outpatient rehabilitation therapy, specialized care
for Alzheimer's disease, hospice care, home healthcare, pharmacy services and
assisted and independent living. The Company also continues to develop
VenTouch(TM), a comprehensive paperless clinical information system designed to
increase the operating efficiencies of the Company's facilities.

On March 21, 1997, the Company completed its acquisition of TheraTx, a provider
of subacute rehabilitation and respiratory therapy program management services
to nursing centers and an operator of 26 nursing centers that provide a broad
range of subacute, specialty and basic medical and other geriatric services. On
June 24, 1997, the Company acquired approximately 95% of the THY Shares, an
operator of 16 long-term acute care hospitals and three satellite facilities in
13 states, through a cash tender offer. The Company completed the merger with
THY on August 26, 1997. THY also owns a 44% voting equity interest (61%
ownership interest) in BHC, an operator of psychiatric and behavioral clinics.
For additional information regarding the TheraTx Merger and the THY
Acquisition, see "Summary--Recent Developments."

BUSINESS STRATEGY

accommodate patients at all levels of long-term care. Key elements of the
Company's strategy for providing full-service integrated networks for long-term
care are set forth below:

Vencare also provides respiratory therapy and subacute care services pursuant
to contracts with nursing and other healthcare facilities owned by third
parties. The Vencare program includes hospice care, management of
cardiopulmonary hospital departments, rehabilitation therapy services, pharmacy
management services and mobile radiology services. Vencare enables the Company
to provide its services to lower acuity patients in cost-efficient settings.

Further Implement Patient Information System. VenTouch(TM) is a software
application which allows nurses, physicians and other clinicians to access and
manage clinical information utilized in the healthcare delivery process. Among
the features of VenTouch(TM) are on-line access and update of an electronic
patient chart, on-line trend analysis using electronic flowsheets and graphs,
and remote access for authorized users. The system is designed to decrease
administrative time, reduce paper and support the delivery of quality care. The
Company installed VenTouch(TM) in all of its existing hospitals during 1995 and
began installing VenTouch(TM) in its nursing centers in 1996. In addition, the
Company intends to offer its VenTouch(TM) information system as part of the
menu of services offered by Vencare to nursing centers not owned by the
Company.

HOSPITAL OPERATIONS

The Company's hospitals primarily provide long-term acute care to medically
complex, chronically ill patients. The Company's hospitals have the capability
to treat patients who suffer from multiple systemic failures or conditions such
as neurological disorders, head injuries, brain stem and spinal cord trauma,
cerebral vascular accidents, chemical brain injuries, central nervous system
disorders, developmental anomalies and cardiopulmonary disorders. Chronic
patients are often dependent on technology for continued life support, such as
mechanical ventilators, total parenteral nutrition, respiration or cardiac
monitors and dialysis machines. Generally, approximately 60% of the Company's
chronic patients are ventilator-dependent for some period of time during their
hospitalization. The Company's patients suffer from conditions which require a
high level of

monitoring and specialized care, yet may not necessitate the continued services
of an intensive care unit. Due to their severe medical conditions, the
Company's hospital patients generally are not clinically appropriate for
admission to a nursing center or rehabilitation hospital. The medical condition
of most of the Company's hospital patients is periodically or chronically
unstable. By combining general acute care services with the ability to care for
chronic patients, the Company believes that its long-term care hospitals
provide its patients with high quality, cost-effective care. During 1996, the
average length of stay for chronic patients in the Company's long-term care
hospitals was approximately 50 days. Although the Company's patients range in
age from pediatric to geriatric, typically more than 70% of the Company's
chronic patients are over 65 years of age. The Company's hospital operations
are subject to regulation by a number of government and private agencies. See
"--Governmental Regulation--Hospitals."

Hospital Facilities
The following table lists by state the number of hospitals and related licensed
beds owned and leased by the Company as of June 30, 1997:

-------------------------

NUMBER OF
FACILITIES
LICENSED ------------------
STATE BEDS OWNED LEASED TOTAL
----- -------- ----- ------ -----

Arizona....................................... 110 2 -- 2
California.................................... 588 8 -- 8
Colorado...................................... 68 1 -- 1
Florida....................................... 564 6 1 7
Georgia....................................... 72 -- 1 1
Illinois...................................... 602 3 2 5
Indiana....................................... 159 2 1 3
Kentucky...................................... 374 1 -- 1
Louisiana..................................... 168 1 -- 1
Massachusetts................................. 81 2 -- 2
Michigan...................................... 400 2 -- 2
Minnesota..................................... 111 1 -- 1
Missouri...................................... 227 2 -- 2
Nevada........................................ 52 1 -- 1
New Mexico.................................... 61 1 -- 1
North Carolina................................ 124 1 -- 1
Ohio.......................................... 94 1 -- 1
Oklahoma...................................... 59 1 -- 1
Pennsylvania.................................. 101 2 -- 2
Tennessee..................................... 49 1 -- 1
Texas......................................... 663 8 2 10
Virginia...................................... 206 1 -- 1
Washington.................................... 80 1 -- 1
Wisconsin..................................... 94 1 1 2
----- --- --- ---
Totals...................................... 5,107 50 8 58
===== === === ===

Services Provided by Hospitals
Chronic. The Company has devised a comprehensive program of care for its
chronic patients that draws upon the talents of interdisciplinary teams,
including licensed pulmonary specialists. The teams evaluate chronic patients
upon admission to determine a treatment plan. Where appropriate, the treatment
programs may involve the services of several disciplines, such as pulmonary and
physical therapy. Individual attention to patients who have the cognitive and
physical abilities to respond to therapy is emphasized. Patients who
successfully complete treatment programs are discharged to nursing centers,
rehabilitation hospitals or home care settings.

General Acute Care. The Company operates two general acute care hospitals.
Certain of the Company's long-term care hospitals also provide general acute
care and outpatient services in support of their long-term care services.
Certain of the Company's hospitals maintain subacute units. General acute care
and outpatient services

may include inpatient services, diagnostic services, emergency services, CT
scanning, one-day surgery, hospice services, laboratory, X-ray, respiratory
therapy, cardiology and physical therapy. The Company may expand its general
acute care and outpatient services as its long-term care hospitals mature.

Major factors contributing to the growth in demand for the Company's intensive
care hospital services include the following:

Increased Patient Population. Improved medical care and advancements in medical
technology have increased the survival rates for infants born with severe
medical problems, as well as victims of disease and trauma of all ages. Many of
these patients never fully recover and require long-term hospital care. The
incidence of chronic respiratory problems increases with age, particularly in
connection with certain degenerative conditions. As the average age of the
United States population increases, the Company believes there will be an
increase in the need for long-term hospital care.

Medically Displaced Patients. The Company's hospital patients require a high
level of monitoring and specialized care, yet may not require the continued
services of an intensive care unit. Due to their extended recovery period, the
Company's hospital patients generally do not receive specialized multi-
disciplinary treatment focused on the unique aspects of a long-term recovery
program in a general acute care hospital and yet are not appropriate for
admission to a nursing center or rehabilitation hospital.

Economically Displaced Patients. Historically, reimbursement policies and
practices designed to control healthcare costs have made it difficult to place
medically complex, chronically ill patients in an appropriate healthcare
setting. Under the Medicare program, general acute care hospitals are
reimbursed under the prospective payment system ("PPS"), a fixed payment system
which provides an economic incentive to general acute care hospitals to
minimize the length of patient stay. As a result, these hospitals generally
receive less than full cost for providing care to patients with extended
lengths of stay. Furthermore, PPS does not provide for reimbursement more
frequently than once every 60 days, placing an additional economic burden on a
general acute care hospital providing long-term care. The Company's long-term
care hospitals, however, are excluded from PPS and thus receive reimbursement
on a more favorable basis for providing long-term hospital care to Medicare
patients. Commercial reimbursement sources, such as insurance companies and
health maintenance organizations ("HMOs"), some of which pay based on
established hospital charges, typically seek the most economical source of care
available. The Company believes that its emphasis on long-term hospital care
allows it to provide high quality care to chronic patients on a cost-effective
basis.

Hospital Patient Admission
Substantially all of the acute and medically complex patients admitted to the
Company's hospitals are transfers from other healthcare providers. Patients are
referred from general acute care hospitals, rehabilitation hospitals, nursing
centers and home care settings. Referral sources include discharge planners,
case managers of managed care plans, social workers, physicians, third party
administrators, HMOs and insurance companies.

The Company employs case managers who educate healthcare professionals from
other hospitals as to the unique nature of the services provided by the
Company's long-term care hospitals. The case managers develop an annual
admission plan for each hospital with assistance from the hospital's
administrator. To identify specific service opportunities, the admission plan
for each hospital is based on a variety of factors, including population
characteristics, physician characteristics and incidence of disability
statistics. The admission plans involve ongoing education of local physicians,
utilization review and case management personnel, acute care hospitals, HMOs
and preferred provider organizations ("PPOs"). The Company maintains a pre-
admission assessment system at its regional referral centers to evaluate
certain clinical and other information in determining the appropriateness of
each patient referred to its hospitals.

Professional Staff
Each of the Company's hospitals is staffed with a multi-disciplinary team of
healthcare professionals. A professional nursing staff trained to care for the
long-term acute patient is on duty 24 hours each day in the Company's
hospitals. Other professional staff includes respiratory therapists, physical
therapists, occupational therapists and registered dietitians.

The physicians at the Company's hospitals generally are not employees of the
Company and may also be members of the medical staff of other hospitals. Each
of the Company's hospitals has a fully credentialed, multi-specialty medical
staff to meet the needs of the patients. Typically, each patient is visited at
least once a day by a physician. Generally, the Company does not enter into
exclusive contracts with physicians to provide services to its hospital
patients. The Company's hospitals and physicians enter into service contracts
providing for pulmonary, radiology, pathology, infection control and
anesthesiology services, most of which are cancelable on no more than 90 days'
notice.

The Company believes that its future success will depend in large part upon its
continued ability to hire and retain qualified personnel. The Company seeks the
highest quality of professional staff within each market.

Centralized Management and Operations
A hospital administrator supervises and is responsible for the day-to-day
operations at each of the Company's hospitals. Each hospital also employs a
controller who monitors the financial matters of each hospital, including the
measurement of actual operating results compared to goals established by the
Company. In addition, each hospital employs an assistant administrator to
oversee the clinical operations of the hospital and a quality assurance manager
to direct an integrated quality assurance program. The Company's corporate
headquarters provides services in the areas of system design and development,
training, human resource management, reimbursement expertise, legal advice,
technical accounting support, purchasing and facilities management. Financial
control is maintained through fiscal and accounting policies that are
established at the corporate level for use at each hospital. The Company has
standardized operating procedures and monitors its hospitals to assure
consistency of operations.

Hospital Management Information System
The financial information for each Company hospital is centralized at the
corporate headquarters through its management information system. The Company
installed its VenTouch(TM) information system, an electronic patient medical
record system, in all of the Company's hospitals in 1995. See "--Management
Information System."

Quality Assessment and Improvement
The Company maintains a strategic outcomes program which includes a centralized
pre-admission evaluation program and concurrent review of all of its patient
population against utilization and quality screenings, as well as quality of
life outcomes data collection and patient and family satisfaction surveys. In
addition, each hospital has an integrated quality assessment and improvement
program administered by a quality review manager which encompasses utilization
review, quality improvement, infection control and risk management. The
objective of these programs is to ensure that patients are appropriately
admitted to the Company's hospitals and that quality healthcare is rendered to
them in a cost-effective manner.

The Company has implemented a program whereby its hospitals will be reviewed
annually by internal quality auditors for compliance with standards of the
Joint Commission on Accreditation of Health Care Organizations ("JCAHO"). The
purposes of this internal review process are to (i) ensure ongoing compliance
with industry recognized standards for hospitals, (ii) assist management in
analyzing each hospital's operations and (iii) provide consulting and
educational opportunities for each hospital to identify opportunities to
improve patient care.

Selected Hospital Operating Data
The following table sets forth certain operating data for the Company's
hospitals:

------------------------------

SIX MONTHS YEAR ENDED DECEMBER 31,
ENDED -------------------------
JUNE 30, 1997 1996 1995 1994
------------- ------- ------- -------

Hospitals in operation at end of
period.......................... 58 38 36 33
Number of licensed beds at end of
period.......................... 5,107 3,325 3,263 2,511
Patient days..................... 323,180 586,144 489,612 403,623
Average daily census............. 1,786 1,601 1,341 1,123
Occupancy percentage............. 57.8% 53.7% 47.6% 48.8%

As used in the above table, the term "licensed beds" refers to the maximum
number of beds permitted in the hospital under its license regardless of
whether the beds are actually available for patient care. "Patient days"

refers to the total number of days of patient care provided by the Company's
hospitals for the periods indicated. "Average daily census" is computed by
dividing each hospital's patient days by the number of calendar days the
respective hospital is in operation. "Occupancy percentage" is computed by
dividing average daily census by the number of licensed beds, adjusted for the
length of time each facility was in operation during each respective period.

Sources of Hospital Revenues
The Company receives payment for hospital services from third-party payors,
including government reimbursement programs such as Medicare and Medicaid and
nongovernment sources such as commercial insurance companies, HMOs, PPOs and
contracted providers. Patients covered by nongovernment payors are generally
more profitable to the Company than those covered by Medicare and Medicaid
programs. The following table sets forth the approximate percentages of the
Company's hospital revenues derived from the specified payor sources indicated:

--------------------------

YEAR ENDED
SIX MONTHS DECEMBER 31,
ENDED ----------------
JUNE 30, 1997 1996 1995 1994
------------- ---- ---- ----

Medicare................................... 62% 59% 57% 56%
Medicaid................................... 9 12 12 11
Private and other.......................... 29 29 31 33

For the year ended December 31, 1996, hospital revenues totaled approximately
$551 million, or 21% of the Company's total revenues. For the six months ended
June 30, 1997, hospital revenues totaled approximately $321 million, or 22% of
the Company's total revenues.

Hospital Competition
As of June 30, 1997, the hospitals owned, leased or managed by the Company were
located in 38 geographic markets in 24 states. In each geographic market, there
are general acute care hospitals which provide services comparable to those
offered by the Company's hospitals. In addition, the Company believes that as
of December 31, 1996, there were approximately 160 hospitals in the United
States certified by Medicare as general long-term hospitals, some of which
provide similar cardiopulmonary services to those provided by the Company's
hospitals. Many of these long-term hospitals are larger and more established
than the Company's hospitals. Certain hospitals that compete with the Company's
hospitals are operated by not-for-profit, nontaxpaying or governmental
agencies, which can finance capital expenditures on a tax-exempt basis, and
which receive funds and charitable contributions unavailable to the Company's
hospitals. Cost containment efforts by Federal and state governments and other
third-party payors designed to encourage more efficient utilization of hospital
services have generally resulted in lower hospital industry occupancy rates in
recent years. As a result of these efforts, a number of acute care hospitals
have converted to specialized care facilities. Some hospitals are developing
step-down units which attempt to serve the needs of patients who require care
at a level between that provided by an intensive care unit and a general
medical/surgical floor. This trend is expected to continue due to the current
oversupply of acute care hospital beds and the increasing consolidation and
affiliation of free-standing hospitals into larger systems. As a result, the
Company may experience increased competition from existing hospitals and
converted facilities.

Competition for patients covered by nongovernment reimbursement sources is
intense. The primary competitive factors in the long-term intensive care
business include quality of services, charges for services and responsiveness
to the needs of patients, families, payors and physicians. Other companies have
entered the long-term intensive care market with licensed hospitals that
compete with the Company's hospitals.

Some nursing centers, while not licensed as hospitals, have developed units
which provide a greater intensity of care than the care typically provided by a
nursing center. The condition of patients in these nursing centers is less
acute than the condition of patients cared for in the Company's hospitals.

The competitive position of any hospital, including the Company's hospitals, is
also affected by the ability of its management to negotiate contracts with
purchasers of group healthcare services, including private employers, PPOs and
HMOs. Such organizations attempt to obtain discounts from established hospital
charges. The

importance of obtaining contracts with PPOs, HMOs and other organizations which
finance healthcare, and its effect on a hospital's competitive position, vary
from market to market, depending on the number and market strength of such
organizations.

The Company also competes with other healthcare companies for hospital and
other healthcare acquisitions.

NURSING CENTER OPERATIONS

At June 30, 1997, the Company's nursing center operations provided long-term
care and subacute medical and rehabilitation services in 311 nursing centers
containing 40,869 licensed beds located in 33 states including 26 nursing
centers acquired in the TheraTx Merger. At June 30, 1997, the Company owned 216
nursing centers and leased 79 nursing centers. The Company also managed 16
nursing centers, including seven centers owned by Tenet Healthcare Corporation,
which holds a greater than 10% interest in the Company. In the first half of
1997, the Company completed the sale of 27 of 34 of its underperforming or non-
strategic nursing centers under contract. The sale of the seven additional
nursing centers under contract will be completed upon receipt of certain
regulatory approvals.

The Company is a leading provider of rehabilitation services, including
physical, occupational and speech therapies. The majority of patients in
rehabilitation programs stay for eight weeks or less. Patients in
rehabilitation programs generally provide higher revenues than other nursing
center patients because they use a higher level of ancillary services. In
addition, management believes that the Company is one of the leading providers
of care for patients with Alzheimer's disease. At June 30, 1997, the Company
offered specialized programs covering approximately 3,300 beds in 94 nursing
centers for patients suffering from Alzheimer's disease. Most of these patients
reside in separate units within the nursing centers and are cared for by teams
of professionals specializing in the unique problems experienced by Alzheimer's
patients.

Nursing Center Marketing
The factors which affect consumers' selection of a nursing center vary by
community and include a nursing center's competitive position and its
relationships with local referral sources. Competition creates the standards
against which nursing centers in a given market are judged by various referral
sources, which include physicians, hospital discharge planners, community
organizations and families. Therefore, the Company's nursing center marketing
efforts are conducted at the local market level by the nursing center
administrators, admissions coordinators and others. Nursing center personnel
are assisted in carrying out their marketing strategies by regional marketing
staffs. The Company's marketing efforts are directed toward improving the payor
mix at the nursing centers by maximizing the census of private pay patients and
Medicare patients.

Nursing Center Operations
Each nursing center is managed by a state-licensed administrator who is
supported by other professional personnel, including a director of nursing,
staff development professional (responsible for employee training), activities
director, social services director, licensed dietitian, business office manager
and, in general, physical, occupational and speech therapists. The directors of
nursing are state-licensed nurses who supervise nursing staffs which include
registered nurses, licensed practical nurses and nursing assistants. Staff size
and composition vary depending on the size and occupancy of each nursing center
and on the level of care provided by the nursing center. The nursing centers
contract with physicians who serve as medical directors and serve on quality
assurance committees.

The nursing centers are supported by regional staff in the areas of nursing,
dietary and rehabilitation services, maintenance, sales and financial services.
In addition, corporate staff provide other services in the areas of sales
assistance, human resource management, state and federal reimbursement, state
licensing and certification, legal, finance and accounting support. Financial
control is maintained principally through fiscal and accounting policies
established at the corporate level for use at the nursing centers.

Quality of care is monitored and enhanced by quality assurance committees and
family satisfaction surveys. The quality assurance committees oversee patient
healthcare needs and resident and staff safety. Additionally, physicians serve
on the quality assurance committees as medical directors and advise on
healthcare policies and

practices. Nursing professionals visit each nursing center periodically to
review practices and recommend improvements where necessary in the level of
care provided and to assure compliance with requirements under applicable
Medicare and Medicaid regulations. Surveys of residents' families are conducted
from time to time in which the families are asked to rate various aspects of
service and the physical condition of the nursing centers. These surveys are
reviewed by nursing center administrators to help ensure quality care.

The Company provides training programs for nursing center administrators,
managers, nurses and nursing assistants. These programs are designed to
maintain high levels of quality patient care.

Substantially all of the nursing centers are currently certified to provide
services under Medicare and Medicaid programs. A nursing center's qualification
to participate in such programs depends upon many factors, such as
accommodations, equipment, services, safety, personnel, physical environment
and adequate policies and procedures.

Selected Nursing Center Operating Data
The following table sets forth certain operating data for the Company's nursing
centers:

-----------------------------------------

SIX MONTHS
ENDED
JUNE 30, YEAR ENDED DECEMBER 31,
1997 1996 1995 1994
---------- ---------- ---------- ----------

Number of nursing centers
in
operation at end of peri-
od........................ 311 313 311 310
Number of licensed beds at
end of period............. 40,869 39,619 39,480 39,423
Patient days............... 6,224,432 12,566,763 12,569,600 12,654,016
Average daily census....... 34,389 34,335 34,437 34,669
Occupancy percentage....... 91.1% 91.9% 92.2% 92.9%

Sources of Nursing Center Revenues
Nursing center revenues are derived principally from Medicare and Medicaid
programs and from private pay patients. Consistent with the nursing home
industry generally, changes in the mix of the Company's patient population
among these three categories significantly affect the profitability of the
Company's operations. Although Medicare and other high acuity patients
generally produce the most revenue per patient day, profitability is reduced by
the costs associated with the higher level of nursing care and other services
required by such patients. The Company believes that private pay patients
generally constitute the most profitable and Medicaid patients generally
constitute the least profitable category.

The following table sets forth certain percentages related to the payor mix of
the Company's owned and leased nursing centers:

--------------------------------------

MEDICARE MEDICAID PRIVATE AND OTHER
----------------- ----------------- -----------------------
SIX
MONTHS PATIENT NET PATIENT NET PATIENT NET
ENDED DAYS REVENUES DAYS REVENUES DAYS REVENUES
- ------ ------- -------- ------- -------- -------- ---------

1997.................... 13% 32% 64% 43% 23% 25%
1996.................... 13 30 65 44 22 26

YEAR
- ----

1996.................... 12% 30% 65% 44% 23% 26%
1995.................... 12 29 65 44 23 27
1994.................... 11 25 65 47 24 28

For the year ended December 31, 1996, nursing center revenues totaled
approximately $1.6 billion, or 62% of the Company's total revenues. For the six
months ended June 30, 1997, nursing center revenues totaled approximately $837
million, or 56% of the Company's total revenues.

Both governmental and private third-party payors employ cost containment
measures designed to limit payments made to healthcare providers. Those
measures include the adoption of initial and continuing recipient eligibility
criteria which may limit payment for services, the adoption of coverage
criteria which limit the services that will
be reimbursed and the establishment of payment ceilings which set the maximum
reimbursement that a provider

may receive for services. Furthermore, government reimbursement programs are
subject to statutory and regulatory changes, retroactive rate adjustments,
administrative rulings and government funding restrictions, all of which may
materially increase or decrease the rate of program payments to the Company for
its services. There can be no assurance that payments under governmental and
private third-party payor programs will remain at levels comparable to present
levels or will be sufficient to cover the costs allocable to patients eligible
for reimbursement pursuant to such programs. In addition, there can be no
assurance that facilities owned, leased or managed by the Company, or the
provision of services and supplies by the Company, will meet the requirements
for participation in such programs. The recently enacted Budget Act requires
the establishment of a prospective payment system for nursing centers for cost
reporting periods beginning on or after July 1, 1998. During the first three
years, the per diem rates for nursing centers will be based on a blend of
facility-specific costs and Federal costs. Thereafter, the per diem rates will
be based solely on Federal costs. The rates for such services have not been
established or published. The prospective payment system also will cover
ancillary services provided to nursing center patients under the Company's
Vencare contract services business. The Company could be adversely affected by
the continuing efforts of governmental and private third-party payors to
contain the amount of reimbursement for healthcare services. See "--
Governmental Regulation--Nursing Centers and Assisted and Independent Living
Communities" and "--Healthcare Reform."

Medicare. The Medicare Part A program provides reimbursement for extended care
services furnished to Medicare beneficiaries who are admitted to nursing
centers after at least a three-day stay in an acute care hospital. Covered
services include supervised nursing care, room and board, social services,
physical and occupational therapies, pharmaceuticals, supplies and other
necessary services provided by nursing centers.

Under the Medicare program, nursing center reimbursement is based upon
reasonable direct and indirect costs of services provided to beneficiaries.
Routine costs are subject to a routine cost limit ("RCL"). The RCL is a
national average cost per patient day which is adjusted for variations in local
wages. Revenues under this program are subject to audit and retroactive
adjustment. Management believes that adequate provisions for loss have been
recorded to reflect any adjustments which could result from such audits.
Settlements of Medicare audits have not had a material adverse effect on the
Company's nursing center operating results.

Medicaid. Medicaid is a state-administered program financed by state funds and
matching Federal funds. The program provides for medical assistance to the
indigent and certain other eligible persons. Although administered under broad
Federal regulations, states are given flexibility to construct programs and
payment methods consistent with their individual goals. Accordingly, these
programs differ from state to state in many respects.

Prior to the Budget Act, Federal law required Medicaid programs to pay rates
that are reasonable and adequate to meet the costs incurred by an efficiently
and economically operated nursing center providing quality care and services in
conformity with all applicable laws and regulations. Despite the Federal
requirements, disagreements frequently arise between nursing centers and states
regarding the adequacy of Medicaid payments. By repealing the Boren Amendment,
the Budget Act eases the restrictions on the states' ability to reduce their
Medicaid reimbursement levels for such services. In addition, the Medicaid
programs are subject to statutory and regulatory changes, administrative
rulings, interpretations of policy by the state agencies and certain government
funding limitations, all of which may materially increase or decrease the level
of program payments to nursing centers operated by the Company. Management
believes that the payments under these programs are not sufficient on an
overall basis to cover the costs of serving residents participating in these
programs. Furthermore, the Omnibus Budget Reconciliation Act of 1987, as
amended ("OBRA"), mandates an increased emphasis on ensuring quality patient
care, which has resulted in additional expenditures by nursing centers.

There can be no assurance that the payments under Medicaid programs will remain
at levels comparable to current levels or, in the future, will be sufficient to
cover the costs incurred in serving residents participating in such programs.
The Company provides to eligible individuals Medicaid-covered services
consisting of nursing care, room and board and social services. In addition,
states may at their option cover other services such as physical, occupational
and speech therapies and pharmaceuticals.

Private Payment. The Company's nursing centers seek to maximize the number of
private pay patients, including those covered under private insurance and
managed care health plans. Private payment patients typically have financial
resources (including insurance coverage) to pay for their monthly services and
do not rely on government programs for support.

Nursing Center Competition
The Company's nursing centers compete on a local and regional basis with other
nursing centers. The Company's competitive position varies within each
community served. The Company believes that the quality of care provided,
reputation, location and physical appearance of its nursing centers and, in the
case of private patients, the charges for services, are significant competitive
factors. Although there is limited, if any, price competition with respect to
Medicare and Medicaid patients (since revenues received for services provided
to such patients are based on fixed rates or cost reimbursement principles)
there is significant competition for private payment patients.

The long-term care industry is divided into a variety of competitive areas
which market similar services. These competitors include nursing centers,
hospitals, extended care centers, assisted living facilities and communities,
home health agencies and similar institutions. The industry includes
government-owned, church-owned, secular not-for-profit and for-profit
institutions.

Nursing Center Facilities
The following table lists by state the number of nursing centers and related
licensed beds operated by the Company as of June 30, 1997:

-----------------------------------

NUMBER OF FACILITIES
LICENSED --------------------------
STATE BEDS OWNED LEASED MANAGED TOTAL
----- -------- ----- ------ ------- -----

Alabama(1)............................... 592 3 1 -- 4
Arizona.................................. 827 5 1 -- 6
California............................... 2,785 13 6 3 22
Colorado................................. 935 4 3 -- 7
Connecticut.............................. 983 8 -- -- 8
Florida(1)............................... 2,828 16 3 2 21
Georgia(1)............................... 1,336 4 6 -- 10
Idaho.................................... 903 7 2 -- 9
Indiana(1)............................... 4,152 14 12 -- 26
Kentucky(1).............................. 2,106 13 4 -- 17
Louisiana................................ 485 -- 1 2 3
Maine(1)................................. 882 11 -- -- 11
Massachusetts(1)......................... 4,247 33 3 2 38
Minnesota................................ 159 1 -- -- 1
Mississippi.............................. 125 -- 1 -- 1
Montana(1)............................... 456 2 1 -- 3
Nebraska................................. 167 -- 1 -- 1
Nevada(1)................................ 314 3 -- -- 3
New Hampshire............................ 622 3 -- 1 4
North Carolina(1)........................ 3,212 20 8 -- 28
Ohio(1).................................. 2,161 11 4 1 16
Oklahoma(1).............................. 100 -- -- 1 1
Oregon(1)................................ 358 2 1 -- 3
Pennsylvania............................. 200 1 1 -- 2
Rhode Island............................. 201 2 -- -- 2
Tennessee(1)............................. 2,541 4 11 -- 15
Texas.................................... 623 -- 2 1 3
Utah..................................... 740 5 -- 1 6
Vermont(1)............................... 428 1 -- 2 3
Virginia(1).............................. 764 4 1 -- 5
Washington............................... 1,504 10 3 -- 13
Wisconsin(1)............................. 2,682 12 3 -- 15
Wyoming(1)............................... 451 4 -- -- 4
------ --- --- --- ---
Totals................................. 40,869 216 79 16 311
====== === === === ===

- -------
(1) These states have Certificate of Need regulations. See "--Governmental
Regulation--Nursing Centers and Assisted and Independent Living
Communities."

VENCARE HEALTH SERVICES OPERATIONS

In 1993, the Company initiated its Vencare health services program. Through
Vencare, the Company has expanded the scope of its cardiopulmonary care by
providing subacute care, rehabilitation therapy and respiratory care services
and supplies to nursing and subacute care centers. The Company also manages
cardiopulmonary departments for other hospitals. The Company provides hospice
services to nursing center patients, hospital patients and persons in private
residences. In November 1996, the Company consolidated its pharmacy operations
under its Vencare health services. In addition, the rehabilitation, respiratory
and other healthcare services previously provided by TheraTx have been
integrated into the Vencare operations. For the year ended December 31, 1996,
revenues from the Vencare program totaled approximately $399 million which
represented 15% of the Company's total revenues. For the six months ended June
30, 1997, revenues from the Vencare program totaled $301 million, which
represented 20% of the Company's total revenues.

Respiratory Care Services
The Company provides respiratory care services and supplies to nursing and
subacute care center patients pursuant to contracts between the Company and the
nursing center or subacute center. The services are provided by respiratory
therapists based at the Company's hospitals. These respiratory therapists
perform a wide variety of procedures, including oxygen therapy, bronchial
hygiene, nebulizer and aerosol treatments, tracheostomy care, ventilator
management and patient respiratory education. Pulse oximeters and arterial
blood gas machines are used to evaluate the patient's condition, as well as the
effectiveness of the treatment. The Company also provides respiratory equipment
and supplies to nursing and subacute centers.

The Company receives payments from the nursing centers and subacute care
centers for services rendered and these facilities, in turn, receive payments
from the appropriate provider. Respiratory therapy and supplies are generally
covered under the Medicare program and reimbursed as an ancillary service when
the service is provided by hospital-based respiratory therapists. Many
commercial insurers and managed care providers are seeking hospital discharge
options for lower acuity respiratory patients. Management believes that the
Company's pricing and successful clinical outcomes make its respiratory care
program attractive to commercial insurers and managed care providers.

At June 30, 1997, the Company had entered into contracts to provide contract
respiratory therapy services and supplies to approximately 1,800 nursing and
subacute care centers, which includes approximately 200 nursing centers owned
or operated by the Company.

Subacute Services
At June 30, 1997, the Company had entered into contracts to provide subacute
care services to 14 nursing and subacute care centers. These services, which
are also an extension of the cardiopulmonary services provided by the Company's
hospitals, may include ventilator management, tracheostomy care, continuation
of airway restoration programs, enteral and parenteral nutritional support, IV
therapy for hydration and medication administration, progressive wound care,
chronic chest tube management, laboratory, radiology, pharmacy and dialysis
services, customized rehabilitation services and program marketing. Subacute
patients generally require assisted ventilation through mechanical ventilation
devices.

Rehabilitation Therapy Services
The Company provides physical, occupational and speech therapies to nursing and
subacute care center patients, as well as home health patients and public
school systems. At June 30, 1997, the Company had entered into contracts to
provide rehabilitation services to patients at 600 facilities.

Hospice Services
The Company provides hospice services to nursing center patients, hospital
patients and persons in private residences. At June 30, 1997, the Company had
entered into approximately 225 contracts to provide hospice services to
patients in nursing and subacute care centers, hospitals and residences.

Mobile Diagnostic Services
The Company is a hospital based provider of on-call mobile X-ray services.
These services are primarily provided to nursing facilities, but the Company
also provides services to correctional facilities, rehabilitation hospitals and
dialysis centers. These services are provided 24 hours a day, 365 days a year
to over 130 facilities.

Competition in the Contract Services Market
Although the respiratory therapy services, rehabilitation services, subacute
services and hospice care markets are fragmented, significant competition
exists for the Company's contract services. The primary competitive factors for
the contract services business are quality of services, charges for services
and responsiveness to the needs of patients, families and the facilities in
which the services are provided. Certain hospitals are establishing and
managing their own step-down and subacute facilities. Other hospital companies
have entered the contract services market through affiliation agreements and
management contracts.

Pharmacies
The Company provides institutional and other pharmacy services. In November
1996, the Company consolidated its Medisave Pharmacies into its Vencare health
services operations and now provides its hospital-based clinical pharmacy
services as part of its Vencare services.

The institutional pharmacy business focuses on providing a full array of
pharmacy services to approximately 700 nursing centers and specialized care
centers. Institutional pharmacy sales encompass a wide variety of products
including prescription medication, prosthetics, respiratory services, infusion
services and enteral therapies. In addition, the Company provides a variety of
pharmaceutical consulting services designed to assist hospitals, nursing
centers, and home health agencies in program administration. The Company is in
the process of selling or closing its retail pharmacies. Management believes
that the expected discontinuance of the retail pharmacy operations in 1997 will
not have a material adverse effect on Vencare's operations.

ASSISTED AND INDEPENDENT LIVING COMMUNITY OPERATIONS

In the third quarter of 1996, the Company completed the IPO through the
issuance of 5.8 million shares of Atria common stock. On June 30, 1997, the
Company owned 10.0 million shares, or 60.7% of Atria's outstanding common
stock. In July 1997, Atria completed the Atria Offering. The Company now owns
42.8% of the outstanding common stock of Atria. Accordingly, the operations of
Atria, which were consolidated with those of the Company prior to the Atria
Offering, have been accounted for under the equity method since July 1, 1997.

As of June 30, 1997, Atria's assisted and independent living operations
consisted of 40 communities. These communities included 3,977 units and were
located in 17 states. Atria owns 29 of these communities, leases two
communities and manages nine communities. Atria also had 35 assisted living
communities under development with a total of approximately 2,459 units as of
June 30, 1997. For the year ended December 31, 1996, assisted and independent
living revenues approximated $52 million, or 2% of the Company's total
revenues. For the six months ended June 30, 1997, assisted and independent
living revenues were approximately $31 million, or 2% of the Company's total
revenues.

Assisted and independent living communities serve more independent and self-
sufficient residents than do the nursing centers. Assisted and independent
living units are typically studio to an occasional three-bedroom unit.
Approximately 40% of a typical community is devoted to common areas and
amenities. Residents typically receive basic services such as health
screenings, meal service, housekeeping, local transportation, 24-hour emergency
call system and social and recreational programs. Atria also offers additional
services to residents who may require assistance with at least one activity of
daily living, such as eating and personal hygiene.

Residents are responsible for monthly fees which typically are paid by the
resident or the resident's family members. Assisted and independent living
operations do not presently qualify for reimbursement under Medicare, Medicaid
or Veterans Administration healthcare programs because they do not offer the
levels of care required under such programs. Monthly fees paid by residents are
based upon the resident's apartment size, the number of services the resident
elects to purchase and the level of personal care required by the resident.

The following table lists by state the number of assisted and independent
living communities operated by Atria as of June 30, 1997:

---------------------------------------
NUMBER OF FACILITIES
NUMBER OF -----------------------------
STATE UNITS OWNED(1) LEASED MANAGED TOTAL
- ----- --------- -------- ------ ------- -----

Alabama................................. 40 1 -- -- 1
Arizona................................. 526 4 -- -- 4
California.............................. 272 2 -- -- 2
Colorado................................ 99 1 -- -- 1
Connecticut............................. 123 -- -- 1 1
Florida................................. 626 4 -- -- 4
Georgia................................. 472 6 -- 5 11
Idaho................................... 115 1 -- -- 1
Indiana................................. 135 1 -- 1 2
Kansas.................................. 155 1 -- -- 1
Massachusetts........................... 555 -- 1 1 2
Missouri................................ 172 1 -- -- 1
New Hampshire........................... 28 1 -- -- 1
Tennessee............................... 221 2 -- 1 3
Texas................................... 56 -- 1 -- 1
Utah.................................... 183 2 -- -- 2
Washington.............................. 199 2 -- -- 2
----- --- --- --- ---
Totals................................ 3,977 29 2 9 40
===== === === === ===

- -------
(1) Includes assisted and independent living communities owned by partnerships
in which Atria has a limited and/or general partnership interest.

In connection with Atria's IPO, Atria entered into a $200 million bank credit
facility (the "Atria Credit Facility"). The obligations under the Atria Credit
Facility are secured by all of Atria's property, the capital stock of Atria's
present and future principal subsidiaries and all intercompany indebtedness
owed to Atria by its subsidiaries. The Atria Credit Facility is conditioned
upon, among other things, ownership by the Company of at least 30% of Atria's
common stock. In addition, the Company has agreed to guarantee up to $100
million in the first year following Atria's IPO, declining to $75 million, $50
million and $25 million in each respective year thereafter. Atria has agreed to
pay the Company a fee equal to 1.5% of the average outstanding sum of the
principal balance of all debts guaranteed by the Company.

HOME HEALTH SERVICES

During the summer of 1996, the Company consolidated its home health services
business to establish Vencor Home Health Services. These services include home
health nursing products and services and home infusion therapy. These services
are generally provided to patients on an individual basis. At June 30, 1997,
the Company provided services from 35 locations in 14 states. For the year
ended December 31, 1996, home health services generated approximately $12
million in revenues, representing less than 1% of the Company's total revenues.
For the six months ended June 30, 1997, home health services revenues were
approximately $8.6 million, or 1% of the Company's total revenues. These
revenues are currently included with Vencare revenues.

Significant competition exists for the Company's home health services. The
Company's home health agencies compete on a local and regional basis with other
providers of home health services. The Company believes that the primary
competitive factors for home health services include quality of service,
charges for services provided and attention to the individual needs of
patients.

MANAGEMENT INFORMATION SYSTEM

The financial information for each Company facility is centralized at the
corporate headquarters through its management information system. The Company
uses a comprehensive financial reporting system which enables it to monitor, on
a daily basis, certain key financial data at each facility such as payor mix,
admissions and

discharges, cash collections, net revenues and staffing. In addition, the
financial reporting system provides monthly budget analysis, financial
comparisons to prior periods and comparisons among the Company's facilities.

The Company has developed the VenTouch(TM) electronic patient medical record
system. VenTouch(TM) is a software application which allows nurses, physicians
and other clinicians to manage clinical information utilized in the patient
care delivery process.

Among the features of VenTouch(TM) are on-line access and update of an
electronic patient chart, an on-line trend analysis using electronic flowsheets
and graphs, and remote access for authorized users. Features specific to the
nursing centers include a complete on-line Resident Assessment Instrument
Process that incorporates state specific guidelines, computer generated
Resident Assessment Protocols, on-line HCFA Resident Assessment Instrument
manual and electronic data transfer capabilities. The system is designed to
decrease administrative time, reduce paper and support the delivery of quality
patient care.

The Company completed the installation of VenTouch(TM) in its hospitals during
1995 and began installation of VenTouch(TM) in its nursing centers in 1996. In
addition, during 1997, the Company intends to offer VenTouch(TM) as part of the
menu of services offered by Vencare to nursing centers not owned by the
Company.

GOVERNMENTAL REGULATION

Hospitals
Certificates of Need and State Licensing. CON regulations control the
development and expansion of healthcare services and facilities in certain
states. CON laws generally provide that approval must be obtained from the
designated state health planning agency 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. The stated objective
of the CON process is to promote quality healthcare at the lowest possible cost
and avoid unnecessary duplication of services, equipment and facilities.
Recently, some states (including Florida, Massachusetts and Tennessee) have
amended their CON regulations to require CON approval prior to the conversion
of a hospital from a general short-term facility to a general long-term
facility. Of the 24 states in which the Company's hospitals were located as of
June 30, 1997, Florida, Georgia, Illinois, Kentucky, Louisiana, Massachusetts,
Michigan, Minnesota, Missouri, Nevada, North Carolina, Tennessee, Virginia and
Washington have CON programs. With one exception, the Company was not required
to obtain a CON in connection with previous acquisitions, due to the relatively
low renovation costs and the absence of the need for additional licensed beds
or changes in services. CONs may be required in connection with the Company's
future hospital and contract services expansion. There can be no assurance that
the Company will be able to obtain the CONs necessary for any or all future
projects. If the Company is unable to obtain the requisite CONs, its growth and
business could be adversely affected.

State licensing of hospitals is a prerequisite to the operation of each
hospital and to participation in government programs. Once a hospital becomes
licensed and operational, it must continue to comply with Federal, state and
local licensing requirements in addition to local building and life-safety
codes. All of the Company's hospitals in operation have obtained the necessary
licenses to conduct business.

Medicare and Medicaid. Medicare is a Federal program that provides certain
hospital and medical insurance benefits to persons age 65 and over and certain
disabled persons. Medicaid is a medical assistance program administered by each
state pursuant to which hospital benefits are available to certain indigent
patients. Within the Medicare and Medicaid statutory framework, there are
substantial areas subject to administrative rulings, interpretations and
discretion which may affect payments made under Medicare and Medicaid. A
substantial portion of the Company's hospital revenues is derived from patients
covered by Medicare and Medicaid. See "--Hospital Operations--Sources of
Hospital Revenues."

In order to receive Medicare reimbursement, each hospital must meet the
applicable conditions of participation set forth by the Department of Health
and Human Services ("HHS") relating to the type of hospital, its equipment,
personnel and standard of medical care, as well as comply with state and local
laws and regulations. The Company has developed a management system to ensure
compliance with the various standards and

requirements. Each of the Company's hospitals employs a person who is
responsible for an on-going quality assessment and improvement program.
Hospitals undergo periodic on-site Medicare certification surveys, which are
generally limited if the hospital is accredited by JCAHO. As of June 30, 1997,
all of the Company's hospitals, except one, were certified as Medicare
providers, and 53 of its hospitals were also certified by their respective
state Medicaid programs. Applications are pending for certification with
respect to the Company's other hospitals. A loss of certification could
adversely affect a hospital's ability to receive payments from Medicare and
Medicaid programs.

Prior to 1983, Medicare reimbursed hospitals for the reasonable direct and
indirect cost of the services provided to beneficiaries. The Social Security
Amendments of 1983 implemented PPS as a means of controlling healthcare costs.
Under PPS, Medicare inpatient costs are reimbursed based upon a fixed payment
amount per discharge using diagnosis related groups ("DRGs"). The DRG payment
under PPS is based upon the national average cost of treating a Medicare
patient's condition. Although the average length of stay varies for each DRG,
the average stay for all Medicare patients subject to PPS is approximately six
days. An additional outlier payment is made for patients with unusually
extended lengths of stay or higher treatment costs. Outlier payments are only
designed to cover marginal costs. Additionally, PPS payments can only be made
once every 60 days. Thus, PPS creates an economic incentive for general short-
term hospitals to discharge chronic Medicare patients as soon as clinically
possible. Hospitals that are certified by Medicare as general long-term
hospitals are excluded from PPS. Management believes that the incentive for
short-term hospitals to discharge chronic medical patients as soon as
clinically possible creates a substantial referral source for the Company's
general long-term hospitals.

The Social Security Amendments of 1983 excluded psychiatric, rehabilitation,
cancer, children's and general long-term hospitals from PPS. A general long-
term hospital is defined as a hospital which has an average length of stay
greater than 25 days. Inpatient operating costs for general long-term hospitals
are reimbursed under the cost-based reimbursement system, subject to a computed
target rate (the "Target") per discharge for inpatient operating costs
established by TEFRA. As discussed below, the recently passed Budget Act makes
significant changes to the current TEFRA provisions.

Medicare operating costs per discharge in excess of the Target currently are
reimbursed at the rate of 50% of the excess up to 10% of the Target. Hospitals
whose operating costs are lower than the Target are reimbursed their actual
costs plus an incentive. This incentive is currently equal to 50% of the
difference between their actual costs and the Target and may not exceed 5% of
the Target. For cost report periods beginning on or after October 1, 1997, the
Budget Act reduces the incentive payments to an amount equal to 15% of the
difference between the actual costs and the Target, but not to exceed 2% of the
Target. Costs in excess of the Target will still be reimbursed at the rate of
50% of the excess up to 10% of the Target but the threshold to qualify for such
payments will be raised from 100% to 110% of the Target. The Budget Act also
caps the Targets based on the 75th percentile for each category of hospital
using 1996 data.

Currently, new hospitals may apply for an exemption from the TEFRA Target
provisions. For hospitals certified prior to October 1, 1992, the exemption was
optional and, if granted, lasted for three years. For certifications since
October 1, 1992, the exemption is automatic and is effective for two years.
Under the Budget Act, a new provider will no longer receive cost-based
reimbursement for its first few years in operation. Instead, for the first two
years, it will be paid the lower of its costs or 110% of the median TEFRA
Target for 1996. During this two year period, providers remain subject to the
TEFRA penalty and incentive payments discussed in the previous paragraph.

As of June 30, 1997, 50 of the Company's hospitals were subject to TEFRA Target
provisions. The Company's other hospitals were not subject to TEFRA because
they had qualified for the new hospital exemptions described above. During
1997, three more of the Company's hospitals will become subject to TEFRA Target
provisions. The TEFRA Target limits have not had a material adverse effect on
the Company's results of operation, and the Company does not expect that the
TEFRA limits will have a material effect on the Company's results of operation
in 1997. The reductions in the TEFRA incentive payments may have an adverse
impact on hospital revenues in the future.

Medicare and Medicaid reimbursements are generally determined from annual cost
reports filed by the Company which are subject to audit by the respective
agency administering the programs. Management believes that adequate provisions
for loss have been recorded to reflect any adjustments which could result from
audits of

these cost reports. Adjustments to the Company's cost reports have not had an
adverse effect on the Company's hospital operating results.

Federal regulations provide that admission to and utilization of hospitals by
Medicare and Medicaid patients must be reviewed by peer review organizations
("PROs") in order to ensure efficient utilization of hospitals and services. A
PRO may conduct such review either prospectively or retroactively and may, as
appropriate, recommend denial of payments for services provided to a patient.
Such review is subject to administrative and judicial appeal. Each of the
Company's hospitals employs a clinical professional to administer the
hospital's integrated quality assurance and improvement program, including its
utilization review program. PRO denials have not had an adverse effect on the
Company's hospital operating results.

Medicare and Medicaid Antikickback Amendments prohibit certain business
practices and relationships that might affect the provision and cost of
healthcare services reimbursable under Medicare and Medicaid. Sanctions for
violating the Antikickback Amendments include criminal and civil penalties and
exclusion from the Medicare and Medicaid programs. Pursuant to the Medicare and
Medicaid Patient and Program Protection Act of 1987, HHS and the Office of the
Inspector General ("OIG") specified certain Safe Harbors which describe conduct
and business relationships permissible under the Antikickback Amendments. These
Safe Harbor regulations may result in more aggressive enforcement of the
Antikickback Amendments by HHS and the OIG.

Section 1877 of the Social Security Act (commonly known as "Stark I") states
that a physician who has a financial relationship with a clinical laboratory is
generally prohibited from referring patients to that laboratory. The Omnibus
Budget Reconciliation Act of 1993 contains provisions ("Stark II") amending
Section 1877 to greatly expand the scope of Stark I. Effective January 1995,
Stark II broadened the referral limitations of Stark I to include, among other
designated health services, inpatient and outpatient hospital services. Under
Stark I and Stark II (collectively referred to as the "Stark Provisions"), a
"financial relationship" is defined as an ownership interest or a compensation
arrangement. If such a financial relationship exists, the entity is generally
prohibited from claiming payment for such services under the Medicare or
Medicaid programs. Compensation arrangements are generally exempted from the
Stark Provisions if, among other things, the compensation to be paid is set in
advance, does not exceed fair market value and is not determined in a manner
that takes into account the volume or value of any referrals or other business
generated between the parties. These laws and regulations, however, are
extremely complex and the industry has the benefit of little judicial or
regulatory interpretation. The Company expects that business practices of
providers and financial relationships between providers will be subject to
increased scrutiny as healthcare reform efforts continue on Federal and state
levels.

The Budget Act provides a number of new antifraud and abuse provisions. The
Budget Act contains new civil monetary penalties for violations of the
Antikickback Amendments and imposes an affirmative duty on providers to insure
that they do not employ or contract with persons excluded from the Medicare
program. The Budget Act also provides a minimum ten year period for exclusion
from participation in Federal healthcare programs for persons convicted of a
prior healthcare offense.

JCAHO Accreditation. Hospitals receive accreditation from JCAHO, a nationwide
commission which establishes standards relating to the physical plant,
administration, quality of patient care and operation of medical staffs of
hospitals. Generally, hospitals and certain other healthcare facilities are
required to have been in operation at least six months in order to be eligible
for accreditation by JCAHO. After conducting on-site surveys, JCAHO awards
accreditation for up to three years to hospitals found to be in substantial
compliance with JCAHO standards. Accredited hospitals are periodically
resurveyed, at the option of JCAHO, upon a major change in facilities or
organization and after merger or consolidation. As of June 30, 1997, 55 of the
Company's hospitals were accredited by JCAHO. The Company intends to apply for
JCAHO accreditation for its other hospitals within the next year. The Company
intends to seek and obtain JCAHO accreditation for any additional facilities it
may purchase or lease and convert into long-term hospitals. The Company does
not believe that the failure to obtain JCAHO accreditation at any hospital
would have a material adverse effect on its results of operations.

State Regulatory Environment. The Company currently operates seven hospitals
and a chronic unit in Florida, a state which regulates hospital rates. These
operations contribute a significant portion of the Company's revenues and
operating income from its hospitals. Accordingly, the Company's hospital
revenues and operating

income could be materially adversely affected by Florida rate setting laws or
other cost containment efforts. The Company also operates ten hospitals in
Texas, eight hospitals in California, and five hospitals in Illinois which
contribute a significant portion of the Company's revenues and operating income
from its hospitals. Although Texas, California and Illinois do not currently
regulate hospital rates, the adoption of such legislation or other cost
containment measures in these or other states could have a material adverse
effect on the Company's hospital revenues and operating income. Moreover, the
repeal of the Boren Amendment by the Budget Act provides the states with
greater flexibility to reduce their Medicaid reimbursement levels. The Company
is unable to predict whether and in what form such legislation will be adopted.
Certain other states in which the Company operates hospitals require disclosure
of specified financial information. In evaluating markets for expansion, the
Company considers the regulatory environment, including but not limited to, any
mandated rate setting.

Nursing Centers and Assisted and Independent Living Communities
The Federal government and all states in which the Company operates regulate
various aspects of the Company's nursing center business. In particular, the
development and operation of nursing centers and assisted and independent
living communities and the provision of healthcare services are subject to
Federal, state and local laws relating to the adequacy of medical care,
equipment, personnel, operating policies, fire prevention, rate-setting and
compliance with building codes and environmental laws. Nursing centers are
subject to periodic inspection by governmental and other authorities to assure
continued compliance with various standards, their continued licensing under
state law, certification under the Medicare and Medicaid programs and continued
participation in the Veterans Administration program. Assisted and independent
living communities and their owners are subject to periodic inspection by
governmental authorities to assure compliance with various standards including
standards relating to the financial condition of the owners of such
communities. The failure to obtain or renew any required regulatory approvals
or licenses could adversely affect the Company's operations.

Effective October 1, 1990, OBRA increased the enforcement powers of state and
Federal certification agencies. Additional sanctions were authorized to correct
noncompliance with regulatory requirements, including fines, temporary
suspension of admission of new patients to nursing centers and, in extreme
circumstances, decertification from participation in the Medicare or Medicaid
programs.

Nursing centers managed and operated by the Company are licensed either on an
annual or bi-annual basis and certified annually for participation in Medicare
and Medicaid programs through various regulatory agencies which determine
compliance with Federal, state and local laws. These legal requirements relate
to the quality of the nursing care provided, the qualifications of the
administrative personnel and nursing staff, the adequacy of the physical plant
and equipment and continuing compliance with the laws and regulations governing
the operation of nursing centers. From time to time the Company's nursing
centers receive statements of deficiencies from regulatory agencies. In
response, the Company implements plans of correction with respect to these
nursing centers to address the alleged deficiencies. The Company believes that
its nursing centers are in material compliance with all applicable regulations
or laws.

In certain circumstances, Federal law mandates that conviction for certain
abusive or fraudulent behavior with respect to one nursing center may subject
other facilities under common control or ownership to disqualification for
participation in Medicare and Medicaid programs. In addition, some state
regulations provide that all nursing centers under common control or ownership
within a state are subject to delicensure if any one or more of such facilities
are delicensed.

Revised Federal regulations under OBRA, which became effective in 1995, affect
the survey process for nursing centers and the authority of state survey
agencies and the Health Care Financing Administration to impose sanctions on
facilities based upon noncompliance with requirements. Available sanctions
include imposition of civil monetary penalties, temporary suspension of payment
for new admissions, appointment of a temporary manager, suspension of payment
for eligible patients and suspension or decertification from participation in
the Medicare and/or Medicaid programs. The Company is unable to project how
these regulatory changes and their implementation will affect the Company.

In addition to license requirements, many states in which the Company operates
have statutes that require a CON to be obtained prior to the construction of a
new nursing center, the addition of new beds or services or the incurring of
certain capital expenditures. Certain states also require regulatory approval
prior to certain changes in ownership of a nursing center. Certain states in
which the Company operates have eliminated their CON programs and other states
are considering alternatives to their CON programs. To the extent that CONs or
other similar approvals are required for expansion of Company operations,
either through facility acquisitions or expansion or provision of new services
or other changes, such expansion could be adversely affected by the failure or
inability to obtain the necessary approvals, changes in the standards
applicable to such approvals or possible delays and expenses associated with
obtaining such approvals.

The Company's operations are also subject to Federal and state laws which
govern financial and other arrangements between healthcare providers. These
laws often prohibit certain direct and indirect payments or fee-splitting
arrangements between healthcare providers that are designed to induce or
encourage the referral of patients to, or the recommendation of, a particular
provider for medical products and services. Such laws include the Antikickback
Amendments. These provisions prohibit, among other things, the offer, payment,
solicitation or receipt of any form of remuneration in return for the referral
of Medicare and Medicaid patients. These operations also are subject to
additional antifraud and abuse provisions contained in the Budget Act. In
addition, some states restrict certain business relationships between
physicians and pharmacies, and many states prohibit business corporations from
providing, or holding themselves out as a provider of, medical care. Possible
sanctions for violation of any of these restrictions or prohibitions include
loss of licensure or eligibility to participate in reimbursement programs as
well as civil and criminal penalties. These laws vary from state to state.

A substantial portion of the Company's nursing center revenues are derived from
patients covered by Medicare and Medicaid. The Budget Act requires the
establishment of a prospective payment system for nursing centers for cost
reporting periods beginning on or after July 1, 1998. During the first three
years, the per diem rates for nursing centers will be based on a blend of
facility-specific costs and Federal costs. Thereafter, the per diem rates will
be based solely on Federal costs. The rates for such services have not been
established or published. The prospective payment system also will cover
ancillary services provided to nursing center patients under the Company's
Vencare contract services business.

Pharmacies
Pharmaceutical operations are subject to regulation by the various states in
which the Company conducts its business as well as by the Federal government.
The Company's pharmacies are regulated under the Food, Drug and Cosmetic Act
and the Prescription Drug Marketing Act, which are administered by the United
States Food and Drug Administration. Under the Comprehensive Drug Abuse
Prevention and Control Act of 1970, which is administered by the United States
Drug Enforcement Administration ("DEA"), dispensers of controlled substances
must register with the DEA, file reports of inventories and transactions and
provide adequate security measures. Failure to comply with such requirements
could result in civil or criminal penalties.

Healthcare Reform
In recent years, an increasing number of legislative proposals have been
introduced or proposed in Congress and in some state legislatures that could
effect major changes in the healthcare system. The Budget Act, enacted in
August 1997, contains extensive changes to the Medicare and Medicaid programs
intended to reduce payments under those programs by $115 billion and $13
billion, respectively, over the next five years. Under the Budget Act, annual
growth rates for Medicare were reduced from over 10% to approximately 7.5% for
the next five years based on specific program baseline projections from the
last five years. Virtually all spending reductions will come from providers and
changes in program components. The Budget Act affects reimbursement systems for
each of the Company's operating units.

The Budget Act will reduce payments made to the Company's hospitals by reducing
TEFRA incentive payments, reducing allowable costs for capital expenditures and
bad debts and reducing payments for services to patients transferred from a
prospective payment system hospital. The Budget Act also requires the
establishment of a prospective payment system for nursing centers for cost
reporting periods beginning on or after July 1, 1998.

During the first three years, the per diem rates for nursing centers will be
based on a blend of facility-specific costs and Federal costs. Thereafter, the
per diem rates will be based solely on Federal costs. The rates for such
services have not been established or published. The prospective payment system
also will cover ancillary services provided to nursing center patients under
the Company's Vencare contract services business. The Budget Act also requires
the establishment of an interim prospective payment system for home health
services for cost reporting periods beginning on or after October 1, 1997. The
interim system will establish per visit limits and per beneficiary annual
limits. A permanent prospective payment system for home health services will be
established by October 1, 1999.

In March 1997, the HCFA issued a proposed rule to change Medicare reimbursement
guidelines for therapy services provided by the Company (including the
rehabilitation contract therapy business acquired as part of the TheraTx
Merger). Under the proposed rule, HCFA would revise the current salary
equivalency guidelines for speech and occupational therapy services. The
proposed guidelines are based on a blend of data from wage rates for hospitals
and nursing facilities, and include salary, fringe benefit and expense factors.
Rates are defined by specific geographic market areas, based upon a modified
version of the hospital wage index. HCFA is considering comments but has not
issued a final rule at this time. The Company cannot predict when the final
regulation will be issued or if changes will be made to the proposed
guidelines.

EMPLOYEES

As of June 30, 1997, the Company had approximately 52,300 full-time and 24,300
part-time and per diem employees. The Company was a party to 24 collective
bargaining agreements covering approximately 2,500 employees as of June 30,
1997.

LIABILITY INSURANCE

The Company's hospitals, contract services, nursing centers and pharmaceutical
operations are insured by the Company's wholly-owned captive insurance company,
Cornerstone Insurance Company. Cornerstone Insurance Company reinsures losses
in excess of $500,000 per claim and $8.0 million in annual aggregation.
Coverages for losses in excess of various limits are maintained through
unrelated commercial insurance carriers to provide $130.0 million limits per
claim and in the aggregate.

The Company believes that its insurance is adequate in amount and coverage.
There can be no assurance that in the future such insurance will be available
at a reasonable price or that the Company will be able to maintain adequate
levels of malpractice insurance coverage.

MANAGEMENT

Set forth below are the present directors and executive officers of the
Company, their ages (as of June 30, 1997) and their positions with the Company:

NAME AGE POSITIONS
- ---- --- ---------

W. Bruce Lunsford(1).... 49 Chairman of the Board, President and Chief Executive Officer
Michael R. Barr......... 48 Chief Operating Officer, Executive Vice President and Director
W. Earl Reed, III....... 45 Chief Financial Officer, Executive Vice President and Director
Thomas T. Ladt.......... 46 Executive Vice President, Operations
Jill L. Force........... 45 Senior Vice President, General Counsel and Corporate Secretary
James H. Gillenwater,
Jr..................... 40 Senior Vice President, Planning and Development
Richard A. Lechleiter... 39 Vice President, Finance and Corporate Controller
Walter F. Beran(2)...... 71 Director
Ulysses L. Bridgeman,
Jr.(3)................. 43 Director
Elaine L. Chao(3)....... 44 Director
Donna R. Ecton(3)....... 50 Director
Greg D. Hudson(2)....... 48 Director
William H.
Lomicka(1)(3).......... 60 Director
R. Gene Smith(1)(2)..... 62 Director

- -------
(1) Member of the Executive Committee, of which W. Bruce Lunsford is Chairman.
(2) Member of the Executive Compensation Committee, of which R. Gene Smith is
Chairman.
(3) Member of the Audit Committee, of which William H. Lomicka is Chairman.

W. Bruce Lunsford, a founder of the Company, certified public accountant and
attorney, has served as Chairman of the Board, President and Chief Executive
Officer of the Company since the Company commenced operations in 1985. Mr.
Lunsford is the Chairman of the Board of Atria Communities, Inc. and a director
of National City Corporation, a bank holding company, Churchill Downs
Incorporated, and Res-Care, Inc., a provider of residential training and
support services for persons with developmental disabilities and certain
vocational training services.

Michael R. Barr, a founder of the Company, physical therapist and certified
respiratory therapist, has served as Chief Operating Officer and Executive Vice
President of the Company since February 1996. From November 1995 to February
1996, he was Executive Vice President of the Company and Chief Executive
Officer of the Company's Hospital Division. Mr. Barr served as Vice President,
Operations from 1985 to November 1995. He has been a director of the Company
since 1985. Mr. Barr is a director of Colorado MEDtech, Inc., a medical
products and equipment company.

W. Earl Reed, III, a certified public accountant, has served as a director of
the Company since 1987. He has been Chief Financial Officer and Executive Vice
President of the Company since November 1995. From 1987 to November 1995, Mr.
Reed served as Vice President, Finance and Development of the Company.

Thomas T. Ladt has served as Executive Vice President, Operations of the
Company since February 1996. From November 1995 to February 1996, he served as
President of the Company's Hospital Division. From 1993 to November 1995, Mr.
Ladt was Vice President of the Company's Hospital Division. From 1989 to
December 1993, Mr. Ladt was a Regional Director of Operations for the Company.
Mr. Ladt is a director of Atria Communities, Inc.

Jill L. Force, a certified public accountant and attorney, has served as Senior
Vice President, General Counsel and Corporate Secretary of the Company since
December 1996. From November 1995 through December 1996, she served as Vice
President, General Counsel and Corporate Secretary of the Company. From 1989 to
1995, she was General Counsel and Corporate Secretary of the Company. Ms. Force
is a director of Healthcare Recoveries, Inc., a provider of health insurance
subrogation and related recovery services.

James H. Gillenwater, Jr. has served as Senior Vice President, Planning and
Development of the Company since December 1996. From November 1995 through
December 1996, he served as Vice President, Planning and Development of the
Company. From 1989 to November 1995, he was Director of Planning and
Development of the Company.

Richard A. Lechleiter, a certified public accountant, has served as Vice
President, Finance and Corporate Controller of the Company since November 1995.
From June 1995 to November 1995, he was Director of Finance of the Company. Mr.
Lechleiter was Vice President and Controller of Columbia/HCA Healthcare Corp.
from September 1993 to May 1995, of Galen Health Care, Inc. from March 1993 to
August 1993, and of Humana Inc. from September 1990 to February 1993.

Walter F. Beran has served as a director of the Company since September 1995.
Since September 1986, Mr. Beran has served as Chairman of the Pacific Alliance
Group, a merger and acquisition services firm. Previously, Mr. Beran served as
Vice Chairman and Western Regional Managing Partner of the accounting firm of
Ernst & Whinney (now Ernst & Young LLP) from 1971 until his retirement in
September 1986. Mr. Beran also serves as a director of Arco Chemical Company,
Pacific Scientific Company and Fleetwood Enterprise, Inc.

Ulysses L. Bridgeman, Jr. has been a director of the Company since May 1997.
Mr. Bridgeman has been President of Bridgeman Foods, Inc., a franchisee of 51
Wendy's Old Fashioned Hamburger Restaurants, since 1988.

Elaine L. Chao has been a director of the Company since May 1997. Ms. Chao is a
Distinguished Fellow of The Heritage Foundation in Washington, D.C. From 1992
to 1996, Ms. Chao was President and Chief Executive Officer of the United Way
of America. From 1991 to 1992, she served as the Director of the Peace Corps.
Ms. Chao is a director of Dole Food Company, Inc. and NASD, Inc.

Donna R. Ecton has served as a director of the Company since 1992. Since
December 1996, Ms. Ecton has been Chief Operating Officer of PETsMART, Inc., a
pet supplies retailer. From 1995 to 1996, she was Chairman, President and Chief
Executive Officer of Business Mail Express, Inc., an expedited print and mail
services company. From 1991 to 1994, she was President and Chief Executive
Officer of Van Houten North America, Inc. and Andes Candies Inc., a
confectionery products businesses. Ms. Ecton is a director of Barnes Group,
Inc., a diversified manufacturing, aerospace and distribution company,
PETsMART, Inc., and H&R Block, Inc.

Greg D. Hudson has served as a director of the Company since 1991. He has been
President of Hudson Chevrolet-Oldsmobile, Inc. since 1988.

William H. Lomicka has served as a director of the Company since 1987. Since
1989, he has served as President of Mayfair Capital, Inc., a private investment
firm. Mr. Lomicka serves as a director of Regal Cinemas, Inc., a regional
motion picture exhibitor, and Sabratek Corporation, a company which designs,
produces and markets medical products for the alternative site healthcare
marketplace.

R. Gene Smith, a founder of the Company, has served as a director of the
Company since 1985 and Vice Chairman of the Board since 1987. From 1987 to
1995, Mr. Smith was President of New Jersey Blockbuster, Ltd., which held the
Blockbuster Video franchise for northern New Jersey. Since 1988, Mr. Smith has
been Chairman of the Board of Taco Tico, Inc., an operator of Mexican fast-food
restaurants. Since 1993, Mr. Smith has been Managing General Partner of Direct
Programming Services, which was a marketer of direct broadcast satellite
television services through 1996. In addition, he has been President and owner
of R. Gene Smith, Inc., a private investment firm, since 1980. Mr. Smith is
also a director of Atria Communities, Inc.

DESCRIPTION OF THE CREDIT AGREEMENT

GENERAL

Morgan Guaranty, as documentation agent and collateral agent, NationsBank, as
administrative agent, and a syndicate of other financial institutions (the
"Bank Group") have established a $2.0 billion revolving credit facility in
favor of the Company pursuant to a Credit Agreement dated as of March 17, 1997,
and as thereafter amended and restated from time to time (the "Credit
Agreement"). Pursuant to the Credit Agreement, the Company has the right to
obtain certain loans and letters of credit to finance acquisitions and capital
expansion projects by the Company and its subsidiaries and to refinance debt
incurred in connection therewith, as well as to support the general corporate
purposes of the Company and its subsidiaries. The Company has the further right
under the Credit Agreement to request NationsBank, as the swingline bank under
the Credit Agreement, to make certain swingline loans to the Company to provide
funds to the Company for the purposes permitted under the Credit Agreement
until the Company obtains a borrowing from the Bank Group. The Credit Agreement
expires on March 31, 2002.

SECURITY

The obligations of the Company under the Credit Agreement have been guaranteed
by those direct and indirect wholly-owned subsidiaries of the Company
designated by the Company as "material subsidiaries." The Company must
designate as "material subsidiaries" those subsidiaries of the Company whose
total assets equal at least 90% of the total assets of the Company and its
subsidiaries as determined on a consolidated basis. The obligations of the
Company under the Credit Agreement are further secured by a pledge of the
equity interests of all "material subsidiaries" of the Company, other than any
such equity interests that constitute margin stock within the meaning of
Regulation U promulgated by the Federal Reserve Board.

INTEREST RATES

Borrowings under the Credit Agreement bear interest, at the option of the
Company, by reference to the Base Rate, the Adjusted CD Rate or the London
Interbank Offered Rate, as each such term is defined in the Credit Agreement.
The actual interest rates applicable to borrowings under the Credit Agreement,
as well as the fees imposed for the issuance or renewal of letters of credit
under the Credit Agreement, are determined based upon the Company's then
existing leverage ratio, which is defined in the Credit Agreement as the ratio
of the Company's consolidated debt for borrowed money to its consolidated
earnings before interest, taxes, depreciation and amortization. The interest
rates and the letter of credit fees set forth in the Credit Agreement are
subject to change as the Company's leverage ratio increases or decreases. The
Company also has the right under the Credit Agreement to solicit the Bank Group
to make certain money market loans to the Company, which are loans to the
Company at interest rates bid by those members of the Bank Group that have
offered to make such money market loans to the Company.

MANDATORY REDUCTION OF CREDIT AGREEMENT

The Credit Agreement is subject to mandatory reduction from $2.0 billion to
$1.5 billion on March 31, 2001.

COVENANTS

The Credit Agreement imposes certain affirmative and negative covenants on the
Company and its subsidiaries. As part of these covenants, the Company is
required to meet four separate financial tests, including a minimum net worth
test, a maximum leverage ratio, a minimum fixed charge coverage ratio and a
maximum senior debt leverage ratio. The negative covenants in the Credit
Agreement restrict or limit, among other things, (i) the incurrence of certain
debt by the Company and its subsidiaries, (ii) the pledge of assets of the
Company and its subsidiaries to secure certain debt for borrowed money, (iii)
certain mergers, consolidations and sales of assets by the Company and its
subsidiaries, (iv) the payment of certain dividends or distributions by the
Company and the redemption, purchase, retirement or other acquisition of the
equity interests of the Company, (v) the investment by the Company and its
subsidiaries in certain minority-owned affiliates, (vi) certain other

transactions with affiliates of the Company and (vii) the Company and its
subsidiaries from agreeing to any restriction, other than in the Credit
Agreement and certain other identified agreements, that prohibits any
subsidiary of the Company from paying dividends or repaying debt to the Company
or any of its subsidiaries, from making any loans or advances to the Company or
any of its subsidiaries, or from granting any liens or security interests in
its assets to secure the obligations of the Company or any of its subsidiaries
under the Credit Agreement.

EVENTS OF DEFAULT

The Credit Agreement provides that certain events will constitute events of
default under the Credit Agreement, which events include the failure by the
Company to pay amounts owed under the Credit Agreement, the failure by the
Company or its subsidiaries to observe or perform the covenants set forth in
the Credit Agreement, the inaccuracy of the representations and warranties set
forth in the Credit Agreement, the imposition of certain judgments against the
Company or its subsidiaries, the failure by the Company or its subsidiaries to
pay certain other debt of the Company and its subsidiaries, the occurrence of
certain bankruptcy or insolvency proceedings or events with respect to the
Company or its subsidiaries, the invalidity or unenforceability of any lien or
guaranty securing the obligations of the Company under the Credit Agreement, or
the occurrence of a change of control of the Company, which is defined in the
Credit Agreement as the acquisition of beneficial ownership of 35% or more of
the outstanding shares of common stock of the Company by a person or a related
group of persons or the replacement of a majority of the members of the board
of directors of the Company within a period of 24 consecutive months.

FEES AND EXPENSES

The Credit Agreement provides that the Company will pay certain facility fees
to the Bank Group, the amount of which is dependent upon the Company's then
existing leverage ratio. The Company is also obligated to pay certain other
fees and third party expenses incurred by Morgan Guaranty as the documentation
agent and the collateral agent under the Credit Agreement and by NationsBank as
the administrative agent under the Credit Agreement.

THE EXCHANGE OFFER

PURPOSE OF THE EXCHANGE OFFER

In connection with the sale of the Old Notes, the Company entered into the
Registration Rights Agreement with the Initial Purchasers, pursuant to which
the Company agreed to use its best efforts to file with the Commission a
registration statement with respect to the exchange of the Old Notes for debt
securities with terms identical in all material respects to the terms of the
Old Notes, except that (i) the offer and sale of the New Notes have been
registered under the Securities Act and therefore the New Notes will not be
subject to certain restrictions on transfer applicable to the Old Notes, will
not contain certain legends relating thereto and will not be entitled to
registration and other rights under the Registration Rights Agreement, and (ii)
the New Notes will not provide for any increase in the interest rate thereon.
In that regard, the Old Notes provide, among other things, that, if the
Exchange Offer is not consummated or the Shelf Registration Statement is not
declared effective by December 18, 1997, the Company will pay additional
interest (in addition to the interest otherwise due on the Old Notes) to each
Holder of Old Notes during the first 90-day period following December 18, 1997,
in an amount equal to 0.25% per annum. The amount of interest will increase by
an additional 0.25% per annum for each subsequent 90-day period until
consummation of the Exchange Offer or the effectiveness of a Shelf Registration
Statement, up to a maximum amount of additional interest of 1.00% per annum.
Upon consummation of the Exchange Offer or the effectiveness of the Shelf
Registration Statement, Holders of Old Notes will not be entitled to any
increase in the rate of interest thereon or any further registration rights
under the Registration Rights Agreement. See "Summary--Certain Consequences of
a Failure to Exchange Old Notes" and "Description of the Old Notes."

The Exchange Offer is not being made to, nor will the Company accept tenders
for exchange from, Holders of Old Notes in any jurisdiction in which the
Exchange Offer or the acceptance therefor would not be in compliance with the
securities or blue sky laws of such jurisdiction.

TERMS OF THE EXCHANGE

The Company hereby offers, upon the terms and subject to the conditions set
forth in this Prospectus and in the accompanying Letter of Transmittal, to
exchange up to $750 million aggregate principal amount of New Notes for a like
aggregate principal amount of Old Notes properly tendered on or prior to the
Expiration Date and not properly withdrawn in accordance with the procedures
described below. The Company will issue, promptly after the Expiration Date, an
aggregate principal amount of up to $750 million of New Notes in exchange for a
like principal amount of outstanding Old Notes tendered and accepted in
connection with the Exchange Offer.

The Exchange Offer is not conditioned upon any minimum principal amount of Old
Notes being tendered. As of the date of this Prospectus, $750 million aggregate
principal amount of Old Notes is outstanding.

Holders of Old Notes do not have any appraisal or dissenters' rights in
connection with the Exchange Offer. Old Notes which are not tendered for
exchange or are tendered but not accepted in connection with the Exchange Offer
will remain outstanding and be entitled to the benefits of the Indenture, but
will not be entitled to any further registration rights under the Registration
Rights Agreement.

If any tendered Old Notes are not accepted for exchange because of an invalid
tender, the occurrence of certain other events set forth herein or otherwise,
certificates for any such unaccepted Old Notes will be returned, without
expense, to the tendering Holder thereof promptly after the Expiration Date.

Holders who tender Old Notes in connection with the Exchange Offer will not be
required to pay brokerage commissions or fees or, subject to the instructions
in the Letter of Transmittal, transfer taxes with respect to the exchange of
Old Notes in connection with the Exchange Offer. The Company will pay all
charges and expenses, other than certain applicable taxes described below, in
connection with the Exchange Offer. See "--Fees and Expenses."

NEITHER THE BOARD OF DIRECTORS OF THE COMPANY NOR THE COMPANY MAKES ANY
RECOMMENDATION TO HOLDERS OF OLD NOTES AS TO WHETHER TO TENDER OR REFRAIN FROM
TENDERING ALL OR ANY PORTION OF THEIR OLD NOTES PURSUANT TO THE EXCHANGE OFFER.
IN ADDITION, NO ONE HAS BEEN AUTHORIZED TO MAKE ANY SUCH RECOMMENDATION.
HOLDERS OF OLD NOTES MUST MAKE THEIR OWN DECISION WHETHER TO TENDER PURSUANT TO
THE EXCHANGE OFFER AND, IF SO, THE AGGREGATE AMOUNT OF OLD NOTES TO TENDER
AFTER READING THIS PROSPECTUS AND THE LETTER OF TRANSMITTAL AND CONSULTING WITH
THEIR ADVISERS, IF ANY, BASED ON THEIR OWN FINANCIAL POSITION AND REQUIREMENTS.

EXPIRATION DATE; EXTENSIONS; AMENDMENTS

The term "Expiration Date" means 5:00 p.m., New York City time, on November 21,
1997, unless the Exchange Offer is extended by the Company (in which case the
term "Expiration Date" shall mean the latest date and time to which the
Exchange Offer is extended).

The Company expressly reserves the right in its sole and absolute discretion,
subject to applicable law, at any time and from time to time, (i) to delay the
acceptance of the Old Notes for exchange, (ii) to terminate the Exchange Offer
(whether or not any Old Notes have theretofore been accepted for exchange) if
the Company determines, in its sole and absolute discretion, that any of the
events or conditions referred to under "--Certain Conditions to the Exchange
Offer" have occurred or exist or have not been satisfied, (iii) to extend the
Expiration Date of the Exchange Offer and retain all Old Notes tendered
pursuant to the Exchange Offer, subject, however, to the right of Holders of
Old Notes to withdraw their tendered Old Notes as described under""--Withdrawal
Rights," and (iv) to waive any condition or otherwise amend the terms of the
Exchange Offer in any respect. If the Exchange Offer is amended in a manner
determined by the Company to constitute a material change, or if the Company
waives a material condition of the Exchange Offer, the Company will promptly
disclose such amendment by means of a prospectus supplement that will be
distributed to the registered Holders of Old Notes, and the Company will extend
the Exchange Offer to the extent required by Rule 14e-1 under the Exchange Act.

Any such delay in acceptance, extension, termination or amendment will be
followed promptly by oral or written notice thereof to the Exchange Agent and
by making a public announcement thereof, and such announcement in the case of
an extension will be made no later than 9:00 a.m., New York City time, on the
next business day after the previously scheduled Expiration Date. Without
limiting the manner in which the Company may choose to make any public
announcement and subject to applicable law, the Company shall have no
obligation to publish, advertise or otherwise communicate any such public
announcement other than by issuing a release to the Dow Jones News Service.

ACCEPTANCE FOR EXCHANGE AND ISSUANCE OF NEW NOTES

Upon the terms and subject to the conditions of the Exchange Offer, the Company
will exchange, and will issue to the Exchange Agent, New Notes for Old Notes
validly tendered and not withdrawn (pursuant to the withdrawal rights described
under "--Withdrawal Rights") promptly after the Expiration Date.

In all cases, delivery of New Notes in exchange for Old Notes tendered and
accepted for exchange pursuant to the Exchange Offer will be made only after
timely receipt by the Exchange Agent of (i) Old Notes or a book-entry
confirmation of a book-entry transfer of Old Notes into the Exchange Agent's
account at The Depository Trust Company ("DTC"), (ii) the Letter of
Transmittal, properly completed and duly executed, with any required signature
guarantees, and (iii) any other documents required by the Letter of
Transmittal.

The term "book-entry confirmation" means a timely confirmation of a book-entry
transfer of Old Notes into the Exchange Agent's account at DTC.

Subject to the terms and conditions of the Exchange Offer, the Company will be
deemed to have accepted for exchange, and thereby exchanged, Old Notes validly
tendered and not withdrawn as, if and when the Company gives oral or written
notice to the Exchange Agent of the Company's acceptance of such Old Notes for
exchange

pursuant to the Exchange Offer. The Exchange Agent will act as agent for the
Company for the purpose of receiving tenders of Old Notes, Letters of
Transmittal and related documents, and as agent for tendering Holders for the
purpose of receiving Old Notes, Letters of Transmittal and related documents
and transmitting New Notes to validly tendering Holders. Such exchange will be
made promptly after the Expiration Date. If, for any reason whatsoever,
acceptance for exchange or the exchange of any Old Notes tendered pursuant to
the Exchange Offer is delayed (whether before or after the Company's acceptance
for exchange of Old Notes) or the Company extends the Exchange Offer or is
unable to accept for exchange or exchange Old Notes tendered pursuant to the
Exchange Offer, then, without prejudice to the Company's rights set forth
herein, the Exchange Agent may, nevertheless, on behalf of the Company and
subject to Rule 14e-1(c) under the Exchange Act, retain tendered Old Notes and
such Old Notes may not be withdrawn except to the extent tendering Holders are
entitled to withdrawal rights as described under "--Withdrawal Rights."

Pursuant to the Letter of Transmittal, a Holder of Old Notes will warrant and
agree in the Letter of Transmittal that it has full power and authority to
tender, exchange, sell, assign and transfer Old Notes, that the Company will
acquire good, marketable and unencumbered title to the tendered Old Notes, free
and clear of all liens, restrictions, charges and encumbrances, and the Old
Notes tendered for exchange are not subject to any adverse claims or proxies.
The Holder also will warrant and agree that it will, upon request, execute and
deliver any additional documents deemed by the Company or the Exchange Agent to
be necessary or desirable to complete the exchange, sale, assignment and
transfer of the Old Notes tendered pursuant to the Exchange Offer.

PROCEDURES FOR TENDERING OLD NOTES

Valid Tender. Except as set forth below, in order for Old Notes to be validly
tendered pursuant to the Exchange Offer, a properly completed and duly executed
Letter of Transmittal, with any required signature guarantees and any other
required documents, must be received by the Exchange Agent at one of its
addresses set forth under "--Exchange Agent," and either (i) tendered Old Notes
must be received by the Exchange Agent, or (ii) such Old Notes must be tendered
pursuant to the procedures for book-entry transfer set forth below and a book-
entry confirmation must be received by the Exchange Agent, in each case on or
prior to the Expiration Date, or (iii) the guaranteed delivery procedures set
forth below must be complied with.

If less than all of the Old Notes are tendered, a tendering Holder should fill
in the amount of Old Notes being tendered in the appropriate box on the Letter
of Transmittal. The entire amount of Old Notes delivered to the Exchange Agent
will be deemed to have been tendered unless otherwise indicated.

THE METHOD OF DELIVERY OF CERTIFICATES, THE LETTER OF TRANSMITTAL AND ALL OTHER
REQUIRED DOCUMENTS IS AT THE OPTION AND SOLE RISK OF THE TENDERING HOLDER, AND
DELIVERY WILL BE DEEMED MADE ONLY WHEN ACTUALLY RECEIVED BY THE EXCHANGE AGENT.
IF DELIVERY IS BY MAIL, REGISTERED MAIL, RETURN RECEIPT REQUESTED, PROPERLY
INSURED, OR AN OVERNIGHT DELIVERY SERVICE IS RECOMMENDED. IN ALL CASES,
SUFFICIENT TIME SHOULD BE ALLOWED TO ENSURE TIMELY DELIVERY.

Book-Entry Transfer. The Exchange Agent will establish an account with respect
to the Old Notes at DTC for purposes of the Exchange Offer within two business
days after the date of this Prospectus. Any financial institution that is a
participant in DTC's book-entry transfer facility system may make a book-entry
delivery of the Old Notes by causing DTC to transfer such Old Notes into the
Exchange Agent's account at DTC in accordance with DTC's procedures for
transfers. However, although delivery of Old Notes may be effected through
book-entry transfer into the Exchange Agent's account at DTC, the Letter of
Transmittal properly completed and duly executed, with any required signature
guarantees and any other required documents, must in any case be delivered to
and received by the Exchange Agent at its address set forth under "--Exchange
Agent" on or prior to the Expiration Date, or the guaranteed delivery
procedures set forth below must be complied with.

DELIVERY OF DOCUMENTS TO DTC IN ACCORDANCE WITH DTC'S PROCEDURES DOES NOT
CONSTITUTE DELIVERY TO THE EXCHANGE AGENT.

Signature Guarantees. Certificates for the Old Notes need not be endorsed and
signature guarantees on the Letter of Transmittal are unnecessary unless (a) a
certificate for the Old Notes is registered in a name other than that of the
person surrendering the certificate or (b) such registered Holder completes the
box entitled "Special Issuance Instructions" or "Special Delivery Instructions"
in the Letter of Transmittal. In the case of (a) or (b) above, such
certificates for Old Notes must be duly endorsed or accompanied by a properly
executed bond power, with the endorsement or signature on the bond power and on
the Letter of Transmittal guaranteed by a firm or other entity identified in
Rule 17Ad-15 under the Exchange Act as an "eligible guarantor institution,"
including (as such terms are defined therein): (i) a bank; (ii) a broker,
dealer, municipal securities broker or dealer or government securities broker
or dealer; (iii) a credit union; (iv) a national securities exchange,
registered securities association or clearing agency; or (v) a savings
association that is a participant in a Securities Transfer Association (an
"Eligible Institution"), unless surrendered on behalf of such Eligible
Institution. See Instruction 1 to the Letter of Transmittal.

Guaranteed Delivery. If a Holder desires to tender Old Notes pursuant to the
Exchange Offer and the certificates for such Old Notes are not immediately
available or time will not permit all required documents to reach the Exchange
Agent on or before the Expiration Date, or the procedures for book-entry
transfer cannot be completed on a timely basis, such Old Notes may nevertheless
be tendered, provided that all of the following guaranteed delivery procedures
are complied with:

(i) such tenders are made by or through an Eligible Institution;

(ii) a properly completed and duly executed Notice of Guaranteed Delivery,
substantially in the form accompanying the Letter of Transmittal, is
received by the Exchange Agent, as provided below, on or prior to the
Expiration Date; and

(iii) the certificates (or a book-entry confirmation) representing all
tendered Old Notes, in proper form for transfer, together with a properly
completed and duly executed Letter of Transmittal, with any required
signature guarantees and any other documents required by the Letter of
Transmittal, are received by the Exchange Agent within three New York Stock
Exchange trading days after the date of execution of such Notice of
Guaranteed Delivery.

The Notice of Guaranteed Delivery may be delivered by hand or transmitted by
mail (or facsimile in the case of an Eligible Institution) to the Exchange
Agent and must include a guarantee by an Eligible Institution in the form set
forth in such notice.

Notwithstanding any other provision hereof, the delivery of New Notes in
exchange for Old Notes tendered and accepted for exchange pursuant to the
Exchange Offer will in all cases be made only after timely receipt by the
Exchange Agent of Old Notes, or of a book-entry confirmation with respect to
such Old Notes, and a properly completed and duly executed Letter of
Transmittal, together with any required signature guarantees and any other
documents required by the Letter of Transmittal. Accordingly, the delivery of
New Notes might not be made to all tendering Holders at the same time, and will
depend upon when Old Notes, book-entry confirmations with respect to Old Notes
and other required documents are received by the Exchange Agent.

The Company's acceptance for exchange of Old Notes tendered pursuant to any of
the procedures described above will constitute a binding agreement between the
tendering Holder and the Company upon the terms and subject to the conditions
of the Exchange Offer.

Determination of Validity. All questions as to the form of documents, validity,
eligibility (including time of receipt) and acceptance for exchange of any
tendered Old Notes will be determined by the Company, in its sole discretion,
whose determination shall be final and binding on all parties. The Company
reserves the absolute right, in its sole and absolute discretion, to reject any
and all tenders determined by it not to be in proper form or the acceptance of
which, or exchange for, may, in the view of counsel to the Company, be
unlawful. The Company also reserves the absolute right, subject to applicable
law, to waive any of the conditions of the Exchange Offer as set forth under
"--Certain Conditions to the Exchange Offer" or any condition or irregularity
in any tender of Old Notes of any particular Holder whether or not similar
conditions or irregularities are waived in the case of other Holders.

The Company's interpretation of the terms and conditions of the Exchange Offer
(including the Letter of Transmittal and the instructions thereto) will be
final and binding. No tender of Old Notes will be deemed to have been validly
made until all irregularities with respect to such tender have been cured or
waived. Neither the Company, any affiliates or assigns of the Company, the
Exchange Agent nor any other person shall be under any duty to give any
notification of any irregularities in tenders or incur any liability for
failure to give any such notification.

If any Letter of Transmittal, endorsement, bond power, power of attorney, or
any other document required by the Letter of Transmittal is signed by a
trustee, executor, administrator, guardian, attorney-in-fact, officer of a
corporation or other person acting in a fiduciary or representative capacity,
such person should so indicate when signing, and unless waived by the Company,
proper evidence satisfactory to the Company, in its sole discretion, of such
person's authority to so act must be submitted.

A beneficial owner of Old Notes that are held by or registered in the name of a
broker, commercial bank, trust company or other nominee or custodian is urged
to contact such entity promptly if such beneficial owner wishes to participate
in the Exchange Offer.

RESALES OF NEW NOTES

The Company is making the Exchange Offer in reliance on the position of the
staff of the Division of Corporation Finance of the Commission as set forth in
certain interpretative letters addressed to third parties in other
transactions. The Company, however, has not sought its own interpretative
letter and there can be no assurance that the staff of the Division of
Corporation Finance of the Commission would make a similar determination with
respect to the Exchange Offer as it has in such interpretative letters to third
parties. Based on these interpretations by the staff of the Division of
Corporation Finance of the Commission, and subject to the two immediately
following sentences, the Company believes that the New Notes issued pursuant to
this Exchange Offer in exchange for Old Notes may be offered for resale, resold
and otherwise transferred by a Holder thereof (other than a Holder who is a
broker-dealer) without further compliance with the registration and prospectus
delivery requirements of the Securities Act, provided that such New Notes are
acquired in the ordinary course of such Holder's business and that such Holder
is not participating, and has no arrangement or understanding with any person
to participate, in a distribution (within the meaning of the Securities Act) of
such New Notes. However, any Holder of Old Notes who is an "affiliate" of the
Company or who intends to participate in the Exchange Offer for the purpose of
distributing New Notes, or any broker-dealer who purchased Old Notes from the
Company to resell pursuant to Rule 144A or any other available exemption under
the Securities Act, (i) will not be able to rely on the interpretations of the
staff of the Division of Corporation Finance of the Commission set forth in the
above-mentioned interpretative letters, (ii) will not be permitted or entitled
to tender such Old Notes in the Exchange Offer and (iii) must comply with the
registration and prospectus delivery requirements of the Securities Act in
connection with any sale or other transfer of such Old Notes unless such sale
is made pursuant to an exemption from such requirements. In addition, as
described below, if any broker-dealer holds Old Notes acquired for its own
account as a result of market-making or other trading activities and exchanges
such Old Notes for New Notes, then such broker-dealer must deliver a prospectus
meeting the requirements of the Securities Act in connection with any resales
of such New Notes.

Each Holder of Old Notes who wishes to exchange Old Notes for New Notes in the
Exchange Offer will be required to represent that (i) it is not an "affiliate"
of the Company, (ii) any New Notes to be received by it are being acquired in
the ordinary course of its business, (iii) it has no arrangement or
understanding with any person to participate in a distribution (within the
meaning of the Securities Act) of such New Notes, and (iv) if such Holder is
not a broker-dealer, such Holder is not engaged in, and does not intend to
engage in, a distribution (within the meaning of the Securities Act) of such
New Notes. Each broker-dealer that receives New Notes for its own account
pursuant to the Exchange Offer must acknowledge that it acquired the Old Notes
for its own account as the result of market-making or other trading activities
and must agree that it will deliver a prospectus meeting the requirements of
the Securities Act in connection with any resale of such New Notes. The Letter
of Transmittal states that by so acknowledging and by delivering a prospectus,
a broker-dealer will not be deemed to admit that it is an "underwriter" within
the meaning of the Securities Act. Based on the position

taken by the staff of the Division of Corporation Finance of the Commission in
the interpretative letters referred to above, the Company believes that broker-
dealers who acquired Old Notes for their own accounts as a result of market-
making or other trading activities ("Participating Broker-Dealers") may fulfill
their prospectus delivery requirements with respect to the New Notes received
upon exchange of such Old Notes (other than Old Notes which represent an unsold
allotment from the original sale of the Old Notes) with a prospectus meeting
the requirements of the Securities Act, which may be the prospectus prepared
for an exchange offer so long as it contains a description of the plan of
distribution with respect to the resale of such New Notes. Accordingly, this
Prospectus may be used by a Participating Broker-Dealer during the period
referred to below in connection with resales of New Notes received in exchange
for Old Notes where such Old Notes were acquired by such Participating Broker-
Dealer for its own account as a result market-making or other trading
activities.

Subject to certain provisions set forth in the Registration Rights Agreement,
the Company has agreed that this Prospectus may be used by a Participating
Broker-Dealer in connection with resales of such New Notes for a period ending
180 days after the Expiration Date (subject to extension under certain limited
circumstances described below) or, if earlier, when all such New Notes have
been disposed of by such Participating Broker-Dealer. Any Participating Broker-
Dealer who is an "affiliate" of the Company may not rely on such interpretative
letters and must comply with the registration and prospectus delivery
requirements of the Securities Act in connection with any resale transaction.
See "Plan of Distribution."

In that regard, each Participating Broker-Dealer who surrenders Old Notes
pursuant to the Exchange Offer will be deemed to have agreed, by execution of
the Letter of Transmittal, that, upon receipt of notice from the Company of the
occurrence of any event or the discovery of any fact which makes any statement
contained or incorporated by reference in this Prospectus untrue in any
material respect or which causes this Prospectus to omit to state a material
fact necessary in order to make the statements contained or incorporated by
reference therein, in light of the circumstances under which they were made,
not misleading or of the occurrence of certain other events specified in the
Registration Rights Agreement, such Participating Broker-Dealer will suspend
the sale of New Notes pursuant to this Prospectus until the Company has amended
or supplemented this Prospectus to correct such misstatement or omission and
has furnished copies of the amended or supplemented Prospectus to such
Participating Broker-Dealer or the Company has given notice that the sale of
New Notes may be resumed, as the case may be. If the Company gives such notice
to suspend the sale of the New Notes, it shall extend the 180-day period
referred to above during which Participating Broker-Dealers are entitled to use
this Prospectus in connection with the sale of New Notes by the number of days
during the period from and including the date of the giving of such notice to
and including the date when Participating Broker-Dealers shall have received
copies of the amended or supplemented Prospectus necessary to permit resales of
the New Notes or to and including the date on which the Company has given
notice that the sale of New Notes may be resumed, as the case may be.

WITHDRAWAL RIGHTS

Except as otherwise provided herein, tenders of Old Notes may be withdrawn at
any time on or prior to the Expiration Date.

In order for a withdrawal to be effective, a written, telegraphic, or facsimile
transmission of such notice of withdrawal must be timely received by the
Exchange Agent at one of its addresses set forth under "--Exchange Agent" on or
prior to the Expiration Date. Any such notice of withdrawal must specify the
name of the person who tendered the Old Notes to be withdrawn, the aggregate
principal amount of Old Notes to be withdrawn, and (if certificates for such
Old Notes have been tendered) the name of the registered Holder of the Old
Notes as set forth on the Old Notes, if different from that of the person who
tendered such Old Notes. If Old Notes have been delivered or otherwise
identified to the Exchange Agent, then prior to the physical release of such
Old Notes, the tendering Holder must submit the serial numbers shown on the
particular Old Notes to be withdrawn and the signature on the notice of
withdrawal must be guaranteed by an Eligible Institution, except in the case of
Old Notes tendered for the account of an Eligible Institution. If Old Notes
have been tendered pursuant to the procedures for book-entry transfer set forth
in "--Procedures for Tendering Old Notes," the notice of

withdrawal will be effective if delivered to the Exchange Agent by written,
telegraphic, telex or facsimile
transmission. Withdrawals of tenders of Old Notes may not be rescinded. Old
Notes properly withdrawn will not be deemed validly tendered for purposes of
the Exchange Offer, but may be retendered at any subsequent time or prior to
the Expiration Date by following any of the procedures described above under
"--Procedures for Tendering Old Notes."

All questions as to the validity, form and eligibility (including time of
receipt) of such withdrawal notices will be determined by the Company, in its
sole discretion, whose determination shall be final and binding on all parties.
Neither the Company, any affiliates or assigns of the Company, the Exchange
Agent nor any other person shall be under any duty to give any notification of
any irregularities in any notice of withdrawal or incur any liability for
failure to give any such notification. Any Old Notes which have been tendered
but which are withdrawn will be returned to Holders thereof promptly after
withdrawal.

INTEREST ON THE NEW NOTES

Each New Note will bear interest at the rate of 8 5/8% per annum from the most
recent date to which interest has been paid or duly provided for on the Old
Notes surrendered in exchange for such New Note or, if no interest has been
paid or duly provided for on such Old Note, from July 21, 1997. Interest on the
New Notes will be payable semiannually on January 15 and July 15 of each year,
commencing on January 15, 1998.

Holders of Old Notes whose Old Notes are accepted for exchange will not receive
accrued interest on such Old Notes for any period from and after the last
Interest Payment Date to which interest has been paid or duly provided for,
will not receive any accrued interest on such Old Notes, and will be deemed to
have waived the right to receive any interest on such Old Notes accrued from
and after such Interest Payment Date or, if no such interest has been paid or
duly provided for, from and after July 21, 1997.

CERTAIN CONDITIONS TO THE EXCHANGE OFFER

Notwithstanding any other provisions of the Exchange Offer, or any extension of
the Exchange Offer, the Company will not be required to accept for exchange, or
to exchange, any Old Notes for any New Notes, and, as described below, may
terminate the Exchange Offer (whether or not any Old Notes have theretofore
been accepted for exchange) or may waive any conditions to or amend the
Exchange Offer, if any of the following conditions have occurred or exists or
have not been satisfied:

(a) the Exchange Offer, or the making of any exchange by a Holder, violates
any applicable law or any applicable interpretation of the staff of the
Commission;

(b) any action or proceeding shall have been instituted or threatened in
any court or by or before any governmental agency or body with respect to
the Exchange Offer which, in the Company's judgment, would reasonably be
expected to impair the ability of the Company to proceed with the Exchange
Offer;

(c) any law, statute, rule or regulation shall have been adopted or enacted
with, in the Company's judgment, would reasonably be expected to impair the
ability of the Company to proceed with the Exchange Offer;

(d) a banking moratorium shall have been declared by Federal or state
authorities which, in the Company's judgment, would reasonably be expected
to impair the ability of the Company to proceed with the Exchange Offer;

(e) trading on the New York Stock Exchange or generally in the United
States over-the-counter market shall have been suspended by order of the
Commission or any other governmental authority which, in the Company's
judgment, would reasonably be expected to impair the ability of the Company
to proceed with the Exchange Offer; or

(f) a stop order shall have been issued by the Commission or any state
securities authority suspending the effectiveness of the Registration
Statement or proceedings shall have been initiated or, to the knowledge of
the Company, threatened for that purpose.

If the Company determines in its sole and absolute discretion that any of
the foregoing events or conditions has occurred or exists or has not been
satisfied, the Company may, subject to applicable law, terminate the

Exchange Offer (whether or not any Old Notes have theretofore been accepted
for exchange) or may waive any such condition or otherwise amend the terms
of the Exchange Offer in any respect. If such waiver or
amendment constitutes a material change to the Exchange Offer, the Company
will promptly disclose such waiver by means of a prospectus supplement that
will be distributed to the registered Holders of the Old Notes, and the
Company will extend the Exchange Offer to the extent required by Rule 14e-1
under the Exchange Act.

EXCHANGE AGENT

First Chicago Trust Company of New York has been appointed as Exchange Agent
for the Exchange Offer. Delivery of the Letters of Transmittal and any other
required documents, questions, requests for assistance, and requests for
additional copies of this Prospectus or of the Letter of Transmittal should be
directed to the Exchange Agent as follows:

By Mail: By Hand: By Overnight Delivery:
Tenders & Exchanges Tenders & Exchanges Tenders & Exchanges
P.O. Box 2569 c/o The Depository Trust Company
14 Wall St., 8th Floor
Suite 4660-VI 55 Water Street, DTC TAD Suite 4680-VI
Jersey City, New Jersey
07303-2569
Vietnam Veterans Memorial Plaza
New York, New York 10054
New York, New York 10041

To Confirm by Telephone or for Information: (201) 222-4707

Delivery to other than one of the above addresses will not constitute a valid
delivery.

FEES AND EXPENSES

The Company has agreed to pay the Exchange Agent reasonable and customary fees
for its services and will reimburse it for its reasonable out-of-pocket
expenses in connection therewith. The Company will also pay brokerage houses
and other custodians, nominees and fiduciaries the reasonable out-of-pocket
expenses incurred by them in forwarding copies of this Prospectus and related
documents to the beneficial owners of Old Notes, and in handling or tendering
for their customers.

Holders who tender their Old Notes for exchange will not be obligated to pay
any transfer taxes in connection therewith. If, however, New Notes are to be
delivered to, or are to be issued in the name of, any person other than the
registered Holder of the Old Notes tendered, or if a transfer tax is imposed
for any reason other than the exchange of Old Notes in connection with the
Exchange Offer, then the amount of any such transfer taxes (whether imposed on
the registered Holder or any other persons) will be payable by the tendering
Holder. If satisfactory evidence of payment of such taxes or exemption
therefrom is not submitted with the Letter of Transmittal, the amount of such
transfer taxes will be billed directly to such tendering Holder.

The Company will not make any payment to brokers, dealers or others soliciting
acceptance of the Exchange Offer.

DESCRIPTION OF THE NEW NOTES

GENERAL

The Old Notes were issued and the New Notes will be issued pursuant to an
Indenture (the "Indenture") between the Company and The Bank of New York, as
Trustee (the "Trustee"). The terms of the New Notes include those stated in the
Indenture and those made part of the Indenture by reference to the Trust
Indenture Act of 1939, as amended (the "Trust Indenture Act"). The New Notes
are subject to all such terms, and Holders of New Notes are referred to the
Indenture and the Trust Indenture Act for a statement thereof. The statements
under this caption relating to the New Notes and the Indenture are summaries
and do not purport to be complete, and where reference is made to particular
provisions of the Indenture, such provisions, including the definitions of
certain terms, are qualified in their entirety by such reference. The
definitions of certain terms used in the following summary are set forth below
under "--Certain Definitions."

The Old Notes and the New Notes will constitute a single series of debt
securities under the Indenture. If the Exchange Offer is consummated, Holders
of the Old Notes who do not exchange their Old Notes for New Notes will vote
together with the Holders of New Notes for all relevant purposes under the
Indenture. In that regard, the Indenture requires that certain actions by the
Holders thereunder (including acceleration following an Event of Default
thereunder) must be taken, and certain rights must be exercised, by specified
minimum percentages of the aggregate principal amount of the outstanding Notes.
In determining whether Holders of the requisite percentage in principal amount
have given any notice, consent or waiver or taken any other action permitted
under the Indenture, any Old Notes which remain outstanding after the Exchange
Offer will be aggregated with the New Notes and the Holders of such Old Notes
and New Notes will vote together as a single series for all such purposes.
Accordingly, all references herein to specified percentages in aggregate
principal amount of the outstanding Notes shall be deemed to mean, at any time
after the Exchange Offer is consummated, such percentage in aggregate principal
amount of the Old Notes and New Notes then outstanding.

The New Notes and the Old Notes are sometimes referred to as, collectively, the
"Notes" and, individually, a "Note."

PRINCIPAL, MATURITY AND INTEREST

The New Notes will be general unsecured obligations of the Company limited in
aggregate principal amount to $750 million and will mature on July 15, 2007.
Interest on the New Notes will accrue at the rate of 8 5/8% per annum and will
be payable semi-annually in arrears on January 15 and July 15 of each year,
commencing on January 15, 1998, to Holders of record on the immediately
preceding January 1 and July 1, respectively. Interest on the New Notes will
accrue from the most recent date to which interest has been paid or duly
provided for on the Old Notes surrendered in exchange for the New Notes or, if
no interest has been paid or duly provided for on the Old Notes, from July 21,
1997.

Interest on the New Notes will be computed on the basis of a 360-day year
comprised of twelve 30-day months. Principal of, premium, if any, and interest
on the New Notes will be payable at the office or agency of the Company
maintained for such purpose within the City and State of New York or, at the
option of the Company, payment of interest may be made by check mailed to
Holders of New Notes at their respective addresses set forth in the register of
Holders of New Notes; provided that all payments with respect to Global Notes
(as defined), the Holders of which have given wire transfer instructions on or
prior to the relevant record date to the paying agent, will be required to be
made by wire transfer of immediately available funds to the accounts specified
by such Holders. Until otherwise designated by the Company, the Company's
office or agency in New York will be the office of the Trustee maintained for
such purpose. The New Notes will be issued in denominations of $1,000 and
integral multiples thereof.

SUBORDINATION

The payment of principal of, premium, if any, and interest on the New Notes
will be subordinated in right of payment, as set forth in the Indenture, to the
prior payment in full of all existing and future Senior Debt. Upon any
distribution to creditors of the Company in a liquidation or dissolution of the
Company or in a bankruptcy,

reorganization, insolvency, receivership or similar proceeding relating to the
Company or its property, an assignment for the benefit of creditors or any
marshaling of the Company's assets and liabilities, the holders of Senior Debt
will be entitled to receive payment in full of all such Senior Debt (including
all Obligations with respect thereto) before Holders of New Notes will be
entitled to receive any payment with respect to the New Notes, and until all
amounts with respect to Senior Debt are paid in full, any distribution to which
Holders of New Notes would be entitled shall be made to the holders of Senior
Debt (except payments made from the trust described under "--Legal Defeasance
and Covenant Defeasance" and except that Holders of New Notes may receive
securities so long as (i) the New Notes are not treated in any case or
proceeding or other event described above as part of the same class of claims
as the Senior Debt or any class of claims on a parity with or senior to the
Senior Debt for any payment or distribution, (ii) such securities are
subordinated at least to the same extent as the New Notes to Senior Debt of the
Company and any securities issued in exchange for such Senior Debt and (iii)
such securities are authorized by an order or decree of a court of competent
jurisdiction in a reorganization proceeding under any applicable bankruptcy,
insolvency or similar law which gives effect to the subordination of the New
Notes to Senior Debt in a manner and with an effect which would be required if
this parenthetical clause were not included in this paragraph; provided that
the Senior Debt is assumed by the new corporation, if any, resulting from any
such reorganization or readjustment and issuing such securities).

The Company also may not make any payment upon or in respect of the New Notes
(except in such subordinated securities as described above or from the trust
described under "--Legal Defeasance and Covenant Defeasance") if (i) a Payment
Default on Designated Senior Debt occurs and is continuing or (ii) any other
default occurs and is continuing with respect to Designated Senior Debt that
permits holders of the Designated Senior Debt as to which such default relates
to accelerate its maturity and the Trustee receives a notice of such default
("a Payment Blockage Notice") from the Company or the representative of the
holders of any Designated Senior Debt. Payments on the New Notes may be resumed
(a) in the case of a Payment Default, upon the date on which such Payment
Default is cured or waived and (b) in case of a nonpayment default, the earlier
of the date on which such nonpayment default is cured or waived or 179 days
after the date on which the applicable Payment Blockage Notice is received,
unless the maturity of any Designated Senior Debt has been accelerated. No new
period of payment blockage may be commenced unless and until 360 days have
elapsed since the effectiveness of the immediately prior Payment Blockage
Notice. No nonpayment default that existed or was continuing on the date of
delivery of any Payment Blockage Notice to the Trustee will be, or be made, the
basis for a subsequent Payment Blockage Notice.

As a result of the subordination provisions described above, in the event of a
liquidation, insolvency or similar proceeding, Holders of New Notes may recover
less ratably than creditors of the Company who are holders of Senior Debt. See
"Risk Factors--Subordination of the Notes; Dependence on Subsidiaries." As of
June 30, 1997, on a pro forma basis after giving effect to the Offering and the
repurchase of certain THY debt, the Company would have had outstanding an
aggregate principal amount of approximately $1.0 billion of Senior Debt, which
would rank senior in right of payment to the New Notes.

The Indenture limits, subject to certain financial tests, the amount of
additional Indebtedness, including Senior Debt, that the Company and its
Restricted Subsidiaries can incur. See "--Certain Covenants--Incurrence of
Indebtedness and Issuance of Disqualified Stock." The operations of the Company
are conducted primarily through its Subsidiaries and, therefore, the Company is
dependent upon the cash flow of its Subsidiaries to meet its obligations,
including obligations under the New Notes. The New Notes effectively will be
subordinated to all outstanding Indebtedness and other liabilities and
commitments (including trade payables and operating lease obligations) of the
Company's Subsidiaries. Any right of the Company to receive assets of any of
its Subsidiaries upon the latter's liquidation or reorganization (and the
consequent right of the Holders of New Notes to participate in those assets)
effectively will be subordinated to the claims of that Subsidiary's creditors,
except to the extent that the Company itself is recognized as a creditor of
such Subsidiary, in which case the claims of the Company would still be
subordinate to any security interest in the assets of such Subsidiary and any
Indebtedness of such Subsidiary senior to that held by the Company. As of June
30, 1997, on a pro forma basis as described above, the outstanding Indebtedness
of the Company's Subsidiaries would have been approximately $160 million,
excluding trade payables and operating lease obligations aggregating
approximately $401 million.

OPTIONAL REDEMPTION

The New Notes will not be redeemable at the Company's option prior to July 15,
2002. Thereafter, the New Notes will be subject to redemption at the option of
the Company, in whole or in part, upon not less than 30 nor more than 60 days'
notice, at the redemption prices (expressed as percentages of principal amount)
set forth below plus accrued and unpaid interest to the applicable redemption
date, if redeemed during the twelve-month period beginning on July 15 of the
years indicated below:

--------

YEAR PERCENTAGE
---- ----------

2002........................................................... 104.3125%
2003........................................................... 102.8750%
2004........................................................... 101.4375%
2005 and thereafter............................................ 100.0000%

If less than all of the outstanding Old Notes and New Notes are to be redeemed
at any time, selection of Notes for redemption will be made by the Trustee on a
pro rata basis, by lot or by such method as the Trustee will deem fair and
appropriate; provided that no Notes of $1,000 or less will be redeemed in part.
Notices of redemption will be mailed by first class mail at least 30 but not
more than 60 days before the redemption date to each Holder of Notes to be
redeemed at its registered address. If any Note is to be redeemed in part only,
the notice of redemption that relates to such Note will state the portion of
the principal amount thereof to be redeemed. A new Note in principal amount
equal to the unredeemed portion thereof will be issued in the name of the
Holder thereof upon cancellation of the original Note. On and after the
redemption date, interest will cease to accrue on Notes or portions of them
called for redemption.

MANDATORY REDEMPTION

Except as set forth below under "--Repurchase at the Option of Holders upon a
Change of Control" and "--Certain Covenants--Asset Sales," the Company will not
be required to make any mandatory redemption or sinking fund payments with
respect to the New Notes.

REPURCHASE AT THE OPTION OF HOLDERS UPON A CHANGE OF CONTROL

Upon the occurrence of a Change of Control, each Holder of New Notes will have
the right to require the Company to repurchase all or any part (equal to $1,000
or an integral multiple thereof) of such Holder's New Notes pursuant to the
offer described below (the "Change of Control Offer") at an offer price in cash
equal to 101% of the aggregate principal amount thereof plus accrued and unpaid
interest thereon to the date of purchase (the "Change of Control Payment") on a
date that is not more than 90 days after the occurrence of such Change of
Control (the "Change of Control Payment Date"). Prior to the mailing of notice
to Holders provided for in the succeeding paragraph, but in any event within 30
days following any Change of Control, the Company covenants to (i) repay in
full all Senior Debt that would prohibit the repurchase of the New Notes as
provided for in the succeeding paragraph or (ii) obtain any requisite consents
under instruments governing any such Senior Debt to permit the repurchase of
the New Notes as provided for in the succeeding paragraph. The Company shall
first comply with the covenant in the preceding sentence before it shall be
required to repurchase New Notes pursuant to the "--Repurchase at the Option of
Holders upon a Change of Control" covenant.

Within 30 days following any Change of Control, the Company will mail, or at
the Company's request the Trustee will mail, a notice to each Holder offering
to repurchase the New Notes held by such Holder pursuant to the procedures
specified in such notice. The Company will comply with the requirements of Rule
14e-1 under the Exchange Act and any other securities laws and regulations
thereunder to the extent such laws and regulations are applicable in connection
with the repurchase of the New Notes as a result of a Change of Control.

On the Change of Control Payment Date, the Company will, to the extent lawful,
(i) accept for payment all New Notes or portions thereof properly tendered and
not withdrawn pursuant to the Change of Control Offer, (ii) deposit with the
paying agent an amount equal to the Change of Control Payment in respect of all
New Notes or portions thereof so tendered and (iii) deliver or cause to be
delivered to the Trustee the New Notes so accepted

together with an Officers' Certificate stating the aggregate principal amount
of New Notes or portions thereof being purchased by the Company. The paying
agent will promptly mail to each Holder of New Notes so tendered the Change of
Control Payment for such New Notes, and the Trustee will promptly authenticate
and mail (or cause to be transferred by book entry) to each Holder a new Note
equal in principal amount to any unpurchased portion of the Notes surrendered,
if any; provided that each such new Note will be in a principal amount of
$1,000 or an integral multiple thereof. The Company will publicly announce the
results of the Change of Control Offer on or as soon as practicable after the
Change of Control Payment Date.

A failure by the Company to comply with the provisions of the three preceding
paragraphs will constitute an Event of Default. Except as described above with
respect to a Change of Control, the Indenture does not contain provisions that
permit Holders of New Notes to require that the Company repurchase or redeem
the New Notes in the event of a takeover, recapitalization or similar
transaction. See "--Events of Defaults and Remedies."

The Credit Agreement provides that a Change of Control will constitute a
default thereunder, which would permit the lenders to cause the indebtedness
under the Credit Agreement to become immediately due and payable or to
institute a payment blockage. See "--Subordination." Any future credit
agreements or other agreements relating to Senior Debt to which the Company
becomes a party may contain similar provisions. In addition, if the Company is
unable to repay all of its Senior Debt that would prohibit repurchase of the
New Notes or is unable to obtain the consents of the holders of such Senior
Debt, if any, of the Company outstanding at the time of a Change of Control
whose consent would be so required to permit the repurchase of New Notes, then
the Company will have breached the "Repurchase at the Option of Holders upon a
Change of Control" covenant of the Indenture. This breach will constitute an
Event of Default with respect to the New Notes under the Indenture after
written notice is given to the Company by the Trustee or the Holders of at
least 25% in aggregate principal amount of the then outstanding Notes.

There can be no assurances that the Company will have sufficient funds
available or will be able to obtain third-party financing at the time of any
Change of Control to make any debt payment (including repurchases of New Notes)
required by the "Repurchase at the Option of Holders upon a Change of Control"
covenant of the Indenture (as well as any similar covenant that may be
contained in other securities of the Company that might be outstanding at the
time). The "Repurchase at the Option of Holders upon a Change of Control"
covenant of the Indenture will, unless the consents referred to above are
obtained, require the Company to repay all Senior Debt then outstanding that by
its terms would prohibit such New Note repurchase, either prior to or
concurrently with such New Note repurchase.

CERTAIN COVENANTS

Restricted Payments
The Indenture provides that the Company will not, and will not permit any of
its Restricted Subsidiaries to, directly or indirectly: (i) declare or pay any
dividend or make any distribution on account of the Company's or any Restricted
Subsidiaries' Equity Interests (other than (x) dividends or distributions
payable in Qualified Equity Interests of the Company and (y) dividends or
distributions payable to the Company or any Restricted Subsidiary of the
Company); (ii) purchase, redeem or otherwise acquire or retire for value any
Equity Interests of the Company or any of its Restricted Subsidiaries; (iii)
make any voluntary or optional principal payment on, or voluntary or optional
purchase, redemption, defeasance, or other acquisition or retirement for value
of, any Subordinated Debt; or (iv) make any Investment that is a Restricted
Investment (all such payments and other actions set forth in clauses (i)
through (iv) above being collectively referred to as "Restricted Payments"),
unless, at the time of and after giving effect to such Restricted Payment (the
amount of any such Restricted Payment, if other than cash, shall be the fair
market value (as conclusively evidenced by a resolution of the Board of
Directors of the Company set forth in an Officers' Certificate delivered to the
Trustee within 60 days prior to the date of such Restricted Payment) of the
asset(s) proposed to be transferred by the Company or such Restricted
Subsidiary, as the case may be, pursuant to such Restricted Payment):

(a) no Default or Event of Default shall have occurred and be continuing or
would occur as a consequence thereof;

(b) the Company would, at the time of such Restricted Payment and after
giving pro forma effect thereto as if such Restricted Payment had been made
at the beginning of the most recently ended four full fiscal quarter period
for which internal financial statements are available immediately preceding
the date of such Restricted Payment, have been permitted to incur at least
$1.00 of additional Indebtedness pursuant to the Fixed Charge Coverage
Ratio test set forth in the first paragraph of the covenant in the
Indenture described below under the caption "Incurrence of Indebtedness and
Issuance of Disqualified Stock"; and

(c) such Restricted Payment, together with the aggregate of all other
Restricted Payments made by the Company and its Restricted Subsidiaries
after June 30, 1997 (excluding Restricted Payments permitted by clauses
(B), (C) and (D) of the next succeeding paragraph), is less than the sum of
(i) 50% of the Consolidated Net Income of the Company for the period (taken
as one accounting period) from the beginning of the first fiscal quarter
commencing after June 30, 1997 to the end of the Company's most recently
ended fiscal quarter for which internal financial statements are available
at the time of such Restricted Payment (or, if such Consolidated Net Income
for such period is a deficit, less 100% of such deficit), plus (ii) 100% of
the aggregate net cash proceeds received by the Company from the issue or
sale (other than to a Restricted Subsidiary) since June 30, 1997 of
Qualified Equity Interests of the Company or of debt securities of the
Company or any of its Restricted Subsidiaries that have been converted into
or exchanged for such Qualified Equity Interests of the Company, plus (iii)
$100 million.

If no Default or Event of Default has occurred and is continuing, or would
occur as a consequence thereof, the foregoing provisions will not prohibit the
following Restricted Payments: (A) the payment of any dividend within 60 days
after the date of declaration thereof, if at said date of declaration such
payment would have complied with the provisions of the Indenture; (B) the
payment of cash dividends on any series of Disqualified Stock issued after the
date of the Indenture in an aggregate amount not to exceed the cash received by
the Company since the date of the Indenture upon issuance of such Disqualified
Stock; (C) the redemption, repurchase, retirement or other acquisition of any
Equity Interests of the Company or any Restricted Subsidiary in exchange for,
or out of the net cash proceeds of, the substantially concurrent sale (other
than to a Restricted Subsidiary of the Company) of Qualified Equity Interests
of the Company; provided that the amount of any such net cash proceeds that are
utilized for any such redemption, repurchase, retirement or other acquisition
shall be excluded from clause (c)(ii) of the preceding paragraph; (D) the
defeasance, redemption or repurchase of Subordinated Debt (including any
Subordinated Debt that constitutes Acquired Debt) with the net cash proceeds
from an incurrence of Permitted Refinancing Indebtedness or in exchange for or
out of the net cash proceeds from the substantially concurrent sale (other than
to a Restricted Subsidiary) of Qualified Equity Interests of the Company;
provided, that the amount of any such net cash proceeds that are utilized for
any such redemption, repurchase, retirement or other acquisition shall be
excluded from clause (c)(ii) of the preceding paragraph; (E) the repurchase,
redemption or other acquisition or retirement for value of any Equity Interests
of the Company or any Restricted Subsidiary held by any member of the Company's
(or any of its Restricted Subsidiaries') management pursuant to any management
equity subscription agreement or stock option agreement; provided that the
aggregate price paid for all such repurchased, redeemed, acquired or retired
Equity Interests shall not exceed $5 million in any twelve-month period; and
(F) the repurchase of any Indebtedness that is pari passu with the New Notes or
any Subordinated Debt at a purchase price not greater than 101% of the
principal amount of such Indebtedness or Subordinated Debt, as the case may be,
in the event of a Change of Control pursuant to a provision similar to the
provision described under "--Repurchase at the Option of Holders upon a Change
of Control"; provided that prior to such repurchase the Company has made a
Change of Control Offer as provided under "--Repurchase at the Option of
Holders upon a Change of Control" and has repurchased all Notes validly
tendered for payment in connection with such Change of Control Offer.

Not later than the date of making any Restricted Payment, the Company shall
deliver to the Trustee an Officers' Certificate stating that such Restricted
Payment is permitted and setting forth the basis upon which the calculations
required by the covenant "Restricted Payments" were computed.

Incurrence of Indebtedness and Issuance of Disqualified Stock
The Indenture provides that the Company will not, and will not permit any of
its Restricted Subsidiaries to, directly or indirectly, create, incur, issue,
assume, Guarantee or otherwise become directly or indirectly liable,
contingently or otherwise, with respect to (collectively, "incur") after the
date of the Indenture any Indebtedness

(including Acquired Debt) and that the Company will not issue any Disqualified
Stock and will not permit any of its Restricted Subsidiaries to issue any
shares of preferred stock; provided, however, that the Company may incur
Indebtedness (including Acquired Debt) and may issue shares of Disqualified
Stock if (i) no Default or Event of Default will have occurred and be
continuing or would occur as a consequence thereof and (ii) the Fixed Charge
Coverage Ratio for the Company's most recently ended four full fiscal quarters
for which internal financial statements are available immediately preceding the
date on which such additional Indebtedness is incurred or such Disqualified
Stock is issued would have been at least 2.25 to 1, determined on a pro forma
basis (including a pro forma application of the net proceeds therefrom) as if
the additional Indebtedness had been incurred, or the Disqualified Stock had
been issued, as the case may be, at the beginning of such four-quarter period.
Indebtedness consisting of reimbursement obligations in respect of a letter of
credit will be deemed to be incurred when the letter of credit is first issued.
The Company will not permit any of its Unrestricted Subsidiaries to incur any
Indebtedness other than Non-Recourse Debt; provided, however, that Atria may
incur Indebtedness under Atria's bank credit facility which is Guaranteed by
the Company and its Restricted Subsidiaries up to an aggregate amount of $100
million through August 26, 1998, declining to $75 million, $50 million and $25
million in each respective one-year period thereafter.

The foregoing provisions do not apply to:

(i) the incurrence by the Company of Senior Debt under the Credit Agreement
in an aggregate principal amount at any time outstanding not to exceed an
amount equal to $2.0 billion less the aggregate amount of all mandatory
payments applied to permanently reduce the commitments with respect to such
Indebtedness;

(ii) the incurrence by the Company of Indebtedness represented by the
Notes;

(iii) Existing Indebtedness;

(iv) the incurrence by the Company or any of its Restricted Subsidiaries of
Permitted Refinancing Indebtedness in exchange for, or the net proceeds of
which are used to extend, refinance, renew, replace, defease or refund,
Indebtedness that was permitted by the Indenture to be incurred (including,
without limitation, Existing Indebtedness);

(v) the incurrence by the Company or any of its Restricted Subsidiaries of
intercompany Indebtedness between or among the Company and any of its
Restricted Subsidiaries; provided that upon either (a) the transfer or
other disposition by a Restricted Subsidiary or the Company of any
Indebtedness so permitted under this clause (v) to a Person other than the
Company or a Restricted Subsidiary or (b) the issuance, sale, transfer or
other disposition of Equity Interests (including by consolidation or
merger) in a Restricted Subsidiary to a Person other than the Company or a
Restricted Subsidiary which results in such Restricted Subsidiary ceasing
to be a Restricted Subsidiary, the provisions of this clause (v) shall no
longer be applicable to such Indebtedness and such Indebtedness shall be
deemed to have been incurred at the time of any such issuance, sale,
transfer or other disposition, as the case may be;

(vi) the incurrence by the Company or any of its Restricted Subsidiaries of
Hedging Obligations or Guarantees thereof, provided that such Hedging
Obligations are incurred for the purpose of fixing or hedging interest rate
or currency risk with respect to any fixed or floating rate Indebtedness
that is permitted by the Indenture to be outstanding or any receivable or
liability, the payment of which is determined by reference to a foreign
currency; provided that the notional principal amount of any such Hedging
Obligation does not exceed the principal amount of the Indebtedness to
which such Hedging Obligation relates;

(vii) the incurrence by the Company or any of its Restricted Subsidiaries
of Indebtedness represented by performance bonds, standby letters of credit
or appeal bonds, in each case to the extent incurred in the ordinary course
of business of the Company or such Restricted Subsidiary;

(viii) the incurrence by any Restricted Subsidiary of Indebtedness, the
aggregate principal amount of which, together with all other Indebtedness
of the Company's Restricted Subsidiaries at the time outstanding (excluding
Existing Indebtedness until repaid or refinanced), does not exceed the
greater of (1) 10% of the Company's Stockholders' Equity as of the date of
incurrence or (2) $10 million; provided that, in the case of clause (1)
only, the Fixed Charge Coverage Ratio for the Company's most recently ended
four full fiscal quarters for which internal financial statements are
available immediately preceding the date on which such

Indebtedness (including Acquired Subsidiary Debt) is incurred would have
been at least 2.25 to 1, determined on a pro forma basis (including a pro
forma application of the net proceeds therefrom), as if such Indebtedness
had been incurred at the beginning of such four-quarter period; provided
further, that solely for the purpose of determining whether the aggregate
principal amount of Indebtedness of the Company's Restricted Subsidiaries
at any time outstanding exceeds 10% of the Company's Stockholders' Equity,
Acquired Subsidiary Debt shall be excluded; and

(ix) the incurrence by the Company of Indebtedness (in addition to
Indebtedness permitted by any other clause of this paragraph) in an
aggregate principal amount at any time outstanding not to exceed $50.0
million.

Asset Sales
The Indenture provides that the Company will not, and will not permit any of
its Restricted Subsidiaries to, consummate an Asset Sale unless (i) the Company
(or the Restricted Subsidiary, as the case may be) receives consideration at
the time of such Asset Sale at least equal to the fair market value (as
conclusively determined by a resolution of the Board of Directors of the
Company set forth in an Officers' Certificate delivered to the Trustee) of the
assets or Equity Interests issued or sold or otherwise disposed of and (ii)
either (x) at least 75% of the consideration therefor received by the Company
or such Restricted Subsidiary is in the form of cash; provided that for
purposes of this provision, the amount of (A) any liabilities (as shown on the
Company's or such Restricted Subsidiary's most recent balance sheet or in the
notes thereto), of the Company or any Restricted Subsidiary (other than, in the
case of an Asset Sale by the Company, liabilities that are by their terms
subordinated to the Notes) that are assumed by the transferee of any such
assets and (B) any securities or other obligations received by the Company or
any such Restricted Subsidiary from such transferee that are immediately
converted by the Company or such Restricted Subsidiary into cash (or as to
which the Company or such Restricted Subsidiary has received at or prior to the
consummation of the Asset Sale a commitment (which may be subject to customary
conditions) from a nationally recognized investment, merchant or commercial
bank to convert into cash within 90 days of the consummation of such Asset Sale
and which are thereafter actually converted into cash within such 90-day
period) will be deemed to be cash (but shall not be deemed to be Net Proceeds
for purposes of the following provisions until reduced to cash) or (y) solely
in the case of Asset Sales involving assets acquired after the date of the
Indenture, the consideration therefor received by the Company or any Restricted
Subsidiary is in the form of Equity Interests of the transferee of such assets;
provided that such transferee does not engage to any material extent in any
business other than the ownership, operation or management of Healthcare
Facilities, including the acceptance of risk for the provision of long-term
care and provided further that the aggregate value of any such Equity Interest,
together with all other Equity Interests acquired by the Company or any of its
Restricted Subsidiaries pursuant to this clause (y) during the twelve month
period preceding the acquisition of such Equity Interest, does not exceed 10%
of the Company's Stockholders' Equity as set forth in the Company's most
recently available quarterly financial statements. Notwithstanding the
foregoing, it will not be a violation of the foregoing provisions if the
Company or a Restricted Subsidiary receives Investments as all or part of the
consideration for an Asset Sale (which consideration is not otherwise
permitted), if such Investments constitute Restricted Investments permitted by
the covenant in the Indenture described above under the caption "--Restricted
Payments."

Pursuant to the Indenture, within 365 days after the receipt of any Net
Proceeds from an Asset Sale, the Company or the Restricted Subsidiary, as the
case may be, may apply such Net Proceeds (i) to purchase one or more Healthcare
Facilities and/or a controlling interest in the Capital Stock of a Person
owning one or more Healthcare Facilities, (ii) to make a capital expenditure or
to acquire other tangible assets, in each case, that are used or useful in any
business in which the Company or any of its Restricted Subsidiaries is
permitted to be engaged pursuant to the covenant described below under the
caption "--Certain Covenants--Line of Business," (iii) to permanently reduce
Existing Indebtedness of a Restricted Subsidiary, or (iv) to permanently reduce
Senior Debt (and to correspondingly reduce commitments with respect thereto).
Any Net Proceeds from Asset Sales that are not applied or invested as provided
in the first sentence of this paragraph will be deemed to constitute "Excess
Proceeds." When the aggregate amount of Excess Proceeds exceeds $15 million,
the Company will be required to make an offer to all Holders of Notes and
holders of any other Indebtedness of the Company ranking on a parity with the
Notes from time to time outstanding with similar provisions requiring the
Company

to make an offer to purchase or to redeem such Indebtedness with the proceeds
from any asset sales, pro rata in proportion to the respective principal
amounts of Notes and such other Indebtedness then outstanding (an "Asset Sale
Offer") to purchase the maximum principal amount of the Notes and such other
Indebtedness that may be purchased out of the Excess Proceeds, at an offer
price in cash equal to 100% of the principal amount thereof plus accrued and
unpaid interest thereon to the date of purchase, in accordance with the
procedures set forth in the Indenture. To the extent that the aggregate amount
of Notes and such other Indebtedness tendered pursuant to an Asset Sale Offer
is less than the Excess Proceeds, the Company may use any remaining Excess
Proceeds for general corporate purposes. If the aggregate principal amount of
Notes and such other Indebtedness surrendered by holders thereof exceeds the
amount of Excess Proceeds, the Notes and such other Indebtedness will be
purchased on a pro rata basis. Upon completion of an Asset Sale Offer, the
amount of Excess Proceeds shall be reset at zero.

The Credit Agreement prohibits the Company from repurchasing Notes pursuant to
an Asset Sale Offer unless certain conditions are met. In order to repurchase
Notes pursuant to an Asset Sale Offer, the Company would have to repay all of
its obligations under the Credit Agreement (and any other agreements relating
to Senior Debt that contain similar provisions) or would have to obtain the
consent of the holders of such Indebtedness. In the event the Company makes an
Asset Sale Offer, the Company will comply with the requirements of Rule 14e-1
under the Exchange Act and any other securities laws and regulations thereunder
to the extent such laws and regulations are applicable in connection with such
Asset Sale Offer.

Liens
The Indenture provides that the Company will not, and will not permit any of
its Restricted Subsidiaries to, directly or indirectly, create, incur, assume
or suffer to exist any Lien (except Permitted Liens) on any asset now owned or
hereafter acquired, or any income or profits therefrom or assign or convey any
right to receive income therefrom unless all payments due under the Indenture
and the Notes are secured on an equal and ratable basis (or on a senior basis,
in case of Subordinated Debt) with the Obligations so secured until such time
as such Obligations are no longer secured by a Lien.

Dividend and Other Payment Restrictions Affecting Restricted Subsidiaries
The Indenture provides that the Company will not, and will not permit any of
its Restricted Subsidiaries to, directly or indirectly, create or otherwise
cause or suffer to exist or become effective any consensual encumbrance or
restriction on the ability of any Restricted Subsidiary to (i)(a) pay dividends
or make any other distributions to the Company or any of its Restricted
Subsidiaries (1) on its Capital Stock or (2) with respect to any other interest
or participation in, or measured by, its profits, or (b) pay any Indebtedness
owed to the Company or any of its Restricted Subsidiaries, (ii) make loans or
advances to the Company or any of its Restricted Subsidiaries or (iii) transfer
any of its properties or assets to the Company or any of its Restricted
Subsidiaries, except for such encumbrances or restrictions existing under or by
reason of (a) Existing Indebtedness as in effect on the date of the Indenture,
(b) the Indenture, (c) applicable law or state insurance regulations, (d) any
instrument governing Indebtedness or Capital Stock of a Person acquired by the
Company or any of its Restricted Subsidiaries as in effect at the time of such
acquisition (except to the extent such Indebtedness was incurred in connection
with or in contemplation of such acquisition or in violation of the covenant
described above under the caption "--Incurrence of Indebtedness and Issuance of
Disqualified Stock"), which encumbrance or restriction is not applicable to any
Person, or the properties or assets of any Person, other than the Person
(including its Subsidiaries), or the property or assets of the Person
(including its Subsidiaries), so acquired, provided that the Consolidated
EBITDA of such Person is not taken into account in determining whether such
acquisition was permitted by the terms of the Indenture except to the extent
that such Consolidated EBITDA would be permitted to be dividended to the
Company without the prior consent or approval of any third party, (e) any
operating lease or capital lease, insofar as the provisions thereof limit
grants of a security interest in, or other assignments of, the related
leasehold interest to any other Person, (f) purchase money obligations for
property acquired in the ordinary course of business that impose restrictions
of the nature described in clause (iii) above on the property so acquired, (g)
Permitted Refinancing Indebtedness, provided that the restrictions contained in
the agreements governing such Permitted Refinancing Indebtedness are no more
restrictive than those contained in the agreements governing the Indebtedness
being refinanced, or (h) the Credit

Agreement and related documentation as the same is in effect on the date of the
Indenture and as amended or replaced from time to time, provided that no such
amendment or replacement is more restrictive as to the matters enumerated above
than the Credit Agreement and related documentation as in effect on the date of
the Indenture. Nothing contained in the provisions of the Indenture described
in this paragraph shall prevent the Company or any Restricted Subsidiary from
entering into any agreement resulting in the incurrence of Liens otherwise
permitted under the provisions of the Indenture described above under "--
Liens."

Line of Business
The Indenture provides that the Company will not, and will not permit any of
its Restricted Subsidiaries to, engage to any material extent in any business
other than the ownership, operation or management of Healthcare Facilities,
including the acceptance of risk for the provision of long-term care.

Limitation on Senior Subordinated Debt
The Indenture provides that the Company will not incur, create, issue, assume,
Guarantee or otherwise become liable for any Indebtedness that is subordinate
or junior in right of payment to any Senior Debt and senior in any respect in
right of payment to the New Notes.

Merger, Consolidation or Sale of Assets
The Indenture provides that the Company will not consolidate or merge with or
into (whether or not the Company is the surviving corporation), or sell,
assign, transfer, lease, convey or otherwise dispose of all or substantially
all of its properties or assets in one or more related transactions, to another
corporation, Person or entity unless (i) the surviving corporation or the
entity or the Person formed by or surviving any such consolidation or merger
(if other than the Company) or to which such sale, assignment, transfer, lease,
conveyance or other disposition shall have been made (the "Surviving Entity")
is a corporation organized or existing under the laws of the United States, any
state thereof or the District of Columbia; (ii) the Surviving Entity assumes
all the obligations of the Company under the Notes and the Indenture pursuant
to a supplemental Indenture in form reasonably satisfactory to the Trustee;
(iii) immediately before and after giving effect to such transaction and
treating any Indebtedness which becomes an obligation of the Company as a
result of such transaction as having been incurred by the Company at the time
of the transaction, no Default or Event of Default shall have occurred and be
continuing; and (iv) the Company or the Surviving Entity (A) will have
Consolidated Net Worth immediately after the transaction and prior to any
purchase accounting adjustments equal to or greater than the Consolidated Net
Worth of the Company immediately preceding the transaction and (B) will, at the
time of such transaction and after giving pro forma effect thereto as if such
transaction had occurred at the beginning of the applicable four-quarter
period, be permitted to incur at least $1.00 of additional Indebtedness
pursuant to the Fixed Charge Coverage Ratio test set forth in the first
paragraph of the covenant in the Indenture described above under the caption
"--Incurrence of Indebtedness and Issuance of Disqualified Stock."

Transactions with Affiliates
The Indenture provides that the Company will not, and will not permit any of
its Restricted Subsidiaries to, sell, lease, transfer or otherwise dispose of
any of its properties or assets to, or purchase any property or assets from, or
enter into or make any contract, agreement, understanding, loan, advance or
Guarantee with, or for the benefit of, any Affiliate (each of the foregoing, an
"Affiliate Transaction"), unless (i) such Affiliate Transaction is on terms
that are no less favorable to the Company or the relevant Restricted Subsidiary
than those that could have been obtained in a comparable transaction by the
Company or such Restricted Subsidiary with an unrelated Person and (ii) the
Company delivers to the Trustee (a) with respect to any Affiliate Transaction
involving aggregate consideration in excess of $5.0 million, a resolution of
the Board of Directors of the Company set forth in an Officers' Certificate
certifying that such Affiliate Transaction complies with clause (i) above and
that such Affiliate Transaction has been approved by a majority of the
disinterested members of the Board of Directors of the Company and (b) with
respect to any Affiliate Transaction involving aggregate

consideration in excess of $15.0 million, an opinion as to the fairness to the
Company or such Restricted Subsidiary of such Affiliate Transaction from a
financial point of view issued by an investment banking firm of
national standing; provided that (v) transactions or payments pursuant to any
employment arrangements, employee relocations or employee or director benefit
plans entered into by the Company or any of its Restricted Subsidiaries in the
ordinary course of business and consistent with the past practice of the
Company or such Restricted Subsidiary, (w) transactions between or among the
Company and/or its Restricted Subsidiaries, (x) transactions pursuant to or
performance of the Affiliate Agreements on the terms in effect on the date of
the Indenture, (y) transactions between a Person and an Affiliate existing at
the time such Person is merged with or into or becomes a Restricted Subsidiary,
except to the extent such transaction was entered into in connection with, or
in contemplation of, such Person merging with or into or becoming a Restricted
Subsidiary and (z) transactions between the Company or any Restricted
Subsidiary and Atria in accordance with agreements (I) in existence on the date
of the Indenture or (II) entered into after the date of the Indenture on terms
no more favorable to Atria than those in the agreements referred to in (I)
above, in each case, shall not be deemed to be Affiliate Transactions.

Notwithstanding the foregoing, any Investment in Affiliates permitted by the
provisions of the Indenture described above under the caption "--Restricted
Payments," shall not be prohibited by the foregoing limitations on Affiliate
Transactions.

Limitations on Issuances of Guarantees of Indebtedness by Restricted
Subsidiaries
The Indenture provides that the Company will not permit any Restricted
Subsidiary, directly or indirectly, to Guarantee or secure the payment of any
other Indebtedness of the Company or any of its Restricted Subsidiaries (except
Indebtedness of a Restricted Subsidiary of such Restricted Subsidiary) unless
such Restricted Subsidiary simultaneously executes and delivers a supplemental
indenture to the Indenture providing for the Guarantee of the payment of the
New Notes by such Restricted Subsidiary, which Guarantee shall be senior to or
pari passu with such Restricted Subsidiary's Guarantee of or pledge to secure
such other Indebtedness. Notwithstanding the foregoing, any such Guarantee by a
Restricted Subsidiary of the New Notes shall provide by its terms that it shall
be automatically and unconditionally released and discharged upon a sale or
other disposition, by way of merger or otherwise, to any Person not an
Affiliate of the Company, of the Company's stock in, or the assets of, such
Restricted Subsidiary, which sale or other disposition results in such
Restricted Subsidiary ceasing to be a Restricted Subsidiary and such sale or
other disposition is made in compliance with, and the Net Proceeds therefrom
are applied in accordance with, the applicable provisions of the Indenture. The
form of such supplemental indenture will be attached as an exhibit to the
Indenture. The foregoing provisions will not be applicable to (i) Guarantees by
Restricted Subsidiaries of the Company's Indebtedness under the Credit
Agreement and with respect to Hedging Obligations related to the Credit
Agreement, (ii) Guarantees by Restricted Subsidiaries of the Company's
Guarantee of (x) Atria's bank credit facility up to an aggregate amount of $100
million through August 26, 1998, declining to $75 million, $50 million and $25
million in each respective one-year period thereafter and (y) Hedging
Obligations related to Atria's bank credit facility for so long as the Company
is permitted to Guarantee amounts under Atria's bank credit facility, (iii)
Guarantees of Indebtedness of a Person by its subsidiaries in effect prior to
the time such Person is merged with or into or became a Restricted Subsidiary,
provided that such Guarantees do not extend to any other Indebtedness of such
Person or any other Person and (iv) any one or more Guarantees of up to $10
million in aggregate principal amount of Indebtedness of the Company or any
Restricted Subsidiary at any time outstanding.

TERMINATION OF CERTAIN COVENANTS IF NOTES RATED INVESTMENT GRADE

Notwithstanding the foregoing, the Company's obligation to comply with the
provisions of the Indenture described above under the captions "--Certain
Covenants--Restricted Payments", "--Incurrence of Indebtedness and Issuance of
Disqualified Stock", "--Asset Sales", "--Dividends and Other Payment
Restrictions Affecting Restricted Subsidiaries", "--Line of Business", "--
Limitation on Senior Subordinated Debt", "--Transactions with Affiliates" and
"--Limitations on Issuances of Guarantees of Indebtedness by Restricted
Subsidiaries" will terminate if and when the New Notes become Investment Grade
Rated.

REPORTS

The Indenture provides that, whether or not required by the rules and
regulations of the Commission, so long as any Notes are outstanding, the
Company will furnish to Holders of New Notes (i) all quarterly and annual
financial information that would be required to be contained in a filing with
the Commission on Forms 10-Q and 10-K if the Company were required to file such
Forms, including a "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and, with respect to the annual information only, a
report thereon by the Company's certified independent accountants and (ii) all
current reports that would be required to be filed with the Commission on Form
8-K if the Company were required to file such reports. In addition, whether or
not required by the rules and regulations of the Commission, the Company will
file a copy of all such information and reports with the Commission for public
availability and make such information available to securities analysts and
prospective investors upon request.

EVENTS OF DEFAULT AND REMEDIES

The Indenture provides that each of the following constitutes an event of
default (an "Event of Default"): (i) default for 30 days in the payment when
due of interest on the New Notes (whether or not prohibited by the provisions
of the Indenture described under "--Subordination" above); (ii) default in
payment when due of the principal of or premium, if any, on the New Notes
(whether or not prohibited by the provisions of the Indenture described under
"--Subordination" above); (iii) failure by the Company to comply with the
provisions described under the captions "--Repurchase at the Option of Holders
upon a Change of Control", "--Certain Covenants--Asset Sales", "--Restricted
Payments" or "--Incurrence of Indebtedness and Issuance of Disqualified Stock";
(iv) failure by the Company for 30 days after notice to comply with any of its
other agreements in the Indenture or the New Notes; (v) any default occurs
under any mortgage, indenture or instrument under which there may be issued or
by which there may be secured or evidenced any Indebtedness for money borrowed
by the Company or any of its Significant Subsidiaries (or the payment of which
is Guaranteed by the Company or any of its Significant Subsidiaries), whether
such Indebtedness or Guarantee exists on the date of the Indenture or is
thereafter created, which default (a) constitutes a Payment Default or (b)
results in the acceleration of such Indebtedness prior to its express maturity
and, in each case, the principal amount of any Indebtedness, together with the
principal amount of any other such Indebtedness under which there has been a
Payment Default or that has been so accelerated, aggregates $25 million or
more; (vi) failure by the Company or any of its Significant Subsidiaries to pay
final judgments aggregating in excess of $25 million, which judgments are not
paid, discharged or stayed for a period of 60 days; and (vii) certain events of
bankruptcy or insolvency with respect to the Company or any of its Significant
Subsidiaries.

If any Event of Default occurs and is continuing, the Trustee or the Holders of
at least 25% in aggregate principal amount of the then outstanding Notes may
declare all the Notes to be due and payable immediately; provided, that for so
long as the Credit Agreement is in effect, such declaration shall not become
effective until the earlier of (i) five Business Days after receipt of the
written notice declaring the Notes to be due and payable immediately by the
Administrative Agent and the Documentation Agent under the Credit Agreement or
(ii) acceleration of the Indebtedness under the Credit Agreement.
Notwithstanding the foregoing, in the case of an Event of Default arising from
certain events of bankruptcy or insolvency with respect to the Company or any
of its Significant Subsidiaries, all outstanding New Notes will become due and
payable without further action or notice. Holders of New Notes may not enforce
the Indenture or the Notes except as provided in the Indenture. Subject to
certain limitations, Holders of a majority in aggregate principal amount of the
then outstanding Notes may direct the Trustee in its exercise of any trust or
power. The Trustee may withhold from Holders of New Notes notice of any
continuing Default or Event of Default (except a Default or Event of Default
relating to the payment of principal or interest) if it determines that
withholding notice is in their interest.

The Holders of a majority in aggregate principal amount of the Notes then
outstanding by notice to the Trustee on behalf of the Holders of the Notes, may
waive any existing Default or Event of Default and its consequences under the
Indenture except a continuing Default or Event of Default in the payment of
interest on, or the principal of, the Notes.

The Company is required to deliver to the Trustee annually a statement
regarding compliance with the Indenture, and the Company is required upon
becoming aware of any Default or Event of Default, to deliver to the Trustee a
statement specifying such Default or Event of Default.

NO PERSONAL LIABILITY OF DIRECTORS, OFFICERS, EMPLOYEES AND STOCKHOLDERS

No director, officer, employee, incorporator or stockholder of the Company, as
such, shall have any liability for any obligations of the Company under the New
Notes, the Indenture or for any claim based on, in respect of, or by reason of,
such obligations or their creation. Each Holder of New Notes by accepting a New
Note waives and releases all such liability. The waiver and release are part of
the consideration for issuance of the New Notes. Such waiver may not be
effective to waive liabilities under the Federal securities laws and it is the
view of the Commission that such a waiver is against public policy.

LEGAL DEFEASANCE AND COVENANT DEFEASANCE

The Company may, at its option and at any time, elect to have all of its
obligations discharged with respect to the outstanding New Notes ("Legal
Defeasance") except for (i) the rights of Holders of outstanding New Notes to
receive payments in respect of the principal of, premium, if any, and interest
on such New Notes when such payments are due from the trust referred to below,
(ii) the Company's obligations with respect to the New Notes concerning issuing
temporary New Notes, registration of New Notes, mutilated, destroyed, lost or
stolen New Notes and the maintenance of an office or agency for payment and
money for security payments held in trust, (iii) the rights, powers, trusts,
duties and immunities of the Trustee, and the Company's obligations in
connection therewith and (iv) the Legal Defeasance provisions of the Indenture.
In addition, the Company may, at its option and at any time, elect to have the
obligations of the Company released with respect to certain covenants that are
described in the Indenture ("Covenant Defeasance") and thereafter any omission
to comply with such obligations shall not constitute a Default or Event of
Default with respect to the New Notes. In the event Covenant Defeasance occurs,
certain events (not including non-payment, bankruptcy, receivership and
insolvency events) described under "Events of Default" will no longer
constitute an Event of Default with respect to the New Notes.

In order to exercise either Legal Defeasance or Covenant Defeasance, (i) the
Company must irrevocably deposit with the Trustee, in trust, for the benefit of
Holders of New Notes, cash in U.S. dollars, noncallable Government Securities,
or a combination thereof, in such amounts as will be sufficient, in the opinion
of a nationally recognized firm of independent public accountants, to pay the
principal of, premium, if any, and interest on such outstanding New Notes on
the stated maturity; (ii) in the case of Legal Defeasance, the Company shall
have delivered to the Trustee an opinion of counsel in the United States
confirming that (A) the Company has received from, or there has been published
by, the Internal Revenue Service a ruling or (B) since the date of the
Indenture, there has been a change in the applicable Federal income tax law, in
either case to the effect that, and based thereon such opinion of counsel shall
confirm that, the Holders of such outstanding New Notes will not recognize
income, gain or loss for Federal income tax purposes as a result of such Legal
Defeasance and will be subject to Federal income tax on the same amounts, in
the same manner and at the same times as would have been the case if such Legal
Defeasance had not occurred; (iii) in the case of Covenant Defeasance, the
Company shall have delivered to the Trustee an opinion of counsel in the United
States confirming that the Holders of such outstanding New Notes will not
recognize income, gain or loss for Federal income tax purposes as a result of
such Covenant Defeasance and will be subject to Federal income tax on the same
amounts, in the same manner and at the same times as would have been the case
if such Covenant Defeasance had not occurred; (iv) no Default or Event of
Default shall have occurred and be continuing on the date of such deposit
(other than a Default or Event of Default resulting from the borrowing of funds
to be applied to such deposit) or insofar as Events of Default from bankruptcy
or insolvency events are concerned, at any time in the period ending on the
91st day after the date of deposit; (v) such Legal Defeasance or Covenant
Defeasance will not result in a breach or violation of, or constitute a default
under any material agreement or instrument (other than the Indenture) to which
the Company or any of its Restricted Subsidiaries is a party or by which the
Company or any of its Restricted Subsidiaries is bound (other than a breach,
violation or default resulting from the borrowing of funds to be applied to
such deposit); (vi) the Company must have delivered to the Trustee an opinion
of counsel to the effect that after the 91st day following the deposit, the
trust funds will not be subject to the effect of any applicable bankruptcy,
insolvency, reorganization or similar laws affecting creditors' rights

generally; (vii) the Company must deliver to the Trustee an Officers'
Certificate stating that the deposit was not made by the Company with the
intent of preferring the Holders of such New Notes over the other creditors of
the Company with the intent of defeating, hindering, delaying or defrauding
creditors of the Company or others; and (viii) the Company must deliver to the
Trustee an Officers' Certificate and an opinion of counsel, each stating that
all conditions precedent provided for relating to the Legal Defeasance or the
Covenant Defeasance, as the case may be, have been complied with.

TRANSFER AND EXCHANGE

A Holder may transfer or exchange New Notes in accordance with the Indenture.
The Registrar and the Trustee may require a Holder, among other things, to
furnish appropriate endorsements and transfer documents and the Company may
require a Holder to pay any taxes and fees required by law or permitted by the
Indenture.

The registered Holder of a New Note will be treated as the owner of it for all
purposes.

AMENDMENT, SUPPLEMENT AND WAIVER

Except as provided in the next two succeeding paragraphs, the Indenture or the
New Notes may be amended or supplemented with the consent of the Holders of at
least a majority in aggregate principal amount of the Notes then outstanding
(including consents obtained in connection with a tender offer or exchange
offer for such Notes), and any existing default or compliance with any
provision of the Indenture or the New Notes may be waived with the consent of
the Holders of a majority in aggregate principal amount of the then outstanding
Notes (including consents obtained in connection with a tender offer or
exchange offer for such Notes).

Without the consent of each Holder affected, an amendment or waiver may not
(with respect to any New Notes held by a non-consenting Holder): (i) reduce the
principal amount of Notes whose Holders must consent to an amendment,
supplement or waiver, (ii) reduce the principal of or change the fixed maturity
of any New Note or alter the provisions with respect to the redemption of the
New Notes (other than provisions relating to the covenants described under the
captions "--Repurchase at the Option of Holders upon a Change of Control" and
"--Certain Covenants--Asset Sales"), (iii) reduce the rate of or change the
time for payment of interest on any New Note, (iv) waive a Default or Event of
Default in the payment of principal of, premium, if any, or interest on, the
New Notes (except a rescission of acceleration of the Notes by the Holders of
at least a majority in aggregate principal amount thereof and a waiver of the
payment default that resulted from such acceleration), (v) make any New Note
payable in money other than that stated in the New Notes, (vi) make any change
in the provisions of the Indenture relating to waivers of past Defaults or the
rights of Holders of New Notes to receive payments of principal of, premium, if
any, or interest on the New Notes, (vii) waive a redemption payment with
respect to any New Note (other than a payment required by one of the covenants
described under the captions "--Repurchase at the Option of Holders upon a
Change of Control" and "--Certain Covenants--Asset Sales"), (viii) modify the
ranking or priority of the New Notes or modify the definition of Senior Debt or
Designated Senior Debt or amend or modify the subordination provisions of the
Indenture in any manner adverse to the Holders or (ix) make any change in the
foregoing amendment and waiver provisions.

Notwithstanding the foregoing, without the consent of any Holder of New Notes,
the Company and the Trustee may amend or supplement the Indenture or the New
Notes to cure any ambiguity, defect or inconsistency, to provide for
uncertificated Notes in addition to or in place of certificated New Notes, to
provide for the assumption of the Company's obligations to Holders of New Notes
in the case of a merger or consolidation, to make any change that would provide
any additional rights or benefits to Holders of New Notes or that does not
adversely affect the legal rights under the Indenture of any such Holder, or to
comply with requirements of the Commission in order to effect or maintain the
qualification of the Indenture under the Trust Indenture Act.

CONCERNING THE TRUSTEE

The Indenture contains certain limitations on the rights of the Trustee, should
the Trustee become a creditor of the Company, to obtain payment of claims in
certain cases, or to realize on certain property received in respect of any
such claim as security or otherwise. The Trustee will be permitted to engage in
other transactions; however, if the Trustee acquires any conflicting interest
(as defined in the Indenture or the Trust Indenture Act) it must eliminate such
conflict within 90 days or resign.

The Holders of a majority in aggregate principal amount of the then outstanding
Notes will have the right to direct the time, method and place of conducting
any proceeding for exercising any remedy available to the Trustee, subject to
certain exceptions. The Indenture provides that in case an Event of Default
shall occur (which shall not be cured), the Trustee will be required, in the
exercise of its power, to use the degree of care of a prudent man in the
conduct of his own affairs. Subject to such provisions, the Trustee will not be
under any obligation to exercise any of its rights or powers under the
Indenture at the request of any Holder of New Notes, unless such Holder shall
have offered to the Trustee security and indemnity satisfactory to it against
any loss, liability or expense.

THE GLOBAL NOTES

Old Notes offered and sold in reliance on Regulation S in the Offering were
initially represented by a single, temporary Global Note in definitive, fully
registered form without interest coupons (the "Temporary Regulation S Global
Note") and were deposited with the Trustee as custodian for DTC and registered
in the name of a nominee of DTC for the accounts of Morgan Guaranty Trust
Company of New York, Brussels office, as operator of the Euroclear System
("Euroclear") or Cedel Bank, S.A. ("Cedel"), The Temporary Regulation S Global
Note is exchangeable for a single, permanent global note (the "Permanent
Regulation S Global Note", and together with the Temporary Regulation S Global
Note, the "Regulation S Global Note").

Old Notes offered and sold to qualified institutional buyers as defined in Rule
144A ("Qualified Institutional Buyers") in the Offering in reliance on Rule
144A are represented by a single, permanent Global Note in definitive, fully
registered form (the "QIB Global Note," and together with the Regulation S
Global Note, the "Global Notes") which were registered in the name of a nominee
of DTC and deposited on behalf of purchasers of the Old Notes represented
thereby with a custodian for DTC for credit to the respective accounts of the
purchasers (or to such other accounts as they directed) at DTC.

Notes originally purchased by or transferred to Qualified Institutional Buyers
who elected to take physical delivery of their certificates instead of holding
their interest through the QIB Global Note (and which were thus ineligible to
trade through DTC) (collectively referred to herein as the "Non-Global
Purchasers") were issued in the form of certificated notes in definitive, fully
registered form (the "Certificated Notes").

Upon the issuance of the Global Notes, DTC or its custodian credits, on its
internal system, the principal amount of Notes of the individual beneficial
interests represented by the Global Notes to the respective accounts of persons
who have accounts with DTC. Ownership of beneficial interests in the Global
Notes was shown on, and the transfer of such ownership will be effected only
through, records maintained by DTC or its nominee (with respect to interests of
Participants (as defined)) and the records of Participants (with respect to
interests of persons other than Participants). Such accounts initially were
designated by or on behalf of the Initial Purchasers, and ownership of
beneficial interests in the Global Notes is limited to persons who have
accounts with DTC ("Participants") or persons who hold interests through
Participants. Interests in the Global Notes may be held directly through DTC,
by Participants, or indirectly through organizations which are Participants.

Investors may hold their interests in the Regulation S Global Note directly
through Cedel or Euroclear, if they are participants in such systems, or
indirectly through organizations which are participants in such systems.
Investors may also hold such interests through organizations other than Cedel
or Euroclear that are Participants in the DTC system. Cedel and Euroclear hold
such interests in the Regulation S Global Note on behalf of their participants
through customers' securities accounts in their respective names on the books
of their respective depositaries, which in turn hold such interests in the
Regulation S Global Note in customers' securities accounts in the depositaries'
names on the books of DTC.

So long as DTC, or its nominee, is the registered owner or Holder of the Global
Notes, DTC or such nominee, as the case may be, will be considered the sole
owner or Holder of Notes represented by such Global Notes for all purposes
under the Indenture. No beneficial owner of an interest in any Global Notes
will be able to transfer that interest except in accordance with applicable
procedures of DTC, Euroclear and Cedel, in addition to those provided for under
the Indenture. Payments of the principal of, premium, if any, and interest on
the Global Notes will be made to DTC or its nominee, as the case may be, as the
registered owner thereof. None of the

Company, the Trustee or any paying agent will have any responsibility or
liability for any aspect of the records relating to or payments made on account
of beneficial ownership interests in the Global Notes or for maintaining,
supervising or reviewing any records relating to such beneficial ownership
interest.

The Company expects that DTC or its nominee, upon receipt of any payment of
principal, premium, if any, or interest in respect of the Global Notes, will
credit Participants' accounts with payments in amounts proportionate to their
respective beneficial interests in the principal amount of the Global Notes as
shown on the records of DTC or its nominee. The Company also expects that
payments by Participants to owners of beneficial interests in the Global Notes
held through such Participants will be governed by standing instructions and
customary practice, as is now the case with securities held for the accounts of
customers registered in the names of nominees for such customers. Such payments
will be the responsibility of such Participants.

Transfers between Participants will be effected in the ordinary way in
accordance with DTC rules and will be settled in immediately available funds.
If a Holder requires physical delivery of a Certificated Note for any reason,
including to sell New Notes to persons in states which require physical
delivery of the New Notes, or to pledge such securities, such Holder must
transfer its interest in a Global Note in accordance with the normal procedures
of DTC and with the procedures set forth in the Indenture.

Transfers by an owner of a beneficial interest in the QIB Global Note to a
transferee who takes delivery of such interest through the Regulation S Global
Note will be made only upon receipt by the Trustee of a certification to the
effect that such transfer is being made in accordance with Regulation S.

Any beneficial interest in one of the Global Notes that is transferred to a
person who takes delivery in the form of an interest in the other Global Note
will, upon transfer, cease to be an interest in such Global Note and become an
interest in the other Global Note and, accordingly, will thereafter be subject
to all transfer restrictions, if any, and other procedures applicable to
beneficial interests in such other Global Note for as long as it remains such
an interest.

DTC has advised the Company that it will take any action permitted to be taken
by a Holder of New Notes (including the presentation of Notes for exchange)
only at the direction of one or more Participants to whose account the DTC
interests in the Global Notes are credited and only in respect of such portion
of the aggregate principal amount of New Notes as to which such Participant or
Participants has or have given such direction. However, if there is an Event of
Default under the Indenture, DTC will exchange the Global Notes in whole for
Certificated Notes, which it will distribute to the Participants.

DTC has advised the Company as follows: DTC is a limited purpose trust company
organized under the laws of the State of New York, a member of the Federal
Reserve System, a "clearing corporation" within the meaning of the Uniform
Commercial Code and a "Clearing Agency" registered pursuant to the provisions
of Section 17A of the Exchange Act. DTC was created to hold securities for
Participants and facilitate the clearance and settlement of securities
transactions between Participants through electronic book-entry changes in
accounts of its Participants, thereby eliminating the need for physical
movement of certificates. Participants include securities brokers and dealers,
banks, trust companies and clearing corporations and certain other
organizations. Indirect access to the DTC system is available to others such as
banks, brokers, dealers and trust companies that clear through or maintain a
custodial relationship with a Participant, either directly or indirectly
("Indirect Participants").

Although DTC, Euroclear and Cedel are expected to follow the foregoing
procedures in order to facilitate transfers of interests in the Global Notes
among Participants of DTC, Euroclear and Cedel, they are under no obligation to
perform such procedures, and such procedures may be discontinued at any time.
Neither the Company nor the Trustee will have any responsibility for the
performance by DTC, Euroclear or Cedel or the Participants or Indirect
Participants of their respective obligations under the rules and procedures
governing their operations.

CERTIFICATED NOTES

If DTC is at any time unwilling or unable to continue as a depositary for the
Global Notes and a successor depositary is not appointed by the Company within
90 days, Certificated Notes will be issued in exchange for the Global Notes.

CERTAIN DEFINITIONS

Set forth below are certain defined terms used in the Indenture. Reference is
made to the Indenture for full disclosure of all such terms, as well as any
other capitalized terms used herein for which no definition is provided.

"Acquired Debt" means, with respect to any specified Person, (i) Indebtedness
of any other Person existing at the time such other Person is merged with or
into or became a Restricted Subsidiary of such specified Person, including,
without limitation, Indebtedness incurred in connection with, or in
contemplation of, such other Person merging with or into or becoming a
Restricted Subsidiary of such specified Person, and (ii) Indebtedness secured
by a Lien encumbering any asset acquired by such specified Person.

"Acquired Subsidiary Debt" means, with respect to any specified Person, (i)
Indebtedness of any other Person existing at the time such other Person is
merged with or into or became a Restricted Subsidiary of such specified Person,
except to the extent such Indebtedness was incurred in connection with, or in
contemplation of, such
other Person merging with or into or becoming a Restricted Subsidiary of such
specified Person, and (ii) Indebtedness secured by a Lien encumbering any asset
acquired by such specified Person, except to the extent such Lien was created
or incurred in connection with, or in contemplation of, such acquisition.

"Affiliate" of any specified Person means any other Person directly or
indirectly controlling or controlled by or under direct or indirect common
control with such specified Person. For purposes of this definition, "control"
(including, with correlative meanings, the terms "controlling," "controlled by"
and "under common control with"), as used with respect to any Person, shall
mean the possession, directly or indirectly, of the power to direct or cause
the direction of the management or policies of such Person, whether through the
ownership of voting securities, by agreement or otherwise; provided that
beneficial ownership of 10% or more of the voting securities of a Person shall
be deemed to be control.

"Affiliate Agreements" means the agreements listed in Schedule III to the
Credit Agreement on the date of the Indenture.

"Asset Sale" means (i) the sale, lease, conveyance or other disposition of any
assets (including, without limitation, by way of a sale and leaseback);
provided that the sale, lease, conveyance or other disposition of all or
substantially all of the assets of the Company and its Restricted Subsidiaries
taken as a whole will be governed by the provisions of the Indenture described
above under the caption "--Repurchase at the Option of Holders upon a Change of
Control" and/or the provisions described above under the caption "--Certain
Covenants--Merger, Consolidation or Sale of Assets" and not by the provisions
of the Asset Sale covenant, and (ii) the issuance or sale by the Company or any
of its Restricted Subsidiaries of Equity Interests of any of the Company's
Restricted Subsidiaries, in the case of either clause (i) or (ii), whether in a
single transaction or a series of related transactions (a) that have a fair
market value in excess of $15 million or (b) for net proceeds in excess of $15
million. Notwithstanding the foregoing: (a) a transfer of assets by the Company
to a Restricted Subsidiary or by a Restricted Subsidiary to the Company or to
another Restricted Subsidiary, (b) an issuance of Equity Interests by a
Restricted Subsidiary to the Company or to another Restricted Subsidiary, (c) a
Remaining Lenox Sale, (d) a Healthcare Facility Swap, (e) sales of assets of
Behavioral Healthcare Corporation and (f) sales of assets comprising the
occupational health business of TheraTx will not be deemed to be an Asset Sale.

"Atria" means Atria Communities, Inc., a Delaware corporation, and its
successors.

"Board of Directors" means, with respect to any Person, the Board of Directors
of such Person, or any authorized committee of the Board of Directors of such
Person.

"Business Day" means any day except a Saturday, Sunday or other day on which
commercial banks in The City of New York are authorized by law to close.

"Capital Lease Obligation" means, at the time any determination thereof is to
be made, the amount of the liability in respect of a capital lease that would
at such time be required to be capitalized on a balance sheet in accordance
with GAAP.

"Capital Stock" means (i) in the case of a corporation, corporate stock, (ii)
in the case of an association or business entity, any and all shares,
interests, participations, rights or other equivalents (however designated) of
corporate stock, (iii) in the case of a partnership, partnership interests
(whether general or limited) and (iv) any other interest or participation that
confers on a Person the right to receive a share of the profits and losses of,
or distributions of assets of, the issuing Person.

"Change of Control" means the occurrence of any of the following: (i) the sale,
lease, transfer, conveyance or other disposition, in one or a series of related
transactions, of all or substantially all of the assets of the Company and its
Restricted Subsidiaries taken as a whole to any Person or group (as such term
is used in Sections 13(d)(3) and 14(d)(2) of the Exchange Act) other than to a
Person or group who, prior to such transaction, held a majority of the voting
power of the voting stock of the Company, (ii) the acquisition by any Person or
group (as defined above) of a direct or indirect interest in more than 50% of
the voting power of the
voting stock of the Company, by way of merger or consolidation or otherwise, or
(iii) the first day on which a majority of the members of the Board of
Directors of the Company are not Continuing Directors.

The phrase "all or substantially all" of the assets of the Company will likely
be interpreted under applicable state law and will be dependent upon particular
facts and circumstances. As a result, there may be a degree of uncertainty in
ascertaining whether a sale or transfer of "all or substantially all" of the
assets of the Company has occurred, in which case a Holder's ability to obtain
the benefit of a Change of Control Offer may be impaired. In addition, no
assurances can be given that the Company will be able to acquire Notes tendered
upon the occurrence of a Change of Control.

"Consolidated EBITDA" means, with respect to any Person for any period, the
Consolidated Net Income of such Person for such period plus (i) an amount equal
to any extraordinary loss plus any net loss realized in connection with an
Asset Sale (to the extent such losses were deducted in computing such
Consolidated Net Income), plus (ii) any non-cash charges (to the extent such
charges were deducted in computing such Consolidated Net Income), except for
any non-cash charges that represent accruals of, or reserves for, cash
disbursements to be made in any future accounting period, plus (iii) provision
for taxes based on income or profits of such Person and its Restricted
Subsidiaries for such period, to the extent such provision for taxes was
included in computing such Consolidated Net Income, plus (iv) the Fixed Charges
of such Person and its Restricted Subsidiaries for such period, to the extent
that such Fixed Charges were deducted in computing such Consolidated Net
Income, plus (v) depreciation and amortization (including amortization of
goodwill and other intangibles but excluding amortization of prepaid cash
expenses that were paid in a prior period) of such Person and its Restricted
Subsidiaries for such period to the extent that such depreciation and
amortization were deducted in computing such Consolidated Net Income, in each
case, on a consolidated basis and determined in accordance with GAAP.
Notwithstanding the foregoing, the amounts referred to in clauses (i) through
(v) above as they relate to a Restricted Subsidiary of the referent Person
shall be added to Consolidated Net Income to compute Consolidated EBITDA only
to the extent (and in same proportion) that the Net Income of such Restricted
Subsidiary was included in calculating the Consolidated Net Income of such
Person and only if a corresponding amount would be permitted at the date of
determination to be dividended to the Company by such Restricted Subsidiary
without prior approval (that has not been obtained), pursuant to the terms of
its charter and all agreements, instruments, judgments, decrees, orders,
statutes, rules and governmental regulations applicable to that Restricted
Subsidiary or its stockholders.

"Consolidated Net Income" means, with respect to any Person for any period, the
aggregate of the Net Income of such Person and its Restricted Subsidiaries for
such period, on a consolidated basis, determined in accordance with GAAP;
provided that (i) the Net Income of any Person that is not a Restricted
Subsidiary or that is accounted for by the equity method of accounting shall be
included only to the extent of the amount of dividends or distributions paid in
cash to the referent Person or a Restricted Subsidiary thereof, (ii) the Net
Income of any Restricted Subsidiary shall be excluded to the extent that the
declaration or payment of dividends or similar distributions by that Restricted
Subsidiary of that Net Income is not at the date of determination permitted
without any prior governmental approval (that has not been obtained) or,
directly or indirectly, by operation of the terms of its charter or any
agreement, instrument, judgment, decree, order, statute, rule or governmental
regulation applicable to that Restricted Subsidiary or its stockholders, (iii)
solely for the purpose of calculating the amount of Restricted Payments that
may be made pursuant to clause (c) of the first paragraph

of the covenant described above under the caption "Certain Covenants--
Restricted Payments", the Net Income of any Person acquired in a pooling of
interests transaction for any period prior to the date of such acquisition
shall be excluded and (iv) the cumulative effect of a change in accounting
principles shall be excluded.

"Consolidated Net Worth" means, with respect to any Person as of any date, the
sum of (i) the consolidated equity of the common stockholders of such Person
and its consolidated Restricted Subsidiaries as of such date plus (ii) the
respective amounts reported on such Person's balance sheet as of such date with
respect to any series of preferred stock (other than Disqualified Stock), less
all write-ups (other than write-ups resulting from foreign currency
translations and write-ups of tangible assets of a going concern business made
in accordance with GAAP as a result of the acquisition of such business)
subsequent to the date of the Indenture in the book value of any asset owned by
such Person or a consolidated Restricted Subsidiary of such Person, and
excluding the cumulative effect of a change in accounting principles, all as
determined in accordance with GAAP.

"Continuing Directors" means, as of any date of determination, any member of
the Board of Directors of the Company who (i) was a member of such Board of
Directors on the date of the Indenture or (ii) was nominated for election or
elected to such Board of Directors with the approval of a majority of the
Continuing Directors who were members of such Board at the time of such
nomination or election.

"Credit Agreement" means that certain Credit Agreement, dated as of March 17,
1997, as amended as of March 31, 1997, and as further amended as of April 22,
1997 and as of May 30, 1997, by and among the Company and Morgan Guaranty Trust
Company of New York, as Documentation Agent and Collateral Agent, Nationsbank
N.A., as Administrative Agent and the other banks that are parties thereto,
including any related notes, collateral documents, instruments and agreements
executed in connection therewith, and in each case as further amended,
modified, extended, renewed, refunded, replaced or refinanced, in whole or in
part, from time to time.

"Default" means any event that is or with the passage of time or the giving of
notice or both would be an Event of Default.

"Designated Senior Debt" means (i) so long as the Credit Agreement is
outstanding, the Credit Agreement and (ii) thereafter, any other Senior Debt
permitted under the Indenture the principal amount of which is $75 million or
more and that has been designated by the Company as "Designated Senior Debt".

"Disqualified Stock" means any Capital Stock that, by its terms (or by the
terms of any security into which it is convertible or for which it is
exchangeable), or upon the happening of any event, matures or is mandatorily
redeemable, pursuant to a sinking fund obligation or otherwise, or redeemable
at the option of the holder thereof, in whole or in part, on or prior to the
date on which the Notes mature.

"Equity Interests" means Capital Stock and all warrants, options or other
rights to acquire Capital Stock (but excluding any debt security that is
convertible into, or exchangeable for, Capital Stock).

"Exchange Act" means the Securities Exchange Act of 1934, as amended.

"Existing Indebtedness" means Indebtedness of the Company and its Restricted
Subsidiaries (other than Indebtedness under the Credit Agreement) in existence
on the date of the Indenture, until such amounts are repaid, including all
reimbursement obligations with respect to letters of credit outstanding as of
the date of the Indenture (other than letters of credit issued pursuant to the
Credit Agreement).

"Fixed Charge Coverage Ratio" means, with respect to any Person for any period,
the ratio of the Consolidated EBITDA of such Person for such period to the
Fixed Charges of such Person for such period. In the event that the Company or
any of its Restricted Subsidiaries incurs, assumes, Guarantees or redeems any
Indebtedness (other than revolving credit borrowings) or issues preferred stock
subsequent to the commencement of the four-quarter reference period for which
the Fixed Charge Coverage Ratio is being calculated but on or prior to the date
on which the event for which the calculation of the Fixed Charge Coverage Ratio
is made (the "Calculation Date"), then the Fixed Charge Coverage Ratio shall be
calculated giving pro forma effect to such incurrence, assumption, Guarantee or
redemption of Indebtedness, or such issuance or redemption of preferred stock,
as if

the same had occurred at the beginning of the applicable four-quarter reference
period. In addition, for purposes of making the computation referred to above,
(i) acquisitions that have been made by the Company or any of its Restricted
Subsidiaries, including through mergers or consolidations and including any
related financing transactions, during the four-quarter reference period or
subsequent to such reference period and on or prior to the Calculation Date
shall be deemed to have occurred on the first day of the four quarter reference
period, and (ii) the Consolidated EBITDA and Fixed Charges attributable to
discontinued operations, as determined in accordance with GAAP, and operations
or businesses disposed of prior to the Calculation Date, shall be excluded.

"Fixed Charges" means, with respect to any Person for any period, the sum,
without duplication, of (i) the consolidated interest expense of such Person
and its Restricted Subsidiaries for such period, whether paid or accrued
(including, without limitation, amortization of original issue discount, non-
cash interest payments, the interest component of any deferred payment
obligations, the interest component of all payments associated with
Capital Lease Obligations, commissions, discounts and other fees and charges
incurred in respect of letters of credit or bankers' acceptance financings, and
net payments (if any) pursuant to Hedging Obligations) and (ii) the
consolidated interest expense of such Person and its Restricted Subsidiaries
that was capitalized during such period, and (iii) any interest expense on
Indebtedness of another Person that is Guaranteed by such Person or one of its
Restricted Subsidiaries or secured by a Lien on assets of such Person or one of
its Restricted Subsidiaries (whether or not such Guarantee or Lien is called
upon) and (iv) the product of (a) all cash dividend payments (and non-cash
dividend payments in the case of a Person that is a Restricted Subsidiary) on
any series of preferred stock of such Person, times (b) a fraction, the
numerator of which is one and the denominator of which is one minus the then
current combined Federal, state and local statutory tax rate of such Person,
expressed as a decimal, in each case, on a consolidated basis and in accordance
with GAAP.

"GAAP" means generally accepted accounting principles set forth in the opinions
and pronouncements of the Accounting Principles Board of the American Institute
of Certified Public Accountants and statements and pronouncements of the
Financial Accounting Standards Board or in such other statements by such other
entities as have been approved by a significant segment of the accounting
profession, as in effect from time to time.

"Guarantee" means a guarantee (other than by endorsement of negotiable
instruments for collection in the ordinary course of business), direct or
indirect, in any manner (including, without limitation, letters of credit and
reimbursement agreements in respect thereof), of all or any part of any
Indebtedness.

"Healthcare Facility" means (i) a hospital, outpatient clinic, nursing center,
assisted or independent living community, long-term care facility or any other
facility that is used or useful in the provision of healthcare or custodial
care services, (ii) any healthcare business affiliated or associated with a
Healthcare Facility or (iii) any business related or ancillary to the provision
of healthcare services or the operation of a Healthcare Facility, including,
but not limited to, contract therapy services such as rehabilitation,
respiratory, speech and occupational therapy services, as well as hospice and
home care services.

"Healthcare Facility Swap" means an exchange of assets by the Company or a
Restricted Subsidiary of the Company for one or more Healthcare Facilities or
for the Capital Stock of any Person owning one or more Healthcare Facilities.

"Hedging Obligations" means, with respect to any Person, the obligations of
such Person under (i) interest rate swap agreements, interest rate cap
agreements and interest rate collar agreements, (ii) foreign exchange contracts
or currency swap agreements and (iii) other agreements or arrangements designed
to protect such Person against fluctuations in interest rates or currency
values.

"Indebtedness" means, with respect to any Person, any indebtedness of such
Person, whether or not contingent, in respect of borrowed money or evidenced by
bonds, notes, debentures or similar instruments (other than Residential Deposit
Bonds) or letters of credit (or reimbursement agreements in respect thereof) or
banker's acceptances or representing Capital Lease Obligations or the balance
deferred and unpaid of the purchase price of any property or representing any
Hedging Obligations, except any such balance that constitutes an accrued
expense or trade payable, if and to the extent any of the foregoing
indebtedness (other than letters of credit and

Hedging Obligations) would appear as a liability upon a balance sheet of such
Person prepared in accordance with GAAP, as well as all indebtedness of others
secured by a Lien on any asset of such Person (whether or not such indebtedness
is assumed by such Person) and, to the extent not otherwise included, the
Guarantee by such Person of any indebtedness of any other Person.

"Investment Grade Rated" means, with respect to the Notes, both a rating of the
Notes by S&P of BBB- or higher and a rating of the Notes by Moody's of Baa3 or
higher.

"Investments" means, with respect to any Person, all investments by such Person
in other Persons (including Affiliates) in the forms of direct or indirect
loans (including Guarantees of Indebtedness or other obligations), advances or
capital contributions, purchases or other acquisitions for consideration of
Indebtedness, Equity Interests or other securities and all other items that are
or would be classified as investments on a balance sheet prepared in accordance
with GAAP. For purposes of the definition of "Unrestricted Subsidiary" and the
"Restricted Payments" covenant described above, (i) "Investment" shall include
the fair market value of the assets (net of liabilities) of any Restricted
Subsidiary at the time that such Restricted Subsidiary is designated an
Unrestricted Subsidiary and shall exclude the fair market value of the assets
(net of liabilities) of any Unrestricted Subsidiary at the time that such
Unrestricted Subsidiary is designated a Restricted Subsidiary and (ii) any
property transferred to or from any Person shall be valued at its fair market
value at the time of such transfer, in each case as determined in good faith by
the Board of Directors of the Company.

"Issue Date" means the original issue date of the Notes.

"Lien" means, with respect to any asset, any mortgage, lien, pledge, charge,
security interest or encumbrance of any kind in respect of such asset given to
secure Indebtedness, whether or not filed, recorded or otherwise perfected
under applicable law (including any conditional sale or other title retention
agreement, any lease in the nature thereof, any option or other agreement to
sell or give a security interest in and any filing of or agreement to give any
financing statement under the Uniform Commercial Code (or equivalent statutes)
of any jurisdiction with respect to any such lien, pledge, charge or security
interest).

"Moody's" means Moody's Investors Services, Inc. and its successors.

"Net Income" means, with respect to any Person for such period, the net income
(loss) of such Person for such period, determined in accordance with GAAP and
before any reduction in respect of preferred stock dividends, excluding,
however, (i) any gain (but not loss), together with any related provision for
taxes on such gain (but not loss), realized in connection with (a) any Asset
Sale (including, without limitation, dispositions pursuant to sale and
leaseback transactions) or (b) the disposition of any securities by such Person
or any of its Restricted Subsidiaries or the extinguishment of any Indebtedness
of such Person or any of its Restricted Subsidiaries and (ii) any extraordinary
or nonrecurring gain (but not loss), together with any related provision for
taxes on such extraordinary or nonrecurring gain (but not loss).

"Net Proceeds" means the aggregate cash proceeds received by the Company or any
of its Restricted Subsidiaries in respect of any Asset Sale, net of the direct
costs relating to such Asset Sale (including, without limitation, legal,
accounting and investment banking fees' and sales commissions) and any other
expenses incurred or to be incurred by the Company or a Restricted Subsidiary
as a direct result of the sale of such assets (including, without limitation,
severance, relocation, lease termination and other similar expenses), taxes
actually paid or payable as a result thereof, payments made to retire
Indebtedness where payment of such Indebtedness is required in connection with
such Asset Sale and any reserve for adjustment in respect of the sale price of
such asset or assets established in accordance with GAAP.

"Non-Recourse Debt" means Indebtedness of a Subsidiary (i) as to which neither
the Company nor any of its Restricted Subsidiaries (a) provides credit support
of any kind (including any undertaking, agreement or instrument that would
constitute Indebtedness of the Company or any of its Restricted Subsidiaries),
or (b) is directly or indirectly liable (as a guarantor or otherwise) and (ii)
no default with respect to which would permit (upon notice, lapse of time or
both) any holder of any other Indebtedness of the Company or any of its
Restricted Subsidiaries to declare a default on such other Indebtedness or
cause the payment thereof to be accelerated or payable prior to its stated
maturity.

"Obligations" means any principal, interest, penalties, fees, indemnifications,
reimbursements, damages and other liabilities payable under the documentation
governing any Indebtedness.

"Payment Default" means any failure to pay any scheduled installment of
principal of, premium, if any, or interest on any Indebtedness within the grace
period provided for such payment in the documentation governing such
Indebtedness.

"Permitted Liens" means (i) Liens securing Senior Debt under the Credit
Agreement or Guarantees thereof; (ii) Liens in favor of the Company; (iii)
Liens on assets of a Person existing at the time such Person is merged into or
consolidated with the Company or any Restricted Subsidiary of the Company or
becomes a Restricted Subsidiary of the Company; provided that such Liens were
in existence prior to the contemplation of such
merger, consolidation or acquisition and do not extend to any assets other than
those of the Person merged into or consolidated with the Company or that
becomes a Restricted Subsidiary of the Company; (iv) Liens on property existing
at the time of acquisition thereof by the Company or any Restricted Subsidiary
of the Company, provided that such Liens were in existence prior to the
contemplation of such acquisition; (v) Liens to secure the performance of
statutory obligations, surety or appeal bonds, performance bonds or other
obligations of a like nature incurred in the ordinary course of business; (vi)
Liens existing on the date of the Indenture; (vii) Liens for taxes, assessments
or governmental charges or claims that are not yet delinquent or that are being
contested in good faith by appropriate proceedings promptly instituted and
diligently concluded, provided that any reserve or other appropriate provision
as shall be required in conformity with GAAP shall have been made therefor;
(viii) Liens on any asset securing Indebtedness incurred or assumed for the
purpose of financing all or any part of the cost of acquiring or constructing
such asset, provided that such Lien attaches to such asset concurrently with or
within 180 days after the acquisition or completion of construction thereof and
attaches to no asset other than such asset so financed; (ix) Liens arising in
the ordinary course of business which (a) do not secure Indebtedness, (b) do
not secure any single obligation (or series of related obligations) in an
amount exceeding $5 million, provided that the limitation in this clause (b)
shall not apply to Liens securing worker's compensation, unemployment insurance
and other types of social security, and (c) do not in the aggregate materially
detract from the value of the assets of the Company and its Restricted
Subsidiaries, taken as a whole, or materially impair the use thereof in the
operation of their business; (x) Liens on cash (not exceeding $20 million in
aggregate amount) of Cornerstone Insurance Company to secure its reimbursement
obligations under letters of credit issued for its account; (xi) other Liens or
title defects (including matters which an accurate survey might disclose) which
(a) do not secure Indebtedness and (b) do not materially detract from the value
of real property or materially impair the use thereof by the Company or any of
its Restricted Subsidiaries in the operation of its business; (xii) Liens
securing Hedging Obligations permitted by the second paragraph of the covenant
described above under the caption "Certain Covenants--Incurrence of
Indebtedness and Issuance of Disqualified Stock"; (xiii) other Liens on assets
of the Company or any Restricted Subsidiary of the Company securing
Indebtedness that is permitted by the terms of the Indenture to be outstanding
having an aggregate principal amount at any one time outstanding not to exceed
5% of the Stockholders' Equity of the Company; and (xiv) Liens to secure
Permitted Refinancing Indebtedness incurred to refinance Indebtedness that was
secured by a Lien permitted under the Indenture and that was incurred in
accordance with the provisions of the Indenture; provided that such Liens do
not extend to or cover any property or assets of the Company or any Restricted
Subsidiary other than assets or property securing the Indebtedness so
refinanced.

"Permitted Refinancing Indebtedness" means any Indebtedness of the Company or
any of its Restricted Subsidiaries issued in exchange for, or the net proceeds
of which are used solely to extend, refinance, renew, replace, defease or
refund, other Indebtedness of the Company or any of its Restricted
Subsidiaries; provided that (i) the principal amount of such Permitted
Refinancing Indebtedness does not exceed the principal amount of the
Indebtedness so extended, refinanced, renewed, replaced, defeased or refunded
(plus the amount of any premiums paid and reasonable expenses incurred in
connection therewith); (ii) such Permitted Refinancing Indebtedness has a final
maturity date later than the final maturity date of, and has a Weighted Average
Life to Maturity equal to or greater than the Weighted Average Life to Maturity
of, the Indebtedness being extended, refinanced, renewed, replaced, defeased or
refunded; (iii) if the Indebtedness being extended, refinanced, renewed,
replaced, defeased or refunded is subordinated in right of payment to the
Notes, such Permitted Refinancing Indebtedness is subordinated in right of
payment to the Notes on terms at least as favorable to the

Holders of Notes as those contained in the documentation governing the
Indebtedness being extended, refinanced, renewed, replaced, defeased or
refunded; and (iv) such Indebtedness is incurred either by the Company or by
the Restricted Subsidiary which is the obligor on the Indebtedness being
extended, refinanced, renewed, replaced, defeased or refunded.

"Person" means an individual, a corporation, a partnership, an association, a
trust or any other entity or organization, including a government or political
subdivision or an agency or instrumentality thereof.

"Qualified Equity Interests" means all Equity Interests of the Company other
than Disqualified Stock of the Company.

"Remaining Lenox Sale" means the sale of those assets comprising the remaining
partnership interests and nursing centers to be sold to Lenox Healthcare, Inc.
or its designee under that certain Agreement of Purchase and Sale of Assets
dated November 25, 1996, by and among First Healthcare Corporation, Nationwide
Care, Inc., Pasatiempo Development Corp., Hillhaven/Westfield Partnership,
Hillhaven/Indiana Partnership, Vencor, Inc., Lenox Healthcare, Inc. and Thomas
M. Clarke, as amended from time to time, provided that such amendments do not
include changes to the economic terms of such agreement.

"Residential Deposit Bonds" means bonds issued by the Company or any of its
Restricted Subsidiaries to tenants of residential units of New Pond Village in
Walpole, Massachusetts evidencing the obligation to repay at the end of their
tenancies amounts paid by them at the beginning of their tenancies, provided
that the aggregate outstanding principal amount of all such bonds (including
any such bonds outstanding on the date of the Indenture) shall not at any time
exceed $53 million.

"Restricted Investment" means (i) an Investment (including Guarantees of
Indebtedness or other obligations) in an Unrestricted Subsidiary, (ii) any
Investment in an Affiliate that is not permitted by the first paragraph of the
covenant described above under the caption "--Certain Covenants--Transactions
with Affiliates" and (iii) Investments received by the Company or its
Restricted Subsidiaries as consideration for Asset Sales which are not
otherwise permitted to be received by the first sentence of the covenant
described above under the caption "--Certain Covenants--Asset Sales".

"Restricted Subsidiary" means any Subsidiary of the Company other than an
Unrestricted Subsidiary and any Subsidiary of an Unrestricted Subsidiary.

"S&P" means Standard & Poor's Rating Group and its successors.

"SEC" means the Securities and Exchange Commission.

"Securities Act" means the Securities Act of 1933, as amended.

"Senior Debt" means (i) all Indebtedness of the Company under the Credit
Agreement, including principal of, premium, if any, and interest on such
Indebtedness and all other amounts due on or in connection with such
Indebtedness including all charges, fees and expenses, (ii) all other
Indebtedness of the Company, including principal of, premium, if any, and
interest on such Indebtedness, unless the instrument under which such
Indebtedness is created, incurred, assumed or Guaranteed expressly provides
that such Indebtedness is not senior or superior in right of payment to the
Notes, and all renewals, extensions modifications, amendments or refinancings
thereof and (iii) all interest on any Indebtedness referred to in clause (i)
and (ii) accruing during the pendency of any bankruptcy or insolvency
proceeding whether or not allowed thereunder. Notwithstanding the foregoing,
Senior Debt shall not include (a) Subordinated Debt of Company; provided,
however, that no Indebtedness shall be deemed to be Subordinated Debt of the
Company solely by reason of such other Indebtedness being secured and such
Indebtedness not being secured, (b) the Notes, (c) any Indebtedness of the
Company to any of its Restricted Subsidiaries and (d) any Indebtedness which,
when incurred and without respect to any election under Section 1111(b) of the
Bankruptcy Code, is without recourse to the Company.

"Significant Subsidiary" means, at any date of determination, any Subsidiary
that, together with its Subsidiaries, (i) for the most recent fiscal year of
the Company, accounted for more than 10% of the consolidated revenues of the
Company and its consolidated subsidiaries or (ii) as of the end of such fiscal
year, was the owner of more than 10% of the consolidated assets of the Company
and its consolidated subsidiaries, all as set forth on the most recently
available financial statements of the Company for such fiscal year.

"Stockholders' Equity" means, with respect to any Person as of any date, the
stockholders' equity of such Person determined in accordance with GAAP as of
the date of the most recent available internal financial statements of such
Person, and calculated on a pro forma basis to give effect to any acquisition
or disposition by such Person consummated or to be consummated since the date
of such financial statements and on or prior to the date of such calculation.

"Subordinated Debt" means any Indebtedness (whether outstanding on the Issue
Date or hereafter incurred) which is by its terms expressly subordinate or
junior in right of payment to the Notes.

"Subsidiary" means, with respect to any Person, (i) any corporation,
association or other business entity of which more than 50% of the total voting
power of shares of Capital Stock entitled (without regard to the occurrence of
any contingency) to vote in the election of directors, managers or trustees
thereof is at the time owned or controlled, directly or indirectly, by such
Person or one or more of the other Subsidiaries of that Person (or a
combination thereof) and (ii) any partnership (a) the sole general partner or
the managing general partner of which is such Person or a Subsidiary of such
Person or (b) the only general partners of which are such Person or of one or
more Subsidiaries of such Person (or any combination thereof). Unrestricted
Subsidiaries shall not be included in the definition of Subsidiary for any
purposes of the Indenture (except, as the context may otherwise require, for
purposes of the definition of "Unrestricted Subsidiary").

"Unrestricted Subsidiary" means Atria and any other Subsidiary that is
designated by the Board of Directors of the Company as an Unrestricted
Subsidiary pursuant to a Board Resolution; but only to the extent that such
Subsidiary (i) has no Indebtedness other than Non-Recourse Debt, (ii) is not
party to any agreement, contract, arrangement or understanding with the Company
or any Restricted Subsidiary of the Company unless the terms of any such
agreement, contract, arrangement or understanding are no less favorable to the
Company or such Restricted Subsidiary than those that might be obtained at the
time from Persons who are not Affiliates of the Company, (iii) is a Person with
respect to which neither the Company nor any of its Restricted Subsidiaries has
any direct or indirect obligation (x) to subscribe for additional Equity
Interests or (y) to maintain or preserve such Person's financial condition or
to cause such Person to achieve any specified levels of operating results and
(iv) has not guaranteed or otherwise directly or indirectly provided credit
support for any Indebtedness of the Company or any of its Restricted
Subsidiaries; provided, however, that Atria will continue to qualify as an
Unrestricted Subsidiary notwithstanding (a) the existence of Indebtedness under
Atria's bank credit facility which does not qualify as Non-Recourse Debt, (b)
the incurrence of Indebtedness Guaranteed by the Company or any Restricted
Subsidiary which Atria is permitted to incur under the first paragraph of the
covenant described above under the caption "--Certain Covenants--Incurrence of
Indebtedness and Issuance of Disqualified Stock" or (c) any transaction between
the Company or any Restricted Subsidiary and Atria which is permitted by the
first paragraph of the covenant described above under the caption "--Certain
Covenants--Transactions with Affiliates", but Atria shall cease to qualify as
an Unrestricted Subsidiary if it otherwise fails to comply with the conditions
set forth in clauses (i) through (iv) above.

Notwithstanding the foregoing, an Unrestricted Subsidiary shall not cease to
qualify as an Unrestricted Subsidiary if the Company Guarantees Indebtedness of
such Unrestricted Subsidiary and such Guarantee is a Restricted Investment
which is permitted by the provisions of the Indenture described above under the
caption
"--Certain Covenants--Restricted Payments".

Any such designation by the Board of Directors of the Company shall be
evidenced to the Trustee by filing with the Trustee a certified copy of the
Board Resolution giving effect to such designation and an Officers' Certificate
certifying that such designation complied with the foregoing conditions and was
permitted under the covenant described above under the caption "--Certain
Covenants--Restricted Payments." If, at any time, any Unrestricted Subsidiary
would fail to meet the foregoing requirements as an Unrestricted Subsidiary, it
shall thereafter cease to be an Unrestricted Subsidiary for purposes of the
Indenture and any Indebtedness of such

Subsidiary shall be deemed to be incurred by a Restricted Subsidiary of the
Company as of such date (and, if such Indebtedness is not permitted to be
incurred as of such date under the Indenture, the Company shall be in Default
under the Indenture). The Board of Directors of the Company may at any time
designate any Unrestricted Subsidiary to be a Restricted Subsidiary; provided
that such designation shall be deemed to be an incurrence of Indebtedness by a
Restricted Subsidiary of the Company of any outstanding Indebtedness of such
Unrestricted Subsidiary and such designation shall only be permitted if (i)
such Indebtedness is permitted under the Indenture, and (ii) no Default or
Event of Default would be in existence following such designation.

"Weighted Average Life to Maturity" means, when applied to any Indebtedness at
any date, the number of years obtained by dividing (i) the sum of the products
obtained by multiplying (a) the amount of each then remaining installment,
sinking fund, serial maturity or other required payments of principal,
including payment at final maturity, in respect thereof, by (b) the number of
years (calculated to the nearest one-twelfth) that will elapse between such
date and the making of such payment, by (ii) the then outstanding principal
amount of such Indebtedness.

DESCRIPTION OF THE OLD NOTES

The terms of the Old Notes are identical in all material respects to the terms
of the New Notes, except that (i) the sale of the Old Notes was not registered
under the Securities Act, therefore, the Old Notes are subject to certain
restrictions on transfer, contain certain legends relating thereto and are
entitled to certain registration rights under the Registration Rights Agreement
(which rights will terminate upon consummation of the Exchange Offer); and (ii)
the New Notes will not provide for any increase in the interest rate thereon.
In that regard, the Old Notes provide that, in the event that the Exchange
Offer is not consummated or the Shelf Registration Statement is not declared
effective on or prior to December 18, 1997, the Company will pay additional
interest (in addition to the interest otherwise due on the Old Notes) to each
Holder of the Old Notes during the first 90-day period following December 18,
1997, in an amount equal to 0.25% per annum. The amount of interest will
increase by an additional 0.25% per annum for each subsequent 90-day period
until consummation of the Exchange Offer or the effectiveness of the Shelf
Registration Statement, up to a maximum amount of additional interest of 1.00%
per annum. Such additional interest will cease accruing on such Old Notes upon
consummation of the Exchange Offer or the effectiveness of the Shelf
Registration Statement. The New Notes are not entitled to any such increase in
the interest rate thereon. In addition, the Old Notes and the New Notes will
constitute a single series of debt securities under the Indenture. See
"Description of the New Notes--General." Accordingly, Holders of Old Notes
should review the information set forth under "Summary--Certain Consequences of
a Failure to Exchange Old Notes" and "Description of the New Notes."

100

CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS

The following summary describes certain United States Federal income tax
considerations to Holders of the New Notes who are subject to U.S. net income
tax with respect to the New Notes ("U.S. persons") and who will hold the New
Notes as capital assets. There can be no assurance that the U.S. Internal
Revenue Service (the "IRS") will take a similar view of the purchase, ownership
or disposition of the New Notes. This discussion is based upon the provisions
of the Internal Revenue Code of 1986, as amended, and regulations, rulings and
judicial decisions now in effect, all of which are subject to change. It does
not include any description of the tax laws of any state, local or foreign
governments or any estate or gift tax considerations that may be applicable to
New Notes or Holders thereof. It does not discuss all aspects of Federal income
taxation that may be relevant to a particular investor in light of the
investor's particular investment circumstances or to certain types of investors
subject to special treatment under the Federal income tax laws (for example,
dealers in securities or currencies, S corporations, life insurance companies,
tax-exempt organizations, taxpayers subject to the alternative minimum tax and
non-U.S. persons) and also does not discuss New Notes held as a hedge against
currency risks or as part of a straddle with other investments or as part of a
"synthetic security" or other integrated investment (including a "conversion
transaction") comprised of a New Note and one or more other investments, or
situations in which the functional currency of the Holders is not the U.S.
dollar.

Holders of Old Notes contemplating acceptance of the Exchange Offer should
consult their own tax advisors with respect to their particular circumstances
and with respect to the effects of state, local or foreign tax laws to which
they may be subject.

EXCHANGE OF NOTES

The exchange of Old Notes for New Notes should not be a taxable event to
Holders for Federal income tax purposes. The exchange of Old Notes for the New
Notes pursuant to the Exchange Offer should not be treated as an "exchange" for
Federal income tax purposes because the New Notes should not be considered to
differ materially in kind or extent from the Old Notes. If, however, the
exchange of the Old Notes for the New Notes were treated as an exchange for
Federal income tax purposes, such exchange should constitute a recapitalization
for Federal income tax purposes. Accordingly, a Holder should have the same
adjusted basis and holding period in the New Notes as the Holder had in the Old
Notes immediately before the exchange.

INTEREST ON THE NEW NOTES

A Holder of a New Note will be required to report as ordinary interest income
for Federal income tax purposes interest earned on the New Note in accordance
with the Holder's method of tax accounting.

DISPOSITION OF NEW NOTES

A Holder's tax basis for a New Note generally will be the Holder's purchase
price for the Old Note. Upon the sale, exchange, redemption, retirement or
other disposition of a New Note, a Holder will recognize gain or loss equal to
the difference (if any) between the amount realized and the Holder's tax basis
in the New Note. Such gain or loss will be long-term capital gain or loss if
the New Note has been held for more than one year (including the period the Old
Note was held) and otherwise will be short-term capital gain or loss (with
certain exceptions to the characterization as capital gain if the New Note was
acquired at a market discount). For a non-corporate Holder to qualify for the
20% maximum tax rate on capital gain, however, the New Note would have to be
held for more than 18 months (including the period the Old Note was held).

BACKUP WITHHOLDING

A Holder of a New Note may be subject to backup withholding at the rate of 31%
with respect to interest paid on the New Note and proceeds from the sale,
exchange, redemption or retirement of the New Note, unless such Holder (a) is a
corporation or comes within certain other exempt categories and, when required,
demonstrates that fact or (b) provides a correct taxpayer identification
number, certifies as to no loss of exemption from backup withholding and
otherwise complies with applicable requirements of the backup withholding
rules. A Holder of a New Note who does not provide the Company with the
Holder's correct taxpayer identification number may be subject to penalties
imposed by the IRS.

101

A Holder of a New Note who is not a U.S. person will generally be exempt from
backup withholding and information reporting requirements, but may be required
to comply with certification and identification procedures in order to obtain
an exemption from backup withholding and information reporting.

Any amount paid as backup withholding will be creditable against the Holder's
Federal income tax liability.

102

PLAN OF DISTRIBUTION

Each Participating Broker-Dealer that receives New Notes for its own account in
connection with the Exchange Offer must acknowledge that it will deliver a
prospectus in connection with any resale of such New Notes. This Prospectus may
be used by Participating Broker-Dealers during the period referred to below in
connection with resales of New Notes received in exchange for Old Notes if such
Old Notes were acquired by such Participating Broker-Dealers for their own
accounts as a result of market-making or other trading activities. The Company
has agreed that this Prospectus may be used by a Participating Broker-Dealer in
connection with resales of such New Notes for a period ending 180 days after
the Expiration Date (subject to extension under certain limited circumstances
described herein) or, if earlier, when all such New Notes have been disposed of
by such Participating Broker-Dealer. See "The Exchange Offer--Resales of New
Notes."

The Company will not receive any cash proceeds from the issuance of the New
Notes offered hereby. New Notes received by broker-dealers for their own
accounts in connection with the Exchange Offer may be sold from time to time in
one or more transactions in the over-the-counter market, in negotiated
transactions, through the writing of options on the New Notes or a combination
of such methods of resale, at market prices prevailing at the time of resale,
at prices related to such prevailing market prices or at negotiated prices. Any
such resale may be made directly to purchasers or to or through brokers or
dealers who may receive compensation in the form of commissions or concessions
from any such broker-dealer and the purchasers of any such New Notes. Any
broker-dealer that resells New Notes that were received by it for its own
account in connection with the Exchange Offer and any broker-dealer that
participates in a distribution of such New Notes may be deemed to be an
"underwriter" within the meaning of the Securities Act, and any profit on any
such resale of New Notes and any commissions or concessions received by any
such persons may be deemed to be underwriting compensation under the Securities
Act. The Letter of Transmittal states that by acknowledging that it will
deliver and by delivering a prospectus, a broker-dealer will not be deemed to
admit that it is an "underwriter" within the meaning of the Securities Act.

For a period of 180 days after the Expiration Date, the Company will promptly
send additional copies of this Prospectus and any amendment or supplement to
this Prospectus to any broker-dealer that requests such documents in the Letter
of Transmittal. The Company has agreed to pay all expenses incident to the
Exchange Offer other than commissions or concessions of any brokers or dealers
and will indemnify the Holders of the Old Notes (including any broker-dealer)
against certain liabilities, including liabilities under the Securities Act.

LEGAL MATTERS

The validity of the issuance of the New Notes by the Company will be passed
upon by Greenebaum Doll & McDonald PLLC, Louisville, Kentucky. Members of
Greenebaum Doll & McDonald PLLC participating in the preparation of this
Prospectus beneficially own approximately 9,900 shares of the Company's Common
Stock.

EXPERTS

The consolidated financial statements of the Company at December 31, 1996 and
1995, and for each of the three years in the period ended December 31, 1996,
appearing in this Prospectus and Registration Statement have been audited by
Ernst & Young LLP, independent auditors, as stated in their report thereon
appearing herein and are included in reliance upon such report given the
authority of such firm as experts in accounting and auditing.

The consolidated financial statements of TheraTx, Incorporated at December 31,
1996 and 1995, and for each of the three years in the period ended December 31,
1996, appearing in this Prospectus and Registration Statement have been audited
by Ernst & Young LLP, independent auditors, as stated in their report thereon
appearing herein, which, as to the year 1994 is based in part on the report of
Coopers & Lybrand L.L.P., independent auditors. The financial statements
referred to above are included in reliance upon such reports given upon the
authority of such firms as experts in accounting and auditing.

103

The consolidated financial statements of Transitional Hospitals Corporation
(formerly Community Psychiatric Centers) at November 30, 1996 and 1995 and for
the years then ended included in this Prospectus have been so included in
reliance on the report of Price Waterhouse LLP, independent accountants, given
on the authority of said firm as experts in auditing and accounting.

The consolidated financial statements of Transitional Hospitals Corporation
(formerly Community Psychiatric Centers) at November 30, 1994 and for the year
then ended, appearing in this Prospectus and Registration Statement have been
audited by Ernst & Young LLP, independent auditors, as stated in their report
thereon appearing herein and are included in reliance upon such report given
the authority of such firm as experts in accounting and auditing.

104

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS

VENCOR, INC. PAGE
----
Report of Independent Auditors............................................ F-2
Consolidated Financial Statements:
Consolidated Statement of Operations for the years ended December 31,
1996, 1995 and 1994..................................................... F-3
Consolidated Balance Sheet, December 31, 1996 and 1995................... F-4
Consolidated Statement of Stockholders' Equity for the years ended Decem-
ber 31, 1996, 1995 and 1994............................................. F-5
Consolidated Statement of Cash Flows for the years ended December 31,
1996, 1995 and 1994..................................................... F-6
Notes to Consolidated Financial Statements............................... F-7
Quarterly Consolidated Financial Information (Unaudited)................. F-19
Condensed Consolidated Financial Statements (Unaudited):
Condensed Consolidated Statement of Income for the quarter and six months
ended June 30, 1997 and 1996............................................ F-20
Condensed Consolidated Balance Sheet, June 30, 1997 and December 31,
1996.................................................................... F-21
Condensed Consolidated Statement of Cash Flows for the six months ended
June 30, 1997 and 1996.................................................. F-22
Notes to Condensed Consolidated Financial Statements..................... F-23
THERATX, INCORPORATED
Report of Independent Auditors............................................ F-27
Consolidated Financial Statements:
Consolidated Statements of Income for the years ended December 31, 1994,
1995 and 1996........................................................... F-29
Consolidated Balance Sheets, December 31, 1995 and 1996.................. F-30
Consolidated Statements of Stockholders' Equity for the years ended De-
cember 31, 1994, 1995 and 1996.......................................... F-31
Consolidated Statements of Cash Flows for the years ended December 31,
1994, 1995 and 1996..................................................... F-32
Notes to Consolidated Financial Statements............................... F-33
TRANSITIONAL HOSPITALS CORPORATION
Report of Independent Accountants......................................... F-47
Consolidated Financial Statements:
Consolidated Balance Sheets, November 30, 1996 and 1995.................. F-50
Consolidated Statements of Operations for the years ended November 30,
1996, 1995 and 1994..................................................... F-52
Consolidated Statements of Stockholders' Equity for the years ended No-
vember 30, 1996, 1995 and 1994.......................................... F-53
Consolidated Statements of Cash Flows for the years ended November 30,
1996, 1995 and 1994..................................................... F-54
Notes to Consolidated Financial Statements............................... F-55
Condensed Consolidated Financial Statements (Unaudited):
Condensed Consolidated Statements of Operations for the six months ended
May 31, 1997 and 1996................................................... F-71
Condensed Consolidated Balance Sheets, May 31, 1997 and November 30,
1996.................................................................... F-72
Condensed Consolidated Statements of Cash Flows for the six months ended
May 31, 1997 and 1996................................................... F-73
Notes to Condensed Consolidated Financial Statements..................... F-74

F-1

REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and Stockholders
Vencor, Inc.

We have audited the accompanying consolidated balance sheet of Vencor, Inc. as
of December 31, 1996 and 1995, and the related consolidated statements of
operations, stockholders' equity, cash flows and related financial statement
schedule for each of the three years in the period ended December 31, 1996.
These financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. 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
Vencor, Inc. at December 31, 1996 and 1995, and the consolidated results of its
operations and cash flows for each of the three years in the period ended
December 31, 1996 in conformity with generally accepted accounting principles.
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.

/s/ Ernst & Young LLP

Louisville, Kentucky
February 17, 1997

F-2

VENCOR, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

1996 1995 1994
---------- ---------- ----------

Revenues.................................. $2,577,783 $2,323,956 $2,032,827
---------- ---------- ----------
Salaries, wages and benefits.............. 1,490,938 1,360,018 1,167,181
Supplies.................................. 218,083 188,754 162,053
Rent...................................... 77,795 79,476 79,371
Other operating expenses.................. 449,335 416,969 366,621
Depreciation and amortization............. 99,533 89,478 79,519
Interest expense.......................... 45,922 60,918 62,828
Investment income......................... (12,203) (13,444) (13,126)
Non-recurring transactions................ 125,200 109,423 (4,540)
---------- ---------- ----------
2,494,603 2,291,592 1,899,907
---------- ---------- ----------
Income from operations before income
taxes.................................... 83,180 32,364 132,920
Provision for income taxes................ 35,175 24,001 46,781
---------- ---------- ----------
Income from operations.................... 48,005 8,363 86,139
Extraordinary loss on extinguishment of
debt, net of income tax benefit of
$14,839 in 1995 and $125 in 1994......... -- (23,252) (241)
---------- ---------- ----------
Net income (loss)...................... 48,005 (14,889) 85,898
Preferred stock dividend requirements and
other items.............................. -- (5,280) (7,753)
Gain on redemption of preferred stock..... -- 10,176 --
---------- ---------- ----------
Income (loss) available to common
stockholders.......................... $ 48,005 $ (9,993) $ 78,145
========== ========== ==========
Earnings (loss) per common and common
equivalent share:
Primary:
Income from operations.................. $ 0.68 $ 0.21 $ 1.37
Extraordinary loss on extinguishment of
debt................................... -- (0.37) --
---------- ---------- ----------
Net income (loss)...................... $ 0.68 $ (0.16) $ 1.37
========== ========== ==========
Fully diluted:
Income from operations.................. $ 0.68 $ 0.29 $ 1.28
Extraordinary loss on extinguishment of
debt................................... -- (0.32) --
---------- ---------- ----------
Net income (loss)...................... $ 0.68 $ (0.03) $ 1.28
========== ========== ==========
Shares used in computing earnings (loss)
per common and common equivalent share:
Primary................................. 70,702 62,318 57,037
Fully diluted........................... 70,702 71,967 69,014

See accompanying notes.

F-3

VENCOR, INC.
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 1996 AND 1995
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

1996 1995
---------- ----------

ASSETS
Current assets:
Cash and cash equivalents............................. $ 112,466 $ 35,182
Accounts and notes receivable less allowance for loss
of $23,915--1996 and $16,785--1995................... 420,758 360,147
Inventories........................................... 24,939 24,862
Income taxes.......................................... 67,808 77,997
Other................................................. 35,162 26,491
---------- ----------
661,133 524,679
Property and equipment, at cost:
Land.................................................. 113,749 111,232
Buildings............................................. 975,399 992,992
Equipment............................................. 435,787 403,338
Construction in progress (estimated cost to complete
and equip after December 31, 1996--$50,000).......... 84,835 44,731
---------- ----------
1,609,770 1,552,293
Accumulated depreciation.............................. (416,608) (362,199)
---------- ----------
1,193,162 1,190,094
Notes receivable less allowance for loss of $15,305--
1995.................................................. -- 78,090
Intangible assets less accumulated amortization of
$25,218--1996 and $22,149--1995....................... 31,608 42,580
Other.................................................. 82,953 77,011
---------- ----------
$1,968,856 $1,912,454
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable...................................... $ 103,518 $ 99,887
Salaries, wages and other compensation................ 111,366 99,937
Other accrued liabilities............................. 71,434 75,617
Long-term debt due within one year.................... 54,692 9,572
---------- ----------
341,010 285,013
Long-term debt......................................... 710,507 778,100
Deferred credits and other liabilities................. 84,053 75,573
Minority interests in equity of consolidated entities.. 36,195 1,704
Contingencies
Stockholders' equity:
Preferred stock, $1.00 par value; authorized 1,000
shares; none issued and outstanding.................. -- --
Common stock, $0.25 par value; authorized 180,000
shares; issued 72,615 shares--1996 and 72,158
shares--1995......................................... 18,154 18,040
Capital in excess of par value........................ 713,527 684,377
Retained earnings..................................... 150,870 102,865
---------- ----------
882,551 805,282
Common treasury stock; 3,730 shares--1996 and 2,025
shares--1995......................................... (85,460) (33,218)
---------- ----------
797,091 772,064
---------- ----------
$1,968,856 $1,912,454
========== ==========

See accompanying notes.

F-4

VENCOR, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

SHARES PAR VALUE
--------------------------- ------------------
COMMON CAPITAL IN COMMON
PREFERRED COMMON TREASURY PREFERRED COMMON EXCESS OF RETAINED TREASURY
STOCK STOCK STOCK STOCK STOCK PAR VALUE EARNINGS STOCK
--------- ------ -------- --------- ------- ---------- -------- --------

Balances, December 31, 1993......... 157 53,208 (2,993) $ 23 $13,302 $451,027 $ 58,911 $(37,713)
Net income......................... 85,898
Cash dividends on preferred stock
($82.50 per share) and provision
for redemption value.............. (3,066)
In-kind dividend on preferred
stock............................. 4 2 4,506 (4,508)
Issuance of common stock in connection
with employee benefit plans....... 360 121 89 5,458 1,518
Issuance of common stock in connection
with acquisitions................. 698 9,089 8,565
Exercise of common stock purchase
warrants.......................... 5,610 1,403 61,897
Tender of preferred stock in connection
with exercise of common stock
purchase warrants................. (63) (10) (63,290)
Other.............................. 3,974 (621)
---- ------ ------ ---- ------- -------- -------- --------
Balances, December 31, 1994......... 98 59,178 (2,174) 15 14,794 472,661 136,614 (27,630)
Net loss........................... (14,889)
Cash dividends on preferred stock
($67.98 per share) and provision
for redemption value.............. (2,380)
In-kind dividend on preferred
stock............................. 3 2,900 (2,900)
Issuance of common stock in connection
with employee benefit plans....... 664 (150) 166 24,111 (11,098)
Issuance of common stock in connection
with acquisitions................. 439 (3,227) 5,498
Increase in value of common stock
purchase warrants of acquired
entities.......................... 9,810 (9,810)
Public offering of common stock.... 2,200 550 65,944
Conversion of long-term debt....... 7,260 1,815 149,645
Issuance of common stock to grantor
trust............................. 3,927 (3,927) 982 87,297 (88,279)
Hillhaven Merger:
Issuance of common stock and
related income tax benefits....... 2,732 683 51,561
Termination of grantor trust....... (3,786) 3,786 (946) (87,146) 88,279
Redemption of preferred stock...... (101) (15) (91,253)
Other.............................. (17) 1 (4) 2,074 (3,770) 12
---- ------ ------ ---- ------- -------- -------- --------
Balances, December 31, 1995......... -- 72,158 (2,025) -- 18,040 684,377 102,865 (33,218)
Net income......................... 48,005
Increase in equity resulting from
initial public offering of Atria
Communities, Inc. common stock.... 19,828
Issuance of common stock in connection
with employee benefit plans....... 457 246 114 9,223 3,083
Repurchase of common stock......... (1,950) (55,305)
Other.............................. (1) 99 (20)
---- ------ ------ ---- ------- -------- -------- --------
Balances, December 31, 1996......... -- 72,615 (3,730) $ -- $18,154 $713,527 $150,870 $(85,460)
==== ====== ====== ==== ======= ======== ======== ========

TOTAL
---------

Balances, December 31, 1993......... $485,550
Net income......................... 85,898
Cash dividends on preferred stock
($82.50 per share) and provision
for redemption value.............. (3,066)
In-kind dividend on preferred
stock............................. --
Issuance of common stock in connection
with employee benefit plans....... 7,065
Issuance of common stock in connection
with acquisitions................. 17,654
Exercise of common stock purchase
warrants.......................... 63,300
Tender of preferred stock in connection
with exercise of common stock
purchase warrants................. (63,300)
Other.............................. 3,353
---------
Balances, December 31, 1994......... 596,454
Net loss........................... (14,889)
Cash dividends on preferred stock
($67.98 per share) and provision
for redemption value.............. (2,380)
In-kind dividend on preferred
stock............................. --
Issuance of common stock in connection
with employee benefit plans....... 13,179
Issuance of common stock in connection
with acquisitions................. 2,271
Increase in value of common stock
purchase warrants of acquired
entities.......................... --
Public offering of common stock.... 66,494
Conversion of long-term debt....... 151,460
Issuance of common stock to grantor
trust............................. --
Hillhaven Merger:
Issuance of common stock and
related income tax benefits....... 52,244
Termination of grantor trust....... 187
Redemption of preferred stock...... (91,268)
Other.............................. (1,688)
---------
Balances, December 31, 1995......... 772,064
Net income......................... 48,005
Increase in equity resulting from
initial public offering of Atria
Communities, Inc. common stock.... 19,828
Issuance of common stock in connection
with employee benefit plans....... 12,420
Repurchase of common stock......... (55,305)
Other.............................. 79
---------
Balances, December 31, 1996......... $797,091
=========

See accompanying notes.

F-5

VENCOR, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(IN THOUSANDS)

1996 1995 1994
--------- --------- ---------

Cash flows from operating activities:
Net income (loss)............................ $ 48,005 $ (14,889) $ 85,898
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization............... 99,533 89,478 79,519
Deferred income taxes....................... (34,814) (23,570) 5,526
Extraordinary loss on extinguishment of
debt....................................... -- 38,091 366
Non-recurring transactions.................. 121,789 102,166 2,500
Other....................................... 5,685 14,809 (1,575)
Change in operating assets and liabilities:
Accounts and notes receivable.............. (64,304) (107,761) (63,247)
Inventories and other assets............... 1,284 (3,478) 12,385
Accounts payable........................... 2,165 22,157 4,718
Other accrued liabilities.................. 4,196 (3,366) 6,946
--------- --------- ---------
Net cash provided by operating
activities............................... 183,539 113,637 133,036
--------- --------- ---------
Cash flows from investing activities:
Purchase of property and equipment........... (135,027) (136,893) (111,486)
Acquisition of healthcare businesses and
previously leased facilities................ (26,236) (59,343) (36,391)
Sale of assets............................... 9,147 899 6,530
Collection of notes receivable............... 78,151 4,715 8,965
Net change in investments.................... (445) (12,779) 14,046
Other........................................ (6,576) (8,241) 3,032
--------- --------- ---------
Net cash used in investing activities..... (80,986) (211,642) (115,304)
--------- --------- ---------
Cash flows from financing activities:
Net change in borrowings under revolving
lines of credit............................. (1,500) 161,600 21,000
Issuance of long-term debt................... 10,495 438,052 18,599
Repayment of long-term debt.................. (31,586) (474,896) (75,124)
Public offering of common stock.............. 52,247 66,494 --
Other issuances of common stock.............. 2,242 6,520 1,289
Repurchase of common stock................... (55,305) -- --
Redemption of preferred stock................ -- (91,268) --
Payment of dividends......................... -- (2,779) (3,070)
Other........................................ (1,862) (9,554) (2,338)
--------- --------- ---------
Net cash provided by (used in) financing
activities............................... (25,269) 94,169 (39,644)
--------- --------- ---------
Change in cash and cash equivalents........... 77,284 (3,836) (21,912)
Cash and cash equivalents at beginning of
period....................................... 35,182 39,018 60,930
--------- --------- ---------
Cash and cash equivalents at end of period.... $ 112,466 $ 35,182 $ 39,018
========= ========= =========
Supplemental information:
Interest payments............................ $ 46,527 $ 69,916 $ 59,733
Income tax payments.......................... 55,303 42,218 37,332

See accompanying notes.

F-6

VENCOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1--ACCOUNTING POLICIES

Reporting Entity
Vencor, Inc. ("Vencor" or "the Company") operates an integrated network of
healthcare services in forty-one states primarily focused on the needs of the
elderly. At December 31, 1996, Vencor operated 38 hospitals (3,325 licensed
beds), 313 nursing centers (39,619 licensed beds), a contract services business
("Vencare") which provides respiratory therapy, rehabilitation therapy,
subacute medical services and pharmacy management services to nursing centers
and other healthcare providers and 21 assisted and independent living
communities with 2,942 units.

On September 28, 1995, Vencor consummated a merger with The Hillhaven
Corporation ("Hillhaven") in a tax-free, stock-for-stock transaction (the
"Hillhaven Merger"). See Note 2.

Prior to its merger with Vencor, Hillhaven consummated a merger with Nationwide
Care, Inc. ("Nationwide") on June 30, 1995 in a tax-free, stock-for-stock
transaction (the "Nationwide Merger"). See Note 3.

In the third quarter of 1996, Vencor completed an initial public offering
related to its assisted and independent living business through the issuance of
5,750,000 common shares of Atria Communities, Inc. ("Atria") (the "IPO"). See
Note 4.

Basis of Presentation
The consolidated financial statements include all subsidiaries. Significant
intercompany transactions have been eliminated.

The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles and include amounts
based upon the estimates and judgments of management. Actual amounts may differ
from these estimates.

The Hillhaven Merger and the Nationwide Merger have been accounted for by the
pooling-of-interests method. Accordingly, the consolidated financial statements
included herein give retroactive effect to these transactions and include the
combined operations of Vencor, Hillhaven and Nationwide for all periods
presented.

In connection with the IPO, Vencor retained a controlling interest in Atria.
Accordingly, the accounts of Atria continue to be consolidated with those of
Vencor, and the Company has recorded minority interests in the earnings and
equity of Atria since consummation of the IPO.

Revenues
Revenues are recorded based upon 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.

A summary of revenues by payor type follows (dollars in thousands):

1996 1995 1994
---------- ---------- ----------

Medicare.................................... $ 822,589 $ 691,297 $ 554,443
Medicaid.................................... 821,828 776,278 731,491
Commercial and other........................ 972,906 865,820 747,267
---------- ---------- ----------
2,617,323 2,333,395 2,033,201
Elimination................................. (39,540) (9,439) (374)
---------- ---------- ----------
$2,577,783 $2,323,956 $2,032,827
========== ========== ==========

F-7

VENCOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 1--ACCOUNTING POLICIES (CONTINUED)

Cash and Cash Equivalents

Cash and cash equivalents include highly liquid investments with an original
maturity of three months or less. Carrying values of cash and cash equivalents
approximate fair value due to the short-term nature of these instruments.

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.

Inventories

Inventories consist primarily of medical supplies and are stated at the lower
of cost (first-in, first-out) or market.

Property and Equipment

Depreciation expense, computed by the straight-line method, was $91.6 million
in 1996, $79.7 million in 1995, and $71.6 million in 1994. Depreciation rates
for buildings range generally from 20 to 45 years. Estimated useful lives of
equipment vary from 5 to 15 years.

During 1996, Vencor adopted Financial Accounting Standards Board Statement No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of." See Note 5.

Intangible Assets

Intangible assets consist primarily of costs in excess of the fair value of
identifiable net assets of acquired entities and are amortized using the
straight-line method over periods ranging from 10 to 25 years. Noncompete
agreements and debt issuance costs are amortized based upon the lives of the
respective contracts or loans.

Professional Liability Risks

Provisions for loss for professional liability risks are based upon actuarially
determined estimates. To the extent that subsequent claims information varies
from management's estimates, earnings are charged or credited.

Earnings per Common Share

Share and per share amounts have been retroactively restated to reflect a 3-
for-2 stock split distributed in October 1994.

The computation of earnings per common and common equivalent share give
retroactive effect to the Hillhaven Merger and the Nationwide Merger and is
based upon the weighted average number of common shares outstanding and the
dilutive effect of common stock equivalents consisting primarily of stock
options. In addition, the 1995 and 1994 computations also include the dilutive
effect of convertible debt securities.

During 1995, all convertible debt securities were redeemed in exchange for cash
or converted into Vencor common stock. Accordingly, the computation of fully
diluted earnings per common share assumes that the equivalent number of common
shares underlying such debt securities were outstanding during the entire year
even though the result thereof is antidilutive.

In connection with the Hillhaven Merger, Vencor realized a gain of
approximately $10.2 million upon the cash redemption of Hillhaven preferred
stock. Although the gain had no effect on net income, fully diluted earnings
per common and common equivalent share were increased by $0.14.

F-8

VENCOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 2--HILLHAVEN MERGER

On September 27, 1995, the stockholders of both Vencor and Hillhaven approved
the Hillhaven Merger, effective September 28, 1995. In connection with the
Hillhaven Merger, Vencor issued approximately 31,651,000 shares of common stock
in exchange for all of the outstanding common stock of Hillhaven (an exchange
ratio of 0.935 of a share of Vencor common stock for each share of Hillhaven
common stock).

The Hillhaven Merger has been accounted for as a pooling of interests, and
accordingly, the consolidated financial statements give retroactive effect to
the Hillhaven Merger and include the combined operations of Vencor and
Hillhaven for all periods presented. The following is a summary of the results
of operations of the separate entities for periods prior to the Hillhaven
Merger (dollars in thousands):

NON-RECURRING
VENCOR HILLHAVEN TRANSACTIONS ELIMINATION CONSOLIDATED
-------- ---------- ------------- ----------- ------------

Nine months ended
September 30,
1995 (unaudited):
Revenues.............. $411,233 $1,322,873 $(24,500) $(3,775) $1,705,831
Income (loss) from
operations........... 31,566 41,367 (93,561) -- (20,628)
Net income (loss)..... 30,711 20,235 (93,561) -- (42,615)
1994:
Revenues.............. $400,018 $1,633,183 $ -- $ (374) $2,032,827
Income from
operations........... 31,416 51,976 2,747 -- 86,139
Net income............ 31,416 51,735 2,747 -- 85,898

NOTE 3--NATIONWIDE MERGER

Prior to its merger with Vencor, Hillhaven completed the Nationwide Merger on
June 30, 1995. In connection therewith, 4,675,000 shares of common stock
(effected for the Hillhaven Merger exchange ratio) were issued in exchange for
all of the outstanding shares of Nationwide.

The Nationwide Merger has been accounted for as a pooling of interests, and
accordingly, the consolidated financial statements give retroactive effect to
the Nationwide Merger and include the combined operations of Hillhaven and
Nationwide for all periods presented. The following is a summary of the results
of operations of the separate entities for periods prior to the Nationwide
Merger (dollars in thousands):

NON-RECURRING
HILLHAVEN NATIONWIDE TRANSACTIONS CONSOLIDATED
---------- ---------- ------------- ------------

Six months ended June 30,
1995 (unaudited):
Revenues.................. $ 803,793 $ 66,800 $ -- $ 870,593
Income from operations.... 23,837 2,147 (3,686) 22,298
Net income................ 23,459 (266) (3,686) 19,507
1994:
Revenues.................. $1,509,729 $123,454 $ -- $1,633,183
Income from operations.... 47,178 4,798 2,747 54,723
Net income................ 46,937 4,798 2,747 54,482

NOTE 4--INITIAL PUBLIC OFFERING OF ATRIA

In the third quarter of 1996, Vencor completed the IPO, the net proceeds from
which aggregated approximately $52.2 million. At December 31, 1996, Vencor
owned 10,000,000 shares, or 63.2%, of Atria's outstanding common stock.
Significant agreements related to the IPO are discussed below.

F-9

VENCOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 4--INITIAL PUBLIC OFFERING OF ATRIA (CONTINUED)

Credit Facility

Concurrently with the consummation of the IPO, Atria entered into a bank credit
facility (the "Atria Credit Facility"), which matures in four years and may be
extended at the option of the banks for an additional year. The Atria Credit
Facility aggregates up to $200 million, including a letter of credit option not
to exceed $70 million. Loans under the Atria Credit Facility bear interest, at
Atria's option, at either (i) a base rate based on PNC Bank's prime rate or the
daily federal funds rate or (ii) a LIBOR rate, plus an additional percentage
based on certain leverage ratios. The obligations under the Atria Credit
Facility are secured by substantially all of Atria's property, the capital
stock of Atria's present and future principal subsidiaries and all intercompany
indebtedness owned to Atria by its subsidiaries. The Atria Credit Facility is
conditioned upon, among other things, Vencor's ownership of at least 30% of
Atria's common stock.

Agreements with Atria

Atria and Vencor or its subsidiaries have entered into certain arrangements
which are intended to facilitate an orderly transition of Atria from a division
of Vencor to a separate publicly held entity which will be minimally disruptive
to both Atria and Vencor. In addition to various agreements related to
administrative support, shared services and real estate leases, significant
agreements with Atria include:

Guarantees--Vencor will guarantee for four years certain borrowings by
Atria under the Atria Credit Facility in amounts up to $100 million in the
first year following the IPO, declining to $75 million, $50 million and $25
million in each respective year thereafter.

Income Taxes--A tax sharing agreement provides for risk-sharing
arrangements in connection with various income tax related issues.

Registration Rights--Atria has granted demand and piggyback registration
rights to Vencor with respect to registration under the Securities Act of
1933 of Atria common stock owned by Vencor. Four demand registrations are
permitted. Atria will pay the fees and expenses of two demand registrations
and the piggyback registrations, while Vencor will pay all underwriting
discounts and commissions. The registration rights expire five years from
the completion of the IPO and are subject to certain conditions and
limitations, including the right of underwriters of an offering to limit
the number of shares owned by Vencor included in such registration.

Liabilities and Indemnifications--Atria has agreed to assume all
contractual liabilities relating to the assets transferred by Vencor to
Atria.

NOTE 5--NON-RECURRING TRANSACTIONS

1996
In the fourth quarter of 1996, Vencor recorded pretax charges aggregating
$125.2 million primarily to complete the integration of Hillhaven. In November
1996, Vencor executed a definitive agreement to sell 34 underperforming or non-
strategic nursing centers in early 1997. A charge of $65.3 million was recorded
in connection with the disposition. In addition, Vencor's previously
independent institutional pharmacy business, acquired as part of the Hillhaven
Merger, was integrated into Vencare, resulting in a charge of $39.6 million
related primarily to costs associated with employee severance and benefit costs
(approximately 500 employees), facility close-down expenses and the writeoff of
certain deferred costs for services to be discontinued. A provision for loss
totaling $20.3 million related to the planned replacement of one hospital and
three nursing centers was also recorded in the fourth quarter.

1995
In the third quarter of 1995, Vencor recorded pretax charges aggregating $128.4
million primarily in connection with the consummation of the Hillhaven Merger.
The charges included (i) $23.2 million of investment advisory

F-10

VENCOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5--NON-RECURRING TRANSACTIONS (CONTINUED)

and professional fees, (ii) $53.8 million of employee benefit plan and
severance costs (approximately 500 employees), (iii) $26.9 million of losses
associated with the planned disposition of certain nursing center properties
and (iv) $24.5 million of charges to reflect Vencor's change in estimates of
accrued revenues recorded in connection with certain prior-year nursing center
third-party reimbursement issues (recorded as a reduction of revenues). During
1996, activities related to the elimination of duplicative corporate and
operational functions was substantially completed, and management expects that
the disposition of certain nursing center properties will be concluded in 1997.

Pretax charges aggregating $5.5 million were recorded in the second quarter
primarily in connection with the Nationwide Merger.

1994
In the first quarter of 1994, Vencor recorded a pretax charge of $2.5 million
in connection with the prior disposition of certain nursing centers. Operating
results in the fourth quarter of 1994 include a pretax gain of $7 million on
the sale of assets.

NOTE 6--BUSINESS COMBINATIONS OTHER THAN HILLHAVEN AND NATIONWIDE

Vencor has acquired a number of healthcare facilities (including certain
previously leased facilities) and other related businesses, substantially all
of which have been accounted for by the purchase method. Accordingly, the
aggregate purchase price of these transactions has been allocated to tangible
and identifiable intangible assets acquired and liabilities assumed based upon
their respective fair values. The consolidated financial statements include the
operations of acquired entities since the respective acquisition dates. The pro
forma effect of these acquisitions on Vencor's results of operations prior to
consummation was not significant.

The following is a summary of acquisitions consummated during the last three
years under the purchase method of accounting (dollars in thousands):

1996 1995 1994
------- -------- --------

Fair value of assets acquired...................... $26,621 $ 78,893 $ 54,045
Fair value of liabilities assumed.................. (385) (16,475) --
------- -------- --------
Net assets acquired.............................. 26,236 62,418 54,045
Cash received from acquired entities............... -- (804) --
Issuance of common stock........................... -- (2,271) (17,654)
------- -------- --------
Net cash paid for acquisitions................... $26,236 $ 59,343 $ 36,391
======= ======== ========

The purchase price paid in excess of the fair value of identifiable net assets
of acquired entities aggregated $4.8 million in 1996, $9.7 million in 1995 and
$8.3 million in 1994.

F-11

VENCOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 7--INCOME TAXES

Provision for income taxes consists of the following (dollars in thousands):

1996 1995 1994
-------- -------- -------

Current:
Federal.......................................... $ 59,470 $ 40,008 $34,697
State............................................ 10,519 7,563 6,558
-------- -------- -------
69,989 47,571 41,255
Deferred.......................................... (34,814) (23,570) 5,526
-------- -------- -------
$ 35,175 $ 24,001 $46,781
======== ======== =======

Reconciliation of federal statutory rate to effective income tax rate follows:

1996 1995 1994
-------- -------- -------

Federal statutory rate............................ 35.0% 35.0% 35.0%
State income taxes, net of federal income tax
benefit.......................................... 3.6 4.3 4.0
Merger and restructuring costs.................... 3.5 34.6 --
Targeted jobs tax credits......................... -- -- (4.5)
Other items, net.................................. 0.2 0.3 0.7
-------- -------- -------
Effective income tax rate....................... 42.3% 74.2% 35.2%
======== ======== =======

A summary of deferred income taxes by source included in the consolidated
balance sheet at December 31 follows (dollars in thousands):

1996 1995
-------------------- -------------------
ASSETS LIABILITIES ASSETS LIABILITIES
-------- ----------- ------- -----------

Depreciation........................... $ -- $47,256 $ -- $40,912
Insurance.............................. 12,058 -- 10,269 --
Doubtful accounts...................... 37,989 -- 26,723 --
Property............................... 34,767 -- 10,148 --
Compensation........................... 17,030 -- 19,133 --
Other.................................. 33,120 19,990 16,127 8,584
-------- ------- ------- -------
$134,964 $67,246 $82,400 $49,496
======== ======= ======= =======

Management believes that the deferred tax assets in the table above will
ultimately be realized. Management's conclusion is based primarily on the
existence of sufficient taxable income within the allowable carryback periods
to realize the tax benefits of deductible temporary differences recorded at
December 31, 1996.

Deferred income taxes totaling $62.4 million and $54.7 million at December 31,
1996 and 1995, respectively, are included in other current assets. Noncurrent
deferred income taxes, included in other long-term assets, totaled $5.3 million
at December 31, 1996. Noncurrent deferred income taxes at December 31, 1995
totaling $21.8 million are included principally in deferred credits and other
liabilities.

F-12

VENCOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 8--PROFESSIONAL LIABILITY RISKS

Vencor has insured a substantial portion of its professional liability risks
through a wholly owned insurance subsidiary since June 1, 1994. Provisions for
such risks underwritten by the subsidiary were $10.4 million for 1996, and
$11.1 million for 1995, and $6.9 million for 1994.

Amounts funded for the payment of claims and expenses incident thereto,
included principally in cash and cash equivalents and other assets, aggregated
$20.7 million and $17.5 million at December 31, 1996 and 1995, respectively.
Allowances for professional liability risks, included principally in deferred
credits and other liabilities, were $21.6 million and $15.9 million at December
31, 1996 and 1995, respectively.

NOTE 9--LONG-TERM DEBT

Capitalization

A summary of long-term debt at December 31 follows (dollars in thousands):

1996 1995
-------- --------

Senior collateralized debt, 4.4% to 12% (rates generally
floating) payable in periodic installments through 2019... $119,634 $140,813
Non-interest bearing residential mortgage bonds, payable in
periodic installments through 2040........................ 33,917 33,344
Bank revolving credit agreements due 2001 (floating rates
averaging 6.3%)........................................... 333,100 205,600
Bank term loans (floating rates averaging 6.3%) payable in
periodic installments through 2001........................ 271,000 400,000
10 1/8% Senior Subordinated Notes due 2001................. 3,291 3,289
Other...................................................... 4,257 4,626
-------- --------
Total debt, average life of seven years (rates averaging
5.9%)................................................... 765,199 787,672
Amounts due within one year................................ (54,692) (9,572)
-------- --------
Long-term debt........................................... $710,507 $778,100
======== ========

Credit Facility

Concurrent with the consummation of the Hillhaven Merger, Vencor entered into a
five and one-half year $1 billion bank credit facility (the "Vencor $1 Billion
Credit Facility") comprising a $400 million term loan and a $600 million
revolving credit facility. The Vencor $1 Billion Credit Facility was
established to finance the redemption of Hillhaven preferred stock, repay
certain higher rate debt and borrowings under prior revolving credit agreements
discussed below, and provide sufficient credit for future expansion. Interest
is payable at rates up to either (i) the prime rate plus 1/4% or the daily
federal funds rate plus 3/4%, (ii) LIBOR plus 1 1/4% or (iii) the bank
certificate of deposit rate plus 1 3/8%. Outstanding borrowings under the $400
million term loan are payable in various installments beginning in 1997. The
Vencor $1 Billion Credit Facility is collateralized by the capital stock of
certain subsidiaries and contains covenants which require maintenance of
certain financial ratios and limit amounts of additional debt and repurchases
of common stock.

Refinancing Activities

During 1995, Vencor recorded $23.3 million of after-tax losses from refinancing
of long-term debt, substantially all of which was incurred in connection with
the Hillhaven Merger. Amounts refinanced in 1995 included $171 million of 10
1/8% Senior Subordinated Notes due 2001 (the "10 1/8% Notes"), $112 million of
outstanding borrowings under prior revolving credit agreements, and $173
million of other senior debt.

In the fourth quarter of 1995, Vencor called for redemption of its $115 million
of 6% Convertible Subordinated Notes due 2002 (the "6% Notes") and $75 million
of 7 3/4% Convertible Subordinated Debentures due 2002 (the

F-13

VENCOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 9--LONG-TERM DEBT (CONTINUED)

"7 3/4% Debentures") which were convertible into Vencor common stock at the
rate of $26.00 and $17.96 per share, respectively. Approximately $80.6 million
principal amount of the 6% Notes were converted into approximately 3,098,000
shares of common stock and the remainder were redeemed in exchange for cash
equal to 104.2% of face value plus accrued interest. All outstanding 7 3/4%
Debentures were converted into approximately 4,161,000 shares of common stock.
These transactions had no material effect on earnings per common and common
equivalent share.

Other Information

On October 30, 1995, Vencor entered into certain interest rate swap agreements
to eliminate the impact of changes in interest rates on $400 million of
floating rate debt outstanding. The agreements expire in April 1997 ($100
million), October 1997 ($200 million) and April 1998 ($100 million) and provide
for fixed rates at 5.7% plus 1/2% to 1 1/4%.

Maturities of long-term debt in years 1998 through 2001 are $66 million, $82
million, $111 million and $313 million, respectively.

The estimated fair value of Vencor's long-term debt was $752 million and $777
million at December 31, 1996 and 1995, respectively, compared to carrying
amounts aggregating $765 million and $788 million. The estimate of fair value
includes the effect of the interest rate swap agreement and is based upon the
quoted market prices for the same or similar issues of long-term debt, or on
rates available to Vencor for debt of the same remaining maturities.

NOTE 10--LEASES

Vencor leases real estate and equipment under cancelable and non-cancelable
arrangements. Future minimum payments and related sublease income under non-
cancelable operating leases are as follows (dollars inthousands):

MINIMUM SUBLEASE
PAYMENTS INCOME
-------- --------

1997.......................................................... $48,341 $ 8,519
1998.......................................................... 42,265 7,335
1999.......................................................... 36,681 6,317
2000.......................................................... 32,655 6,116
2001.......................................................... 23,011 4,962
Thereafter.................................................... 61,414 17,608

Sublease income aggregated $8.8 million, $13.7 million and $13.2 million for
1996, 1995 and 1994, respectively.

NOTE 11--CONTINGENCIES

Management continually evaluates contingencies based upon the best available
evidence. In addition, allowances for loss are provided currently for disputed
items that have continuing significance, such as certain third-party
reimbursements and deductions that continue to be claimed in current cost
reports and tax returns.

Management believes that allowances for losses have been provided to the extent
necessary and that its assessment of contingencies is reasonable. Management
believes that resolution of contingencies will not materially affect Vencor's
liquidity, financial position or results of operations.

F-14

VENCOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 11--CONTINGENCIES (CONTINUED)

Principal contingencies are described below:

Revenues--Certain third-party payments are subject to examination by
agencies administering the programs. Vencor is contesting certain issues
raised in audits of prior year cost reports.

Professional liability risks--Vencor has provided for loss for professional
liability risks based upon actuarially determined estimates. Actual
settlements may differ from the provisions for loss.

Interest rate swap agreements--Vencor is a party to certain agreements
which reduce the impact of changes in interest rates on $400 million of its
floating rate long-term debt. In the event of nonperformance by other
parties to these agreements, Vencor may incur a loss to the extent that
market rates exceed contract rates.

Guarantees of indebtedness--Letters of credit and guarantees of
indebtedness aggregated $29 million at December 31, 1996.

Income taxes--Vencor is contesting adjustments proposed by the Internal
Revenue Service for years 1990, 1991 and 1992.

Litigation--Various suits and claims arising in the ordinary course of
business are pending against Vencor.

NOTE 12--CAPITAL STOCK

Plan Descriptions

In September 1995, Vencor common stockholders voted to increase the number of
authorized shares of common stock from 60 million to 180 million and increase
the number of common shares issuable under certain employee benefit plans from
approximately 3.2 million to 6.9 million. At December 31, 1996, approximately
5.6 million shares of common stock were reserved for issuance under Vencor's
stock compensation plans.

Vencor has plans under which options to purchase common stock may be granted to
officers, employees and certain directors. Options have been granted at not
less than market price on the date of grant. Exercise provisions vary, but most
options are exercisable in whole or in part beginning one to four years after
grant and ending ten years after grant. Activity in the plans is summarized
below:

SHARES WEIGHTED
UNDER OPTION PRICE AVERAGE
OPTION PER SHARE EXERCISE PRICE
--------- ---------------- --------------

Balances, December 31, 1993.......... 1,660,826 $ 0.53 to $24.25
Granted............................ 536,239 11.53 to 22.75
Exercised.......................... (102,230) 0.53 to 22.09
Canceled or expired................ (48,185) 5.35 to 22.09
---------
Balances, December 31, 1994.......... 2,046,650 0.53 to 24.25
Granted............................ 1,537,820 11.50 to 32.50
Exercised.......................... (593,918) 0.53 to 29.14
Canceled or expired................ (51,151) 5.35 to 28.50
---------
Balances, December 31, 1995.......... 2,939,401 0.53 to 32.50
Granted............................ 1,467,451 25.50 to 38.38 $26.02
Exercised.......................... (368,758) 0.53 to 28.50 6.10
Canceled or expired................ (351,271) 14.17 to 32.63 26.65
---------
Balances, December 31, 1996.......... 3,686,823 $ 0.53 to $38.38 $23.54
=========

F-15

VENCOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 12--CAPITAL STOCK (CONTINUED)

Plan Descriptions (Continued)

A summary of stock options outstanding at December 31, 1996 follows:

OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------- ---------------------
NUMBER NUMBER
OUTSTANDING WEIGHTED EXERCISABLE WEIGHTED
AT REMAINING AVERAGE AT AVERAGE
RANGE OF DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE
EXERCISE PRICES 1996 LIFE PRICE 1996 PRICE
- --------------- ------------ ------------- -------- ------------ --------

$0.53 to $5.95....... 219,032 1 to 4 years $ 2.87 219,032 $ 2.87
$14.17 to $24.25..... 821,635 5 to 7 years 19.08 629,517 18.99
$25.50 to $38.38..... 2,646,156 8 to 10 years 26.63 294,139 27.49
--------- ---------
3,686,823 $23.54 1,142,688 $18.09
========= =========

The weighted average remaining contractual life of options outstanding at
December 31, 1996 approximated eight years. Shares of common stock available
for future grants were 1,387,396 at December 31, 1996 and 2,470,066 at December
31, 1995.

In 1995, Vencor issued long-term incentive agreements to certain officers and
key employees whereby the Company may annually issue shares of common stock to
such individuals in satisfaction of predetermined performance goals. Share
awards aggregated 80,913 for 1996 and 92,500 for 1995.

In 1993, Vencor adopted a Shareholder Rights Plan under which common
stockholders have the right to purchase Series A Preferred Stock in the event
of accumulation of or tender offer for 15% or more of Vencor's common stock.
The rights will expire in 2003 unless redeemed earlier by Vencor.

Statement No. 123 Data

Vencor has elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25") and related
interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under FASB
Statement No. 123, "Accounting for Stock-Based Compensation" ("Statement No.
123"), requires use of option valuation models that were not developed for use
in valuing employee stock options. Under APB 25, because the exercise price of
Vencor's employee stock options is equal to the market price of the underlying
stock on the date of grant, no compensation expense is recognized.

Pro forma information regarding net income and earnings per share is required
by Statement No. 123, which also requires that the information be determined as
if Vencor has accounted for its employee stock options granted subsequent to
December 31, 1994 under the fair value method of that Statement. The fair value
of such options was estimated at the date of grant using a Black-Scholes option
pricing model with the following weighted average assumptions: risk-free
interest rate of 6.33% for 1996 and 1995; no dividend yield; expected term of
seven years and volatility factors of the expected market price of the
Company's common stock of .24 for 1996 and .25 for 1995.

The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because Vencor's employee stock options have characteristics significantly
different from those of traded options, and because the 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 employee stock options.

F-16

VENCOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 12--CAPITAL STOCK (CONTINUED)

Statement No. 123 Data (Continued)

For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the respective vesting period. The weighted
average fair values of options granted during 1996 and 1995 under the Black-
Scholes model were $10.95 and $11.74, respectively. Pro forma information
follows (in thousands except per share amounts):

1996 1995
------- --------

Pro forma income (loss) available to common stockholders.... $42,530 $(10,842)
Pro forma earnings (loss) per common and common equivalent
share:
Primary................................................... 0.61 (0.17)
Fully diluted............................................. 0.61 (0.05)

Because Statement No. 123 is applicable only to options granted subsequent to
December 31, 1994, its pro forma effect will not be fully reflected until 1999.

NOTE 13--EMPLOYEE BENEFIT PLANS

Vencor maintains defined contribution retirement plans covering employees who
meet certain minimum eligibility requirements. Benefits are determined as a
percentage of a participant's contributions and are generally vested based upon
length of service. Retirement plan expense was $8.8 million for 1996, $9.7
million for 1995 and $7.0 million for 1994. Amounts equal to retirement plan
expense are funded annually.

NOTE 14--ACCRUED LIABILITIES

A summary of other accrued liabilities at December 31 follows (dollars in
thousands):

1996 1995
------- -------

Interest....................................................... $ 3,502 $ 3,582
Taxes other than income........................................ 20,238 22,000
Patient accounts............................................... 17,919 13,319
Merger related costs........................................... 16,640 19,071
Other.......................................................... 13,135 17,645
------- -------
$71,434 $75,617
======= =======

NOTE 15--SPIN-OFF AND RELATED TRANSACTIONS

Hillhaven became an independent public company in January 1990 as a result of a
spin-off transaction with Tenet Healthcare Corporation (formerly National
Medical Enterprises, Inc.) ("Tenet"). The following is a summary of significant
transactions with Tenet:

Debt guarantees--Tenet and Vencor are parties to a guarantee agreement
under which Vencor pays a fee to Tenet in consideration for Tenet's
guarantee of certain Vencor obligations. Such fees totaled $3.0 million in
1996, $3.8 million in 1995, and $5.0 million in 1994.

Insurance--Prior to June 1, 1994, substantially all of the professional and
general liability risks of Hillhaven were insured by a subsidiary of Tenet.
Provisions for loss were $3.1 million in 1994.

Leases--Vencor leases certain nursing centers from a joint venture in which
Tenet has a minority interest. Lease payments to the joint venture
aggregated $10.3 million, $9.9 million and $9.3 million for 1996, 1995 and
1994, respectively.

F-17

VENCOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 15--SPIN-OFF AND RELATED TRANSACTIONS (CONTINUED)

Equity ownership--At December 31, 1996, Tenet owned 8,301,067 shares of
Vencor common stock. Prior to the Hillhaven Merger, Tenet also owned all of
Hillhaven's outstanding Series C and Series D Preferred Stock.

Management agreements--Fees paid by Tenet for management, consulting and
advisory services in connection with the operation of seven nursing centers
owned or leased by Tenet aggregated $2.7 million in both 1996 and 1995 and
$2.5 million in 1994.

NOTE 16--FAIR VALUE DATA

A summary of fair value data at December 31 follows (dollars in thousands):

1996 1995
----------------- -----------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
-------- -------- -------- --------

Cash and cash equivalents.................. $112,466 $112,466 $ 35,182 $ 35,182
Notes receivable........................... -- -- 88,729 89,992
Long-term debt, including amounts due
within one year........................... 765,199 751,843 787,672 777,090

NOTE 17--STOCK REPURCHASE PROGRAM

In June 1996, the Board of Directors authorized the repurchase of up to
2,000,000 shares of Vencor common stock. As of December 31, 1996, Vencor had
repurchased 1,950,000 shares at an aggregate cost of approximately $55.3
million.

NOTE 18--EVENTS (UNAUDITED) SUBSEQUENT TO THE DATE OF THE REPORT OF INDEPENDENT
AUDITORS

On March 21, 1997, Vencor completed the acquisition of TheraTx, Incorporated
("TheraTx"), a provider of rehabilitation and respiratory therapy management
services and nursing center operator (the "TheraTx Merger"). Under the terms of
the merger agreement, Vencor paid $17.10 cash for each outstanding share of
TheraTx common stock, which aggregated approximately 20.6 million shares at
December 31, 1996. The TheraTx Merger will be recorded using the purchase
method of accounting.

In connection with the TheraTx Merger, Vencor entered into a new five-year bank
credit facility aggregating $1.6 billion on March 18, 1997, replacing the
Vencor $1 Billion Credit Facility.

F-18

VENCOR, INC.
QUARTERLY CONSOLIDATED FINANCIAL INFORMATION (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

1996
--------------------------------------------
FIRST SECOND THIRD FOURTH
-------- -------- -------- --------

Revenues....................... $626,337 $634,554 $650,551 $666,341
Net income (loss) (a).......... 27,610 30,865 33,558 (44,028)
Per common share:
Primary earnings (loss)....... 0.39 0.43 0.48 (0.64)
Fully diluted earnings
(loss)....................... 0.39 0.43 0.48 (0.64)
Market prices (b):
High......................... 39 7/8 35 34 1/2 33 1/4
Low.......................... 31 1/2 28 1/8 25 1/2 27 1/2

1995
--------------------------------------------
FIRST SECOND THIRD FOURTH
-------- -------- -------- --------

Revenues....................... $552,178 $578,314 $575,339 $618,125
Net income (loss):
Income (loss) from operations
(c).......................... 21,172 21,087 (62,887) 28,991
Extraordinary loss on
extinguishment of debt....... (66) (2,725) (19,196) (1,265)
Net income (loss)........... 21,106 18,362 (82,083) 27,726
Per common share:
Primary earnings (loss):
Income (loss) from operations
(c)......................... 0.33 0.32 (0.91) 0.43
Extraordinary loss on
extinguishment of debt...... -- (0.05) (0.32) (0.02)
Net income (loss)........... 0.33 0.27 (1.23) 0.41
Fully diluted earnings (loss):
Income (loss) from operations
(c)......................... 0.31 0.30 (0.91) 0.41
Extraordinary loss on
extinguishment of debt...... -- (0.04) (0.32) (0.02)
Net income (loss)........... 0.31 0.26 (1.23) 0.39
Market prices (b):
High......................... 37 38 36 1/8 33 3/4
Low.......................... 27 1/8 28 1/2 28 1/4 26

- -------
(a) Fourth quarter results includes $79.9 million ($1.16 per share) of costs in
connection with the sale of 34 nursing centers, the restructuring of the
pharmacy operations and the planned replacement of certain facilities. See
Note 5 of the Notes to Consolidated Financial Statements.
(b) Vencor common stock is traded on the New York Stock Exchange (ticker
symbol--VC).
(c) Second quarter results include $3.7 million ($0.05 per share) of costs
related to the Nationwide Merger. Third quarter loss includes $89.9 million
($1.50 per share) of costs related to the Hillhaven Merger. See Note 5 of
the Notes to Consolidated Financial Statements.

F-19

VENCOR, INC.
CONDENSED CONSOLIDATED STATEMENT OF INCOME
FOR THE QUARTER AND SIX MONTHS ENDED JUNE 30, 1997 AND 1996
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

QUARTER SIX MONTHS
------------------ ----------------------
1997 1996 1997 1996
-------- -------- ---------- ----------

Revenues........................... $778,295 $634,554 $1,458,991 $1,260,891
-------- -------- ---------- ----------
Salaries, wages and benefits....... 449,806 366,705 846,379 739,023
Supplies........................... 77,328 64,075 143,361 126,183
Rent............................... 21,783 19,102 40,731 38,269
Other operating expenses........... 118,935 100,797 228,721 194,952
Depreciation and amortization...... 29,479 24,846 53,851 49,639
Interest expense................... 20,674 12,141 31,334 24,621
Investment income.................. (1,746) (3,300) (3,313) (6,878)
-------- -------- ---------- ----------
716,259 584,366 1,341,064 1,165,809
-------- -------- ---------- ----------
Income from operations before in-
come taxes........................ 62,036 50,188 117,927 95,082
Provision for income taxes......... 25,026 19,323 46,935 36,607
-------- -------- ---------- ----------
Income from operations............. 37,010 30,865 70,992 58,475
Extraordinary loss on extinguish-
ment of debt, net of income tax
benefit........................... (1,590) -- (3,849) --
-------- -------- ---------- ----------
Net income..................... $ 35,420 $ 30,865 $ 67,143 $ 58,475
======== ======== ========== ==========
Earnings per common and common
equivalent share:
Primary:
Income from operations........... $ 0.52 $ 0.43 $ 1.00 $ 0.82
Extraordinary loss on extinguish-
ment of debt.................... (0.02) -- (0.05) --
-------- -------- ---------- ----------
Net income..................... $ 0.50 $ 0.43 $ 0.95 $ 0.82
======== ======== ========== ==========
Fully diluted:
Income from operations........... $ 0.52 $ 0.43 $ 1.00 $ 0.82
Extraordinary loss on extinguish-
ment of debt.................... (0.02) -- (0.05) --
-------- -------- ---------- ----------
Net income..................... $ 0.50 $ 0.43 $ 0.95 $ 0.82
======== ======== ========== ==========
Shares used in computing earnings
per common and common equivalent
share:
Primary........................... 71,016 71,373 70,678 71,415
Fully diluted..................... 71,144 71,373 71,037 71,415

See accompanying notes.

F-20

VENCOR, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)

JUNE 30, DECEMBER 31,
1997 1996
ASSETS ---------- ------------

Current assets:
Cash and cash equivalents........................... $ 106,476 $ 112,466
Accounts and notes receivable less allowance for
loss of $52,687--June 30 and $23,915--December 31.. 639,889 420,758
Inventories......................................... 36,525 24,939
Income taxes........................................ 103,556 67,808
Other............................................... 52,200 35,162
---------- ----------
938,646 661,133
Property and equipment, at cost...................... 2,050,914 1,609,770
Accumulated depreciation............................. (462,968) (416,608)
---------- ----------
1,587,946 1,193,162
Intangible assets less accumulated amortization of
$29,238--June 30 and
$25,218--December 31................................ 699,671 31,608
Investments in affiliates............................ 85,974 7,965
Other................................................ 97,820 74,988
---------- ----------
$3,410,057 $1,968,856
========== ==========

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Accounts payable.................................... $ 146,427 $ 103,518
Salaries, wages and other compensation.............. 153,304 111,366
Other accrued liabilities........................... 132,631 71,434
Long-term debt due within one year.................. 24,747 54,692
---------- ----------
457,109 341,010
Long-term debt....................................... 1,935,019 710,507
Deferred credits and other liabilities............... 97,503 84,053
Minority interest in equity of consolidated entities. 42,839 36,195
Stockholders' equity:
Common stock, $.25 par value; authorized 180,000
shares; issued 72,859
shares--June 30 and 72,615 shares--December 31..... 18,215 18,154
Capital in excess of par value...................... 724,294 713,527
Retained earnings................................... 218,013 150,870
---------- ----------
960,522 882,551
Common treasury stock; 3,528 shares--June 30 and
3,730 shares--December 31.......................... (82,935) (85,460)
---------- ----------
877,587 797,091
---------- ----------
$3,410,057 $1,968,856
========== ==========

See accompanying notes.

F-21

VENCOR, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996
(UNAUDITED)
(IN THOUSANDS)

1997 1996
----------- -----------

Cash flows from operating activities:
Net income.......................................... $ 67,143 $ 58,475
Adjustments to reconcile net income to net cash pro-
vided by operating activities:
Depreciation and amortization...................... 53,851 49,639
Extraordinary loss on extinguishment of debt....... 6,265 --
Deferred income taxes.............................. 5,935 2,671
Other.............................................. 3,143 11,430
Changes in operating assets and liabilities:
Accounts and notes receivable..................... (53,838) (26,458)
Inventories and other assets...................... (3,694) 1,332
Accounts payable.................................. 23,832 5,151
Income taxes...................................... 26,932 28,127
Other accrued liabilities......................... (5,825) (13,341)
----------- -----------
Net cash provided by operating activities........ 123,744 117,026
----------- -----------
Cash flows from investing activities:
Purchase of property and equipment.................. (132,900) (61,454)
Acquisition of TheraTx, Incorporated................ (354,647) --
Acquisition of Transitional Hospitals Corporation... (574,971) --
Acquisition of other healthcare businesses and pre-
viously leased facilities.......................... (25,030) (5,182)
Sale of assets...................................... 12,165 6,171
Collection of notes receivable...................... 390 23,366
Net change in investments........................... (4,845) (532)
Other............................................... (2,381) (3,895)
----------- -----------
Net cash used in investing activities............ (1,082,219) (41,526)
----------- -----------
Cash flows from financing activities:
Net change in borrowings under revolving lines of
credit............................................. 1,075,250 (40,600)
Issuance of long-term debt.......................... 2,818 1,677
Repayment of long-term debt......................... (122,835) (18,471)
Payment of deferred financing costs................. (5,483) --
Issuance of common stock............................ 2,813 928
Other............................................... (78) 146
----------- -----------
Net cash provided by (used in) financing activi-
ties............................................ 952,485 (56,320)
----------- -----------
Change in cash and cash equivalents.................. (5,990) 19,180
Cash and cash equivalents at beginning of period..... 112,466 35,182
----------- -----------
Cash and cash equivalents at end of period........... $ 106,476 $ 54,362
=========== ===========
Supplemental information:
Interest payments................................... $ 32,919 $ 24,704
Income tax payments................................. 23,353 7,071

See accompanying notes.

F-22

VENCOR, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 1--REPORTING ENTITY

Vencor, Inc. ("Vencor" or the "Company") operates an integrated network of
healthcare services in 46 states primarily focused on the needs of the elderly.
At June 30, 1997, Vencor operated 58 hospitals (5,107 licensed beds), 311
nursing centers (40,869 licensed beds), a contract services business
("Vencare") which provides respiratory and rehabilitation therapies, medical
services and pharmacy management services to nursing centers and other
healthcare providers, and through its affiliate, Atria Communities, Inc.
("Atria"), 40 assisted and independent living communities with 3,977 units.

On March 21, 1997, Vencor completed the acquisition of TheraTx, Incorporated
("TheraTx"), a provider of rehabilitation and respiratory therapy management
services and operator of nursing centers (the "TheraTx Merger") in a cash-for-
stock transaction. See Note 5.

On June 24, 1997, Vencor acquired substantially all of the outstanding common
stock of Transitional Hospitals Corporation ("Transitional"), an operator of 19
long-term acute care hospitals (the "Transitional Acquisition") in a cash-for-
stock transaction. See Note 6.

NOTE 2--BASIS OF PRESENTATION

The TheraTx Merger and Transitional Acquisition have been accounted for by the
purchase method. Accordingly, the accompanying condensed consolidated financial
statements include the operations of TheraTx and Transitional since March 21,
1997 and June 24, 1997, respectively.

The accompanying condensed consolidated financial statements do not include all
of the disclosures normally required by generally accepted accounting
principles or those normally required in annual reports on Form
10-K. Accordingly, these statements should be read in conjunction with the
audited consolidated financial statements of Vencor for the year ended December
31, 1996 filed with the Securities and Exchange Commission on Form 10-K.

The accompanying condensed consolidated financial statements have been prepared
in accordance with Vencor's customary accounting practices and have not been
audited. Management believes that the financial information included herein
reflects all adjustments necessary for a fair presentation of interim results
and that all such adjustments are of a normal and recurring nature. Certain
prior year amounts have been reclassified to conform with the current year
presentation.

NOTE 3--REVENUES

Revenues are recorded based upon 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.

A summary of revenues by payor type follows (dollars in thousands):

QUARTER SIX MONTHS
------------------ ----------------------
1997 1996 1997 1996
-------- -------- ---------- ----------

Medicare............................ $246,134 $204,755 $ 479,267 $ 401,483
Medicaid............................ 206,868 199,022 406,374 398,857
Private and other................... 344,115 241,939 603,892 479,954
-------- -------- ---------- ----------
797,117 645,716 1,489,533 1,280,294
Elimination......................... (18,822) (11,162) (30,542) (19,403)
-------- -------- ---------- ----------
$778,295 $634,554 $1,458,991 $1,260,891
======== ======== ========== ==========

F-23

VENCOR, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)

NOTE 4--EARNINGS PER SHARE

The computation of earnings per common and common equivalent share is based
upon the weighted average number of common shares outstanding adjusted for the
dilutive effect of common stock equivalents consisting primarily of stock
options.

In February 1997, the Financial Accounting Standards Board issued Statement No.
128 "Earnings Per Share," which will require Vencor to change the current
method of computing earnings per common share and restate all prior periods.
Statement No. 128 is required to be adopted on December 31, 1997 and requires,
among other things, that the calculation of primary earnings per common share
exclude the dilutive effect of common stock options. The change in the
calculation method is not expected to have a material impact on previously
reported earnings per common share.

NOTE 5--THERATX MERGER

On March 21, 1997, the TheraTx Merger was consummated following a cash tender
offer in which Vencor paid $17.10 for each outstanding share of TheraTx common
stock. A summary of the TheraTx Merger follows (dollars in thousands):

Fair value of assets acquired......................................... $627,167
Fair value of liabilities assumed..................................... 257,605
--------
Net assets acquired................................................. 369,562
Cash received from acquired entity.................................... (14,915)
--------
Net cash paid....................................................... $354,647
========

The purchase price paid in excess of the fair value of identifiable net assets
acquired (to be amortized over 40 years by the straight-line method) aggregated
$322 million.

NOTE 6--TRANSITIONAL ACQUISITION

On June 24, 1997, Vencor acquired approximately 95% of the outstanding shares
of common stock of Transitional through a cash tender offer in which Vencor
paid $16.00 per common share. Vencor expects to complete the merger of its
wholly-owned subsidiary with and into Transitional in the third quarter of
1997. A summary of the Transitional Acquisition follows (dollars in thousands):

Fair value of assets acquired......................................... $713,097
Fair value of liabilities assumed..................................... 85,252
--------
Net assets acquired................................................. 627,845
Cash received from acquired entity.................................... (52,874)
--------
Net cash paid....................................................... $574,971
========

The purchase price paid in excess of the fair value of identifiable net assets
acquired (to be amortized over 40 years by the straight-line method) aggregated
$333 million.

F-24

VENCOR, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)

NOTE 7--PRO FORMA INFORMATION

The pro forma effect of the TheraTx Merger and Transitional Acquisition
assuming that the transactions occurred on January 1, 1996 follows (dollars in
thousands, except per share amounts):

SIX MONTHS ENDED
JUNE 30,
---------------------
1997 1996
---------- ----------

Revenues................................................. $1,707,261 $1,719,622
Income from operations................................... 53,709 52,817
Net income............................................... 49,860 52,817
Earnings per common and common equivalent share:
Primary:
Income from operations................................. $ 0.76 $ 0.74
Net income............................................. 0.71 0.74
Fully diluted:
Income from operations................................. $ 0.75 $ 0.74
Net Income............................................. 0.70 0.74

For both periods presented, pro forma financial data have been derived by
combining the financial results of Vencor and TheraTx (based upon six month
reporting periods ending on June 30) and Transitional (based upon six month
reporting periods ending on May 31).

Pro forma income from operations for 1997 includes upon costs incurred by both
TheraTx and Transitional in connection with the acquisitions which reduced net
income by $10.3 million.

NOTE 8--LONG-TERM DEBT

In connection with the TheraTx Merger, Vencor entered into a new five-year bank
credit facility (the "Vencor Credit Facility") aggregating $1.75 billion on
March 31, 1997, replacing a $1.0 billion bank credit facility. On June 24,
1997, the Vencor Credit Facility was amended to increase the amount of the
credit to $2.0 billion. Interest is payable, depending on certain leverage
ratios and the period of borrowing, at rates up to either (i) the prime rate
plus 1/2% or the daily federal funds rate plus 1%, (ii) LIBOR plus 1 1/8% or
(iii) the bank certificate of deposit rate plus 1 1/4%. The Vencor Credit
Facility is collateralized by the capital stock of certain subsidiaries and
intercompany borrowings and contains covenants which require, among other
things, maintenance of certain financial ratios and limit amounts of additional
debt and repurchases of common stock. Outstanding borrowings under the Vencor
Credit Facility aggregated $1.79 billion at June 30, 1997.

During the second quarter of 1997, Vencor repurchased substantially all of the
outstanding TheraTx $100 million 8% Convertible Subordinated Noted Due 2002
assumed in connection with the TheraTx Merger. The after-tax loss associated
with this transaction approximated $1.6 million.

During the first quarter of 1997, the Company recorded an after-tax charge of
$2.3 million in connection with the refinancing of the bank credit agreements
of both Vencor and TheraTx.

The Company entered into certain interest rate swap agreements in the fourth
quarter of 1995 to eliminate the impact of changes in interest rates on $400
million of floating rate debt outstanding. The agreements expire in varying
amounts through April 1998 and provide for fixed rates at 5.7% plus 3/8% to 1
1/8%. In addition, the Company entered into interest rate swap agreements in
May 1997 on $300 million of floating rate debt. These agreements expire in $100
million increments in May 1999, November 1999 and May 2000, and provide for
fixed rates at 6.4% plus 3/8% to 1 1/8%. The fair values of the swap agreements
are not recognized in the condensed consolidated financial statements.

F-25

VENCOR, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)

NOTE 9--LITIGATION

The Company's subsidiary, American X-Rays, Inc. ("AXR"), is the defendant in a
qui tam lawsuit which was filed in the United States District Court for the
Eastern District of Arkansas and served on the Company on July 7, 1997. The
United States Department of Justice intervened in the suit which was brought
under the Federal Civil False Claims Act. AXR provides portable X-ray services
to nursing facilities (including those operated by the Company) and other
healthcare providers. The Company acquired an interest in AXR when The
Hillhaven Corporation was merged into the Company in September 1995 and
purchased the remaining interest in AXR in February 1996. The suit alleges that
AXR submitted false claims to the Medicare and Medicaid programs. In
conjunction with the qui tam action, the United States Attorney's office for
the Eastern District of Arkansas also is conducting a criminal investigation
into the allegations contained in the qui tam complaint. The Company is
cooperating fully in the investigation.

On June 19, 1997, a class action lawsuit was filed in the United States
District Court for the District Court of Nevada on behalf of a class consisting
of all persons who sold shares of Transitional during the period from February
26, 1997 through May 4, 1997, inclusive. The complaint alleges that
Transitional was purchasing shares of its common stock from members of the
investing public after it had received a written offer to acquire all of
Transitional's common stock and without making the required disclosure that
such an offer had been made. The complaint further alleges that defendants
disclosed that there were "expressions of interest" in acquiring Transitional
when, in fact, at that time, the negotiations had reached an advanced stage
with actual firm offers at substantial premiums to the trading price of
Transitional's stock having been made which were actively being considered by
Transitional's Board of Directors. The complaint asserts claims pursuant to
Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended,
and common law principles of negligent misrepresentation and names as
defendants Transitional as well as certain senior executives and directors of
Transitional.

On June 6, 1997, Transitional announced that it had been advised that it was
the target of a grand jury investigation arising from the activities of
Transitional's formerly owned dialysis business. The investigation involves
purported Medicare fraud involving certain laboratory tests performed by a
partnership which existed from June 1987 to June 1992 between Damon Corporation
and Transitional. Transitional spun off its dialysis business, now called Vivra
Incorporated, on September 1, 1989. The Company is cooperating fully in the
investigation.

NOTE 10--SUBSEQUENT EVENTS

Private Placement of Debt

On July 21, 1997, Vencor completed the private placement of $750 million
aggregate principal amount of 8 5/8% Senior Subordinated Notes Due 2007 (the
"Notes"). The Notes were issued at 99.575% of face value and are not callable
by the Company until 2002. The net proceeds of the offering were used to reduce
outstanding borrowings under the Vencor Credit Facility.

Atria Secondary Equity Offering

In July 1997, Atria issued 6.9 million shares of its common stock in a public
offering (the "Atria Offering"), the net proceeds from which aggregated
approximately $91 million. The net proceeds will be used primarily to finance
Atria's expansion and development activities. As a result of the Atria
Offering, Vencor now owns 42.8% of the outstanding common stock of Atria.
Accordingly, beginning in July 1997, Atria's financial statements will no
longer be consolidated with those of the Company; however, the Company's
investment in Atria will be accounted for under the equity method.

F-26

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors
TheraTx, Incorporated

We have audited the accompanying consolidated balance sheets of TheraTx,
Incorporated and Subsidiaries as of December 31, 1995 and 1996, and the related
consolidated statements of income, stockholders' equity, cash flows and related
financial statement schedule for each of the three years in the period ended
December 31, 1996. These financial statements and schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and schedule based on our audits. We did
not audit the financial statements and schedule of Helian Health Group, Inc.
and subsidiaries for the year ended November 30, 1994; which statements reflect
total net revenues constituting 22% in 1994 and total net income of 12% in 1994
of the related consolidated totals. Those statements and schedule were audited
by other auditors whose report has been furnished to us, and our opinion,
insofar as it relates to data included for Helian Health Group, Inc. and
subsidiaries for the year ended November 30, 1994, is based solely on the
report of the other auditors.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits 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 and the report of other
auditors provide a reasonable basis for our opinion.

In our opinion, based on our audits and the report of other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of TheraTx, Incorporated
and Subsidiaries at December 31, 1995 and 1996, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1996, in conformity with generally accepted accounting
principles. 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.

/s/ Ernst & Young LLP

Atlanta, Georgia
March 21, 1997

F-27

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors
Helian Health Group, Inc.

We have audited the consolidated financial statements and consolidated
financial statement schedule of Helian Health Group, Inc. and subsidiaries as
of November 30, 1994 and for the year then ended. These financial statements
and financial statement schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and financial statement schedule based on our audit.

We conducted our audit in accordance with generally accepted auditing
standards. 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 audit provides a reasonable basis
for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Helian Health
Group, Inc. and subsidiaries as of November 30, 1994, and the results of
their operations and their cash flows for the year ended November 30, 1994, in
conformity with generally accepted accounting principles. In addition, in our
opinion, the financial statement schedule referred to above, when considered in
relation to the basic financial statements taken as a whole, presents fairly,
in all material respects the information required to be included therein.

/s/ Coopers & Lybrand L.L.P.

San Jose, California
February 3, 1995

F-28

THERATX, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)

YEAR ENDED DECEMBER 31,
------------------------------
1994 1995 1996
--------- --------- ---------

Revenues:
Patient care revenues, net.................... $ 168,829 $ 287,365 $ 359,949
Management services and other................. 3,880 6,915 10,678
Sales of medical supplies and related
services..................................... 1,573 19,896 20,528
--------- --------- ---------
Total net revenues......................... 174,282 314,176 391,155
Operating costs and expenses:
Costs of revenues:
Salaries, wages and benefits................. 97,009 167,704 209,480
Other operating expenses..................... 24,303 44,753 54,707
Cost of medical supply sales and related
services.................................... 611 16,173 16,613
Corporate, general and administrative......... 25,024 33,268 39,608
Depreciation and amortization................. 5,745 9,274 11,022
Rent.......................................... 4,600 7,729 11,146
Merger costs.................................. -- 4,600 --
--------- --------- ---------
Total operating costs and expenses......... 157,292 283,501 342,576
--------- --------- ---------
Income from operations......................... 16,990 30,675 48,579
Interest and other expense, net................ 2,426 9,902 12,463
--------- --------- ---------
Income before income taxes, minority interest
and extraordinary item........................ 14,564 20,773 36,116
Provision for income taxes..................... 3,417 9,589 13,364
--------- --------- ---------
Income before minority interest and
extraordinary item............................ 11,147 11,184 22,752
Minority interest.............................. 446 73 (35)
--------- --------- ---------
Income before extraordinary item............... 11,593 11,257 22,717
Extraordinary item, net of income taxes........ -- (428) (1,134)
--------- --------- ---------
Net income..................................... $ 11,593 $ 10,829 $ 21,583
========= ========= =========
Earnings per common share:
Income before extraordinary item.............. $ 0.73 $ 0.55 $ 1.11
Extraordinary item............................ -- (0.02) (0.06)
--------- --------- ---------
Net income.................................... $ 0.73 $ 0.53 $ 1.05
========= ========= =========
Weighted average number of shares outstanding.. 15,972 20,407 20,544

See accompanying notes.

F-29

THERATX, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PAR VALUE DATA)

DECEMBER 31,
------------------
1995 1996
-------- --------

ASSETS
Current assets:
Cash and cash equivalents................................. $ 10,530 $ 10,708
Short-term investments.................................... 1,023 --
Accounts receivable less allowances for doubtful accounts
and denials of $8,024 and $12,221 at December 31, 1995
and 1996, respectively................................... 76,766 103,225
Third-party settlements................................... 7,084 11,822
Prepaid expenses and other current assets................. 3,942 9,851
Inventory................................................. 5,415 5,977
Current note receivable................................... -- 10
Receivable from stockholder............................... 379 --
Income taxes receivable................................... 2,010 698
Deferred income taxes..................................... 1,737 5,527
-------- --------
Total current assets................................... 108,886 147,818
Property and equipment, net................................ 111,677 125,652
Intangible assets, net of accumulated amortization of
$5,276 and $9,137 at December 31, 1995 and 1996,
respectively.............................................. 97,844 104,284
Long-term notes receivable................................. 8,404 4,910
Other assets............................................... 2,987 2,658
-------- --------
Total assets........................................... $329,798 $385,322
======== ========

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Accounts payable.......................................... $ 9,560 $ 9,292
Accrued payroll and related expenses...................... 16,819 19,814
Accrued interest payable.................................. 3,679 3,863
Other accrued expenses.................................... 6,902 5,506
Long-term debt, current portion........................... 656 792
-------- --------
Total current liabilities.............................. 37,616 39,267
Long-term debt, net of current portion..................... 51,741 77,474
Subordinated debt.......................................... 100,000 100,000
Other liabilities.......................................... 327 47
Deferred income taxes...................................... 213 6,020
Minority interests......................................... 2 140
Commitments and contingencies
Stockholders' equity:
Common stock, $.001 par value:
Authorized Shares--50,000; issued and outstanding
shares--20,437 and 20,614 at December 31, 1995 and 1996,
respectively............................................ 20 20
Additional paid-in capital................................ 121,403 122,691
Note receivable from stockholder.......................... (100) (100)
Retained earnings......................................... 18,576 39,763
-------- --------
Total stockholders' equity............................. 139,899 162,374
-------- --------
Total liabilities and stockholders' equity............. $329,798 $385,322
======== ========

See accompanying notes.

F-30

THERATX, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)

NOTES
PREFERRED STOCK COMMON STOCK ADDITIONAL RECEIVABLE TOTAL
------------------ ----------------- PAID IN FROM RETAINED STOCKHOLDERS'
SHARES PAR VALUE SHARES PAR VALUE CAPITAL STOCKHOLDERS EARNINGS EQUITY
------- --------- ------ --------- ---------- ------------ -------- -------------

Balance at January 1,
1994................... 16,465 $ 17 5,963 $ 6 $ 28,679 $(290) $(3,471) $ 24,941
Issuance of common
stock upon exercise of
stock options and
other................. -- -- 294 -- 648 -- -- 648
Issuance of common and
preferred stock in
connection with
PersonaCare
acquisition........... 2,421 2 811 1 29,997 -- -- 30,000
Issuance of common
stock in initial
public offering....... -- -- 4,010 4 43,323 -- -- 43,327
Conversion of preferred
stock................. (18,886) (19) 7,909 8 11 -- -- --
Repayment of officer
note receivable....... -- -- -- -- -- 8 -- 8
Issuance of stock
options............... -- -- -- -- 90 -- -- 90
Purchase of common
stock................. -- -- (57) -- (140) -- -- (140)
Cash dividends paid.... -- -- -- -- -- -- (223) (223)
Net income............. -- -- -- -- -- -- 11,593 11,593
------- ---- ------ ---- -------- ----- ------- --------
Balance at December 31,
1994................... -- -- 18,930 19 102,608 (282) 7,899 110,244
Issuance of common
stock upon exercise of
stock options and
other................. -- -- 298 -- 652 -- -- 652
Repayment of officer
note receivable....... -- -- -- -- -- 182 -- 182
Issuance of common
stock in connection
with mergers and
acquisitions.......... -- -- 1,209 1 18,043 -- -- 18,044
Merger costs paid by
former shareholders of
acquired company...... -- -- -- -- 100 -- -- 100
Cash dividends paid.... -- -- -- -- -- -- (152) (152)
Net income............. -- -- -- -- -- -- 10,829 10,829
------- ---- ------ ---- -------- ----- ------- --------
Balance at December 31,
1995................... -- -- 20,437 20 121,403 (100) 18,576 139,899
Issuance of common
stock upon exercise of
stock options and
other................. -- -- 177 -- 1,288 -- -- 1,288
Net loss for Helian
Health Group, Inc. for
the month ended
December 31, 1995..... -- -- -- -- -- -- (378) (378)
Cash dividends paid.... -- -- -- -- -- -- (18) (18)
Net income............. -- -- -- -- -- -- 21,583 21,583
------- ---- ------ ---- -------- ----- ------- --------
Balance at December 31,
1996................... -- $ -- 20,614 $ 20 $122,691 $(100) $39,763 $162,374
======= ==== ====== ==== ======== ===== ======= ========

See accompanying notes.

F-31

THERATX, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

YEAR ENDED DECEMBER 31,
----------------------------
1994 1995 1996
-------- -------- --------

OPERATING ACTIVITIES:
Net income...................................... $ 11,593 $ 10,829 $ 21,583
Net loss for Helian Health Group, Inc. for the
month ended December 31, 1995.................. -- -- (378)
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Write-off of deferred financing costs.......... -- 612 --
Disposal of business........................... -- -- 1,800
Depreciation and amortization.................. 5,745 9,274 11,022
Amortization of deferred financing costs....... -- 652 646
Provisions for bad debts and denials........... 5,496 4,627 5,324
Deferred income taxes.......................... 479 807 1,816
Net (gain) loss on sale of assets.............. -- 1,032 (299)
Minority interest in consolidated subsidiar-
ies........................................... (446) (73) 35
Other, net..................................... (88) 27 445
Changes in operating assets and liabilities:
Accounts receivable and third-party settle-
ments........................................ (22,587) (37,413) (33,636)
Prepaid expenses and other current assets..... (198) (147) (5,895)
Inventory..................................... -- (2,084) (606)
Income taxes receivable or payable............ (1,064) (2,305) 1,294
Other assets.................................. (5) -- --
Accounts payable and accrued liabilities...... 2,489 9,882 (2,329)
-------- -------- --------
Net cash provided by (used in) operating ac-
tivities................................... 1,414 (4,280) 822
-------- -------- --------
INVESTING ACTIVITIES:
Acquisition of companies and payments related to
acquisitions................................... (1,828) (88,636) (9,903)
Purchases of property and equipment............. (4,711) (8,800) (18,056)
Proceeds from sales of assets................... -- -- 647
Purchases of short-term investments............. (1,539) (1,000) --
Sales of short-term investments................. 258 1,595 1,023
Issuance of notes receivable.................... (4,080) (25) --
Repayment of notes receivable................... 1,298 177 --
Cash acquired in acquisitions................... 1,749 77 470
Other, net...................................... (235) (1,379) (1,221)
-------- -------- --------
Net cash used in investing activities....... (9,088) (97,991) (27,040)
-------- -------- --------
FINANCING ACTIVITIES:
Payments on line of credit...................... (6,800) -- --
Proceeds from convertible debt.................. -- 100,000 --
Proceeds from long-term debt.................... 37,210 18,105 27,000
Payments on long-term debt...................... (56,702) (11,334) (2,231)
Retirement of put warrants...................... (1,350) -- --
Capitalized financing costs..................... (669) (5,000) --
Payments on notes receivable from stockholders.. -- -- 379
Proceeds from notes payable to stockholders..... 2,070 -- --
Payments on notes payable to stockholders....... (3,641) -- --
Payments on capital lease obligations........... (434) (1,212) (22)
Proceeds from issuance of common stock.......... 43,974 652 1,288
Other, net...................................... (162) 30 (18)
-------- -------- --------
Net cash provided by financing activities... 13,496 101,241 26,396
-------- -------- --------
Increase (decrease) in cash and cash equiva-
lents.......................................... 5,822 (1,030) 178
Cash and cash equivalents, beginning of year.... 5,738 11,560 10,530
-------- -------- --------
Cash and cash equivalents, end of year.......... $ 11,560 $ 10,530 $ 10,708
======== ======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMA-
TION:
Cash paid for interest.......................... $ 3,593 $ 8,001 $ 12,732
Cash paid for income taxes...................... 2,554 11,442 9,637

See accompanying notes.

F-32

THERATX, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. NATURE OF BUSINESS

TheraTx, Incorporated and its subsidiaries ("TheraTx" or the "Company") provide
outcomes-oriented healthcare services with a focus in two specialized practice
areas: postacute care and occupational health.

TheraTx provides subacute rehabilitation and respiratory therapy management
services to nursing facilities, operates owned, leased and managed inpatient
facilities that provide a broad range of subacute, specialty and basic medical
and other geriatric services and provides occupational healthcare and related
services in outpatient clinics. In addition to its primary practice areas,
TheraTx operates outpatient surgery centers, owns and operates an acute-care
specialty hospital, provides respiratory therapy and related services to
hospitals and provides medical supply distribution and related services to the
long-term care industry.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation
The consolidated financial statements of TheraTx have been prepared to give
effect to the May 1, 1995 merger with Respiratory Care Services, Inc. and its
majority-owned subsidiaries ("RCS") and the December 28, 1995 merger with
Helian Health Group, Inc. and its majority-owned subsidiaries ("Helian"). These
transactions have been accounted for as poolings of interests and, accordingly,
the consolidated financial statements have been restated for all periods prior
to the acquisitions to give effect to the accounts of RCS and Helian. (See Note
4.)

Helian's financial results prior to 1996 have been prepared on a fiscal year
ending November 30. Accordingly, Helian financial results for the fiscal year
ending November 30 have been combined with TheraTx's results for the fiscal
year ending December 31 for all periods presented prior to 1996.

Effective January 1, 1996, Helian's fiscal year-end was changed from November
30 to December 31 to conform to the Company's year-end. Accordingly, Helian's
operations for the one month ended December 31, 1995, including net sales of
$2,791,000 and a net loss of $378,000, have been excluded from combined results
and reported as an adjustment to consolidated retained earnings as of January
1, 1996.

All material intercompany accounts and transactions have been eliminated in
consolidation. Certain amounts in prior year periods have been reclassified to
conform to current year presentation.

Use of Estimates
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements
and accompanying notes. Actual results could differ from those estimates.

Cash and Cash Equivalents
The Company classifies short-term highly liquid investments with original
maturities of ninety days or less as cash equivalents.

The cash balances at December 31, 1995 and 1996 include $750,000 that is
restricted under the Senior Credit Facility. (See Note 7.) These funds are in
an interest-bearing account and will be released upon the occurrence
of specified events.

Short-Term Investments
Investments consist of certificates of deposit and are carried at cost that
approximates market.

Patient Care Revenues, Net and Related Receivables
Patient care revenues include amounts reimbursable by third-party payors under
contractual arrangements. These contractual arrangements provide for payments
based on prospective payment, cost reimbursement and

F-33

THERATX, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Patient Care Revenues, Net and Related Receivables (Continued)
other payment formulas. The difference between established billing rates and
amounts estimated to be received are accounted for as contractual allowances.
Final determination of amounts earned under certain contractual arrangements is
subject to audit or adjustment by third-party payors. The financial statements
include provisions for estimated adjustments resulting from such audits or
other changes in circumstances during the year.

The Company is reimbursed by Medicare for medical and rehabilitation services
provided in the Company's nursing facilities at an interim rate with final
settlement determined after submission of annual cost reports by the Company
and audits thereof by the government fiscal intermediary. Differences between
amounts accrued and final settlements, if any, are recorded in operations in
the year of settlement.

The Company bills third-party nursing facility customers directly for services
provided in its programs at such third-party facilities. Substantially all of
such customers are subject to federal and state regulations. A significant
portion of the cost of the Company's services is ultimately reimbursed to the
Company's customers by Medicare. Although Medicare accepts charges by the
Company's customers for usual, customary and reasonable charges at market
rates, such charges are subject to audit and retroactive adjustment. The
Company reimburses its customers for any charges that are denied by Medicare in
accordance with its customer contracts. The financial statements include
provisions for estimated future denials.

Inventory
Inventory, which is comprised primarily of medical supplies held for sale and
durable medical equipment, is valued at the lower of cost (determined by the
first-in, first-out method) or market.

Property and Equipment
Property and equipment are stated at cost. Property includes the cost of
acquiring and renovating facilities and equipment. The cost of repairs and
maintenance is charged to operations as incurred. Depreciation is provided
using the straight-line method over the estimated useful life (forty years for
buildings; three to ten years for equipment and furniture; and the lesser of
the lease term or ten years for leasehold improvements). Depreciation expense
of $4,232,000, $6,915,000 and $7,481,000 includes amortization of assets
recorded under capital leases for years ended December 31, 1994, 1995 and 1996,
respectively.

Property and equipment consists of the following at December 31 (in thousands):

1995 1996
-------- --------

Land and improvements....................................... $ 9,945 $ 10,958
Buildings and improvements.................................. 79,886 83,921
Construction-in-progress.................................... 1,334 5,325
Furniture, fixtures and equipment........................... 31,240 38,771
Leasehold improvements...................................... 3,510 7,738
-------- --------
125,915 146,713
Accumulated depreciation and amortization................... (14,238) (21,061)
-------- --------
$111,677 $125,652
======== ========

Intangible Assets
Intangible assets consist primarily of goodwill and deferred financing costs.
Goodwill represents the excess of cost over the market value of assets acquired
and is amortized using the straight-line method over forty years.

Deferred financing costs are amortized using the straight-line method over the
term of the related debt.

F-34

THERATX, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Carrying Value of Long-Lived Assets and Long-Lived Assets to be Disposed Of
In accordance with FASB Statement No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long Lived Assets to be Disposed Of, the Company
records impairment losses on long-lived assets when events and circumstances
indicate that the assets might be impaired and the undiscounted cash flows
estimated to be generated by those assets are less than the carrying amounts of
those assets. Based on the Company's estimate of future undiscounted cash
flows, the Company expects to recover the carrying amounts of its long-lived
assets. Nonetheless, it is reasonably possible that the estimate of
undiscounted cash flows may change in the near term resulting in the need to
write-down those assets to fair value.

Employee Stock Options
The Company grants stock options for a fixed number of shares to employees and
directors with an exercise price at least equal to the fair value of the shares
at the date of grant. The company accounts for stock option grants in
accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees,
and, accordingly, recognizes no compensation expense for the stock option
grants. Pro forma information regarding net income as required by SFAS No. 123,
Accounting for Stock-Based Compensation, is included in Note 13.

Net Income Per Share
Net income per common share is calculated using the weighted average number of
common and common equivalent shares outstanding during the respective periods.
Common stock equivalents consist of (i) the number of common shares issuable
upon conversion of preferred stock and (ii) the number of shares issuable upon
exercise of warrants and stock options.

Pursuant to the requirements of the Securities and Exchange Commission, common
shares and common equivalent shares issued at prices below the public offering
price of $12.00 per share during the twelve months immediately preceding the
date of the initial filing of the registration statement, excluding common
shares and common equivalent shares issued in connection with the acquisition
of PersonaCare, have been included in the calculation of common shares and
common equivalent shares, using the treasury stock method, as if they were
outstanding for all periods prior to the date of the initial public offering.

In 1994 and 1995, the number of shares issuable upon the exercise of warrants
and stock options was calculated using the treasury stock method.

In 1996, the weighted average common equivalent shares outstanding were
computed using the "modified treasury stock method" in accordance with
Accounting Principles Board Opinion No. 15 ("APB 15"). The modified treasury
stock method is used when the number of shares obtainable upon exercise of
outstanding options, warrants and their equivalents, in the aggregate, exceeds
20% of the Company's outstanding common stock. Under this method, all options,
warrants and their equivalents are assumed to have been exercised, whether or
not dilutive and the aggregate proceeds used to repurchase up to 20% of the
outstanding shares. Excess proceeds not utilized for the purchase of such
shares are assumed to be utilized to reduce outstanding debt with any remainder
invested in interest bearing securities. Net earnings is increased for the
assumed interest savings or interest income, net of taxes. For the fiscal year
ending December 31, 1996, the effects of the application of the modified
treasury stock method were anti-dilutive; thus, as prescribed by APB 15, common
equivalent shares were excluded in determining net income per common share.

3. FINANCIAL INSTRUMENTS

Carrying Value of Financial Instruments
The carrying amount reported in the balance sheet for cash and cash
equivalents, accounts receivable and accounts payable and borrowings under the
Company's Senior Credit Facility approximates fair value.

F-35

THERATX, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. FINANCIAL INSTRUMENTS (CONTINUED)

The fair value of the Company's subordinated debt at December 31, 1996 is
$94,000,000 and is based on quoted market prices.

Concentration of Credit Risk
At December 31, 1995 and 1996, approximately 12.2% and 11.1%, respectively, of
the Company's accounts receivable and 100% of the Company's third-party
settlements are due from Medicare and Medicaid programs for services provided
in the Company's owned or leased inpatient facilities. Additionally, at
December 31, 1995 and 1996, approximately 53.3% and 58.0%, respectively, of the
Company's accounts receivable are from third-party long-term care facilities
for services provided by the Company at such facilities. A significant portion
of the cost of these services is ultimately reimbursed to the third-party long-
term care facilities by Medicare. Should the related government agencies
suspend or significantly reduce contributions to the Medicare and Medicaid
programs, the Company's ability to collect on its receivables would be
adversely affected. At December 31, 1996, the Company had recorded receivables
of $20,786,000 and $4,288,000 due directly from Medicare intermediaries and
Medicaid programs, respectively. The Medicaid receivables primarily relate to
the states of Texas, Rhode Island, Connecticut, Georgia, Florida, Pennsylvania,
Ohio and Alabama.

Management believes the remaining receivable balances due from various payors
subject to differing economic conditions do not represent any concentrated
credit risks to the Company. Management continually monitors and adjusts its
reserves and allowances associated with these receivables.

4. MERGERS AND ACQUISITIONS

RCS Merger. Effective May 5, 1995, TheraTx issued approximately 724,000
shares of common stock in exchange for all of the outstanding common stock of
RCS. RCS provides respiratory therapy services, cardio-pulmonary services and
sleep diagnostic services in hospitals and subacute facilities. RCS also sells
and rents home durable medical equipment. This transaction has been accounted
for as a pooling of interests. (See Note 2.)

Helian Merger. Effective December 28, 1995, TheraTx issued approximately
2,456,000 shares of TheraTx common stock in exchange for all outstanding shares
of common stock of Helian. Helian operates eleven occupational medical
facilities, three ambulatory surgery centers and one surgical specialty
hospital. This transaction has been accounted for as a pooling of interests.
(See Note 2.)

Net revenues and net income (loss) for the merged companies for 1994 and 1995
through the dates of mergers are as follows (in thousands):

NET
NET INCOME
REVENUES (LOSS)
-------- -------

Year Ended December 31, 1994
The Company.................................................. $126,787 $ 9,607
Helian....................................................... 38,205 1,395
RCS.......................................................... 9,290 591
-------- -------
Combined.................................................... $174,282 $11,593
======== =======
Year Ended December 31, 1995
The Company.................................................. $275,853 $11,856
Helian....................................................... 35,397 (1,091)
RCS.......................................................... 2,926 64
-------- -------
Combined.................................................... $314,176 $10,829
======== =======

F-36

THERATX, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. MERGERS AND ACQUISITIONS (CONTINUED)

Acquisition of PersonaCare, Inc. On May 31, 1994, TheraTx acquired
PersonaCare, Inc. ("PersonaCare"), a company that owns and operates inpatient
facilities. In conjunction with the acquisition, TheraTx issued an aggregate of
3,232,221 shares of stock, comprised of 811,416 shares of common stock and
2,420,805 shares of Series E preferred stock in exchange for all outstanding
common and preferred stock of PersonaCare. Each share of preferred stock
converted into one share of common stock upon consummation of the initial
public offering. (See Note 5.) The holders of shares received in the merger
have certain registration rights.

The acquisition was recorded using the purchase method of accounting and the
results of PersonaCare's operations subsequent to May 31, 1994, have been
included in the accompanying financial statements. The PersonaCare stock
received by TheraTx was valued at $30,000,000 and the Company recorded costs of
approximately $1,200,000 in connection with the merger. The assets and
liabilities of PersonaCare have been recorded at fair market value. The
purchase price in excess of the net identifiable assets acquired of $25,886,000
was recorded as goodwill. In conjunction with the acquisition, the Company
assumed certain subordinated notes payable that were repaid during July 1994
from the net proceeds received in the Company's initial public offering.

Acquisition of SMS Business. Effective April 1, 1995, the Company acquired
certain of the assets and assumed certain liabilities from eight companies
managed by Southern Management Services, Inc. ("SMS"), including five nursing
facilities, an adult congregate living facility, a medical products
distribution company and a Medicare Part B billing and supply service company
(collectively, the "SMS Business"). The purchase price paid by the Company for
the SMS Business included (i) approximately $34,180,000 in cash paid at closing
by the Company to certain lenders of the SMS Business in connection with the
retirement of bank debt and mortgage debt and (ii) $43,250,000 in cash and
1,097,407 shares of the Company's common stock. In addition, 888,889 shares of
the Company's common stock were issued into escrow (the "Escrow Shares"). The
Escrow Shares were to be released if certain financial goals for the SMS
Business were achieved during the period commencing April 1, 1995 and ending
February 29, 1996 ("the Earn-Out Period"), and the purchase price was to be
further increased by as much as $20,000,000 payable in either shares of the
Company's stock or cash, at the option of the sellers, if certain financial
goals were exceeded during the Earn-Out Period. The Company has concluded that
the sellers of the SMS Business are not entitled to the Escrow Shares and are
not entitled to any earn-out payment as the financial performance of the SMS
Business was, as a whole, significantly below the threshold entitling the
sellers to any payment under the earn-out. As a result, none of the Escrow
Shares are included as outstanding as of December 31, 1996 for financial
reporting purposes. The holders of shares received in the acquisition have
certain registration rights.

The acquisition was recorded April 1, 1995 using the purchase method of
accounting. The common stock issued in the transaction was valued at $16.75 per
share based on the last reported sale price of the Company's common stock on
March 31, 1995. The assets and liabilities of SMS have been recorded at fair
market value. Intangible assets of approximately $64,306,000, representing the
cost of the acquisition in excess of the identifiable assets acquired and
liabilities assumed, consist primarily of goodwill that is being amortized over
forty years using the straight-line method.

Pro Forma Results. The following unaudited pro forma results were developed
assuming PersonaCare and the SMS Business had been acquired on January 1, 1994
(in thousands, except per share data):

PRO FORMA
YEAR ENDED DECEMBER 31,
-----------------------
1994 1995
----------- -----------

Net revenues........................................... $ 259,362 $ 329,521
Net income............................................. 10,445 10,891
Pro forma net income per share......................... 0.57 0.53

F-37

THERATX, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. MERGERS AND ACQUISITIONS (CONTINUED)

The unaudited pro forma sales and earnings information is not necessarily
indicative of the combined results that would have occurred had the acquisition
taken place on January 1, 1994, nor are they necessarily indicative of results
that may occur in the future.

5. INITIAL PUBLIC OFFERING

On June 24, 1994, the Company's initial public offering was declared effective
by the Securities and Exchange Commission. The Company issued 4,010,000 shares
of common stock at an offering price of $12.00 per share and received net
proceeds of approximately $43,327,000 (after deducting underwriting discounts
and offering costs of $4,793,000).

6. LONG-TERM NOTES RECEIVABLE

The long-term notes receivable at December 31, 1995 and 1996 include a wrap-
around third mortgage note receivable from the lessor of the Wisconsin facility
for $4,222,000. The note is collateralized by the lessor's property and
equipment. Additionally, the note serves as collateral for certain long-term
debt. (See Note 7.) The note bears interest at a rate designated to approximate
the Company's required lease payment to the lessor. Interest only is receivable
monthly on the note that becomes due at the end of the lease term. Interest
income of $545,000 related to this note has been recorded for each of the years
ended December 31, 1995 and 1996.

7. LONG-TERM DEBT

Long-term debt consists of the following (in thousands):

DECEMBER 31
----------------
1995 1996
------- -------

Senior Credit Facility....................................... $48,000 $75,000
Notes payable, Wisconsin facility, payable in monthly
installments of principal plus fixed interest (8.9% average
interest rate) through the end of the lease term............ 2,518 2,300
Note payable to bank, interest at bank's prime rate plus
1.75%, (11.0% at November 30, 1995) collateralized by a
building with principal and interest payable in
monthly installments........................................ 651 --
Notes payable to a financial institution, interest at 7.82%
and 7.56%, collateralized by property and equipment, with
principal and interest payable in monthly installments
through November 1997 and August 1998, respectively......... 454 279
Note payable to a financial institution, interest at 7.66%,
collateralized by property
and equipment, with principal and interest payable in
monthly installments through December 1998.................. 727 491
Other........................................................ 47 196
------- -------
52,397 78,266
Less current portion......................................... (656) (792)
------- -------
$51,741 $77,474
======= =======

In September 1994, the Company entered into a $65,000,000 Revolving Credit
Facility (the "Revolving Credit Facility"). In conjunction with the Revolving
Credit Facility, during 1994, the Company restructured $33,000,000 of mortgage
debt assumed in the acquisition of PersonaCare and repaid $13,375,000 of
PersonaCare debt and accrued interest out of the net proceeds received from the
Company's initial public offering.

F-38

THERATX, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. LONG-TERM DEBT (CONTINUED)

On May 8, 1995, TheraTx entered into a $125,000,000 Senior Credit Facility
("Senior Credit Facility") with a group of lenders. The Senior Credit Facility
was used to refinance the Company's Revolving Credit Facility. Borrowings under
the Senior Credit Facility bear interest at a maximum rate of LIBOR plus 1.5%,
adjusted for certain leverage ratios. The Senior Credit Facility provides for a
$5,000,000 swing line to accommodate same- day borrowings and a $5,000,000
stand-by letter of credit facility. Future borrowings under the Senior Credit
Facility will be used to fund working capital requirements, purchases of
property and equipment, acquisitions, and general corporate requirements.
Borrowings under the Senior Credit Facility are secured by substantially all of
the assets of the Company and its subsidiaries, including all of the capital
stock of each subsidiary. The Senior Credit Facility contains various financial
covenants, including, but not limited to, requirements for minimum net worth,
maximum funded debt and other financial ratios, and restrictions on payments of
dividends, capital expenditures and acquisitions. Subsequent to December 31,
1996, all borrowings under the Senior Credit Facility were repaid in
conjunction with the merger with Vencor, Inc. (See Note 17.)

In 1995, the Company recorded charges in connection with the write-off of
certain deferred financing costs related to the Company's Revolving Credit
Facility. Additionally, the Company incurred costs in conjunction with the
early extinguishment of certain capital lease obligations. These items,
totaling $701,000, have been reported as an extraordinary item, net of income
taxes of $273,000 during the year ended December 31, 1995.

Certain letters of credit totaling $1,989,500 have been issued under the Senior
Credit Facility and are outstanding as of December 31, 1996. These letters of
credit, which mature throughout 1997, reduce the amount available to be
borrowed under the Senior Credit Facility.

The notes payable, Wisconsin facility, pertain to a facility that the Company
leases. The notes are collateralized by notes receivable from the lessor. In
connection with the notes payable, Wisconsin facility, the Company has agreed
to pay the debt service on the notes during the five-year term of the lease and
any subsequent renewal periods as a part of the rental agreement. At the end of
the lease term, any remaining balance on the notes payable becomes the
obligation of the lessor and the note receivable, serving as collateral, is
reduced by a like amount.

At December 31, 1996, the aggregate maturities of long-term debt for the five
years ending December 31, 2001 and thereafter are as follows (in thousands):

1997..................................................... $ 792
1998..................................................... 592
1999..................................................... 131
2000..................................................... 75,087
2001..................................................... 49
Thereafter............................................... 1,615
-------
$78,266
=======

8. CONVERTIBLE SUBORDINATED NOTES

On February 16, 1995, the Company completed a private placement of $100,000,000
of seven-year convertible subordinated notes due 2002, with a coupon rate of
8%. The notes are redeemable at the option of the Company after February 3,
1998. The proceeds primarily have been used to finance the acquisition and
assumption by the Company of certain assets and liabilities of the SMS
Business. (See Note 4.) As a result of the merger with Vencor subsequent to
December 31, 1996, the Company is required to offer to repurchase the Notes for
100% of the principal amount, together with accrued interest. (See Note 17.)

F-39

THERATX, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

9. LEASES

The Company operates facilities pursuant to the terms of long-term operating
leases. The operating leases have initial terms ranging from five to fifteen
years. The leases provide for renewals, at the Company's option, ranging from
two to three periods of five years each. Generally, the leases contain options
for the Company to purchase the facilities at the end of the lease terms at an
amount related to the fair market value of the facility at the time the option
is exercised.

The Company also rents office space and office equipment under non-cancelable
operating leases.

On April 25, 1995, the Company entered into a twenty-year operating lease
relating to the construction and lease of approximately 107,000 square feet of
corporate office space. The lease agreement provides for an annual base lease
rate of approximately $1,800,000, adjusted annually for inflation. In addition
to the base lease rate, the Company will pay certain building operating costs.
The lease term began in July 1996 upon completion of the office building.

Future minimum lease commitments for all non-cancelable operating leases as of
December 31, 1996 are as follows (in thousands):

Year Ending December 31,
1997.................................................... $ 11,944
1998.................................................... 11,499
1999.................................................... 10,179
2000.................................................... 9,665
2001.................................................... 9,414
Thereafter.............................................. 53,932
--------
Total minimum lease payments.......................... $106,633
========

10. INCOME TAXES

The provision for income taxes consists of the following (in thousands):

YEAR ENDED DECEMBER 31,
------------------------
1994 1995 1996
------- ------- --------

Current income tax expense:
Federal.......................................... $ 2,629 $ 7,382 $ 10,425
State............................................ 295 1,053 457
------- ------- --------
Total current income tax expense................ 2,924 8,435 10,882
Deferred income tax expense...................... 493 1,154 2,482
------- ------- --------
Total provision for income taxes................ $ 3,417 $ 9,589 $ 13,364
======= ======= ========

F-40

THERATX, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. INCOME TAXES (CONTINUED)

A reconciliation of the provision for income taxes to the federal statutory
rate of 35% in 1994, 1995 and 1996, is as follows (in thousands):

YEAR ENDED DECEMBER 31,
---------------------------
1994 1995 1996
-------- ------- --------

Tax at statutory rate.............................. $ 5,085 $ 7,275 $ 12,640
Surtax exemption................................... (100) -- --
State taxes, net of federal benefit................ 609 793 410
Goodwill amortization.............................. 224 262 423
Merger costs....................................... -- 1,561 --
Other.............................................. 211 425 100
Change in valuation reserve........................ (2,612) (727) (209)
-------- ------- --------
$ 3,417 $ 9,589 $ 13,364
======== ======= ========

The tax effects of temporary differences and carryforwards that give rise to
significant portions of deferred tax assets (liabilities) consist of the
following (in thousands):

YEAR ENDED DECEMBER 31,
------------------------
1995 1996
----------- -----------

Deferred tax assets:
Net operating loss carryforwards.................... $ 1,311 $ 458
Asset valuation allowances.......................... 2,985 4,610
Intangible assets................................... 998 816
Accrued liabilities................................. 6,009 5,041
Other............................................... 78 776
----------- -----------
Gross deferred assets............................... 11,381 11,701
Valuation allowance................................. (2,090) (1,881)
----------- -----------
9,291 9,820
Deferred tax liabilities:
Depreciation........................................ (5,672) (5,964)
Deferred revenue.................................... (710) (2,125)
Intangible asset.................................... (794) (1,833)
Cash-to-accrual..................................... (431) (168)
Other............................................... (160) (223)
----------- -----------
$ 1,524 $ (493)
=========== ===========

At December 31, 1996, the Company had available net operating loss
carryforwards of approximately $1,206,000 for income tax purposes. The net
operating loss carryforwards expire beginning in 2005 through 2008. Because of
changes in ownership of the Company, the annual utilization of these losses in
the future may be limited.

11. STOCKHOLDERS' EQUITY
On May 25, 1994, the Company effected a one-for-three reverse stock split on
the Company's outstanding common stock. All share and per share amounts have
been restated to reflect the reverse stock split for all periods presented.

F-41

THERATX, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

11. STOCKHOLDERS' EQUITY (CONTINUED)

Upon consummation of the initial public offering, each outstanding share of
Series A, B, C, and D preferred stock converted into .333333 shares of common
stock and each share of Series E preferred stock converted into one share of
common stock. (See Note 5.) In addition, upon conversion of the preferred stock
into common stock, outstanding warrants to purchase preferred stock converted
into warrants to purchase common stock exercisable over the remaining term of
the preferred stock warrant at an exercise price equal to the exercise price
per share under the preferred stock warrant, as adjusted for the reverse stock
split.

The Board of Directors has the authority to issue up to 5,000,000 shares of
preferred stock in one or more series and to fix the rights, qualifications,
preferences, privileges, limitations or restrictions of each such series.

The Company has reserved a total of 5,522,000 common shares for future issuance
upon exercise of stock warrants and stock options.

The Company has issued warrants to purchase 190,450 shares of its common stock
at prices ranging from $4.90 to $12.00 per share, which in management's
opinion, equaled or exceeded the fair market value of the stock at the date of
issuance. At December 31, 1996, warrants to purchase 78,925 shares of common
stock were outstanding. The warrants expire through July 2004.

On April 25, 1996, the Board of Directors adopted an Employee Stock Purchase
Plan (the "Purchase Plan") and reserved 1,000,000 shares of common stock for
future issuance. As of December 31, 1996, the company has not implemented the
Purchase Plan.

12. STOCKHOLDERS' RIGHTS PLAN

On July 27, 1995, the Company's Board of Directors adopted a Stockholders'
Rights Plan (the "Rights Plan"). In conjunction with the Rights Plan, the Board
of Directors declared a dividend of one right ("Right") to purchase one one-
hundredth of a share of Series A Junior Participating Preferred Stock on each
share of common stock. Under the terms of the Rights Plan, the Rights become
exercisable only if a person or group acquires 15% or more of the Company's
common stock or announces a Tender Offer that would result in ownership by a
person or group of 15% or more of the Company's common stock (an "Acquiring
Person"), subject to certain exceptions. Each Right has an exercise price of
$60.00 and, in certain circumstances, may become exercisable or exchangeable
for consideration. Each Right, following the time the Rights become
exercisable, may be redeemed for $0.01 at the option of the Board of Directors.
Subsequent to December 31, 1996, the Company amended the Rights Agreement to
provide that Vencor, Inc. and its affiliates shall not be deemed to be an
Acquiring Person. (See Note 17.)

13. STOCK OPTION PLANS

On April 25, 1996, the Board of Directors adopted the 1996 Stock Option/Stock
Issuance Plan (the "1996 Plan") and reserved 2,000,000 shares of common stock
for issuance over the ten-year term of the 1996 Plan. This share reserve will
automatically increase on the first trading day of each calendar year,
beginning with the 1997 calendar year, by an amount equal to 2% of the total
number of shares of common stock outstanding on the last trading day of the
immediately preceding calendar year. In no event may any one participant in the
1996 Plan be granted stock options, separately exercisable stock appreciation
rights or direct stock issuances for more than 750,000 shares in the aggregate
under the 1996 Plan per calendar year.

The 1996 Plan contains three separate equity incentive programs: (i) a
Discretionary Option Grant Program (the "Discretionary Program"); (ii) a Stock
Issuance Program; and (iii) an Automatic Option Grant Program. The
Discretionary Program and the Stock Issuance Program are administered by the
Compensation Committee of the Board (the "Committee"). The Committee has
complete discretion (subject to the provisions of the 1996 Plan)

F-42

THERATX, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. STOCK OPTION PLANS (CONTINUED)

to determine the terms of each grant. However, all grants under the Automatic
Option Grant Program are made in strict compliance with the provisions of that
program.

The exercise price per share of options granted under the Discretionary Program
may not be less than 100% of the fair market value of such shares at the date
of grant and the term of the options may not exceed ten years.

The purchase price of shares issued under the Stock Issuance Program may not be
less than 100% of the fair market value of such shares at the time of issuance.
Shares issued as a bonus for past services are vested upon issuance. All other
shares issued under the program are subject to a vesting schedule tied to the
performance of service or the attainment of performance goals.

During 1996, the Committee has generally granted options with service-based
options to vest over four years.

On March 3, 1994, the Board of Directors adopted the 1994 Stock Option/Stock
Issuance Plan (the "1994 Plan"). The 1994 Plan replaced the 1990 Stock Option
Plan and became effective upon registration of the Company's outstanding common
stock under the Securities Exchange Act of 1933. All outstanding options under
the 1990 Stock Option Plan have been incorporated into the 1994 Plan as of its
effective date. Under the 1994 Plan, the Company is authorized to issue up to
4,495,467 Shares of common stock to employees, consultants and independent
contractors. The purchase price of the shares subject to incentive options
granted will not be less than 100% of the fair market value of such shares at
the date of grant. The purchase price of shares subject to non-qualified
options granted will not be less than 85% of the fair market value of such
shares at the date of grant. The Plan is administered by the Committee, which
has the authority to determine the terms of each grant. The Committee generally
has granted options with either service-based vesting or performance-based
vesting. Service-based options generally vest over four years. The performance-
based options provide for vesting at the end of seven years, with accelerated
vesting over a five-year period if certain earnings targets are achieved. The
options have a term of ten years.

In connection with the acquisition of PersonaCare, the Company assumed the
PersonaCare, Inc. 1992 Stock Option Plan (the "PersonaCare Plan"). Immediately
following the acquisition, 54,863 Shares of the Company's common stock were
subject to the outstanding options assumed under the PersonaCare Plan. In
connection with the merger with Helian, TheraTx assumed the Helian Health
Group, Inc. 1989 Stock Option Plan (the "Helian Plan"). Immediately following
the acquisition, 237,683 shares of the Company's common stock were subject to
the outstanding options assumed under the Helian Plan. All of the assumed
options under the PersonaCare and Helian Plans accelerated automatically upon
consummation of the respective mergers and are now fully exercisable for vested
shares of the Company's common stock. No further option grants will be made
under either plan other than in connection with any regrant or repricing
programs that the Compensation Committee of the Company's Board of Directors
may authorize.

Effective May 30, 1996, the Committee approved a plan to reprice certain
options granted to employees pursuant to the 1994 Stock Option Plan. The
options were repriced effective May 30, 1996. Options originally priced from
$16.25 to $21.50 per share were repriced at $14.38 per share, the closing
market price of the common stock on May 30, 1996. Each of the repriced options,
whether vested or not vested, cannot be exercised for a period of one year
ending May 30, 1997, unless certain events defined under the 1994 Plan
occurred. At May 30, 1996, options to purchase a total of 242,000 shares of
common stock were repriced, of which approximately 58,000 were fully vested
prior to repricing.

Also, on May 30, 1996, the Committee approved a change to the 1994 Plan
providing for performance-based options to become service-based options at that
date, with vesting to occur over a period of four years. At May 30, 1996,
1,200,000 performance-based options were exchanged for service-based options.

F-43

THERATX, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. STOCK OPTION PLANS (CONTINUED)

Following is a summary of stock option plan activity:

SHARES UNDER WEIGHTED
OPTION EXERCISE PRICES AVERAGE PRICE
------------ --------------- -------------

Outstanding at January 1, 1994....... 717,055 .09-18.95 6.36
Granted............................. 1,419,170 4.50-21.50 14.42
Exercised........................... (148,568) .09- 7.50 0.85
Forfeited........................... (205,362) .12-18.95 13.49
---------
Outstanding at December 31, 1994..... 1,782,295 .09-21.50 12.16
Granted............................. 2,087,639 8.36-18.25 16.69
Exercised........................... (183,340) .09-12.13 1.82
Forfeited........................... (173,762) .15-18.26 14.73
---------
Outstanding at December 31, 1995..... 3,512,832 .09-21.50 14.45
Granted............................. 1,224,434 10.00-16.69 13.84
Exercised........................... (133,493) .15-16.25 9.47
Forfeited........................... (200,246) .15-21.50 14.91
---------
Outstanding at December 31, 1996..... 4,403,527 .09-21.50 14.83
=========

The following table summarizes information concerning outstanding and
exercisable options at December 31, 1996:

OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------ --------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
RANGE OF NUMBER REMAINING AVERAGE NUMBER AVERAGE
EXERCISE OPTIONS CONTRACTUAL EXERCISE OPTIONS EXERCISE
PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- ----------- ----------- ----------- -------- ----------- --------

.09- .48 75,221 5.8 .43 70,559 .42
3.75- 8.92 253,725 7.5 6.22 159,588 5.69
11.00-16.69 2,337,077 8.5 13.66 594,878 13.15
18.25-21.50 1,737,504 8.0 18.26 201,515 18.31
--------- --- ----- --------- -----
4,403,527 8.2 14.83 1,026,540 12.12
========= === ===== ========= =====

In January 1996, the Company adopted FASB Statement No. 123, Accounting for
Stock-Based Compensation. Under Statement No. 123, the Company may continue
following existing accounting rules or adopt a new fair value method of valuing
stock-based awards. The Company has elected to continue to follow APB Opinion
No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related
Interpretations in accounting for its employee stock options and not adopt the
alternative fair value method of accounting provided under Statement No. 123.
Under APB 25, because the exercise price of the Company's employee stock
options equals the market price of the underlying stock on the date of grant,
no compensation expense is recognized.

Pro forma information regarding net income and earnings per share is required
by Statement 123, which also requires that the information be determined as if
the Company has accounted for its employee stock options granted subsequent to
December 31, 1994 under the fair value method of that Statement. The fair value
for these options was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted-average assumptions for both
1995 and 1996: risk free interest rates of 5.36% to 7.05% depending on the date
of grant; a dividend yield of 0%; volatility factors of the expected market
price of the Company's common stock of 0.507; and a weighted-average expected
life of the option of five years.

F-44

THERATX, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. STOCK OPTION PLANS (CONTINUED)

For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The Company's pro
forma information follows (in thousands, except for earnings per share
information):

YEAR ENDED DECEMBER 31,
------------------------
1995 1996
----------- ------------

Pro forma net income.................................. $ 7,758 $ 16,148
Pro forma earnings per share.......................... 0.38 0.79

The weighted-average fair value of options granted during 1995 and 1996 is
$8.86 and $6.33, respectively. Because Statement 123 is applicable only to
options granted subsequent to December 31, 1994, its pro forma effect will not
be fully reflected until 1999.

14. RETIREMENT PLAN

The Company has a defined contribution 401(k) plan. The plan is for the benefit
of generally all employees and permits voluntary employee contributions and
Company profit sharing contributions. The Company contributed $104,000,
$355,000, and $522,000 to the plan for the years ended December 31, 1994, 1995
and 1996, respectively.

15. COMMITMENTS AND CONTINGENCIES

The Company maintains professional liability coverage on an occurrence basis.
The policy covers claims made up to $1,000,000 per incident, subject to an
aggregate limit of $3,000,000. In addition, the Company maintains claims-made
basis professional liability coverage for certain physicians and facilities.
The claims-made basis policies cover claims up to $1,000,000 per incident,
subject to an aggregate limit of $3,000,000. Management intends to renew the
existing or similar policies annually and expects to be able to obtain
reasonable coverage.

16. MAJOR CUSTOMERS

The Company had one major customer representing 12.5% of net revenues in 1994.
In 1995 and 1996, the Company had no major customers that represented 10% or
more of net revenues.

17. SUBSEQUENT EVENTS

Effective January 31, 1997, the Company closed an ambulatory surgery center
located in Northridge, California. The surgery center was owned by a limited
partnership in which the Company holds a 48.8% ownership interest and serves as
the general partner. The Company also served as the manager of the surgery
center under a management agreement. The Company recorded charges in connection
with the write-off of certain assets and the direct costs related to the
closure of the facility. The surgery center was acquired in the Helian merger
dated December 28, 1995, which was accounted for as a pooling of interests. As
required by APB 16, Business Combinations, the loss on the closure totaling
$1.8 million has been reported as an extraordinary item, net of income taxes of
$666,000, in 1996 based on the following; (i) the 1995 operating loss incurred
by the surgery center is significant to the 1995 operating results of the
former Helian business, (ii) the loss on the closure is material in relation to
the 1996 operating performance of the former Helian business and (iii) the
surgery center operations were discontinued within two years of the effective
date of the Helian merger.

On February 9, 1997, the Company entered into an Agreement and Plan of Merger
with Vencor, Inc. ("Vencor") and Peach Acquisition Corp., a wholly owned
subsidiary of Vencor ("Peach"), pursuant to which Peach commenced a tender
offer on February 14, 1997 to purchase all of the outstanding shares of the

F-45

THERATX, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
17. SUBSEQUENT EVENTS (CONTINUED)

Company's common stock and the associated rights to purchase Series A Junior
Participating Stock at a cash price of $17.10 per share (the "Tender Offer").
The Tender Offer expired on March 18, 1997 and Vencor purchased approximately
99% of the outstanding shares of the Company's common stock at that time.
Following the merger which was effective March 21, 1997, the Company became a
wholly-owned subsidiary of Vencor. The shares of common stock that were not
acquired in the Tender Offer have been converted into the right to receive
$17.10 per share in cash.

As a result of the merger with Vencor, pursuant to the terms of the convertible
subordinated notes, the Company is required to offer to repurchase the notes
for 100% of the principal amount, together with accrued interest, within
fifteen days after the expiration of the Tender Offer.

Additionally, in conjunction with the merger with Vencor, the Company entered
into a note payable to Vencor upon demand (the "Vencor Note"). Advances under
the Vencor Note are to be used to repay existing debt and to fund working
capital requirements, purchases of property and equipment, acquisitions and
general corporate requirements. On March 18, 1997, all borrowings under the
Senior Credit Facility were repaid and the Senior Credit Facility was
terminated. The Company also repaid approximately $1.3 million in debt
outstanding. As of March 21, 1997, approximately $95 million was outstanding
under the Vencor Note.

18. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

The following is a summary of the quarterly results of operations for the years
ended December 31, 1995 and 1996 (in thousands, except per share data):

1995 1996
-------------------------------- ---------------------------------
THREE MONTHS ENDED THREE MONTHS ENDED
-------------------------------- ---------------------------------
MAR. 31 JUN. 30 SEPT. 30 DEC. 31 MAR. 31 JUN. 30 SEPT. 30 DEC. 31
------- ------- -------- ------- ------- ------- -------- --------

Net revenues............ $59,500 $81,466 $84,609 $88,601 $93,324 $95,859 $99,417 $102,555
Income from operations.. 5,995 8,064 11,002 5,614 11,663 11,844 12,822 12,250
Income before income
taxes, minority
interest, and
extraordinary
item................... 4,931 5,324 8,288 2,230 8,634 9,137 9,560 8,785
Income before
extraordinary item..... 2,926 2,908 5,108 315 5,324 5,807 6,066 5,520
Net income.............. 2,926 2,480 5,108 315 5,324 5,807 6,066 4,386
Earnings per common
share:
Income, before
extraordinary
item................. 0.15 0.14 0.25 0.02 0.26 0.28 0.29 0.27
Net income............ $ 0.15 $ 0.12 $ 0.25 $ 0.02 $ 0.26 $ 0.28 $ 0.29 $ 0.21
Weighted average shares
outstanding............ 19,598 20,708 20,651 20,711 20,689 20,963 21,222 20,600

Amounts for the quarter ended March 31, 1995 have been restated to include
Helian and RCS. The quarters ending June 30 and September 30, 1995 include the
operations of RCS as reported and have been restated to include Helian. The
five quarters ended December 31, 1996 include RCS and Helian as reported.

F-46

REPORT OF INDEPENDENT ACCOUNTANTS

To The Board of Directors and Shareholders of
Transitional Hospitals Corporation

In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations and stockholders' equity and of cash
flows present fairly, in all material respects, the financial position of
Transitional Hospitals Corporation (formerly Community Psychiatric Centers) and
its subsidiaries at November 30, 1996 and 1995 and the results of their
operations and their cash flows for the years then ended in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which 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, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.

As discussed in Note 4 to the consolidated financial statements, the Company
adopted Statement of Financial Accounting Standard No. 121 "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" in
1995.

/s/ Price Waterhouse LLP

PRICE WATERHOUSE LLP
Los Angeles, California
January 24, 1997

F-47

REPORT OF INDEPENDENT AUDITORS

Board of Directors
Transitional Hospitals Corporation

We have audited the accompanying consolidated statements of operations,
stockholders' equity, cash flows and related financial statement schedule of
Transitional Hospitals Corporation (formerly Community Psychiatric Centers) for
the year ended November 30, 1994. These financial statements and schedule are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements and schedule based on our
audit.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated results of Transitional
Hospitals Corporation's (formerly Community Psychiatric Centers) operations and
their cash flows for the year ended November 30, 1994, in conformity with
generally accepted accounting principles. Also, in our opinion, the related
financial statement schedule as it relates to the year ended November 30, 1994,
when considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.

/s/ Ernst & Young LLP

Los Angeles, California
January 27, 1995

F-48

[THIS PAGE INTENTIONALLY LEFT BLANK]

F-49

TRANSITIONAL HOSPITALS CORPORATION AND SUBSIDIARIES
(FORMERLY COMMUNITY PSYCHIATRIC CENTERS)
CONSOLIDATED BALANCE SHEETS

NOVEMBER 30
-----------------
1996 1995
-------- --------
(In thousands)

ASSETS
------
Current assets:
Cash and cash equivalents................................. $ 84,313 $ 17,263
Short-term investments.................................... 16,777 7,601
Accounts receivable, less allowance for doubtful accounts
(1996--$21,448 and 1995--$24,682)........................ 55,557 113,686
Receivable from third parties under reimbursement con-
tracts................................................... -- 4,550
Prepaid expenses and other current assets................. 14,784 14,756
Property held for sale.................................... 13,393 15,512
Refundable income taxes................................... 15,722 21,028
Deferred income taxes..................................... 5,697 951
-------- --------
Total current assets.................................... 206,243 195,347
Property, buildings and equipment, at cost, less allowances
for depreciation........................................... 153,933 354,192
Other assets:
Investment in affiliate................................... 69,859 --
Refundable income taxes................................... 9,275 --
Deferred income taxes..................................... 6,691 21,334
Other assets.............................................. 19,889 24,862
-------- --------
105,714 46,196
Excess of investment in subsidiaries over net assets ac-
quired, less accumulated amortization (1996--$62 and 1995--
$2,351).................................................... 57 8,890
-------- --------
$465,947 $604,625
======== ========

See notes to consolidated financial statements.

F-50

TRANSITIONAL HOSPITALS CORPORATION AND SUBSIDIARIES
(FORMERLY COMMUNITY PSYCHIATRIC CENTERS)
CONSOLIDATED BALANCE SHEETS (CONTINUED)

NOVEMBER 30
--------------------------------------
1996 1995
------------------ ------------------
(In thousands, except par value data)

LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Accounts payable..................... $ 9,136 $ 18,194
Accrued payroll and other expenses... 15,549 34,949
Income taxes payable................. 131 4,425
Payable to third parties under reim-
bursement contracts................. 13,954 --
Other accrued liabilities............ 17,796 3,693
Current maturities on long-term
debt................................ 8,467 18,764
------------------ ------------------
Total current liabilities............ 65,033 80,025
Long-term debt, exclusive of current
maturities............................ 14,858 84,883
Deferred credits:
Deferred income taxes and other lia-
bilities............................ 3,857 19,678
Commitments and contingencies
Obligations to be settled in common
stock................................. -- 21,250
Stockholders' equity:
Preferred stock, par value $1 a
share; authorized 2,000 shares; none
issued.............................. -- --
Common stock, par value $1 a share;
authorized 100,000 shares; issued
46,856 in 1996 and 1995............. 46,856 46,856
Additional paid-in capital........... 56,657 62,096
Unrealized gains on investments in
debt securities..................... 163 --
Retained earnings.................... 321,710 327,062
Foreign currency translation adjust-
ment................................ -- (2,943)
------------------ ------------------
425,386 433,071
Less cost of treasury stock--4,988
shares in 1996 and 3,166 shares in
1995.................................. (43,187) (34,282)
------------------ ------------------
382,199 398,789
------------------ ------------------
$465,947 $604,625
================== ==================

See notes to consolidated financial statements.

F-51

TRANSITIONAL HOSPITALS CORPORATION AND SUBSIDIARIES
(FORMERLY COMMUNITY PSYCHIATRIC CENTERS)
CONSOLIDATED STATEMENTS OF OPERATIONS

YEAR ENDED NOVEMBER 30,
----------------------------
1996 1995 1994
-------- -------- --------
(In thousands, except per
share amounts)

Revenues:
Net operating revenues.......................... $503,266 $514,991 $423,955
Investment and other income..................... 3,928 2,513 3,785
-------- -------- --------
507,194 517,504 427,740
Costs and expenses:
Operating expense............................... 402,686 393,146 328,508
General and administrative expense.............. 33,029 39,444 33,775
Bad debt expense................................ 20,101 28,732 26,966
Depreciation and amortization................... 22,364 23,344 18,649
Interest expense................................ 3,889 5,256 3,545
Non-recurring transactions, net................. 33,524 94,116 (875)
-------- -------- --------
515,593 584,038 410,568
-------- -------- --------
Income (loss) before income taxes................. (8,399) (66,534) 17,172
Income taxes (benefit)............................ (3,047) (24,902) 6,952
-------- -------- --------
Net income (loss)................................. $ (5,352) $(41,632) $ 10,220
======== ======== ========
Net income (loss) per common share................ $ (0.12) $ (0.95) $ 0.24
======== ======== ========
Average number of common shares................... 43,942 43,642 43,465
======== ======== ========

See notes to consolidated financial statements.

F-52

TRANSITIONAL HOSPITALS CORPORATION AND SUBSIDIARIES
(FORMERLY COMMUNITY PSYCHIATRIC CENTERS)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

AMOUNTS DUE
FROM FOREIGN
ADDITIONAL EMPLOYEES CURRENCY
COMMON PAID-IN FOR EXERCISE OF UNREALIZED RETAINED TRANSLATION TREASURY STOCK
STOCK CAPITAL STOCK OPTIONS GAINS EARNINGS ADJUSTMENT SHARES AMOUNT
------- ---------- --------------- ---------- -------- ----------- -------- --------
(In thousands, except per share amounts)

Balance at November 30,
1993................... $46,856 $65,341 $(35) $ 0 $359,345 $(3,815) (3,763) $(45,200)
Exercise of employees'
stock options......... (4,052) 498 9,735
Income tax benefits
derived from employee
stock option
transactions.......... 68
Net income for the
year.................. 10,220
Dividends paid, $.01
per common share...... (434)
Foreign currency
translation
adjustment............ 2,010
------- ------- ---- ---- -------- ------- ------ --------
Balance at November 30,
1994................... 46,856 61,357 (35) 0 369,131 (1,805) (3,265) (35,465)
Exercise of employees'
stock options......... (206) 102 1,235
Expiration of employee
stock options......... 17 35 (3) (52)
Income tax benefits
derived from employee
stock option
transactions.......... 928
Net loss for the year.. (41,632)
Dividends paid, $.01
per common share...... (437)
Foreign currency
translation
adjustment............ (1,138)
------- ------- ---- ---- -------- ------- ------ --------
Balance at November 30,
1995................... 46,856 62,096 0 0 327,062 (2,943) (3,166) (34,282)
Exercise of employees'
stock options......... (36) 16 186
Issuance of shares
related to settlement
of shareholder
litigation............ (5,482) 2,342 26,732
Stock repurchased...... (4,180) (35,823)
Income tax benefits
derived from employee
stock option
transactions.......... 79
Net loss for the year.. (5,352)
Foreign currency
translation
adjustment............ 2,943
Unrealized gains from
changes in market
value of investments
in debt securities,
net of income taxes... 163
------- ------- ---- ---- -------- ------- ------ --------
Balance at November 30,
1996................... $46,856 $56,657 $ 0 $163 $321,710 $ 0 (4,988) $(43,187)
======= ======= ==== ==== ======== ======= ====== ========

See notes to consolidated financial statements

F-53

TRANSITIONAL HOSPITALS CORPORATION AND SUBSIDIARIES
(FORMERLY COMMUNITY PSYCHIATRIC CENTERS)
CONSOLIDATED STATEMENTS OF CASH FLOWS

YEAR ENDED NOVEMBER 30
-----------------------------
1996 1995 1994
--------- -------- --------
(In thousands)

CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss).............................. $ (5,352) $(41,632) $ 10,220
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization................ 22,364 23,344 18,649
Provision for uncollectible accounts......... 20,101 28,732 26,966
Nonrecurring transactions.................... 33,378 70,446 (2,845)
Other........................................ (821) (3,033) (1,800)
Changes in assets and liabilities, exclusive of
business acquisitions and disposals:
Accounts receivable.......................... (17,570) (39,290) (50,070)
Receivable/payable to third parties under
reimbursement contracts..................... 9,529 (10,352) 812
Prepaid expenses and other current assets.... (6,259) 1,615 (1,837)
Accounts payable and accrued expenses........ (1,506) 4,340 10,438
Other accrued liabilities.................... (5,626) 154 (942)
Dividends payable............................ -- -- (111)
Income taxes................................. (3,252) (34,435) 9,709
--------- -------- --------
Net cash provided from (used for) operations... 44,986 (111) 19,189
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from revolving credit facilities...... -- 39,195 41,982
Dividends paid................................. -- (437) (434)
Purchase of treasury shares.................... (35,823) -- --
Payments of deferred compensation.............. (162) (634) (162)
Net proceeds from exercise of stock options.... 150 1,029 5,683
Payments on long-term debt..................... (80,341) (18,859) (1,402)
--------- -------- --------
Net cash provided from (used for) financing
activities.................................... (116,176) 20,294 45,667
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of short-term investments.. 7,601 16,884 1,934
Purchases of short-term investments............ (16,614) (10,729) (4,758)
Payment received on notes...................... 2,151 4,591 3,437
Purchase of property, buildings and equipment.. (35,419) (40,139) (48,760)
Investment in pre-opening costs................ (3,177) (2,899) (4,225)
Proceeds from sale of psychiatric hospitals.... 186,643 5,289 7,393
Loans made to officers......................... (825) (4,055) (1,242)
Payment for business acquisitions:
Property, buildings and equipment............ (320) (8,604) (4,787)
Excess of purchase price over fair value of
assets acquired............................. (1,800) (521) (1,225)
--------- -------- --------
Net cash provided from (used for) investing
activities.................................... 138,240 (40,183) (52,233)
--------- -------- --------
Net increase (decrease) in cash and cash
equivalents................................... 67,050 (20,000) 12,623
Beginning cash and cash equivalents............ 17,263 37,263 24,640
--------- -------- --------
Ending cash and cash equivalents............... $ 84,313 $ 17,263 $ 37,263
========= ======== ========

See notes to consolidated financial statements

F-54

TRANSITIONAL HOSPITALS CORPORATION
(FORMERLY COMMUNITY PSYCHIATRIC CENTERS)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation
The consolidated financial statements include the accounts of Transitional
Hospitals Corporation (formerly Community Psychiatric Centers) and its
subsidiaries (THY or the Company). All material intercompany transactions have
been eliminated in the accompanying consolidated financial statements.

The Company provides long-term acute care services to patients suffering from
long-term complex medical problems in the United States. As of November 30,
1996, THY operated 14 long-term care hospitals and two satellite facilities
with a total of 1,340 beds, located in 12 states. THY also provides respiratory
therapy services to other healthcare providers.

In June of 1996, the Company sold its United Kingdom psychiatric operations
(see Note 2). In November 1996, the company sold its U.S. psychiatric
operations to Behavioral Healthcare Corporation ("BHC") for $60 million in cash
and stock valued at approximately $70 million (see Note 3).

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amount of assets and liabilities and 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.
Actual results could differ from those estimates.

Cash Equivalents
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents. Those highly liquid
assets with a maturity of more than three months are classified as short-term
investments.

Short-Term Investments
The Company has investments in debt securities which are classified as
available for sale. These investments consist primarily of U.S. corporate
securities and have various maturity dates which do not exceed one year.
Securities classified as available-for-sale are carried at fair value with
unrealized gains, net of tax, reported in a separate component of stockholders'
equity. There were no unrealized losses on any investments held at November 30,
1996. Realized gains and losses are included in investment income and are
immaterial for all years presented.

Property, Buildings and Equipment
Depreciation is computed on the straight-line method based on the estimated
useful lives of fixed assets of 31.5 to 40 years for buildings and three to ten
years for furniture and equipment.

Preopening Costs
Costs incurred prior to the opening of new facilities are deferred and
amortized on a straight-line basis over a five-year period.

Capitalization of Interest
Interest incurred in connection with development and construction of hospitals
is capitalized as part of the related property.

Net Operating Revenues
Net operating revenues include amounts for hospital services estimated by
management to be reimbursable by federal and state government programs
(Medicare, Medicaid and CHAMPUS); managed care programs (managed care
companies, health maintenance organizations and preferred provider
organizations) and private

F-55

TRANSITIONAL HOSPITALS CORPORATION
(FORMERLY COMMUNITY PSYCHIATRIC CENTERS)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

pay payors (private sources and insurance companies which base reimbursement on
the Company's price schedule).

The following table summarizes the percent of net operating revenues generated
from all payors.

1996 1995 1994
---- ---- ----

Medicare........................................................ 47% 37% 28%
Medicaid........................................................ 9 11 13
CHAMPUS......................................................... 3 4 4
--- --- ---
Total Government.............................................. 59 52 45
Managed Care.................................................... 24 27 33
Private pay and other........................................... 17 21 22
--- --- ---
Total......................................................... 100% 100% 100%
=== === ===

Amounts received are generally less than the established billing rates of the
Company and the difference is reported as a contractual allowance and deducted
from operating revenues. Final determination of amounts earned for hospital
services is subject to audit by the payors. In the opinion of management,
adequate provision has been made for any adjustments that may result from such
audits. Differences between estimated provisions and final settlement are
reflected as charges and credits to operating revenues in the year the audit
reports are finalized. In the current year, the Company received approximately
$5.6 million in excess of recorded amounts related to prior year Medicare
settlements. These amounts are included in operating revenues.

Concentration of Credit Risk
Financial instruments that potentially subject the Company to significant
concentrations of credit consist principally of cash and short-term investments
and receivables from government programs.

The Company maintains cash equivalents and short-term investments with various
financial institutions. The Company's policy is designed to limit exposure to
any one institution. The Company performs periodic evaluations of the relative
credit standing to those financial institutions that are considered in the
Company's investment strategy. The Company and management do not believe that
there are any significant credit risks associated with receivables from
governmental programs. Negotiated and private receivables consist of
receivables from various payors, including individuals involved in diverse
activities, subject to differing economic conditions, and do not represent any
concentrated credit risks to the Company. Furthermore, management continually
monitors and adjusts its reserves and allowances associated with these
receivables.

Stock Options
Proceeds from the exercise of stock options are credited to common stock, to
the extent of par value, and the balance to additional paid-in capital, except
when shares held in the treasury are issued. The difference between the cost of
the treasury stock and the option price is charged or credited to additional
paid-in capital. No charges or credits are made to earnings with respect to
options granted or exercised. Income tax benefits derived from exercise of non-
incentive stock options and from sales of stock obtained from incentive stock
options before the minimum holding period are credited to additional paid-in
capital.

Earnings (Loss) Per Share
Earnings (loss) per share have been computed based upon the weighted average
number of shares of common stock outstanding during the year. Dilutive common
stock equivalents have not been included in the computation of earnings per
share because the aggregate potential dilution resulting therefrom is less than
3%.

F-56

TRANSITIONAL HOSPITALS CORPORATION
(FORMERLY COMMUNITY PSYCHIATRIC CENTERS)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Translation of Foreign Currencies
The Company sold its United Kingdom psychiatric hospitals in June of 1996. For
periods prior to the sale, the financial statements of the Company's foreign
subsidiaries have been translated into U.S. dollars in accordance with FASB
Statement No. 52. All balance sheet accounts were translated at year-end
exchange rates. Statements of earnings amounts have been translated at the
average exchange rate for the applicable years. The resulting currency
translation adjustments were made directly to a separate component of
Stockholders' Equity. The effect on the statement of earnings of translation
gains and losses is insignificant for all years presented.

Recent Accounting Pronouncements
In October 1995, the FASB issued Statement of Financial Accounting Standards
No. 123 ("FAS 123"), "Accounting for Stock-Based Compensation", which becomes
effective for fiscal years beginning after December 15, 1995. FAS 123
establishes new financial accounting and reporting standards for stock-based
compensation plans. Entities will be allowed to measure compensation expense
for stock-based compensation under FAS 123 or APB Opinion No. 25, "Accounting
for Stock Issued to Employees". Entities electing to remain with the accounting
in APB Opinion No. 25 will be required to make pro forma disclosures of net
income and earnings per share as if the provisions of FAS 123 had been applied.
The Company is in the process of evaluating the Statement. The potential impact
on the Company of adopting the new standard has not been quantified at this
time. This Company must adopt FAS 123 in fiscal year 1997.

Reclassifications
Certain amounts have been reclassified to conform with 1996 presentations.

NOTE 2--NON-RECURRING TRANSACTIONS

On November 30, 1996 the company sold its U.S. psychiatric operations to BHC
for $60 million in cash and stock valued at approximately $70 million. THY will
have a 44.2% common equity interest in future BHC earnings. BHC is
headquartered in Nashville, Tennessee, and is now the second largest
psychiatric hospital network in the country, with 38 hospitals and 4
residential treatment centers in 18 states and Puerto Rico, comprising
approximately 3,500 beds. With the combination of these hospitals, BHC is a
leading provider of psychiatric/behavioral services for adults, adolescents and
children with acute psychiatric, emotional, substance abuse and behavioral
disorder.

The Company also announced the closure of Southwind Hospital, a psychiatric
facility in Oklahoma City, Oklahoma in November of 1996 due to poor financial
performance. Net operating revenue and net operating income or (loss) for
Southwind totaled $4.7 million and $(.8) million for fiscal year 1996, $8.1
million and $(.1) million for fiscal year 1995 and $7.1 million and $.8 million
for fiscal year 1994. The hospital is being held for sale. The Company has
reached an agreement to settle the whistleblower suit related to Southwind with
the United States Government for $750,000 (see Note 14).

The effects on income of the above described transactions are classified as
non-recurring transactions for fiscal year 1996 and include the following: i)
$62.0 million loss on the sale of the psychiatric operations to BHC, ii) $14.4
million of expenses related to the transaction that consist of $6.7 million of
severance costs and payments pursuant to employment contracts, $4.0 million of
transaction costs related primarily to legal and investment banking services,
and $3.7 million related to legal expenses and settlement costs for the
Southwind whistleblower suit (see Note 14) and one other lawsuit related
specifically to the US psychiatric division, iii) $2.1 million for a settlement
of a claim from a former Chairman of Community Psychiatric Centers related to
his contract with the Company (see further discussion in Note 11), iv)
impairment charges of $6.7 million to writedown the property value of Southwind
and certain other closed hospitals to their current estimated fair

F-57

TRANSITIONAL HOSPITALS CORPORATION
(FORMERLY COMMUNITY PSYCHIATRIC CENTERS)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--NON-RECURRING TRANSACTIONS (CONTINUED)

market value, and v) $1.7 million related to termination benefits and other
exit costs related to the closure of Southwind. Approximately 150 employees
were terminated due to the Southwind closure and approximately 80 corporate
employees were terminated due to the sale of the U.S. psychiatric division. As
of November 30, 1996, approximately $7.8 million is included in other accrued
liabilities for severance and other exit costs related to the corporate office
and Southwind hospital.

During the first three quarters of 1996, the Company recorded net restructuring
charges of $2.1 million for termination benefits and other exit costs related
to the closure of four U.S. psychiatric division hospitals. Approximately 280
employees were terminated as a result of the closure of these hospitals. Two of
these properties were sold to BHC and two are being held for sale.

On June 21, 1996, the Company sold its United Kingdom psychiatric hospitals
("Priory Hospitals Group" or "PHG") to Foray 911 Limited ("Foray"), a new
corporation formed by Mercury Development Capital, a division of Mercury Asset
Management plc ("Mercury"). PHG operates 15 freestanding acute psychiatric
hospitals and chemical dependency facilities, including one 42 bed hospital
that was 50% owned by PHG. Based on the number of licensed hospital beds, PHG
is the leading commercial provider of psychiatric services in the United
Kingdom where psychiatric services are generally available to residents without
charge from government-owned NHS hospitals. The total purchase price for the
PHG facilities was approximately $135 million, which includes a $4.6 million
subordinated note due in 2009 issued by Foray. Included in non-recurring
transactions is the net gain on the sale of these facilities of $55.5 million.
Transaction expenses related to legal, investment banking and severance costs
totaled approximately $4.8 million and are reflected in the $55.5 million gain.

During fiscal year 1995, the Company recorded impairment charges related to the
adoption of FASB statement 121 (see Note 4) and settlements costs related to
shareholder lawsuits filed in 1991 (See Note 14). Each matter resulted in
charges of $46.0 million, for a total of $92.0 million.

Effective November 30, 1995, the Company recorded a restructuring charge
totaling $4.6 million ($2.8 million after tax), determined in accordance with
the provisions of the January 1995 Financial Accounting Standards Board
Emerging Issues Task Force Consensus No. 94-3 "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs incurred in a Restructuring)", ("EITF 94-3"), in
connection with the decision to close six psychiatric facilities and three
regional offices. EITF 94-3 requires the accrual of certain employee
termination costs and costs resulting from a plan to exit an activity that are
not associated with or that do not benefit activities that will continue and
prohibits accrual of expected future operating losses of the activity exited.
The charge comprised $3.4 million for employee termination benefits related to
hospital operations and overhead personnel and $1.2 million for non-cancelable
operating leases and other exit costs. Approximately 314 hospital employees and
65 corporate and regional employees were terminated. Amounts charged against
the reserve approximated amounts accrued. Of the six closed hospitals, three
have been sold, two were fully converted to THY hospitals, and one was
exchanged for a similar building held by another health care provider and was
converted into a satellite hospital of a THY facility in October 1996.

Effective May 31, 1995, the Company recorded a restructuring credit totaling
$2.5 million ($1.5 million after tax) from the resolution of previously
restructured psychiatric assets. The restructuring credit resulted from
divesting two restructured properties at higher prices than the 1993 writedown
of the facilities anticipated and the Company's success in collecting accounts
receivable balances that were reserved for as part of the February 28, 1994
restructuring charge.

F-58

TRANSITIONAL HOSPITALS CORPORATION
(FORMERLY COMMUNITY PSYCHIATRIC CENTERS)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--INVESTMENT IN AFFILIATE

On November 30, 1996, THY consummated the sale of effectively all of its
psychiatric operations in the U.S. and Puerto Rico (with certain limited
exceptions set forth below) to BHC. Prior to such sale, BHC owned 17
psychiatric hospitals. At the November 30 closing, the Company transferred
title to 22 freestanding psychiatric hospitals, a joint venture interest in
another psychiatric operation, an outpatient psychiatric center, two closed
hospitals and vacant land located at three sites in California. Two other
operating hospitals and a joint venture interest (the "Escrowed Assets") are to
be transferred to BHC upon receipt of necessary regulatory approvals, which
management believes are perfunctory. Additionally, effective November 30, 1996,
BHC and the Company entered into a management agreement which grants BHC, with
limited protective rights retained by THY, exclusive and complete
responsibility and discretion in the management and control of the Escrowed
Assets as well as the economic benefit thereof. Accordingly, for accounting
purposes, the sale of the Escrowed Assets has been recorded with an effective
date of November 30, 1996. At the initial closing, the Company received
$60,000,000 in cash, 2,214,400 shares of BHC Common Stock, 5,072,579 shares of
BHC Series A Preferred Stock and 46,902 shares of BHC Series B Preferred Stock.
In general, the Series A Preferred Stock converts into BHC Common Stock on a
share for share basis upon sales and dispositions of the Series A Preferred
Stock by the Company and under certain other limited circumstances. Upon
receipt of the necessary regulatory approvals related to the Escrowed Assets,
the Company will receive an additional 3,785,600 shares of BHC Common Stock, an
additional 578,844 shares of BHC Series A Preferred Stock and 3,350 additional
share of BHC Series B Preferred Stock. Upon distribution of all shares, the
Company will have a common equity interest amounting to 44.2% of BHC's Common
Stock outstanding. An agreement has been entered into between BHC and the
Company requiring THY to vote all shares in excess of 20% of BHC's outstanding
Common Stock as instructed by a majority of BHC's Board of Directors which
includes three members of THY's Board of Directors. THY's Chairman of the Board
and Chief Executive Officer, Richard Conte, will serve as BHC's Chairman of the
Board. THY's common equity interest in future BHC earnings will be recorded on
the equity method of accounting. In determining the amount of the consideration
to be paid to the Company, the parties compared their respective EBITDAs
(Earnings before interest, taxes, depreciation, and amortization) and used
multiples generally accorded to publicly-traded psychiatric hospitals. Based on
this analysis, the total value of the equity interest in BHC was determined to
be approximately $70 million.

NOTE 4--IMPAIRMENT OF ASSETS

In the fourth quarter of fiscal year 1995, the Company adopted the provisions
of FASB Statement 121, "Accounting for the Impairment of Long-Lived Assets and
for long-Lived Assets to Be Disposed Of" ("FAS 121"). The statement requires
impairment losses to be recognized for long-lived assets used in operations
when indicators of impairment are present and the undiscounted cash flows are
not sufficient to recover the assets' carrying amount. The impairment loss is
measured by comparing the fair value of the asset to its carrying amount. FAS
121 also requires that assets to be disposed of be written down to fair value
less selling costs. Based on a comparison of the recorded values of long-lived
assets (defined as land, buildings, fixed assets and goodwill) to the expected
future cash flows to be generated by the assets of three U.S. Psychiatric
facilities that were closed in November 1995 as well as three U.S. Psychiatric
facilities which experienced declines in operating performance in fiscal 1995,
and after applying the principles of measurement contained in FAS 121, the
Company recorded an asset impairment charge of approximately $26.5 million in
fiscal 1995.

Using the same principles as described above, the Company recorded an asset
impairment charge of approximately $5.3 million on land that was being held for
sale. The closed facilities as well as the land held for sale were classified
as assets held for sale with a carrying value of $13.7 million after the
impairment writedown as of November 30, 1995. All assets held for sale pertain
to the U.S. Psychiatric Division. All of these assets, with the exception of
three closed hospitals, were sold in fiscal 1996.

F-59

TRANSITIONAL HOSPITALS CORPORATION
(FORMERLY COMMUNITY PSYCHIATRIC CENTERS)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--IMPAIRMENT OF ASSETS (CONTINUED)

The Company completed an installation of a new computer system in the first
quarter of 1995. As several of the promised applications did not function as
specified, an impairment loss of approximately $8.1 million ($6.8 million
related to the U.S. Psychiatric Division and $1.3 million related to THY) was
recorded in the fourth quarter of 1995 to write down a portion of the total
cost of the system. The Company also shortened the estimated useful life of the
system to two years in anticipation of implementing an alternative system.

In November of 1995, the Company closed Harvard Medical Limited, a patient
liaison business in West Germany due to declines in operating performance in
fiscal 1995. Based on these factors, the Company recorded an impairment loss of
$4.1 million to write off the goodwill related to this Company.

In the fourth quarter of 1996, the Company recorded impairment charges totaling
$6.7 million related to the writedown of Southwind psychiatric hospital, which
was closed in December 1996 and two other closed hospitals, one of which was
sold in November 1996.

NOTE 5--ACQUISITIONS

During 1996, the Company exchanged a closed psychiatric hospital with a book
value of $7.3 million for a closed acute care hospital and $.9 million. The
hospital acquired was converted into a THY satellite hospital which opened in
October 1996. No gain or loss was recorded on the exchange.

During 1995, the Company purchased for $5.8 million, the land, building, and
fixed assets for a THY facility that had been managed by THY since May of 1994.
All other acquisitions in 1994 to 1996 consisted of psychiatric entities which
were sold in fiscal year 1996.

NOTE 6--PROPERTY, BUILDINGS AND EQUIPMENT

Property, buildings and equipment are summarized as follows:

NOVEMBER 30
-------------------
1996 1995
-------- ---------
(In thousands)

Land...................................................... $ 18,585 $ 51,598
Buildings and improvements................................ 102,092 300,388
Furniture, fixtures and equipment......................... 61,914 92,933
Construction in progress (estimated additional cost to
complete at November 30, 1996--$12.0 million)............ 2,496 12,599
-------- ---------
185,087 457,518
Less accumulated depreciation............................. (31,154) (103,326)
-------- ---------
$153,933 $ 354,192
======== =========

The Company incurred interest expense of $4.9 million, $7.2 million, and $4.8
million in 1996, 1995, and 1994, respectively, including $1.0 million, $1.9
million, and $1.3 million which was capitalized in 1996, 1995, and 1994,
respectively.

Interest paid was $5.8 million, $7.3 million and $4.1 million during 1996,
1995, and 1994, respectively.

F-60

TRANSITIONAL HOSPITALS CORPORATION
(FORMERLY COMMUNITY PSYCHIATRIC CENTERS)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 7--INCOME TAXES

The Company accounts for income taxes under the liability method required by
FASB Statement No. 109, "Accounting for Income Taxes". Deferred income taxes
reflect the net tax effects of temporary differences between the carrying
amounts of assets and liabilities for financial reporting purposes and the
amounts used for income tax purposes. Significant components of the Company's
deferred tax liabilities and assets as of November 30, 1996 and November 30,
1995, are as follows (in thousands):

1996 1995
------- -------

Deferred tax liabilities:
Excess tax depreciation..................................... $ 5,389 $23,425
Disposition of subsidiary................................... 4,337 --
Other....................................................... 1,543 2,018
Sale of hospitals........................................... (4,612) --
Restructuring charge........................................ (3,059) (7,784)
------- -------
Total deferred tax liabilities.......................... $ 3,598 $17,659
======= =======
Deferred tax assets:
Current:
Excess of book over tax bad debt provision................ $ 3,485 $ 701
Insurance................................................. 2,057 --
Other..................................................... 155 250
------- -------
Total current deferred tax assets....................... $ 5,697 $ 951
======= =======
Non-current:
Impairment loss............................................. $ 2,996 $18,108
Net operating loss.......................................... 9,833 5,952
Sale of hospitals........................................... 701 --
Restructuring charge........................................ 452 1,094
Disposition of subsidiary................................... (487) --
Excess tax depreciation..................................... (522) (1,649)
Other....................................................... 19 (9)
Net operating loss valuation reserve........................ (6,301) (2,162)
------- -------
Total non-current deferred tax assets................... $ 6,691 $21,334
======= =======

Deferred tax liabilities and assets by tax jurisdictions are as follows as of
November 30, 1996 (in thousands):

DEFERRED DEFERRED
TAX ASSETS TAX LIABILITIES
--------------- ---------------
NON- NON-
CURRENT CURRENT CURRENT CURRENT
------- ------- ------- -------

U.S. Federal Income Taxes (consolidated)........ $4,932 $2,533 $-- $3,598
State........................................... 765 4,158 -- --
------ ------ --- ------
$5,697 $6,691 $-- $3,598
====== ====== === ======

F-61

TRANSITIONAL HOSPITALS CORPORATION
(FORMERLY COMMUNITY PSYCHIATRIC CENTERS)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 7--INCOME TAXES (CONTINUED)

Income before income taxes includes the following components:

1996 1995 1994
-------- -------- -------
(In thousands)

Pretax income (loss):
United States..................................... $(15,100) $(79,772) $ 7,846
Foreign........................................... 6,701 13,238 9,326
-------- -------- -------
$ (8,399) $(66,534) $17,172
======== ======== =======

Provision for income taxes consists of the following:

1996 1995 1994
------- -------- ------
(In thousands)

Current:
Federal............................................ $(3,409) $(14,931) $1,497
Foreign............................................ 2,418 4,580 1,996
State.............................................. (223) (1,507) 1,614
------- -------- ------
Total current.................................... $(1,214) $(11,858) $5,107
Deferred:
Federal............................................ $(2,558) $ (9,992) $1,295
Foreign............................................ 4 331 1,364
State.............................................. 721 (3,383) (814)
------- -------- ------
Total deferred................................... (1,833) (13,044) 1,845
------- -------- ------
$(3,047) $(24,902) $6,952
======= ======== ======

Reconciliation of federal statutory rate to effective income tax rate follows:

1996 1995 1994
---------------- ----------------- --------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------- ------- -------- ------- ------ -------
(Amount in thousands)

Tax at U.S. statutory
rates.................. $(2,855) (34)% $(22,622) (34)% $5,838 34%
State income taxes, net
of federal taxes bene-
fit (charge)........... 329 4 (3,227) (5) 528 3
Goodwill................ (2,428) (29) -- -- -- --
Non-deductible ex-
penses................. 1,170 14 -- -- -- --
Other................... 737 9 947 2 586 4
------- --- -------- --- ------ ---
$(3,047) (36)% $(24,902) (37)% $6,952 41%
======= === ======== === ====== ===

The Company received income tax refunds (net of income taxes paid of $5.7
million) of $1.3 million in 1996. The Company made income tax payments of $8.0
million in 1995. The Company received income tax refunds (net of income taxes
paid of $4.5 million) of $2.3 million in 1994.

At November 30, 1996, the Company has deferred tax assets totalling $9.8
million related to State net operating loss carryforwards which expire in 1997
through 2012. Deferred tax assets related to State net operating loss

F-62

TRANSITIONAL HOSPITALS CORPORATION
(FORMERLY COMMUNITY PSYCHIATRIC CENTERS)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 7--INCOME TAXES (CONTINUED)

carryforwards increased $3.9 million in the current year primarily due to the
loss recorded on the sale of the U.S. psychiatric hospitals. The valuation
reserve was increased in fiscal 1996 to reserve for these losses as it is
likely, at this time, that the Company will not receive future tax benefits
therefrom. In fiscal year 1995, the Company decreased the valuation reserve by
$.2 million for THY State net operating loss carryforwards that were realized
in fiscal 1995 and for those that are expected to be realized in future years.

NOTE 8--LONG TERM DEBT

Long term debt is summarized as follows:

1996 1995
------- -------
(In thousands)

Borrowings under revolving credit agreements................... $16,800 $90,326
5 3/4% Convertible Subordinated Debentures due 2012, convert-
ible into Common Stock of the Company at $35.89 per share, may
be redeemed at 103.75% of face value as of October 15, 1992
declining annually to 100% of face value on or after October
15, 1999...................................................... 6,511 6,885
8 3/4% Subordinated Guaranteed Debentures due 1996............. -- 4,980
Other.......................................................... 14 1,456
------- -------
23,325 103,647
Less current portion........................................... 8,467 18,764
------- -------
$14,858 $84,883
======= =======

During May 1994, the Company and Bank of America National Trust and Savings
Association entered into a credit agreement whereby THY was able to borrow,
repay and reborrow up to $50 million through February 28, 1997. The Company
repaid $50 million which was outstanding through June 21, 1996 under this
agreement.

During September 1993, the Company entered into a credit agreement with Bank of
America National Trust and Savings Association whereby the Company was able to
borrow up to $25 million through November 30, 1995 (the revolving loan period),
at which time the amount outstanding was converted into a term loan payable in
equal quarterly installments through November 30, 1998. As of November 30,
1996, interest was payable at LIBOR plus 1.0%. As of November 30, 1996, $16.8
million was outstanding under this agreement.

The credit agreement contains provisions which, among other things, place
restrictions on borrowing, capital expenditures and the payment of dividends,
and requires the maintenance of certain financial ratios including tangible net
worth, fixed charge coverage and funded debt. The Company is currently in
compliance with or has received a waiver for all material covenants and
restrictions contained in the agreement. Borrowings are unsecured and are
guaranteed by the Company's domestic subsidiaries.

The conversion price of the convertible debentures is subject to antidilutive
provisions.

The annual maturities of debt for five years ending November 30, 2001 and
thereafter are as follows (in thousands):

1997................................................................ $8,467
1998................................................................ 8,347
1999................................................................ -0-
2000................................................................ -0-
2001................................................................ -0-
Thereafter.......................................................... 6,511

F-63

TRANSITIONAL HOSPITALS CORPORATION
(FORMERLY COMMUNITY PSYCHIATRIC CENTERS)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 9--CAPITAL STOCK AND STOCK OPTIONS

The Company has stock option plans whereby options may be granted at not less
than 100% of fair market value at the date of grant and are exercisable at any
time thereafter for a period of ten years, or five years for options granted
prior to November 8, 1990. Options granted on and after November 8, 1990, are
exercisable 20% at date of grant with the remaining 80% becoming exercisable at
the rate of 20% each December 1 thereafter. At the time of exercise, at least
one-third is payable in cash and the balance, if any, with a five-year note
bearing interest at 8%. Stock options may also be exercised by the return of
previously acquired shares of common stock. Shares obtained by such exercises
are included in treasury stock and valued at the market value at date of
exercise.

On May 20, 1993, the Company issued 860,000 of non-qualified options to several
key executives. The option price was $20 above the closing price of the
Company's stock on the date of grant, or $29.50 per share. During fiscal year
1994, 146,000 shares of converging options were issued at an option price of
$24.50 per share. For each year during which the Company meets specified
performance targets, the option price will decrease by $5.00 until the option
price and market price converge. The option price will be fixed at the market
price on the date of convergence and the options will vest.

If convergence does not occur during the first five years after grant of the
options, the options will be canceled and the shares will revert to the 1989
Stock Incentive Plan and be available for reissuance. The Company met these
targets for fiscal 1993. The Company did not meet these targets in fiscal years
1994-1996.

A summary of activity under the plans during 1996, 1995 and 1994 is as follows:

NUMBER OF PRICE AGGREGATE
SHARES PER SHARE OPTION PRICE
---------- ------------ ------------

Options outstanding at November 30,
1993.................................... 3,578,000 $ 9.50-33.00 $ 61,399
Options granted........................ 1,264,000 12.38-24.50 18,591
Options cancelled and expired.......... (498,000) 9.50-33.00 (5,673)
Treasury stock issued on exercise...... (355,000) 9.50-33.00 (5,295)
Options converged...................... -- 24.50 (4,300)
---------- ------------ --------
Options outstanding at November 30,
1994.................................... 3,989,000 9.50-28.88 64,722
Options granted........................ 1,676,000 9.88-12.88 18,243
Options cancelled and expired.......... (758,000) 9.50-24.50 (10,839)
Treasury stock issued on exercise...... (102,000) 9.50-12.88 (1,029)
---------- ------------ --------
Options outstanding at November 30,
1995.................................... 4,805,000 9.50-28.88 71,097
Options granted........................ 1,311,000 8.00-12.00 12,721
Treasury stock issued on exercise...... (16,000) 9.50-9.875 (150)
Options cancelled and expired.......... (1,735,000) 8.00-28.88 (29,016)
---------- ------------ --------
Options outstanding at November 30,
1996.................................... 4,365,000 $8.00-28.875 $ 54,652
========== ============ ========

The market value of the Company's common stock at the date the options were
exercised was $10.875-$12.00, $10.88-$13.63, $11.88-$18.75 for 1996, 1995 and
1994, respectively.

At November 30, 1996, 2.4 million options were exercisable and 1.2 million (.7
million and 1.7 million at November 30, 1995 and 1994) were available for grant
under the plans.

F-64

TRANSITIONAL HOSPITALS CORPORATION
(FORMERLY COMMUNITY PSYCHIATRIC CENTERS)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 10--PROFIT SHARING PLAN

The Company has a noncontributory, trusteed profit sharing plan which is
qualified under Section 401 of the Internal Revenue Code. All regular non-union
employees in the United States (union employees are eligible if the collective
bargaining agreement so specifies) with at least 1,000 hours of service per
annum, over 21 years of age, and employed at year-end are eligible for
participation in the plan after one year of employment. The Company's
contribution to the plan for any fiscal year, as determined by the Board of
Directors, is discretionary, but is limited to an amount which is deductible
for federal income tax purposes. Contributions to the plan are allocated among
eligible participants in the proportion of their salaries to the total salaries
of all participants. There were no contributions made by the Company in 1996,
1995 and 1994. During 1993, a 401(k) segment was added to the plan which allows
employees to defer a portion of their salary on a pre-tax basis. The Company
may match a portion of the amount deferred. The Company's matching contribution
is determined by the Board of Directors each year. During 1996, 1995, and 1994
no matching contribution was made.

NOTE 11--DEFERRED COMPENSATION

Effective November 30, 1989, a former Chairman of the Board of Directors of
Community Psychiatric Centers terminated his employment with the Company and
began receiving deferred compensation benefits. Approximately $162,000 of the
annual payment of $323,000 was charged to expense as consideration for services
rendered over the term of the consulting and noncompetition agreements which
was to extend to November 30, 2000. In 1995, such former Chairman notified the
Company of his position that certain provisions in the contract that accelerate
the payment of certain deferred compensation were triggered and that up to $4.5
million was due from the Company thereunder.

In January 1997, the Company settled this claim for $3.9 million. Of the amount
to be paid, $1.8 million had been previously accrued and, as described in Note
2, $2.1 million of the settlement was accrued in November 1996. The settlement
amount was paid in February 1997.

F-65

TRANSITIONAL HOSPITALS CORPORATION
(FORMERLY COMMUNITY PSYCHIATRIC CENTERS)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 12--BUSINESS SEGMENT INFORMATION

With the sales of the Company's U.S., Puerto Rico and United Kingdom
psychiatric divisions in fiscal 1996, the Company is now primarily a provider
of long-term acute care services in the United States. The following tables
have been prepared in accordance with the requirements of FASB Statement No.
14. This information has been derived from the Company's accounting records.

YEAR ENDED NOVEMBER 30
----------------------------
1996 1995 1994
-------- -------- --------
(In thousands)

Net operating revenues:
U.S. psychiatric division..................... $202,069 $248,408 $276,698
U.K. psychiatric division..................... 37,190 63,319 46,226
Long-term acute care division................. 264,007 203,264 101,031
-------- -------- --------
$503,266 $514,991 $423,955
Operating profit:
U.S. psychiatric division..................... $ 7,584 $ 14,345 $ 29,778
U.K. psychiatric division..................... 9,442 17,880 12,558
Long-term acute care division................. 30,424 21,444 (7,630)
-------- -------- --------
$ 47,450 $53,669 $ 34,706
Other income and expense:
Other income.................................. $ 3,928 $ 2,513 $ 3,785
Depreciation and amortization................. (22,364) (23,344) (18,649)
Interest expense.............................. (3,889) (5,256) (3,545)
Non-recurring transaction, net................ (33,524) (94,116) 875
-------- -------- --------
Earnings (loss) before income taxes......... $ (8,399) $(66,534) $ 17,172
Identifiable assets:
U.S. psychiatric division(1).................. $ 69,859 $343,082 $396,377
U.K. psychiatric division..................... -- 78,248 68,640
Long-term acute care division................. 396,088 183,295 134,987
-------- -------- --------
$465,947 $604,625 $600,004
Depreciation and amortization expense:
U.S. psychiatric division..................... $ 10,267 $ 12,318 $ 11,197
U.K. psychiatric division..................... 1,954 3,214 2,514
Long-term acute care division................. 10,143 7,812 4,938
-------- -------- --------
$ 22,364 $ 23,344 $ 18,649
Capitalized expenditures for property, building,
and equipment:(2)
U.S. psychiatric division..................... $ 10,096 $ 13,276 $ 11,194
U.K. psychiatric division..................... 5,973 7,962 6,209
Long-term acute care division................. 19,350 18,901 31,357
-------- -------- --------
$ 35,419 $ 40,139 $ 48,760

- -------
(1) The U.S. psychiatric division was sold to Behavioral Healthcare Corporation
on November 30, 1996. Amount represents the equity interest received as
partial compensation for the sale of the division.
(2) Excludes assets acquired in business acquisitions of $2.1 million, $8.6
million and $4.8 million in 1996, 1995 and 1994, respectively.

F-66

TRANSITIONAL HOSPITALS CORPORATION
(FORMERLY COMMUNITY PSYCHIATRIC CENTERS)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 13--FAIR VALUE OF FINANCIAL INSTRUMENTS

The following methods and assumptions were used by the Company in estimating
its fair value disclosures for financial instruments:

Cash and Cash Equivalents: The carrying amount reported in the balance
sheet for cash and cash equivalents approximates its fair value.

Short-Term Investments: The fair values for investment in debt securities
are based on quoted market prices with unrealized gains, or losses, net of
tax, reported in a separate component of stockholders' equity.

Long-Term and Short-Term Debt: The carrying amounts of the Company's long-
term and short-term debt approximates its fair value.

NOTE 14--COMMITMENTS AND CONTINGENCIES

On September 28, 1995, the Company reached an agreement to settle certain
consolidated securities class action lawsuits and a related shareholder
derivative action. Although management of the Company believed that the claims
asserted in such suits lacked merit, the Company believed that it was prudent
to settle these cases due to the continuing substantial costs of defense, the
distraction of management's attention and the risks associated with litigation.
During the third and fourth quarter of 1995, the Company recorded charges
totaling $46.0 million ($28.9 million after tax) relating to settlement of the
lawsuits and associated legal fees and expenses. The suits, filed in late 1991,
alleged violations of the federal securities laws by the Company and certain
individuals between September 1990 and November 1991 arising from the
activities of the U.S. Psychiatric Division. The principal terms of the
agreement called for a settlement amount of $42.5 million consisting of a cash
settlement fund of $21.25 million and shares of the Company's common stock with
a value of $21.25 million. The cash amount, plus interest, was paid in November
1995. The shares issued to the plaintiff class were previously repurchased by
the Company pursuant to a stock buyback program during late 1991 through early
1993. On March 4, 1996 the Company issued 689,189 of common shares to the
plaintiffs' attorney which represented a portion of the settlement to be made
in common stock. The remaining portion of the settlement in common stock
totaled 1,652,778 shares which were issued on August 21, 1996. Upon issuance,
these shares had a dilutive effect on the Company's earnings per share. As a
result of the stock issued upon the settlement of this lawsuit, a large number
of shareholders became holders of less than 100 shares of the Company's stock.
To reduce administrative costs related to servicing these small shareholders,
on January 21, 1997, the Company implemented a small shareholder selling
program offering shareholders who own less than 100 shares a convenient method
for selling their shares.

In July 1995, the Government served a whistleblower suit against the Company's
Subsidiary, CPC Oklahoma, Inc., under the Federal False Claims Act. CPC
Oklahoma, Inc. operated Southwind Hospital, a psychiatric hospital located in
Oklahoma City, Oklahoma. The suit was originally filed by a former employee and
a relative of another employee under the qui tam provisions of the Act.
Invoking its rights under the Act, the United States took over the case. In
November 1996, Southwind and the Government reached an agreement in principle
under which Southwind would pay $750,000 to the Government in exchange for a
release of the Government's civil and administrative claims. The settlement was
paid in February 1997. In a related action, on August 4, 1995, federal and
state authorities executed a search warrant at Southwind and seized various
records. In December 1996, the Government notified Southwind that it had
decided to discontinue any further criminal investigation of this matter.

The Company is subject to ordinary and routine litigation incidental to its
business, including those arising from patient treatment, injuries or death for
which it is covered by liability insurance, and those arising from actions
involving employees. Management believes that the ultimate resolution of such
proceedings will not have a material adverse effect on the Company.

F-67

TRANSITIONAL HOSPITALS CORPORATION
(FORMERLY COMMUNITY PSYCHIATRIC CENTERS)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 15--QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

The following is a tabulation of the unaudited quarterly data for the two years
ended November 30, 1996:

THREE MONTHS ENDED
-------------------------------------------
FEBRUARY 28 MAY 31 AUGUST 31 NOVEMBER 30
----------- -------- --------- -----------
(In thousands, except per share data)

1996
Total revenues.................... $127,975 $142,282 $120,001 $116,936
Net income (loss)................. 3,723 6,226 39,108 (54,409)
Earnings (loss) per common
share*........................... 0.09 0.14 0.88 (1.26)
Per common share:
Dividend declared................. -- -- -- --
Stock prices:
High.......................... 12 1/4 10 9 3/4 9 1/2
Low........................... 8 5/8 8 7 3/4 8
1995
Total revenues.................... $121,609 $138,479 $130,909 $126,507
Net income (loss)................. 5,930 9,178 (24,332) (32,408)
Earnings (loss) per common
share**.......................... 0.14 0.21 (0.56) (0.74)
Per common share:
Dividend declared................. -- 0.01 -- --
Stock prices:
High.......................... 12 1/2 13 3/4 13 1/2 12 1/2
Low........................... 9 5/8 11 1/2 10 1/2 10 1/4

- -------
* Included in earnings per share for the first, second and third quarter of
1996 are restructuring charges of $.01, $.01 and $.01 per share,
respectively, related to employee termination benefits and other exit costs
resulting from the closure of four psychiatric hospitals in fiscal year
1996. Included in earnings per share for the third quarter of 1996 is a net
gain of $.81 per share on the sale of the Company's United Kingdom
psychiatric hospitals. Included in earnings per share for the fourth quarter
is a loss of $(1.28) per share related primarily to the sale of the
Company's U.S. psychiatric hospitals.
** Included in earnings per share for the second quarter of 1995 is a
restructuring credit $(.03) totaling $2.5 million ($1.5 million after tax)
from the resolution of previously restructured psychiatric assets. Earnings
per share in the third quarter of 1995 include $(.65) for a pre-tax charge
of $45.0 million ($28.4 million after tax) relating to the settlement of
shareholder litigation. Earnings per share in the fourth quarter of 1995
include a charge of $(.01) related to legal expenses associated with the
legal settlement and $(.65) for a pre-tax charge of $46.0 million ($28.4
million after tax) related to impairment of assets. Also included in the
fourth quarter of 1995 is a pre-tax restructuring charge of $4.6 million
($2.8 million after tax) or $.07 per share related to employee termination
benefits and other costs in connection with the decision to close six
psychiatric hospitals and three regional offices.

NOTE 16--PREFERRED STOCK PURCHASE RIGHTS AND PREFERRED STOCK

On June 21, 1996 the Board of Directors of the Company declared a dividend of
one preferred stock purchase right (the "Rights") on each outstanding share of
common stock, payable to stockholders of record on July 16, 1996. Each Right
will entitle the holder thereof after the Rights become exercisable and until
June 20, 2006 (or the earlier redemption, exchange or termination of the
Rights), to buy one one-hundredth of a share of Series B Junior Participating
Preferred Stock (the "Preferred Stock") at an exercise price of $45.00, subject
to certain

F-68

TRANSITIONAL HOSPITALS CORPORATION
(FORMERLY COMMUNITY PSYCHIATRIC CENTERS)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 16--PREFERRED STOCK PURCHASE RIGHTS AND PREFERRED STOCK (CONTINUED)

antidilution adjustments (the "Purchase Price"). The Rights will be represented
by the Common Stock certificates and will not be exercisable or transferable
apart from the Common Stock until the earlier of (i) the tenth day after the
public announcement that a Person or group has become an Acquiring Person (a
Person who has acquired, or obtained the right to acquire, beneficial ownership
of 15% or more of the Common Stock), or (ii) the tenth day after a person or
group commences, or announces an intention to commence, a tender or exchange
offer, the consummation of which would result in the beneficial ownership by a
Person or group of 15% or more of the Common Stock (the earlier of (i) and (ii)
being called herein the "Distribution Date"). Prior to the Distribution Date,
the Board of Directors has the power, under certain circumstances, to postpone
the Distribution Date. The Rights will first become exercisable on the
Distribution Date, unless earlier redeemed or exchanged, and may then begin
trading separately from the Common Stock. The Rights will at no time have any
voting rights.

With certain exceptions, in the event that (i) the Company were acquired in a
merger or other business combination transaction in which the Company is not
the surviving corporation or its Common Stock is changed or exchanged (other
than a merger which follows certain cash offers for all outstanding Common
Stock approved by the board) or (ii) more than 50% of the Company's assets or
earning power were sold, proper provision shall be made so that each holder of
a Right (except Rights which previously have been voided as set forth above)
shall thereafter have the right to receive, upon exercise thereof, that number
of share of common stock of the acquiring company which at the time of such
transaction would have a market value of two times the then-current exercise
price of one Right.

At any time after a Person has become an Acquiring Person and prior to the
acquisition of 50% or more of the then-outstanding Common Stock by such
Acquiring Person, the Board of Directors may cause the Company to acquire the
Rights (other than Rights owned by an Acquiring person which have become void),
in whole or in part, in exchange for that number of shares of Common Stock
having an aggregate value equal to the excess of the value of the Common Stock
issuable upon exercise of a Right after a Person becomes an Acquiring Person
over the Purchase Price.

The Rights are redeemable at $0.01 per Right prior to the first date of public
announcement that a Person or group has become an Acquiring Person. Prior to
the expiration of the period during which the Rights may be redeemed, the Board
of Directors has the power, under certain circumstances, to extend the
redemption period. The Rights will expire on June 20, 2006 (unless earlier
redeemed or exchanged).

The Purchase Price payable, and the number of shares of Preferred Stock or
other securities or property issuable upon exercise of the Rights are subject
to adjustment from time to time to prevent dilution.

NOTE 17--SUBSEQUENT EVENTS (UNAUDITED)

On June 18, 1997, THY entered into an agreement and plan of merger with Vencor,
Inc. (the "Vencor Merger Agreement") under which Vencor would acquire all of
the Company's outstanding stock at $16.00 per share (the "Acquisition"). The
Acquisition is structured as a cash tender offer to be followed by a second-
step merger pursuant to which a wholly-owned subsidiary of Vencor will acquire
all remaining shares which have not been tendered. Vencor's wholly-owned
subsidiary acquired 37,247,234 shares (approximately 95.5% of the
outstanding THY shares) in the tender offer which expired on June 19, 1997. THY
and Vencor are in the process of completing the merger of Vencor's wholly-owned
subsidiary with and into THY. Upon consummation of the merger, each share not
purchased through the tender offer will be converted into the right to receive
$16.00 in cash. The closing of the Acquisition is subject to customary
conditions. The merger is expected to be completed within 60 to 75 days of the
expiration of the tender offer.

F-69

TRANSITIONAL HOSPITALS CORPORATION
(FORMERLY COMMUNITY PSYCHIATRIC CENTERS)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 17--SUBSEQUENT EVENTS (UNAUDITED) (CONTINUED)

Prior to entering into the Vencor Merger Agreement, THY had entered into an
agreement and plan of merger with Select Medical Corporation ("Select") whereby
Select would acquire all of the outstanding shares of THY for $14.55 per share
(the "Select Merger Agreement"). The Select Merger Agreement was terminated
prior to the execution of the Agreement with Vencor. Pursuant to the terms of
the Select Merger Agreement, THY paid Select a break-up fee of approximately
$19.4 million in June 1997.

On June 6, 1997, THY announced that it had been advised that it was a target of
a grand jury investigation arising from activities of THY's formerly owned
dialysis business. The investigation involves purported Medicare fraud
involving certain laboratory tests performed by a partnership which existed
from June 1987 to June 1992 between Damon Corporation and THY. THY spun off its
dialysis business, now called Vivra Incorporated, on September 1, 1989. Based
on the current status of this matter, management is not able to determine what
impact, if any, the resolution of this matter will have on the Company's
financial position or results of operations.

F-70

TRANSITIONAL HOSPITALS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

SIX MONTHS ENDED THREE MONTHS ENDED
MAY 31 MAY 31
----------------- -------------------
1997 1996 1997 1996
-------- -------- --------- ---------

(000s omitted except per share data)
REVENUES:
Net operating revenues.................. $156,543 $269,223 $ 81,627 $ 141,734
Investment and other income............. 5,872 1,240 3,344 754
-------- -------- -------- ---------
162,415 270,463 84,971 142,488
COSTS AND EXPENSES:
Operating expenses...................... 126,178 210,760 67,186 109,483
General and administrative expenses..... 11,536 16,631 6,227 8,696
Bad debt expense........................ 3,821 10,379 2,242 5,480
Depreciation and amortization........... 6,969 11,776 3,470 6,133
Interest expense........................ 606 3,228 248 1,855
Non-recurring transactions.............. 6,606 1,643 6,606 800
-------- -------- -------- ---------
155,716 254,417 85,979 132,447
INCOME (LOSS) BEFORE INCOME TAXES......... 6,699 16,046 (1,008) 10,041
Income Taxes............................ 5,189 6,097 2,183 3,815
-------- -------- -------- ---------
NET INCOME (LOSS)......................... $ 1,510 $ 9,949 $ (3,191) $ 6,226
======== ======== ======== =========
NET INCOME (LOSS) PER COMMON SHARE........ $ 0.04 $ 0.23 $ (0.08) $ 0.14
======== ======== ======== =========
WEIGHTED AVERAGE COMMON SHARES............ 39,768 44,051 38,860 44,396
======== ======== ======== =========

See notes to condensed consolidated financial statements.

F-71

TRANSITIONAL HOSPITALS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS

MAY 31 NOVEMBER 30
1997 1996
----------- -----------
(UNAUDITED) (AUDITED)

(000s omitted except per share data)
ASSETS
CURRENT:
Cash and cash equivalents.......................... $ 60,359 $ 84,313
Short-term investments............................. 5,888 16,777
Accounts receivable, less allowances for doubtful
accounts
1997--$12,728/1996--$21,448....................... 59,098 55,557
Prepaid expenses and other current assets.......... 12,669 14,784
Property held for sale............................. 8,533 13,393
Refundable and deferred income taxes............... 16,881 21,419
-------- --------
TOTAL CURRENT ASSETS............................... 163,428 206,243
PROPERTY, BUILDINGS & EQUIPMENT--at cost less allow-
ances for
depreciation........................................ 164,466 153,933
INVESTMENT IN AFFILIATE.............................. 72,480 69,859
REFUNDABLE AND DEFERRED INCOME TAXES................. 6,099 15,966
OTHER ASSETS......................................... 23,390 19,946
-------- --------
$429,863 $465,947
======== ========
LIABILITIES & STOCKHOLDERS' EQUITY
CURRENT:
Accounts payable................................... $ 9,387 $ 9,136
Accrued payroll and other expenses................. 15,920 15,680
Income taxes payable............................... 451 --
Payable to third parties under reimbursement con-
tracts............................................ 15,840 13,954
Other accrued liabilities.......................... 8,921 17,796
Current maturities on long-term debt............... 8,371 8,467
-------- --------
TOTAL CURRENT LIABILITIES............................ 58,890 65,033
LONG-TERM DEBT, EXCLUSIVE OF CURRENT MATURITIES...... 10,442 14,858
DEFERRED INCOME TAXES AND OTHER LIABILITIES.......... 3,505 3,857
STOCKHOLDERS' EQUITY:
Preferred stock, par value $1.00, authorized 2,000
shares; none issued............................... -- --
Common Stock, par value $1.00, authorized 100,000
shares;
issued 1997--46,856 shares 1996--46,856 shares.... 46,856 46,856
Additional paid-in capital......................... 57,173 56,657
Unrealized gains on investments in debt securi-
ties.............................................. 34 163
Retained earnings.................................. 323,220 321,710
Less treasury stock-at cost 1997--7,862 shares and
1996--4,988 shares................................ (70,257) (43,187)
-------- --------
357,026 382,199
-------- --------
$429,863 $465,947
======== ========

NOTE: The balance sheet at November 30, 1996 has been derived from the audited
financial statement at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.

See notes to condensed consolidated financial statements.

F-72

TRANSITIONAL HOSPITALS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

SIX MONTHS ENDED
MAY 31
------------------
1997 1996
-------- --------
(000s omitted)

CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................. $ 1,510 $ 9,949
Adjustments to reconcile net income to cash used for op-
erating activities:
Depreciation and amortization.......................... 6,969 11,776
Provision for bad debts................................ 3,821 10,379
Non-recurring transactions............................. 6,100 1,643
Gain on the sale of property........................... -- (103)
Other.................................................. (1,785) 1,038
Changes in assets and liabilities, exclusive of business
acquisitions and disposals:
Accounts receivable.................................... (7,362) (12,882)
Payable to third parties under reimbursement con-
tracts................................................ 1,886 9,304
Prepaid expenses and other current assets.............. (1,015) (4,901)
Accounts payable and accrued expenses.................. 491 (9,020)
Other accrued liabilities.............................. (14,975) (5,199)
Income taxes........................................... 14,762 11,445
-------- --------
Net cash provided from operations.......................... 10,402 23,429
CASH FLOWS FROM FINANCING ACTIVITIES:
Purchase of treasury shares.............................. (28,531) --
Payment of deferred compensation......................... (545) --
Net proceeds from exercise of stock options.............. 1,975 150
Payments on long-term debt............................... (4,512) (11,939)
-------- --------
Net cash used for financing activities..................... (31,613) (11,789)
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of short-term investments............ 20,516 5,601
Purchases of short-term investments...................... (9,756) --
Payments received on notes............................... 3,358 1,145
Loans made to officers................................... (300) (750)
Purchase of property, buildings and equipment............ (9,414) (18,917)
Proceeds from the sale of property, buildings and equip-
ment.................................................... 4,534 1,632
Investment in joint venture.............................. (4,009) --
Investment in pre-opening costs.......................... (1,435) (831)
Payments for business acquisitions:
Property, buildings and equipment...................... (6,057) --
Excess of purchase price over value of assets ac- (180) --
quired................................................ -------- --------
Net cash used for investing activities..................... (2,743) (12,120)
-------- --------
Net decrease in cash and cash equivalents.................. (23,954) (480)
Beginning cash and cash equivalents........................ 84,313 17,263
-------- --------
Ending cash and cash equivalents........................... $ 60,359 $ 16,783
======== ========

See notes to condensed consolidated financial statements.

F-73

TRANSITIONAL HOSPITALS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
MAY 31, 1997

NOTE A: BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Rule
10-01 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for
a fair presentation have been included. For further information, refer to the
consolidated financial statements and footnotes thereto included in the
Transitional Hospitals Corporation (the "Company") Annual Report on Form 10-K
for the year ended November 30, 1996.

NOTE B: MERGER WITH VENCOR, INC.

On June 18, 1997, the Company entered into an agreement and plan of merger with
Vencor, Inc. (the "Vencor Merger Agreement") under which Vencor, Inc.
("Vencor") would acquire all of the Company's outstanding common stock at
$16.00 per share (the "Acquisition"). The Acquisition is structured as a cash
tender offer to be followed by a second-step merger pursuant to which a wholly-
owned subsidiary of Vencor will acquire all shares which were not acquired in
the tender offer. Vencor's wholly-owned subsidiary acquired 37.2 million shares
(approximately 95.5% of the outstanding shares of the Company) in the tender
offer which expired on June 19, 1997. On June 24, 1997, the Company completed
the tender offer, after which time operations of the Company will be
consolidated with those of Vencor. The Company and Vencor are in the process of
completing the merger of Vencor's wholly-owned subsidiary with and into the
Company. Upon consummation of the merger, each share not purchased through the
tender offer will be converted into the right to receive $16.00 in cash. The
closing of the Acquisition is subject to customary conditions. The merger is
expected to be completed within 45 to 60 days of the expiration of the tender
offer.

Prior to entering into the Vencor Merger Agreement, the Company had entered
into an agreement and plan of merger with Select Medical Corporation ("Select")
whereby Select would acquire all of the outstanding common stock of the Company
for $14.55 per share (the "Select Merger Agreement"). The Select Merger
Agreement was terminated prior to the execution of the Vencor Merger Agreement.
Pursuant to the terms of the Select Merger Agreement, the Company paid Select a
break-up fee of approximately $19.4 million in June 1997. This payment is not
included in the statement of operations for the six months ended May 31, 1997.

NOTE C: TRANSACTION EXPENSES (NON-RECURRING TRANSACTIONS)

As of May 31, 1997, $6.6 million had been expensed for investment banking and
legal fees related to the sale of the Company. These transaction expenses are
considered to be permanent differences for income tax purposes, and thus are
not tax effected for purposes of calculating the fiscal year 1997 tax
provision.

For the six months and quarter ended May 31, 1996, non-recurring transaction
costs totaling $1.6 million and $.8 million, respectively, for termination
benefits and other exit costs were incurred in connection with the decision to
close three psychiatric hospitals.

F-74

TRANSITIONAL HOSPITALS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
MAY 31, 1997

NOTE D: DISPOSALS OF PSYCHIATRIC HOSPITALS

As more fully described in the Company's 1996 Annual Report to Stockholders and
Annual Report on Form 10-K, the Company sold its United Kingdom psychiatric
operations on June 21, 1996 and substantially all of its U.S. psychiatric
operations on November 30, 1996. The U.S. psychiatric operations were sold to
Behavioral Healthcare Corporation ("BHC") for $60 million in cash and a 61%
(44.2% voting equity interest) ownership interest in BHC. Following is a
summary of unaudited summary financial information for the above described
entities included in the Company's historical statement of operations.

SIX MONTHS ENDED THREE MONTHS ENDED
MAY 31 MAY 31
----------------- -------------------
1997 1996 1997 1996
-------- -------- --------- ---------
(000s omitted except per share data)

U.K. psychiatric operations:
Total revenues........................... -- $ 33,094 -- $ 17,840
Income before taxes...................... -- 6,496 -- 4,397
Net income............................... -- 4,222 -- 2,858
Earnings per share....................... -- 0.10 -- 0.06
U.S. psychiatric operations:
Total revenues........................... -- $109,479 -- $ 56,823
Income before taxes*..................... -- 1,568 -- 1,373
Net income............................... -- 810 -- 737
Earnings per share....................... -- 0.02 -- 0.02

* Included in the statements of operations for the six months and quarter ended
May 31, 1996 are operating losses and restructuring charges related to nine
U.S. psychiatric hospitals that were closed between November 1995 and April
1996. Total operating losses for these facilities were $4.2 million and $2.4
million, respectively, for the six months and quarter ended May 31, 1996. Total
restructuring charges for the closure of these facilities were $1.6 million and
$0.8 million for the six months and quarter ended May 31, 1996.

F-75

TRANSITIONAL HOSPITALS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
MAY 31, 1997

NOTE E: INVESTMENT IN AFFILIATE

As described in Note D, the Company retained a 61% (44.2% voting equity
interest) ownership interest in BHC. The investment is accounted for under the
equity method of accounting and thus only the Company's share of BHC's net
income is included in the statement of operations for both the six months and
quarter ended May 31, 1997. A summary of unaudited BHC statement of operations
information is described below:

SIX MONTHS ENDED THREE MONTHS ENDED
MAY 31, 1997 MAY 31, 1997
---------------- ------------------
(000s omitted except per share
data)

Total revenues.............................. $159,254 $83,496
Income before taxes......................... 10,872 7,961
Net income.................................. 6,558 4,774
Company's share of BHC net income........... 2,901 2,112
Earnings per share.......................... 0.04 0.03

NOTE F: CONTINGENCIES

On June 20, 1997, the Company was made aware of a lawsuit that was filed
against the Company and certain senior executives and directors of the Company
alleging that the Company failed to make timely disclosure to stockholders that
it had received a written offer to acquire all of the Company's common stock.
The complaint asserts claims pursuant to Sections 10(b) and 20(a) of the
Securities Exchange Act of 1934, as amended, and common law principles of
negligent misrepresentation. The plaintiffs in the suit are persons who sold
the Company's common stock between February 26, 1997 and May 4, 1997. The
Company has not been served with this lawsuit nor is the Company able to
determine what impact, if any, that the lawsuit would have on the Company's
financial position or results of operations.

On June 6, 1997, the Company announced that it had been advised that it was a
target of a grand jury investigation arising from activities of the Company's
formerly owned dialysis business. The investigation involves purported Medicare
fraud involving certain laboratory tests performed by a partnership which
existed from June 1987 to June 1992 between Damon Corporation and the Company.
The Company spun off its dialysis business, now called Vivra Incorporated, on
September 1, 1989. Based on the current status of this matter, management is
not able to determine what impact, if any, the resolution of this matter will
have on the Company's financial position or results of operations.

F-76

TRANSITIONAL HOSPITALS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
MAY 31, 1997

NOTE F: CONTINGENCIES (CONTINUED)

On May 14, 1997, Charles Miller and Kenneth Steiner, former stockholders of the
Company, filed a purported class action lawsuit against the Company and each of
its directors in the District Court for Clark County, Nevada. The complaint
alleges that the Board breached its fiduciary duty by entering into the Select
Merger Agreement, and seeks, among other things, (i) injunctive relief barring
the Company from consummating the transactions contemplated by the Select
Merger Agreement, (ii) declaratory relief to invalidate the provisions of the
Select Merger Agreement providing for the termination fee of $19.4 million
payable to Select under certain circumstances, and (iii) damages against the
Company's directors for breaching their fiduciary duties in connection with the
negotiation and execution of the Select Merger Agreement. The Company believes
that the allegations in the complaint are without merit.

On May 7, 1997, Vencor, Jill L. Force and Patrick Mattingly (the "Vencor
Complaint") filed a complaint in the United States District Court of Nevada
against the Company, each of the directors of the Company and SM Acquisition
Co. (a wholly owned subsidiary of Select). The issues raised in the Vencor
Complaint were similar to those raised in the Miller/Steiner complaint noted
above. The Vencor Complaint was dismissed without prejudice in June 1997.

F-77

LOGO

PART II

INFORMATION NOT REQUIRED IN PROSPECTUS

ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS

Section 145 of the Delaware General Corporation Law ("GCL") permits a Delaware
corporation to indemnify any person who was or is, or is threatened to be made,
a party to any threatened, pending or completed action, suit or proceeding,
whether civil, criminal, administrative or investigative (other than an action
by or in the right of such corporation) by reason of the fact that such person
is or was a director, officer, employee or agent of such corporation, or is or
was serving at the request of such corporation as a director, officer, employee
or agent of another corporation, partnership, joint venture, trust or other
enterprise. The indemnity may include expenses (including attorneys' fees),
judgments, fines and amounts paid in settlement actually and reasonably
incurred by such person in connection with such action, suit or proceeding,
provided that such person acted in good faith and in a manner such person
reasonably believed to be in or not opposed to the best interests of the
corporation, and, with respect to any criminal action or proceeding, such
person had no reasonable cause to believe the person's conduct was unlawful. A
Delaware corporation may indemnify such persons in actions brought by or in the
right of the corporation to procure a judgment in its favor under the same
conditions except that no indemnification is permitted in respect of any claim,
issue or matter as to which such person has been adjudged to be liable to the
corporation unless and to the extent the Court of Chancery of the State of
Delaware or the court in which such action or suit was brought determines upon
application that, in view of all the circumstances of the case, such person is
fairly and reasonably entitled to indemnify for such expenses as the Court of
Chancery or other such court deems proper. To the extent that a present or
former director or officer has been successful on the merits or otherwise in
defense of any action referred to above, or in defense of any claim, issue or
matter therein, the corporation must indemnify such person against expenses
(including attorneys' fees) actually and reasonably incurred by such person in
connection therewith. Corporations, under certain circumstances, may pay
expenses incurred by an officer or director in advance of the final disposition
of an action for which indemnification may be permitted or required. The
indemnification and advancement of expenses provided for or granted pursuant to
Section 145 are not exclusive of any other rights to which those seeking
indemnification or advancement of expenses may be entitled under any bylaw,
agreement, vote of stockholders or disinterested directors or otherwise.
Section 145 further provides that a corporation may maintain insurance against
liabilities for which indemnification is not expressly provided by statute.

Pursuant to Section 102(b)(7) of the GCL, the Company's Certificate of
Incorporation, as amended, eliminates certain liability of the Company's
directors for breach of their fiduciary duty of care. Article VIII of the
Certificate of Incorporation provides that neither of the Company nor its
stockholders may recover monetary damages from the Company's directors for
breach of the duty of care in the performance of their duties as directors of
the Company. Article VIII does not, however, eliminate the liability of the
Company's directors (i) for a breach of the director's duty of loyalty, (ii)
for acts or omissions not in good faith or which involve intentional misconduct
or a knowing violation of law, (iii) under Section 174 of the GCL (relating to
unlawful distributions), or (iv) for any improper personal benefit.

Pursuant to Article IX of the Company's Certificate of Incorporation, the
Company provides mandatory indemnification of its directors and officers to the
fullest extent authorized by the GCL against all expenses, liabilities and
losses actually and reasonably incurred or suffered in connection with any
action, suit or proceeding to which such officer or director is a party, or is
threatened to be made a party. Article IX also provides mandatory
indemnification of any person who is made a party, or is threatened to be made
a party, to an action, suit or proceeding because he was serving at the request
of the Company as a director, officer, employee, trustee or agent of another
corporation, partnership, joint venture, trust or other enterprise. In
connection with the foregoing indemnification, the Company is permitted to
advance expenses incurred by directors or officers in defending a proceeding if
authorized

II-1

by the Board of Directors and if the Company receives an undertaking by or on
behalf of such persons to repay the amounts advanced unless it is ultimately
determined that indemnification is required of the Company.

The indemnification mandated by Article IX is a contract right which continues
as to persons who cease to be a director or officer of the Company, their
heirs, executors and administrators. No amendment to the Company's Certificate
of Incorporation, as amended, may increase the liability of any director or
officer for their acts or omissions occurring prior to such amendment. The
mandatory indemnification provided by Article IX is expressly nonexclusive of
any other rights to which persons seeking indemnification may be entitled.

The Company may purchase and maintain insurance on behalf of any person for
whom indemnification is mandated by Article IX or any employee or agent of the
Company, whether or not the Company would have the power or the obligation to
indemnify such person under the Certificate of Incorporation, as amended, or
the GCL. The Company currently has in effect an officers and directors
liability insurance policy. The policy covers any negligent act, error or
omission of a director or officer, subject to certain exclusions. The limit of
liability under the policy is $30 million in the aggregate annually for
coverages in excess of deductibles.

ITEM 21. EXHIBITS AND FINANCIAL STATEMENTS SCHEDULES.

(a) EXHIBITS

3.1 Certificate of Incorporation of the Company, as amended. Exhibit 3
to the Company's Form 10-Q for the quarter ended September 30,
1995 (Comm. File No. 1-10989) is hereby incorporated by reference.
3.2 Second Amended and Restated Bylaws of the Company. Exhibit 3.2 to
the Company's Form 10-K for the year ended January 31, 1995 (Comm.
File No. 1-10989) is hereby incorporated by reference.
4.1 Indenture dated July 21, 1997, between the Company and The Bank of
New York, as Trustee. Exhibit 4.2 to the Company's Current Report
on Form 8-K dated July 21, 1997 (Comm. File No. 1-10989) is hereby
incorporated by reference.
4.2 Form of Exchange Note (included in Exhibit 4.1).
4.3 Registration Rights Agreement dated July 21, 1997, by and among
the Company and the Initial Purchasers. Exhibit 99.1 to the
Company's Current Report on Form 8-K dated July 21, 1997 (Comm.
File No. 1-10989) is hereby incorporated by reference.
5* Opinion of Greenebaum Doll & McDonald PLLC.
11.1* Computation of Earnings Per Common and Common Equivalent Share for
the years ended December 31, 1996, 1995 and 1994.
11.2* Computation of Earnings Per Common and Common Equivalent Share for
the quarter and six months ended June 30, 1997 and 1996.
12* Computation of Ratio of Earnings to Fixed Charges.
23.1* Consent of Ernst & Young LLP.
23.2* Consent of Ernst & Young LLP.
23.3* Consent of Coopers & Lybrand L.L.P.
23.4* Consent of Price Waterhouse LLP.

II-2

23.5* Consent of Ernst & Young LLP.
23.6* Consent of Greenebaum Doll & McDonald PLLC (included in Exhibit
5).
24* Power of Attorney (included in Signature Page to Registration
Statement).
25* Statement of Eligibility of Trustee.
27* Financial Data Schedule (included only in filings submitted under
the Electronic Data Gathering, Analysis, and Retrieval system).
99.1 Form of Letter of Transmittal.
99.2 Form of Notice of Guaranteed Delivery.
99.3 Form of Instructions to Registered Holders.
99.4 Form of Letter to Registered Holders and Depository Trust Company
Participants.
99.5 Form of Letter to Clients.

- --------

*Previously filed.

(b) FINANCIAL STATEMENT SCHEDULES

SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS

1. Vencor, Inc. for the years ended December 31, 1996, 1995 and 1994.

2. TheraTx, Incorporated for the years ended December 31, 1996, 1995
and 1994.

3. Transitional Hospitals Corporation for the years ended November 30,
1996, 1995 and 1994.

All other schedules have been omitted because they are not applicable, not
required, or the information is included in the financial statements or notes
thereto.

ITEM 22. UNDERTAKINGS

The undersigned registrant hereby undertakes that, for purposes of determining
any liability under the Securities Act of 1933 (the "Act"), each filing of the
registrant's annual report pursuant to section 13(a) or section 15(d) of the
Securities Exchange Act of 1934 (and, where applicable, each filing of an
employee benefit plan's annual report pursuant to section 15(d) of the
Securities Exchange Act of 1934) that is incorporated by reference in the
registration statement shall be deemed to be a new registration statement
relating to the securities offered therein, and the offering of such securities
at the same time shall be deemed to be the initial bona fide offering thereof.

Insofar as indemnification for liabilities arising under the Act may be
permitted to directors, officers, and controlling persons of the registrant
pursuant to the foregoing provisions described under Item 20, or otherwise, the
registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer, or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) as asserted by such director, officer, or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question of
whether such indemnification by it is against public policy as expressed in the
Act and will be governed by the final adjudication of such issue.

The undersigned registrant hereby undertakes to respond to requests for
information that is incorporated by reference into the prospectus pursuant to
Items 4, 10(b), 11, or 13 of this Form, within one business day of receipt of
such request, and to send the incorporated documents by first class mail or
other equally prompt means. This includes information contained in documents
filed subsequent to the effective date of the registration statement through
the date of responding to the request.

The undersigned registrant hereby undertakes to supply by means of a post-
effective amendment all information concerning a transaction, and the Company
being acquired involved therein, that was not the subject of and included in
the registration statement when it became effective.

II-3

SIGNATURES

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT, THE REGISTRANT HAS DULY
CAUSED THIS AMENDMENT TO THE REGISTRATION STATEMENT TO BE SIGNED ON ITS BEHALF
BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE CITY OF LOUISVILLE,
COMMONWEALTH OF KENTUCKY, ON OCTOBER 3, 1997.

Vencor, Inc.

/s/ W. Bruce Lunsford
By: _________________________________
W. Bruce Lunsford
Chairman of the Board, President
and Chief Executive Officer

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS AMENDMENT TO
THE REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE
CAPACITIES AND ON THE DATES INDICATED.

SIGNATURE TITLE DATE
--------- ----- ----

* Chairman of the Board, October 3, 1997
____________________________________ President and Chief
W. Bruce Lunsford Executive Officer

* Executive Vice President, October 3, 1997
____________________________________ Chief Operating Officer and
Michael R. Barr Director

* Executive Vice President, October 3, 1997
____________________________________ Chief Financial Officer
W. Earl Reed, III (Principal Financial
Officer) and Director

* Vice President, Finance and October 3, 1997
____________________________________ Corporate Controller
Richard A. Lechleiter (Principal Accounting
Officer)

* Director October 3, 1997
____________________________________
Walter F. Beran

* Director October 3, 1997
____________________________________
Ulysses L. Bridgeman, Jr.

II-4

SIGNATURE TITLE DATE
--------- ----- ----

* Director October 3, 1997
____________________________________
Elaine L. Chao

* Director October 3, 1997
____________________________________
Donna R. Ecton

* Director October 3, 1997
____________________________________
Greg D. Hudson

* Director October 3, 1997
____________________________________
William H. Lomicka

* Vice Chairman of the Board October 3, 1997
____________________________________ and Director
R. Gene Smith
/s/ Jill L. Force October 3, 1997
*By: _______________________________
Jill L. Force
Attorney-in-Fact

II-5

ITEM 21(B).1

VENCOR, INC.
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(IN THOUSANDS)

ADDITIONS
-----------------------
BALANCE AT CHARGED TO CHARGED BALANCE
BEGINNING COSTS AND TO OTHER DEDUCTIONS AT END
OF PERIOD EXPENSES ACCOUNTS OR PAYMENTS OF PERIOD
---------- ---------- -------- ----------- ---------

Allowances for loss on
accounts and notes
receivable:
Year ended December 31,
1994.................. $21,316 $ 9,055 $ (344)(a) $ (1,762) $28,265
Year ended December 31,
1995.................. 28,265 7,851 -- (4,026) 32,090
Year ended December 31,
1996.................. 32,090 15,001 -- (23,176) 23,915
Allowances for loss on
assets held for
disposition:
Year ended December 31,
1994.................. $56,646 $ -- $(56,646)(a)(b) $ -- $ --
Year ended December 31,
1995.................. -- 26,900 (c) -- -- 26,900
Year ended December 31,
1996.................. 26,900 64,000 (d) -- (22,812) 68,088

- -------
(a) Adjustment to reflect change in fiscal year of acquired entities.
(b) Includes $54.6 million related to reinstatement of assets previously held
for disposition.
(c) Reflects provision for loss associated with the planned disposition of
certain nursing center properties recorded in connection with the
Hillhaven Merger.
(d) Reflects provision for loss associated with the sale of 34 nursing centers
and the planned replacement of one hospital and three nursing centers.

ITEM 21(B).2

THERATX, INCORPORATED AND SUBSIDIARIES
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)

ADDITIONS
---------------------- ---
BALANCE AT CHARGED TO OTHER BALANCE AT
BEGINNING COSTS AND ADDITIONS-- DEDUCTIONS-- END OF
DESCRIPTION OF PERIOD EXPENSES DESCRIBE DESCRIBE PERIOD
- ----------- ---------- ---------- ----------- ------------ ----------

Year Ended December 31,
1996:
Deducted from asset ac-
counts:
Allowance for doubtful
accounts.............. $ 5,449 $3,571 $ 196(A) $(1,449)(C) $ 7,767
Allowance for denials.. 2,575 1,753 126(B) -- 4,454
Valuation allowance for
deferred tax
assets................ 2,090 -- -- (209)(D) 1,881
------- ------ ------ ------- -------
Total................. $10,114 $5,324 $ 322 $(1,658) $14,102
======= ====== ====== ======= =======
Year Ended December 31,
1995:
Deducted from asset ac-
counts:
Allowance for doubtful
accounts.............. $ 4,360 $3,221 $ 25(A) $(2,157)(C) $ 5,449
Allowance for denials.. 1,372 1,406 -- (203)(C) 2,575
Valuation allowance for
deferred
tax assets............ 2,817 -- -- (727)(D) 2,090
------- ------ ------ ------- -------
Total................. $ 8,549 $4,627 $ 25 $(3,087) $10,114
======= ====== ====== ======= =======
Year Ended December 31,
1994:
Deducted from asset ac-
counts:
Allowance for doubtful
accounts.............. $ 2,810 $4,653 $ 673(A) $(3,776)(C) $ 4,360
Allowance for denials.. 561 843 -- (32)(C) 1,372
Valuation allowance for
deferred
tax assets............ 3,338 -- 2,091(A) (2,612)(D) 2,817
------- ------ ------ ------- -------
Total................. $ 6,709 $5,496 $2,764 $(6,420) $ 8,549
======= ====== ====== ======= =======

- -------
(A) Balances recorded in connection with acquisitions.
(B) Amounts recovered from previous write-offs.
(C) Uncollectable accounts written off.
(D) Reduction in valuation allowance, increasing net deferred tax assets.

ITEM 21(B).3

TRANSITIONAL HOSPITALS CORPORATION AND SUBSIDIARIES
(FORMERLY COMMUNITY PSYCHIATRIC CENTERS)
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS

COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
- -------- ----------- ------------------------ ------------ -----------
ADDITIONS
------------------------
CHARGED TO
BALANCE AT CHARGED TO OTHER BALANCE AT
BEGINNING COSTS AND ACCOUNTS-- DEDUCTIONS-- END OF
DESCRIPTION OF PERIOD EXPENSES DESCRIBE DESCRIBE PERIOD
- ----------- ----------- ----------- ------------ ------------ -----------

Year ended November 30,
1994................... $22,658,000 $26,966,000 $(20,325,000) (1) $29,381,000
82,000 (2)
Year ended November 30,
1995................... 29,381,000 28,732,000 (33,383,000) (1) 24,682,000
(48,000) (2)
Year ended November 30,
1996................... 24,682,000 20,101,000 (3,586,000) (1) 21,448,000
(17,317,000) (3)
(2,432,000) (4)

- -------
(1) Write-offs, net of recoveries.
(2) Foreign currency translation adjustment.
(3) Represent allowance for bad debts for the U.S. psychiatric hospitals that
were sold on November 30, 1996.
(4) Represent allowance for bad debts for the U.K. psychiatric hospitals that
were sold on June 21, 1996.

EXHIBIT INDEX

EHIBITX
NO. DESCRIPTION OF DOCUMENT
- ------- -----------------------

3.1 Certificate of Incorporation of the Company, as amended. Exhibit 3 to the
Company's Form 10-Q for the quarter ended September 30, 1995 (Comm. File No. 1-
10989) is hereby incorporated by reference.
3.2 Second Amended and Restated Bylaws of the Company. Exhibit 3.2 to the Company's
Form 10-K for the year ended January 31, 1995 (Comm. File No. 1-10989) is hereby
incorporated by reference.
4.1 Indenture dated July 21, 1997, between the Company and The Bank of New York, as
Trustee. Exhibit 4.2 to the Company's Current Report on Form 8-K dated July 21,
1997 is hereby incorporated by reference.
4.2 Form of Exchange Note (included in Exhibit 4.1).
4.3 Registration Rights Agreement dated July 21, 1997, by and among the Company and
the Initial Purchasers. Exhibit 99.1 to the Company's Current Report on Form 8-K
dated July 21, 1997 is hereby incorporated by reference.
5* Opinion of Greenebaum Doll & McDonald PLLC.
11.1* Computation of Earnings Per Common and Common Equivalent Share for the years ended
December 31, 1996, 1995 and 1994.
11.2* Computation of Earnings Per Common and Common Equivalent Share for the quarter and
six months ended June 30, 1997 and 1996.
12* Computation of Ratio of Earnings to Fixed Charges.
23.1* Consent of Ernst & Young LLP.
23.2* Consent of Ernst & Young LLP.
23.3* Consent of Coopers & Lybrand L.L.P.
23.4* Consent of Price Waterhouse LLP.
23.5* Consent of Ernst & Young LLP.
23.6* Consent of Greenebaum Doll & McDonald PLLC (included in Exhibit 5).
24* Power of Attorney (included in Signature Page to Registration Statement).
25* Statement of Eligibility of Trustee.
27* Financial Data Schedule (included only in filings submitted under the Electronic
Data Gathering, Analysis, and Retrieval system).
99.1 Form of Letter of Transmittal.
99.2 Form of Notice of Guaranteed Delivery.
99.3 Form of Instructions to Registered Holders.
99.4 Form of Letter to Registered Holders and Depository Trust Company Participants.
99.5 Form of Letter to Clients.

- --------

*Previously filed.