<PAGE>

               UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549
                                   FORM 10-Q

(Mark One)
[X]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
     ACT OF 1934

                 For the Quarterly Period Ended June 30, 2001

                                      OR

[_]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934

           For the Transition Period from ___________ to ___________


                        Commission File Number: 0-17969
                                                -------


                               NEXTHEALTH, INC.
                              ------------------
            (Exact Name of Registrant as Specified in its Charter)


             Delaware                                 86-0589712
--------------------------------         --------------------------------------
(State or Other Jurisdiction of          (I.R.S. Employer Identification No.)
Incorporation or Organization)


16600 N. Lago Del Oro Parkway, Tucson, Arizona                 85739
----------------------------------------------             ------------
(Address of Principal Executive Offices)                    (Zip Code)


                                (520) 818-5800
             ----------------------------------------------------
             (Registrant's Telephone Number, including Area Code)


                                      N/A
--------------------------------------------------------------------------------
  (Former name, former address and former fiscal year, if changed since last
                                   report).


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. [X] YES [_] NO

On August 1, 2001, there were 8,638,888 shares of the registrant's Common Stock
outstanding.

Reference is made to the listing beginning on page 17 of all exhibits filed as a
part of this report.
<PAGE>

                               NEXTHEALTH, INC.
                                   FORM 10-Q
                               TABLE OF CONTENTS

<TABLE>
<CAPTION>
Part I - Financial Information                                                                                 Page
------------------------------                                                                                 ----
<S>                                                                                                            <C>
Item 1.   Financial Statements

          Consolidated Balance Sheets as of June 30, 2001 (unaudited) and December
             31, 2000.............................................................................              3

          Unaudited Consolidated Statements of Operations for the three and six-month
             periods ended June 30, 2001 and 2000 ................................................              4

          Unaudited Consolidated Statements of Cash Flows for the six-month periods
             ended June 30, 2001 and 2000 ........................................................              5

          Unaudited Consolidated Statements of Changes in Stockholders' Equity for the
             six-month period ended June 30, 2001 ................................................              6

          Unaudited Notes to the Consolidated Financial Statements ...............................              7

Item 2.   Management's Discussion and Analysis of Financial Condition and Results of
             Operations ..........................................................................             10


Part II - Other Information
---------------------------

Item 1.   Legal Proceedings ......................................................................             17

Item 4.   Submission of Matters to a Vote of Security Holders ....................................             17

Item 6.   Exhibits and Reports on Form 8-K .......................................................             17

Signatures .......................................................................................             18
</TABLE>

                                       2
<PAGE>

                        PART I - FINANCIAL INFORMATION
                        ------------------------------

ITEM 1.   FINANCIAL STATEMENTS


                       NEXTHEALTH, INC. AND SUBSIDIARIES
                          CONSOLIDATED BALANCE SHEETS
                  (000s, except share and per share amounts)

<TABLE>
<CAPTION>
                                                                      June 30    December 31,
                                                                        2001        2000
                                                                     -----------  ----------
                                                                     (Unaudited)
ASSETS
------
<S>                                                                   <C>          <C>
  Current Assets:
    Cash and equivalents ...........................................   $ 15,995    $ 12,737
    Accounts receivable, less allowance for doubtful accounts
       of $393 and $368, respectively ..............................        840       1,467
    Prepaid expenses ...............................................        928         701
    Other current assets ...........................................        661         708
                                                                       --------    --------
         Total current assets ......................................     18,424      15,613

  Property and equipment, net ......................................     32,495      32,871
  Long-term receivables, less allowance for doubtful accounts
      of $20 and $21, respectively .................................         59          64
  Intangible assets, less amortization of $43 and $527, respectively         72         214
  Other assets .....................................................         21          22
                                                                       --------    --------

         Total assets ..............................................   $ 51,071    $ 48,784
                                                                       ========    ========

LIABILITIES AND STOCKHOLDERS' EQUITY
  Current Liabilities:
    Accounts payable, trade ........................................   $    470    $  1,192
    Accrued expenses and other liabilities .........................      4,195       5,808
    Short-term debt ................................................     12,291          --
                                                                       --------    --------
         Total current liabilities .................................     16,956       7,000

Long-term debt and financing obligation ............................        226      12,587
                                                                       --------    --------
         Total liabilities .........................................     17,182      19,587

Minority interest ..................................................        629         547

  Stockholders' Equity:
    Preferred stock - undesignated, $.01 par value, 3,924,979
      shares authorized, no shares outstanding .....................        --           --
    Preferred stock, Series A, $.01 par value, 46,065 shares
      authorized; 46,065 shares outstanding at June 30, 2001
      and December 31, 2000 ........................................        --           --
    Common stock, $.01 par value, 16,000,000 shares authorized;
      8,638,888 shares outstanding at June 30, 2001 and
      8,623,513 shares outstanding at December 31, 2000 ............         86          86
    Additional paid-in capital .....................................     48,168      48,146
    Accumulated deficit ............................................    (14,994)    (19,582)
                                                                       --------    --------

         Total stockholders' equity ................................     33,260      28,650
                                                                       --------    --------

         Total liabilities and stockholders' equity ................   $ 51,071    $ 48,784
                                                                       ========    ========
</TABLE>

The accompanying notes are an integral part of the consolidated financial
statements.

                                       3
<PAGE>

                       NEXTHEALTH, INC. AND SUBSIDIARIES
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                  (000s, except share and per share amounts)
                                  (Unaudited)

<TABLE>
<CAPTION>
                                                                         Three Months Ended             Six Months Ended
                                                                              June 30,                       June 30,
                                                                       --------------------------    -----------------------
                                                                            2001         2000            2001         2000
                                                                       -----------   ------------    -----------   ---------
<S>                                                                    <C>           <C>             <C>           <C>
Revenue:
   Net operating revenue ...........................................   $    10,663   $    10,437   $    22,517   $    21,145
   Other revenue ...................................................           211            81           401           143
                                                                       -----------   -----------   -----------   -----------

         Total net revenue .........................................        10,874        10,518        22,918        21,288

Operating expenses:
   Salaries and related benefits ...................................         4,495         3,958         8,889         7,918
   General and administrative ......................................         3,719         3,271         7,365         6,467
   Depreciation and amortization ...................................           582           704         1,113         1,399
   Interest expense ................................................           276           333           587           658
   Investment loss .................................................           --             --           288            --
                                                                       -----------   -----------   -----------   -----------
         Total operating expenses ..................................         9,072         8,266        18,242        16,442
                                                                       -----------   -----------   -----------   -----------

Income before income taxes .........................................         1,802         2,252         4,676         4,846

Income tax provision ...............................................            32            97            88            97
                                                                       -----------   -----------   -----------   -----------
Net income .........................................................   $     1,770   $     2,155   $     4,588   $     4,749
                                                                       ===========   ===========   ===========   ===========

Shares used in basic per share
  calculation ......................................................     8,638,888     8,619,488     8,638,888     8,619,488
                                                                       ===========   ===========   ===========   ===========

Shares used in diluted per share
  calculation ......................................................    14,554,719    14,127,030    14,528,871    14,103,780
                                                                       ===========   ===========   ===========   ===========
Basic income per common
  share ............................................................   $       .20   $       .25   $       .53   $       .55
                                                                       ===========   ===========   ===========   ===========

Diluted income per common
  share ............................................................   $       .12   $       .15   $       .32   $       .34
                                                                       ===========   ===========   ===========   ===========

</TABLE>

   The accompanying notes are an integral part of the consolidated financial
                                  statements.

                                       4
<PAGE>

                       NEXTHEALTH, INC. AND SUBSIDIARIES
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                    (000s)
                                  (Unaudited)

<TABLE>
<CAPTION>
                                                                          Six Months Ended
                                                                              June 30,
                                                                    ---------------------
                                                                        2001         2000
                                                                    --------    ---------
<S>                                                                <C>          <C>

Cash flows from operating activities:
  Net income ..............................................         $  4,588    $   4,749
  Adjustments to reconcile net income to cash
    provided by operating activities:
        Depreciation and amortization .....................            1,113        1,399
        Provision for bad debts ...........................              114           63
        Provision for income tax ..........................              (37)          97
        Minority Interest .................................               82           83
        Charge for non-employee options ...................               --            4
Changes in operating assets and liabilities:
     Decrease (increase) in assets:
        Accounts receivable ...............................              518          (22)
        Other assets ......................................             (181)        (302)
     Decrease in liabilities:
        Accounts payable, accrued expenses
          and other liabilities ...........................           (2,329)         (78)
                                                                    ---------   ----------
Net cash provided by operating activities .................            3,868        5,993

Cash flows from investing activities:
     Purchase of property and equipment ...................             (563)        (504)
                                                                    --------    ---------
Net cash used in investing activities .....................             (563)        (504)

Cash flows from financing activities:
     Proceeds from sale of stock ..........................               22          120
     Reduction of long-term borrowings and
        financing obligation ..............................              (69)         (64)
                                                                    --------    ---------
Net cash (used in) provided by financing activities........              (47)          56
                                                                    --------    ---------

Net increase in cash and
  equivalents .............................................            3,258        5,545

Cash and equivalents at beginning of period ...............           12,737        3,803
                                                                    --------    ---------

Cash and equivalents at end of period .....................         $ 15,995    $   9,348
                                                                    ========    =========
</TABLE>

   The accompanying notes are an integral part of the consolidated financial
                                  statements.

                                       5
<PAGE>

                       NEXTHEALTH, INC. AND SUBSIDIARIES
          CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
                         (000s, except share amounts)
                                  (Unaudited)

<TABLE>
<CAPTION>

                                                 Additional                  Total
                              Common Stock        Paid-in    Accumulated  Stockholders'
                            ----------------
                            Cost     Shares       Capital      Deficit      Equity
                            ----     -------   ----------  ----------   -----------
<S>                        <C>     <C>        <C>         <C>          <C>
Balance at
 December 31, 2000          $ 86   8,623,513   $  48,146   $ (19,582)   $  28,650

Sale of common stock          --      15,375          22          --           22

Net income for the
 six months ended
 June 30, 2001                --          --          --       4,588        4,588
                            ----   ---------   ---------   ---------    ---------


Balance at
 June 30, 2001              $ 86   8,638,888   $  48,168   $ (14,994)   $  33,260
                            ====   =========   =========   =========    =========
</TABLE>


   The accompanying notes are an integral part of the consolidated financial
                                  statements.

                                       6
<PAGE>

                               NEXTHEALTH, INC.
                NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
                                    (000s)
                                  (Unaudited)
NOTE 1 - ORGANIZATION

NextHealth, Inc. and subsidiaries (collectively, the "Company") have operations
in two principal business segments; Treatment, and Health and Leisure through
which it provides both behavioral health care and wellness and preventive health
services. The Treatment segment includes Sierra Tucson, LLC ("Sierra Tucson"),
an inpatient, state licensed, special psychiatric hospital and behavioral health
care center providing treatment for substance abuse and a broad range of mental
health and behavioral disorders. The Health and Leisure segment, Sierra
Health-Styles, Inc. d/b/a Miraval ("Miraval"), is a luxury health resort and spa
which provides a unique vacation experience blending mindfulness, personal
growth and self-awareness programs with a full range of personal services and
recreational activities. The current operations of the Company are located in
Tucson, Arizona.

NOTE 2 - BASIS OF PRESENTATION

The unaudited consolidated financial statements presented herein should be read
in conjunction with the consolidated financial statements and notes thereto
included in the Company's Annual Report on Form 10-K/A for the year ended
December 31, 2000. The accompanying interim consolidated financial statements as
of June 30, 2001 and for the three and six-month periods ended June 30, 2001 and
2000 included herein are unaudited, but reflect, in the opinion of management,
all adjustments (consisting of normal recurring adjustments) considered
necessary to fairly present the results for such periods. Operating results for
the three and six-month periods ended June 30, 2001 are not necessarily
indicative of the results that may be expected for the year ended December 31,
2001.

NOTE 3 - NEW PRONOUNCEMENTS

In June 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 141, Business Combinations, and No. 142,
Goodwill and Other Intangible Assets, effective for fiscal years beginning after
December 15, 2001. Under the new rules, goodwill (and intangible assets deemed
to have indefinite lives) will no longer be amortized but will be subject to
annual impairment tests in accordance with the Statements. Other intangible
assets will continue to be amortized over their useful lives. The Company does
not anticipate these statements to have a material impact on the Company's
financials.

NOTE 4 - NET INCOME PER SHARE

Shares used in the diluted per share calculation for the three and six-month
periods ending June 30, 2001 and 2000 are as stated below:

                                  Three-month period         Six-month period
                                     ended June 30,            ended June 30,
                               -------------------------------------------------
                                   2001         2000        2001          2000
                               ----------   ----------   ----------   ----------

Common shares                   8,638,888    8,619,488    8,638,888    8,619,488
Convertible preferred shares    4,606,500    4,606,500    4,606,500    4,606,500
Dilutive options                  589,439      301,042      569,356      277,792
Dilutive warrants                 719,892      600,000      714,127      600,000
                               ----------   ----------   ----------   ----------

Diluted shares                 14,554,719   14,127,030   14,528,871   14,103,780
                               ==========   ==========   ==========   ==========

                                       7
<PAGE>

NOTE 5 - BUSINESS SEGMENT AND OTHER OPERATING DATA

The Company operates in two principal business segments; Treatment, and Health
and Leisure (the Segments) through which it provides both behavioral health care
and wellness and preventive health services. The Segments are located in and
derive all their revenues from their facilities in Tucson, Arizona. The
Treatment Segment is an inpatient, state licensed, special psychiatric hospital
and behavioral health care center providing treatment for substance abuse and a
broad range of mental health and behavioral disorders. Substantially all
revenues in this Segment result from inpatient charges, therapy, professional
fees, and pharmacy charges. The Health and Leisure Segment consists of a luxury
health resort and spa which provides a unique vacation experience blending
mindfulness, personal growth and self-awareness programs with a full range of
personal services and recreational activities. Substantially all revenues in
this Segment result from guest bookings, group bookings and retail sales of
goods and services.

Information about the Company's operations in different business segments for
the three and six-month periods ending June 30, 2001 and 2000 is as follows:

<TABLE>
<CAPTION>
                                                                       Corporate
                                                         Health &         and
                                          Treatment      Leisure      Other Items      Consolidated
                                          ---------     ---------     -----------      ------------
<S>                                       <C>            <C>          <C>              <C>
Three-month period ended
June 30, 2001
------------------------
Total revenue.........................    $   6,018      $  4,849     $       7        $   10,874
Income (loss) before
  income tax expense..................        2,097           442         ( 737)            1,802
Identifiable assets...................       13,762        33,592         3,717            51,071
Capital expenditures..................          155           134             0               289
Depreciation & amortization
  expense.............................          121           457             4               582
Interest expense......................          177            99             0               276

Six-month period ended
June 30, 2001
----------------------
Total revenue.........................    $  11,933      $ 10,963     $      22        $   22,918
Income (loss) before
  income tax expense..................        4,221         1,692        (1,237)            4,676
Identifiable assets...................       13,762        33,592         3,717            51,071
Capital expenditures..................          219           341             3               563
Depreciation & amortization
  expense.............................          214           890             9             1,113
Interest expense......................          376           211             0               587

Three-month period ended
June 30, 2000
------------------------
Total revenue.........................    $   5,631      $  4,879     $       8        $   10,518
Income (loss) before
  income tax expense..................        2,359           241          (348)            2,252
Identifiable assets...................       10,545        32,166         2,054            44,765
Capital expenditures..................          145            70            --               215
Depreciation & amortization
  expense.............................           95           605             4               704
Interest expense......................          212           120             1               333
</TABLE>

                                       8
<PAGE>

<TABLE>
<CAPTION>
                                                                        Corporate
                                                        Health &           and
                                       Treatment         Leisure       Other Items      Consolidated
                                      -----------      -----------    -------------    --------------
<S>                                   <C>              <C>            <C>              <C>
Six-month period ended
June 30, 2000
----------------------
Total revenue...................      $   10,750       $    10,514    $       24       $     21,288
Income (loss) before
  income tax expense............           4,280             1,175          (609)             4,846
Identifiable assets.............          10,545            32,166         2,054             44,765
Capital expenditures............             190               314            --                504
Depreciation & amortization
  expense.......................             188             1,203             8              1,399
Interest expense................             420               237             1                658
</TABLE>

NOTE 6- INCOME TAXES

A provision for income taxes was recorded in the three and six-month periods
ended June 30, 2001 due to the existence of Alternative Minimum Tax (AMT)
requirements. A valuation allowance has been recorded to offset deferred tax
assets which principally consist of net operating loss carryforwards. The
Company intends to recognize the benefits of deferred tax assets as the net
operating loss carryforwards are utilized in the near term.

                                       9
<PAGE>

ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS

The following discussion and analysis relates to factors which have affected the
consolidated financial condition and results of operations of the Company for
the three and six-month periods ended June 30, 2001. Reference should also be
made to the Company's unaudited consolidated financial statements and related
notes thereto included elsewhere in this document.

General
-------

NextHealth, Inc. is a leading provider of a broad range of alternative health
care services which focus on prevention and self care. For over fifteen years,
the Company has provided effective programs and services which address
individual wellness and quality-of-life issues through a whole person, mind-body
approach.

For the quarter ended June 30, 2001, the Treatment segment accounted for
approximately 55.3% of the Company's operating revenues and approximately 43.2%
of its operating expenses, while the Health and Leisure segment accounted for
approximately 44.6% of the Company's operating revenue and approximately 48.6%
of its operating expenses.

Material Changes in Financial Condition
---------------------------------------

Cash and equivalents for the quarter increased $1.3 million to $16.0 million or
9.1%. The increase is a result of cash flow from operating activities during the
period. See Consolidated Statements of Cash Flows for more information.

Material Changes in Results of Operations
-----------------------------------------

Three-month period ended June 30, 2001 compared to three-month period ended June
30, 2000

The significant changes in results of operations and net cash provided by
operating activities for the three-month period ended June 30, 2001, compared to
the same period in 2000 are discussed below.

<TABLE>
<CAPTION>
                                                             Three Months Ended
                                                                 June 30,
                                                      ----------------------------------
                                                        2001       2000       % Change
                                                      --------  ----------  ------------
<S>                                                   <C>       <C>         <C>
Financial results: (000s, except per share amounts)
  Total net revenue ...............................   $10,874   $ 10,518          3.4 %
  Total operating expenses ........................     9,072      8,266          9.8
  Income before income taxes ......................     1,802      2,252        (20.0)
  Basic income per common share ...................       .20        .25        (20.0)
  Diluted income per common share .................       .12        .15        (20.0)
  Net cash provided by operating activities .......     1,656      2,121        (21.9)
Operating data:
  Patient days - Sierra Tucson ....................     6,224      5,921          5.1
  Average daily census - Sierra Tucson ............        68         65          5.2
  Guest days - Miraval ............................     8,845      9,524         (7.1)
  Room occupancy - Miraval ........................        59%        66%        (9.9)
</TABLE>

                                      10
<PAGE>

For the three-month period ended June 30, 2001, net income before income taxes
decreased $450,000 to $1.8 million or 20% when compared to second quarter of
2000. Net cash provided by operating activities decreased 21.9% resulting in net
cash provided by operating activities of $1.7 million compared to the same
period in 2000.

Total net revenue increased 3.4% to $10.9 million, an increase of $356,000 when
compared to the same period in 2000. Results reflect a less than 1% revenue
decrease at Miraval and a 7.0% revenue increase at Sierra Tucson, when compared
to the corresponding quarter of 2000.

Salaries and related benefits increased 3.7% as a percentage of revenue during
the quarter. Salaries and related benefits increased $537,000 to $4.5 million, a
13.6% increase over the comparable period in 2000. The increase was primarily
attributable to staffing changes in the patient care areas at Sierra Tucson.

General and administrative expense increased 3.1% as a percentage of revenue
during the second quarter of 2001. General and administrative expense increased
$448,000 to $3.7 million, an increase of 13.7% when compared to the same period
in 2000. Included in corporate general and administrative expenses is $398,000
for ongoing activities related to the proposed merger transaction previously
disclosed by the Company. Additional merger-related expenses totaling $252,000,
incurred following the Company's acceptance of the April 16, 2001 Agreement and
Plan of Merger, have been deferred.

Interest expense decreased $57,000 to $276,000 or 17.1% when compared to second
quarter 2000. The decrease reflects the more favorable interest rate on the loan
outstanding in the second quarter 2001 compared to the rate charged in the
corresponding quarter of 2000.

The Company recognized pre-tax income of $1.8 million for the three-month period
ended June 30, 2001. A $32,000 provision for income taxes was recorded during
this period due to the existence of Alternative Minimum Tax (AMT) requirements.
A valuation allowance has been recorded to offset deferred tax assets which
principally consist of net operating loss carryforwards. The Company intends to
recognize the benefits of deferred tax assets as the net operating loss
carryforwards are utilized. However, management will continue to evaluate the
necessity of maintaining the valuation allowance in light of the Company's
profitability results for 2000 and expectations for 2001 and 2002. The
continuation of such positive trends in profitability could allow management to
appropriately reduce the valuation allowance significantly and result in the
recognition of deferred tax assets on the balance sheet perhaps in the latter
part of 2001.

Six-month period ended June 30, 2001 compared to six-month period ended June 30,
2000

The significant changes in results of operations and net cash provided by
operating activities for the six-month period ended June 30, 2001, compared to
the same period in 2000 are discussed below.

<TABLE>
<CAPTION>
                                                                        Six Months Ended
                                                                            June 30,
                                                           -------------------------------------------
                                                               2001          2000           % Change
                                                           ----------     ----------      ------------
<S>                                                        <C>            <C>             <C>
Financial results: (000's except per share amounts)
  Total net revenue ...............................        $  22,918      $   21,288           7.7 %
  Total operating expenses ........................           18,242          16,442          11.0
  Income before income taxes ......................            4,676           4,846         ( 3.5)
  Basic income per common share ...................             0.53            0.55         ( 3.6)
  Diluted income per common share .................             0.32            0.34         ( 5.9)
  Net cash provided by operating activities .......            3,868           5,993         (35.5)
Operating data:
  Patient days - Sierra Tucson ....................           12,447          11,579           7.5
  Average daily census - Sierra Tucson ............               69              64           7.5
  Guest days - Miraval ............................           18,591          19,294         ( 3.6)
  Room occupancy - Miraval ........................               64%             67%        ( 4.8)
</TABLE>

                                      11

<PAGE>

For the six-month period ended June 30, 2001, net income before income taxes
decreased 3.5% to $4.7 million compared to $4.8 million for the same period of
2000. Net cash provided by operating activities decreased to $3.9 million
compared to $6.0 million for the six-month period of 2000. Cash flow was
affected by the first quarter 2001 payment of a deposit of $1.6 million for
preliminary settlement of the 1994 IRS Audit.

Total net revenue for the six-month period ended June 30, 2001 increased $1.6
million or 7.7% to $22.9 million when compared to the same period of 2000. The
increase is attributable to an 11.3% revenue increase at Sierra Tucson and a
4.3% revenue increase at Miraval.

Salaries and related benefits increased 1.6% as a percentage of revenue during
the six-month period. Salaries and related benefits increased $971,000 to $8.9
million or 12.3% when compared to 2000. The increase is due primarily to
staffing changes in the patient care areas at Sierra Tucson.

General and administrative expense increased 1.8% as a percentage of revenue
during the six-month period ended June 30, 2001. General and administrative
expense increased $898,000 or 13.9% to $7.4 million when compared to the same
period of 2000. Included in corporate general and administrative expenses is
$617,000 in costs associated with the proposed merger transaction. Additional
merger-related expenses totaling $252,000, incurred following the Company's
acceptance of the April 16, 2001 Agreement and Plan of Merger, have been
deferred.

Interest expense decreased $71,000 to $587,000 or 10.8% when compared to the
previous year. The increase reflects the more favorable rate on the loan
outstanding in 2001 as compared to the rate charged on the loan outstanding in
2000.

The Company recognized pre-tax income of $4.7 million for the six-month period
ended June 30, 2001. An $88,000 provision for income taxes was recorded during
this period due to the existence of Alternative Minimum Tax (AMT) requirements.
A valuation allowance has been recorded to offset deferred tax assets which
principally consist of net operating loss carryforwards. The Company intends to
recognize the benefits of deferred tax assets as the net operating loss
carryforwards are utilized. However, management will continue to evaluate the
necessity of maintaining the valuation allowance in light of the Company's
profitability results for 2000 and expectations for 2001 and 2002. The
continuation of such positive trends in profitability could allow management to
appropriately reduce the valuation allowance significantly and result in the
recognition of deferred tax assets on the balance sheet perhaps in the latter
part of 2001.

Liquidity and Capital Resources
-------------------------------

Net cash provided by the Treatment segment's operating activities is primarily
affected by census levels and net revenue per patient day. This segment
contributed positive cash flow to the Company's operations during the three and
six-month periods ended June 30, 2001. During the three-month period ended June
30, 2001, 46% of patient revenue was derived from retail payments and the
remaining 54% from insurance, contracts and other third party payors. Based on
current census levels and operating expenses, Sierra Tucson believes that it
will generate adequate cash flows to sustain the Treatment segment's ongoing
operational requirements and to fund anticipated capital projects. Effective May
1, 2001, Sierra Tucson instituted a rate increase in some of its treatment
programs.

The Company currently leases the Sierra Tucson buildings from a related party,
ODE, L.L.C. The Company amended its lease ("Building Lease") with ODE for the
buildings to provide for a lease term which, when combined with successive
10-year option renewals ("Renewal Options"), will be of the same duration as the
State Land Lease for the property on which the buildings are located. The annual
rent for the buildings is subject to an increase for the term of each subsequent
Renewal Option (if exercised) based upon or determined by independent appraisal.
The first Renewal Option commenced in March 2001, and the annual rent increased
to an agreed upon fair market rental of $500,000 plus an annual increase based
on the Consumer Price Index, not to exceed 3% per annum.

                                      12
<PAGE>

Results in the Health and Leisure segment are primarily affected by room
occupancy and average daily rate in addition to expense management. During
second quarter 2001, Miraval's room occupancy rate was approximately 59%, as
compared to 66% for the same quarter last year. This segment also contributed
positive cash flow to the Company's operations during the quarter. Based on
second quarter occupancy, management believes that Miraval may have experienced
some negative impact from the general economic downturn.

For the three-month period ended June 30, 2001, the Company had capital
expenditures of approximately $289. At June 30, 2001, the Company's cash and
equivalents were $16.0 million. On July 2, 2001, the Company paid $12.4 million
from its cash reserves to fully retire the outstanding indebtedness to Lehman
Brothers Holdings Inc.

Management believes that funds from operations will provide the cash necessary
to meet its short-term capital needs. The Company must continue to focus on
revenue growth and expense controls in order to preserve and improve its
liquidity position. Insufficient occupancy levels at Miraval or any significant
decrease in Sierra Tucson's patient levels would adversely affect the Company's
financial position, results of operations and cash flows.

Business Outlook
----------------

In the Treatment segment (Sierra Tucson), particular emphasis will be placed on
increasing awareness of Sierra Tucson's innovative treatment programs through a
combination of focused advertising, direct mail, field sales, conference
sponsorships and outbound telemarketing campaigns. In addition to continuing its
traditional marketing efforts to the referent therapist community and alumni,
Sierra Tucson will participate in various conferences and professional boards
and organizations. Marketing field representatives will continue their efforts
to enhance Sierra Tucson's national exposure and to increase the number of
prospective patients.

Clinically, Sierra Tucson continually strives to refine its programs. In
response to census increases, staffing adjustments have been made to ensure high
staff to patient ratios and to further enhance the quality of the treatment
experience. Sierra Tucson continues to incorporate new credible therapeutic
techniques, and based on a trend of higher acuity, assessment tools for higher
risk patients have been enhanced, ensuring a better clinical match.

In July 1998, the Company relocated the Sierra Tucson operations to the
facilities previously used by the Company's adolescent care unit (which ceased
operations in 1993). The facilities are located on state leased land, and in
October 1998, the Company entered into a 50-year Commercial Land Lease Agreement
for the property with the Arizona State Land Department. In 1999, the Company
expanded the Sierra Tucson facilities through the addition of administrative
offices and space for 16 additional beds, bringing the total number of beds to
79. In 2000, construction was completed on a 4,220 square foot wing named Desert
Oasis. The new area houses group rooms and medical records as well as staff
offices. In addition, Sierra Tucson also renovated and updated its fitness
center in 2000. Effective May 1, 2001, Sierra Tucson instituted a rate increase
in some of its treatment programs.

The Company currently leases the Sierra Tucson buildings from a related party,
ODE, L.L.C. The Company amended its lease ("Building Lease") with ODE for the
Buildings to provide for a lease term which, when combined with successive
10-year option renewals ("Renewal Options"), will be of the same duration as the
State Land Lease. The annual rent for the Buildings is subject to an increase
for the term of each subsequent Renewal Option (if exercised) based upon or
determined by independent appraisal. The first Renewal Option commenced in
March, 2001 and the annual rent increased to an agreed upon fair market rental
of $500,000 plus an annual increase based on the Consumer Price Index, not to
exceed 3% per annum.

Miraval, the Company's health resort and spa, will continue its focused sales
efforts in targeted cities in 2001 and will also continue to build national
awareness by capitalizing on the media support received in 2000. In

                                      13
<PAGE>

November 2000, Miraval was rated the Top Spa in the Zagat Survey 2001 Top U.S.
Hotels, Resorts & Spas. Miraval received a rating of 29 out of a possible 30 in
the Zagat Survey rating system and was thus named the top stand-alone spa in the
United States. In September 2000, Miraval was named the #2 Best Spa in America
in Travel and Leisure's readers' poll. In November 1999, Miraval was voted the
#1 Spa in the World in the Conde Nast Traveler's Readers' Poll, ahead of such
competitors as Canyon Ranch, the Lodge at Skylonda, Rancho La Puerta and Golden
Door. As part of the same poll, Miraval was ranked Number 29 in the "Best of the
Best" among a world-wide combination of resorts, hotels, cruise lines, islands,
monuments, spas and cities. Of the U.S. facilities listed in the "Best of the
Best", Miraval was the third highest.

Miraval's affiliations with American Express Platinum and Virtuoso have proved
to be very successful and the relationships will continue in 2001. In addition,
Miraval has established itself with top corporate meeting planners and incentive
houses. Miraval's advertising campaign has remained solid and benefits have been
realized from sending a consistent message to the public. In addition to
developing relationships with online travel companies, Miraval has launched its
new web site which was developed to maximize and enhance their presence on the
world-wide web.

In 2001, Miraval will continue to focus on improving visibility in the local
market by attending charitable, convention and Chamber of Commerce events. In
addition, specialty programs will be evaluated in an effort to improve occupancy
during summer and shoulder seasons. Based on second quarter occupancy,
management believes that Miraval may have experienced some negative impact from
the general economic downturn.

Zoning for the property currently occupied by Miraval and the property which is
located to the north of Miraval permits a total of 356 resort hotel rooms and up
to 226 residential units.

As indicated below under the heading "Factors That May Affect Future Results",
the Company has entered into a merger agreement with an entity controlled by
certain members of management that, if completed, would result in the Company
becoming privately held.

Factors That May Affect Future Results
--------------------------------------

Management's Discussion and Analysis of Financial Condition and Results of
Operations contains forward looking statements regarding plans and expectations
for the future. Statements looking forward in time are included pursuant to the
"safe harbor" provision of the Private Securities Litigation Reform Act of 1995.
These statements are based on the Company's current expectations or beliefs and
are subject to a number of factors and uncertainties that could cause actual
results to differ materially from those described in the forward-looking
statements. The factors that could cause actual results to differ materially
from those described in the forward-looking statements include: the failure of
the Company's stockholders to approve the merger, and other reasons that could
cause the Merger Agreement (as defined below) to terminate in accordance with
its terms (including Anam's (as defined below) inability to complete the
financing for the merger); competition from other resort hotel/spas and/or
behavioral health facilities; seasonality; or a continuing economic downturn
that could limit leisure activity spending. Further, the Company operates in an
industry sector where securities values may be volatile and may be influenced by
economic and other factors beyond the Company's control. In the context of the
forward-looking information provided in this report, please refer to the
discussion of Factors That May Affect Future Results detailed in the
Management's Discussion and Analysis of Financial Condition and Results of
Operations included in the Company's annual report on Form 10-K/A for the year
ended December 31, 2000, and the current reports on Form 8-K dated April 18,
2001 and June 22, 2001.

The information below should be read in conjunction with the Company's unaudited
consolidated financial statements and related notes thereto included elsewhere
and in other portions of this document.

In addition, the following other factors could cause actual results and
conditions relating to liquidity and capital resources to differ materially.

                                      14
<PAGE>

The Company's Treatment segment participates in the highly competitive mental
and behavioral health industry, and faces competition for market share resulting
from aggressive pricing practices and increasing competition from companies with
greater resources. Some of these competitors have tax exempt, non-profit status,
are government subsidized or have endowment-related financial support which may
provide lower costs of capital.

Sierra Tucson's operations are accredited by the Joint Commission on
Accreditation of Healthcare Organizations ("JCAHO"). JCAHO accreditation is
important to the operations of Sierra Tucson since most insurance companies
require such accreditation in order for the treatment of patients to qualify for
insurance payment or reimbursement. If Sierra Tucson were unable to maintain its
JCAHO accreditation, its business would be adversely affected. In May 1999,
Sierra Tucson successfully completed its JCAHO review by receiving accreditation
with commendation. The next scheduled review by JCAHO will be in May 2002.

Miraval competes for national and international consumers' discretionary income
typically expended upon luxury hotel and resort spas, holistic health and other
related upscale vacation experiences. While management believes that Miraval
occupies a unique market niche, it nevertheless competes with a broad spectrum
of vacation alternatives. It has been categorized as a destination spa, creating
competition with a relatively small number of well-known spas, however, it also
competes in the resort/hotel spa industry. Some of Miraval's competitors may
have greater name recognition as well as longer-standing relationships with
travel agents and meeting planners. While the Company believes that there is
strong consumer demand for Miraval's products and services, historical data does
not exist in this unique market niche to be certain the demand will continue.

While the Company anticipates continued growth in revenues and is committed to
increased profitability, operating results could be adversely impacted if the
business is unable to accurately anticipate customer demand, is unable to
differentiate its products from those of its competitors, is unable to offer
services expeditiously in response to customer demand, is negatively impacted by
a continuing economic downturn that could limit leisure activity spending, or is
further impacted by managed care restrictions on payor reimbursement.

On April 16, 2001, NextHealth, Inc. (the "Company") entered into an Agreement
and Plan of Merger (the "Merger Agreement") with Anam LLC, a Delaware limited
liability company ("Anam"), and NHI Acquisition Corp., a Delaware corporation
("NHI") and a wholly owned subsidiary of Anam. Anam is controlled by William T.
O'Donnell, Jr., the Company's Chairman and Chief Executive Officer, and George
L. Ruff, a Director of the Company, pursuant to which NHI will be merged with
and into the Company (the "Merger"). Upon completion of the Merger (which is
subject to certain conditions, including those described below), the Company's
stockholders (other than Anam and its subsidiaries) will receive cash in the
amount of $5.65 per share of outstanding common stock (including shares of
common stock issuable upon conversion of outstanding preferred stock). In
addition, all unexercised Company employee and director options and outstanding
warrants will be converted into a right to receive cash in the amount of $5.65
(less the applicable exercise price) for each share of common stock issuable
upon the exercise of such options and warrants.

The Company's Board of Directors unanimously approved the Merger Agreement and
the transactions contemplated thereby based upon the unanimous recommendation of
a Special Committee of the Board and the receipt of an opinion from Prudential
Securities Incorporated that the Merger consideration to be received by the
Company's stockholders pursuant to the Merger Agreement is fair to such
stockholders (other than Anam and its controlling affiliates) from a financial
point of view. The Special Committee of the Board is composed exclusively of
directors with no financial interest in the Merger that is different from the
interests of the Company's stockholders generally.

Consummation of the Merger is subject to certain conditions, including the
approval of the Merger, the Merger Agreement and the transactions contemplated
thereby by the Company's stockholders, the receipt of required regulatory
approvals and the completion of Anam's financing for the Merger. The Merger
Agreement also contains customary non-solicitation provisions and termination
fee provisions. Consistent with its fiduciary

                                      15
<PAGE>

duties and subject to the terms of the Merger Agreement, the Company's Board of
Directors has reserved its ability to respond to third parties where
appropriate. Assuming Anam obtains the necessary financing and that all required
regulatory approvals have been received, the Company expects to hold a meeting
of its stockholders to vote on the Merger in the fourth quarter of this year
and, if approved by the Company's stockholders, the closing of the Merger is
expected to occur shortly thereafter, subject to the satisfaction of the other
terms and conditions set forth in the Merger Agreement.

Anam has deposited a letter of credit in the amount of $2,500,000 into an escrow
account as security for the performance of its obligations under the Merger
Agreement. Anam is required to deposit into the escrow account cash or a letter
of credit in the additional amount of $500,000 when Anam has been notified by
the Company that the Securities and Exchange Commission ("SEC") has no further
comment on the Company's proxy material and related Schedule 13E-3 filed in
connection with the Merger. As required by the Merger Agreement, on June 15,
2001, Anam furnished the Company with term sheets for debt financing from
lending sources that aggregate more than $40,000,000. The term sheets do not
represent a firm commitment to provide financing for the Merger contemplated by
the Merger Agreement and there can be no assurance that such financings will be
completed, or that Anam will be able to obtain the additional debt or equity
financing necessary to complete the Merger.

In the event the Company accepts a third party offer or the Merger Agreement is
terminated following the occurrence of certain other events set forth in the
Merger Agreement, Anam will be entitled to receive payments in an aggregate
amount of up to $2,400,000 and the return of its deposit.

A copy of the Merger Agreement was attached to the Company's Form 8-K dated and
filed with the SEC on April 18, 2001. The foregoing description of the Merger
Agreement, and the transactions contemplated thereby, do not purport to be
complete and is qualified in its entirety by reference to the full text thereof.

A preliminary proxy statement and a related Schedule 13E-3 have been filed by
the Company with the SEC in connection with a special meeting of the Company's
stockholders to be held for the purpose of voting on the Merger, the Merger
Agreement and the transactions contemplated thereby. Following the completion of
the SEC's review of such documents, a definitive proxy statement will be mailed
to each stockholder, together with notice of the special meeting. The Schedule
13E-3 was filed with the SEC because the Merger is subject to the "going
private" rules and regulations of the SEC.

                                      16
<PAGE>

                          PART II - OTHER INFORMATION
                          ---------------------------


ITEM 1.  LEGAL PROCEEDINGS

The Company is involved in various litigation and administrative proceedings
arising in the normal course of business. In the opinion of management, any
liabilities that may result from these claims will not, individually or in the
aggregate, have a material adverse effect on the Company's financial position,
results of operations or cash flows.

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

         NONE

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

         (a)  Exhibits
              --------

              NONE

         (b)  Reports on Form 8-K
              -------------------

              Form 8-K dated April 18, 2001
              Form 8-K dated June 22, 2001

                                      17
<PAGE>

                                  SIGNATURES

Pursuant to the requirements 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.

                                         NextHealth, Inc.
                                         -------------------------------------
                                         Registrant



DATE:   August 13, 2001                  BY:/s/ William T. O'Donnell, Jr.
                                            ----------------------------------
                                         WILLIAM T. O'DONNELL, JR.
                                         President and Chief Executive Officer



DATE:   August 13, 2001                  BY:/s/ Loree Thompson
                                            ----------------------------------
                                         LOREE THOMPSON
                                         Chief Financial Officer

                                      18