Ventas
VTR
#618
Rank
$41.73 B
Marketcap
$81.36
Share price
-3.15%
Change (1 day)
17.49%
Change (1 year)
Ventas, Inc. is a real estate investment trust specializing in the ownership and management of health care facilities in the United States, Canada and the United Kingdom.
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K

<TABLE>
<CAPTION>
(Mark One)
<S> <C>
[X]Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934
For the fiscal year ended December 31, 1997
OR
[ ]Transition report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
</TABLE>

COMMISSION FILE NUMBER: 1-10989

VENCOR, INC.
(Exact name of registrant as specified in its charter)

<TABLE>
<CAPTION>
DELAWARE 61-1055020
<S> <C>
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
</TABLE>

<TABLE>
<S> <C>
3300 AEGON CENTER
400 WEST MARKET STREET
LOUISVILLE, KENTUCKY 40202
(Address of principal executive offices) (Zip Code)
</TABLE>

(502) 596-7300
(Registrant's telephone number, including area code)

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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:

<TABLE>
<CAPTION>
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
<S> <C>
Common Stock, par value $.25 per share New York Stock Exchange
</TABLE>

SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:

None

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K ((S)229.405 of this chapter) is not contained herein,
and will not be contained, to the best of Registrant's knowledge, in
definitive proxy or information statements incorporated by reference in Part
III of this Form 10-K or any amendment of this Form 10-K. [X]

As of February 27, 1998, there were 67,468,848 shares of the Registrant's
Common Stock, $.25 par value, outstanding. The aggregate market value of the
shares of the Registrant held by non-affiliates of the Registrant, based on
the closing price of such stock on the New York Stock Exchange on February 27,
1998, was approximately $1,820,047,000. For purposes of the foregoing
calculation only, all directors and executive officers of the Registrant have
been deemed affiliates.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's Proxy Statement for the Annual Meeting of
Stockholders to be held on April 23, 1998 are incorporated by reference into
Part III of this Form 10-K.

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TABLE OF CONTENTS

<TABLE>
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PAGE
----
<S> <C> <C>
PART I
Item 1. Business.............................................................................. 3
Item 2. Properties............................................................................ 27
Item 3. Legal Proceedings..................................................................... 27
Item 4. Submission of Matters to a Vote of Security Holders................................... 28
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters................. 31
Item 6. Selected Financial Data............................................................... 32
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. 33
Item 7A. Quantitative and Qualitative Disclosures About Market Risk............................ 41
Item 8. Financial Statements and Supplementary Data........................................... 41
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.. 41
PART III
Item 10. Directors and Executive Officers of the Registrant.................................... 41
Item 11. Executive Compensation................................................................ 41
Item 12. Security Ownership of Certain Beneficial Owners and Management........................ 41
Item 13. Certain Relationships and Related Transactions........................................ 41
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K....................... 41
</TABLE>

2
PART I

ITEM 1. BUSINESS

GENERAL

Vencor, Inc. ("Vencor" or the "Company") is one of the largest providers of
long-term healthcare services in the United States. At December 31, 1997, the
Company's operations included 60 long-term acute care hospitals containing
5,273 licensed beds, 309 nursing centers containing 40,383 licensed beds, and
the Vencare contract services business which provides respiratory and
rehabilitation therapies and medical and pharmacy management services to
approximately 2,900 healthcare facilities. The Company currently operates in
46 states. Healthcare services provided through this network include long-term
hospital care, nursing care, contract respiratory therapy services, subacute
and post-operative care, in-patient and out-patient rehabilitation therapy,
specialized care for Alzheimer's disease, hospice care, home healthcare and
pharmacy services. 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.

The Company was incorporated in Kentucky in 1983 as Vencare, Inc. and
commenced operations in 1985. It was reorganized as a Delaware corporation in
1987 and changed its name to Vencor, Incorporated in 1989 and to Vencor, Inc.
in 1993. On September 28, 1995, The Hillhaven Corporation ("Hillhaven") merged
with and into the Company (the "Hillhaven Merger"). On March 21, 1997, the
Company acquired TheraTx, Incorporated ("TheraTx"), a provider of subacute
rehabilitation and respiratory therapy program management services to nursing
centers and an operator of 26 nursing centers. On June 24, 1997, the Company
acquired Transitional Hospitals Corporation ("Transitional"), an operator of
16 long-term acute care hospitals and three satellite facilities located in 13
states.

In January 1998, the Board of Directors authorized management to proceed
with a plan to separate the Company into two publicly held corporations, one
to operate the hospital, nursing center and Vencare businesses ("Operating
Company") and the other to own substantially all of the real property of the
Company ("Realty Company") and to lease such real property to Operating
Company (the "Reorganization Transactions"). Realty Company intends to become
a real estate investment trust for Federal income tax purposes beginning
January 1, 1999. The Reorganization Transactions will be effected through the
issuance to the Company's common stockholders of all of the outstanding shares
of Operating Company (the "Distribution"). Following the Distribution, Realty
Company will be named VenTrust, Inc. and Operating Company will assume the
name of Vencor, Inc. The Reorganization Transactions and the Distribution are
contingent upon, among other things, stockholder approval, regulatory and
other approvals, tax considerations and the consummation of a capitalization
plan for each entity. The Company filed a preliminary proxy statement
concerning the Reorganization Transactions and the Distribution with the
Securities and Exchange Commission on January 30, 1998. Management anticipates
that the Reorganization Transactions and Distribution will be completed in the
second quarter of 1998.

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
medical complications 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.

3
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 to develop 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 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 business or the operations of a facility
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 these facilities.


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

During 1997, the Company initiated the sale of its Vencare full service
ancillary services contracts to provide a full range of services to nursing
centers not operated by the Company. Management believes that by bundling
services through one provider, nursing centers can provide quality patient
care more efficiently with the added benefit of centralizing their medical
records. Under the new prospective payment system imposed by the Balanced
Budget Act of 1997 (the "Budget Act"), ancillary services provided by nursing
centers will be subject to fixed payments. In this new environment, management
believes that its full service ancillary services contracts will enhance the
ability of nursing center operators to manage effectively the cost of
providing quality patient care.

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 patient
care. Prior to the acquisition of Transitional, the Company had installed
VenTouch(TM) in all of its hospitals. The Company

4
expects to install VenTouch(TM) in the 19 former Transitional hospitals during
1998. At December 31, 1997, 51 of the Company's nursing centers were utilizing
the VenTouch(TM) information system. The Company expects to install
VenTouch(TM) in 40 to 50 of its nursing centers during 1998. In addition, the
Company intends to offer VenTouch(TM) in connection with the services offered
by Vencare to nursing centers not operated 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 1997, the average length of stay for chronic patients
in the long-term care hospitals operated by the Company was approximately 43
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."

5
HOSPITAL FACILITIES

The following table lists by state the number of hospitals and related
licensed beds owned or leased from third parties by the Company as of December
31, 1997:

<TABLE>
<CAPTION>
NUMBER OF FACILITIES
-----------------------
LICENSED
STATE BEDS OWNED LEASED TOTAL
----- -------- ------ ------- ------
<S> <C> <C> <C> <C>
Arizona.............................. 109 2 - 2
California........................... 635 9 - 9
Colorado............................. 68 1 - 1
Florida(1)........................... 564 6 1 7
Georgia(1)........................... 72 - 1 1
Illinois(1).......................... 613 3 2 5
Indiana.............................. 159 2 1 3
Kentucky(1).......................... 374 1 - 1
Louisiana............................ 168 1 - 1
Massachusetts(1)..................... 86 2 - 2
Michigan(1).......................... 400 2 - 2
Minnesota............................ 111 1 - 1
Missouri(1).......................... 227 2 - 2
Nevada............................... 52 1 - 1
New Mexico........................... 61 1 - 1
North Carolina(1).................... 124 1 - 1
Ohio................................. 94 1 - 1
Oklahoma............................. 59 1 - 1
Pennsylvania......................... 115 2 - 2
Tennessee(1)......................... 49 1 - 1
Texas................................ 663 8 2 10
Virginia(1).......................... 206 1 - 1
Washington(1)........................ 80 1 - 1
Wisconsin............................ 184 2 1 3
1
----- ------ ------ ------
Totals............................. 5,273 52 8 60
===== ====== ====== ======
</TABLE>
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(1) These states have Certificate of Need ("CON") regulations. See "--
Governmental Regulation--Hospitals."

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 treatment programs. 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.

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


6
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 would 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 generally 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, speech therapists, pharmacists,
registered dietitians and social workers.

The physicians at the Company's hospitals generally are not employees of the
Company and may be members of the medical staff of other hospitals. Each of
the Company's hospitals has a fully credentialed, multi-

7
specialty medical staff to meet the needs of the clinically complex, long-term
acute patient. Typically, each patient is visited at least once a day by a
physician. A broad range of physician services is available including, but not
limited to, pulmonology, internal medicine, infectious diseases, neurology,
nephrology, cardiology, radiology and pathology. Generally, the Company does
not enter into exclusive contracts with physicians to provide services to its
hospital patients.

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 hospital is centralized at the corporate
headquarters through its management information system. Prior to the
acquisition of Transitional, the Company had installed its VenTouch(TM)
information system, an electronic patient medical record system, in all of its
hospitals. The Company expects to install VenTouch(TM) in the 19 former
Transitional hospitals during 1998. 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 programs for each hospital to identify opportunities to improve
patient care.

8
SELECTED HOSPITAL OPERATING DATA

The following table sets forth certain operating data for the Company's
hospitals:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Hospitals in operation at end of period........... 60 38 36
Number of licensed beds at end of period.......... 5,273 3,325 3,263
Patient days...................................... 767,810 586,144 489,612
Average daily census.............................. 2,104 1,601 1,341
Occupancy percentage.............................. 52.9% 53.7% 47.6%
</TABLE>

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 will generally
be 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 patient days and revenues derived from the payor sources
indicated:

<TABLE>
<CAPTION>
MEDICARE MEDICAID PRIVATE AND OTHER
---------------- ---------------- ---------------------
PATIENT PATIENT PATIENT
YEAR DAYS REVENUES DAYS REVENUES DAYS REVENUES
---- ------- -------- ------- -------- -------- ---------
<S> <C> <C> <C> <C> <C> <C>
1997............. 68% 63% 12% 8% 20% 29%
1996............. 64 59 17 12 19 29
1995............. 64 57 16 12 20 31
</TABLE>

For the year ended December 31, 1997, hospital revenues totaled
approximately $785.8 million, or 24.7% of the Company's total revenues.
Changes caused by the Budget Act will reduce the level of Medicare payments
made to the Company's hospitals by reducing incentive payments under the Tax
Equity and Fiscal Responsibility Act of 1982 ("TEFRA") and allowable costs of
capital expenditures and bad debts, and payments for services to patients
transferred from a PPS hospital. See "--Governmental Regulation--Healthcare
Reform Legislation."

HOSPITAL COMPETITION

As of December 31, 1997, the hospitals operated 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, 1997 there were approximately 180 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 general acute care hospitals and 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

9
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 non-government 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 typically provided by a nursing
center. The condition of patients in these nursing centers is less acute than
the condition of patients 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 December 31, 1997, the Company provided long-term care and subacute
medical and rehabilitation services in 309 nursing centers containing 40,383
licensed beds located in 32 states. At December 31, 1997, the Company owned
218 nursing centers and leased 78 nursing centers from third parties. The
Company also managed 13 nursing centers, including seven centers owned by
Tenet Healthcare Corporation ("Tenet"), which holds a greater than 10%
interest in the Company. During 1997, the Company completed the sale of 28 of
its underperforming or non-strategic nursing centers. One additional nursing
center was sold and one nursing center was closed in January 1998, and two
additional nursing centers are expected to be sold upon receipt of certain
regulatory approvals.

The Company's nursing centers provide 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 require 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 December 31, 1997, the
Company offered specialized programs covering approximately 3,100 beds in 88
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 payment
patients and Medicare patients.

10
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 staff
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 district and/or 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 patient and staff safety. Additionally,
physicians serve on the quality assurance committees as medical directors and
advise on healthcare policies and practices. Regional 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 patients' 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 patient 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:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Number of nursing centers in operation
at end of period...................... 309 313 311
Number of licensed beds at end of
period................................ 40,383 39,619 39,480
Patient days........................... 12,622,238 12,566,763 12,569,600
Average daily census................... 34,581 34,335 34,437
Occupancy percentage................... 90.5% 91.9% 92.2%
</TABLE>

SOURCES OF NURSING CENTER REVENUES

Nursing center revenues are derived principally from Medicare and Medicaid
programs and from private payment patients. Consistent with the nursing center
industry, 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

11
by such patients. The Company believes that private payment patients generally
constitute the most profitable category and Medicaid patients generally
constitute the least profitable category.

The following table sets forth the approximate percentages of the Company's
nursing center patient days and revenues derived from the payor sources
indicated:

<TABLE>
<CAPTION>
PRIVATE AND
MEDICARE MEDICAID OTHER
---------------- ---------------- ----------------
PATIENT PATIENT PATIENT
YEAR DAYS REVENUES DAYS REVENUES DAYS REVENUES
---- ------- -------- ------- -------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
1997...................... 13% 32% 65% 43% 22% 25%
1996...................... 12 30 65 44 23 26
1995...................... 12 29 65 44 23 27
</TABLE>

For the year ended December 31, 1997, nursing center revenues totaled
approximately $1.72 billion, or 54.1% 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. 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 new prospective payment system also will cover ancillary
services provided to nursing center patients under the Vencare contract
services business. 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 operated by the Company, or the provision of
services and supplies by the Company, will meet the requirements for
participation in such programs. 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 "--Governmental Regulation--Healthcare Reform
Legislation."

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.

Until the implementation of the new prospective payment system, nursing
center reimbursement will continue to be based upon reasonable direct and
indirect costs of services provided to beneficiaries. Under the Medicare
program, 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. 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

12
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, generally referred to as the Boren
Amendment, 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 arose between nursing centers and states regarding
the adequacy of Medicaid payments. By repealing the Boren Amendment, the
Budget Act eases the impediments on the states' ability to reduce their
Medicaid reimbursement levels for such services. In addition, 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 many of these programs
may not be sufficient on an overall basis to cover the costs of serving
certain 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 patients 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 payment 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.

13
NURSING CENTER FACILITIES

The following table lists by state the number of nursing centers and related
licensed beds operated by the Company as of December 31, 1997:

<TABLE>
<CAPTION>
NUMBER OF FACILITIES
--------------------------
LICENSED
STATE BEDS OWNED LEASED MANAGED TOTAL
- ----- -------- ----- ------ ------- -----
<S> <C> <C> <C> <C> <C>
Alabama(1).................................. 592 3 1 - 4
Arizona..................................... 827 5 1 - 6
California.................................. 2,516 13 6 2 21
Colorado.................................... 935 4 3 - 7
Connecticut(1).............................. 983 8 - - 8
Florida(1).................................. 2,828 16 3 2 21
Georgia(1).................................. 1,336 4 6 - 10
Idaho....................................... 903 8 1 - 9
Indiana(1).................................. 4,152 14 12 - 26
Kentucky(1)................................. 2,089 13 4 - 17
Louisiana(1)................................ 485 - 1 2 3
Maine(1).................................... 882 11 - - 11
Massachusetts(1)............................ 4,232 33 3 2 38
Minnesota................................... 159 1 - - 1
Mississippi(1).............................. 125 - 1 - 1
Montana(1).................................. 456 2 1 - 3
Nebraska(1)................................. 167 - 1 - 1
Nevada(1)................................... 288 3 - - 3
New Hampshire(1)............................ 622 3 - 1 4
North Carolina(1)........................... 3,212 20 8 - 28
Ohio(1)..................................... 2,161 11 4 1 16
Oregon(1)................................... 358 2 1 - 3
Pennsylvania................................ 200 1 1 - 2
Rhode Island(1)............................. 201 2 - - 2
Tennessee(1)................................ 2,541 4 11 - 15
Texas....................................... 623 1 1 1 3
Utah........................................ 848 5 1 1 7
Vermont(1).................................. 310 1 - 1 2
Virginia(1)................................. 764 4 1 - 5
Washington(1)............................... 1,504 10 3 - 13
Wisconsin(1)................................ 2,633 12 3 - 15
Wyoming..................................... 451 4 - - 4
------ --- --- --- ---
Totals................................... 40,383 218 78 13 309
====== === === === ===
</TABLE>
- --------
(1) These states have CON regulations. See "--Governmental Regulation--Nursing
Centers."

14
VENCARE HEALTH SERVICES OPERATIONS

Through its Vencare health services operations, 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 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, 1997, revenues from
the Vencare operations totaled approximately $642.5 million which represented
20.2% of the Company's total revenues.

During 1997, the Company initiated the sale of its Vencare full-service
ancillary services contracts to provide a full range of ancillary services to
nursing centers not operated by the Company. Management believes that by
bundling services through one provider, nursing centers can provide quality
patient care more efficiently with the added benefit of centralizing their
medical records. Under the new prospective payment system imposed by the
Budget Act, ancillary services provided by nursing centers will be subject to
fixed payments. In this new environment, the Company believes that its full-
service ancillary services contract will enhance the ability of nursing center
operators to manage effectively the cost of providing quality patient care.

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 third-party payor. Respiratory therapy and supplies are
generally covered under the Medicare program. 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 December 31, 1997, the Company had entered into contracts to provide
respiratory therapy services and supplies to approximately 1,600 nursing and
subacute care centers, which includes approximately 300 nursing centers
operated by the Company.

SUBACUTE SERVICES

At December 31, 1997, the Company had entered into contracts to provide
subacute care services to 11 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 December 31, 1997, the Company had entered into contracts
to provide rehabilitation services to patients at 400 facilities.

15
HOSPICE SERVICES

The Company provides hospice services to nursing center patients, hospital
patients and persons in private residences. At December 31, 1997, the Company
had entered into approximately 275 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.

HOME CARE SERVICES

During 1996, the Company consolidated its home care services business to
establish Vencor Home Care 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 December 31, 1997,
the Company provided services from 28 locations in 13 states. For the year
ended December 31, 1997, home care services generated approximately $19.3
million in revenues, representing less than 1% of the Company's total
revenues.

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. In addition, many nursing
centers are developing internal staff to provide those services, particularly
in response to the planned implementation of the new prospective payment
system for nursing centers.

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 over 600 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. During 1997, the
Company sold or closed all of its retail pharmacies except one which is in the
process of being sold. The discontinuance of the retail pharmacy operations in
1997 did not have a material adverse effect on Vencare's operations.



16
MANAGEMENT INFORMATION SYSTEM

The financial information for each of the Company's facilities is
centralized at the corporate headquarters through its management information
system. The Company uses a comprehensive financial reporting system which
enables it to monitor 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.

Prior to the acquisition of Transitional, the Company had completed the
installation of VenTouch(TM) information system in its hospitals. The Company
expects to install VenTouch(TM) in the 19 former Transitional hospitals during
1998. At December 31, 1997, 51 of the Company's nursing centers were utilizing
the VenTouch(TM) information system. The Company expects to install
VenTouch(TM) in 40 to 50 of its nursing centers during 1998. In addition, the
Company intends to offer VenTouch(TM) in connection with the services offered
by Vencare to nursing centers not operated 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
December 31, 1997, Florida, Georgia, Illinois, Kentucky, Massachusetts,
Michigan, Missouri, 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
respective growth and businesses 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.


17
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 are 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 December 31, 1997, all of the Company's hospitals
were certified as Medicare providers and 53 of such 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, it takes 60 days or more for
PPS payments to be made. 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
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 Budget Act makes
significant changes to the current TEFRA provisions.

Prior to the Budget Act, Medicare operating costs per discharge in excess of
the Target were reimbursed at the rate of 50% of the excess up to 10% of the
Target. Hospitals whose operating costs were lower than the Target were
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 hospitals using 1996 data.

Prior to October 1, 1997, new hospitals could 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.

18
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 unlimited 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 adjusted for inflation.
During this two year period, providers remain subject to the TEFRA penalty and
incentive payments discussed in the previous paragraph.

As of December 31, 1997, 50 of the hospitals operated by the Company were
subject to TEFRA Target provisions. The Company's other long-term hospitals
were not subject to TEFRA because they had qualified for the new hospital
exemptions described above. During 1998, five 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 operations, and
the Company does not expect that the TEFRA limits will have a material adverse
effect on its results of operations in 1998. The reductions in the TEFRA
incentive payments, which are expected to be effective beginning on September
1, 1998 with respect to the Company's hospitals, will have an adverse impact
on hospital revenues in the future.

Medicare and Medicaid reimbursements were 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 a material adverse effect on the Company's hospital operating
results.

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 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 (as hereinafter defined) 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 the Federal and state levels.

19
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 December 31, 1997, 58 of
the hospitals operated by the Company 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 the
Company's results of operations.

State Regulatory Environment. The Company 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, nine 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 eases the impediments on the states' ability 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 will consider
the regulatory environment, including but not limited to, any mandated rate
setting.

NURSING CENTERS

The Company's nursing center business is subject to various Federal and
state regulations. In particular, the development and operation of nursing
centers 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. 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.

The 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

20
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 nursing centers receive statements of deficiencies from regulatory
agencies. In response, the Company will implement plans of correction with
respect to these nursing centers to address the alleged deficiencies. The
Company believes that its nursing centers are currently 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 ("HCFA") 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 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 incurrence of certain capital
expenditures. Certain states also require regulatory approval prior to certain
changes in ownership of a nursing center. Certain states 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 the Company's operations, either through facility acquisitions,
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. The Company's 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. See "--Nursing Center
Operations--Sources of Nursing Center Revenues." 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.

21
PHARMACIES

The Company's 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 LEGISLATION

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 the projected amount of increase in 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 will be 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 will affect 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, allowable costs for capital expenditures
and bad debts, and payments for services to patients transferred from a PPS
hospital. The reductions in allowable costs for capital expenditures became
effective October 1, 1997. The reductions in the TEFRA incentive payments and
allowable costs for bad debts are expected to be effective beginning on
September 1, 1998 with respect to the Company's hospitals. The reductions for
payments for services to patients transferred from a PPS hospital are expected
to be effective October 1, 1998. 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 payments received under the new prospective
payment system will cover all services for Medicare patients, including all
ancillary services, such as respiratory therapy, physical therapy,
occupational therapy, speech therapy and certain covered drugs. The Budget Act
also requires an adjustment to the payment system for home health services for
cost reporting periods beginning on or after October 1, 1997. The new system
will adjust per visit limits and establish per beneficiary annual spending
limits. A prospective payment system for home health services will be
established by October 1, 1999.

Management believes that the Budget Act will adversely impact its hospital
business by reducing the payments previously described. Based on information
currently available, management believes that the new prospective payment
system will benefit nursing center operations because (i) management believes
that the average acuity levels of its patients will exceed the national
average (which should result in increased payments per patient day) and (ii)
because the Company expects to benefit from its ability to reduce the cost of
providing ancillary services to patients in its facilities. The new Medicare
prospective payment rates and related patient acuity measures will be
established by HCFA, and as of the date hereof the Company does not know what
these amounts will be. Management believes that its anticipated growth in
nursing center profitability would be reduced if Congress acts to delay the
effective date of the prospective payment system. As the nursing center
industry adapts to the cost containment measures inherent in the new
prospective payment system, management believes that the volume of ancillary
services provided per patient day to nursing center patients could decline. In
addition, as a result of these changes, many nursing centers may elect to
provide ancillary services to their patients through internal staff and will
no longer contract with outside parties for ancillary services. For these
reasons and others, since the enactment of the Budget Act, sales of new
contracts have declined and may continue to decline subject to the Company's
success in implementing its Vencare comprehensive, full-service

22
contracts sales strategy. The Company is actively implementing strategies and
operational modifications to address changes in the Federal reimbursement
system.

In January 1998, HCFA issued rules changing Medicare reimbursement
guidelines for therapy services provided by the Company (including the
rehabilitation contract therapy business acquired as part of the acquisition
of TheraTx). Under the new rules, HCFA established salary equivalency limits
for speech and occupational therapy services and revised existing limits for
physical and respiratory therapy services. The limits 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. The
new limits are effective for services provided on or after April 1, 1998 and
are expected to impact negatively Vencare operating results in 1998. The
Company will continue to charge client nursing centers in accordance with the
revised guidelines until such nursing centers transition to the new
prospective payment system. Under the new prospective payment system, the
reimbursement for these services provided to nursing center patients will be a
component of the total reimbursement allowed per nursing center patient and
the salary equivalency guidelines will no longer be applicable. Most of the
Company's client nursing centers are expected to transition to the new
prospective payment system on or before January 1, 1999.

There also continues 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 applicable to the Company's 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 existing impediments on the states'
ability to reduce their Medicaid reimbursement levels.

There can be no assurance that the Budget Act, new 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.

ADDITIONAL COMPANY INFORMATION

EMPLOYEES

As of December 31, 1997, the Company had approximately 52,800 full-time and
24,000 part-time and per diem employees. The Company was a party to 27
collective bargaining agreements covering approximately 2,550 employees as of
December 31, 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 is reinsured for losses in excess of $500,000 per claim and $8.5
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.

23
CAUTIONARY STATEMENTS

This Report includes forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). All
statements regarding the Company's expected future financial position, results
of operations, cash flows, dividends, financing plans, business strategy,
budgets, projected costs and capital expenditures, competitive positions,
growth opportunities, plans and objectives of management for future operations
and words such as "anticipate," "believe," "plan," "estimate," "expect,"
"intend," and other similar expressions are forward-looking statements. Such
forward-looking statements are inherently uncertain, and stockholders must
recognize that actual results may differ from the Company's expectations as a
result of a variety of factors, including, without limitation, the following:

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 1997 and
1996, the Company derived approximately 60% and 62% of its total revenues from
the Medicare and Medicaid programs, respectively. Such programs are highly
regulated and subject to frequent and substantial changes. The Budget Act is
intended to reduce the increase in 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 to be 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 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.
In the ordinary course of its business, the Company is subject regularly to
inquiries, investigations and audits by the Federal and state agencies that
oversee these laws and regulations.

Pursuant to the Medicare and Medicaid Patient and Program Protection Act of
1987, 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

24
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 little judicial or
regulatory interpretation exists. 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. CONs, 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 11 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 the projected amount of increase in
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 will be 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 will affect 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, allowable costs for capital expenditures
and bad debts, and payments for services to patients transferred from a PPS
hospital. The reductions in allowable costs for capital expenditures became
effective October 1, 1997. The reductions in the TEFRA incentive payments and
allowable costs for bad debts are expected to be effective beginning on
September 1, 1998 with respect to the Company's hospitals. The reductions for
payments for services to patients transferred from a PPS hospital are expected
to be effective October 1, 1998. 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 payments received under the new prospective
payment system will cover all services for Medicare patients including all

25
ancillary services, such as respiratory therapy, physical therapy,
occupational therapy, speech therapy and certain covered drugs. The Budget Act
also requires an adjustment to the payment system for home health services for
cost reporting periods beginning on or after October 1, 1997. The new system
will adjust per visit limits and establish per beneficiary annual spending
limits. A prospective payment system for home health services will be
established by October 1, 1999.

Management believes that the Budget Act will adversely impact its hospital
business by reducing the payments previously described. Based on information
currently available, management believes that the new prospective payment
system will benefit nursing center operations because (i) management believes
that the average acuity levels of its patients will exceed the national
average (which should result in increased payments per patient day) and (ii)
because the Company expects to benefit from its ability to reduce the cost of
providing ancillary services to patients in its facilities. The new Medicare
prospective payment rates and related patient acuity measures will be
established by HCFA, and as of the date hereof the Company does not know what
these amounts will be. Management believes that its anticipated growth in
nursing center profitability would be reduced if Congress acts to delay the
effective date of the prospective payment system. As the nursing center
industry adapts to the cost containment measures inherent in the new
prospective payment system, management believes that the volume of ancillary
services provided per patient day to nursing center patients could decline. In
addition, as a result of these changes, many nursing centers may elect to
provide ancillary services to their patients through internal staff and will
no longer contract with outside parties for ancillary services. For these
reasons and others, since the enactment of the Budget Act, sales of new
contracts have declined and may continue to decline subject to the Company's
success in implementing its Vencare comprehensive, full-service contracts
sales strategy. The Company is actively implementing strategies and
operational modifications to address changes in the Federal reimbursement
system.

In January 1998, HCFA issued rules changing Medicare reimbursement
guidelines for therapy services provided by the Company (including the
rehabilitation contract therapy business acquired as part of the acquisition
of TheraTx). Under the new rules, HCFA established salary equivalency limits
for speech and occupational therapy services and revised existing limits for
physical and respiratory therapy services. The limits are based on a blend of
data from wage rates for hospitals and nursing centers, 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. The
new limits are effective for services provided on or after April 1, 1998 and
are expected to impact negatively Vencare operating results in 1998. The
Company will continue to charge client nursing centers in accordance with the
revised guidelines until such nursing centers transition to the new
prospective payment system. Under the new prospective payment system, the
reimbursement for these services provided to nursing center patients will be a
component of the total reimbursement allowed per nursing center patient and
the salary equivalency guidelines will no longer be applicable. Most of the
Company's client nursing centers are expected to transition to the new
prospective payment system on or before January 1, 1999.

There also continues 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 applicable to the Company's 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 existing impediments on the states'
ability to reduce their Medicaid reimbursement levels.

There can be no assurance that the Budget Act, new 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.

26
HIGHLY COMPETITIVE INDUSTRY

The healthcare services industry is highly competitive. The Company faces
competition from general acute care hospitals and 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. The Company may experience increased competition from existing
hospitals as well as hospitals converted, in whole or in part, 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 operations. It is also expected that the Company will continue
to compete with other healthcare companies for the acquisition and development
of additional hospitals, nursing facilities and other healthcare assets and
businesses.

ABILITY 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. 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 acquired entities 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.

ITEM 2. PROPERTIES

For information concerning the hospitals and nursing centers operated by the
Company, see "Business--Hospital Operations--Hospital Facilities," and
"Business--Nursing Center Operations--Nursing Center Facilities." The Company
believes that its facilities are adequate for the Company's future needs in
such locations.

ITEM 3. LEGAL PROCEEDINGS

A class action lawsuit entitled A. Carl Helwig v. Vencor, Inc., et al. was
filed on December 24, 1997 in the United States District Court for the Western
District of Kentucky (Civil Action No. 3-97CV-8354). The class action claims
were brought by an alleged stockholder of the Company against the Company and
certain executive officers and directors of the Company, namely W. Bruce
Lunsford, W. Earl Reed, III, Michael R. Barr, Thomas T. Ladt, Jill L. Force
and James H. Gillenwater, Jr. The complaint alleges that the Company and
certain executive officers of the Company during a specified time frame
violated Sections 10(b) and 20(a) of the Exchange Act, by, among other things,
issuing to the investing public a series of false and misleading statements
concerning the Company's current operations and the inherent value of the
Company's Common Stock. The complaint further alleges that as a result of
these purported false and misleading statements concerning the Company's
revenues and successful acquisitions, the price of the Company's Common Stock
was artificially inflated. In particular, the complaint alleges that the
Company issued false and misleading financial statements during the first,
second and third calendar quarters of 1997 which misrepresented and
understated the impact that changes in Medicare reimbursement policies would
have on the Company's core services and profitability. The complaint further
alleges that the Company issued a series of materially false statements
concerning the purportedly successful integration of its recent acquisitions
and prospective earnings per share for 1997 and 1998 which the Company knew
lacked any reasonable basis and were not being achieved. The suit seeks
damages in an amount to be proven at trial, pre-judgment and post-judgment
interest, reasonable attorneys' fees, expert witness fees and other costs, and
any extraordinary equitable and/or injunctive relief permitted by law or
equity to assure that the plaintiff has an effective remedy. The Company
believes that the allegations in the complaint are without merit and intends
to defend vigorously this action.

27
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 consisting of
all persons who sold shares of Transitional common stock during the period from
February 26, 1997 through May 4, 1997, inclusive. The complaint alleges that
Transitional purchased 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 disclosing 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
Exchange Act and common law principles of negligent misrepresentation and names
as defendants Transitional as well as certain senior executives and directors
of Transitional. The plaintiff seeks class certification, unspecified damages,
attorneys' fees and costs. The Company has filed a motion to dismiss and is
awaiting the court's decision. The Company is vigorously defending this action.

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 provided 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 suit seeks damages in an amount of not
less than $1,000,000, treble damages and civil penalties. The Company is
cooperating fully in the investigation.

On June 6, 1997, Transitional 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 (the "USAO") arising
from activities of Transitional'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 Transitional. Transitional spun off its dialysis business, now called Vivra
Incorporated, on September 1, 1989. In January 1998, the Company was informed
that no criminal charges would be filed against the Company. The Company has
been informed that the USAO intends to file a civil action against Transitional
relating to the partnership's former business. If such a suit is filed, the
Company will vigorously defend the action.

As is typical in the healthcare industry, the Company is subject to claims
and legal actions by patients and others in the ordinary course of business.
The Company believes that all such claims and actions currently pending against
it either are adequately covered by insurance or would not have a material
adverse effect on the Company if decided in a manner unfavorable to the
Company. In addition, the Company is subject regularly to inquiries,
investigations and audits by Federal and state agencies that oversee various
healthcare regulations and laws.

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

Not applicable.

28
EXECUTIVE OFFICERS OF THE REGISTRANT

Set forth below are the names, ages (as of January 1, 1998) and present and
past positions of the persons who are the current executive officers of the
Company.

NAME AND AGE

PRESENT AND PAST POSITIONS

W. Bruce Lunsford, 50........ A founder of the Company, certified public
accountant and attorney, Mr. Lunsford 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, 48.......... A founder of the Company, physical therapist
and certified respiratory therapist, Mr. Barr
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. Mr. Barr has been an
executive officer of the Company since 1985.

W. Earl Reed, III, 46........ A certified public accountant, Mr. Reed 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. Mr. Reed has been
an executive officer of the Company since 1987.

Thomas T. Ladt, 47........... Mr. 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. Mr. Ladt has been an
executive officer of the Company since 1993.

29
NAME AND AGE

PRESENT AND PAST POSITIONS

Jill L. Force, 45............ Ms. Force, a certified public accountant and
attorney, has served as Senior Vice President,
General Counsel and Assistant Secretary of the
Company since January 1, 1998. From December
1996 to January 1998, she served as Senior Vice
President, General Counsel and Secretary of the
Company. From November 1995 through December
1996, she served as Vice President, General
Counsel and Secretary of the Company. From 1989
to 1995, she was General Counsel and Secretary
of the Company. Ms. Force is a director of
Healthcare Recoveries, Inc., a provider of
health insurance subrogation and related
recovery services. Ms. Force has been an
executive officer of the Company since 1995.

Richard E. Chapman, 48....... Mr. Chapman has served as Senior Vice President
and Chief Information Officer of the Company
since October 1997. From March 1993 to October
1997, Mr. Chapman was Senior Vice President of
Information Systems of Columbia/HCA Healthcare
Corp., Vice President of Galen Health Care,
Inc. from March 1993 to August 1993, and of
Humana Inc. from 1974 to March 1993.
Mr. Chapman has been an executive officer of
the Company since 1997.

James H. Gillenwater, Jr., Mr. Gillenwater has served as Senior Vice
40........................... 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. Mr. Gillenwater has been an executive
officer of the Company since 1995.

Richard A. Lechleiter, 39.... Mr. 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.
Mr. Lechleiter has been an executive officer of
the Company since 1995.

30
PART II

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

MARKET PRICE FOR COMMON STOCKAND DIVIDEND HISTORY

The Company's Common Stock is traded on the New York Stock Exchange (NYSE)
under the ticker symbol of VC. The Company has approximately 40,000
stockholders based on the number of record holders of Common Stock and an
estimate of the number of individual participants represented by security
position listings. The prices in the table below, for the calendar quarters
indicated, represent the high and low sales prices for the Common Stock as
reported by the NYSE Composite Tape. No cash dividends have been paid on the
Common Stock during such period.

The Company does not intend to pay cash dividends on its Common Stock for
the foreseeable future so that it may reinvest its earnings in the development
of its business and reduce indebtedness. The payment of dividends in the
future will be at the discretion of the Board of Directors. Restrictions
imposed by the Company's existing debt obligations also may limit the payment
of dividends by the Company.

<TABLE>
<CAPTION>
SALES PRICE
OF
CALENDAR YEAR COMMON STOCK
------------- -----------------
HIGH LOW
------ ------
<S> <C> <C>
1996:
First Quarter....................... $39 7/8 $31 1/2
Second Quarter...................... 35 28 1/8
Third Quarter....................... 34 1/2 25 1/2
Fourth Quarter...................... 33 1/4 27 1/2
1997:
First Quarter....................... 40 3/8 29
Second Quarter...................... 45 1/8 36 5/8
Third Quarter....................... 44 3/8 37 3/8
Fourth Quarter...................... 43 5/16 23
</TABLE>

31
ITEM 6.  SELECTED FINANCIAL DATA

VENCOR, INC.
SELECTED FINANCIAL DATA
AS OF AND FOR THE YEARS ENDED DECEMBER 31
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS AND STATISTICS)
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Revenues................ $3,116,004 $2,577,783 $2,323,956 $2,032,827 $1,727,436
---------- ---------- ---------- ---------- ----------
Salaries, wages and
benefits............... 1,788,053 1,490,938 1,360,018 1,167,181 985,163
Supplies................ 303,140 261,621 233,066 216,587 186,473
Rent.................... 89,474 77,795 79,476 79,371 74,323
Other operating
expenses............... 490,327 405,797 372,657 312,087 270,014
Depreciation and
amortization........... 123,865 99,533 89,478 79,519 69,126
Interest expense........ 102,736 45,922 60,918 62,828 73,559
Investment income....... (6,057) (12,203) (13,444) (13,126) (16,056)
Non-recurring
transactions........... - 125,200 109,423 (4,540) 5,769
---------- ---------- ---------- ---------- ----------
2,891,538 2,494,603 2,291,592 1,899,907 1,648,371
---------- ---------- ---------- ---------- ----------
Income before income
taxes.................. 224,466 83,180 32,364 132,920 79,065
Provision for income
taxes.................. 89,338 35,175 24,001 46,781 10,089
---------- ---------- ---------- ---------- ----------
Income from operations.. 135,128 48,005 8,363 86,139 68,976
Extraordinary loss on
extinguishment of debt,
net of income taxes.... (4,195) - (23,252) (241) (2,217)
Cumulative effect on
prior years of a change
in accounting for
income taxes........... - - - - (1,103)
---------- ---------- ---------- ---------- ----------
Net income (loss)..... $ 130,933 $ 48,005 $ (14,889) $ 85,898 $ 65,656
========== ========== ========== ========== ==========
Earnings (loss) per
common share:
Basic:
Income from operations. $ 1.96 $ 0.69 $ 0.22 $ 1.41 $ 1.28
Extraordinary loss on
extinguishment of
debt.................. (0.06) - (0.38) - (0.04)
Cumulative effect on
prior years of a
change in accounting
for income taxes...... - - - - (0.02)
---------- ---------- ---------- ---------- ----------
Net income (loss)..... $ 1.90 $ 0.69 $ (0.16) $ 1.41 $ 1.22
========== ========== ========== ========== ==========
Diluted:
Income from operations. $ 1.92 $ 0.68 $ 0.29 $ 1.28 $ 1.22
Extraordinary loss on
extinguishment of
debt.................. (0.06) - (0.32) - (0.04)
Cumulative effect on
prior years of a
change in accounting
for income taxes...... - - - - (0.02)
---------- ---------- ---------- ---------- ----------
Net income (loss)..... $ 1.86 $ 0.68 $ (0.03) $ 1.28 $ 1.16
========== ========== ========== ========== ==========
Shares used in comput-
ing earnings (loss)
per common share:
Basic.................. 68,938 69,704 61,196 55,522 51,985
Diluted................ 70,359 70,702 71,967 69,014 60,640
FINANCIAL POSITION:
Working capital......... $ 445,086 $ 320,123 $ 239,666 $ 129,079 $ 114,339
Assets.................. 3,334,739 1,968,856 1,912,454 1,656,205 1,563,350
Long-term debt.......... 1,919,624 710,507 778,100 746,212 784,801
Stockholders' equity.... 905,350 797,091 772,064 596,454 485,550
OPERATING DATA:
Number of hospitals..... 60 38 36 33 26
Number of hospital
licensed beds.......... 5,273 3,325 3,263 2,511 2,198
Number of hospital
patient days........... 767,810 586,144 489,612 403,623 293,367
Number of nursing
centers................ 309 313 311 310 325
Number of nursing center
licensed beds.......... 40,383 39,619 39,480 39,423 40,759
Number of nursing center
patient days........... 12,622,238 12,566,763 12,569,600 12,654,016 12,770,435
Number of Vencare
contracts.............. 3,877 4,346 4,072 2,648 1,628
</TABLE>

32
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

The Selected Financial Data in Item 6 and the consolidated financial
statements included in this Report 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.

GENERAL

The Company is one of the largest providers of long-term healthcare services
in the United States. At December 31, 1997, the Company operated 60 long-term
acute care hospitals (5,273 licensed beds), 309 nursing centers (40,383
licensed beds) and the Vencare contract services business which primarily
provides respiratory and rehabilitation therapies, medical services and
pharmacy management services to approximately 2,900 healthcare facilities.

HILLHAVEN MERGER. 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 independent and
assisted 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 a merger with
Nationwide Care, Inc. ("Nationwide") (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 independent and assisted
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 the Nationwide Merger have been accounted for by the
pooling-of-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.

STOCK OFFERINGS OF ATRIA. In August 1996, the Company completed the initial
public offering of Atria Communities, Inc. ("Atria"), its independent and
assisted living business, through the issuance of 5,750,000 shares of Atria
common stock (the "Atria IPO"). For accounting purposes, the accounts of Atria
continued to be consolidated with those of the Company and minority interests
in the earnings and equity of Atria were recorded from the consummation date
of the Atria IPO through June 30, 1997. In July 1997, Atria completed a
secondary equity offering which reduced the Company's ownership percentage to
less than 50%. Accordingly, the Company's investment in Atria beginning July
1, 1997 has been accounted for under the equity method. At December 31, 1997,
the Company owned 10,000,000 shares, or approximately 43%, of Atria's
outstanding common stock. See Note 4 of the Notes to Consolidated Financial
Statements for a description of the Atria stock offerings.

THERATX MERGER. On March 21, 1997, the merger with TheraTx was completed
following a cash tender offer (the "TheraTx Merger"). At the time of the
TheraTx Merger, TheraTx primarily provided rehabilitation and respiratory
therapy management services and operated 26 nursing centers. Annualized
revenues approximated $425 million.

The TheraTx Merger has been accounted for by the purchase method, which
requires that the accounts of acquired entities be included with those of the
Company since the acquisition of a controlling interest. Accordingly, the
accompanying consolidated financial statements include the operations of
TheraTx since March 21, 1997. See Note 5 of the Notes to Consolidated
Financial Statements for a description of the
TheraTx Merger.

TRANSITIONAL MERGER. On June 24, 1997, the Company acquired approximately
95% of the outstanding common stock of Transitional through a cash tender
offer, after which time the operations of Transitional were consolidated with
those of the Company in accordance with the purchase method of accounting. On
August 26,

33
1997, the merger with Transitional was completed (the "Transitional Merger").
At the time of the Transitional Merger, Transitional operated 19 long-term
acute care hospitals and provided respiratory therapy management services.
Annualized revenues approximated $350 million. In addition, Transitional owns
a 44% voting equity interest (61% ownership interest) in Behavorial Healthcare
Corporation, an operator of psychiatric and behavioral clinics. See Note 6 of
the Notes to Consolidated Financial Statements for a description of the
Transitional Merger.

RESULTS OF OPERATIONS

A summary of key operating data follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
REVENUES (IN THOUSANDS):
Hospitals............................... $ 785,829 $ 551,268 $ 456,486
Nursing centers......................... 1,722,416 1,615,141 1,512,679 (a)
Vencare................................. 642,471 399,068 316,254
Atria................................... 31,199 51,846 47,976
---------- ---------- ----------
3,181,915 2,617,323 2,333,395
Elimination............................. (65,911) (39,540) (9,439)
---------- ---------- ----------
$3,116,004 $2,577,783 $2,323,956
========== ========== ==========
HOSPITAL DATA:
Revenue mix %:
Medicare............................... 63.0 59.4 57.5
Medicaid............................... 8.1 12.3 11.7
Private and other...................... 28.9 28.3 30.8
Patient days:
Medicare............................... 520,144 375,128 314,009
Medicaid............................... 96,490 97,521 76,781
Private and other...................... 151,176 113,495 98,822
---------- ---------- ----------
767,810 586,144 489,612
========== ========== ==========
Average daily census.................... 2,104 1,601 1,341
Occupancy %............................. 52.9 53.7 47.6
NURSING CENTER DATA:
Revenue mix %:
Medicare............................... 32.1 29.7 28.6
Medicaid............................... 42.9 44.3 44.5
Private and other...................... 25.0 26.0 26.9
Patient days:
Medicare............................... 1,610,470 1,562,645 1,511,259
Medicaid............................... 8,152,503 8,191,450 8,146,881
Private and other...................... 2,859,265 2,812,668 2,911,460
---------- ---------- ----------
12,622,238 12,566,763 12,569,600
========== ========== ==========
Average daily census.................... 34,581 34,335 34,437
Occupancy %............................. 90.5 91.9 92.2
ANCILLARY SERVICES DATA:
End of period data:
Number of Vencare single service con-
tracts................................ 3,846 4,346 4,072
Number of Vencare full service con-
tracts................................ 31 - -
---------- ---------- ----------
3,877 4,346 4,072
========== ========== ==========
</TABLE>
- --------
(a) Includes a charge of $24.5 million recorded in connection with the
Hillhaven Merger.

Hospital revenues increased in both 1997 and 1996 from the acquisition of
facilities and growth in same-store patient days. Hospital patient days rose
31% to 767,810 in 1997 and 20% to 586,144 in 1996. Same-store patient days
grew 6% in 1997. Revenues attributable to the Transitional Merger were $138.9
million. Hospital revenues in 1997 were also favorably impacted by increases
in both Medicare and private patient days (for which payment rates are
generally higher than Medicaid) and a decline in Medicaid patient days. Price
increases in both 1997 and 1996 were not significant.

34
During 1997, the Company sold 28 under-performing or non-strategic nursing
centers and acquired 26 nursing centers in connection with the TheraTx Merger.
Excluding the effect of these sales and acquisitions, nursing center revenues
increased 3%, while patient days declined 2%. The increase in same-store
nursing center revenues resulted primarily from price increases and a 3%
increase in Medicare patient days.

Excluding the effect of sales and acquisitions, nursing center revenue
growth was adversely impacted by a 5% decline in private patient days in 1997.
In an effort to attract increased volumes of Medicare and private payment
patients, the Company implemented a plan to expend approximately $200 million
during 1997 and 1998 to improve existing facilities and expand the range of
services provided to accommodate higher acuity patients.

Vencare revenues for 1997 include $199.4 million related to contract
rehabilitation therapy and certain other ancillary service businesses acquired
as part of the TheraTx Merger. Excluding the TheraTx Merger and other sales
and acquisitions, Vencare revenues grew 12% in 1997 and 26% in 1996 primarily
as a result of growth in volume of ancillary services provided per contract
and, in 1996, growth in the number of contracts. Vencare ancillary service
contracts in effect at December 31, 1997 totaled 3,877 compared to 4,346 at
December 31, 1996 and 4,072 at December 31, 1995. During 1997, the Company
terminated approximately 700 contracts which did not meet certain growth
criteria and eliminated approximately 670 contracts by combining previously
separate pharmacy, enteral and infusion therapy contracts.

Pharmacy revenues (included in Vencare operations) declined 4% to $167.1
million in 1997 from $174.1 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. Pharmacy revenues
rose 3% in 1996 from $168.8 million in 1995.

As discussed in Note 4 of the Notes to Consolidated Financial Statements,
the decline in Atria revenues in 1997 resulted from a change to the equity
method of accounting for the Company's investment in Atria beginning July 1,
1997. The increase in 1996 revenues resulted primarily from price increases,
growth in occupancy and expansion of ancillary services.

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 certain under-performing or non-strategic nursing
centers. 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. See Note 9 of the Notes to Consolidated Financial Statements.

During 1997, the Company sold 28 of the 34 non-strategic nursing centers
planned for disposition. Proceeds from the transaction aggregated $11.2
million. In addition, one facility was sold and one was closed in January
1998, and two nursing centers are expected to be sold pending regulatory
approvals. In February 1998, the Company was unable to receive the necessary
licensure approvals to sell two non-strategic nursing centers for which
provisions for loss had been recorded in 1996. The Company intends to continue
to operate these facilities. Accrued provisions for loss at December 31, 1997
were not significant. The reorganization of the institutional pharmacy
business was substantially completed in 1997, which included the elimination
of duplicative administrative functions and establishment of the pharmacy
operations as an integrated part of the Company's hospital operations. The
Company expects that construction activities related to the replacement of one
hospital and three nursing centers will be completed in 1998 and 1999. Accrued
provision for loss related to the facilities to be sold or replaced aggregated
$22.2 million at December 31, 1997.

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

35
(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. 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. See Note 9 of the Notes to
Consolidated Financial Statements.

Income from operations for 1997 totaled $135.1 million, compared to $48.0
million and $8.3 million for 1996 and 1995, respectively. Excluding the effect
of non-recurring transactions, income from operations increased 6% in 1997
from $127.9 million ($1.81 per share-diluted) in 1996 and 25% in 1996 from
$101.9 million ($1.45 per share-diluted) in 1995.

Operating results in 1997 were adversely impacted by a decline in fourth
quarter income from operations to $27.2 million ($0.40 per share-diluted) from
$35.9 million ($0.51 per share-diluted) in the fourth quarter of 1996
(excluding non-recurring charges). The reduction in earnings resulted
primarily from (i) a loss of certain large Vencare contracts and growth in
costs associated with the shift in Vencare product mix from fee-for-service to
fixed fee arrangements in anticipation of the new prospective payment system
affecting Medicare reimbursement for nursing centers expected to take effect
on July 1, 1998 and (ii) operating losses associated with the Transitional
Merger. Vencare revenues were $158.2 million in the fourth quarter of 1997
compared to the previous quarter total of $183.2 million. In the fourth
quarter of 1997, the sale of certain non-strategic assets acquired in
connection with the TheraTx Merger resulted in a $13.5 million decline in
Vencare revenues from the third quarter. See "--Healthcare Reform
Legislation."

In 1997, the Company initiated the marketing of its Vencare full-service
ancillary services contracts to provide a full range of services to nursing
centers not operated by the Company. The change in the Company's marketing
strategy for selling ancillary services was developed in response to the
anticipated prospective payment system established under the Budget Act.
Management believes that by bundling services through one provider, nursing
centers can provide quality patient care more efficiently with the added
benefit of centralized patient medical records. Under the new prospective
payment system, ancillary services provided by nursing centers will be subject
to fixed payments. In this new environment, management believes that its full-
service ancillary services contracts will enhance the ability of nursing
center operators to manage effectively the costs of providing quality patient
care.

As the nursing center industry adapts to the cost containment measures
inherent in the new prospective payment system, management believes that the
volume of ancillary services provided per patient day to nursing center
patients could decline. In addition, as a result of these changes, many
nursing centers may elect to provide ancillary services to patients through
internal staff and will no longer contract with outside parties for ancillary
services. For these reasons and others, since the enactment of the Budget Act,
sales of new contracts have declined and may continue to decline subject to
the Company's success in implementing its Vencare comprehensive, full-service
contract sales strategy.

Operating results (including interest costs) associated with the hospitals
acquired in the Transitional Merger reduced income from operations in the
fourth quarter by $3.7 million or $0.05 per share and $9.2 million or $0.13
per share for the second half of 1997.

Excluding the effect of non-recurring transactions, growth in operating
income in 1996 resulted primarily from increased hospital volume, growth in
higher margin ancillary services in both Vencare and the nursing center
business and 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.

36
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 11 of the Notes to Consolidated Financial
Statements.

LIQUIDITY

Cash provided by operations totaled $270.9 million for 1997 compared to
$183.5 million for 1996 and $113.6 million for 1995. Despite growth in
operating cash flows during each of the past three years, cash flows from
operations have been adversely impacted by growth in the outstanding days of
revenues in accounts receivable. Days of revenues in accounts receivable
increased to 67 at December 31, 1997 compared to 54 at December 31, 1996.
Growth in accounts receivable was primarily attributable to growth in
rehabilitation contracts resulting from the TheraTx Merger (collection periods
for which typically require in excess of three months), delays associated with
the conversion of Transitional hospital financial systems and, in 1997 and
1996, the restructuring of the Company's pharmacy operations. Management
believes that certain of these factors may have an adverse effect on cash
flows from operations in 1998.

In connection with the TheraTx Merger and the Transitional Merger, the
Company increased the amount of its bank credit facility from $1.0 billion to
$2.0 billion in 1997 (the "Bank Facility"). At December 31, 1997, available
borrowings under the Bank Facility approximated $822 million.

As discussed in Note 13 of the Notes to Consolidated Financial Statements,
the Company completed the $750 million private placement of its 8 5/8% Senior
Subordinated Notes due 2007 (the "Notes") in July 1997. The net proceeds of
the offering were used to reduce outstanding borrowings under the Bank
Facility.

The Company has agreed to guarantee up to $75 million of Atria's $200
million bank credit facility (the "Atria Bank Facility") at December 31, 1997
and lesser amounts each year thereafter through 2000. At December 31, 1997,
there were no outstanding guaranteed borrowings under the Atria Bank Facility.

Working capital totaled $445.1 million at December 31, 1997 compared to
$320.1 million at December 31, 1996. Management believes that current levels
of working capital are sufficient to meet expected liquidity needs.

At December 31, 1997, the Company's ratio of debt to debt and equity
approximated 68% compared to 49% at December 31, 1996. Management intends to
reduce the Company's leverage ratio from current levels. The primary sources
of funds expected to reduce long-term debt in 1998 include proceeds from the
sale of certain non-strategic assets, including the Company's investment in
Atria.

In connection with the Reorganization Transactions, the Company will be
required to refinance, repurchase or assign substantially all of its long-term
debt, including the Bank Facility and the Notes. In lieu of repurchasing the
Notes, the Company may assign to Operating Company, and Operating Company
would assume, the Notes. Management is considering a capitalization plan for
both Operating Company and Realty Company to be effected on or before the date
of the Distribution in which the Company's long-term debt is expected to be
refinanced, repurchased or assumed by either Operating Company or Realty
Company at interest rates and terms which may be less favorable than those of
the Company's current debt arrangements. There can be no assurance that
sufficient financing will be available on terms that are acceptable to either
Operating Company or Realty Company, or that either entity will have the
financial resources necessary to implement its respective acquisition and
development plans following the Distribution.

CAPITAL RESOURCES

Excluding acquisitions, capital expenditures totaled $281.7 million for 1997
compared to $135.0 million for 1996 and $136.9 million for 1995 which include
$22.6 million, $7.4 million and $4.0 million related to Atria, respectively.
Planned capital expenditures in 1998 (excluding acquisitions) are expected to
approximate $250 million to $300 million and include significant expenditures
related to nursing center improvements, construction of additional nursing
centers, information systems and administrative facilities. If the
Reorganization Transactions are consummated, proceeds from the sale of certain
newly constructed facilities to Realty Company in 1998 could approximate $125
million to $150 million. Management believes that its capital expenditure
program is adequate to expand, improve and equip existing facilities.


37
During 1997, the Company expended approximately $359.4 million and $615.6
million in connection with the TheraTx Merger and the Transitional Merger,
respectively. These acquisitions were financed primarily through the issuance
of long-term debt. See Notes 5 and 6 of the Notes to Consolidated Financial
Statements for a discussion of these acquisitions. The Company also expended
$36.6 million, $26.2 million and $59.3 million for acquisitions of new
facilities (and related healthcare businesses) and previously leased nursing
centers during 1997, 1996, and 1995, respectively, of which $14.6 million,
$5.2 million and $44.2 million related to additional hospital facilities.
Subject to certain limitations related to management's plans to reduce long-
term debt discussed above, the Company intends to acquire additional
hospitals, nursing centers and ancillary service businesses in the future.

Capital expenditures during the last three years were financed primarily
through additional borrowings, internally generated funds and, in 1996, from
the collection of notes receivable aggregating $78.2 million. In addition,
capital expenditures in 1995 were financed through the public offering of 2.2
million shares of the Company's Common Stock, the proceeds from which totaled
$66.5 million. The Company intends to finance a substantial portion of its
capital expenditures with internally generated funds and additional long-term
debt. Sources of capital include available borrowings under the Bank Facility,
public or private debt and equity. At December 31, 1997, the estimated cost to
complete and equip construction in progress approximated $119 million.

In the fourth quarter of 1997, the Company repurchased 2,925,000 shares of
the Company's Common Stock at an aggregate cost of $81.7 million. Repurchases
of 1,950,000 shares of the Company's Common Stock in 1996 totaled $55.3
million. These transactions were financed primarily through borrowings under
the Bank Facility.

At December 31, 1997, the Company was a party to certain interest rate swap
agreements that eliminate the impact of changes in interest rates on $400
million of outstanding floating rate debt. One agreement for $100 million
expires in April 1998 and provides for fixed rates at 5.7% plus 3/8% to 1
1/8%. A second agreement on $300 million of floating rate debt provides for
fixed rates at 6.4% plus 3/8% to 1 1/8% and expires in $100 million increments
in May 1999, November 1999 and May 2000. The fair values of the swap
agreements are not recognized in the consolidated financial statements. See
Notes 1 and 13 of the Notes to Consolidated Financial Statements.

As discussed in Note 13 of the Notes to Consolidated Financial Statements,
the Company called for redemption all of its outstanding convertible debt
securities in the fourth quarter of 1995, resulting in the issuance of
approximately 7,259,000 shares of the Company's 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 share.

HEALTHCARE REFORM LEGISLATION

The Budget Act, enacted in August 1997, contains extensive changes to the
Medicare and Medicaid programs intended to reduce the projected amount of
increase in 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 will be 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, allowable costs for capital expenditures
and bad debts, and payments for services to patients transferred from a PPS
hospital. The reductions in allowable costs for capital expenditures became
effective October 1, 1997. The reductions in the TEFRA incentive payments and
allowable costs for bad debts are expected to be effective beginning on
September 1, 1998 with respect to the Company's hospitals. The reductions for
payments for services to patients transferred from a PPS hospital are expected
to be effective October 1, 1998.

38
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 payments
received under the new prospective payment system will cover all services for
Medicare patients, including all ancillary services, such as respiratory
therapy, physical therapy, occupational therapy, speech therapy and certain
covered drugs. The Budget Act also requires an adjustment to the payment
system for home health services for cost reporting periods beginning on or
after October 1, 1997. The new system will adjust per visit limits and
establish per beneficiary annual spending limits. A prospective payment system
for home health services will be established by October 1, 1999.

Management believes that the Budget Act will adversely impact its hospital
business by reducing the payments previously described. The TEFRA limits have
not had a material adverse effect on the Company's results of operations, and
the Company does not expect that the TEFRA limits will have a material adverse
effect on its results of operations in 1998. The reductions in the TEFRA
incentive payments which are expected to be effective beginning on September
1, 1998 with respect to the Company's hospitals, will have an adverse impact
on hospital revenues in the future.

Based on information currently available, management believes that the new
prospective payment system will benefit nursing center operations because (i)
management believes that the average acuity levels of its patients will exceed
the national average (which should result in increased payments per patient
day) and (ii) because the Company expects to benefit from its ability to
reduce the cost of providing ancillary services to patients in its facilities.
The new Medicare prospective payment rates and related patient acuity measures
will be established by HCFA, and as of the date hereof the Company does not
know what these amounts will be. Management believes that its anticipated
growth in nursing center profitability would be reduced if Congress acts to
delay the effective date of the prospective payment system. As the nursing
center industry adapts to the cost containment measures inherent in the new
prospective payment system, management believes that the volume of ancillary
services provided per patient day to nursing center patients could decline. In
addition, as a result of these changes, many nursing centers may elect to
provide ancillary services to their patients through internal staff and will
no longer contract with outside parties for ancillary services. For these
reasons and others, since the enactment of the Budget Act, sales of new
contracts have declined and may continue to decline subject to the Company's
success in implementing its Vencare comprehensive, full-service contracts
sales strategy. The Company is actively implementing strategies and
operational modifications to address changes in the Federal reimbursement
system.

In January 1998, HCFA issued rules changing 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 new rules, HCFA established salary equivalency limits for
speech and occupational therapy services and revised existing limits for
physical and respiratory therapy services. The limits are based on a blend of
data from wage rates for hospitals and nursing centers 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. The
new limits are effective for services provided on or after April 1, 1998 and
are expected to impact negatively Vencare operating results in 1998. The
Company will continue to charge client nursing centers in accordance with the
revised guidelines until such nursing centers transition to the new
prospective payment system. Under the new prospective payment system, the
reimbursement for these services provided to nursing center patients will be a
component of the total reimbursement allowed per nursing center patient and
the salary equivalency guidelines will no longer be applicable. Most of the
Company's client nursing centers are expected to transition to the new
prospective payment system on or before January 1, 1999.

There also continues 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

39
moratorium on the designation of additional long-term care hospitals and
changes in Medicaid reimbursement system applicable to the Company's
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
existing impediments on the states' ability to reduce their Medicaid
reimbursement levels.

There can be no assurance that the Budget Act, new 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 or
liquidity.

Medicare revenues as a percentage of total revenues were 34%, 31% and 30%
for 1997, 1996 and 1995, respectively, while Medicaid percentages of revenues
approximated 26%, 31% and 33% for the respective periods.

OTHER INFORMATION

In June 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 certain discounts 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. 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. 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 1998.

The Company has initiated a program to prepare its information systems,
clinical equipment and facilities for the year 2000. An external professional
organization has been engaged to assist in the management and implementation
of this program. Management is currently implementing a plan to replace
substantially all of the Company's financial information systems before the
year 2000, the costs of which have not been determined. Most of these costs
will be capitalized and amortized over a three to five year period. Required
modifications to the Company's proprietary VenTouch(TM) and Therasys(TM)
clinical information systems are minimal and will generally be accomplished
through the use of existing internal resources. Clinical equipment in the
Company's facilities will generally be replaced or modified as needed through
the use of external professional resources. Incremental costs to complete the
necessary changes to clinical equipment could approximate $10 million to $20
million over the next two years.

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 results of operations. See Notes 15
and 23 of the Notes to Consolidated Financial Statements.

Both the Bank Facility and the Notes 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 December 31, 1997. If the Bank Facility
is not refinanced in connection with the Reorganization Transactions, the
Distribution will violate certain covenants contained therein. Management
expects that Operating Company will be in compliance with all covenants
related to the Notes which may be assumed by Operating Company in connection
with the Reorganization Transactions. Management is considering a
capitalization plan for Operating Company and Realty Company to be effected on
or before the Distribution date in which substantially all of the Company's
long-term debt is expected to be refinanced or assumed by either Operating
Company or Realty Company. See "-- Liquidity."

As discussed in Note 1 of the Notes to Consolidated Financial Statements, on
December 31, 1997, Statement of Financial Accounting Standards No. 128
required the Company to change the method of computing earnings per common
share on a retroactive basis. The change in calculation method did not have a
material impact on previously reported earnings per common share.


40
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not Applicable.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The information required by this Item 8 is included in appendix pages F-2
through F-25 of this Report.

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

Not applicable.

PART III

ITEMS 10, 11, 12 AND 13. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT;
EXECUTIVE COMPENSATION; SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT; AND CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by these Items other than the information set forth
above under Part I, "Executive Officers of the Registrant," is omitted because
the Company is filing a definitive proxy statement pursuant to Regulation 14A
not later than 120 days after the end of the fiscal year covered by this
Report which includes the required information. The required information
contained in the Company's proxy statement is incorporated herein by
reference.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a)(1) Index to Consolidated Financial Statements and Financial Statement
Schedules:
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Auditors......................................... F-2
Consolidated Financial Statements:
Consolidated Statement of Operations for the years ended December 31,
1997, 1996, and 1995.............................................. F-3
Consolidated Balance Sheet, December 31, 1997 and 1996............... F-4
Consolidated Statement of Stockholders' Equity for the years ended
December 31, 1997, 1996 and 1995.................................. F-5
Consolidated Statement of Cash Flows for the years ended December 31,
1997, 1996 and 1995............................................... F-6
Notes to Consolidated Financial Statements........................... F-7
Quarterly Consolidated Financial Information (Unaudited)............. F-25
Financial Statement Schedules (a):
Schedule II--Valuation and Qualifying Accounts for the years ended
December 31, 1997, 1996 and 1995.................................. F-26
</TABLE>
- --------
(a) All other schedules have been omitted because the required information is
not present or not present in material amounts.

41
(a)(2) Index to Exhibits:

EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
<C> <S> <C>
3.1 Certificate of Incorporation of the Company, as amended. Exhibit
3 to the Company's Form 10-Q for the quarterly period ended
September 30, 1995 (Comm. File No. 1-10989) is hereby
incorporated by reference.
3.2 Third Amended and Restated Bylaws of the Company.
4.1 Specimen Common Stock Certificate. Exhibit 4.1 to the Company's
Form 10-K for the year ended December 31, 1995 (Comm. File No.
1-10989) is hereby incorporated by reference.
4.2 Article IV of the Certificate of Incorporation of the Company is
included in Exhibit 3.1.
4.3 $2.0 billion Amended and Restated Credit Agreement dated as of
May 30, 1997, amending and restating the Credit Agreement dated
as of March 17, 1997, as amended as of March 31, 1997 and April
22, 1997, among the Company, the various banks party thereto,
the Swingline Bank party, the LC Issuing Banks party thereto,
the Managing Agents and Co-Agents party thereto, Morgan Guaranty
Trust Company of New York, as Documentation Agent and Collateral
Agent, and Nationsbank, N.A., as Administrative Agent. Exhibit
(b)(3) to Amendment No. 8 to the Statement on Schedule 14D-1 of
the Company and LV Acquistion Corp., dated May 7, 1997 (Comm.
File No. 1-10989) is hereby incorporated by reference.
4.4 Amendment No. 1, dated as of June 24, 1997, to the $2.0 billion
Amended and Restated Credit Agreement dated as of May 30, 1997,
amending and restating the Credit Agreement dated of March 17,
1997, as amended as of March 31, 1997 and April 22, 1997, among
the Company, the various banks party thereto, the Swingline Bank
party, the LC Issuing Banks party thereto, the Managing Agents
and Co-Agents party thereto, Morgan Guaranty Trust Company of
New York, as Documentation Agent and Collateral Agent, and
Nationsbank, N.A., as Administrative Agent. Exhibit 4.3 to the
Company's Form 10-Q for the quarterly period ended June 30, 1997
(Comm. File No. 1-10989) is hereby incorporated by reference.
4.5 Amendment No. 2, dated as of October 24, 1997, to the $2.0
billion Amended and Restated Credit Agreement dated as of May
30, 1997, as amended as of June 24, 1997 among the Company, the
various banks party thereto, the Swingline Bank party, the LC
Issuing Banks party thereto, the Managing Agents and Co-Agents
party thereto, Morgan Guaranty Trust Company of New York, as
Documentation Agent and Collateral Agent, and Nationsbank, N.A.,
as Administrative Agent.
4.6 Form of 8 5/8% Senior Subordinated Notes due 2007. Exhibit 4.1
to the Company's Current Report on Form 8-K dated July 21, 1997
(Comm. File No. 1-10989) is hereby incorporated by reference.
4.7 Indenture dated as of 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.
4.8 Rights Agreement dated as of July 20, 1993 between the Company
and National City Bank, as Rights Agent. Exhibit 1 to the
Company's Registration Statement on Form 8-A (Comm. File No. 1-
10989) is hereby incorporated by reference.
4.9 First Amendment to Rights Agreement dated as of August 11, 1995
between the Company and National City Bank, as Rights Agent.
Exhibit 2 to the Company's Registration Statement on Form 8-A/A
(Comm. File No. 1-10989) is hereby incorporated by reference.
4.10 Second Amendment to Rights Agreement dated February 1, 1998
between the Company and National City Bank, as Rights Agent.
Exhibit 1 to the Company's Registration Statement on Form 8-A/A
(Reg. No. 33-30212) is hereby incorporated by reference.
10.1* Directors and Officers Insurance and Company Reimbursement
Policies. Exhibit 10.1 to the Company's Form 10-K for the year
ended December 31, 1995 (Comm. File No. 1-10989) is hereby
incorporated by reference.
</TABLE>


42
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
<C> <S>
10.2* Vencor Retirement Savings Plan Amended and Restated as of January 1,
1997.
10.3* Amendment No. 1 to the Vencor Retirement Savings Plan Amended and
Restated dated July 1, 1997.
10.4* Amendment No. 2 to the Vencor Retirement Savings Plan Amended and
Restated dated December 31, 1997.
10.5* Amendment No. 3 to the Vencor Retirement Savings Plan Amended and
Restated dated December 31, 1997.
10.6* Vencor, Inc. 401(k) Master Trust Agreement dated January 1, 1997 by
and between the Company and Wachovia Bank of North Carolina, N.A.
10.7* Amendment No. 1 to Vencor, Inc. 401(k) Master Trust Agreement by and
between the Company and Wachovia Bank of North Carolina, N.A.
10.8* Retirement Savings Plan for Certain Employees of Vencor and its
Affiliates Amended and Restated as of January 1, 1997.
10.9* 1987 Non-Employee Directors Stock Option Plan. Exhibit 10.10 to the
Company's Registration Statement on Form S-1 (Reg. No. 33-30212) is
hereby incorporated by reference.
10.10* 1987 Incentive Compensation Program. Exhibit 10.9 to the Company's
Registration Statement on Form S-1 (Reg. No. 33-30212) is hereby
incorporated by reference.
10.11* Amendment to the Vencor, Inc. 1987 Incentive Compensation Program
dated May 15, 1991. Exhibit 4.4 to the Company's Registration
Statement on Form S-8 (Reg. No. 33-40949) is hereby incorporated by
reference.
10.12* Amendments to the Vencor, Inc. 1987 Incentive Compensation Program
dated May 18, 1994. Exhibit 10.13 to the Company's Form 10-K for the
year ended December 31, 1994 (Comm. File No. 1-10989) is hereby
incorporated by reference.
10.13* Amendment to the Vencor, Inc. 1987 Incentive Compensation Program
dated February 15, 1995. Exhibit 10.14 to the Company's Form 10-K for
the year ended December 31, 1994 (Comm. File No. 1-10989) is hereby
incorporated by reference.
10.14* Amendment to the Vencor, Inc. 1987 Incentive Compensation Program
dated September 27, 1995. Exhibit 10.17 to the Company's Form 10-K for
the year ended December 31, 1995 (Comm. File No. 1-10989) is hereby
incorporated by reference.
10.15* Amendment to the Vencor, Inc. 1987 Incentive Compensation Program
dated May 15, 1996. Exhibit 10.19 to the Company's Form 10-K for the
year ended December 31, 1996 (Comm. File No. 1-10989) is hereby
incorporated by reference.
10.16* Form of Vencor, Inc. Incentive Compensation Program Performance Share
Award, as amended. Exhibit 10.18 to the Company's Form 10-K for the
year ended December 31, 1995 (Comm. File No. 1-10989) is hereby
incorporated by reference.
10.17* Vencor, Incorporated Non-Employee Directors Deferred Compensation
Plan. Exhibit 10.19 to the Company's Form 10-K for the year ended
December 31, 1995 (Comm. File No. 1-10989) is hereby incorporated by
reference.
10.18* Amendment to Vencor, Incorporated Non-Employee Directors Deferred
Compensation Plan dated September 26, 1995. Exhibit 10.20 to the
Company's Form 10-K for the year ended December 31, 1995 (Comm. File
No. 1-10989) is hereby incorporated by reference.
10.19* Vencor, Inc. 1997 Incentive Compensation Plan dated December 31, 1996.
Exhibit 10.23 to the Company's Form 10-K for the year ended December
31, 1996 (Comm. File No. 1-10989) is hereby incorporated by reference.
10.20* Amendment No. 1 dated May 8, 1997 to the Vencor, Inc. 1997 Incentive
Compensation Plan. Exhibit 10.3 to the Company's Form 10-Q for the
quarterly period ended June 30, 1997 (Comm. File No. 1-10989) is
hereby incorporated by reference.
</TABLE>


43
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
<C> <S>
10.21* Vencor, Inc. Deferred Compensation Plan dated January 1, 1996. Exhibit
10.24 to the Company's Form 10-K for the year ended December 31, 1996
(Comm. File No. 1-10989) is hereby incorporated by reference.
10.22* Vencor, Inc. 1997 Stock Option Plan for Non-Employee Directors dated
December 31, 1996. Exhibit 10.25 to the Company's Form 10-K for the
year ended December 31, 1996 (Comm. File No. 1-10989) is hereby
incorporated by reference.
10.23* TheraTx, Incorporated Amended and Restated 1994 Stock Option/Stock
Issuance Plan, as amended. Exhibit 10.7 to the Registration Statement
on Form S-1 of TheraTx (Reg. No. 33-92402) is hereby incorporated by
reference.
10.24* Amendment to the TheraTx, Incorporated Amended and Restated 1994 Stock
Option/Stock Issuance Plan. Exhibit 4.7 to the Company's Registration
Statement on Form S-8 (Reg. No. 333-25519) is hereby incorporated by
reference.
10.25* TheraTx, Incorporated 1996 Stock Option/Stock Issuance Plan. Exhibit
99.1 to the Registration Statement on Form S-8 of TheraTx (Reg. No.
333-15171) is hereby incorporated by reference.
10.26* 1989 Amended and Restated Stock Option Plan of Helian Health Group,
Inc. ("Helian"). Exhibit 10.47 to the Registration Statement on Form
S-8 of Helian (Reg. No. 33-31520), Amendment No. 2 thereto filed
November 21, 1989 and Post-Effective Amendment No. 1 and No. 2 thereto
filed November 22, 1990 and January 16, 1991, is hereby incorporated
by reference.
10.27* Vencor, Inc. Employee Benefit Trust Agreement dated December 27, 1990
by and between the Company and First Kentucky Trust Company. Exhibit
10.20 to the Company's Registration Statement on Form S-1 (Reg. No.
33-39017) is hereby incorporated by reference.
10.28* The Amended Hillhaven Corporation Board of Directors Retirement Plan.
Exhibit 10.25 to the Company's Form 10-K for the year ended December
31, 1995 (Comm. File No. 1-10989) is hereby incorporated by reference.
10.29* The Hillhaven Corporation Annual Incentive Plan, amended as of
December 6, 1994. Exhibit 10.27 to the Company's Form 10-K for the
year ended December 31, 1995 (Comm. File No. 1-10989) is hereby
incorporated by reference.
10.30* The Hillhaven Corporation Supplemental Executive Retirement Plan.
Exhibit 10.29 to the Company's Form 10-K for the year ended December
31, 1995 (Comm. File No. 1-10989) is hereby incorporated by reference.
10.31* Form of Indemnification Agreement between Vencor, Inc. and certain of
its officers and employees. Exhibit 10.31 to the Company's Form 10-K
for the year ended December 31, 1995 (Comm. File No. 1-10989) is
hereby incorporated by reference.
10.32* Form of Vencor, Inc. Change-in-Control Severance Agreement.
10.33 Form of Indemnification Agreement for directors of TheraTx. Exhibit
10.13 to the Registration Statement on Form S-1 of TheraTx (Reg. No.
33-78786) is hereby incorporated by reference.
10.34 Form of Indemnification Agreement between Transitional Hospitals
Corporation and its Directors and Executive Officers. Exhibit C to the
Proxy Statement of Transitional, dated April 24, 1987 relating to its
annual meeting of its stockholders on June 1, 1987 (Comm. File No.
1-7008) is hereby incorporated by reference.
10.35 Services Agreement between Hillhaven and Tenet, dated as of January
31, 1990. Exhibit 10.33 to the Company's Form 10-K for the year ended
December 31, 1995 (Comm. File No. 1-10989) is hereby incorporated by
reference.
10.36 Government Programs Agreement between Hillhaven and Tenet, dated
January 31, 1990. Exhibit 10.34 to the Company's Form 10-K for the
year ended December 31, 1995 (Comm. File No. 1-10989) is hereby
incorporated by reference.
</TABLE>


44
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
<C> <S>
10.37 Insurance Agreement between Hillhaven and Tenet, dated as of January
31, 1990. Exhibit 10.35 to the Company's Form 10-K for the year ended
December 31, 1995 (Comm. File No. 1-10989) is hereby incorporated by
reference.
10.38* Employee and Employee Benefits Agreement between Hillhaven and Tenet,
dated as of January 31, 1990. Exhibit 10.36 to the Company's Form 10-K
for the year ended December 31, 1995 (Comm. File No. 1-10989) is
hereby incorporated by reference.
10.39 Form of Assignment and Assumption of Lease Agreement between Hillhaven
and certain subsidiaries, on the one hand, and Tenet and certain
subsidiaries on the other hand, together with the related Guaranty by
Hillhaven, dated on or prior to January 31, 1990. Exhibit 10.37 to the
Company's Form 10-K for the year ended December 31, 1995 (Comm. File
No. 1-10989) is hereby incorporated by reference.
10.40 Form of Management Agreement between First Healthcare Corporation and
certain Tenet subsidiaries, dated on or prior to January 31, 1990.
Exhibit 10.38 to the Company's Form 10-K for the year ended December
31, 1995 (Comm. File No. 1-10989) is hereby incorporated by reference.
10.41 Reorganization and Distribution Agreement between Hillhaven and Tenet,
dated as of January 8, 1990, as amended on January 30, 1990. Exhibit
10.39 to the Company's Form 10-K for the year ended December 31, 1995
(Comm. File No. 1-10989) is hereby incorporated by reference.
10.42 Guarantee Reimbursement Agreement between Hillhaven and Tenet, dated
as of January 31, 1990. Exhibit 10.40 to the Company's Form 10-K for
the year ended December 31, 1995 (Comm. File No. 1-10989) is hereby
incorporated by reference.
10.43 First Amendment to Guarantee Reimbursement Agreement between Hillhaven
and Tenet, dated as of October 30, 1990. Exhibit 10.41 to the
Company's Form 10-K for the year ended December 31, 1995 (Comm. File
No. 1-10989) is hereby incorporated by reference.
10.44 First Amendment to Guarantee Reimbursement Agreement between Hillhaven
and Tenet, dated as of May 30, 1991. Exhibit 10.42 to the Company's
Form 10-K for the year ended December 31, 1995 (Comm. File No. 1-
10989) is hereby incorporated by reference.
10.45 Second Amendment to Guarantee Reimbursement Agreement between
Hillhaven and Tenet, dated as of October 2, 1991. Exhibit 10.43 to the
Company's Form 10-K for the year ended December 31, 1995 (Comm. File
No. 1-10989) is hereby incorporated by reference.
10.46 Third Amendment to Guarantee Reimbursement Agreement between Hillhaven
and Tenet, dated as of April 1, 1992. Exhibit 10.44 to the Company's
Form 10-K for the year ended December 31, 1995 (Comm. File No. 1-
10989) is hereby incorporated by reference.
10.47 Fourth Amendment to Guarantee Reimbursement Agreement between
Hillhaven and Tenet, dated as of November 12, 1992. Exhibit 10.45 to
the Company's Form 10-K for the year ended December 31, 1995 (Comm.
File No. 1-10989) is hereby incorporated by reference.
10.48 Fifth Amendment to Guarantee Reimbursement Agreement between Hillhaven
and Tenet, dated as of February 19, 1993. Exhibit 10.46 to the
Company's Form 10-K for the year ended December 31, 1995 (Comm. File
No. 1-10989) is hereby incorporated by reference.
10.49 Sixth Amendment to Guarantee Reimbursement Agreement between Hillhaven
and Tenet, dated as of May 28, 1993. Exhibit 10.47 to the Company's
Form 10-K for the year ended December 31, 1995 (Comm. File No. 1-
10989) is hereby incorporated by reference.
10.50 Seventh Amendment to Guarantee Reimbursement Agreement between
Hillhaven and Tenet, dated as of May 28, 1993. Exhibit 10.48 to the
Company's Form 10-K for the year ended December 31, 1995 (Comm. File
No. 1-10989) is hereby incorporated by reference.
10.51 Eighth Amendment to Guarantee Reimbursement Agreement between
Hillhaven and Tenet, dated as of September 2, 1993. Exhibit 10.49 to
the Company's Form 10-K for the year ended December 31, 1995 (Comm.
File No. 1-10989) is hereby incorporated by reference.
</TABLE>


45
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
<C> <S>
10.52 Facility Agreement among First Healthcare Corporation and Certain
Limited Partnerships, dated as of April 23, 1992 relating to the sale
of 32 nursing centers. Exhibit 10.50 to the Company's Form 10-K for
the year ended December 31, 1995 (Comm. File No. 1-10989) is hereby
incorporated by reference.
10.53 First Amendment to Facility Agreement among First Healthcare
Corporation and Certain Limited Partnerships, dated as of July 31,
1992 relating to the sale of 32 nursing centers. Exhibit 10.51 to the
Company's Form 10-K for the year ended December 31, 1995 (Comm. File
No. 1-10989) is hereby incorporated by reference.
10.54 Forbearance Agreement among First Healthcare Corporation, Medisave
Pharmacies, Inc. and Certain Limited Partnerships, dated as of August
25, 1995. Exhibit 10.52 to the Company's Form 10-K for the year ended
December 31, 1995 (Comm. File No. 1-10989) is hereby incorporated by
reference.
10.55 Letter of Intent dated June 22, 1993 between Hillhaven and Tenet.
Exhibit 10.53 to the Company's Form 10-K for the year ended December
31, 1995 (Comm. File No. 1-10989) is hereby incorporated by reference.
10.56 Trust Agreement between The Hillhaven Corporation and Wachovia Bank of
North Carolina, N.A., as Trustee, dated as of January 16, 1995.
Exhibit 10.55 to the Company's Form 10-K for the year ended December
31, 1995 (Comm. File No. 1-10989) is hereby incorporated by reference.
10.57 Strategic Alliance Agreement dated as of June 10, 1997 by and between
the Company, Continental Casualty Company and Valley Forge Life
Insurance Company. Exhibit 10.1 to the Company's Form 10-Q for the
quarterly period ended June 30, 1997 (Comm. File No. 1-10989) is
hereby incorporated by reference.
10.58 Amended and Restated Agreement and Plan of Share Exchange and
Agreements to Assign Partnership Interests dated as of February 27,
1995 by and among The Hillhaven Corporation, Nationwide Care, Inc.,
Phillippe Enterprises, Inc., Meadowvale Skilled Care Center, Inc. and
Specified Partners of Camelot Care Centers, Evergreen Woods, Ltd. and
Shangri-La Partnership. Exhibit 10.56 to the Company's Form 10-K for
the year ended December 31, 1995 (Comm. File No. 1-10989) is hereby
incorporated by reference.
10.59 Amended and Restated Agreement and Plan of Merger. Appendix A to
Amendment No. 2 to the Company's Registration Statement on Form S-4
(Reg. No. 33-59345) is hereby incorporated by reference.
10.60 Agreement and Plan of Merger dated as of February 9, 1997 among
TheraTx, the Company and Peach Aquisition Corp. ("Peach"). Exhibit
(c)(1) to the Statement on Schedule 14D-1 of the Company and Peach,
dated February 14, 1997 (Comm. File No. 1-10989) is hereby
incorporated by reference.
10.61 Amendment No. 1 to Agreement and Plan of Merger dated as of February
28, 1997 among TheraTx, the Company and Peach. Exhibit (c)(3) of
Amendment No. 2 to the Statement on Schedule 14D-1 of the Company and
Peach, dated March 3, 1997 (Comm. File No. 1-10989) is hereby
incorporated by reference.
10.62 Agreement and Plan of Merger dated June 18, 1997 by and among the
Company, LV Acqusition Corp. and Transitional Hospitals Corporation.
Exhibit 2.1 to the Company's Current Report on Form 8-K dated July 3,
1997 (Comm. File No. 1-10989) is hereby incorporated by reference.
10.63 Agreement and Plan of Merger, dated May 2, 1997, among Select Medical
Corporation, SM Acquisition Co. and Transitional Hospitals
Corporation. Exhibit 99.1 to the Current Report on Form 8-K of
Transitional dated May 2, 1997 (Comm. File No. 1-7008) is hereby
incorporated by reference.
10.64 Asset Purchase Agreement between Transitional Hospitals Corporation
and Behavioral Healthcare Corporation, dated October 22, 1996. Exhibit
99.1 to the Current Report on Form 8-K of Transitional dated October
22, 1996 (Comm. File No. 1-7008) is hereby incorporated by reference.
</TABLE>


46
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
<C> <S>
10.65 Agreement and Plan of Merger between Transitional Hospitals
Corporation and Behavioral Healthcare Corporation, dated October 22,
1996. Exhibit 99.2 to the Current Report on Form 8-K of Transitional
dated October 22, 1996 (Comm. File No. 1-7008) is hereby incorporated
by reference.
10.66 First Amendment to Asset Purchase Agreement between Transitional
Hospitals Corporation and Behavioral Healthcare Corporation, dated
November 30, 1996. Exhibit 99.1 to the Current Report on Form 8-K of
Transitional dated December 16, 1996 (Comm. File No. 1-7008) is hereby
incorporated by reference.
10.67 Amendment to Agreement and Plan of Merger between Transitional
Hospitals Corporation and Behavioral Healthcare Corporation, dated
November 30, 1996. Exhibit 99.2 to the Current Report on Form 8-K of
Transitional dated December 16, 1996 (Comm. File No. 1-7008) is hereby
incorporated by reference.
10.68 Other Debt Instruments--Copies of debt instruments for which the
related debt is less than 10% of total assets will be furnished to the
Commission upon request.
10.69 Parent Guaranty dated as of August 15, 1996 among Atria Communities,
Inc., as Borrower, Vencor, Inc., as Parent Guarantor, First Healthcare
Corporation, Northwest Health Care, Inc., Medisave Pharmacies, Inc.,
Hillhaven of Central Florida, Inc., and Nationwide Care, Inc., as
Supporting Guarantors, and PNC Bank, National Association, as
Administrative Agent. Exhibit 10.59 to the Company's Form 10-K for the
year ended December 31, 1996 (Comm. File No. 1-10989) is hereby
incorporated by reference.
10.70 Amendment No. 1 to Parent Guaranty dated as of March 27, 1997 among
Atria Communities, Inc., as Borrower, Vencor, Inc., as Parent
Guarantor, First Healthcare Corporation, Northwest Health Care, Inc.,
Medisave Pharmacies, Inc., Nationwide Care, Inc., TheraTx,
Incorporated, Vencor Hospitals Illinois, Inc., Vencor Hospitals South,
Inc., Vencor Hospitals East, Inc., Vencor Hospitals California, Inc.,
Vencor Hospitals Texas, Ltd., Ventech Systems, Inc., Pasatiempo
Development Corp., VCI Specialty Services, Inc., and Vencor
Properties, Inc., as Supporting Guarantors, and PNC Bank, National
Association, as Administrative Agent. Exhibit 10.6 to the Company's
Form 10-Q for the quarterly period ended March 31, 1997 (Comm. File
No. 1-10989) is hereby incorporated by reference.
10.71 Amendment No. 2 to Parent Guaranty dated as of May 27, 1997 by Atria
Communities, Inc., as Borrower, Vencor, Inc., as Parent Guarantor,
First Healthcare Corporation, Northwest Health Care, Inc., Medisave
Pharmacies, Inc., Nationwide Care, Inc., TheraTx, Incorporated, Vencor
Hospitals Illinois, Inc., Vencor Hospitals South, Inc., Vencor
Hospitals East, Inc., Vencor Hospitals California, Inc., Vencor
Hospitals Texas, Ltd., Ventech Systems, Inc., Pasatiempo Development
Corp., VCI Specialty Services, Inc., and Vencor Properties, Inc., as
Supporting Guarantors, and PNC Bank, National Association, as
Administration Agent. Exhibit 10.2 to the Company's Form 10-Q for the
quarterly period ended June 30, 1997 (Comm. File No. 1-10989) is
hereby incorporated by reference.
21 Subsidiaries of the Company.
23 Consent of Ernst & Young LLP.
27 Financial Data Schedule (included only in filings under the Electronic
Data Gathering, Analysis, and Retrieval System).
</TABLE>
- --------
* Compensatory plan or arrangement required to be filed as an exhibit
pursuant to Item 14(c) of Form 10-K.

(b)Reports on Form 8-K.

On October 21, 1997, the Company filed a Current Report on Form 8-K to set
forth certain cautionary statements for purposes of obtaining the safe harbors
under the 1995 Private Securities Litigation Reform Act. On October 22, 1997,
the Company filed a Current Report on Form 8-K to disclose third quarter
earnings and to

47
disclose a projected downward revision to its earnings estimates. On October
23, 1997, the Company filed a Current Report on Form 8-K to announce that its
Board of Directors had approved the repurchase of up to 3,000,000 shares of
the Company's Common Stock.

(c)Exhibits.

The response to this portion of Item 14 is submitted as a separate section
of this Report.

(d)Financial Statement Schedules.

The response to this portion of Item 14 is included in appendix page F-25 of
this Report.


48
SIGNATURES

PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED
ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.

Date: March 11, 1998 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 EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.

SIGNATURES TITLE DATE

/s/ Michael R. Barr Executive Vice March 11, 1998
- ------------------------------------- President, Chief
MICHAEL R. BARR Operating Officer
and Director

/s/ Walter F. Beran Director March 11, 1998
- -------------------------------------
WALTER F. BERAN

/s/ Ulysses L. Bridgeman, Jr. Director March 11, 1998
- -------------------------------------
ULYSSES L. BRIDGEMAN, JR.

/s/ Elaine L. Chao Director March 11, 1998
- -------------------------------------
ELAINE L. CHAO

/s/ Donna R. Ecton Director March 11, 1998
- -------------------------------------
DONNA R. ECTON


/s/ Greg D. Hudson Director March 11, 1998
- -------------------------------------
GREG D. HUDSON

/s/ Richard A. Lechleiter Vice President, March 11, 1998
- ------------------------------------- Finance and
RICHARD A. LECHLEITER Corporate
Controller
(Principal
Accounting Officer)

/s/ William H. Lomicka Director March 11, 1998
- -------------------------------------
WILLIAM H. LOMICKA

/s/ W. Bruce Lunsford Chairman of the March 11, 1998
- ------------------------------------- Board, President,
W. BRUCE LUNSFORD Chief Executive
Officer (Principal
Executive Officer)
and Director

/s/ W. Earl Reed, III Executive Vice March 11, 1998
- ------------------------------------- President, Chief
W. EARL REED, III Financial Officer
and Director

/s/ R. Gene Smith Vice Chairman of the March 11, 1998
- ------------------------------------- Board and Director
R. GENE SMITH


49
VENCOR, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Auditors............................................ F-2
Consolidated Financial Statements:
Consolidated Statement of Operations for the years ended December 31,
1997, 1996 and 1995.................................................... F-3
Consolidated Balance Sheet, December 31, 1997 and 1996.................. F-4
Consolidated Statement of Stockholders' Equity for the years ended
December 31, 1997, 1996 and 1995....................................... F-5
Consolidated Statement of Cash Flows for the years ended December 31,
1997, 1996 and 1995.................................................... F-6
Notes to Consolidated Financial Statements.............................. F-7
Quarterly Consolidated Financial Information (Unaudited)................ F-25
Financial Statement Schedules (a):
Schedule II--Valuation and Qualifying Accounts for the years ended
December 31, 1997, 1996 and 1995....................................... F-26
</TABLE>
- --------
(a) All other schedules have been omitted because the required information is
not present or not present in material amounts.

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, 1997 and 1996, and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 1997. Our audits also included the financial
statement schedule listed on page F-1. 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, 1997 and 1996, and the consolidated results of
its operations and cash flows for each of the three years in the period ended
December 31, 1997 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.

LOGO
Louisville, Kentucky
January 26, 1998


F-2
VENCOR, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Revenues................................... $3,116,004 $2,577,783 $2,323,956
---------- ---------- ----------
Salaries, wages and benefits............... 1,788,053 1,490,938 1,360,018
Supplies................................... 303,140 261,621 233,066
Rent....................................... 89,474 77,795 79,476
Other operating expenses................... 490,327 405,797 372,657
Depreciation and amortization.............. 123,865 99,533 89,478
Interest expense........................... 102,736 45,922 60,918
Investment income.......................... (6,057) (12,203) (13,444)
Non-recurring transactions................. - 125,200 109,423
---------- ---------- ----------
2,891,538 2,494,603 2,291,592
---------- ---------- ----------
Income before income taxes................. 224,466 83,180 32,364
Provision for income taxes................. 89,338 35,175 24,001
---------- ---------- ----------
Income from operations..................... 135,128 48,005 8,363
Extraordinary loss on extinguishment of
debt, net of income
tax benefit of $2,634 in 1997 and $14,839
in 1995................................... (4,195) - (23,252)
---------- ---------- ----------
Net income (loss)....................... 130,933 48,005 (14,889)
Preferred stock dividend requirements and
other items............................... - - (5,280)
Gain on redemption of preferred stock...... - - 10,176
---------- ---------- ----------
Income (loss) available to common stock-
holders................................ $ 130,933 $ 48,005 $ (9,993)
========== ========== ==========
Earnings (loss) per common share:
Basic:
Income from operations................... $ 1.96 $ 0.69 $ 0.22
Extraordinary loss on extinguishment of
debt.................................... (0.06) - (0.38)
---------- ---------- ----------
Net income (loss)....................... $ 1.90 $ 0.69 $ (0.16)
========== ========== ==========
Diluted:
Income from operations................... $ 1.92 $ 0.68 $ 0.29
Extraordinary loss on extinguishment of
debt.................................... (0.06) - (0.32)
---------- ---------- ----------
Net income (loss)....................... $ 1.86 $ 0.68 $ (0.03)
========== ========== ==========
Shares used in computing earnings (loss)
per common share:
Basic.................................... 68,938 69,704 61,196
Diluted.................................. 70,359 70,702 71,967
</TABLE>

See accompanying notes.

F-3
VENCOR, INC.
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 1997 AND 1996
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................. $ 82,473 $ 112,466
Accounts and notes receivable less allowance for loss
of $63,551--1997
and $23,915--1996.................................... 619,068 420,758
Inventories........................................... 27,605 24,939
Income taxes.......................................... 73,413 67,808
Other................................................. 55,589 35,162
---------- ----------
858,148 661,133
Property and equipment, at cost:
Land.................................................. 144,074 113,749
Buildings............................................. 1,084,770 975,399
Equipment............................................. 592,335 435,787
Construction in progress (estimated cost to complete
and equip after December 31, 1997--$119,000)......... 174,851 84,835
---------- ----------
1,996,030 1,609,770
Accumulated depreciation.............................. (488,212) (416,608)
---------- ----------
1,507,818 1,193,162
Goodwill less accumulated amortization of $18,886--1997
and $7,228--1996...................................... 659,311 14,644
Investments in affiliates.............................. 178,301 14,837
Other.................................................. 131,161 85,080
---------- ----------
$3,334,739 $1,968,856
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable...................................... $ 106,019 $ 103,518
Salaries, wages and other compensation................ 163,642 111,366
Other accrued liabilities............................. 115,933 71,434
Long-term debt due within one year.................... 27,468 54,692
---------- ----------
413,062 341,010


Long-term debt......................................... 1,919,624 710,507
Deferred credits and other liabilities................. 94,653 84,053
Minority interests in equity of consolidated entities.. 2,050 36,195
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 73,470 shares--1997 and 72,615 shares--1996... 18,368 18,154
Capital in excess of par value........................ 766,078 713,527
Retained earnings..................................... 281,803 150,870
---------- ----------
1,066,249 882,551
Common treasury stock; 6,159 shares--1997 and 3,730
shares--1996......................................... (160,899) (85,460)
---------- ----------
905,350 797,091
---------- ----------
$3,334,739 $1,968,856
========== ==========
</TABLE>

See accompanying notes.

F-4
VENCOR, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
SHARES PAR VALUE
-------------------------------- ----------------- CAPITAL IN COMMON
PREFERRED COMMON COMMON PREFERRED COMMON EXCESS OF RETAINED TREASURY
STOCK STOCK TREASURY STOCK STOCK STOCK PAR VALUE EARNINGS STOCK TOTAL
--------- ------ -------------- --------- ------- ---------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balances, December 31,
1994................... 98 59,178 (2,174) $15 $14,794 $472,661 $136,614 $ (27,630) $596,454
Net loss............... (14,889) (14,889)
Cash dividends on
preferred stock
($67.98 per share) and
provision for
redemption value...... (2,380) (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) 13,179
Issuance of common
stock in connection
with acquisitions..... 439 (3,227) 5,498 2,271
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 66,494
Conversion of long-term
debt.................. 7,260 1,815 149,645 151,460
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 52,244
Termination of grantor
trust................. (3,786) 3,786 (946) (87,146) 88,279 187
Redemption of preferred
stock................. (101) (15) (91,253) (91,268)
Other.................. (17) 1 (4) 2,074 (3,770) 12 (1,688)
---- ------ ------ --- ------- -------- -------- --------- --------
Balances, December 31,
1995................... - 72,158 (2,025) - 18,040 684,377 102,865 (33,218) 772,064
Net income............. 48,005 48,005
Increase in equity
resulting from initial
public offering of
Atria Communities,
Inc. common stock..... 19,828 19,828
Issuance of common
stock in connection
with employee benefit
plans................. 457 246 114 9,223 3,083 12,420
Repurchase of common
stock................. (1,950) (55,305) (55,305)
Other.................. (1) 99 (20) 79
---- ------ ------ --- ------- -------- -------- --------- --------
Balances, December 31,
1996................... - 72,615 (3,730) - 18,154 713,527 150,870 (85,460) 797,091
Net income............. 130,933 130,933
Increase in equity
resulting from
secondary public
offering of Atria
Communities, Inc.
common stock.......... 22,553 22,553
Issuance of common
stock in connection
with employee benefit
plans................. 855 496 214 29,336 6,212 35,762
Repurchase of common
stock................. (2,925) (81,651) (81,651)
Other.................. 662 662
---- ------ ------ --- ------- -------- -------- --------- --------
Balances, December 31,
1997................... - 73,470 (6,159) $ - $18,368 $766,078 $281,803 $(160,899) $905,350
==== ====== ====== === ======= ======== ======== ========= ========
</TABLE>

See accompanying notes.

F-5
VENCOR, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)

<TABLE>
<CAPTION>
1997 1996 1995
----------- -------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)........................... $ 130,933 $ 48,005 $ (14,889)
Adjustments to reconcile net income (loss)
to net cash
provided by operating activities:
Depreciation and amortization.............. 123,865 99,533 89,478
Provision for doubtful accounts............ 31,176 15,001 7,851
Deferred income taxes...................... 53,164 (34,814) (23,570)
Extraordinary loss on extinguishment of
debt...................................... 6,829 - 38,091
Non-recurring transactions................. - 121,789 102,166
Other...................................... (9,737) (9,316) 6,958
Change in operating assets and liabilities:
Accounts and notes receivable............. (87,914) (64,304) (107,761)
Inventories and other assets.............. (2,309) 1,284 (3,478)
Accounts payable.......................... (14,177) 2,165 22,157
Income taxes payable...................... 22,850 (23,892) 5,356
Other accrued liabilities................. 16,251 28,088 (8,722)
----------- -------- ---------
Net cash provided by operating
activities............................. 270,931 183,539 113,637
----------- -------- ---------
Cash flows from investing activities:
Purchase of property and equipment.......... (281,672) (135,027) (136,893)
Acquisition of TheraTx, Incorporated........ (359,439) - -
Acquisition of Transitional Hospitals
Corporation................................ (615,620) - -
Other acquisitions.......................... (36,630) (26,236) (59,343)
Sale of assets.............................. 75,988 9,147 899
Collection of notes receivable.............. 8,687 78,151 4,715
Net change in investments................... (4,513) (445) (12,779)
Other....................................... (20,461) (6,576) (8,241)
----------- -------- ---------
Net cash used in investing activities... (1,233,660) (80,986) (211,642)
----------- -------- ---------
Cash flows from financing activities:
Net change in borrowings under revolving
lines of credit............................ 418,700 (1,500) 161,600
Issuance of long-term debt.................. 734,630 10,495 438,052
Repayment of long-term debt................. (130,516) (31,586) (474,896)
Payment of deferred financing costs......... (22,052) (1,816) (3,863)
Public offering of common stock............. - 52,247 66,494
Other issuances of common stock............. 13,832 2,242 6,520
Repurchase of common stock.................. (81,651) (55,305) -
Redemption of preferred stock............... - - (91,268)
Payment of dividends........................ - - (2,779)
Other....................................... (207) (46) (5,691)
----------- -------- ---------
Net cash provided by (used in) financing
activities............................. 932,736 (25,269) 94,169
----------- -------- ---------
Change in cash and cash equivalents.......... (29,993) 77,284 (3,836)
Cash and cash equivalents at beginning of
period...................................... 112,466 35,182 39,018
----------- -------- ---------
Cash and cash equivalents at end of period... $ 82,473 $112,466 $ 35,182
=========== ======== =========
Supplemental information:
Interest payments........................... $ 76,864 $ 46,527 $ 69,916
Income tax payments......................... 16,042 55,303 42,218
</TABLE>

See accompanying notes.


F-6
VENCOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1--ACCOUNTING POLICIES

REPORTING ENTITY

Vencor, Inc. (the "Company") operates an integrated network of healthcare
services in 46 states primarily focused on the needs of the elderly. At
December 31, 1997, the Company operated 60 long-term acute care hospitals
(5,273 licensed beds), 309 nursing centers (40,383 licensed beds) and the
Vencare contract services business ("Vencare") which primarily provides
respiratory and rehabilitation therapies, medical services and pharmacy
management services to approximately 2,900 healthcare facilities.

On September 28, 1995, the Company 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 the Company, 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, the Company completed an initial public
offering related to its independent and assisted living business through the
issuance of 5,750,000 common shares of Atria Communities, Inc. ("Atria") (the
"Atria IPO"). See Note 4.

On March 21, 1997, the Company completed the acquisition of TheraTx,
Incorporated ("TheraTx"), a provider of rehabilitation and respiratory therapy
management services and operator of nursing centers (the "TheraTx Merger"),
pursuant to a cash tender offer. See Note 5.

On June 24, 1997, the Company acquired substantially all of the outstanding
common stock of Transitional Hospitals Corporation ("Transitional"), an
operator of 19 long-term acute care hospitals, pursuant to a cash tender
offer. The Company completed the merger of its wholly owned subsidiary with
and into Transitional on August 26, 1997 (the "Transitional Merger"). See Note
6.

BASIS OF PRESENTATION

The consolidated financial statements include all subsidiaries. Significant
intercompany transactions have been eliminated. Investments in affiliates in
which the Company has a 50% or less interest are accounted for by the equity
method.

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 the Company, Hillhaven and Nationwide for
all periods presented.

The TheraTx Merger and Transitional Merger have been accounted for by the
purchase method, which requires that the accounts and operations of acquired
entities be included with those of the Company since the acquisition of a
controlling interest. Accordingly, the accompanying consolidated financial
statements include the operations of TheraTx and Transitional since March 21,
1997 and June 24, 1997, respectively. The Company expects to finalize the
purchase price allocations related to these transactions in 1998.

For accounting purposes, the accounts of Atria continued to be consolidated
with those of the Company and minority interests in the earnings and equity of
Atria were recorded from the consummation date of the Atria IPO through June
30, 1997. In July 1997, Atria completed a secondary equity offering which
reduced the Company's ownership percentage to less than 50%. Accordingly, the
Company's investment in Atria beginning July 1, 1997 has been accounted for
under the equity method.

F-7
VENCOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


NOTE 1--ACCOUNTING POLICIES (CONTINUED)

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):

<TABLE>
<CAPTION>
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Medicare.................................... $1,068,624 $ 822,589 $ 691,297
Medicaid.................................... 841,598 821,828 776,278
Private and other........................... 1,271,693 972,906 865,820
---------- ---------- ----------
3,181,915 2,617,323 2,333,395
Elimination................................. (65,911) (39,540) (9,439)
---------- ---------- ----------
$3,116,004 $2,577,783 $2,323,956
========== ========== ==========
</TABLE>

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. Amounts recorded
include estimated provisions for loss related to uncollectible accounts and
disputed items that have continuing significance, such as third-party
reimbursements that continue to be claimed in current cost reports.

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 $105.3
million in 1997, $91.6 million in 1996 and $79.7 million in 1995. Depreciation
rates for buildings range generally from 20 to 45 years. Estimated useful lives
of equipment vary from 5 to 15 years.

GOODWILL

Costs in excess of the fair value of identifiable net assets of acquired
entities are amortized using the straight-line method principally over 40
years. Amortization expense for 1997, 1996 and 1995 totaled $11.4 million, $2.7
million and $2.0 million, respectively.

The Company regularly reviews the carrying value of certain long-lived assets
and the related identifiable intangible assets with respect to any events or
circumstances that indicate impairment or that the amortization period may
require adjustment. If such circumstances suggest the recorded amounts cannot
be recovered, calculated based on estimated cash flows (undiscounted) over the
remaining amortization period, the carrying value of such assets are reduced
accordingly. At December 31, 1997, the Company does not believe that the
carrying value or the amortization period of its long-lived assets and related
identifiable intangibles requires such adjustments.

F-8
VENCOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


NOTE 1--ACCOUNTING POLICIES (CONTINUED)

PREOPENING COSTS

Costs incurred prior to the opening of new facilities are deferred and
amortized on a straight-line basis over a three year period. At December 31,
1997 and 1996, the Company's unamortized preopening costs (included in other
assets) were $15.0 million and $1.5 million, respectively.

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.

DERIVATIVE INSTRUMENTS

The Company is a party to interest rate swap agreements that eliminate the
impact of changes in interest rates on certain outstanding floating rate debt.
Each interest rate swap agreement is associated with all or a portion of the
principal balance of a specific debt obligation. These agreements involve the
exchange of amounts based on variable rates for amounts based on fixed
interest rates over the life of the agreement, without an exchange of the
notational amount upon which the payments are based. The differential to be
paid or received as interest rates change is accrued and recognized as an
adjustment of interest expense related to the debt, and the related amount
payable to or receivable from counterparties is included in accrued interest.
The fair values of the swap agreements are not recognized in the financial
statements. Gains and losses on terminations of interest rate swap agreements
are deferred (included in other assets) and amortized as an adjustment to
interest expense over the remaining term of the original contract life of the
terminated swap agreement.

EARNINGS PER COMMON SHARE

In 1997, the Financial Accounting Standards Board (the "FASB") issued
Statement No. 128, "Earnings Per Share" ("SFAS 128"), replacing the
calculation of primary and fully diluted earnings per share with basic and
diluted earnings per share. Unlike primary earnings per share, basic earnings
per share excludes any dilutive effects of options, warrants and convertible
securities. Diluted earnings per share is similar to the previously reported
fully diluted earnings per share. Earnings per share for all periods presented
have been restated to conform to the requirements of SFAS 128. The impact of
the restatement was not significant.

The computation of diluted earnings per common 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 computation also includes the dilutive effect of
convertible debt securities.

During 1995, all convertible debt securities were redeemed in exchange for
cash or converted into the Company's common stock. Accordingly, the
computation of 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, the Company realized a gain in 1995
of approximately $10.2 million upon the cash redemption of Hillhaven preferred
stock. Although the gain had no effect on net income, diluted earnings per
common and common equivalent share were increased by $0.14.

F-9
VENCOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


NOTE 1--ACCOUNTING POLICIES (CONTINUED)

RECENT ACCOUNTING PRONOUNCEMENTS

In June 1997, the FASB issued Statement No. 131, "Disclosures about Segments
of an Enterprise and Related Information" ("SFAS 131"), which will become
effective on December 31, 1998 and requires interim disclosures beginning in
1999. SFAS 131 requires public companies to report certain information about
operating segments, products and services, the geographic areas in which they
operate, and major customers. The operating segments are to be based on the
structure of the enterprise's internal organization whose operating results
are regularly reviewed by senior management. Management has not yet determined
the effect, if any, of SFAS 131 on the consolidated financial statements.

RECLASSIFICATIONS

Certain prior year amounts have been reclassified to conform with the 1997
presentation.

NOTE 2--HILLHAVEN MERGER

On September 27, 1995, the stockholders of both the Company and Hillhaven
approved the Hillhaven Merger, effective September 28, 1995. In connection
with the Hillhaven Merger, the Company 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 Company 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 the Company and
Hillhaven for all periods presented. The following is a summary of the 1995
results of operations of the separate entities prior to the Hillhaven Merger
(dollars in thousands):

<TABLE>
<CAPTION>
NON-
RECURRING
VENCOR HILLHAVEN TRANSACTIONS ELIMINATION CONSOLIDATED
-------- ---------- ------------ ----------- ------------
<S> <C> <C> <C> <C> <C>
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)
</TABLE>

NOTE 3--NATIONWIDE MERGER

Prior to its merger with the Company, 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 1995
results of operations of the separate entities prior to the Nationwide Merger
(dollars in thousands):

<TABLE>
<CAPTION>
NON-
RECURRING
HILLHAVEN NATIONWIDE TRANSACTIONS CONSOLIDATED
--------- ---------- ------------ ------------
<S> <C> <C> <C> <C>
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 (loss)............. 23,459 (266) (3,686) 19,507
</TABLE>

F-10
VENCOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


NOTE 4--STOCK OFFERINGS OF ATRIA

In the third quarter of 1996, the Company completed the Atria IPO, the
proceeds from which aggregated approximately $52.2 million. In connection with
the Atria IPO, the Company entered into various agreements with Atria relating
to risk-sharing for prior year income tax issues, registration rights,
administrative services and liabilities and indemnifications. In addition, the
Company guaranteed up to $75 million of Atria's $200 million bank credit
facility (the "Atria Bank Facility") at December 31, 1997 and lesser amounts
each year thereafter through 2000. At December 31, 1997, there were no
outstanding guaranteed borrowings under the Atria Bank Facility.

In July 1997, Atria completed a secondary equity offering which reduced the
Company's ownership percentage to less than 50%. Accordingly, the Company's
investment in Atria beginning July 1, 1997 has been accounted for under the
equity method. At December 31, 1997, the Company owned 10,000,000 shares, or
approximately 43%, of Atria common stock.

Gains on issuances of Atria common stock have been recorded as adjustments
to common stockholders' equity and have not been credited to earnings.

NOTE 5--THERATX MERGER

On March 21, 1997, the TheraTx Merger was consummated following a cash
tender offer in which the Company paid $17.10 for each outstanding share of
TheraTx common stock. A summary of the TheraTx Merger follows (dollars in
thousands):

<TABLE>
<S> <C>
Fair value of assets acquired........................................ $ 633,793
Fair value of liabilities assumed.................................... (259,439)
---------
Net assets acquired................................................. 374,354
Cash received from acquired entity................................... (14,915)
---------
Net cash paid....................................................... $ 359,439
=========
</TABLE>

The purchase price paid in excess of the fair value of identifiable net
assets acquired aggregated $307.6 million. In September and October 1997, the
Company completed the sales of certain non-strategic assets acquired in
connection with the TheraTx Merger. Proceeds from the transactions aggregated
$54.6 million.

NOTE 6--TRANSITIONAL MERGER

On June 24, 1997, the Company acquired approximately 95% of the outstanding
shares of common stock of Transitional through a cash tender offer in which
the Company paid $16.00 per common share. The Company completed the merger of
its wholly owned subsidiary with and into Transitional on August 26, 1997. A
summary of the Transitional Merger follows (dollars in thousands):

<TABLE>
<S> <C>
Fair value of assets acquired......................................... $713,336
Fair value of liabilities assumed..................................... (44,842)
--------
Net assets acquired.................................................. 668,494
Cash received from acquired entity.................................... (52,874)
--------
Net cash paid........................................................ $615,620
========
</TABLE>

The purchase price paid in excess of the fair value of identifiable net
assets acquired aggregated $349.1 million.

F-11
VENCOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


NOTE 7--BUSINESS COMBINATIONS OTHER THAN HILLHAVEN, NATIONWIDE, THERATX AND
TRANSITIONAL

The Company 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
the Company'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):

<TABLE>
<CAPTION>
1997 1996 1995
-------- ------- --------
<S> <C> <C> <C>
Fair value of assets acquired...................... $ 71,601 $26,621 $ 78,893
Fair value of liabilities assumed.................. (34,971) (385) (16,475)
-------- ------- --------
Net assets acquired............................... 36,630 26,236 62,418
Cash received from acquired entities............... - - (804)
Issuance of common stock........................... - - (2,271)
-------- ------- --------
Net cash paid for acquisitions.................... $ 36,630 $26,236 $ 59,343
======== ======= ========
</TABLE>

The purchase price paid in excess of the fair value of identifiable net
assets of acquired entities aggregated $5.7 million in 1997, $4.8 million in
1996 and $9.7 million in 1995.

NOTE 8--PRO FORMA INFORMATION (UNAUDITED)

The pro forma effect of the TheraTx Merger and Transitional Merger assuming
that the transactions occurred on January 1, 1996 follows (dollars in
thousands, except per share amounts):

<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
---------------------
1997 1996
---------- ----------
<S> <C> <C>
Revenues................................................. $3,364,274 $3,475,217
Income from operations................................... 98,446 14,001
Net income............................................... 94,251 12,867
Earnings per common share:
Basic:
Income from operations.................................. $ 1.43 $ 0.20
Net income.............................................. 1.37 0.18
Diluted:
Income from operations.................................. $ 1.40 $ 0.20
Net income.............................................. 1.34 0.18
</TABLE>

For both periods presented, pro forma financial data have been derived by
combining the financial results of the Company and TheraTx (based upon year
end reporting periods ending on December 31) and Transitional (based upon year
end reporting periods ending on November 30).

Pro forma income from operations for 1997 includes costs incurred by both
TheraTx and Transitional in connection with the acquisitions which reduced net
income by $29.7 million. Pro forma income from operations for 1996 includes a
gain on the sale of Transitional's United Kingdom psychiatric hospitals
aggregating $33 million and losses of $53 million related primarily to the
sale of Transitional's United States psychiatric hospitals.

F-12
VENCOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


NOTE 9--NON-RECURRING TRANSACTIONS

1996

In the fourth quarter of 1996, the Company recorded pretax charges
aggregating $125.2 million primarily to complete the integration of Hillhaven.
In November 1996, the Company 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,
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 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.

During 1997, the Company sold 28 of the 34 non-strategic nursing centers
planned for disposition. Proceeds from the transaction aggregated $11.2
million. In addition, one facility was sold and one was closed in January
1998, and two nursing centers are expected to be sold pending regulatory
approvals. In February 1998, the Company was unable to receive the necessary
licensure approvals to sell two non-strategic nursing centers for which
provisions for loss had been recorded in 1996. The Company intends to continue
to operate these facilities. Accrued provisions for loss at December 31, 1997
were not significant. The reorganization of the institutional pharmacy
business was substantially completed in 1997, which included the elimination
of duplicative administrative functions and establishment of the pharmacy
operations as an integrated part of the Company's hospital operations. The
Company expects that construction activities related to the replacement of one
hospital and three nursing centers will be completed in 1998 and 1999. Accrued
provision for loss related to the facilities to be sold or replaced aggregated
$22.2 million at December 31, 1997.

1995

In the third quarter of 1995, the Company 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 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 (recorded as a reduction
of revenues). During 1996 and 1997, these activities were substantially
completed.

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

F-13
VENCOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


NOTE 10--INVESTMENTS IN AFFILIATES

Affiliated companies accounted for on the equity method include Atria (since
July 1, 1997), Behavioral Healthcare Corporation ("BHC"), a non-public
operator of psychiatric and behavioral centers, and various other healthcare
related companies. The Company obtained a 44% voting equity interest in BHC
(61% ownership interest) as part of the Transitional Merger. Summarized
financial data reported by these affiliates and a summary of the amounts
recorded in the Company's consolidated financial statements as of and for the
year ended December 31, 1997 follow (for the six month period ended December
31, 1997 for Atria and BHC) (dollars in thousands):

<TABLE>
<CAPTION>
ATRIA BHC OTHER TOTAL
-------- ------- ------- --------
<S> <C> <C> <C> <C>
Financial position:
Current assets.............................. $194,761 $74,526 $44,107 $313,394
Current liabilities......................... 14,100 32,876 18,359 65,335
Working capital............................. 180,661 41,650 25,748 248,059
Noncurrent assets........................... 280,702 196,394 22,916 500,012
Noncurrent liabilities...................... 268,524 112,190 16,908 397,622
Stockholders' equity........................ 192,839 125,854 31,756 350,449
Results of operations:
Revenues.................................... 37,679 158,597 97,604 293,880
Net income.................................. 4,328 788 9,913 15,029
Amounts recorded by the Company:
Investments in affiliates................... 85,886 73,046 19,369 178,301
Equity in earnings.......................... 1,870 407 5,904 8,181
</TABLE>

The fair value of the Company's investment in Atria approximated $171.3
million at December 31, 1997.

NOTE 11--INCOME TAXES

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

<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Current:
Federal.............................................. $31,006 $59,470 $40,008
State................................................ 5,168 10,519 7,563
------- ------- -------
36,174 69,989 47,571
Deferred.............................................. 53,164 (34,814) (23,570)
------- ------- -------
$89,338 $35,175 $24,001
======= ======= =======
</TABLE>

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

<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Federal statutory rate........................................ 35.0% 35.0% 35.0%
State income taxes, net of federal income tax benefit......... 3.6 3.6 4.3
Merger and restructuring costs................................ - 3.5 34.6
Goodwill amortization......................................... 1.6 - -
Other items, net.............................................. (0.4) 0.2 0.3
---- ---- ----
Effective income tax rate..................................... 39.8% 42.3% 74.2%
==== ==== ====
</TABLE>

F-14
VENCOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


NOTE 11--INCOME TAXES (CONTINUED)

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

<TABLE>
<CAPTION>
1997 1996
-------------------- --------------------
ASSETS LIABILITIES ASSETS LIABILITIES
-------- ----------- -------- -----------
<S> <C> <C> <C> <C>
Depreciation......................... $ - $65,018 $ - $47,256
Insurance............................ 17,948 - 12,058 -
Doubtful accounts.................... 37,689 - 37,989 -
Property............................. 23,428 - 34,767 -
Compensation......................... 16,154 - 17,030 -
Subsidiary net operating losses
(expiring in 2017).................. 15,864 - - -
Other................................ 26,236 27,170 33,120 19,990
-------- ------- -------- -------
$137,319 $92,188 $134,964 $67,246
======== ======= ======== =======
</TABLE>

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, 1997.

Deferred income taxes totaling $73.4 million and $62.4 million at December
31, 1997 and 1996, respectively, are included in other current assets.
Noncurrent deferred income taxes, included in other long-term liabilities,
totaled $28.3 million at December 31, 1997. Noncurrent deferred income taxes
at December 31, 1996 totaling $5.3 million are included in other long-term
assets.

NOTE 12--PROFESSIONAL LIABILITY RISKS

The Company insures a substantial portion of its professional liability
risks through a wholly owned insurance subsidiary. Provisions for such risks
underwritten by the subsidiary were $10.7 million for 1997, and $10.4 million
for 1996, and $11.1 million for 1995.

Amounts funded for the payment of claims and expenses incident thereto,
included principally in cash and cash equivalents and other assets, aggregated
$26.4 million and $20.7 million at December 31, 1997 and 1996, respectively.
Allowances for professional liability risks, included principally in deferred
credits and other liabilities, were $26.3 million and $21.6 million at
December 31, 1997 and 1996, respectively.

NOTE 13--LONG-TERM DEBT

Capitalization

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

<TABLE>
<CAPTION>
1997 1996
---------- --------
<S> <C> <C>
Senior collateralized debt, 5% to 10% (rates generally
floating) payable in periodic
installments through 2019............................... $ 55,651 $119,634
Non-interest bearing residential mortgage bonds.......... - 33,917
Bank revolving credit agreement due 2002 (floating rates
averaging 6.6%)......................................... 1,129,300 333,100
Bank term loan (floating rates averaging 6.3%)........... - 271,000
8 5/8% Senior Subordinated Notes due 2007................ 750,000 -
Other.................................................... 12,141 7,548
---------- --------
Total debt, average life of six years (rates averaging
7.3%)................................................. 1,947,092 765,199
Amounts due within one year.............................. (27,468) (54,692)
---------- --------
Long-term debt......................................... $1,919,624 $710,507
========== ========
</TABLE>

F-15
VENCOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


NOTE 13--LONG-TERM DEBT (CONTINUED)

In connection with the TheraTx Merger, the Company entered into a new five-
year bank credit facility (the "Bank Facility") aggregating $1.75 billion on
March 31, 1997, replacing the Company's $1.0 billion bank credit facility. On
June 24, 1997, the Bank 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 Bank 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 the amount of additional
debt and repurchases of common stock.

In July 1997, the Company 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 Bank Facility. The Company exchanged
the Notes for publicly registered Notes having identical terms and conditions
in November 1997.

REFINANCING ACTIVITIES

In connection with the TheraTx Merger and the Transitional Merger, the
Company refinanced a substantial portion of its long-term debt. These
transactions resulted in after-tax losses of $4.2 million in 1997. During
1995, the Company 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, $112 million of outstanding
borrowings under prior revolving credit agreements, and $173 million of other
senior debt.

In the fourth quarter of 1995, the Company called for the redemption of its
6% Convertible Subordinated Notes due 2002 aggregating $115 million (the "6%
Notes") and its 7 3/4% Convertible Subordinated Debentures due 2002
aggregating $75 million (the "7 3/4% Debentures") which were convertible into
the Company's 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 share.

OTHER INFORMATION

At December 31, 1997, the Company was a party to certain interest rate swap
agreements that eliminate the impact of changes in interest rates on $400
million of floating rate debt outstanding. One agreement for $100 million
expires in April 1998 and provides for fixed rates at 5.7% plus 3/8% to 1
1/8%. A second agreement provides for fixed rates on $300 million of floating
rate debt at 6.4% plus 3/8% to 1 1/8% and expires in $100 million increments
in May 1999, November 1999 and May 2000. The fair value of the swap agreements
(a payable position of $2.9 million and $139,000 at December 31, 1997 and
1996, respectively) has not been recognized in the consolidated financial
statements. The fair value of the swap agreements represents the estimated
amount the Company would pay to terminate the agreements based on current
interest rates.

Maturities of long-term debt in years 1999 through 2002 are $25.8 million,
$25.4 million, $27.6 million and $1.0 billion, respectively.

F-16
VENCOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


NOTE 13--LONG-TERM DEBT (CONTINUED)

The estimated fair value of the Company's long-term debt was $1.96 billion
and $752 million at December 31, 1997 and 1996, respectively, compared to
carrying amounts aggregating $1.95 billion and $765 million. The estimate of
fair value includes the effect of the interest rate swap agreements and is
based upon the quoted market prices for the same or similar issues of long-
term debt, or on rates available to the Company for debt of the same remaining
maturities.

NOTE 14--LEASES

The Company 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 in thousands):

<TABLE>
<CAPTION>
MINIMUM SUBLEASE
PAYMENTS INCOME
-------- --------
<S> <C> <C>
1998.......................................................... $57,728 $7,119
1999.......................................................... 56,879 6,101
2000.......................................................... 46,376 5,886
2001.......................................................... 34,924 4,513
2002.......................................................... 24,020 2,221
Thereafter.................................................... 86,048 13,425
</TABLE>

Sublease income aggregated $8.0 million, $8.8 million and $13.7 million for
1997, 1996 and 1995, respectively.

NOTE 15--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 the Company's liquidity, financial position or results of operations.

Principal contingencies are described below:

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

Professional liability risks--The Company 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--The Company 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, the Company may incur a loss to the
extent that market rates exceed contract rates.

Guarantees of indebtedness--Letters of credit and guarantees of
indebtedness aggregated $140 million at December 31, 1997, of which $75
million relates to the Atria Bank Facility.

F-17
VENCOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


NOTE 15--CONTINGENCIES (CONTINUED)

Income taxes--The Company 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 the Company. See Note 23.

NOTE 16--EARNINGS PER COMMON SHARE

A computation of the earnings per common share follows (in thousands, except
per share amounts):

<TABLE>
<CAPTION>
1997 1996 1995
-------- ------- -------
<S> <C> <C> <C>
Earnings (loss):
Income (loss) available to common stockholders--ba-
sic computation .................................. $130,933 $48,005 $(9,993)
Interest addback on convertible securities, net of
income tax benefit................................ - - 7,380
-------- ------- -------
Income (loss) available to common stockholders--
diluted
computation...................................... $130,933 $48,005 $(2,613)
======== ======= =======
Shares used in the computation:
Weighted average shares outstanding--basic
computation....................................... 68,938 69,704 61,196
Dilutive effect of employee stock options and other
dilutive securities............................... 1,421 998 10,771
-------- ------- -------
Adjusted weighted average shares outstanding--
diluted computation............................... 70,359 70,702 71,967
======== ======= =======
Earnings (loss) per common share:
Basic:
Income from operations............................ $ 1.96 $ 0.69 $ 0.22
Extraordinary loss on extinguishment of debt...... (0.06) - (0.38)
-------- ------- -------
Net income (loss)................................ $ 1.90 $ 0.69 $ (0.16)
======== ======= =======
Diluted:
Income from operations............................ $ 1.92 $ 0.68 $ 0.29
Extraordinary loss on extinguishment of debt...... (0.06) - (0.32)
-------- ------- -------
Net income (loss)................................ $ 1.86 $ 0.68 $ (0.03)
======== ======= =======
</TABLE>

F-18
VENCOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 17--CAPITAL STOCK

PLAN DESCRIPTIONS

The Company has plans under which options to purchase common stock may be
granted to officers, employees and certain non-employee 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:

<TABLE>
<CAPTION>
SHARES WEIGHTED
UNDER OPTION PRICE AVERAGE
OPTION PER SHARE EXERCISE PRICE
--------- ---------------- --------------
<S> <C> <C> <C>
Balances, December 31, 1994......... 2,046,650 $ 0.53 to $24.25 $12.77
Granted............................ 1,537,820 11.50 to 32.50 27.32
Exercised.......................... (593,918) 0.53 to 29.14 11.57
Canceled or expired................ (51,151) 5.35 to 28.50 21.02
---------
Balances, December 31, 1995......... 2,939,401 0.53 to 32.50 20.48
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
Granted............................ 1,309,900 25.50 to 43.88 30.47
Assumed in connection with TheraTx
Merger............................ 475,643 0.20 to 38.83 27.05
Exercised.......................... (775,431) 0.53 to 35.46 17.90
Canceled or expired................ (301,765) 19.92 to 34.25 26.78
---------
Balances, December 31, 1997......... 4,395,170 $ 0.20 to $43.88 $26.77
=========
</TABLE>

A summary of stock options outstanding at December 31, 1997 follows:

<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------- ------------------------
NUMBER WEIGHTED NUMBER WEIGHTED
OUTSTANDING REMAINING AVERAGE EXERCISABLE AVERAGE
RANGE OF AT DECEMBER 31, CONTRACTUAL EXERCISE AT DECEMBER 31, EXERCISE
EXERCISE PRICES 1997 LIFE PRICE 1997 PRICE
--------------- --------------- ------------- -------- --------------- --------
<S> <C> <C> <C> <C> <C>
$0.20 to $24.86......... 120,692 1 to 4 years $ 8.30 120,692 $ 8.30
$1.02 to $38.83......... 482,941 5 to 7 years 21.72 419,578 21.40
$23.37 to $43.88........ 3,791,537 8 to 10 years 28.00 991,485 27.00
--------- ---------
4,395,170 $26.77 1,531,755 $23.99
========= =========
</TABLE>

The weighted average remaining contractual life of options outstanding at
December 31, 1997 approximated eight years. Shares of common stock available
for future grants were 3,980,678, 1,387,396 and 2,740,066 at December 31,
1997, 1996 and 1995, respectively. The number of options exercisable at
December 31, 1996 and 1995 were 1,142,688 and 1,021,168, respectively.

In 1995, the Company 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 74,330 for 1997, 80,913 for 1996 and 92,500 for
1995.

F-19
VENCOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


NOTE 17--CAPITAL STOCK (CONTINUED)

PLAN DESCRIPTIONS (CONTINUED)

In May 1997, stockholders voted to approve a stock option plan for non-
employee directors and an employee incentive compensation plan. Shares
issuable under the plans aggregated 200,000 and 3,400,000, respectively.

A Shareholder Rights Plan allows common stockholders the right to purchase
Series A Preferred Stock in the event of accumulation of or tender offer for
15% (reduced to 9.9% in February 1998) or more of the Company's common stock.
The rights will expire in 2003 unless redeemed earlier by the Company.

STATEMENT NO. 123 DATA

The Company 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
the Company'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 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 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 5.50% for 1997, 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 .31 for 1997,
.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 the Company'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.

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 1997, 1996 and 1995
under the Black-Scholes model were $13.75, $10.95 and $11.74, respectively.
Pro forma information follows (in thousands except per share amounts):

<TABLE>
<CAPTION>
1997 1996 1995
-------- ------- --------
<S> <C> <C> <C>
Pro forma income (loss) available to common
stockholders...................................... $120,941 $42,530 $(10,842)
Pro forma earnings (loss) per common and common
equivalent share:
Basic............................................. $ 1.75 $ 0.61 $ (0.18)
Diluted........................................... 1.71 0.61 (0.05)
</TABLE>

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.


F-20
VENCOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 18--EMPLOYEE BENEFIT PLANS

The Company 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 $13.0 million
for 1997, $8.8 million for 1996 and $9.7 million for 1995. Amounts equal to
retirement plan expense are funded annually.

NOTE 19--ACCRUED LIABILITIES

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

<TABLE>
<CAPTION>
1997 1996
-------- -------
<S> <C> <C>
Interest...................................................... $ 30,662 $ 3,502
Taxes other than income....................................... 15,462 20,238
Income taxes payable.......................................... 7,737 -
Patient accounts.............................................. 21,370 17,919
Merger related costs.......................................... 15,338 16,640
Other......................................................... 25,364 13,135
-------- -------
$115,933 $71,434
======== =======
</TABLE>

NOTE 20--TRANSACTIONS WITH TENET HEALTHCARE CORPORATION

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 the Company are parties to a guarantee
agreement under which the Company pays a fee to Tenet in consideration for
Tenet's guarantee of certain obligations of the Company. Such fees totaled
$2.0 million in 1997, $3.0 million in 1996, and $3.8 million in 1995.

Leases--The Company leases certain nursing centers from a joint venture
in which Tenet has a minority interest. Lease payments to the joint venture
aggregated $9.4 million, $10.3 million and $9.9 million for 1997, 1996 and
1995, respectively.

Equity ownership--At December 31, 1997, Tenet owned 8,301,067 shares of
the Company's 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 $2.6 million in 1997 and $2.7 million
in both 1996 and 1995.

NOTE 21--FAIR VALUE DATA

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

<TABLE>
<CAPTION>
1997 1996
--------------------- -----------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
---------- ---------- -------- --------
<S> <C> <C> <C> <C>
Cash and cash equivalents.............. $ 82,473 $ 82,473 $112,466 $112,466
Long-term debt, including amounts due
within one year....................... 1,947,092 1,955,097 765,199 751,843
</TABLE>

F-21
VENCOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


NOTE 22--STOCK REPURCHASES

In the fourth quarter of 1997, the Company repurchased 2,925,000 shares of
common stock at an aggregate cost of $81.7 million. Repurchases of 1,950,000
shares common stock in 1996 totaled $55.3 million. These transactions were
financed primarily through borrowings under the Bank Facility.

NOTE 23--LITIGATION

A class action lawsuit entitled A. Carl Helwig v. Vencor, Inc., et al. was
filed on December 24, 1997 in the United States District Court for the Western
District of Kentucky (Civil Action No. 3-97CV-8354). The class action claims
were brought by an alleged stockholder of the Company against the Company and
certain executive officers and directors of the Company, namely W. Bruce
Lunsford, W. Earl Reed, III, Michael R. Barr, Thomas T. Ladt, Jill L. Force
and James H. Gillenwater, Jr. The complaint alleges that the Company and
certain executive officers of the Company during a specified time frame
violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, by,
among other things, issuing to the investing public a series of false and
misleading statements concerning the Company's current operations and the
inherent value of the Company's common stock. The complaint further alleges
that as a result of these purported false and misleading statements concerning
the Company's revenues and successful acquisitions, the price of the Company's
common stock was artificially inflated. In particular, the complaint alleges
that the Company issued false and misleading financial statements during the
first, second and third calendar quarters of 1997 which misrepresented and
understated the impact that changes in Medicare reimbursement policies would
have on the Company's core services and profitability. The complaint further
alleges that the Company issued a series of materially false statements
concerning the purportedly successful integration of its recent acquisitions
and prospective earnings per share for 1997 and 1998 which the Company knew
lacked any reasonable basis and were not being achieved. The suit seeks
damages in an amount to be proven at trial, pre-judgment and post-judgment
interest, reasonable attorneys' fees, expert witness fees and other costs, and
any extraordinary equitable and/or injunctive relief permitted by law or
equity to assure that the plaintiff has an effective remedy. The Company
believes that the allegations in the complaint are without merit and intends
to defend vigorously this action.

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 consisting of
all persons who sold shares of Transitional common stock during the period
from February 26, 1997 through May 4, 1997, inclusive. The complaint alleges
that Transitional purchased 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 disclosing 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 and common law principles of negligent
misrepresentation and names as defendants Transitional as well as certain
senior executives and directors of Transitional. The plaintiff seeks class
certification, unspecified damages, attorneys' fees and costs. The Company has
filed a motion to dismiss and is awaiting the court's decision. The Company is
vigorously defending this action.

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 provided 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

F-22
VENCOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 23--LITIGATION (CONTINUED)

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 suit seeks damages in an
amount of not less than $1,000,000, treble damages and civil penalties. The
Company is cooperating fully in the investigation.

On June 6, 1997, Transitional 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 (the "USAO")
arising from activities of Transitional'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 Transitional. Transitional spun off its dialysis business, now
called Vivra Incorporated, on September 1, 1989. In January 1998, the Company
was informed that no criminal charges would be filed against the Company. The
Company has been informed that the USAO intends to file a civil action against
Transitional relating to the partnership's former business. If such a suit is
filed, the Company will vigorously defend the action.

Management believes that the ultimate resolution of these claims will not
have a material adverse effect on the Company's financial position, results of
operations or liquidity. Accordingly, no provisions for loss related to the
previously discussed litigation matters have been recorded in the consolidated
financial statements.

NOTE 24--SUBSEQUENT EVENT

In January 1998, the Board of Directors of the Company authorized management
to proceed with a plan to separate the Company into two publicly held
corporations, one to operate the hospital, nursing center and Vencare
businesses ("Operating Company") and the other to own substantially all of the
real property of the Company ("Realty Company") and to lease such real
property to Operating Company (the "Reorganization Transactions"). Realty
Company intends to become a real estate investment trust for Federal income
tax purposes beginning January 1, 1999. The Board's action is subject to,
among other things, Company stockholder approval, regulatory and other
approvals, tax considerations and the consummation of a capitalization plan
for each entity. The Company filed a preliminary proxy statement concerning
the Reorganization Transactions and the Distribution with the Securities and
Exchange Commission on January 30, 1998. Management anticipates that the
Reorganization Transactions and Distribution will be completed in the second
quarter of 1998.

The Reorganization Transactions will be effected through the issuance to
Company common stockholders of all of the outstanding shares of Operating
Company (the "Distribution"). Subsequent to the Distribution, Vencor, Inc.
will be the name of the legal entity that will comprise Operating Company and
VenTrust, Inc. will be the name of the legal entity comprising Realty Company.

For accounting purposes the historical consolidated financial statements of
the Company will become the historical consolidated financial statements of
Operating Company at the time of the Distribution. Realty Company will not
have been operated as a real estate investment trust prior to the
Distribution. Accordingly, the consolidated financial statements of Realty
Company will consist solely of its operations after the Distribution. The
assets and liabilities of both Operating Company and Realty Company will be
recorded at their respective historical carrying values at the time of the
Distribution.

In connection with the Reorganization Transactions, the Company will be
required to refinance, repurchase or assign substantially all of its long-term
debt, including the Bank Facility and the Notes. In lieu of repurchasing the
Notes, the Company may assign to Operating Company, and Operating Company
would assume, the Notes. Management is considering a capitalization plan for
both Operating Company and Realty Company to be effected on or before the date
of the Distribution in which the Company's long-term debt is expected to be
refinanced,

F-23
VENCOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 24--SUBSEQUENT EVENT (CONTINUED)

repurchased or assumed by either Operating Company or Realty Company at
interest rates and terms which may be less favorable than those of the
Company's current debt arrangements. There can be no assurance that sufficient
financing will be available on terms that are acceptable to either Operating
Company or Realty Company, or that either entity will have the financial
resources necessary to implement its respective acquisition and development
plans following the Distribution.


F-24
VENCOR, INC.
QUARTERLY CONSOLIDATED FINANCIAL INFORMATION (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
1997
--------------------------------------------
FIRST SECOND THIRD FOURTH
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues...................... $680,696 $778,295 $844,740 $812,273
Net income:
Income from operations....... 33,982 37,010 36,902 27,234
Extraordinary loss on extin-
guishment of debt........... (2,259) (1,590) (346) -
Net income................. 31,723 35,420 36,556 27,234
Per common share:
Basic earnings:
Income from operations...... 0.49 0.53 0.53 0.40
Extraordinary loss on extin-
guishment of debt.......... (0.03) (0.02) - -
Net income................. 0.46 0.51 0.53 0.40
Diluted earnings:
Income from operations...... 0.48 0.52 0.52 0.40
Extraordinary loss on extin-
guishment of debt.......... (0.03) (0.02) (0.01) -
Net income................. 0.45 0.50 0.51 0.40
Market prices (a):
High........................ 40 3/8 45 1/8 44 3/8 43 5/16
Low......................... 29 36 5/8 37 3/8 23
<CAPTION>
1996
--------------------------------------------
FIRST SECOND THIRD FOURTH
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues...................... $626,337 $634,554 $650,551 $666,341
Net income (loss) (b)......... 27,610 30,865 33,558 (44,028)
Per common share:
Basic earnings (loss)........ 0.39 0.44 0.48 (0.64)
Diluted earnings (loss)...... 0.39 0.43 0.48 (0.64)
Market prices (a):
High........................ 39 7/8 35 34 1/2 33 1/4
Low......................... 31 1/2 28 1/8 25 1/2 27 1/2
</TABLE>
- --------
Earnings per share amounts for all periods presented have been restated to
comply with the provisions of SFAS 128. See Notes 1 and 16 of the Notes to
Consolidated Financial Statements.

(a) The Company's common stock is traded on the New York Stock Exchange
(ticker symbol--VC).

(b) Fourth quarter results include $79.9 million ($1.16 per share) of costs in
connection with the sale of certain nursing centers, the restructuring of
the pharmacy operations and the planned replacement of certain facilities.
See Note 9 of the Notes to Consolidated Financial Statements.

F-25
VENCOR, INC.
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)

<TABLE>
<CAPTION>
ADDITIONS
-------------------------
BALANCE
BALANCE AT CHARGED TO AT END
BEGINNING COSTS AND DEDUCTIONS OF
OF PERIOD EXPENSES ACQUISITIONS OR PAYMENTS PERIOD
---------- ---------- ------------ ----------- -------
<S> <C> <C> <C> <C> <C>
Allowances for loss on
accounts and
notes receivable:
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
Year ended December
31, 1997............. 23,915 31,176 26,144 (17,684) 63,551
Allowances for loss on
assets held
for disposition:
Year ended December
31, 1995............. $ - $26,900(a) $ - $ - $26,900
Year ended December
31, 1996............. 26,900 64,000(b) - (22,812) 68,088
Year ended December
31, 1997............. 68,088 - 7,225 (43,891) 31,422
</TABLE>
- --------
(a) Reflects provision for loss associated with the planned disposition of
certain nursing center properties recorded in connection with the
Hillhaven Merger.

(b) Reflects provision for loss associated with the sale of certain nursing
centers and the planned replacement of one hospital and three nursing
centers.

F-26