<PAGE>   1

                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                   FORM 10-K

              ANNUAL REPORT PURSUANT TO THE SECTION 13 OR 15(d) OF
                    THE SECURITIES AND EXCHANGE ACT OF 1934

                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997

                         COMMISSION FILE NUMBER 1-12055

                       PARACELSUS HEALTHCARE CORPORATION
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)


         CALIFORNIA                                   95-3565943
(State or other jurisdiction of                       (IRS Employer
incorporation or organization)                      Identification No.)


                 515 W. GREENS ROAD, SUITE 800, HOUSTON, TEXAS
                    (Address of principal executive offices)

         77067                                      (281) 774-5100
       (Zip Code)                      (Registrant's telephone number, including
                                                area code)


Securities registered pursuant to Section 12(b) of the Act:

    COMMON STOCK, NO STATED VALUE            NEW YORK STOCK EXCHANGE
    -----------------------------            -----------------------
          (Title of Class)           (Name of each exchange on which registered)

   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 is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. [ ]

The number of shares of Registrant's Common Stock outstanding on March 23, 1998
was 55,093,417. The aggregate market value of voting stock held by
non-affiliates of the Registrant, based upon the closing price of the
Registrant's Common Stock on March 23, 1998 was $118,478,589*.

Part III of this Report is incorporated by reference from the Company's Proxy
Statement issued in connection with the Annual Meeting of Stockholders to be
held on May 14, 1998, which will be filed with the Commission no later than
April 30, 1998.

*   Excludes 30,477,047 shares deemed to be held by directors and officers, and
    stockholders whose ownership exceeds ten percent of the shares of Common
    Stock outstanding at March 23, 1998. Exclusion of shares held by any person
    should not be construed to indicate that such person possesses the power,
    direct or indirect, to direct or cause the direction of the management or
    policies of the Registrant, or that such person is controlled by, or under
    common control with, the Registrant.



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<PAGE>   2




                       PARACELSUS HEALTHCARE CORPORATION
                            FORM 10-K ANNUAL REPORT
                          YEAR ENDED DECEMBER 31, 1997




                               TABLE OF CONTENTS
<TABLE>
<CAPTION>

                                                                                                    PAGE REFERENCE
                                                                                                      FORM 10-K
                                                                                                    --------------
<S>                            <C>                                                                  <C>

PRELIMINARY STATEMENT                                                                                       3
---------------------
PART I
------



      Item 1.                  Business                                                                     4
      Item 2.                  Properties                                                                  18
      Item 3.                  Legal Proceedings                                                           19
      Item 4.                  Submission of Matters to a Vote of Security Holders                         21
Part II
-------
      Item 5.                  Market for the Registrant's Common Equity and Related
                                  Stockholder Matters                                                      22
      Item 6.                  Selected Financial Data                                                     22
      Item 7.                  Management's Discussion and Analysis of Financial
                                  Condition and Results of Operations                                      24
      Item 8.                  Financial Statements and Supplementary Data                                 37
      Item 9.                  Changes In and Disagreements with Accountants on
                                  Accounting and Financial Disclosure                                      80
Part III
--------
      Item 10.                 Directors and Executive Officers of the Registrant                          80
      Item 11.                 Executive Compensation                                                      80
      Item 12.                 Security Ownership of Certain Beneficial Owners
                                  and Management                                                           80
      Item 13.                 Certain Relationships and Related Transactions                              80
Part IV
-------
      Item 14.                 Exhibits, Financial Statement Schedule and Reports
                                  on Form 8-K                                                              80



</TABLE>                                       2
<PAGE>   3



FORWARD-LOOKING STATEMENTS

         Certain statements in this Form 10-K are "forward-looking statements"
made pursuant to the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995. Forward-looking statements involve a number of
risks and uncertainties. Factors which may cause the Company's actual results
in future periods to differ materially from forecast results include, but are
not limited to: the outcome of litigation pending against the Company and
certain affiliated persons; continued satisfactory relations with the Company's
senior lenders; general economic and business conditions, both nationally and
in the regions in which the Company operates; industry capacity; demographic
changes; existing government regulations and changes in, or the failure to
comply with government regulations; legislative proposals for healthcare
reform; the ability to enter into managed care provider arrangements on
acceptable terms; changes in Medicare and Medicaid reimbursement levels;
revisions to amounts recorded for losses associated with the impairment of
assets; liabilities and other claims asserted against the Company; competition;
the loss of any significant customer; changes in business strategy, divestiture
and development plans; the ability to attract and retain qualified personnel,
including physicians; fluctuations in interest rates on the Company's variable
rate indebtedness; and the availability and terms of capital to fund working
capital requirements and the expansion of the Company's business, including the
acquisition of our partner's interest in DHHS and additional facilities.




                                       3
<PAGE>   4






                                     PART I

ITEM 1.     BUSINESS

GENERAL

         Paracelsus Healthcare Corporation, a California corporation ("PHC"),
was incorporated in November 1980. PHC, either directly or through its
subsidiaries (collectively, the "Company" or the "Registrant"), owns and
operates acute care and related healthcare businesses in selected markets. In
August 1996, the Company acquired Champion Healthcare Corporation ("Champion")
by exchanging one share of the Company's Common Stock for each share of
Champion's Common Stock and two shares of the Company's Common Stock for each
share of Champion's Preferred Stock (the "Merger"). The Company's hospitals
offer a broad array of general medical and surgical services on an inpatient,
outpatient and emergency basis. In addition, certain hospitals and their
related facilities offer rehabilitative medicine, psychiatric, home health and
skilled nursing care. As of December 31, 1997, the Company owned or operated 26
hospitals in nine states, including 23 acute care hospitals with 2,492 licensed
beds, two psychiatric hospitals with 114 licensed beds and a rehabilitation
hospital with 60 licensed beds. Of the 26 hospitals, 20 are owned, including
one acute care hospital operated through a 50% owned partnership interest known
as Dakota Heartland Health Systems ("DHHS"), and six are leased. The Company
also operates four skilled nursing facilities with a total of 232 licensed beds
in California, of which one is leased.

         On August 20, 1997, Dakota Medical Foundation (the "Foundation"), the
Company's partner in DHHS, exercised its right to require the Company to
purchase the Foundation's 50% partnership interest in DHHS. DHHS owns and
operates a 215-bed general acute care hospital in Fargo, North Dakota. Under
the agreement, the Company has until August 20, 1998 to complete its purchase.

DEBT REDUCTION AND DIVESTITURE OF NON-CORE ASSETS

         The Company is proceeding with its plan to exit the psychiatric
hospital business through the disposition of all of the remaining four
psychiatric hospitals, including two that were previously closed. It is also
proceeding with its plan to exit the Los Angeles metropolitan ("LA metro")
market through the disposition of the hospitals in that area. Management
anticipates that the sale of all such operations will be completed by the end
of 1998. There can be no assurance that the Company will be able to sell any or
all of such hospitals.

         In addition to the Company's initiative to dispose of its remaining LA
metro and psychiatric hospitals, the Company intends to further deleverage the
Company through the disposition of certain non-core assets with the net
proceeds of such dispositions used to reduce the Company's indebtedness.
Realization of this objective will allow the Company to further concentrate its
efforts on core markets, as well as create additional debt capacity to expand
and further integrate its presence in existing markets and to pursue
acquisitions in markets compatible with the Company's overall acquisition
strategy. The Company is currently evaluating a number of inquiries on many of
its hospitals from qualified buyers. As part of its divestiture strategy, the
Company expects to reduce its senior indebtedness by a minimum of $85.0
million from the net proceeds of divestitures in 1998. However, there can be
no assurance that the Company will consummate any or all of these transactions,
or that the net proceeds of any transactions consummated will result in a
significant reduction of the Company's indebtedness.

         On December 15, 1997, the Company signed a definitive agreement to sell
the 123-bed Chico Community Hospital and the 60-bed Chico Rehabilitation
Hospital in Chico, California. This transaction is subject to the completion of
customary closing conditions and obtaining




                                       4
<PAGE>   5

certain regulatory approvals. There can be no assurance that the Company will
be able to consummate this transaction.

RECENT DIVESTITURES / CLOSURES

         On April 29, 1997, in conjunction with its plan to exit the
psychiatric hospital business, the Company sold the 149-bed Lakeland Regional
Hospital in Springfield, Missouri and the 70-bed Crossroads Regional Hospital
in Alexandria, Louisiana.

         On May 15, 1997, the Company closed the inpatient services at the
125-bed PHC Regional Hospital and Medical Center ("PHC Regional Hospital") in
Salt Lake City, Utah and substantially all remaining services in June 1997. The
Company plans to begin construction in the second quarter of 1998 to expand PHC
Regional Hospital to accommodate the transfer of certain acute care services
presently performed at Salt Lake Regional Medical Center.

         While proceeding with its plan to dispose of the LA metro hospitals
and the remaining psychiatric hospitals, the Company closed the 104-bed Orange
Community Hospital on January 31, 1997 and consolidated services into the
55-bed Orange County Hospital of Buena Park ("Buena Park"). On May 15, 1997, a
wholly owned subsidiary of the Company entered into a joint venture with a
group of physicians, in which the subsidiary leased Buena Park and the 85-bed
Bellwood General Hospital in Bellflower, California to a limited liability
company formed by the joint venture. The subsidiary owns a 51% interest in the
joint venture.

BUSINESS STRATEGY

         The Company generally seeks to operate hospitals in small to mid-sized
markets with more favorable demographics and lower levels of penetration by
managed care plans and alternative niche competitors than larger metropolitan
areas. It focuses on increasing its market share by implementing operating
strategies at each of its hospitals or hospital networks to be the provider of
higher quality and lower cost healthcare services than its competitors. When
appropriate, the Company pursues its growth through selective acquisition of
additional hospitals in markets where the Company can develop a preeminent
market position. The Company may from time to time elect to divest certain
sectors of its business that no longer fit its long term business strategy.

ACQUISITION STRATEGY

         The Company's primary criteria for its target markets include: (i) a
service area population of between 30,000 and 500,000; (ii) favorable
demographics including diversified economic and business base; (iii) low levels
of managed care penetration; and (iv) limited competition. Additionally, it may
consider an acquisition candidate that is a preeminent healthcare service
provider in its market. The Company assesses possible acquisitions based on the
potential to increase market penetration, expected improvement in operating
efficiencies, future capital requirements and historical cash flow. Acquisition
targets are generally unaffiliated not-for-profit hospitals and facilities
being divested by hospital systems for strategic, regulatory or performance
reasons.

         Upon acquisition of a hospital, the Company takes immediate steps to
implement financial and operating policies to achieve its financial and
operating goals and improve efficiency through effective staff management,
volume purchasing through national purchasing contracts and renegotiation or
elimination of existing purchased services, where appropriate. The Company also
employs experienced chief executive officers, chief financial officers and
directors of nursing to carry out the strategic plan at each hospital.



                                       5
<PAGE>   6

         The Company's efforts in 1998 will be directed primarily toward
reducing the Company's indebtedness and divesting certain non-core assets.
Other than the acquisition of its partner's interest in DHHS, the Company does
not anticipate significant acquisitions in 1998.



HOSPITAL OPERATING STRATEGY

         The Company believes that the delivery of healthcare services is a
local business. Accordingly, each hospital's operating strategy and program are
designed to meet the healthcare needs of the local market through local
management initiative, responsibility and accountability, combined with
corporate support and oversight. Incentive compensation programs are offered to
reward local managers for accomplishing predetermined goals.

         The significant components of the Company's hospital operating
strategy are as follows:

         MARKET PENETRATION - The Company seeks to increase its market share
(i) by offering a full range of hospital and related healthcare services, (ii)
by providing high quality and low cost services and (iii) through physician
development efforts.

         The Company selectively adds new services such as obstetrics,
rehabilitation, open-heart surgery and skilled nursing beds at its hospitals
and, where appropriate, invests in new technologies. The Company also develops
complementary healthcare businesses such as primary care clinics, home health
agencies and rehabilitative clinics to augment the service capabilities and
create a larger service network for its existing hospitals and enable the
delivery of care in the most cost effective and medically appropriate setting.
In some cases, the Company may also acquire or merge with other providers or
establish alliances with such providers through affiliation agreements, joint
venture arrangements or partnerships.

         The Company has implemented a licensed event reduction program (the
"PRIDE program") in six of its hospitals to measurably improve quality care and
lower costs by eliminating or significantly reducing the number of errors in
the patient care process. The PRIDE program was originally developed by
Champion Healthcare Corporation ("Champion") in conjunction with an outside
firm to identify and measure the incidence of patient treatment errors in 225
separate clinical categories. By focusing on improving patient care processes
through staff involvement and education, the Company experienced a significant
reduction in patient care process errors during 1997 in those hospitals in
which the program was implemented. Additionally, the Company believes the
capability to quantify data regarding the quality of care in its hospitals may
enhance its ability to obtain managed care contracts, improve its customer
satisfaction rate and reduce its liability risk. The Company plans to implement
the PRIDE program in each of the Company's hospitals.

         A proprietary customer service program, ServiceAdvantage, developed to
ensure that hospital employees are responding to patient needs, has been
implemented in 17 of the Company's hospitals. Such objective is achieved
through employee training programs and through the program's questionnaire
process.

         As physicians still direct the majority of hospital admissions, the
Company focuses on supporting and retaining existing physicians and attracting
additional qualified physicians in existing or underserved medical specialties.
The Company may affiliate, joint venture or partner with physician practices
or, in selected cases, manage or acquire such physician practices. Certain
joint ventures have nonexclusive use of office space and equipment in hospitals
which they use to provide specialized medical and surgical services to
patients.

         COST CONTROLS - The Company seeks to position each of its hospitals as
a low cost provider in its market by controlling costs. One of the key aspects
of the Company's disciplined cost control system is




                                       6
<PAGE>   7

to (i) implement staffing standards and manage resources to optimize staffing
efficiency, (ii) utilize national purchasing contracts and monitor supply
usage, (iii) renegotiate or eliminate purchased service contracts, where
appropriate, (iv) evaluate and eliminate on an ongoing basis underutilized or
unprofitable services and (v) implement a proprietary utilization management
program to help monitor and manage clinical resources to render medically
appropriate and cost effective care. Corporate staff support is available for
key operating and cost decisions, as well as for reimbursement, insurance/risk
management, purchasing, and other significant accounting and support functions.

         NETWORKS - In each of its markets, the Company seeks to develop an
integrated healthcare delivery network which includes local physicians and has
its hospital as the nucleus of healthcare services offered. In selected
markets, such as Salt Lake City, Utah, which has a population base of
approximately 800,000, or 43% of the state's population, and a high level of
managed care penetration, the Company has created an integrated provider system
to provide both extensive geographic coverage and a full range of healthcare
services, including the formation of MountainNet HealthCare, L.L.C., a network
consisting of Paracelsus hospitals and approximately 350 physicians. In order
to increase its profitability under its managed care contracts, the Company is
implementing several cost saving strategies, including sharing and combining
services among hospitals and renegotiating existing contractual arrangements
with a variety of service providers. The Company has modified its Provider
Service Agreement with PacifiCare (formerly FHP) to provide healthcare services
to enrollees on a discounted fee for service basis rather than a fixed premium
per member per month ("capitated contract"). It also has contracts with CIGNA,
United Health and Blue Cross of Utah which cover approximately 265,000
non-capitated enrollees. See "Item 7 - Operations - Salt Lake City, Utah" for
management's outlook of the Company's operations in this market.

OPERATIONS

         The Company seeks to create a local healthcare system in each of its
markets that offers a continuum of inpatient, outpatient, emergency and
alternative care options. In many such markets, the Company will establish its
acute care hospitals as the hub of a local provider system that can include
skilled nursing facilities, home health agencies, clinics, physician practices
and medial office buildings. These operations are described below.

         ACUTE CARE HOSPITALS - The Company owns and operates 23 acute care
hospitals (including one acute care hospital owned by DHHS) with a total of
2,492 licensed beds in nine states. Each of the Company's acute care hospitals
provides a broad array of general medical and surgical services on an
inpatient, outpatient and emergency basis, including some or all of the
following: intensive and cardiac care, diagnostic services, radiological
services and obstetrics on an inpatient basis and ambulatory surgery,
laboratory and radiology services on an outpatient basis. The Company owns a
50% interest in and is responsible for the operations of DHHS, which owns an
acute care hospital in Fargo, North Dakota. On August 20, 1997, Dakota Medical
Foundation (the "Foundation"), the Company's partner in DHHS, exercised its
right to require the Company to purchase the Foundation's 50% partnership
interest in DHHS. Under the agreement, the Company has until August 20, 1998 to
complete its purchase. The Company is proceeding with its plan to exit the LA
metro market principally through the disposition of the hospitals located in
that area, including a hospital that was previously closed in March 1996.

         SPECIALTY HOSPITALS - The Company owns and operates two psychiatric
hospitals with 114 licensed beds and one rehabilitation hospital with 60
licensed beds, all located in California. On May 15, 1997, one of the
psychiatric hospitals, along with an acute care hospital, were leased to a
joint venture formed between a subsidiary of the Company and a group of
physicians. The Company has entered into a definitive agreement to sell the
rehabilitation hospital along with a related acute care hospital, subject to
completion of customary closing conditions and the obtainment of certain
regulatory approvals. The Company is proceeding with its plan to dispose of the
remaining psychiatric hospitals and exit the psychiatric care hospital
business.



                                       7

<PAGE>   8

         SKILLED NURSING FACILITIES - The Company owns and operates four
skilled nursing facilities with a total of 232 licensed beds in California that
provide 24-hour nursing care, principally for the elderly, by registered or
licensed nurses and related medical services prescribed by the patient's
physician.

         HOME HEALTH AGENCIES - The Company provides home health services
through twelve of its hospitals (including DHHS) in seven states. These services
include home nursing, infusion therapy, physical therapy, respiratory services
and other rehabilitative services.

         PHYSICIAN PRACTICES - The Company owns and operates the assets of a
number of physician practices in rural and urban settings. Most of these
practices are primary care physician offices where the physicians are employed
by or are under contract with one of the Company's hospitals or a related
entity. The physician practices serve to complement the Company's acute care
hospitals in their respective markets by allowing the Company to provide a
wider range of services in optimal settings and provide the opportunity to
attract patients to the Company's hospitals.

         PHYSICIAN ARRANGEMENTS - The Company owns a majority interest in and
operates six physician joint ventures. Certain of the joint ventures have
nonexclusive use of office space and equipment in certain hospitals which they
use to provide specialized medical and surgical services to patients. In all
cases, the minority interests in the joint ventures are held directly or
indirectly by a physician or a group of physicians. Additionally, several of
the Company's hospitals have assisted with the formation of and participate in
physician hospital organizations or management services organizations. The
Company believes that its physician arrangements are in compliance with
applicable Federal and state laws. However, there can be no assurance that such
arrangements will not be challenged by governmental agencies.

         MEDICAL OFFICE BUILDINGS - The Company owns, leases or manages 33
medical office buildings located adjacent to certain of its hospitals.

COMPETITION

         Competition for patients among hospitals and other healthcare
providers has intensified in recent years. During this period, hospital
occupancy rates have declined as a result of cost containment pressures,
changes in technology, changes in government regulations and reimbursement and
utilization management. Such factors have prompted new competitive strategies
by hospitals and other healthcare providers as well as an increase in the
consolidation of such providers. In certain areas in which the Company
operates, there are other hospitals or facilities that provide services
comparable to those offered by the Company's hospitals. Many of these hospitals
may have greater financial resources and may offer a wider range of services
than the Company's hospitals. In addition, hospitals owned by government
agencies or other tax-exempt entities benefit from endowments, charitable
contributions and tax-exempt financing, none of which is available to the
Company.

         The competitive position of the Company's hospitals also has been, and
in all likelihood will continue to be, affected by the increased initiatives
undertaken during the past several years by Federal and state governments and
other major purchasers of healthcare, including insurance companies and
employers, to revise payment methodologies and monitor healthcare expenditures
in an effort to contain healthcare costs. In certain markets, the competitive
position of a hospital is affected by its ability to negotiate provider
contracts with purchasers of group healthcare services, including employers,
Preferred Provider Organizations ("PPOs"), Health Maintenance Organizations ("
HMOs") and managed care plans. These organizations attempt to direct and
control the use of hospital services through "managed care" programs and to
obtain discounts from hospitals' established charges. In return, hospitals
acquire access to a large number of potential patients.

         The Company's hospitals are dependent upon the physicians practicing
in the communities served by the hospitals. A small number of physicians
account for a significant portion of patient





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admissions at some of the Company's hospitals. The competition for physicians
in some specialty areas, including primary care, is intense. While the Company
seeks to retain physicians of varied specialties on its hospitals' medical
staffs and to attract other qualified physicians, there can be no assurance
that the Company's hospitals will succeed in doing so. In addition, certain
physicians are affiliated with managed care providers that may preclude them
from utilizing the Company's facilities for their patients, or referring
patients to doctors using the Company's facilities, if the facility or referred
doctors are not currently contracting with such managed care providers.


LINES OF BUSINESS

         The Company's operations are classified into two lines of business:
acute care and psychiatric care. In September 1996, the Company adopted a plan
to exit the psychiatric hospital business through the disposition of all of its
psychiatric hospitals. Accordingly, operating results of the psychiatric
hospitals for all periods presented have been reported separately as
"Discontinued operations-Loss from operations of discontinued psychiatric
hospitals" in the Consolidated Statements of Operations and net assets of the
discontinued operations have been segregated in the Consolidated Balance Sheet
under the caption "Long-term assets of discontinued operations, net," (See Item
8 - Financial Statements). Information regarding net revenue, operating income
(loss) and identifiable assets of the psychiatric care line of business for
each of the three years ended December 31, 1997, 1996 and 1995, and as of the
end of each such calendar year is disclosed under Item 8 - Note 6.

SOURCES OF REVENUE

         The Company receives payment for services rendered to patients from
private payors (primarily private insurance), managed care providers, the
Federal government under the Medicare program and state governments under their
respective Medicaid programs. See "Hospital Accreditation and Government
Regulation - Medicare, Medicaid." During 1996, the Company entered into a
capitated contract arrangement at PHC Regional Hospital in Salt Lake City, Utah
to provide healthcare services for approximately 94,000 capitated enrollees.
Under the capitated contract, the Company was financially committed to provide
healthcare services to members under the contract in return for a fixed premium
per member per month. During 1997, the Company modified such contract to
provide services to a lesser number of enrollees on a discounted fee for
service basis.




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<PAGE>   10




         The table below sets forth by each line of business the percentages of
gross patient revenue received by the Company's hospitals from each category of
payor during each of the periods indicated.


<TABLE>
<CAPTION>

                                                                              YEAR ENDED DECEMBER 31,
                                                               ------------------------------------------------------
                                                                    1997               1996                1995
                                                               ---------------    ---------------     ---------------
ACUTE CARE -
<S>                                                            <C>                <C>                 <C>
   Medicare...............................................             43.1%              45.0%               48.4%
   Medicaid...............................................             13.8%              13.4%               12.9%
   Private insurance, capitation and other payors.........             43.1%              41.6%               38.7%
                                                                   --------          ---------           ---------
                                                                      100.0%             100.0%              100.0%
                                                                   ========          =========           =========
PSYCHIATRIC CARE -
   Medicare...............................................             56.0%              29.2%               22.3%
   Medicaid...............................................             26.5%               7.5%                  -
   Private insurance and other payors.....................             17.5%              63.3%               77.7%
                                                                   --------          ---------           ---------
                                                                      100.0%             100.0%              100.0%
                                                                   ========          =========           =========

</TABLE>

         The Company's revenue primarily depends on the level of inpatient
census, the volume of outpatient services, the acuity of patients' conditions
and charges for services. Reimbursement rates for inpatient routine services
vary significantly depending on the type of service and the geographic location
of the hospital. Consistent with the trend in the hospital industry, the
Company experienced an increase in the percentage of patient revenues
attributable to outpatient services. Such increase was attributable to advances
in technologies as well as increased pressures from third party payors for
hospitals to provide more care on an outpatient basis as a more cost-effective
alternative for inpatient care. The increase in gross revenue attributable to
Medicare/Medicaid at the psychiatric facilities in 1997 was due primarily to
the closure of one facility in January 1997, the disposition of two facilities
in April 1997, and the consolidation of one facility into the operations of an
acute care hospital in May 1997, all of which derived a significantly larger
percentage of gross revenue from private insurance and other payors than the
Company's remaining psychiatric hospital. See "Outpatient Utilization" under
the "Selected Operating Statistics" table below.



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SELECTED OPERATING STATISTICS

         The following table sets forth selected operating statistics for the
Company's consolidated hospitals for the periods and dates indicated.

<TABLE>
<CAPTION>

                                                    YEAR ENDED DECEMBER 31,
                                           ---------------------------------------
                                             1997           1996           1995
                                           ---------      ---------      ---------
<S>                                        <C>            <C>            <C>
ACUTE CARE HOSPITALS(1):
     Total number of hospitals ........           23             24             19
     Licensed beds at end of period ...        2,337          2,461          1,768
     Patient days .....................      328,331        277,553        246,107
     Inpatient admissions .............       69,997         58,693         45,574
     Average length of stay (days).....          4.7            4.7            5.4
     Outpatient visits (2) ............    1,529,736      1,256,124        998,551
     Deliveries .......................        9,728          6,694          2,476
     Surgery cases ....................       48,488         37,136         27,699
     Occupancy rate ...................         36.9%          38.5%          38.8%
     Outpatient utilization (3) .......         39.3%          36.0%          32.6%


PSYCHIATRIC HOSPITALS(4):
     Total number of hospitals ........            2              5              3
     Licensed beds at end of period....          114            437            218
     Patient days .....................       19,554         42,949         46,493
     Inpatient admissions .............        1,462          4,432          4,749
     Average length of stay (days).....         13.4            9.7            9.8
     Outpatient visits ................       16,998         31,840         24,916
     Occupancy rate ...................         35.9%          40.4%          53.4%
     Outpatient utilization (3) .......         15.8%          11.9%           7.8%

</TABLE>


--------------------
(1)   Includes a rehabilitation hospital and excludes DHHS.
(2)   Includes home health visits.
(3)   Gross Outpatient Revenue as a percent of Total Gross Patient Revenue.
(4)   Commencing on May 15, 1997, Orange County Hospital of Buena Park, a
      psychiatric hospital, was leased, along with Bellwood General Hospital,
      an acute care hospital, to a joint venture entered into between a
      subsidiary of the Company and a group of physicians. All statistical data
      for Buena Park has been included under the acute care statistical
      information since such date as part of the joint venture operations.

HOSPITAL ACCREDITATION AND GOVERNMENT REGULATION

         All hospitals, and the healthcare industry generally, are subject to
compliance with various Federal, state and local regulations relating to
licensure, operations, billing, reimbursement, relationships with physicians,
construction of new facilities, expansion or acquisition of existing facilities
and offering of new services. All facilities receive periodic inspection by
state and local licensing agencies, as well as by non-governmental
organizations acting under contract or pursuant to Federal law, to review
compliance with standards of medical care and requirements concerning
facilities, equipment, staffing, cleanliness and related matters. Failure to
comply with applicable laws and regulations could result in, among other
things, the imposition of fines, temporary suspension of the ability to admit
new patients to the facility or, in extreme circumstances, exclusion from
participation in government healthcare reimbursement programs such as Medicare
and Medicaid (from which the Company derives substantial revenues) or the
revocation of facility licenses. While all of the Company's hospitals have
obtained the licenses that the Company believes are necessary under applicable
law for the operation of the hospitals,




                                      11
<PAGE>   12

there can be no assurance that its hospitals will be able to comply in the
future or that future regulatory changes will not have an adverse impact on the
Company. At December 31, 1997, all of the Company's hospitals are accredited by
the Joint Commission on Accreditation of Healthcare Organizations ("JCAHO")
except for one rural hospital in Georgia, which is surveyed annually by state
regulatory authorities. Hospitals accredited by JCAHO or state regulatory
authorities are allowed to participate in the Medicare/Medicaid programs.

         CERTIFICATE OF NEED - In many of the states in which the Company's
owned or leased hospitals operate, certificate of need ("CON") regulations
control the development and expansion of healthcare services and facilities.
Those regulations generally require proper government approval for the
expansion or acquisition of existing facilities, the construction of new
facilities, the addition of new beds, the acquisition of major items of
equipment and the introduction of certain new services. Failure to obtain
necessary approval can result in the inability to complete a project, the
imposition of civil and, in some cases, criminal sanctions, the inability to
receive Medicare and Medicaid reimbursement and/or the revocation of a
facility's license. Of the nine states in which the Company operates, a CON is
required in Florida, Georgia, Mississippi, Tennessee and Virginia.

         MEDICARE - The Federal Medicare program provides medical insurance
benefits, including hospitalization, principally to persons 65 and older and to
certain disabled persons. Each of the Company's hospitals is certified as a
provider of services under the Medicare program. A substantial portion of the
Company's revenue is derived from patients covered by this program. See
"Sources of Revenue" above. The Medicare program has undergone significant
changes during the past several years to reduce overall healthcare costs, which
have resulted in reduced rates of growth in reimbursement payments for a
substantial portion of hospital procedures and charges. In addition, the
requirements for certification in the Medicare program are subject to change.
In order to remain qualified for the program, it may be necessary for the
Company to make changes from time to time in its facilities, equipment,
personnel and services. Although the Company intends to continue its
participation in the Medicare program, there is no assurance that it will
continue to qualify for participation.

         Pursuant to the Social Security Act Amendments of 1983 and subsequent
budget reconciliation and modifications, Congress adopted a prospective payment
system ("PPS"). PPS is a fixed payment system in which illnesses are classified
into Diagnostic Related Groups ("DRGs") which do not consider a specific
hospital's costs, but are adjusted for an area wage differential. Each DRG is
assigned a fixed payment amount that forms the basis for calculating the amount
that the hospital is reimbursed for each Medicare patient. Generally, under
PPS, if the costs of meeting the health care needs of the patient are greater
than the predetermined payment rate, the hospital must absorb the loss.
Conversely, if the cost of the services provided is less than the predetermined
payment, the hospital retains the difference. DRG payments include
reimbursement for capital costs. Since DRG rates are based upon a statistically
normal distribution of severity, patients falling outside the normal
distribution may afford additional payments which are defined as "outliers."

         Prior to 1988, Medicare reimbursed hospitals for 100% of their share
of capital related costs, which included depreciation, interest, taxes and
insurance related to plant and equipment for inpatient hospital services. The
reimbursed rate was reduced thereafter to 90% of costs. Federal regulations,
effective October 1, 1991, created a PPS for inpatient capital costs to be
phased in over a ten-year transition period from a hospital-based rate to a
fully Federal payment rate or a per-case rate, which is likely to result in
further reductions in the rate of growth in reimbursement payments. Beginning
with cost reporting periods on or after October 1, 2001, all hospitals are to
be paid at the standard Federal rate. Additionally, pursuant to the Balanced
Budget Act of 1997 ("1997 Budget Act"), capital rates are reduced by an
additional 2.1%. Such change in capital cost payment could have a material
adverse effect on the operating revenues of the Company.

         Psychiatric and rehabilitation hospitals, as well as psychiatric or
rehabilitation units that are distinct parts of a hospital, are exempt from PPS
and continue to be reimbursed on a reasonable cost


                                      12
<PAGE>   13

basis, with limits placed upon the annual rate of increase in operating costs
per discharge. Pursuant to the 1997 Budget Act, the annual updates for fiscal
year 1998 is set at 0%. For fiscal year 1999 through fiscal year 2002, the
annual update factor is dependent upon where the hospital's costs fall in
relation to the limits set by the Tax Equity and Fiscal Responsibility Act of
1982 ("TEFRA"). The annual update factor will range from 0% to the market
basket percentage increase, depending upon whether the hospital's costs are at,
below or above the TEFRA target limits.

         Many outpatient services continue to be reimbursed, subject to certain
regulatory limitations, on a modified cost-reimbursement basis, at the lower of
customary charges or a percentage of actual costs. Congress has established
additional limits on reimbursement of the following outpatient services: (i)
clinical laboratory services, which are reimbursed based upon a fee schedule
and (ii) ambulatory surgery procedures and certain imaging and other diagnostic
procedures, which are reimbursed based upon the lower of the hospital's
specific costs or a blend of the hospital's specific costs and the rate paid by
Medicare to non-hospital providers for such services. The 1997 Budget Act
requires the development of a prospective payment system for outpatient
services beginning on January 1, 1999. The financial effect of such change in
payment methodology may have a negative impact on the Company.

         The 1997 Budget Act mandates that home health care reimbursement must
transition to a prospective payment system on October 1, 1999, as well as a 15%
reduction in the cost limits and per beneficiary limits effective September 30,
1999. During a transition period of not longer than 4 years, home health care
reimbursement rates will be a blend of agency-specific costs and the
regional-specific costs, until a fully prospective payment rate is achieved.
The Company currently has twelve hospitals that provide home health care
services. The financial effect of such change in payment methodology may have a
negative impact on the Company.

         The 1997 Budget Act mandated numerous other adjustments and reductions
to the Medicare system that may adversely impact the Company's operations. With
respect to the valuation of capital assets as a result of a change in hospital
ownership, the 1997 Budget Act eliminates the allowance for return on equity
capital, and bases reimbursement on the book value of the assets, recognizing
no gain or recapture of depreciation. In addition, the 1997 Budget Act mandated
the following changes: (i) a reduction in reimbursement for Medicare enrollee
deductible and coinsurance bad debts of 25% for fiscal year 1998, 40% for
fiscal year 1999 and 45% for fiscal year 2000 and periods thereafter, (ii) a
reduction in the bonus payments made to hospitals whose costs are below the
target amounts from 5% of the target amount to 2% and (iii) the transitioning
of skilled nursing home reimbursement to PPS, based upon 1995 allowable costs,
with a three year transition period beginning on or after July 1, 1998.

         Congressional action to lower or control the growth in the Federal
budget deficit could have an adverse effect on the Company's Medicare revenues.
The Company anticipates that the rate of growth in reimbursement payments to
hospitals will be reduced as a result of future legislation but is unable to
project the actual amount of any such reductions and their impact on the
Company.

         MEDICAID - Medicaid is a federally mandated medical assistance program
that is administered and funded in part by each state pursuant to which
hospital benefits are available to indigent persons. Each of the Company's
hospitals is certified for participation in the various state Medicaid
programs. A substantial portion of the Company's revenue is derived from
patients covered by this program. See "Sources of Revenue." Medicaid payment
methodology varies from state to state, with most payments being made on a
prospective payment system or under programs which negotiate payment levels
with individual hospitals. Many states have adopted broad-based
hospital-specific taxes to help fund the state's share of its Medicaid program.
In addition, certain states have obtained or are applying for waivers from HCFA
to replace their Medicaid program with a managed care program.

         The 1997 Budget Act repealed the Boren Amendment to the Medicaid Act
to give states greater flexibility in establishing Medicaid payment methods and
rates. The Boren Amendment previously required states to undertake a financial
analysis and provide assurance to the Federal government that




                                      13
<PAGE>   14

the Medicaid rates were reasonable in meeting the costs incurred by healthcare
providers in providing care to Medicaid patients. In lieu thereof, Congress has
mandated that states employ a rate setting process that requires prior
publication and an opportunity for provider comment on the rates, effective for
rates of payment on and after January 1, 1998.

         The Medicare and Medicaid programs make additional payments to those
healthcare providers that serve a disproportionate share of low income
patients. The qualification and funding for disproportionate share payments
vary by year, and by state as applicable to Medicaid. Disproportionate share
payments for future years could vary significantly from historical payments.

         Within the statutory framework of the Medicare and Medicaid programs,
there are substantial areas subject to administrative rulings, interpretations
and discretion that may affect payments made under these programs. Funds
received from these programs are subject to audit. These audits can result in
retroactive adjustments of such payments. There can be no assurance that future
audits will not result in material retroactive adjustments.

         To ensure efficient utilization of facilities and services, Federal
regulations require that admission to and utilization of facilities by Medicare
and Medicaid patients must be reviewed by a Peer Review Organization ("PRO"). A
PRO may address the appropriateness of patient admissions and discharges, the
quality of care provided, the validity of DRG classifications and
appropriateness of cases with extraordinary length of stay or cost. The PRO may
deny admission or payment. Such review may be conducted either prospectively or
retroactively and is subject to administrative and judicial appeal.

         Federal and state legislators continue to consider legislation that
could significantly impact Medicare, Medicaid and other government funding of
healthcare costs. Initiatives currently before Congress, if enacted, would
reduce the rate of growth in reimbursement payments under various government
programs including, among others, payments to disproportionate share and
teaching hospitals. A reduction in these payments would adversely affect net
revenue and operating margins at certain of the Company's hospitals. The
Company is unable to predict what legislation, if any, will be enacted at the
Federal and state level in the future or what effect such legislation may have
on the Company's financial position, results of operations or liquidity.

         ANTI-KICKBACK AND SELF-REFERRAL REGULATIONS Federal law prohibits the
knowing and willful payment, receipt or offer of remuneration by healthcare
providers to any person, including physicians, to induce referrals of Medicare
and Medicaid patients or in exchange for such referrals (the "Anti-Kickback
Law"). Federal law also prohibits a physician from referring Medicare and
Medicaid patients to certain designated health services in which the physicians
have ownership or certain other financial arrangements, unless an exception is
available (the "Stark II Law"). Many states have adopted or are considering
similar legislative proposals to extend beyond the Medicaid program to include
all payors. Violations of the Anti-Kickback Law and Stark II Law may result in
certain civil sanctions, such as civil monetary penalties, and exclusion from
participating in the Medicare and Medicaid programs. Violations of the
Anti-Kickback Law can also result in the imposition of criminal sanctions.

         The Office of the Inspector General of Health and Human Services
("OIG") has promulgated regulations that define certain safe harbors to offer
protection to certain common business arrangements under the Anti-Kickback Law.
The failure of an arrangement to meet the requirements of a safe harbor does
not render the arrangement illegal. Those arrangements, however, are subject to
scrutiny by the OIG's office and other enforcement agencies. None of the
Company's joint ventures with physician investors falls within any of the
defined safe harbors. Under the Company's joint venture arrangements, physician
investors are not under any obligation to refer or admit their patients,
including Medicare or Medicaid beneficiaries, to receive services at the
Company's facilities, nor are distributions to those physician investors
contingent upon or calculated with reference to referral by the physician
investors. On the basis thereof, the Company does not believe the ownership of
interests in or receipt of distributions from its joint ventures would be
construed to be knowing and willful payments to the




                                      14
<PAGE>   15

physician investors to induce them to refer patients in violation of the
Anti-Kickback Law. In addition, the Company has entered into various other
relationships and arrangements with physicians, including the acquisition of
physician practices. There can be no assurance that such arrangements will not
be challenged by government enforcement agencies. In addition, in certain
circumstances, private citizens may bring a civil action to recover sums paid
in violation of Federal law.

         Federal and state government agencies have announced heightened and
coordinated civil and criminal enforcement efforts. The Company cannot predict
the effect on the Company's financial position, revenues, earnings and
liquidity of possible judgments, if any, that may result from any inquisitions,
nor the impact of new Federal or state laws and regulations that could require
the Company to restructure certain of its arrangements. (See Item 3 - "Legal
Proceedings")

         STATE HOSPITAL RATE-SETTING ACTIVITY - Certain states in which the
Company operates hospitals mandate rates for hospitals or levy taxes on
hospital revenues, assessments or licensure fees to fund indigent healthcare
within the state.

         In Florida, where the Company owns one hospital with a total of 129
licensed beds, a budget review process and a limit on rates of increase in
gross revenue and net revenue per adjusted admission are in effect. The maximum
annual percentage any hospital may increase its revenue per adjusted admission
is limited to an administratively determined cost of healthcare index plus an
annual percentage in excess thereof. Rate increases are reviewed annually. This
law limits the ability of hospitals located in Florida to increase rates in
order to maintain operating margins. There can be no assurance that other
states in which the Company operates will not enact similar rate-setting
provisions.

ENVIRONMENTAL MATTERS

         The Company is subject to various Federal, state and local statutes
and ordinances regulating the discharge of materials into the environment. The
Company's management does not believe that the Company will be required to
expend any material amounts in order to comply with these laws and regulations
or that compliance will materially affect its capital expenditures, earnings or
competitive position.

SEASONALITY

         The hospital industry is seasonal, with the strongest demand for
hospital services generally occurring during January through April and the
weakest during the summer months. Accordingly, in the absence of acquisitions,
the Company's revenues and earnings are generally highest during the first
quarter and lowest during the third quarter.

MEDICAL STAFF AND EMPLOYEES

         At December 31, 1997, the Company had approximately 7,600 full-time
and part-time employees. The Company also had 1,500 licensed physicians who
were members of the medical staffs of the Company's hospitals. Physician staff
members may also serve on the medical staffs of other hospitals and each may
terminate his or her affiliation with the Company's hospital at any time.

         At December 31, 1997,  DHHS had approximately 1,300 employees.  It also
had 175 physicians who were active members of the medical staff.

LIABILITY INSURANCE

         The Company is subject to claims and suits in the ordinary course of
business, including those arising from care and treatment afforded at its
facilities. The Company maintains insurance and, where appropriate, reserves
with respect to the possible liability arising from such claims. For periods
from



                                      15
<PAGE>   16

October 1992 to December 1996, the Company, excluding the former Champion
entities, insured the first $500,000 of general and professional liability
claims through its wholly owned subsidiary, Hospital Assurance Company Ltd.
("HAC"). The Company had third-party excess insurance coverage over the first
$500,000 per occurrence up to $100.0 million. Commencing January 1, 1997, in
conjunction with the Company's plan to cease all underwriting activity of HAC,
the Company became self-insured for the first $1.0 million per occurrence of
general and professional liability claims, with excess insurance amounts up to
$100.0 million covered by a third party insurance carrier, including all claims
incurred but not reported ("IBNR") as of December 31, 1996 for all
subsidiaries, including Champion. The Company is self-insured for reported
claims related to former Champion facilities for periods prior to 1997 up to
$1.0 million per occurrence and $4.0 million in the aggregate, with amounts in
excess of $1.0 million but less than $10 million covered by a third party
insurance carrier. Effective October 1, 1997, the Company changed its general
and professional liability insurance carrier. The Company continues to
self-insure the first $1.0 million per occurrence of general and professional
liability claims and $4.0 million in the aggregate; however, excess insurance
amounts up to $50.0 million are now covered by third party insurance carriers.
The Company accrues an estimated liability for its uninsured exposure and
self-insured retention based on historical loss patterns and actuarial
projections. Although the Company believes that its insurance and loss reserves
are adequate, there can be no assurance that such insurance and loss reserves
will cover all potential claims that may be asserted.

ITEM 1A.     EXECUTIVE OFFICERS OF THE REGISTRANT

The following is certain information regarding the executive officers of the
Company.

         CHARLES R. MILLER, age 59, has served as President, Chief Operating
Officer and a director of the Company since August 1996. From 1990 to 1996, he
was Chairman, President and Chief Executive Officer of Champion, which he
co-founded. From 1987 to 1989, he co-owned and operated an acute care hospital
in El Paso, Texas, which he sold in 1988. From 1981 to 1986, he co-founded
Republic Health Corporation ("Republic") and served as President and director
until his resignation as a result of his election not to participate in a
leveraged buy-out of Republic, which was then the fifth largest publicly-held
hospital management company. Prior thereto, he was employed in various
management positions for seven years by Hospital Affiliates International
("HAI").

         JAMES G. VANDEVENDER, age 50, a Senior Executive Vice President since
June 1997, has served as Executive Vice President, Chief Financial Officer and
a director of the Company since August 1996. From 1990 to 1996, he was
Executive Vice President, Chief Financial Officer, Secretary and a director of
Champion, which he co-founded. From 1987 to 1989, Mr. VanDevender pursued
private investments. From 1981 to 1987, he was Senior Vice President of
Republic, primarily responsible for acquisitions and development, and held
other senior management positions in the areas of accounting and finance. Prior
thereto, he was employed in various management positions for four years by HAI.

         RONALD R. PATTERSON, age 56, has served as Executive Vice President
and President, Healthcare Operations of the Company since August 1996. He was
Executive Vice President and Chief Operating Officer of Champion from 1994 to
1996 and Senior Vice President-Operations from 1992 to 1994. From 1990 to 1991,
he was Senior Vice President of Harris Methodist Health System, a
not-for-profit healthcare system. From 1988 to 1990, he was a healthcare
consultant, specializing in private turnaround management. From 1982 to 1988,
he was with Republic, initially as Operations Vice President and subsequently
as Senior Vice President of one of its major operating divisions. Prior
thereto, he was employed in various management positions for six years by HAI.

         LAWRENCE A. HUMPHREY, age 42, an Executive Vice President - Finance
since June 1997, has served as Senior Vice President, Corporate Finance since
August 1996. From 1993 to 1994, he was Operations Controller, and from
September 1994 to 1996, he was Vice President Operations Finance of Champion.
Effective February 1996, Mr. Humphrey was promoted to Senior Vice President -
Corporate Finance. Prior thereto, he was employed in various management
positions for 12 years by NME. Mr. Humphrey is a Certified Public Accountant.




                                      16
<PAGE>   17

         MICHAEL M. BROOKS, age 49, has served as Senior Vice President,
Acquisitions since August 1996. From 1992 to 1994, he was Operations Controller
and from September 1994 to 1996 he was Vice President - Administration and
Development of Champion. Effective February 1996, Mr. Brooks became Senior Vice
President - Development. From 1989 to 1992, he was a healthcare consultant and
was associated with Champion in that capacity during 1991. From 1987 to 1988, he
co-owned and operated an acute care hospital in El Paso, Texas. From 1983 to
1986, he was employed in various senior management positions by Republic.

         GARY L. CHANDLER, age 52, a Senior Vice President, Managed Care and
Strategic Development since June 1997, has served as Vice President, Managed
Care and Strategic Development since August 1996. From 1995 to 1996, he was
Vice President, Managed Care and Strategic Development of Champion. Prior
thereto, he was Vice President of the Austin operations for New York Life/Sanus
from 1994 to 1995 and a development officer for the Austin Diagnostic Clinic
and Chief Operating Officer of an affiliated individual practice
association/management services organization from 1987 to 1994. Mr. Chandler
held various positions in large hospitals, Healthcare Maintenance Organization
and healthcare consulting practice.

         DEBORAH H. FRANKOVICH, age 50, a Senior Vice President and Treasurer
since June 1997, has served as Vice President and Treasurer since August 1996.
From 1994 to 1996, she was Vice President and Treasurer of Champion. From 1990
to 1994, she was a healthcare financing consultant. Prior thereto, she was Vice
President and Treasurer of Healthcare International, Inc. from 1985 to 1989,
and Vice President and Treasurer of HealthVest, which she co-founded, from 1986
to 1990. Prior to joining Healthcare International, she worked in the New York
healthcare lending group of Citibank for seven years.

         ROBERT M. STARLING, age 38, a Senior Vice President and Controller
since June 1997, has served as Vice President and Controller since August 1996.
From 1995 to 1996, he was Vice President and Controller of Champion. Prior
thereto, he was Director of Finance for Columbia/HCA Healthcare Corporation
from July 1994 to December 1994 and an Audit Manager with Coopers and Lybrand
L.L.P from 1986 to 1994. Mr. Starling is a Certified Public Accountant.

         RONALD L. WATSON,  age 45, a Senior Vice President, Operations Finance
and Systems Support since June 1997, has served as Vice President, Operations
Finance and Systems Support since August 1996. From 1995 to 1996, he was
Regional Controller of Champion, and effective February 1996, was promoted to
Vice President of Operations - Finance. Prior thereto, Mr. Watson was Director
of Operations - Finance for Health Management Associates, Inc. for five years.
From 1985 to 1990, Mr. Watson was a Senior Audit Manager with Arthur Young (now
Ernst & Young LLP). Mr. Watson is a Certified Public Accountant.

         W. WARREN WILKEY, age 53, has served as Senior Vice President,
Operations since August 1996. He is responsible for hospital operations of the
Company in the Western Division. From 1995 to 1996, he was Vice President -
Operations of Champion, and effective February 1996, was promoted to Senior
Vice President - Market Operations. Prior thereto, Mr. Wilkey was Vice
President and Director of Group Operations for EPIC Healthcare Group for six
years.

         During 1997, Mr. Robert C. Joyner,  Senior Vice President,  Secretary
and General Counsel, and Mr. George Asbell, Senior Vice President, Operations
were both terminated as executive officers of the Company in conjunction with a
corporate reorganization.


                                      17
<PAGE>   18




ITEM 2.     PROPERTIES

         The following table sets forth the name, location, type of facility,
date of acquisition and number of licensed beds for each of the hospitals
operated by the Company as of December 31, 1997. Unless otherwise indicated,
all hospitals are owned by the Company.

<TABLE>
<CAPTION>

                                                                                TYPE OF           DATE OF       LICENSED
                  LICENSED FACILITY                          LOCATION           FACILITY        ACQUISITION       BEDS
                  -----------------                          --------           --------        -----------     --------
<S>                                                    <C>                  <C>                   <C>           <C>
CALIFORNIA
----------
Bellwood General Hospital (1)                          Bellflower           Acute Care            02/08/82           85
Chico Community Hospital                               Chico                Acute Care            04/28/85          123
Chico Community Rehabilitation Hospital (2)            Chico                Rehabilitative        06/30/94           60
Hollywood Community Hospital of
   Hollywood (1)                                       Los Angeles          Acute Care            12/22/82          100
Hollywood Community Hospital of
   Van Nuys (1)                                        Van Nuys             Psychiatric           11/01/82           59
Lancaster Community Hospital                           Lancaster            Acute Care            02/01/81          131
Los Angeles Community Hospital (1)                     Los Angeles          Acute Care            08/08/83          130
Monrovia Community Hospital (1) (3)                    Monrovia             Acute Care            02/01/81           49
Norwalk Community Hospital (1) (4)                     Norwalk              Acute Care            02/01/81           50
Orange County Hospital of Buena Park (1)               Buena Park           Psychiatric           02/01/81           55
FLORIDA
-------
Santa Rosa Medical Center (2)                          Milton               Acute Care            05/17/96          129
GEORGIA
-------
Flint River Community Hospital (2)                     Montezuma            Acute Care            01/01/86           49
MISSISSIPPI
-----------
Senatobia Community Hospital (1)                       Senatobia            Acute Care            01/01/86           76
NORTH DAKOTA
------------
Dakota Heartland Health System (5)                     Fargo                Acute Care            08/16/96           215
TENNESSEE
---------
Cumberland River Hospital North                        Celina               Acute Care            10/01/85           36
Cumberland River Hospital South (2)                    Gainesboro           Acute Care            09/05/95           41
Fentress County General Hospital                       Jamestown            Acute Care            10/01/85           84
Bledsoe County Hospital (2)                            Pikeville            Acute Care            10/01/85           32
TEXAS
-----
BayCoast Medical Center                                Baytown              Acute Care            08/16/96          191
The Medical Center of Mesquite                         Mesquite             Acute Care            10/01/90          176
Westwood Medical Center                                Midland              Acute Care            08/16/96          101
UTAH
----
Davis Hospital and Medical Center                      Layton               Acute Care            05/17/96          126
Jordan Valley Hospital                                 West Jordan          Acute Care            08/16/96           50
Pioneer Valley Hospital (2)                            West Valley City     Acute Care            05/17/96          139
Salt Lake Regional Medical Center                      Salt Lake City       Acute Care            08/16/96          200
VIRGINIA
--------
Capitol Medical Center (6)                             Richmond             Acute Care            08/16/96          179
                                                                                                                 ------

     Total Licensed Beds                                                                                          2,666
                                                                                                                 ======

</TABLE>

-------------------------
(1)  Facilities are being held for sale. Commencing on May 15, 1997, Bellwood
     General Hospital and Orange County Hospital of Buena Park were leased to a
     joint venture formed between a subsidiary of the Company and a group of
     physicians in which the subsidiary has a 51% ownership interest.
(2)  Hospital facility is leased.




                                      18
<PAGE>   19

(3)  Monrovia Community Hospital is operated as a joint venture with a
     physician investor. Paracelsus owns a 51.0% interest in this joint
     venture.
(4)  The Company closed the emergency room and the intensive care unit of this
     facility in December 1996. This facility has been operating at a reduced
     level since such date.
(5)  The Company owns a 50.0% interest in and operates DHHS, a partnership that
     owns the hospital. The other partner has tendered its rights to require
     the Company to purchase the remaining 50% interest by August 20, 1998 (See
     Item 8 - Note 4). Previously, DHHS was comprised of the 215-bed Dakota
     Hospital and the 146-bed Heartland Medical Center. Effective January 1,
     1998, DHHS did not renew its hospital license for the 146-bed Heartland
     Medical Center, thereby reducing the licensed beds from 361 to 215. This
     change is reflected in the above schedule.
(6)  The Company owns an 88.7% general partnership interest in a limited
     partnership that owns the hospital (formerly known as Metropolitan
     Hospital).

            The Company also owns three facilities in California and one in
Utah that have been closed. The Company plans to reopen the Utah hospital (See
Item 7 "Operations - Salt Lake City, Utah"). The three California facilities
are part of the assets held for sale.

         The Company owns, leases or manages medical office buildings located
adjacent to certain of its hospitals. Most of the space in each medical office
building is leased or subleased, primarily to local physicians. The remaining
space is used by the Company for hospital administration and clinical purposes
or held for future development.

         The Company leases its corporate offices in Houston, Texas. The
Company subleases its leased offices in Pasadena, California to a third party.

ITEM 3.     LEGAL PROCEEDINGS

STOCKHOLDERS' LITIGATION - The Company and Champion are defendants in a class
action lawsuit filed in April 1996 in the Court of Chancery of the State of
Delaware in and for New Castle County by a Champion stockholder. This lawsuit
alleges, among other things, that the Merger and the consideration to be paid
to Champion's stockholders was unfair and grossly inadequate and that the
defendants violated their fiduciary duties to Champion and the stockholders of
Champion. In this action, the plaintiff seeks to rescind the Merger transaction
or award Champion stockholders rescissory damages, plus costs and attorneys'
fees.

         Since October 11, 1996, a number of complaints have been filed against
the Company by current or former stockholders of the Company relating to the
Merger of the Company and Champion. Seven of these complaints purport to be
class actions filed on behalf of persons who, between August 13, 1996 and
October 9, 1996, received the Company's common stock through the Merger with
Champion, purchased common stock, or purchased the Company's $325.0 million 10%
Senior Subordinated Notes (the "Notes"). Two other complaints purport to be
derivative actions filed on behalf of Champion. Two of the putative class
action complaints were filed in the Superior Court of the State of California,
County of Los Angeles, one in the District Court of Harris County, Texas and
four in the United States District Court for the Southern District of Texas,
Houston Division. The only currently active class action lawsuit is in the U.S.
District Court for the Southern District of Texas, where plaintiffs filed a
Consolidated Class Action Compliant captioned In re Paracelsus Corp. Securities
Litigation, Master File No. H-96-3464, which consolidated and amended the
earlier federal class action complaints. The three state court class actions
have since been suspended in deference to the Federal class action. The two
derivative complaints are also pending in the U.S. District Court for the
Southern District of Texas under the captions Caven v. Miller, No. H-96-4291,
and Orovitz v. Miller, No. H-97-2752.

         The federal stockholder class action complaint asserts claims against
the Company under sections 11 and 12(a)(2) of the Securities Act of 1933, and
claims against certain existing and former officers and directors of the
Company under sections 11 and 15 of the Securities Act of 1933. The




                                      19
<PAGE>   20

Company has terminated an agreement with representatives of certain stockholder
claimants tolling the statute of limitations as to certain other unasserted
claims. The plaintiffs allege that during the class period the defendants
disseminated materially misleading statements and omitted disclosing material
facts about the Company and its business, specifically in the reporting and
disclosure of reserves, bad debt expenses, collection expenses and facility
closure costs, and that the price of the Company's common stock was
artificially inflated. The plaintiffs also allege that statements contained in
the various registration statements and prospectuses for securities offerings
during the class period were materially inaccurate and misleading. The
plaintiffs seek damages in an unspecified amount and equitable or injunctive
relief, plus costs and attorneys' fees. The derivative actions assert various
state law claims against the Company, certain of its existing and former
officers and directors or their affiliates, and other persons. Defendants moved
to dismiss certain of the class action and derivative claims. In ruling on
defendants' motions to dismiss, the federal court granted dismissal of the
claims involving the sale of the Notes, but permitted all other claims in the
federal actions to proceed to discovery.

         In light of the Company's restatement of financial information
contained in the various registration statements and prospectuses, the Company
believes an unfavorable outcome is probable for at least some of the claims
asserted in the stockholder class action. Efforts to settle the stockholder
claims are ongoing. Absent such a settlement within the Company's financial
resources, the Company will continue to defend the litigation vigorously. Many
factors will ultimately affect and determine the results of the litigation, and
the Company can provide no assurance that the results will not have a material
adverse effect on the Company.

         OTHER LITIGATION - In October 1995, two former hospital employees of
the Company (the "relators") filed a civil complaint under seal on behalf of
the United States and the State of California against Paracelsus, certain of
its subsidiaries, and others in the United States District Court for the
Central District of California. The relators asserted violations of the U.S.
and California False Claims Acts, alleging that the defendants, among other
things, submitted false claims to obtain payments from Medicare and MediCal,
paid for patient referrals, improperly admitted Medicare and MediCal patients,
improperly waived co-payments and deductibles, and billed for treatments not
rendered. Without identifying any specific amounts, the complaint demanded
three times the damages the United States sustained from the violations, a
civil penalty for each violation, attorneys' fees, and costs and expenses.

         Although the relators filed the complaint in October 1995, the Company
did not learn of the case until late July 1997 after the Court permitted the
United States to provide a copy of the complaint to the defendants solely for
purposes of settlement negotiations. Shortly after the Company learned of the
complaint, the Company received a subpoena from the Office of the Inspector
General of the Department of Health and Human Services seeking documents
relating to certain of the same matters. In early November 1997, the Court
authorized the Company to disclose certain information about the complaint and
the case, but not the names of the relators or other defendants, in its public
reports and filings required by the Federal securities laws. Otherwise, a Court
order continues to maintain the case under seal and to prohibit the Company
from making any disclosure of the complaint or the case without a further
order. The Company has not been formally served with the complaint, and the
United States has not intervened in the case.

         Without relinquishing its rights to assert a vigorous defense, the
Company is engaged in discussions with counsel for the United States to
determine whether the parties can reach a mutually acceptable settlement. Those
discussions have been devoted to a substantially narrower set of issues than
those alleged in the complaint and have related exclusively to certain alleged
practices at three Los Angeles area hospitals that are currently closed and/or
held for sale. The relators have various rights in this type of case, including
a right to object to a settlement and continue litigating any issues not
resolved by it. The Court must determine the fairness and adequacy of any
settlement.

         The Company is not currently able to predict whether the above
litigation will settle or whether the outcome, by settlement or litigation,
will have a material adverse effect on the Company.




                                      20
<PAGE>   21

         On September 10,1997, twelve health care insurers and/or
administrators filed an action encaptioned Blue Cross and Blue Shield United of
Wisconsin et al. v. Paracelsus Healthcare Corporation, Case No. 97-6760 SVW
(RCx), in the United States District Court for the Central District of
California against the Company and two of its subsidiaries. Plaintiffs allege
that over many years Defendants fraudulently induced them to make payments
under their members' plans through a variety of allegedly improper practices,
principally in connection with certain psychiatric treatment programs
previously operated at certain of the Company's psychiatric hospitals in the
Los Angeles area. The alleged improper practices include systematic waiver of
co-insurance obligations and misrepresentation of patients' symptoms,
conditions, diagnosis and/or treatment. Plaintiffs assert claims under the
Racketeer Influenced and Corrupt Organizations Act ("RICO") and the Employee
Retirement Income Security Act ("ERISA"), as well as for fraud, negligent
misrepresentation, unjust enrichment, and conversion.

         On February 13, 1998, the court granted, in major part, the Company's
motion to dismiss the Complaint. Of Plaintiffs' seven claims for relief, the
court dismissed six for inadequate pleading and, in one case, for failure to
state a claim. Only Plaintiffs' ERISA claim was allowed to stand. The court
also ruled that Plaintiffs had failed adequately to explain their failure to
discover the alleged misconduct within the applicable statutes of limitations,
thereby limiting their fraud claims to those arising after September 10, 1994,
and their RICO claims to those arising after September 10, 1993. The court
permitted the Plaintiffs to replead their claims.

         On March 10, 1998, Plaintiffs filed their First Amended Complaint
restating each of their causes of action. In their First Amended Complaint,
Plaintiffs seek damages exceeding $30.5 million, treble damages under RICO,
restitution under ERISA, together with reasonable attorneys' fees and various
costs and expenses. The Company does not believe Plaintiffs have cured the
defects in their original Complaint and intends to file a motion to dismiss the
First Amended Complaint, including the ERISA claim, on grounds that Plaintiffs
have still not pleaded their claims with sufficient particularity and still not
adequately explained their failure to discover the alleged misconduct within
the applicable statutes of limitations. If the motion is unsuccessful, the
Company intends vigorously to defend the action.

         The Company is currently unable to predict the litigation's outcome or
whether any adverse outcome will have a materially adverse effect on the
Company.

         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 are either adequately covered by insurance or will not have
a material adverse effect on the Company's financial condition, results of
operations or liquidity.

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

         No matters were submitted to a vote of security holders during the
fourth quarter of the year ended December 31, 1997.




                                      21

<PAGE>   22



                                    PART II

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

         On August 16, 1996, the Company completed an initial public offering
of its Common Stock and acquired Champion, a publicly-traded company. The
Company's Common Stock began trading on the New York Stock Exchange ("NYSE")
under the symbol "PLS" on August 16, 1996. At March 26, 1998, there were
approximately 1,156 holders of record of the Company's Common Stock. The
following table sets forth the high and low sale prices per share of the
Company's Common Stock for the periods indicated, as reported by the NYSE.


<TABLE>
<CAPTION>
                                                                HIGH                    LOW
                                                                ----                    ---
      Fiscal Year Ended December 31, 1997
<S>                                                          <C>                      <C>
        First Quarter .................................        $  5 3/4               $  2 7/8
        Second Quarter ................................           5 1/4                  2 7/8
        Third Quarter .................................           8 1/2                  4 5/8
        Fourth Quarter ................................           7 1/2                  2 13/16

      Fiscal Year Ended December 31, 1996
        Third Quarter .................................        $ 10 1/8               $  8 1/8
        Fourth Quarter ................................          10 1/2                  3 1/8
</TABLE>


         The Company paid to its former sole shareholder, Park Hospital GmbH
(herein after the "Former Sole Shareholder"), a German Corporation wholly owned
by Dr. Manfred G. Krukemeyer, its former Chairman of the Board of Directors,
cash dividends of $24.9 million and $5.4 million during 1996 and 1995,
respectively (See Item 8 Notes 13 and 16). As a publicly-traded company, the
Company has not declared any cash dividends and does not anticipate the payment
of any cash dividends in the foreseeable future. See Item 8 - Note 9 for
information regarding certain restrictions on the Company's ability to pay cash
dividends. The Company did not make any sale of registered securities during
1997.

ITEM 6.     SELECTED FINANCIAL DATA

         The following table summarizes certain selected financial data of the
Company and should be read in conjunction with the related Consolidated
Financial Statements and accompanying Notes to Consolidated Financial
Statements (See Item 8).



                                      22
<PAGE>   23

<TABLE>
<CAPTION>



(IN 000'S, EXCEPT PER SHARE DATA AND RATIOS)
----------------------------------------------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31,                       1997            1996            1995            1994            1993
                                             ---------       ---------       ---------       ---------       ---------

INCOME STATEMENT DATA
<S>                                          <C>             <C>             <C>             <C>             <C>
Net revenue                                  $ 659,219       $ 493,106       $ 434,179       $ 438,625       $ 392,199
Operating expenses                            (587,559)       (496,782)       (399,019)       (393,550)       (355,054)
Capital costs (a)                              (77,551)        (54,761)        (31,719)        (28,846)        (24,968)
Equity in earnings of Dakota Heartland
  Health System                                  9,794           3,207            --              --              --
Impairment charges (b)                          (7,782)        (72,322)           --              --              --
Merger costs                                      --           (40,804)           --              --              --
Unusual items (c)                                6,531         (60,521)           --              --              --
Gain on sale of facilities                        --              --             9,026            --              --
Minority interests                              (1,996)         (1,806)         (1,803)         (2,449)         (2,643)
                                             ---------       ---------       ---------       ---------       ---------

Income (loss) from continuing
    operations before income
    taxes and extraordinary loss                   656        (230,683)         10,664          13,780           9,534
Provision (benefit) for income taxes (d)         1,812         (76,186)          4,375           5,818           4,290
                                             ---------       ---------       ---------       ---------       ---------

Income (loss) from continuing
    operations before extraordinary loss        (1,156)       (154,497)          6,289           7,962           5,244
Income (loss) from discontinued
    operations (d)                              (5,243)        (70,995)         (2,852)           (106)         (2,288)
                                             ---------       ---------       ---------       ---------       ---------

Income before extraordinary loss                (6,399)       (225,492)          3,437           7,856           2,956
Extraordinary loss (d) (e)                        --            (7,724)           --               (33)           (464)
                                             ---------       ---------       ---------       ---------       ---------


Net income (loss)                            $  (6,399)      $(233,216)      $   3,437       $   7,823       $   2,492
                                             =========       =========       =========       =========       =========


Income (loss) per share - Basic and
   assuming dilution:
    Continuing operations                    $   (0.02)      $   (3.94)      $    0.21       $    0.26       $    0.18
    Discontinued operations                      (0.10)          (1.81)          (0.09)           --             (0.08)
    Extraordinary loss                            --             (0.20)           --              --             (0.02)
                                             ---------       ---------       ---------       ---------       ---------
Income (loss) per share                      $   (0.12)      $   (5.95)      $    0.12       $    0.26       $    0.08
                                             =========       =========       =========       =========       =========

Weighted average common shares
    outstanding (f)                             54,946          39,213          29,772          29,772          29,772
BALANCE SHEET DATA
Cash and cash equivalents                    $  28,173       $  17,771       $   4,418       $   2,004       $   1,282
Working capital                                 37,378          33,762          57,011          66,410          47,388
Total assets                                   734,824         772,832         333,386         324,650         300,297
Long-term debt (g)                             491,914         491,057         130,352         122,252         103,316
Stockholders' equity                            42,003          48,487          86,721          88,337          84,064
Book value per share                              0.76            0.88            2.91            2.97            2.82
RATIOS
Adjusted EBITDA  (h)                            79,458          (2,275)         33,357          42,626          34,502
Adjusted EBITDA Margin                            12.1%           (0.5)%           7.7%            9.7%            8.8%
Current ratio                                   1.27:1          1.21:1          1.82:1          2.10:1          1.83:1
Debt to total debt and equity                     92.1%           91.0%           60.0%           58.1%           55.1%
</TABLE>

---------

(a)  Includes interest, depreciation and amortization.




                                      23
<PAGE>   24



(b)  Consists of an additional write down of $7.8 million ($0.09 per share) in
     1997 of certain hospitals in the LA metro area and the write down in 1996
     of PHC Regional Hospital for $52.5 million ($0.90 per share) and certain
     hospitals in the LA metro area for $11.9 million ($0.20 per share) and two
     other facilities and estimated disposal costs of $7.9 million ($0.13 per
     share) (See Item 8 - Note 7).
(c)  Consists in 1997 of (i) a reversal of a loss contract accrual of $15.5
     million ($0.17 per share), (ii) a charge of $3.5 million ($0.03 per share)
     relating to the closure of PHC Regional Hospital (iii) a charge of $2.5
     million ($0.03 per share) for a corporate reorganization and (iv) a charge
     of $3.0 million ($0.04 per share) for the settlement of certain
     litigation. Consists in 1996 of charges of $38.1 million ($0.65 per share)
     for a loss contract and $22.4 million ($0.38 per share) for expenses
     relating to the Special Committee's investigation and other litigation
     matters.
(d)  Includes a reduction in income tax benefits of $50.0 million ($1.27 per
     share) in 1996 from the recording of a valuation allowance, which offsets
     the Company's net deferred tax assets. Of this amount, $17.7 million was
     applied to reduce income tax benefits on losses from continuing operations
     and the remaining $32.3 million to reduce income tax benefits on losses
     from discontinued operations and an extraordinary loss. As a result, no
     income tax benefits have been recognized on the losses from discontinued
     operations and the extraordinary loss recorded in 1996.
(e)  Reflects loss associated with the early extinguishment of debt.
(f)  Reflects the effect of the 66,159.426-for-one stock split in conjunction
     with the merger of the Company and Champion Healthcare Corporation.
(g)  Excludes current maturities of long-term debt.
(h)  Adjusted EBITDA represents income (loss) from continuing operations before
     income taxes and extraordinary loss, depreciation and amortization,
     interest, impairment charges, merger costs, unusual items and gain from
     sale of a hospital. While EBITDA is not a substitute for operating cash
     flows determined in accordance with generally accepted accounting
     principles, it is a commonly used tool for measuring a company's ability
     to service debt.

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

FORWARD-LOOKING STATEMENTS

         Certain statements in this Form 10-K are "forward-looking statements"
made pursuant to the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995. Forward-looking statements involve a number of
risks and uncertainties. Factors which may cause the Company's actual results
in future periods to differ materially from forecast results include, but are
not limited to: the outcome of litigation pending against the Company and
certain affiliated persons; continued satisfactory relations with the Company's
senior lenders; general economic and business conditions, both nationally and
in the regions in which the Company operates; industry capacity; demographic
changes; existing government regulations and changes in, or the failure to
comply with government regulations; legislative proposals for healthcare
reform; the ability to enter into managed care provider arrangements on
acceptable terms; changes in Medicare and Medicaid reimbursement levels;
revisions to amounts recorded for losses associated with the impairment of
assets; liabilities and other claims asserted against the Company; competition;
the loss of any significant customer; changes in business strategy, divestiture
and development plans; the ability to attract and retain qualified personnel,
including physicians; fluctuations in interest rates on the Company's variable
rate indebtedness; and the availability and terms of capital to fund working
capital requirements and the expansion of the Company's business, including the
acquisition of our partner's interest in DHHS and additional facilities.

RESULTS OF OPERATIONS

         The comparison of operating results for 1997 with prior years is
difficult given the numerous acquisitions and divestitures by the Company in
prior years. "Same hospitals" as used in the following discussion, where
appropriate, consist of acute care hospitals owned throughout the periods of
which comparative operating results are presented. See Item 8 - Note 5 for a
description of acquisitions and





                                      24
<PAGE>   25

divestitures during the three years ended December 31, 1997. Operating results
of the Company's psychiatric hospitals are reflected under the caption "
Discontinued operations - Loss from operations of discontinued psychiatric
hospitals, net" and " Discontinued operations - Loss on disposal of
discontinued psychiatric hospitals, net" in the Consolidated Statements of
Operations for all periods presented.

OPERATIONS DATA

         The following table summarizes, for the periods indicated, changes in
selected operating percentages for the Company's facilities, excluding the
discontinued psychiatric hospitals. The discussion that follows should be read
in conjunction with the Company's consolidated financial statements and the
notes thereto included elsewhere herein.

<TABLE>
<CAPTION>

                                                         YEAR ENDED DECEMBER 31,
                                                    --------------------------------
                                                     1997         1996         1995
                                                    ------       ------       ------
<S>                                                 <C>          <C>          <C>
Percentage of Net Revenue
-------------------------

Net revenue                                          100.0%       100.0%       100.0%
                                                    ------       ------       ------
Salaries and benefits                                (41.2)       (48.3)       (45.8)
Other operating expenses                             (40.8)       (44.6)       (40.7)
Provision for bad debts                               (7.1)        (7.8)        (5.4)
                                                    ------       ------       ------
Operating costs                                      (89.1)      (100.7)       (91.9)
                                                    ------       ------       ------

Operating margin                                      10.9         (0.7)         8.1

Capital costs (a)                                    (11.8)       (11.1)        (7.3)
Equity in earnings of Dakota Heartland
    Health System                                      1.5          0.6           --
Impairment charges                                    (1.2)       (14.7)          --
Merger costs                                            --         (8.3)          --
Unusual items                                          1.0        (12.3)          --
Gain on sale of facilities                              --           --          2.1
Minority interests                                    (0.3)        (0.3)        (0.4)
                                                    ------       ------       ------
Income (loss) from continuing operations before
    income taxes and extraordinary loss                0.1%       (46.8)%        2.5%
                                                    ======       ======       ======

</TABLE>

--------------------
(a)      Includes interest, depreciation and amortization.

YEAR ENDED DECEMBER 31, 1997
COMPARED WITH YEAR ENDED DECEMBER 31, 1996

         Net revenue for the year ended December 31, 1997 was $659.2 million,
an increase of $166.1 million, or 33.7%, from $493.1 million for the same
period of 1996. The $166.1 million increase was attributable to an increase of
$137.6 million contributed by hospitals acquired, net of hospitals divested or
closed in 1996, and an increase of $28.5 million from "same hospitals." The
$28.5 million increase in "same hospitals" was primarily attributable to
incremental contribution by a joint venture formed in May 1997 involving two
hospitals located in the LA metro area (See Item 8 - Note 5) and additional
services offered at certain hospitals. The increase for the year was partially
offset by a $4.8 million charge to net revenue in the fourth quarter to revise
estimates of amounts due to the Company with respect to Medicare/Medicaid
receivables, a majority of which relates to prior years, and a decline in
reimbursement rates and other charges totaling $2.4 million attributable to the
enactment of the 1997 Budget Act, effective October 1, 1997, and other recently
announced initiatives by the Federal government with respect to reimbursement
practices and policies. The increase was also offset by a decline in
reimbursement at hospitals located primarily in Tennessee and the closure of
underperforming operating units.



                                      25
<PAGE>   26

         The Company's acute care volumes experienced a 19.3% increase in
inpatient admissions from 58,693 in 1996 to 69,997 in 1997. Patient days
increased 18.3% from 277,553 in 1996 to 328,331 in 1997. Outpatient visits
(including home health) increased 21.8% from 1,256,124 in 1996 to 1,529,736 in
1997. Admissions in "same hospitals" decreased 2.6% from 37,669 in 1996 to
36,683 in 1997, primarily as a result of management's decision to close
underperforming operating units. Outpatient visits in "same hospitals"
decreased 3.5% from 864,137 in 1996 to 834,264 in 1997, primarily as a result
of a 6.5% decrease in home health visits.

         Expressed as a percentage of net revenue, operating expenses (salaries
and benefits, other operating expenses and provision for bad debts) decreased
from 100.7% in 1996 to 89.1% in 1997 as operating margin increased from (0.7)%
to 10.9%. General factors contributing to the improvement in operating margin
percentage include (i) management's efforts to control costs, including a
corporate reorganization completed in May 1997 to reduce corporate overhead
costs, (ii) efficiency and productivity gains resulting from the implementation
of improved operating standards and benchmarks, (iii) divestiture or closure of
underperforming facilities and (iv) negotiation of new contracts under more
favorable terms that resulted in lower operating costs. Such increase in
operating margin was further due to the write off of working capital assets in
1996 related to the hospitals exchanged in May 1996 and a hospital closed in
March 1996.

         Interest expense increased $16.4 million from $31.0 million in 1996 to
$47.4 million in 1997, primarily due to (i) an increase in outstanding
indebtedness from the issuance of $325.0 million 10% Senior Subordinated Notes
(the "Notes") and additional borrowings under the $400.0 million Reducing
Revolving Credit Facility (the "Credit Facility") issued in August 1996 in
conjunction with the merger with Champion Healthcare Corporation (the "Merger")
to finance acquisitions and to fund certain lawsuit settlement costs, Champion
merger costs, working capital requirements and capital expenditures, (ii) an
increase in interest rate on the Credit Facility during 1997, net of (iii) the
redemption in August 1996 of $75.0 million of senior subordinated notes.
Approximately $2.7 million of interest expense incurred in 1997, which related
to borrowings to finance the acquisition of PHC Regional Hospital, was charged
to the loss contract accrual previously established at December 31, 1996.
Accordingly, such amount was not reflected as interest expense in the 1997
Consolidated Statement of Operations.

         Depreciation and amortization expense increased to $30.2 million in
1997 from $23.7 million for the same period of 1996. The $6.5 million increase
consisted of $9.1 million primarily attributable to the Merger and other
facilities acquired, net of divested facilities, since May 1996, offset by a
decrease of $2.6 million at the acute care LA metro hospitals held for sale as
a result of recording these facilities at their fair value as of September 30,
1996 in accordance with Statement of Financial Accounting Standards ("SFAS")
No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of."

         Loss from operations of the discontinued psychiatric hospitals was
$1.1 million in 1997, as compared to $13.6 million (excluding a charge of $19.9
million for settlement costs related to a lawsuit settled in March 1996) in
1996. The significant loss recorded in 1996 as compared to 1997 was primarily
attributable to additional provision for bad debts on uncollectible accounts
receivable. The loss recorded in 1997 was significantly reduced as a result of
management's decision to close an underperforming facility and consolidate
services of certain other facilities. In accordance with APB No. 30, the 1997
operating loss was charged to the disposal loss accrual previously established
in September 1996. Accordingly, such amount was not reflected in the 1997
Consolidated Statement of Operations. During 1997, the Company recorded an
additional after-tax disposal loss of $5.2 million (net of tax benefits of $3.7
million) on these facilities, consisting of an impairment charge of $1.9
million to reduce psychiatric hospital assets to their estimated net realizable
value based upon the most recent offers from third party purchasers and a
charge of $3.3 million relating to certain outstanding litigation matters (See
"Litigation").


                                      26
<PAGE>   27

         During 1997, the Company recorded income tax expense of $1.8 million
on pre-tax income of $656,000 as a result of nondeductible goodwill
amortization expense. During 1996, the Company recognized a reduction in income
tax benefits of $50.0 million, $17.7 million of which was applied to continuing
operations. The remaining $32.3 million was applied to reduce the tax benefits
of the losses from discontinued operations and the extraordinary loss.

         Net loss for the year ended December 31, 1997 was $6.4 million, or
$0.12 per share, compared to a net loss of $233.2 million, or $5.95 per share,
for the same period of 1996. Weighted average shares outstanding increased
40.1% from 39.2 million in 1996 to 54.9 million in 1997 from the issuance of
19.8 million shares in connection with the Merger and from the public offering
of 5.2 million shares, both completed in August 1996. Included in 1997 income
from continuing operations before income taxes, net loss and net loss per share
were net aggregate non-recurring charges of $1.3 million, $6.0 million and
$0.11 per share, respectively. Included in the 1996 loss from continuing
operations before income taxes and extraordinary loss, net loss and net loss
per share were non-recurring charges of $173.6 million, $195.1 million and
$4.97 per share, respectively. Aggregate non-recurring charges for the years
ended December 31, 1997 and December 31, 1996 were comprised of the following
items ($ in 000's, except per share amounts):

<TABLE>
<CAPTION>

                                                              YEAR ENDED DECEMBER 31,
                                              ----------------------------------------------------------------------------------
                                                               1997                                       1996
                                              --------------------------------------      --------------------------------------
                                              PRE-TAX        AFTER TAX        EPS          PRE-TAX       AFTER-TAX        EPS
                                              ---------      ---------      --------      ---------      ---------      --------

<S>                                           <C>            <C>            <C>           <C>            <C>            <C>
Impairment charge
   (Item 8 - Note 2)                          $  (7,782)     $  (4,591)     $  (0.09)     $ (72,322)     $ (48,456)     $  (1.23)
Merger costs
   (Item 8 - Note 5)                                 --             --            --        (40,804)       (27,339)        (0.70)
Unusual items
   (Item 8 - Note 2)                              6,531          3,853          0.07        (60,521)       (40,549)        (1.03)
Discontinued operations
   (Item 8 - Note 6)(a)                              --         (5,243)        (0.09)            --        (70,995)        (1.81)
Extraordinary loss
   (Item 8 - Note 9)(a)                              --             --            --             --         (7,724)        (0.20)
                                              ---------      ---------      --------      ---------      ---------      --------
Total impact of
   non-recurring items                        $  (1,251)     $  (5,981)     $  (0.11)     $(173,647)     $(195,063)     $  (4.97)
                                              =========      =========      ========      =========      =========      ========

</TABLE>


(a)  In 1996, no income tax benefits were recognized on the losses associated
     with the discontinued operations and the extraordinary loss as a result of
     recording a valuation allowance on deferred tax assets (See Item 8 Note
     8).

YEAR ENDED DECEMBER 31, 1996
COMPARED WITH YEAR ENDED DECEMBER 31, 1995

         Net revenue for the year ended December 31, 1996 was $493.1 million,
an increase of $58.9 million, or 13.6%, from $434.2 million for the same period
of 1995. The $58.9 million increase was primarily attributable to an increase
of $65.1 million contributed by hospitals acquired during 1996, net of divested
hospitals, and a decrease of $6.2 million from "same hospitals." The $6.2
million decrease in "same hospital" net revenue was attributable to a decrease
of $13.8 million at the LA metro hospitals, offset by an increase of $7.6
million at hospitals located outside of the LA metro area. The $13.8 million
decrease at the LA metro hospitals was due to a change in payor mix from
private insurance to managed care and Medicare/Medicaid, which increased
deductions from revenue, and due to a change in acuity level. The $7.6 million
increase at the remaining hospitals was due primarily to an increase in home
health business, an increase in services offered (e.g., open heart surgery) and
medical staff development efforts.



                                      27

<PAGE>   28

         The Company's acute care hospitals experienced a 28.8% increase in
inpatient admissions from 45,574 in 1995 to 58,693 in 1996. Patient days
increased 12.8% from 246,107 in 1995 to 277,553 in 1996. Outpatient visits
(including home health) increased 25.8% from 998,551 in 1995 to 1,256,124 in
1996. Admissions in "same hospitals" increased 8.2% from 34,803 in 1995 to
37,669 in 1996.

         Expressed as a percentage of net revenue, operating expenses (salaries
and benefits, provision for bad debts and other operating expenses) increased
from 91.9% in 1995 to 100.7% in 1996 and operating margin decreased from 8.1%
to (0.7%). Such decrease was due to (i) an increase in salaries and benefits
and other operating expenses as a percentage of net revenue, primarily as a
result of a reduction in "same hospital" net revenue due to a change in payor
mix, a change in acuity level and increased deductions from revenue, (ii) the
write off of assets related to the hospitals exchanged in May 1996, (iii) the
under performance of PHC Regional Hospital, (iv) additional home health
business which was profitable but produced lower margins than other types of
services and (v) an increase of 2.4% in the provision for bad debts as a
percentage of net revenue during 1996 as compared to 1995, primarily
attributable to a decrease in "same hospital" net revenue for reasons stated
above and to an increase in services that were subject to more bad debt
write-off.

         Interest expense increased $15.1 million from $15.9 million in 1995 to
$31.0 million in 1996, primarily due to an increase in outstanding indebtedness
during 1996 from the issuance of the Notes in August 1996 and additional
borrowings under the Credit Facility effective with the Merger to finance
acquisitions and to fund Merger costs, working capital requirements and capital
expenditures, net of the redemption in August 1996 of $75.0 million of senior
subordinated notes. See "Liquidity and Capital Resources" for terms to the
Credit Facility amended during 1997.

         Depreciation and amortization increased to $23.7 million in 1996 from
$15.9 million for the same period of 1995. Of the $7.8 million increase, $7.4
million was attributable to the facilities acquired or divested during 1996,
including amortization of goodwill of $1.6 million, and $1.2 million from
purchases of medical equipment, physician practices and clinics and facility
improvements at hospitals not held for sale. Such increase was offset by a
decrease of $754,000 at the acute care LA metro hospitals held for sale,
primarily attributable to the elimination of depreciation expense, commencing
on October 1, 1996, in accordance with SFAS No. 121.

         Loss from operations of the discontinued psychiatric hospitals for the
nine months ended September 30, 1996 was $33.5 million, compared to $2.9
million for the year ended December 31, 1995. The $30.6 million additional loss
was attributable to (i) a charge of $19.9 million relating to a lawsuit settled
in March 1996 (the "Aetna lawsuit") (See Item 8 - Note 6), (ii) no income tax
benefits recognized in 1996 on the losses resulting from the discontinued
operations (See Item 8 - Note 8) and (iii) continuing accounts receivable
collection issues attributable in general to the fact that insurance companies
are becoming more stringent in their payments to providers of psychiatric care,
and particularly in 1996, to the impact of the Aetna lawsuit. The Company also
recorded in 1996 an estimated disposal loss of $37.5 million on these
facilities to reduce the related assets to their estimated net realizable value
and to accrue for estimated operating losses of approximately $4.3 million
during the phase out period. The additional provision for net disposal loss of
$22.5 million over the amount previously accrued at September 30, 1996 was due
primarily to (i) a lower estimated net realizable value for these facilities,
based on independent third party appraisals (ii) no income tax benefits
recognized on the disposal loss of the discontinued operations in 1996 (See
Item 8 - Note 8) and (iii) additional write-offs of certain impaired assets.
See discussion under "Disposition of the Psychiatric Hospitals and other LA
Metro Hospitals."

         The Company's effective ongoing tax rate was 40.7% in 1996 as compared
to 41.0% in 1995 before giving effect to the valuation allowance (See Item 8 -
Note 8). The Company recognized a reduction in income tax benefits of $50.0
million in 1996, $17.7 million of which was applied to continuing operations.
The remaining $32.3 million was applied to reduce the tax benefits of the
losses from discontinued operations and the extraordinary loss. The income tax
benefit for continuing




                                      28

<PAGE>   29

operations in 1996 was recorded at an effective tax rate of 33.0%, and no net
tax benefit was recognized with respect to discontinued operations or the
extraordinary loss.

         Net loss for the year ended December 31, 1996 was $233.2 million, or
$5.95 per share, compared to net income of $3.4 million, or $0.12 per share,
for the same period of 1995. Weighted average shares outstanding increased
31.7% from 29.8 million in 1995 to 39.2 million in 1996 from the issuance of
19.8 million shares in connection with the Merger and from the public offering
of 5.2 million shares, both completed in August 1996. Included in 1996 income
from continuing operations before income taxes, net income and net income per
share were net aggregate non-recurring charges of $173.6 million, $195.1
million and $4.97 per share, respectively. Included in 1995 income from
continuing operations before income taxes, net income and net income per share
were net aggregate non-recurring gains of $9.0 million, $2.5 million and $0.08
per share, respectively. Aggregate non-recurring gains (charges) for the years
ended December 31, 1996 and 1995 were comprised of the following items ($ in
000's, except per share amounts):


<TABLE>
<CAPTION>

                                                                  YEAR ENDED DECEMBER 31,
                                                ---------------------------------------------------------------------------------
                                                                1996                                       1995
                                                ---------------------------------------   ---------------------------------------
                                                 PRE-TAX       AFTER-TAX        EPS          PRE-TAX      AFTER-TAX        EPS
                                                ---------      ---------      --------      ---------     ---------      --------
<S>                                             <C>            <C>            <C>           <C>           <C>            <C>
Impairment charges
   (Item 8 - Note 2)                            $ (72,322)     $ (48,456)     $  (1.23)     $      --     $      --      $     --
Merger costs (Item 8 - Note 5)                    (40,804)       (27,339)        (0.70)            --            --            --
Unusual items (Item 8 - Note 2)                   (60,521)       (40,549)        (1.03)            --            --            --
Gain on sale of facilities
   (Item 8 - Note 5)                                   --             --            --          9,026         5,325          0.18
Discontinued operations
   (Item 8 - Note 6) (a)                               --        (70,995)        (1.81)            --        (2,852)        (0.10)
Extraordinary loss
   (Item 8 - Note 9) (a)                               --         (7,724)        (0.20)            --            --
                                                ---------      ---------      --------      ---------     ---------      --------

   Total impact of
      non-recurring items                       $(173,647)     $(195,063)     $  (4.97)     $   9,026     $   2,473      $   0.08
                                                =========      =========      ========      =========     =========      ========
</TABLE>

--------

(a)  No income tax benefits were recognized on the losses associated with the
     discontinued operations and the extraordinary loss as a result of
     recording a valuation allowance on deferred tax assets in 1996 (See Item 8
     - Note 8).

         See "Operations - Salt Lake City, Utah" below for a discussion of the
performance of PHC Regional Hospital and the unusual items recorded during
1996.

LIQUIDITY AND CAPITAL RESOURCES

         Net cash provided by operating activities for the year ended December
31, 1997 was $4.0 million, compared to net cash used in operating activities of
$22.1 million for the same period of 1996. The $26.1 million increase in net
cash flows from operating activities was mainly attributable to (i) a smaller
net loss recorded for 1997 as compared to 1996, which was primarily
attributable to Merger-related costs, a settlement charge for certain lawsuits
and a deterioration in the operating condition at the LA metro hospitals and
(ii) net federal income tax refunds of $24.1 million received in 1997, offset
by (iii) payments made in 1997 for (a) increased interest expense, (b) the loss
contract at PHC Regional Hospital prior to the Amendment of the Provider
Agreement with PacifiCare of Utah (See "Operations - Salt Lake City, Utah") and
(c) the Special Committee's investigation. Net cash provided by investing
activities was $10.0 million during 1997, as compared to net cash used in
investing activities of $140.9 million during 1996. The $150.9 million increase
was primarily attributable to (i) a use of cash of $117.8 million to acquire
hospitals during 1996, as compared to $12.2 million in cash received from a
sale of certain hospitals during 1997 and (ii) cash of $20.0 million received
from the liquidation of marketable




                                      29
<PAGE>   30
securities held by the Company's wholly-owned subsidiary, Hospital Assurance
Company Ltd., during 1997, as compared to $4.5 million received during 1996.
Net cash used in financing activities during 1997 was $3.6 million, compared to
net cash provided by financing activities of $176.4 million during 1996. Such
decrease was due to significant financing transactions completed in 1996
consisting of (i) the issuance of the Notes, (ii) the issuance of 5.2 million
shares of the Company's common stock, (iii) incremental borrowings under the
Credit Facility, net of amounts used therefrom to repay $75.0 million of senior
subordinated notes, certain indebtedness assumed from the Merger and amounts
outstanding under the previous $230.0 million revolving line of credit, offset
by (iv) dividends paid in 1996 to the Former Sole Shareholder.

         Net working capital was $37.4 million at December 31, 1997, an
increase of $3.6 million from $33.8 million at December 31, 1996. The Company's
long-term debt as a percentage of total capitalization was 92.1% at December
31, 1997, compared to 91.0% at December 31, 1996.

         On March 30, 1998, the Company entered into an Amended and Restated
Credit Agreement (the "Restated Credit Agreement"), which provided for a $180.0
million five-year Reducing Revolving Credit Facility (the "$180.0 million
Facility") and $75.0 million in Term Loan Facilities (the "$75.0 million
Facilities"), consisting of a five-year $25.0 million Term Loan Facility
("Tranche A Facility") and a six-year $50.0 million Term Loan Facility ("Tranche
B Facility"). The $180.0 million Facility is available for (i) general corporate
purposes, including funding working capital needs, Permitted Acquisitions and
capital expenditures, (ii) issuance of letters of credit up to $25.0 million and
(iii) replacing existing indebtedness of the Company under its prior credit
facility. It is subject to mandatory quarterly reductions of $12.0 million,
commencing on March 31, 2000, and a limit of $50.0 million availability for
working capital needs. The $75.0 million Facilities are available for replacing
existing indebtedness of the Company under its prior credit facility and
initial Permitted Acquisition advances. The Tranche A Facility is payable in
quarterly installments ranging from $600,000 to $2,500,000, with the final
payment due on March 31, 2003. The Tranche B Facility is payable in annual
installments of $500,000 with the final balloon payment due on March 31, 2004.
The Company is further required to make mandatory prepayments under the
Facilities equal to 100% of (i) net cash proceeds from permitted asset sales,
(ii) debt issuances and (iii) equity issuances, subject to certain allowable
exclusions for debt and equity as described in the Restated Credit Agreement.
Such prepayments do not result in a mandatory reduction in borrowing capacity
under the $180.0 million Facility but may result, in certain circumstances, in a
mandatory permanent reduction of the $75.0 million Facilities. See Item 8 - Note
9 for interest rate terms, fees  and collateralized structure. As of March 31,
1998, there was $90.1 million available for borrowings under the Facilities.

         The Company has an agreement with an unaffiliated trust (the "Trust")
to provide up to $65.0 million in accounts receivable financing. Under such
arrangement, the Company sells its eligible accounts receivable (the "Eligible
Receivables") on a nonrecourse basis to the Trust. A special purpose subsidiary
of a major lending institution agrees to provide up to $65.0 million in
commercial paper financing to the Trust to finance the purchase of the Eligible
Receivables from the Company, with the Eligible Receivables serving as
collateral. At December 31, 1997, Eligible Receivables sold to the Trust were
$38.3 million as compared to $49.8 million at December 31, 1996. Additionally,
at December 31, 1997, the Company was not in compliance with certain provisions
of the Trust agreement; accordingly, the Company has obtained a waiver of such
provisions from the Trust.

         In 1997, the Company received approximately $24.1 million in net
refunds of previously paid Federal and state income taxes. Such refunds were
used to pay interest costs and for general working capital needs. The Company
expects to receive additional Federal and state income tax refunds of
approximately $7.7 million in 1998.

         In August 1997, the Company received notice from Dakota Medical
Foundation (the "Foundation") exercising its right to require the Company to
purchase the Foundation's 50% interest in Dakota Heartland Health System
("DHHS"). The Company has until August 20, 1998 to complete its purchase of
DHHS. The Company has negotiated a purchase price of $64.5 million, inclusive
of working capital, and expects to complete the transaction by August 1998. If
the purchase is not completed within the allowable period, the Foundation can
exercise various options, including seeking remedies available



                                      30
<PAGE>   31

at law against the Company for breach of its obligation. The Company will
finance such acquisition through borrowings under the Facilities.

         The Company anticipates that internally generated cash flows from
earnings, existing cash balances, borrowings under the Facilities, proceeds
from the sale of facilities, proceeds from the sale of hospital accounts
receivable under the Company's commercial paper program, income tax refunds and
permitted equipment leasing arrangements will be sufficient to fund future
capital expenditures and working capital requirements through 1998. There can
be no assurance that future developments in the hospital industry or general
economic trends will not adversely affect the Company's operations or its
liquidity. See "Litigation" for a discussion regarding certain pending
litigation, the resolution of which could adversely affect the Company's
liquidity in general, including the necessary funding for DHHS.

YEAR 2000 COMPLIANCE

         Many existing computer programs use only two digits to identify a year
in the date field. These programs were designed and developed without
considering the impact of the upcoming change in the century. If not corrected,
many computer applications could fail or create erroneous results by or at the
Year 2000 ("the Year 2000 Problem"). In 1997, the Company initiated an effort
to upgrade and standardize the management information systems in use at its
hospitals and corporate office with the concurrent goal of ensuring that all
systems are Year 2000 compliant. Modifications to standardize and upgrade the
Company's management information systems are underway and are expected to be
completed by early 1999 at an aggregate cost of approximately $8.0 million. The
Company does not expect to incur material incremental costs to upgrade these
systems with respect to the Year 2000 Problem. Additionally, the Company has
initiated a comprehensive assessment of embedded systems and other applications
that control certain medical and other equipment. The Company has not yet
completed an estimate of the costs of bringing these applications, including
embedded systems, into compliance. Furthermore, the Company presently has no
assurance that the systems of the Federal and State governments, other payors
or other companies with which the Company's systems interface or on which they
rely, will be upgraded on a timely basis. The Company, therefore, is not able
to determine whether the Year 2000 Problem will materially affect future
financial results or future financial conditions. Generally accepted accounting
principles require that the costs of modifying computer software for the Year
2000 Problem be charged to expense as they are incurred.

PENDING ASSET SALES

         On December 15, 1997, the Company signed a definitive agreement to sell
the 123-bed Chico Community Hospital and the 60-bed Chico Rehabilitation
Hospital in Chico, California. This transaction is subject to the completion of
customary closing conditions and obtaining certain regulatory approvals. Net
proceeds will be used to reduce bank debt and general corporate purposes;
however, there can be no assurance that the Company will be able to consummate
this transaction.

LITIGATION

Stockholder's Litigation - The Company and Champion are defendants in a class
action lawsuit filed in April 1996 in the Court of Chancery of the State of
Delaware in and for New Castle County by a Champion stockholder. This lawsuit
alleges, among other things, that the Merger and the consideration to be paid
to Champion's stockholders was unfair and grossly inadequate and that the
defendants violated their fiduciary duties to Champion and the stockholders of
Champion. In this action, the plaintiff seeks to rescind the Merger transaction
or award Champion stockholders rescissory damages, plus costs and attorneys'
fees.

                                      31

<PAGE>   32

         Since October 11, 1996, a number of complaints have been filed against
the Company by current or former stockholders of the Company relating to the
Merger of the Company and Champion. Seven of these complaints purport to be
class actions filed on behalf of persons who, between August 13, 1996 and
October 9, 1996, received the Company's common stock through the Merger with
Champion, purchased common stock, or purchased the Company's $325 million 10%
Senior Subordinated Notes (the "Notes"). Two other complaints purport to be
derivative actions filed on behalf of Champion. Two of the putative class
action complaints were filed in the Superior Court of the State of California,
County of Los Angeles, one in the District Court of Harris County, Texas and
four in the United States District Court for the Southern District of Texas,
Houston Division. The only currently active class action lawsuit is in the U.S.
District Court for the Southern District of Texas, where plaintiffs filed a
Consolidated Class Action Compliant captioned In re Paracelsus Corp. Securities
Litigation, Master File No. H-96-3464, which consolidated and amended the
earlier federal class action complaints. The three state court class actions
have since been suspended in deference to the Federal class action. The two
derivative complaints are also pending in the U.S. District Court for the
Southern District of Texas under the captions Caven v.
Miller, No. H-96-4291, and Orovitz v. Miller, No. H-97-2752.

         The federal stockholder class action complaint asserts claims against
the Company under sections 11 and 12(a)(2) of the Securities Act of 1933, and
claims against certain existing and former officers and directors of the
Company under sections 11 and 15 of the Securities Act of 1933. The Company has
terminated an agreement with representatives of certain stockholder claimants
tolling the statute of limitations as to certain other unasserted claims. The
plaintiffs allege that during the class period the defendants disseminated
materially misleading statements and omitted disclosing material facts about
the Company and its business, specifically in the reporting and disclosure of
reserves, bad debt expenses, collection expenses and facility closure costs,
and that the price of the Company's common stock was artificially inflated. The
plaintiffs also allege that statements contained in the various registration
statements and prospectuses for securities offerings during the class period
were materially inaccurate and misleading. The plaintiffs seek damages in an
unspecified amount and equitable or injunctive relief, plus costs and
attorneys' fees. The derivative actions assert various state law claims against
the Company, certain of its existing and former officers and directors or their
affiliates, and other persons. Defendants moved to dismiss certain of the class
action and derivative claims. In ruling on defendants' motions to dismiss, the
federal court granted dismissal of the claims involving the sale of the Notes,
but permitted all other claims in the federal actions to proceed to discovery.

         In light of the Company's restatement of financial information
contained in the various registration statements and prospectuses, the Company
believes an unfavorable outcome is probable for at least some of the claims
asserted in the stockholder class action. Efforts to settle the stockholder
claims are ongoing. Absent such a settlement within the Company's financial
resources, the Company will continue to defend the litigation vigorously. Many
factors will ultimately affect and determine the results of the litigation, and
the Company can provide no assurance that the results will not have a material
adverse effect on the Company. During 1996, the Company recorded provisions to
estimate the cost of the ultimate disposition of all of these proceedings and
to estimate the legal fees that it expected to incur. However, there can be no
assurance that the ultimate liability related to the above legal proceedings
will not exceed the Company's estimates.

         OTHER LITIGATION - In October 1995, two former hospital employees of
the Company (the "relators") filed a civil complaint under seal on behalf of
the United States and the State of California against Paracelsus, certain of
its subsidiaries, and others in the United States District Court for the
Central District of California. The Company did not learn of the case until
late July 1997 after the Court permitted the United States to provide a copy of
the complaint to the defendants solely for purposes of settlement negotiations.
Shortly after the Company learned of the complaint, the Company received a
subpoena from the Office of the Inspector General of the Department of Health
and Human Services seeking documents relating to certain of the same matters.
See "Item 3 - Legal Proceedings" of this report for a description of such
litigation.


                                      32

<PAGE>   33

         Without relinquishing its rights to assert a vigorous defense, the
Company is engaged in discussions with counsel for the United States to
determine whether the parties can reach a mutually acceptable settlement. Those
discussions have been devoted to a substantially narrower set of issues than
those alleged in the complaint and have related exclusively to certain alleged
practices at three Los Angeles area hospitals that are currently closed and/or
held for sale. The relators have various rights in this type of case, including
a right to object to a settlement and continue litigating any issues not
resolved by it. The Court must determine the fairness and adequacy of any
settlement.

         The Company is not currently able to predict whether the above
litigation will settle or whether the outcome, by settlement or litigation,
will have a material adverse effect on the Company.

         On September 10,1997, twelve health care insurers and/or
administrators filed an action encaptioned Blue Cross and Blue Shield United of
Wisconsin et al. v. Paracelsus Healthcare Corporation, Case No. 97-6760 SVW
(RCx), in the United States District Court for the Central District of
California against the Company and two of its subsidiaries. Plaintiffs allege
that over many years Defendants fraudulently induced them to make payments
under their members' plans through a variety of allegedly improper practices,
principally in connection with certain psychiatric treatment and alcohol or
chemical dependency programs previously operated at the Company's psychiatric
hospitals in the Los Angeles area. The alleged improper practices include
systematic waiver of co-insurance obligations and misrepresentation of
patients' symptoms, conditions, diagnosis and/or treatment. Plaintiffs assert
claims under the Racketeer Influenced and Corrupt Organizations Act ("RICO")
and the Employee Retirement Income Security Act ("ERISA"), as well as for
fraud, negligent misrepresentation, unjust enrichment, and conversion.

         On February 13, 1998, the court granted, in major part, the Company's
motion to dismiss the Complaint. Of Plaintiffs' seven claims for relief, the
court dismissed six for inadequate pleading and, in one case, for failure to
state a claim. Only Plaintiffs' ERISA claim was allowed to stand. The court
also ruled that Plaintiffs had failed adequately to explain their failure to
discover the alleged misconduct within the applicable statutes of limitations,
thereby limiting their fraud claims to those arising after September 10, 1994,
and RICO claims to those arising after September 10, 1993. The court permitted
the Plaintiffs to replead their claims.

         On March 10, 1998, Plaintiffs filed their First Amended Complaint
restating each of their causes of action. In their First Amended Complaint,
Plaintiffs seek damages exceeding $30.5 million, treble damages under RICO,
restitution under ERISA, together with reasonable attorneys' fees and various
costs and expenses. The Company does not believe Plaintiffs have cured the
defects in their original Complaint and intends to file a motion to dismiss the
First Amended Complaint, including the ERISA claim, on grounds that Plaintiffs
have still not pleaded their claims with sufficient particularity and still not
adequately explained their failure to discover the alleged misconduct within
the applicable statutes of limitations. If the motion is unsuccessful, the
Company intends vigorously to defend the action.

         The Company is currently unable to predict the litigation's outcome or
whether any adverse outcome will have a materially adverse effect on the
Company.

         With respect to the Other Litigation discussed above, the Company has
recorded $5.7 million as an estimate of the ultimate resolution of such
litigation, including an estimate for legal fees. However, there can be no
assurance that the ultimate liability regarding these matters will not exceed
the Company's estimate. Such amount is reflected under the caption,
"Discontinued operations - Loss on disposal of discontinued psychiatric
hospitals, net" in the Company's Consolidated Statement of Operations.

         During 1997, the Company settled for $3.0 million a lawsuit brought by
a relator on behalf of the United States Government regarding allegations of
Medicare and Medicaid abuse. The suit pertained to billings from 1989 through
1993 submitted to the government for alcohol and drug abuse programs in




                                      33
<PAGE>   34

one of its hospitals. The Company did not admit liability and settled the suit
to avoid protracted litigation. There was no intentional misconduct and the
Company did not engage in Medicare and Medicaid fraud.

         During March 1996, the Company settled two lawsuits in connection with
the operations of its psychiatric programs. The Company recorded a charge for
settlement costs totaling $22.4 million. Such charge consisted primarily of
settlement payments, legal fees and the write off of certain psychiatric
accounts receivable. The Company did not admit liability in either case but
resolved its dispute through the settlements in order to facilitate the
Champion acquisition, re-establish a business relationship and/or avoid further
legal costs in connection with the disputes.

         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 are either adequately covered by insurance or will not have
a material adverse effect on the Company's financial condition, results of
operations or liquidity.

DISPOSITION OF THE PSYCHIATRIC HOSPITALS AND OTHER LA METRO HOSPITALS

         In September 1996, the Company adopted a plan to exit the psychiatric
hospital business through the disposition of all of its psychiatric hospitals.
It also adopted a plan to exit the LA metro market principally through the
disposition of the under performing hospitals in that area. The disposition of
these hospitals will enable the Company to remain focused on operating its
acute care hospitals and to exit a market heavily penetrated by managed care
organizations where it is not a preeminent provider of healthcare services.
During 1997, the Company sold two of its psychiatric hospitals and expects to
complete the disposition of the remaining hospitals by the end of 1998.
Management expects the LA metro hospitals, as a group, to generate positive
cash flows through their disposition date. During the fourth quarter of 1997,
management recorded additional disposal losses of $5.2 million (net of income
tax benefits of $3.7 million), of which $1.9 million represents a further write
down of assets to their estimated net realizable value based upon most recent
offers from third party purchasers and $3.3 million for charges relating to
certain outstanding litigation matters. Also in the fourth quarter of 1997, the
Company recorded an impairment charge of $4.6 million (net of income tax
benefits of $3.2 million) to further write down the assets of the
non-psychiatric, LA metro hospitals to their estimated net realizable value
based upon the latest available offers from third party purchasers.

DEBT REDUCTION AND DIVESTITURE OF NON-CORE ASSETS

         In addition to the Company's initiative to dispose of its remaining LA
metro and psychiatric hospitals, the Company intends to further deleverage the
Company through the disposition of certain non-core assets with the net
proceeds of such dispositions used to reduce the Company's indebtedness.
Realization of this objective will allow the Company to further concentrate its
efforts on core markets, as well as create additional debt capacity to expand
and further integrate its presence in existing markets and to pursue
acquisitions in markets compatible with the Company's overall acquisition
strategy. The Company is currently evaluating a number of inquiries on many of
its hospitals from qualified buyers. As part of its divestiture strategy, the
Company expects to reduce its senior indebtedness by a minimum of $85.0
million from the net proceeds of divestitures in 1998. However, there can be
no assurance that the Company will consummate any or all of these transactions,
or that the net proceeds of any transactions consummated will result in a
significant reduction of the Company's indebtedness.

         In light of the above initiative, the Company does not expect to make
significant acquisitions in 1998 other than the acquisition of its partner's
interest in DHHS.



                                      34

<PAGE>   35


OPERATIONS - SALT LAKE CITY, UTAH

         With respect to the Utah hospitals, the Company recorded earnings
before interest, income taxes, depreciation and amortization ("EBITDA") of $31.6
million, or 30.7% of the Company's consolidated hospitals' EBITDA, for the year
ended December 31, 1997 after excluding operating losses of closed or divested
hospitals. Excluded costs with respect to PHC Regional Hospital include $9.5
million associated with a loss contract and closure costs of $3.5 million in
connection with the closing of that hospital in May 1997. Operating losses
relating to the loss contract, in addition to interest expense of $2.7 million
attributable to borrowings to finance the acquisition of PHC Regional Hospital,
were charged to the loss contract accrual previously established in 1996.

         In August 1997, the Company executed an Amended and Restated Provider
Agreement with PacifiCare of Utah (formerly FHP International Corp.)
retroactive to July 1, 1997 (the "Agreement") to (i) receive payment for
services provided to FHP enrollees on a per diem basis instead of a capitation
basis, (ii) revise the contract term from 15 years to 5 years ending in June
2002, (iii) no longer provide exclusive service to FHP enrollees and (iv) agree
on a mechanism to resolve disagreements regarding the administration of the
capitation agreement prior to July 1, 1997. Management believes the revised
agreement will eliminate further losses under the loss contract while
maintaining an ongoing relationship with PacifiCare at the Company's Utah
facilities. During the fourth quarter of 1997, management obtained additional
information concerning the loss contract and revised downward its estimate of
the ultimate loss under such contract by $15.5 million. Such amount was
recorded in unusual items in the Company's Consolidated Statement of
Operations. The loss contract is subject to final agreement of the parties and
the ultimate resolution of such contract may result in significant revisions to
the Company's estimated loss under the contract.

           The Company plans to begin construction on PHC Regional Hospital in
the second quarter of 1998 whereby PHC Regional Hospital will be expanded to
accommodate the transfer of certain acute care services presently performed at
SLRMC. The Company will then expand the long term care operations of SLRMC and
potentially joint venture long term care services with other providers in the
area. The expansion project is expected to be completed in phases and will take
approximately 18 months to complete. The total capital costs associated with
the project are estimated to be approximately $11.0 million.

VALUATION ALLOWANCE ON DEFERRED TAX ASSETS

         For financial accounting purposes, a valuation allowance of $53.3
million had been recognized at December 31, 1996 to offset the deferred tax
assets related to the Company's net operating losses, bad debt allowances and
other accrued expenses that resulted from the significant write-downs of assets
during the year, approximately $3.0 million of which resulted from the Merger
with the remaining valuation allowance recognized as a reduction in income tax
benefits in 1996. During 1997, no change in the valuation allowance was
recorded. In assessing the need for and amount of the valuation allowance, the
Company has relied principally upon future income generated by tax planning
strategies, including the planned divestiture of certain non-core assets. In
the event the Company believes these transactions will be consummated, a
substantial portion of the Company's deferred tax assets will be realized. The
Company is also relying, in part, on future taxable income to determine the
valuation allowance required; however, by its very nature, future taxable
income requires estimates and judgments about future events and is considered
difficult to measure objectively. Accordingly, the Company has only considered
one year of future earnings in assessing the need for and amount of a valuation
allowance.

         If the Company determines in the future that such tax planning
strategies will not be completed or if future income does not prove to be
sufficient to realize the benefit previously recorded, an adjustment to the
valuation allowance would be charged to income in the period such determination
was made.



                                      35
<PAGE>   36

         The Company has significant net operating losses to offset future
taxable income. However, U.S. Federal income tax law limits a corporation's
ability to utilize net operating losses if it experiences an ownership change
of greater than 50% over a three-year period. In the event of such a future
ownership change, the Company's net operating loss carryforward would be
subject to an annual limitation. This may require an adjustment to the
valuation allowance that would be charged to income in the period such an
ownership change occurred.

REGULATORY MATTERS

         Healthcare reform legislation has been proposed at both Federal and
state levels. In August 1997, the President signed into law the 1997 Budget
Act, which projects to produce a net savings of $115 billion for Medicare and
$13 billion for Medicaid over five years. The changes in Medicare reimbursement
mandated by the 1997 Budget Act include, among others, (i) no increases in the
rates paid to acute care hospitals for inpatient care through September 30,
1998, (ii) a reduction in capital reimbursement rate, (iii) a conversion of
payments for certain Medicare outpatient services from a cost-based approach,
subject to certain limits, to a prospective payment system and (iv) phase-in
reduction in reimbursement for disproportionate share and bad debt. While such
changes in the Medicare program will generally result in lower payments to the
Company, management expects to offset any material adverse financial impact of
such changes through further cost reduction efforts and other means. However,
management cannot predict the impact future reforms may have on its business,
nor can there be any assurance that the Company will be able to mitigate the
impact of any future reforms through additional cost reductions. Accordingly,
such reforms may have a material adverse effect on the Company's results of
operations, financial position or liquidity.

IMPACT OF INFLATION

         The healthcare industry is labor intensive. Wages and other expenses
increase during periods of inflation and when shortages of qualified personnel
in the marketplace occur. The Company has, to date, offset increases in other
operating costs by increasing charges, expanding services and implementing cost
control measures to curb increases in operating costs. The Company's ability to
increase prices is limited by various Federal and state laws that establish
payment limitations for hospital services rendered to Medicare and Medicaid
patients and by other factors. The Company's ability to increase prices may
also be affected by its need to remain competitive. There can be no assurance
that the Company will be able to continue to offset such future cost increases.

RECENT PRONOUNCEMENT

         In June 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income", which is effective for financial statements for periods
beginning after December 15, 1997 and which will apply to the Company beginning
with its fiscal year ending December 31, 1998.

         SFAS No.130 establishes standards for reporting and display of
comprehensive income and its components in a full set of general purpose
financial statements. Comprehensive income includes net income and is defined
as the change in net assets of a business enterprise during a period from
transactions and other events and circumstances from nonowner sources. It
includes all changes in equity during a period except those from investments by
owners and distributions to owners. Examples of comprehensive income, other
than net income, include unrealized gains and losses on certain investments in
debt and equity securities and foreign currency items.



                                      36
<PAGE>   37




  ITEM 8.     FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA


<TABLE>
<CAPTION>

                                            INDEX TO FINANCIAL STATEMENTS


                                                                                                         PAGE
                                                                                                         ----
<S>                                                                                                       <C>
    Paracelsus Healthcare Corporation Consolidated Financial Statements:
         Report of Independent Auditors.................................................................   38
         Consolidated Balance Sheets - December 31, 1997 and 1996.......................................   39
         Consolidated Statements of Operations - for the years ended December 31, 1997, 1996
            and 1995....................................................................................   41
         Consolidated Statements of Stockholders' Equity - for the years ended December 31,
            1997, 1996 and 1995.........................................................................   42
         Consolidated Statements of Cash Flows - for the  years ended December 31, 1997,
            1996 and 1995...............................................................................   43
         Notes to Consolidated Financial Statements.....................................................   45

    Dakota Heartland Health System Consolidated Financial Statements:
         Report of Independent Auditors.................................................................   70
         Consolidated Balance Sheets - December 31, 1997 and 1996.......................................   71
         Consolidated Statements of Income - for the years ended December 31, 1997 and 1996.............   72
         Consolidated Statements of Partners' Equity - for the years ended December 31, 1997
            and 1996....................................................................................   73
         Consolidated Statements of Cash Flows - for the years ended December 31, 1997 and 1996 .......    74
         Notes to Consolidated Financial Statements.....................................................   75


</TABLE>


                                      37

<PAGE>   38



                         REPORT OF INDEPENDENT AUDITORS



Board of Directors and Stockholders
Paracelsus Healthcare Corporation

We have audited the accompanying consolidated balance sheets of Paracelsus
Healthcare Corporation 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 in the index at Item 14(a)(2).
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 financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Paracelsus
Healthcare Corporation at December 31, 1997 and 1996, and the consolidated
results of its operations and its 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.

Effective September 30, 1996, the Company adopted Statement of Accounting
Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of."



  /s/   ERNST & YOUNG LLP


  ERNST & YOUNG LLP

  Houston, Texas
  March 31, 1998




                                      38
<PAGE>   39
                       PARACELSUS HEALTHCARE CORPORATION
                          CONSOLIDATED BALANCE SHEETS
                                  ($ in 000's)

<TABLE>
<CAPTION>


                                                                    DECEMBER 31,
                                                              ------------------------
                                                                 1997           1996
                                                              ---------      ---------
<S>                                                           <C>            <C>
ASSETS
Current assets:
     Cash and cash equivalents ..........................     $  28,173      $  17,771
     Restricted cash ....................................         6,457          2,358
     Marketable securities (Note 3) .....................         2,157         22,243
     Accounts receivable, net of allowance for doubtful
        accounts 1997- $54,442; 1996- $36,469 ...........        70,675         64,687
     Supplies ...........................................        13,700         14,406
     Deferred income taxes (Note 8) .....................        25,818         28,739
     Refundable income taxes ............................         7,698         31,003
     Prepaid expenses and other current assets ..........        19,329         16,423
                                                              ---------      ---------
        Total current assets ............................       174,007        197,630

Property and equipment (Notes 5, 9 and 10):
     Land and improvements ..............................        27,022         26,372
     Buildings and improvements .........................       261,740        252,298
     Equipment ..........................................       141,030        131,278
     Construction in progress ...........................         9,000         10,749
                                                              ---------      ---------
                                                                438,792        420,697
Less: Accumulated depreciation and amortization .........      (130,728)      (109,862)
                                                              ---------      ---------
                                                                308,064        310,835

Long-term assets of discontinued operations, net (Note 6)         3,842         18,499
Assets held for sale, net (Note 7) ......................        15,182         22,095
Investment in Dakota Heartland Health System (Note 4) ...        48,499         48,463
Deferred income taxes (Note 8) ..........................        25,027         14,414
Goodwill, net of accumulated amortization 1997 - $5,395;
   1996 - $1,631 (Note 5) ...............................       114,404        118,168
Other assets ............................................        45,799         42,728
                                                              ---------      ---------

Total Assets ............................................     $ 734,824      $ 772,832
                                                              =========      =========

</TABLE>


                                      39
<PAGE>   40



                       PARACELSUS HEALTHCARE CORPORATION
                          CONSOLIDATED BALANCE SHEETS
                                  ($ in 000's)

<TABLE>
<CAPTION>


                                                                             DECEMBER 31,
                                                                      ------------------------
                                                                        1997           1996
                                                                      ---------      ---------
<S>                                                                   <C>            <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
     Accounts payable ...........................................     $  46,722      $  40,408
     Due to government third parties ............................         8,409         16,292
     Accrued liabilities:
           Accrued salaries and benefits ........................        22,424         36,560
           Accrued interest .....................................        13,559         13,177
           Other ................................................        39,306         52,752
     Current maturities of long-term debt .......................         6,209          4,679
                                                                      ---------      ---------
           Total current liabilities ............................       136,629        163,868

Long-term debt (Note 9) .........................................       491,914        491,057
Other long-term liabilities (Notes 2, 14 and 15) ................        64,278         69,420

Commitments and contingencies (Notes 2, 9, 10 and 15)

Stockholders' equity (Note 13):
     Preferred Stock, $.01 par value per share, 25,000,000 shares
        authorized, none outstanding ............................            --             --
     Common Stock, no stated value, 150,000,000 shares
         authorized, 55,094,000 shares outstanding in 1997 and
         54,814,000 in 1996 .....................................       224,475        224,472
     Additional paid-in capital .................................           390            390
     Unrealized gains on marketable securities, net (Note 3) ....            12            100
     Accumulated deficit ........................................      (182,874)      (176,475)
                                                                      ---------      ---------
        Total stockholders' equity ..............................        42,003         48,487
                                                                      ---------      ---------

Total Liabilities and Stockholders' Equity ......................     $ 734,824      $ 772,832
                                                                      =========      =========


</TABLE>


                            See accompanying notes.



                                       40
<PAGE>   41



                       PARACELSUS HEALTHCARE CORPORATION
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                      ($ in 000's, except per share data)

<TABLE>
<CAPTION>


                                                                     YEAR ENDED DECEMBER 31,
                                                             ---------------------------------------
                                                                1997           1996           1995
                                                             ---------      ---------      ---------

<S>                                                          <C>            <C>            <C>
Net revenue ............................................     $ 659,219      $ 493,106      $ 434,179
Costs and expenses:
  Salaries and benefits ................................       271,300        238,074        198,914
  Other operating expenses .............................       269,653        220,387        176,572
  Provision for bad debts ..............................        46,606         38,321         23,533
  Interest .............................................        47,372         31,034         15,847
  Depreciation and amortization ........................        30,179         23,727         15,872
  Equity in earnings of Dakota Heartland Health
     System (Note 4) ...................................        (9,794)        (3,207)            --
  Impairment charges (Note 2) ..........................         7,782         72,322             --
  Merger costs (Note 5) ................................            --         40,804             --
  Unusual items (Note 2) ...............................        (6,531)        60,521             --
                                                             ---------      ---------      ---------

Total costs and expenses ...............................       656,567        721,983        430,738
Gain on sale of facilities .............................            --             --          9,026
Income (loss) from continuing operations before minority
   interests, income taxes and extraordinary loss ......         2,652       (228,877)        12,467
Minority interests .....................................        (1,996)        (1,806)        (1,803)
                                                             ---------      ---------      ---------
Income (loss) from continuing operations before income
   taxes and extraordinary loss ........................           656       (230,683)        10,664
Provision (benefit) for income taxes ...................         1,812        (76,186)         4,375
                                                             ---------      ---------      ---------
Income (loss) from continuing operations before
   extraordinary loss ..................................        (1,156)      (154,497)         6,289
Discontinued operations (Note 6):
     Loss from operations of discontinued psychiatric
        hospitals, net .................................            --        (33,545)        (2,852)
     Loss on disposal of discontinued psychiatric
        hospitals, net .................................        (5,243)       (37,450)            --
                                                             ---------      ---------      ---------
Income (loss) before extraordinary loss ................        (6,399)      (225,492)         3,437
Extraordinary loss from early extinguishment of
   debt, net (Note 9) ..................................            --         (7,724)            --
                                                             ---------      ---------      ---------

Net income (loss) ......................................     $  (6,399)     $(233,216)     $   3,437
                                                             =========      =========      =========

Net income (loss) per share - Basic and assuming
   dilution:
       Continuing operations ...........................     $   (0.02)     $   (3.94)     $    0.21
       Discontinued operations .........................         (0.10)         (1.81)         (0.09)
       Extraordinary loss ..............................            --          (0.20)            --
                                                             ---------      ---------      ---------

Net income (loss) per share ............................     $   (0.12)     $   (5.95)     $    0.12
                                                             =========      =========      =========


</TABLE>

                            See accompanying notes.


                                       41
<PAGE>   42



                       PARACELSUS HEALTHCARE CORPORATION
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                  YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
                            ($ and shares in 000's)

<TABLE>
<CAPTION>



                                                                         UNREALIZED
                                                                         GAIN (LOSS)   RETAINED
                                             COMMON STOCK     ADDITIONAL     ON        EARNINGS
                                       ---------------------   PAID-IN    MARKETABLE (ACCUMULATED
                                       SHARES      AMOUNT      CAPITAL    SECURITIES    DEFICIT)       TOTAL
                                      ---------   ---------   ---------   ---------- ------------    ---------

<S>                                   <C>         <C>         <C>         <C>          <C>          <C>
Balance at December 31, 1994 ......           1   $   4,500   $     390   $    (134)   $  83,581    $  88,337

Cash dividends to stockholder .....          --          --          --          --       (5,399)      (5,399)
Change in unrealized gains on
   marketable securities, net of
   taxes ..........................          --          --          --         346           --          346
Net income ........................          --          --          --          --        3,437        3,437
                                      ---------   ---------   ---------   ---------    ---------    ---------

Balance at December 31, 1995 ......           1       4,500         390         212       81,619       86,721

66,159.426-for-one stock split ....      29,771          --          --          --           --           --
Acquisition of Champion ...........      19,762     158,449          --          --           --      158,449
Sale of common stock ..............       5,200      39,841          --          --           --       39,841
Grant of value options (Note 13) ..          --      21,642          --          --           --       21,642
Exercise of stock subscription
   rights .........................          80          40          --          --           --           40
Cash dividends to stockholder .....          --          --          --          --      (24,878)     (24,878)
Change in unrealized gains on
   marketable securities, net of
   taxes ..........................          --          --          --        (112)          --         (112)
Net loss ..........................          --          --          --          --     (233,216)    (233,216)
                                      ---------   ---------   ---------   ---------    ---------    ---------

Balance at December 31, 1996 ......      54,814     224,472         390         100     (176,475)      48,487

Exercise of stock options .........         280           3          --          --           --            3

Change in unrealized gains on
   marketable securities, net of
   taxes ..........................          --          --          --         (88)          --          (88)

Net loss ..........................          --          --          --          --       (6,399)      (6,399)
                                      ---------   ---------   ---------   ---------    ---------    ---------

Balance at December 31, 1997 ......      55,094   $ 224,475   $     390   $      12    $(182,874)   $  42,003
                                      =========   =========   =========   =========    =========    =========

</TABLE>


                            See accompanying notes.



                                       42
<PAGE>   43



                       PARACELSUS HEALTHCARE CORPORATION
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  ($ in 000's)

<TABLE>
<CAPTION>


                                                                            YEAR ENDED DECEMBER 31,
                                                                     -----------------------------------
                                                                        1997         1996         1995
                                                                     ---------    ---------    ---------
<S>                                                                  <C>          <C>          <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) ................................................   $  (6,399)   $(233,216)   $   3,437
Adjustments to reconcile net income (loss) to net cash provided by
   (used in) operating activities:
  Depreciation and amortization ..................................      30,179       23,727       15,872
  Impairment charges .............................................       7,782       72,322           --
  Unusual items ..................................................      (6,531)      60,521           --
  Disposal loss on discontinued operations .......................       8,887       37,450           --
  Non-cash merger expenses .......................................          --       16,565           --
  Gain on sale of facilities .....................................          --           --       (9,026)
  Deferred income taxes ..........................................      (7,660)     (50,955)     (12,801)
  Extraordinary loss .............................................          --        7,724           --
  Minority interests .............................................       1,996        1,806        1,803
  Equity in  Dakota Heartland Health System, net of distributions          (36)       5,063           --
  Changes in operating assets and liabilities, net of effects of
      acquisitions:
       Accounts receivable .......................................      (5,988)       5,464        2,270
       Federal income tax refunds, net ...........................      24,077           --           --
       Supplies, prepaid expenses and other current assets .......     (10,203)     (15,246)       2,251
       Accounts payable and other accrued liabilities ............     (32,109)      46,638        9,607
                                                                     ---------    ---------    ---------
Net cash provided by (used in) operating activities ..............       3,995      (22,137)      13,413
                                                                     ---------    ---------    ---------

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of available-for-sale securities ........................          --       (4,332)      (4,608)
Sale of marketable securities ....................................      19,967        4,513           --
Maturities of held-to-maturity securities ........................          --          150          213
Acquisitions of facilities, net of cash acquired .................          --     (117,835)      (3,010)
Proceeds from disposal of facilities .............................      12,201           --       18,564
Additions to property and equipment, net .........................     (16,524)     (14,513)     (19,396)
Increase (decrease) in minority interests ........................         291       (2,389)      (1,832)
Increase in other assets .........................................      (5,945)      (6,467)      (3,741)
                                                                     ---------    ---------    ---------
Net cash provided by (used in) investing activities ..............       9,990     (140,873)     (13,810)
                                                                     ---------    ---------    ---------

CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under Revolving Credit Facility .......................      38,000      446,500       58,500
Repayments under Revolving Credit Facility .......................     (34,593)    (342,000)     (49,000)
Proceeds from long-term borrowings ...............................          --      336,038          503
Repayments of debt ...............................................      (5,388)    (266,598)      (1,793)
Deferred financing costs .........................................      (1,602)     (12,540)          --
Sale of common stock, net ........................................          --       39,841           --
Dividends to shareholder .........................................          --      (24,878)      (5,399)
                                                                     ---------    ---------    ---------
Net cash provided by (used in) financing activities ..............      (3,583)     176,363        2,811
                                                                     ---------    ---------    ---------

Increase in cash and cash equivalents ............................      10,402       13,353        2,414
Cash and cash equivalents at beginning of year ...................      17,771        4,418        2,004
                                                                     ---------    ---------    ---------
Cash and cash equivalents at end of year .........................   $  28,173    $  17,771    $   4,418
                                                                     =========    =========    =========


</TABLE>

                            See accompanying notes.

                                       43
<PAGE>   44



                       PARACELSUS HEALTHCARE CORPORATION
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  ($ in 000's)

Supplemental schedule of noncash investing and financing activities:

<TABLE>
<CAPTION>


                                                               YEAR ENDED DECEMBER 31,
                                                           -----------------------------------
                                                              1997         1996         1995
                                                           ---------    ---------    ---------
<S>                                                        <C>          <C>          <C>
Details of unrealized gains or (losses) on marketable
securities:
    Marketable securities ..............................   $    (133)   $    (170)   $     524
    Deferred taxes .....................................          45           58         (178)
                                                           ---------    ---------    ---------
    Increase (decrease) in stockholders' equity ........   $     (88)   $    (112)   $     346
                                                           =========    =========    =========


    Leases capitalized .................................   $     915    $     230    $     117
                                                           =========    =========    =========

Details of businesses acquired in purchase transactions:
    Fair value of assets acquired ......................   $      --    $ 502,426    $   3,010
    Liabilities assumed ................................          --     (220,624)          --
    Stock and stock options issued .....................          --     (163,967)          --
                                                           ---------    ---------    ---------
Cash paid for acquisitions .............................   $      --    $ 117,835    $   3,010
                                                           =========    =========    =========


                            See accompanying notes.

</TABLE>



                                       44
<PAGE>   45



                       PARACELSUS HEALTHCARE CORPORATION
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                               DECEMBER 31, 1997

NOTE 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

         ORGANIZATION - Paracelsus Healthcare Corporation (the "Company") was
incorporated in November 1980 for the principal purpose of owning and operating
acute care and related healthcare businesses in selected markets. Prior to
August 16, 1996, the Company was wholly owned by Park Hospital GmbH (the
"Former Sole Shareholder"), a German Corporation wholly owned by Dr. Manfred G.
Krukemeyer, the Company's former Chairman of the Board of Directors. On August
16, 1996, the Company acquired Champion Healthcare Corporation ("Champion")
(the "Merger") and completed an initial public equity offering. The results of
Champion have been included in the operations of the Company since August 16,
1996. As of December 31, 1997, the Company operated 26 hospitals with 2,666
licensed beds in nine states (including two psychiatric hospitals with 114
licensed beds (See Note 6)). The Company also operates four skilled nursing
facilities with 232 licensed beds.

         BASIS OF PRESENTATION - Certain reclassifications to the prior years'
financial statements have been made to conform to the 1997 presentation.

         PRINCIPLES OF CONSOLIDATION - The consolidated financial statements
include the accounts of the Company and its wholly-owned or majority owned
subsidiaries and partnerships. All significant intercompany accounts and
transactions have been eliminated in consolidation. Investment in affiliates,
of which the Company owns more than 20% but not in excess of 50%, are recorded
on the equity method. Minority interests represent income allocated to the
minority partners' investment.

         USE OF ESTIMATES - The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.

         CASH EQUIVALENTS - The Company considers highly liquid investments
with original maturities of three months or less to be cash equivalents.

         RESTRICTED CASH - The Company has restricted cash of $6.5 million at
December 31, 1997 for payments of fees and interest related to the commercial
paper financing program (See Note 11) and for other financial commitments.

         MARKETABLE SECURITIES - Marketable securities, consisting of corporate
bonds, mortgage-backed bonds, government securities and equity securities, are
stated at amortized cost if classified as held-to-maturity and at fair value if
classified as available-for-sale. Unrealized gains and losses, net of tax, of
available-for-sale securities are included as a component of stockholders'
equity until realized. Available-for-sale securities that are available for use
in current operations are classified as current assets regardless of the
securities' contractual maturity dates. As of December 31, 1997, the Company
classified all marketable securities as available-for-sale (See Note 3).

         SUPPLIES - Supplies, principally medical supplies, are stated at the
lower of cost (first-in, first-out basis) or market.

         PROPERTY AND EQUIPMENT - Property and equipment are recorded at cost.
Depreciation is computed using the straight-line method over the estimated
useful lives of the land improvements (5-25 years), buildings and improvements
(5-40 years) and equipment (3-20 years). Leaseholds are amortized on a
straight-line basis over the lesser of the terms of the respective leases or
their estimated useful lives.




                                      45
<PAGE>   46

Expenditures for renovations and other significant improvements are
capitalized; however, maintenance and repairs which do not improve or extend
the useful lives of the respective assets are charged to operations as
incurred. Depreciation expense was $22.1 million, $19.0 million and $13.9
million for the years ended December 31, 1997, 1996 and 1995, respectively.

         GOODWILL AND OTHER ASSETS - Goodwill, representing costs in excess of
net assets acquired, is amortized on a straight line basis over a period of 20
to 35 years. The Company regularly reviews the carrying value of goodwill in
relation to the operating performance and future undiscounted cash flows of the
underlying hospitals. The Company records to expense, on a current basis, any
diminution in values based on the difference between the sum of the future
discounted cash flows and net book value. Debt issuance costs are amortized on
a straight-line basis (which approximates the interest method) over the term of
the related debt. Amortization expense was $8.1 million, $4.7 million and $2.0
million for the years ended December 31, 1997, 1996 and 1995, respectively.

         NET REVENUE - Net revenue includes amounts estimated by management to
be reimbursable by Medicare under the Prospective Payment System and by
Medicare and Medicaid programs under the provisions of cost-reimbursement and
other payment formulas. Payments for services rendered to patients covered by
such programs are generally less than billed charges. Deductions from revenue
are made to reduce the charges to these patients to estimated receipts based on
each program's principle of payment/reimbursement. Final settlements under
these programs are subject to administrative review and audit by third parties.
For the acute care hospitals, approximately 56.9%, 58.4% and 61.3% of gross
patient revenue for the years ended December 31, 1997, 1996 and 1995,
respectively, related to services rendered to patients covered by Medicare and
Medicaid programs. Approximately 82.5%, 36.7% and 22.3% of gross patient
revenue of the psychiatric hospitals were derived from such programs for the
same respective periods.


         Laws and regulations governing the Medicare and Medicaid programs are
complex and subject to interpretation. The Company believes that it is in
compliance with all applicable laws and regulations and is not aware of any
pending or threatened investigations involving allegations of potential
wrongdoing other than those discussed in Note 15. Compliance with such laws and
regulations can be subject to future government review and interpretation as
well as significant regulatory action including fines, penalties, and exclusion
from the Medicare and Medicaid programs.

         In the ordinary course of business, the Company renders services free
of charge to patients who are financially unable to pay for hospital care. The
value of these services rendered is not material to the Company's consolidated
results of operations.

         INCOME TAXES - The Company records its income taxes under the
liability method. Under this method, deferred income tax assets and liabilities
are recognized for the tax consequences of temporary differences by applying
enacted statutory tax rates applicable to future years to differences between
the financial statement carrying amounts and the tax bases of existing assets
and liabilities.




                                      46
<PAGE>   47




         NET INCOME (LOSS) PER SHARE - The following table sets forth the
computation of basic and diluted income (loss) per share from continuing
operations as required by Statement of Financial Accounting Standards (" SFAS")
No. 128, Earnings per Share, which the Company adopted during the fourth
quarter of 1997 (in thousands). Per share amounts for 1996 and 1995 have been
restated in accordance with SFAS No. 128:


<TABLE>
<CAPTION>

                                                          1997             1996             1995
                                                       ---------        ---------        ---------
<S>                                                    <C>              <C>              <C>
Numerator:
  Income (loss) from continuing operations
   before extraordinary loss                           $  (1,156)       $(154,497)       $   6,289
                                                       ---------        ---------        ---------
   Numerator for diluted income (loss) per
     share from continuing operations to  common
     stockholders after assumed conversions               (1,156)        (154,497)           6,289
                                                       =========        =========        =========

Denominator:
  Denominator for basic income (loss) per
    share from continuing operations - weighted-
    average shares                                        54,946           39,213           29,772

Effect of dilutive securities:
  Employee stock options                                      --               --               --
  Warrants                                                    --               --               --
                                                       ---------        ---------        ---------
 Dilutive potential common shares                             --               --               --
                                                       ---------        ---------        ---------
 Denominator for diluted income (loss) per
     share - adjusted weighted-average shares
     and assumed conversion                               54,946           39,213           29,772
                                                       =========        =========        =========

 Basic income (loss) per share from continuing
   operations                                          $   (0.02)       $   (3.94)       $    0.21
                                                       =========        =========        =========
 Diluted income (loss) per share from
   continuing operations                               $   (0.02)       $   (3.94)       $    0.21
                                                       =========        =========        =========


</TABLE>

         Weighted average number of common shares outstanding for all periods
presented have been adjusted to reflect the 66,159.426-for-one stock split in
conjunction with the Merger.

         EMPLOYEE STOCK OPTIONS - The Company has elected to continue following
the existing accounting rules under Accounting Principles Board Opinion ("APB")
No. 25, "Accounting for Stock Issued to Employees" in accounting for its
employee stock options. See Note 13 for certain pro forma disclosures required
under SFAS No. 123, "Accounting for Stock Issued to Employees."

NOTE 2. IMPAIRMENT CHARGES AND UNUSUAL ITEMS

         IMPAIRMENT CHARGES - During the fourth quarter of 1997, the Company
recorded an impairment charge of $7.8 million ($4.6 million after-tax) on
certain of the Los Angeles metropolitan ("LA metro") hospitals held for sale
(See Note 7) to reduce the book value of those assets to their estimated net
realizable value based upon the latest available offers received from third
party purchasers. During 1996, in conjunction with the Company's adoption of
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and
Long-Lived Assets to Be Disposed of," the Company recorded impairment charges
of $72.3 million ($48.5 million after-tax) for the write down of the long-lived
assets of the following acute care hospitals: (i) $52.5 million ($35.2 million
after-tax) for PHC Regional Hospital and Medical Center in Salt Lake City, Utah
("PHC Regional Hospital") (See Note 5), (ii) $11.9 million ($8.0 million
after-tax) for four of the acute care LA metro hospitals held for sale and a
related clinic (See Note 7) and (iii) $7.9 million ($5.3 million after-tax) for
two other facilities and other estimated disposition costs, based on
independent third party appraisals. See Note 6 for information relating to the
write down to estimated net realizable value of the psychiatric hospitals.



                                      47
<PAGE>   48


         UNUSUAL ITEMS - During 1997, the Company recorded unusual items
totaling $6.5 million ($3.9 million after-tax), consisting of (i) a reduction
of $15.5 million ($9.2 million after-tax) in the loss contract accrued at PHC
Regional Hospital based upon the most recent available operating information
associated with the contract, offset by charges of (ii) $3.5 million ($2.0
million after-tax) relating to the closure of PHC Regional Hospital in June
1997, (iii) $3.0 million ($1.8 million after-tax) for settlement costs
associated with a lawsuit and (iv) $2.5 million ($1.5 million after-tax) for a
corporate reorganization completed in May 1997. Such charges consisted
primarily of employee severance and related costs, and to a lesser extent,
certain other contract termination costs. The $15.5 million reduction in the
loss contract and $3.0 million charge for settlement costs were recorded in the
fourth quarter of 1997. The ultimate resolution of the loss contract is subject
to final agreement of the parties which could result in significant revisions
to the Company's estimated loss under the contract.

         During 1996, the Company recorded unusual charges of $60.5 million
($40.5 million after-tax), consisting of $38.1 million ($25.5 million
after-tax) for a loss contract at PHC Regional Hospital and $22.4 million
($15.0 million after-tax) for expenses related to the Special Committee's
investigation and other litigation matters. The loss contract charge was based
on a study conducted by the Company with the assistance of independent third
party consultants, which projected future healthcare and maintenance costs
under the then capitated contract to exceed future premiums. The Special
Committee was appointed by the Board of Directors to supervise and direct the
conduct of an inquiry by outside legal counsel regarding, among other things,
the Company's accounting and financial reporting practices and procedures for
the periods prior to the quarter ended September 30, 1996.

NOTE 3. MARKETABLE SECURITIES

         At December 31, 1997, the Company classified all marketable securities
held by its wholly owned insurance subsidiary, Hospital Assurance Company Ltd.
("HAC"), as available-for-sale. In January 1997, the Company ceased all
underwriting activity of HAC and placed it into runoff (See Note 17). HAC paid
a dividend to the Company thereupon leaving a minimum capital surplus to runoff
workers' compensation liabilities relating to California and Texas exposures
for fiscal years 1993, 1994, and 1995. The Company then received all assets and
assumed all other liabilities of HAC. During 1997, the Company liquidated a
major portion of HAC's investment in marketable securities since such holdings
were no longer required for statutory purposes. The Company received proceeds
from maturities or sales of fixed maturity securities totaling $20.0 million,
$4.7 million and $213,000 during 1997, 1996 and 1995, respectively. The Company
recognized gains in connection with such dispositions of $61,000 and $84,000 in
1997 and 1996, respectively. No such gains were realized in 1995.

         In December 1996, pursuant to its plan to cease all underwriting
activity of HAC, the Company transferred all of its held-to-maturity debt
securities to the available-for-sale category. The amortized cost of those
securities at the time of transfer was $9.0 million and the gross unrealized
loss on those securities was $147,000.



                                      48

<PAGE>   49



         The following table summarizes marketable securities at December 31,
1997 and 1996 ($ in 000's):

<TABLE>
<CAPTION>

                                                                        DECEMBER 31, 1997
                                                  -------------------------------------------------------------
                                                                    GROSS             GROSS           ESTIMATED
                                                  AMORTIZED       UNREALIZED        UNREALIZED          FAIR
                                                     COST           GAINS             LOSSES            VALUE
                                                  ---------       ----------        ----------        ---------
<S>                                               <C>             <C>               <C>               <C>
Available-for-sale securities:
  Corporate bonds ...........................     $     559       $       14        $       --        $     573
  U.S. Government notes .....................           100                3                --              103
  Mortgage-backed bonds .....................           870               --               (15)             855
  Obligations of states and municipalities ..           608               18                --              626
                                                  ---------       ----------        ----------        ---------
                                                  $   2,137       $       35        $      (15)       $   2,157
                                                  =========       ==========        ==========        =========

</TABLE>


<TABLE>
<CAPTION>

                                                                         DECEMBER 31, 1996
                                                  --------------------------------------------------------------
                                                                  GROSS              GROSS            ESTIMATED
                                                 AMORTIZED      UNREALIZED         UNREALIZED           FAIR
                                                   COST           GAINS             LOSSES              VALUE
                                                 ---------       ----------        ----------        ---------
<S>                                              <C>             <C>               <C>               <C>
Available-for-sale securities:
  Corporate bonds .........................      $   1,664       $      136        $       --        $   1,800
  U.S. Government notes ...................          1,099               42                --            1,141
  Mortgage-backed bonds ...................         12,117              127              (349)          11,895
  Obligations of states and municipalities           6,700              109                (2)           6,807
  Equity securities .......................            510               90                --              600
                                                 ---------       ----------        ----------        ---------
                                                 $  22,090       $      504        $     (351)       $  22,243
                                                 =========       ==========        ==========        =========

</TABLE>

         The stated maturity distribution of the Company's marketable
securities at December 31, 1997, is as follows:

<TABLE>
<CAPTION>


                                                          AMORTIZED       ESTIMATED
                                                            COST         FAIR VALUE
                                                         ---------       ----------
Fixed maturities due:
<S>                                                      <C>             <C>
   After one through five years ..................       $     659       $      675
   After five through ten years ..................             608              627
   After ten years ...............................             870              855
                                                         ---------       ----------
                                                         $   2,137       $    2,157
                                                         =========       ==========

</TABLE>


         The fair value of the marketable securities was based on quoted market
prices. Maturity dates were based on stated maturities of the securities.

NOTE 4. PARTNERSHIP WITH DAKOTA HEARTLAND HEALTH SYSTEM ("DHHS")

         The Company, through a wholly owned subsidiary, owns 50% of a
partnership operated as DHHS. At December 31, 1997, DHHS owned and operated two
general acute care hospitals with a total of 361 beds in Fargo, North Dakota.
Effective January 1, 1998, DHHS did not renew the bed license at one of these
facilities, thereby reducing the licensed beds to 215. The Company has a
contract with DHHS to manage the combined operations of both hospitals. It
accounts for its investment in DHHS under the equity method.

         Pursuant to the terms of the partnership, the Company is required if
necessary to advance funds to DHHS to cover any operating deficits. To date, no
such advances have been required. The Company is entitled to receive 55% of
DHHS' net income and distributable cash flow ("DCF"), as defined in the
partnership agreement, until such time as it has recovered on a cumulative
basis an additional $10.0



                                      49
<PAGE>   50


million of DCF in the form of an excess distribution. The Company has received
total cash distributions of $14.8 million since August 16, 1996.

         On August 20, 1997, Dakota Medical Foundation (the "Foundation"), the
Company's partner in DHHS, exercised its right to require the Company to
purchase the Foundation's 50% partnership interest in DHHS. The Company has
negotiated a purchase price of $64.5 million, inclusive of working capital, and
expects to complete the transaction by August 1998. The Company expects to
finance this acquisition through borrowings under the Restated Credit Agreement
(See Note 9). If the purchase is not completed within the allowable period, the
Foundation can exercise various options, including seeking remedies available
at law against the Company for breach of its obligation.

         Upon completion of the purchase of the Foundation's interest in the
partnership, the Company will account for DHHS under the consolidation method
of accounting. Pro forma net revenue and earnings from continuing operations
before interest, taxes and depreciation and amortization ("EBITDA") for the
year ended December 31, 1997, respectively, assuming the Company owned 100% of
DHHS on January 1, 1997, would have been as follows ($ in 000's):

<TABLE>
<CAPTION>

                                                      AS CURRENTLY
                                                        REPORTED               PRO FORMA           INCREASE
                                                      ------------             ---------           --------

<S>                                                      <C>                   <C>                 <C>
                                Net Revenue              $  659,219            $ 759,146           $ 99,927
                                EBITDA(a)                    79,458               92,646             13,188
</TABLE>

--------------------
(a) Excludes unusual items of $6.5 million and impairment charge of $7.8
    million. See Note 2.

NOTE 5. ACQUISITIONS, DISPOSITIONS AND CLOSURES OF HOSPITALS

Acquisitions

         On August 16, 1996, the Company acquired Champion through the merger
of a wholly owned subsidiary of the Company with and into Champion. The Company
issued approximately 19.8 million shares of its common stock in exchange for
all of the issued and outstanding shares of Champion's common stock and
preferred stock, and assumed all of Champion's outstanding liabilities totaling
approximately $220.5 million. Additionally, outstanding options, subscription
rights, warrants and convertible notes to acquire Champion's common stock were
converted to similar rights to acquire approximately 1.9 million shares of the
Company's common stock. The total purchase price, including all costs
associated with the transaction and liabilities assumed, was approximately
$394.4 million. The Merger was accounted for using the purchase method of
accounting. The Company recorded goodwill of $103.5 million, which is being
amortized on a straight line basis over an estimated useful life of 35 years.

         The Company incurred approximately $56.2 million in Merger-related
costs, of which $40.8 million was expensed and $15.4 million was capitalized as
part of the purchase price of Champion. Merger costs of $40.8 consisted
primarily of cash payments, provision for benefits and grants of stock options
to certain executives and employees of the Company in accordance with the
Merger terms (See Notes 13 and 14) and corporate office consolidation costs.
Capitalized merger costs of $15.4 million consisted primarily of payments for
legal and other closing costs, cash payments and benefits provided to certain
former Champion executives.

         On May 17, 1996, the Company acquired PHC Regional Hospital, including
certain current assets, for approximately $71.0 million in cash. The Company
financed the acquisition with amounts borrowed under the then existing credit
facility. In connection with the adoption of SFAS No. 121 and the significant
operating losses recognized at this facility since its acquisition date, the
Company, in conjunction with an independent appraisal, recorded an impairment
charge of $52.5 million ($35.2



                                      50
<PAGE>   51

million after-tax) at December 1996, including initially recorded goodwill of
$15.8 million. The results of PHC Regional Hospital have been included in the
operations of the Company since May 17, 1996.

         On May 17, 1996, the Company acquired the 139-bed Pioneer Valley
Hospital in West Valley City, Utah, the 126-bed Davis Hospital and Medical
Center in Layton, Utah and the 129-bed Santa Rosa Medical Center in Milton,
Florida from another healthcare company. In exchange, the other party received
the Company's 119-bed Peninsula Medical Center in Ormond Beach, Florida, the
135-bed Elmwood Medical Center in Jefferson, Louisiana, the 190-bed Halstead
Hospital in Halstead, Kansas and $38.5 million in cash, net of a working
capital differential. The Company also purchased the real property of Elmwood
and Halstead from a real estate investment trust ("REIT"), exchanged the
Elmwood and Halstead real property for the Pioneer real property and then sold
the Pioneer real property to the REIT. The acquisition of these facilities was
accounted for as a purchase transaction. The Company financed the acquisition
from borrowings under the then existing revolving line of credit. The Company
recorded goodwill of $15.2 million, which is being amortized on a straight line
basis over an estimated useful life of 20 years. The results of the acquired
hospitals have been included in the operations of the Company since May 17,
1996. No material gain or loss was recorded on the hospitals exchanged.

         On September 5, 1995, the Company acquired the real and personal
property and inventory of the 41-bed Jackson County Hospital in Gainesboro,
Tennessee for $.6 million in cash. The Company currently operates the facility
under the name of Cumberland River Hospital - South.

Dispositions and Closures

         On December 15, 1997, the Company signed a definitive agreement to sell
the 123-bed Chico Community Hospital and the 60-bed Chico Rehabilitation
Hospital in Chico, California. This transaction is subject to the completion of
customary closing conditions and obtaining certain regulatory approvals. There
can be no assurance that the Company will be able to consummate this
transaction.

         On May 15, 1997, the Company closed the inpatient services at PHC
Regional Hospital and substantially all remaining services in June 1997. The
Company closed the hospital as a result of continuing losses under the
capitated contract with FHP International Inc. (now owned by PacifiCare of
Utah). In August 1997, the Company executed an Amended and Restated Provider
Agreement with PacifiCare of Utah, retroactive to July 1, 1997, to (i) receive
payment for services provided to FHP enrollees on a per diem basis instead of a
capitation basis; (ii) revise the contract term from 15 years to 5 years ending
in June 2002; (iii) no longer provide exclusive service to FHP enrollees; and
(iv) agree on a mechanism to resolve disagreements regarding the administration
of the capitation agreement prior to July 1, 1997.

         On May 15, 1997, a wholly owned subsidiary of the Company entered into
a joint venture with a group of physicians in which the subsidiary leased the
55-bed Orange County Hospital of Buena Park ("Buena Park") and the 85-bed
Bellwood General Hospital in Bellflower, California to a limited liability
company formed by the joint venture. The subsidiary owns a 51% interest in the
joint venture. Operating results of Buena Park subsequent to the formation of
the joint venture are included in income from continuing operations.

         On April 28, 1997, the Company completed the sale of two psychiatric
facilities, the 149-bed Lakeland Regional Hospital in Springfield, Missouri and
the 70-bed Crossroads Regional Hospital in Alexandria, Louisiana.
No gain or loss was recognized in connection with such divestiture.

         On January 31, 1997, the Company closed the 104-bed Orange County
Community Hospital of Orange and consolidated services into Buena Park.

         On March 15, 1996, the Company closed the 119-bed Desert Palms
Community Hospital in Palmdale, California.

         On September 30, 1995, the Company sold Womans Hospital in Jackson,
Mississippi to the facility's lessee for $17.8 million in cash, resulting in a
gain of $9.2 million. Previously, in August 1994, the Company divested the
operations of this facility, entered into an operating lease agreement with the
lessee and sold the land and a medical office building to the lessee for $1.0
million.



                                      51
<PAGE>   52


         On April 24, 1995, the Company closed the 67-bed Bellwood Health
Center, a psychiatric facility in Bellflower, California. In connection with
the closure, the Company recorded a charge of $973,000 ($574,000 after-tax) for
employee severance benefits and contract termination costs. Such charge was
included in "Discontinued operations - Loss from operations of discontinued
psychiatric hospitals, net" in the Consolidated Statements of Operations.

NOTE 6. DISCONTINUED OPERATIONS

         The Company's operations are classified into two lines of business:
acute care and psychiatric care. In September 1996, the Company approved a plan
to exit the psychiatric hospital business through the disposition of all of its
psychiatric hospitals (the "discontinued operations"), including one of which
was previously closed in April 1995. Management anticipates that the sale or
closure of all such operations will be completed on or before December 31,
1998. During 1996, the Company recorded an estimated loss on disposal of the
discontinued operations of $37.5 million (no income tax benefit - see Note 8)
to reduce the related assets to their estimated net realizable value and to
accrue for estimated operating losses of approximately $4.3 million during the
phase out period. During the fourth quarter of 1997, the Company recorded an
additional estimated disposal loss of $5.2 million (net of income tax benefits
of $3.7 million), of which $1.9 million was for a further write down of assets
to their estimated net realizable value based upon most recent offers from
third party purchasers and $3.3 million for charges relating to certain
outstanding litigation matters. During 1997, in accordance with APB No. 30,
losses of $1.1 million from operations of the discontinued psychiatric
hospitals were charged to the disposal loss accrual previously established in
September 1996. Accordingly, such losses were not reflected in the 1997
Consolidated Statement of Operations.

         Long-term net assets of $3.8 million and $18.5 million of the
discontinued operations have been segregated in the Consolidated Balance Sheet
at December 31, 1997 and 1996 under the caption "Long-term assets of
discontinued operations, net", respectively.

         During 1996, the Company recorded a charge for settlement costs
totaling $22.4 million regarding two lawsuits, of which $19.9 million was
related to a case involving the operation of its psychiatric programs. Such
charge consisted primarily of settlement payments, legal fees and the write off
of certain psychiatric accounts receivable. The Company did not admit liability
in either case but resolved its dispute through the settlements in order to
facilitate the Champion acquisition, re-establish a business relationship
and/or avoid further legal costs in connection with the disputes. Operating
results of the discontinued operations for the year ended December 31, 1996,
including the settlement charge of $19.9 million but excluding the estimated
disposal loss, have been reported separately as "Discontinued operations - Loss
from operations of discontinued psychiatric hospitals, net" in the Consolidated
Statements of Operations. Summarized operating financial data for the
discontinued psychiatric care line of business for the years ended December 31,
1996 and 1995 is as follows ($ in 000's):

<TABLE>
<CAPTION>

                                                                         YEAR ENDED DECEMBER 31,
                                                                       --------------------------
                                                                        1996(a)             1995
                                                                        -------             ----

<S>                                                                   <C>               <C>
   Net revenue...............................................          $ 37,323          $ 57,454
   Operating loss (b)........................................           (14,892)           (2,781)
   Loss from operations before income tax benefit............           (33,545)           (4,840)
   Income tax benefit (See Note 8)...........................                --             1,988
   Net loss from operation of discontinued operations........           (33,545)           (2,852)(c)

</TABLE>


--------------------
(a)  Represents operating results for the nine months ended September 30, 1996.
     Operating results for the three months ended December 31, 1996 and
     estimated operating losses through the expected disposition date have been
     included in "Discontinued operations - Loss on disposal of discontinued
     psychiatric hospitals, net" in the Consolidated Statements of Operations.




                                      52
<PAGE>   53


(b)  Operating income (loss) was derived by subtracting from net revenue,
     salaries and benefits, provision for bad debts and other operating
     expenses.
(c)  Includes a charge of $973,000 ($574,000 after-tax) recorded in 1995 for
     employee severance benefits and contract termination costs related to the
     closure of a hospital.

NOTE 7. ASSETS HELD FOR SALE

         In September 1996, the Company approved a plan to exit the LA metro
market principally through the disposition of the under performing hospitals in
that area. Such dispositions will enable the Company to exit a market heavily
penetrated by managed care organizations where the Company is not a preeminent
provider of healthcare services. The Company is proceeding with its plan to
dispose of the selected hospitals and expects the sale or closure of all such
operations will be completed on or before December 1998. Net assets related to
these facilities have been segregated from the remaining assets of the Company
and are classified in the Consolidated Balance Sheet as "Assets held for sale,
net" at December 31, 1997 and 1996, respectively. Operating results of the LA
metro hospitals included in the Consolidated Statements of Operations are as
follows ($ in 000's):


<TABLE>
<CAPTION>

                                                                 YEAR ENDED DECEMBER 31,
                                                            ---------------------------------
                                                            1997            1996           1995
                                                            ----            ----           ----

<S>                                                        <C>          <C>           <C>
     Net revenue......................................     $95,864      $  92,518     $  121,812
     Operating income (loss)(a).......................       5,726         (6,440)        10,928

</TABLE>


-------------------
(a)  Operating income (loss) was derived by subtracting from net revenue,
     salaries and benefits, provision for bad debts and other operating
     expenses.

         During 1996, in conjunction with the disposition plan of these
hospitals and the Company's adoption of SFAS No. 121, the Company recorded an
impairment charge of $ 11.9 million ($8.0 million after-tax) to reduce the net
assets of four of these facilities and a related clinic to their estimated fair
value. During 1997, the Company recorded an additional impairment charge of
$7.8 million ($4.6 million after-tax) to further write down assets of these
facilities to their estimated net realizable value based upon the most recent
offers from third party purchasers.

NOTE 8. INCOME TAXES

         The provision for income taxes consists of the following ($ in 000's).
All amounts reflect the effect of the restatement entries.

<TABLE>
<CAPTION>

                                                                   YEAR ENDED DECEMBER 31,
                                                           ----------------------------------------
                                                             1997            1996            1995
                                                           --------        --------        --------
<S>                                                        <C>             <C>             <C>
Continuing Operations:
Current:
   Federal .........................................       $     --        $(18,852)       $  8,478
   State ...........................................            813          (3,075)          1,460
Deferred:
   Federal .........................................            853         (44,162)         (4,746)
   State ...........................................            146         (10,097)           (817)
                                                           --------        --------        --------
Total income tax provision (benefit) from continuing
   operations ......................................          1,812         (76,186)          4,375
Discontinued operations ............................         (3,644)             --          (1,982)
Extraordinary losses ...............................             --              --              --
                                                           --------        --------        --------
Total income tax provision (benefit) ...............       $ (1,832)       $(76,186)       $  2,393
                                                           ========        ========        ========

</TABLE>

                                      53
<PAGE>   54


         During 1992, the Company changed its method of reporting income for
tax purposes from cash to accrual basis. Under the cash basis, the Company
deferred approximately $72.0 million of taxable income for periods ending prior
to October 1, 1991. Of the amounts deferred, $16.8 million and $11.0 million
were included in taxable income of years ended December 31, 1996 and 1995,
respectively. As of December 31, 1996, all income that had been deferred by the
use of cash-basis accounting had been included in taxable income. Hence, no
deferred income was included in taxable income for 1997.

         The following table reconciles the differences between the statutory
Federal income tax rate and the effective tax rate for continuing operations ($
in 000's):

<TABLE>
<CAPTION>

                                                                     YEAR ENDED DECEMBER 31,
                                            --------------------------------------------------------------------------
                                                1997          %            1996           %            1995          %
                                            --------       ----        --------        ----        --------       ----

<S>                                         <C>            <C>         <C>             <C>         <C>            <C>
Federal statutory rate ..............       $    230        35.0       $(80,739)        (35.0)     $  3,735       35.0
State income taxes, net of Federal
  income tax benefit ................             39         6.0        (14,640)        (6.3)           640        6.0
Non-deductible merger and
  acquisition costs .................             --         --             897          0.4             --         --
Non-deductible goodwill amortization:
  Federal ...........................          1,317       200.9            571          0.2             --         --
  State .............................            226        34.4             --           --             --         --
Adjustment to valuation allowance ...             --         --          17,725          7.7             --         --
                                            --------       -----       --------        -----       --------       ----
Effective income tax rate ...........       $  1,812       276.3       $(76,186)       (33.0)      $  4,375       41.0
                                            ========       =====       ========        =====       ========       ====
</TABLE>

         The tax effects of temporary differences that give rise to significant
portions of the Federal and state deferred tax assets and liabilities are
comprised of the following ($ in 000's):




<TABLE>
<CAPTION>


                                                                DECEMBER 31,
                                                        --------------------------
                                                          1997             1996
                                                        ---------        ---------
<S>                                                     <C>              <C>
DEFERRED TAX LIABILITIES:
  Accelerated depreciation ......................       $   3,684        $   9,766
                                                        ---------        ---------
     Total deferred tax liabilities .............           3,684            9,766
                                                        ---------        ---------

DEFERRED TAX ASSETS:
  Allowance for bad debts .......................         (19,923)         (22,678)
  Accrued expenses ..............................         (47,629)         (35,551)
  Net operating losses ..........................         (21,600)         (39,643)
  Other - net ...................................         (18,658)          (8,328)
                                                        ---------        ---------
     Total deferred tax assets ..................        (107,810)        (106,200)
  Valuation allowance against deferred tax assets          53,281           53,281
                                                        ---------        ---------
     Net deferred tax assets ....................         (54,529)         (52,919)
                                                        ---------        ---------

Net deferred tax assets .........................         (50,845)         (43,153)
Less: Current deferred tax assets ...............         (25,818)         (28,739)
                                                        ---------        ---------
Long-term deferred tax assets ...................       $ (25,027)       $ (14,414)
                                                        =========        =========

</TABLE>


         For financial accounting purposes, a valuation allowance of $53.3
million has been recognized as of December 31, 1997 to offset the deferred tax
assets principally related to the Company's net operating losses, bad debt
allowances and other accrued expenses. The Company considered prudent and
feasible tax planning strategies in assessing the need for a valuation
allowance. The Company assumed $45.8 million of benefit attributable to tax
planning strategies, primarily through the sale of appreciated non-core
hospital assets. In the event the Company were to determine in the future that
any such tax planning strategies would not be implemented, an adjustment to the
deferred tax asset of up to $45.8 million would be charged to income in the
period of such determination. The Company also assumed a $5.0 million benefit
related to future taxable income. As a result of recording the above valuation
allowance,



                                      54


<PAGE>   55

the Company recognized a reduction in income tax benefits of $50.0 million in
1996, $17.7 million of which was applied to the continuing operations and the
remaining $32.3 million to the discontinued operations and the extraordinary
loss. Consequently, no income tax benefits were recognized on the losses from
discontinued operations and the extraordinary loss during 1996. No changes were
recorded to the valuation allowance during 1997.

         At December 31, 1997, the Company has net operating loss carryforwards
of $50.8 million, inclusive of $24.0 million acquired from Champion in the
Merger, for U.S. Federal income tax purposes that will expire in 2010. Champion
had $24.3 million of net operating losses at August 16, 1996. The benefit
associated with the Champion net operating losses was applied to reduce
goodwill. All Champion net operating losses can only be used to offset the
separate company income of the Champion group. In addition, as a result of the
change in ownership of the Champion group at August 16, 1996, the Champion net
operating losses are also limited under Section 382 of the Internal Revenue
Code.

         The deferred tax valuation increased by $53.3 million during 1996 and
remained unchanged during 1997. The 1996 increase was principally attributable
to deferred tax assets related to net operating losses, bad debt allowances and
other accrued expenses that may not be realized, with approximately $3.3
million of the increase resulting from the Champion merger. Any future
decreases of the valuation allowance will be reported as reductions of income
tax expense when recognized in financial statements for subsequent years.

         The Company received net income tax refunds of $24.1 million in 1997
and paid income taxes, net of refunds, of $1.0 million and $14.3 million during
1996 and 1995, respectively.

NOTE 9. LONG TERM DEBT

         The Company's long-term debt consists of the following ($ in 000's):

<TABLE>
<CAPTION>

                                                                DECEMBER 31,
                                                         --------------------------
                                                            1997             1996
                                                         ---------        ---------

<S>                                                      <C>              <C>
Revolving Credit Facility ........................       $ 149,238        $ 146,000
10% Senior Subordinated Notes ....................         325,000          325,000
6.51% Subordinated Note ..........................           7,185            7,185
Capital Lease Obligations (See Note 10) ..........           9,434            9,956
Other ............................................           7,266            7,595
                                                         ---------        ---------
                                                           498,123          495,736
Less current maturities ..........................          (6,209)          (4,679)
                                                         ---------        ---------
Total Long-term Debt .............................       $ 491,914        $ 491,057
                                                         =========        =========

</TABLE>


         REVOLVING CREDIT FACILITY - On August 16, 1996, the Company entered
into a credit agreement (the "Credit Agreement") which provided for a $400.0
million five-year Reducing Revolving Credit Facility (the "Credit Facility").
During 1997, the Company entered into the First, Second and Third Amendments to
the Credit Agreement, which, among other things, reduced the credit commitment
to $200.0 million effective April 14, 1997 and to $165.0 million effective
August 14, 1997. Borrowings under the Credit Facility bore interest at the
Company's option, from August 1996 to April 13, 1997, at (i) LIBOR plus a
margin of 2.0% or (ii) the prime rate plus a margin of .75%. Pursuant to the
various amendments, the interest rate was increased (a) effective April 14,
1997 through June 30, 1997, by .50% and (b) effective July 1, 1997 through
August 13, 1997, the interest rate was increased an additional .50% on a
monthly basis as compared to rates otherwise in effect prior thereto and (c)
effective August 14, 1997 through March 29, 1998, at the Company's option, at a
rate equal to LIBOR plus a margin of 3.25% or the prime rate plus a margin of
2.25%. The Company was required to pay annual commitment fees ranging from .25%
to .50% on the unused portion of the Credit Facility. Letters of credit issued
under the Credit Facility required annual fees equal to the then required LIBOR
increment. The weighted average borrowing rate for the year ended December 31,
1997 was 8.3% under the Credit Facility. As of





                                      55
<PAGE>   56
December 31, 1997, the Company had outstanding borrowings of $149.2 million and
outstanding letters of credit of $15.8 million.

         On March 30, 1998, the Company entered into an Amended and Restated
Credit Agreement (the "Restated Credit Agreement"), which provided for a $180.0
million five-year Reducing Revolving Credit Facility (the "$180.0 million
Facility") and $75.0 million in Term Loan Facilities (the "$75.0 million
Facilities")(collectively, the "Facilities"), consisting of a five-year $25.0
million Term Loan Facility ("Tranche A Facility") and a six-year $50.0 million
Term Loan Facility ("Tranche B Facility"). The $180.0 million Facility is
available for (i) general corporate purposes, including funding working capital
needs, Permitted Acquisitions and capital expenditures, (ii) issuance of letters
of credit up to $25.0 million and (iii) replacing existing indebtedness of the
Company under its prior Credit Agreement. It is subject to mandatory quarterly
reductions of $12.0 million, commencing on March 31, 2000, and a limit of $50.0
million availability for working capital needs. The $75.0 million Facilities are
available for replacing existing indebtedness of the Company under its prior
Credit Agreement and initial Permitted Acquisition advances. Tranche A Facility
is payable in quarterly installments ranging from $600,000 to $2,500,000, with
the final payment due on March 31, 2003. Tranche B Facility is payable in annual
installments of $500,000 with the final balloon payment due on March 31, 2004.
The Company is further required to make mandatory prepayments under the
Facilities equal to 100% of (i) net cash proceeds from permitted asset sales,
(ii) debt issuances and (iii) equity issuances, subject to certain allowable
exclusions for debt and equity as described in the Restated Credit Agreement.
Such prepayments do not result in a mandatory reduction in borrowing capacity
under the $180.0 million Facility but may result, in certain circumstances, in a
mandatory permanent reduction of the $75.0 million Facilities. The Company is
subject to certain fees in the event targeted levels of asset dispositions are
not achieved by June 30, 1998 and September 30, 1998. Borrowings under the
$180.0 million Facility and the Tranche A Facility bear interest at the
Company's option, at (i) LIBOR plus a margin ranging from 1.25% to 2.75% or (ii)
the prime rate plus a margin ranging from 0.0% to 1.25%. Borrowings under the
Tranche B Facility bear interest at LIBOR plus 2.75% and may be reduced in
certain circumstances. The Company is required to pay annual commitment fees
ranging from .25% to .50% of the unused portion of the $180.0 million Facility.
Letters of credit issued under the $180.0 million Facility require annual fees
equal to the effective LIBOR increment and are to be paid quarterly in arrears.

         The Facilities are secured by the right of lenders to a first priority
lien in certain of the real and personal properties of the Company and its
subsidiaries and a first priority interest in the capital stock of all of the
Company's present and future subsidiaries, except for the Excluded Subsidiaries
as defined in the Restated Credit Agreement.

         During 1996, the Company recognized an extraordinary loss for the
write-off of deferred loan costs of $1.7 million relating to the credit
facility in existence prior to August 1996.

         SENIOR SUBORDINATED NOTES - On August 16, 1996, the Company completed
a $325.0 million registered offering of 10% Senior Subordinated Notes (the
"Notes"). Of the $315.2 million net proceeds received from the offering, $81.6
million was used to repay the 9.875% Senior Subordinated Notes (the "9.875%
Notes"), including $3.9 million in tender and consent fees, $177.7 million to
repay certain Champion existing debt assumed upon the consummation of the
Merger, and the remaining $55.9 million to repay amounts outstanding under the
Company's previous revolving credit facility. The Notes are general unsecured
senior subordinated obligations of the Company and will mature on August 15,
2006. The Notes are not subject to any mandatory redemption and may not be
redeemed prior to August 15, 2001.

         On August 22, 1996, all of the 9.875% Notes were redeemed, which
resulted in an extraordinary loss of $6.0 million, consisting of $3.9 million
in tender and consent fees and $2.1 million for the write-off of deferred
financing costs.

         6.51% SUBORDINATED NOTE - Pursuant to an agreement in conjunction with
the Merger, the Former Sole Shareholder received a $7.2 million 6.51%
subordinated note from the Company. The note provides for payments of principal
and interest in an aggregate annual amount of $1.0 million over a term of 10
years. In connection with the Company's execution of the First Amendment to the
Credit Agreement, the Former Sole Shareholder waived its right to receive
principal payments under the note until all obligations of the Company under
the Restated Credit Agreement have been satisfied.



                                      56
<PAGE>   57
         OTHER DEBT - Other debt at December 31, 1997 and 1996 consists
primarily of mortgage notes and other collateralized and unsecured notes. These
obligations mature in various installments through 2016 at interest rates
ranging from 8.8% to 10.0% in 1997 and 9.0% to 12.5% in 1996.

         The terms of the various debt agreements include certain restrictive
covenants. Among other restrictions, the covenants include limitations on
investments, borrowings, liens, change of control acquisitions and dispositions
of assets and transactions with affiliates, and require maintenance of certain
ratios regarding fixed charge coverage, leverage, minimum EBITDA, net worth and
maintenance of the commercial paper program (see Note 11). The Company may
declare and pay cash dividends in an aggregate amount not to exceed $250,000 in
connection with a merger consummated by Champion prior to its acquisition by the
Company. Under certain circumstances, the Company may repurchase its own common
stock from directors, officers and employees in an aggregate amount not to
exceed $1.0 million dollars per year. The Company was in compliance with or
received permanent waivers for all loan covenants to which it was subject as of
December 31, 1997 and 1996.

         Maturities of long-term debt outstanding as of December 31, 1997 for
the next five years and thereafter are ($ in 000's):

<TABLE>
<CAPTION>
<C>                                            <C>
1998 .................................         $    6,209
1999 .................................             52,610
2000 .................................             51,366
2001 .................................             50,573
2002 .................................              1,359
Thereafter ...........................            336,006
                                               ----------
  Total                                        $  498,123
                                               ==========
</TABLE>

         The Company paid interest of $46.4 million,  $20.0 million and $16.0
million during 1997, 1996 and 1995, respectively.

NOTE 10. LEASES

         The Company leases property and equipment under cancelable and
non-cancelable leases. Future minimum operating and capital lease payments as
of December 31, 1997, including amounts relating to leased hospitals, for the
next five years and thereafter are ($ in 000's):

<TABLE>
<CAPTION>
                YEARS ENDED DECEMBER 31,                 OPERATING       CAPITAL
                ------------------------                 ---------       -------

<S>                                                      <C>            <C>
    1998............................................     $   17,276     $   2,208
    1999............................................         16,499         1,728
    2000............................................         15,259         1,019
    2001............................................         14,206           924
    2002............................................         13,441           850
    Thereafter......................................         30,009         7,310
                                                          ---------      --------
    Total minimum future payments...................     $  106,690        14,039
                                                         ==========
    Less amount representing interest...............                       (4,605)
                                                                         --------
                                                                            9,434
    Less current portions...........................                       (1,522)
                                                                         --------
    Long-term capital lease obligations.............                    $   7,912
                                                                        =========
</TABLE>

         The following summarized amounts relate to assets leased by the
Company under capital leases ($ in 000's):


<TABLE>
<CAPTION>
                                        DECEMBER 31,
                                  ----------------------
                                    1997           1996
                                  -------        -------


<S>                               <C>            <C>
Property, Plant & Equipment...    $ 6,612        $ 9,551
Accumulated Depreciation .....     (2,419)        (3,500)
                                  -------        -------
   Net Book Value ............    $ 4,193        $ 6,051
                                  =======        =======
</TABLE>


                                      57


<PAGE>   58


         Depreciation of assets under capital leases is included in
depreciation and amortization in the Consolidated Statements of Operations.
Rental expense was $25.6 million, $20.1 million and $18.3 million for 1997,
1996 and 1995, respectively.

NOTE 11. SALE OF ACCOUNTS RECEIVABLE

         A subsidiary of the Company has an agreement with an unaffiliated
trust (the "Trust") to sell the Company's hospital eligible accounts receivable
(the "Eligible Receivables") on a nonrecourse basis to the Trust. A special
purpose subsidiary of a major lending institution provides up to $65.0 million
in commercial paper financing to the Trust to finance the purchase of the
Eligible Receivables from the Company's subsidiary, with the Eligible
Receivables serving as collateral. The commercial paper notes have a term of
not more than 120 days. Eligible receivables sold to the Trust at December 31,
1997, 1996 and 1995 were $38.3 million, $49.8 million and $65.0 million,
respectively. Interest expense charged to the Trust related to the commercial
paper financing is passed through to the Company and included as interest
expense in the Company's consolidated financial statements. Interest expense
incurred by the Company related to this program was $2.5 million, $3.2 million
and $4.0 million for the years ended December 31, 1997, 1996 and 1995,
respectively.

         As of December 31, 1997 and 1996, the Company was in not in compliance
with certain provisions under the Trust agreement. The Company has received a
waiver of such provisions under the Trust.

NOTE 12. CREDIT RISK AND FAIR VALUE OF FINANCIAL INSTRUMENTS

         CREDIT RISK - Financial instruments that potentially subject the
Company to concentration of credit risk consist principally of investments in
marketable securities and accounts receivable. The Company's investments in
marketable securities are managed by a professional investment manager within
guidelines established by the Board of Directors, which, as a matter of policy,
limit the amounts that may be invested in any one issuer. Credit risk on
accounts receivable is limited because a majority of the receivables are due
from governmental agencies, commercial insurance companies and managed care
organizations. The Company continually monitors and adjusts its reserves and
allowances associated with these receivables.

         FAIR VALUES OF FINANCIAL INSTRUMENTS - All financial instruments are
held for purposes other than trading. The estimated fair values of all
financial instruments, other than marketable securities and long-term debt,
approximated their carrying amounts in the consolidated balance sheets due to
the short-term maturity of these instruments. The carrying amount and fair
value of marketable securities are disclosed at Note 3. The carrying amount and
fair value of long-term debt are as follows ($ in 000's):

<TABLE>
<CAPTION>

                                                            DECEMBER 31,
                                             -----------------------------------------------
                                                     1997                      1996
                                             --------------------      ---------------------
                                             CARRYING       FAIR       CARRYING       FAIR
                                              AMOUNT        VALUE       AMOUNT       VALUE
                                             --------     --------     --------     --------
<S>                                          <C>          <C>          <C>          <C>
Long-term Debt:
    Revolving Credit Facility ..........     $149,238     $149,238     $146,000     $146,000
    10% Senior Subordinated Notes ......      325,000      331,500      325,000      305,500
    6.51% Subordinated Note ............        7,185        6,790        7,185        6,557

</TABLE>


     The fair value of the Credit Facility approximated the carrying amount
since the interest rate is based on a current market rate. The fair value of
the Notes was based on the quoted market price. The fair value of the remaining
debt was estimated using discounted cash flow analyses, based on the Company's
current incremental borrowing rate for similar types of borrowing arrangements.


                                       58
<PAGE>   59


NOTE 13. STOCKHOLDERS' EQUITY

         COMMON AND PREFERRED STOCK - The Company has 150.0 million authorized
shares of common stock, no stated value per share. Each share is entitled to
one vote and does not have any cumulative voting rights. The Company is also
authorized to issue 25.0 million shares of preferred stock at $.01 par value
per share, which may be issued in such series and have such rights, preferences
and other provisions as may be determined by the Board of Directors without
approval by the holders of common stock.

         Pursuant to a Shareholder Protection Rights Agreement, the Company
designated 1.5 million of its 25.0 million authorized preferred shares as
Participating Preferred Stock ("Preferred Share") and paid a dividend of one
Preferred Share purchase right ("Right") for each outstanding share of the
Company's common stock to stockholders of record as of August 15, 1996. Similar
rights will be issued with respect to common stock subsequently issued. Each
Preferred Share will be entitled to an aggregate quarterly dividend equal to
the greater of 25% of each Right's exercise price or 100 times the quarterly
dividend declared on the Company's common stock. In the event of liquidation,
the holder of each Preferred Share will be entitled to receive a liquidation
payment of $100 per share plus any accrued but unpaid dividends. Each Preferred
Share will have 100 votes, voting together with the common stock. No Preferred
Shares are currently outstanding. Each Right entitles the registered holder to
purchase from the Company, one one-hundredth of a Preferred Share at a price of
$42.50, subject to an adjustment that could include the right to acquire,
subject to certain conditions, common stock in the Company or such other entity
with which the Company engages in certain types of transactions, such as a
merger. The Rights currently are not exercisable and will be exercisable only
if a person or group acquires beneficial ownership of 25% or more of the
Company's outstanding shares of common stock (i.e., becomes an "Acquiring
Person" as defined in the related Rights Agreement). The Rights, which expire
on August 16, 2006, are redeemable in whole, but not in part, at the Company's
option at a price of $.01 per Right at any time before such dates specified in
the Rights Agreement in relation to a person becoming an Acquiring Person.

         In connection with the Merger, in August 1996, all 450 outstanding
shares of the Company's common stock, which were solely owned by the Former
Sole Shareholder, were split into an aggregate of 29.8 million shares as a
result of a 66,159.426-for-one stock split. Upon the consummation of the
Merger, each share of Champion common and preferred stock was exchanged for one
and two shares of the Company's common stock, respectively. Accordingly, the
Company issued 19.8 million shares of its common stock in connection with such
exchange. On August 16, 1996, the Company's common stock began trading on the
New York Stock Exchange under the symbol "PLS."

         During the 1996 period prior to the Merger, the Company paid cash
dividends of $3.8 million to the Former Sole Shareholder. In conjunction with
the Merger, the Company declared a dividend of $21.1 million to the Former Sole
Shareholder, which was paid on August 30, 1996. After receipt of the $21.1
million dividend and accrued interest of $104,000, and pursuant to a related
agreement, the Former Sole Shareholder paid approximately $3.0 million plus
accrued interest in full satisfaction of a note payable to the Company.
Additionally, the Former Sole Shareholder loaned the Company $7.2 million and
received a $7.2 million 6.51% subordinated note from the Company (See Note 9).

         On August 16, 1996, the Company completed a sale of 5.2 million shares
of its common stock at $8.50 per share. Net proceeds of $39.8 million were used
along with proceeds from the Notes offering (See Note 9) to repay existing and
acquired indebtedness as well as pay for Merger related costs (See Note 5).

         STOCK OPTION PLAN - On July 15, 1996, the Company adopted the 1996
Stock Incentive Plan (the "Incentive Plan") to provide stock-based incentive
awards, including incentive stock options, non-qualified stock options,
restricted stock, performance shares, stock appreciation rights and deferred
stock, to key employees, consultants and advisors. Pursuant to the termination
of the Company's




                                      59
<PAGE>   60

Phantom Equity Long-Term Incentive Plan in connection with the Merger, options
to purchase 1.6 million shares of the Company's common stock were granted at an
exercise price of $.01 per share ("Value Options") to certain directors and
officers of the Company in addition to aggregated cash payments of $20.7
million, which if combined, approximated the accrued value of the canceled
phantom stock appreciation rights and/or preferred stock units thereunder.
Additionally, pursuant to the various employment agreements, Value Options were
granted to certain senior executive officers to purchase 1.2 million shares in
addition to options to purchase 2.8 million shares of the Company's common
stock at an exercise price of $8.50 per share. The Company recognized merger
expenses totaling $32.0 million related to the cancellation of the Phantom
Equity Long-Term Incentive Plan and the issuance of certain Value Options.

         In connection with the Merger, the Company also assumed and converted
all Champion outstanding options, subscription rights, warrants and convertible
notes to similar rights to acquire approximately 1.9 million shares of the
Company's common stock.

         At December 31, 1997, there were 9.8 million shares of common stock
reserved for exercise of options. Except for the Value Options as noted above,
stock options were generally granted at an exercise price equal to the
estimated fair market value of the shares on the date of grant and expire ten
years from the grant date. The Value Options are fully vested on the date of
grant, with the remaining options vesting generally over a period of 3 to 4
years from the date of grant. Options generally expire upon certain events
(such as termination of employment with the Company), except for Value Options,
which remain exercisable until the end of the 10-year option term. The
following table presents the number of shares covered by options outstanding
and the related number of options granted, assumed, exercised and canceled
since August 1996 (in 000's):


<TABLE>
<CAPTION>

                                                                                               WEIGHTED
                                                      NUMBER               EXERCISE             AVERAGE
                                                        OF                  PRICE              EXERCISE
                                                      OPTIONS             PER SHARE              PRICE
                                                      -------             ----------           -----------
<S>                                                   <C>             <C>                      <C>
Outstanding at January 1, 1996....................         --                    --                     --

  Granted.........................................      5,530         $ .01 to $8.50            $     4.28
  Assumed.........................................      1,335         $1.00 to $9.00                  5.96
  Exercised.......................................         --                  -                        --
  Canceled........................................         --                  -                        --
                                                      -------

Outstanding at December 31, 1996..................      6,865         $ .01 to $9.00                  4.60


Granted...........................................      1,105         $5.19                           5.19
Exercised.........................................       (280)        $ .01                           0.01
Canceled..........................................       (135)        $ .01 to $9.00                  2.18
                                                      -------
Outstanding at December 31, 1997..................      7,555         $ .01 to $9.00            $     4.90
                                                      =======



</TABLE>



                                      60

<PAGE>   61




         The following table summarizes information concerning currently
outstanding and exercisable options as of December 31, 1997 (in 000's):


<TABLE>
<CAPTION>


                     OPTIONS OUTSTANDING                                                 OPTIONS EXERCISABLE
          ------------------------------------------------------------------    ---------------------------------
                                              Weighted
                                               Average          Weighted                            Weighted
             Range of                         Remaining          Average                             Average
             Exercise         Number         Contractual         Exercise          Number           Exercise
              Price        Outstanding          Life              Price         Exercisable           Price
          ---------------- --------------- ---------------- ----------------    ---------------- ----------------

         <S>               <C>             <C>              <C>                 <C>              <C>
          $0.01                2,369          8.6 years            $0.01             2,369            $0.01
          $1.00-$9.00          5,186          7.8 years            $7.14             1,799            $6.40

</TABLE>

         The Company has elected to follow APB No. 25 and related
Interpretations in accounting for its employee stock options. Pro forma
information regarding net income and earnings per share is required by SFAS
123, and has been determined as if the Company had accounted for its employee
stock options under the fair value method of that Statement. The weighted
average grant-date fair value of options granted during 1997 was $3.66, using
the Black-Scholes option pricing model with the following weighted-average
assumptions for 1997 and 1996, respectively: risk-free interest rates of 5.60%
and 6.25%; dividend yields of 0.0%; volatility factors of the expected market
price of the Company's stock of 97.4% and 49.2%; and a weighted-average
expected life of the option of 4 years.

         The Black-Scholes option pricing 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 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 purpose of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information for 1997 and 1996 are as follows and includes
compensation expense of $5.6 million ($3.3 million after-tax) and $2.0 million
($1.2 million after-tax), respectively, ($ in 000's, except for earnings per
share data):

<TABLE>
<CAPTION>

                                                             1997               1996
                                                       ---------------     ---------------

<S>                                                       <C>                <C>
Pro forma net loss...............................         $   (9,687)        $ (234,464)
Pro forma net loss per share:
   Basic and Assuming dilution...................              (0.18)             (5.98)


</TABLE>

         WARRANTS AND CONVERTIBLE SECURITIES - As of December 31, 1997, the
Company had outstanding warrants to purchase 422,286 shares of Common Stock at
an exercise price ranging from $.01 to $9.00 per share and expiring from June
1, 1999 through December 31, 2003. In addition, it had certain outstanding
rights or securities which are convertible into 60,067 shares of Common Stock.

NOTE 14. EMPLOYEE BENEFIT PLANS

         The Company has a defined contribution 401(k) retirement plan covering
all eligible employees at its hospitals and the corporate office. Pursuant to
an amendment effective April 1, 1997, participants may contribute up to 15% of
pretax compensation, not exceeding a limit set annually by the Internal Revenue
Service. The Company matches $.25 for each $1.00 of employee contributions up
to 6% of employees' gross pay and may make additional discretionary
contributions. Total expense for employer contributions to the plan for 1997,
1996 and 1995 was $1.6 million, $1.3 million and $1.5 million, respectively.




                                      61
<PAGE>   62


         The Company has a supplemental executive retirement plan ("SERP") to
provide additional post-termination benefits to a selected group of management
and highly compensated employees. As a result of a change in control from the
Merger, officers and employees of the Company who were participants in the SERP
prior to the Merger became fully vested in all benefits thereunder. During 1996,
the Company recognized Merger expenses of $5.1 million related to the vesting of
such benefits. Pursuant to their respective employment agreements, certain
Champion executives became participants in the SERP and received retroactive
benefits for their years of service with Champion. The Company capitalized
approximately $1.9 million of such non-cash charges as part of the purchase
price of Champion. In April 1997, the Board of Directors elected to terminate
the provision of future benefits for certain participants under the plan which
resulted in a plan curtailment. Such curtailment substantially offset plan
expenses of $1.75 million for the year ended December 31, 1997, resulting in net
expenses under the plan of approximately $141,000 in 1997. Total expenses for
the plan were $1.1 million and $850,000 for the years ended December 31, 1996
and 1995, respectively.


NOTE 15. COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS' LITIGATION - The Company and Champion are defendants in a class
action lawsuit filed in April 1996 in the Court of Chancery of the State of
Delaware in and for New Castle County by a Champion stockholder. This lawsuit
alleges, among other things, that the Merger and the consideration to be paid
to Champion's stockholders was unfair and grossly inadequate and that the
defendants violated their fiduciary duties to Champion and the stockholders of
Champion. In this action, the plaintiff seeks to rescind the Merger transaction
or award Champion stockholders rescissory damages, plus costs and attorneys'
fees.

         Since October 11, 1996, a number of complaints have been filed against
the Company by current or former stockholders of the Company relating to the
Merger of the Company and Champion. Seven of these complaints purport to be
class actions filed on behalf of persons who, between August 13, 1996 and
October 9, 1996, received the Company's common stock through the Merger with
Champion, purchased common stock, or purchased the Company's $325 million 10%
Senior Subordinated Notes (the "Notes"). Two other complaints purport to be
derivative actions filed on behalf of Champion. Two of the putative class
action complaints were filed in the Superior Court of the State of California,
County of Los Angeles, one in the District Court of Harris County, Texas and
four in the United States District Court for the Southern District of Texas,
Houston Division. The only currently active class action lawsuit is in the U.S.
District Court for the Southern District of Texas, where plaintiffs filed a
Consolidated Class Action Compliant captioned In re Paracelsus Corp. Securities
Litigation, Master File No. H-96-3464, which consolidated and amended the
earlier federal class action complaints. The three state court class actions
have since been suspended in deference to the Federal class action. The two
derivative complaints are also pending in the U.S. District Court for the
Southern District of Texas under the captions Caven v.
Miller, No. H-96-4291, and Orovitz v. Miller, No. H-97-2752.

         The federal stockholder class action complaint asserts claims against
the Company under sections 11 and 12(a)(2) of the Securities Act of 1933, and
claims against certain existing and former officers and directors of the
Company under sections 11 and 15 of the Securities Act of 1933. The Company has
terminated an agreement with representatives of certain stockholder claimants
tolling the statute of limitations as to certain other unasserted claims. The
plaintiffs allege that during the class period the defendants disseminated
materially misleading statements and omitted disclosing material facts about
the Company and its business, specifically in the reporting and disclosure of
reserves, bad debt expenses, collection expenses and facility closure costs,
and that the price of the Company's common stock was artificially inflated. The
plaintiffs also allege that statements contained in the various registration
statements and prospectuses for securities offerings during the class period
were materially inaccurate and misleading. The plaintiffs seek damages in an
unspecified amount and equitable or injunctive relief, plus costs and
attorneys' fees. The derivative actions assert various state law claims against
the Company, certain of its existing and former officers and directors or their
affiliates, and other




                                      62
<PAGE>   63


persons. Defendants moved to dismiss certain of the class action and derivative
claims. In ruling on defendants' motions to dismiss, the federal court granted
dismissal of the claims involving the sale of subordinated notes, but permitted
all other claims in the federal actions to proceed to discovery.

         In light of the Company's restatement of financial information
contained in the various registration statements and prospectuses, the Company
believes an unfavorable outcome is probable for at least some of the claims
asserted in the stockholder class action. Efforts to settle the stockholder
claims are ongoing. Absent such a settlement within the Company's financial
resources, the Company will continue to defend the litigation vigorously. Many
factors will ultimately affect and determine the results of the litigation, and
the Company can provide no assurance that the results will not have a material
adverse effect on the Company.

OTHER LITIGATION - In October 1995, two former hospital employees of the
Company (the "relators") filed a civil complaint under seal on behalf of the
United States and the State of California against Paracelsus, certain of its
subsidiaries, and others in the United States District Court for the Central
District of California. The Company did not learn of the case until late July
1997 after the Court permitted the United States to provide a copy of the
complaint to the defendants solely for purposes of settlement negotiations.
Shortly after the Company learned of the complaint, the Company received a
subpoena from the Office of the Inspector General of the Department of Health
and Human Services seeking documents relating to certain of the same matters.

         Without relinquishing its rights to assert a vigorous defense, the
Company is engaged in discussions with counsel for the United States to
determine whether the parties can reach a mutually acceptable settlement. Those
discussions have been devoted to a substantially narrower set of issues than
those alleged in the complaint and have related exclusively to certain alleged
practices at three Los Angeles area hospitals that are currently closed and/or
held for sale. The relators have various rights in this type of case, including
a right to object to a settlement and continue litigating any issues not
resolved by it. The Court must determine the fairness and adequacy of any
settlement.

         The Company is not currently able to predict whether the above
litigation will settle or whether the outcome, by settlement or litigation,
will have a material adverse effect on the Company.

         On September 10,1997, twelve health care insurers and/or
administrators filed an action encaptioned Blue Cross and Blue Shield United of
Wisconsin et al. v. Paracelsus Healthcare Corporation, Case No. 97-6760 SVW
(RCx), in the United States District Court for the Central District of
California against the Company and two of its subsidiaries. Plaintiffs allege
that over many years Defendants fraudulently induced them to make payments
under their members' plans through a variety of allegedly improper practices,
principally in connection with certain psychiatric treatment and alcohol or
chemical dependency programs previously operated at the Company's psychiatric
hospitals in the Los Angeles area. The alleged improper practices include
systematic waiver of co-insurance obligations and misrepresentation of
patients' symptoms, conditions, diagnosis and/or treatment. Plaintiffs assert
claims under the Racketeer Influenced and Corrupt Organizations Act ("RICO")
and the Employee Retirement Income Security Act ("ERISA"), as well as for
fraud, negligent misrepresentation, unjust enrichment, and conversion.

         On February 13, 1998, the court granted, in major part, the Company's
motion to dismiss the Complaint. Of Plaintiffs' seven claims for relief, the
court dismissed six for inadequate pleading and, in one case, for failure to
state a claim. Only Plaintiffs' ERISA claim was allowed to stand. The court
also ruled that Plaintiffs had failed adequately to explain their failure to
discover the alleged misconduct within the applicable statutes of limitations,
thereby limiting their fraud claims to those arising after September 10, 1994,
and RICO claims to those arising after September 10, 1993. The court permitted
the Plaintiffs to replead their claims.



                                      63
<PAGE>   64


         On March 10, 1998, Plaintiffs filed their First Amended Complaint
restating each of their causes of action. In their First Amended Complaint,
Plaintiffs seek damages exceeding $30.5 million, treble damages under RICO,
restitution under ERISA, together with reasonable attorneys' fees and various
costs and expenses. The Company does not believe Plaintiffs have cured the
defects in their original Complaint and intends to file a motion to dismiss the
First Amended Complaint, including the ERISA claim, on grounds that Plaintiffs
have still not pleaded their claims with sufficient particularity and still not
adequately explained their failure to discover the alleged misconduct within
the applicable statutes of limitations. If the motion is unsuccessful, the
Company intends vigorously to defend the action.

         The Company is currently unable to predict the litigation's outcome or
whether any adverse outcome will have a materially adverse effect on the
Company.

         With respect to the Other Litigation discussed above, the Company has
recorded $5.7 million as an estimate of the ultimate resolution of such
litigation, including an estimate for legal fees. However, there can be no
assurance that the ultimate liability regarding these matters will not exceed
the Company's estimate. Such amount is reflected under the caption,
"Discontinued operations - Loss on disposal of discontinued psychiatric
hospitals, net" in the Company's Consolidated Statement of Operations.

         PROFESSIONAL AND LIABILITY RISKS - The Company is subject to claims
and suits in the ordinary course of business, including those arising from care
and treatment afforded at its facilities. The Company maintains insurance and,
where appropriate, reserves with respect to the possible liability arising from
such claims. For periods from October 1992 to December 1996, the Company,
excluding the former Champion entities, insured the first $500,000 of general
and professional liability claims through its wholly owned subsidiary, Hospital
Assurance Company Ltd. ("HAC"). The Company had third-party excess insurance
coverage over the first $500,000 per occurrence up to $100 million. Commencing
January 1, 1997, pursuant to the Company's plan to cease all underwriting
activity of HAC, the Company became self-insured for the first $1 million of
general and professional liability claims, with excess insurance amounts up to
$100 million covered by a third party insurance carrier, including all claims
incurred but not reported as of December 31, 1996 for all subsidiaries,
including Champion. The Company is self-insured for reported claims related to
former Champion facilities for periods prior to 1997 up to $1.0 million per
occurrence and $4.0 million in the aggregate, with amounts in excess of $1.0
million but less than $10 million covered by a third party insurance carrier.
Effective October 1, 1997, the Company changed its professional and general
liability insurance carrier. The Company continues to self-insure the first
$1.0 million per occurrence of general and professional liability claims and
$4.0 million in the aggregate; however, excess insurance amounts up to $50.0
million are now covered by third party insurance carriers. The Company accrues
an estimated liability for its uninsured exposure and self-insured retention
based on historical loss patterns and actuarial projections.

         The Company believes that its insurance and loss reserves are adequate
to cover potential claims that may be asserted and that the outcome of such
claims will not have a material effect on the Company's financial position,
results of operations or cash flows.

NOTE 16. CERTAIN RELATED PARTY TRANSACTIONS

         The Company paid dividends of $24.9 million and $5.4 million to the
Former Sole Shareholder during the years ended December 31, 1996 and 1995,
respectively. The Company also paid accrued interest of $104,000 to the Former
Sole Shareholder in connection with the dividend paid in August 1996, pursuant
to the terms of the Merger agreement. After receipt of the dividend paid in
August 1996 and pursuant to a related agreement, the Former Sole Shareholder
paid approximately $3.0 million plus accrued interest in full satisfaction of a
note payable to the Company. Additionally, the Former Sole Shareholder loaned
the Company $7.2 million and received a $7.2 million 6.51% subordinated note
from the Company (See Note 9).




                                      64
<PAGE>   65


         Effective August 1996, the Company is a party to an agreement with Dr.
Krukemeyer, pursuant to which he provides management and strategic advisory
services to the Company for an annual consulting fee of $1.0 million, for a term
not to exceed ten years. Effective April 15, 1997, the annual consulting fee to
Dr. Krukemeyer was reduced to $250,000 until all obligations of the Company
under the Restated Credit Agreement have been satisfied. Payments of $500,000
and $375,000 were made to Dr. Krukemeyer during 1997 and 1996, respectively.

         Prior to the consummation of the merger with Champion, the Company was
a party to an Amended and Restated Know-how Contract with Paracelsus Klinik, a
sole proprietorship owned by Dr. Krukemeyer, which provided for the transfer of
specified know-how to the Company for an annual payment of the lesser of
$400,000 or 0.75% of Paracelsus' net operating revenue, as defined in the
Know-how Contract. Such contract was terminated in August 1996. Payments of
$250,000 and $400,000 were made to Paracelsus Klinik during 1996 and 1995,
respectively.



NOTE 17. SUBSEQUENT EVENTS

         In March 1998, the Company entered into an Amended and Restated Credit
Agreement, which provides for a $180.0 million Reducing Revolving Credit
Facility and $75.0 million Term Loan Facilities (See Note 9).

         On February 27, 1998, the Company's wholly owned subsidiary, HAC,
entered into an agreement with a third party insurance carrier to commute any
and all remaining workers compensation liabilities of HAC. The agreement, which
was effective January 1, 1998, provided that HAC would pay the third party
insurance carrier $1.8 million, in return the insurance carrier assumed all of
HAC remaining workers compensation liabilities (recorded and unrecorded) which
totaled $1.8 million at January 1, 1998. Accordingly, the Company expects to
complete its wind down of HAC in early 1998.




                                      65
<PAGE>   66


NOTE 18. QUARTERLY DATA (UNAUDITED)

         The following table summarizes the Company's quarterly financial data
for the years ended December 31, 1997 and 1996 ($ in 000's, except per share
data):

<TABLE>
<CAPTION>

                                                                                           INCOME (LOSS) PER SHARE
                                                                                 ---------------------------------------------
                                       INCOME
                                       (LOSS)
                                        FROM                            NET                                           NET
                          NET        CONTINUING     DISCONTINUED       INCOME      CONTINUING     DISCONTINUED      INCOME
      QUARTERS          REVENUE      OPERATIONS      OPERATIONS        (LOSS)      OPERATIONS      OPERATIONS       (LOSS)
------------------------------------------------------------------------------------------------------------------------------
<S>                    <C>          <C>             <C>               <C>          <C>            <C>             <C>
First Quarter -

    1997               $168,490     $    5,168      $       --        $   5,168    $    0.09      $      --       $  0.09
    1996(a)             115,323         (2,927)        (11,422)         (14,349)       (0.10)         (0.38)        (0.48)

Second Quarter -
    1997(b)             167,256         (3,017)             --           (3,017)       (0.05)            --         (0.05)
    1996                119,863         (1,237)         (3,925)          (5,162)       (0.04)         (0.13)        (0.17)

Third Quarter -
    1997                166,661            138              --              138           --             --            --
    1996(c)             126,008        (45,348)        (19,196)         (69,101)       (1.08)         (0.45)        (1.63)

Fourth Quarter -
    1997(d) (e)         156,812         (3,445)         (5,243)          (8,688)       (0.06)         (0.10)        (0.16)
    1996(f)             131,912       (104,985)        (36,452)        (144,604)       (1.92)         (0.67)        (2.64)

</TABLE>

-------------------------
(a)  Includes an after-tax charge for settlement costs of $13.2 million ($0.44
     per share)  relating to certain lawsuits.
(b)  Includes after-tax unusual charges of $3.5 million ($0.07 per share),
     consisting of $2.0 million ($0.04 per share) relating to the closure of a
     hospital and $1.5 million ($0.03 per share) relating to a corporate
     reorganization.
(c)  Includes net aggregate after-tax non-recurring charges of $40.1 million
     ($0.95 per share), consisting of impairment charge of $7.9 million ($0.18
     per share), merger costs of $27.6 million ($0.65 per share) and
     extraordinary loss from early extinguishment of debt of $4.6 million
     ($0.11 per share). Quarterly results also include $4.5 million ($0.11 per
     share) recorded for contractual expenses related to revised estimates of
     allowances on accounts receivable under the Medicare and Medicaid programs
     for periods prior to the quarter ended September 30, 1996.
(d)  Includes after-tax unusual charges consisting of a reversal of a loss
     contract accrual of $9.2 million ($0.17 per share), offset by a charge of
     $1.8 million ($0.03 per share) for the settlement of certain litigation.
     Quarterly results also include an after-tax impairment charge of $4.6
     million ($0.08 per share), and contractual expenses of $2.8 million ($0.05
     per share) to revise estimates of amounts due to the Company with respect
     to Medicare/Medicaid receivables, the majority of which relate to prior
     years, and other after-tax charges totaling $1.4 ($0.03 per share) million
     attributable to the enactment of the Balanced Budget Act of 1997 effective
     October 1, 1997 and other recently announced initiatives by the Federal
     government with respect to reimbursement practices and policies.
(e)  Discontinued operations includes an after-tax disposal loss of $5.2
     million ($0.09 per share) on these facilities, consisting of an impairment
     charge of $1.9 ($0.03 per share) million to reduce psychiatric hospital
     assets to their estimated net realizable value based upon the most recent
     offers from third party purchasers and a charge of $3.3 ($0.06 per share)
     million relating to certain outstanding litigation matters.
(f)  Includes net aggregate after-tax non-recurring charges of $78.8 million
     ($1.43 per share), consisting of an accrued loss for a loss contract of
     $27.0 million ($0.49 per share), additional impairment charge of $41.9
     million ($0.76 per share), expenses for Special Committee's investigation
     and other litigation matters of $14.2 million ($0.26 per share), net of
     reversal of excess merger costs of $4.3 million ($0.08 per share).
     Quarterly results also include $15.7 million ($0.29 per share) recorded
     for contractual expenses related to revised estimates of allowances on
     accounts receivable under the Medicare, Medicaid and other programs for
     periods prior to the quarter ended December 31, 1996.




                                      66
<PAGE>   67


         The results of Champion have been included in the operations of the
Company since August 16, 1996. Per share data for quarters prior to the quarter
ended September 30, 1996 have been restated to reflect the 66,159.426-for-one
stock split in August 1996.

         Quarterly operating results are not necessarily representative of
operations for a full year for various reasons including levels of occupancy,
fluctuations in interest rates, and acquisitions and divestitures.

NOTE 19. RECENT PRONOUNCEMENT

         In June 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income", which is effective for financial statements for periods
beginning after December 15, 1997 and which will apply to the Company beginning
with its fiscal year ending December 31, 1998.

         SFAS No.130 establishes standards for reporting and display of
comprehensive income and its components in a full set of general purpose
financial statements. Comprehensive income includes net income and is defined
as the change in net assets of a business enterprise during a period from
transactions and other events and circumstances from nonowner sources. It
includes all changes in equity during a period except those from investments by
owners and distributions to owners. Examples of comprehensive income, other
than net income, include unrealized gains and losses on certain investments in
debt and equity securities and foreign currency items.





                                      67
<PAGE>   68



                       CONSOLIDATED FINANCIAL STATEMENTS

                         DAKOTA HEARTLAND HEALTH SYSTEM

                     YEARS ENDED DECEMBER 31, 1997 AND 1996





                                      68
<PAGE>   69
                         Dakota Heartland Health System

                       Consolidated Financial Statements


                     Years ended December 31, 1997 and 1996


                                    CONTENTS


<TABLE>
<S>                                                                                                    <C>
Report of Independent Auditors..........................................................................70

Consolidated Financial Statements

Consolidated Balance Sheets.............................................................................71
Consolidated Statements of Income.......................................................................72
Consolidated Statements of Partners Equity..............................................................73
Consolidated Statements of Cash Flows...................................................................74
Notes to Consolidated Financial Statements..............................................................75

</TABLE>











                                       69
<PAGE>   70




                         Report of Independent Auditors

Board of Governors
Dakota Heartland Health System

We have audited the accompanying consolidated balance sheets of Dakota
Heartland Health System (the "Partnership") as of December 31, 1997 and 1996,
and the related consolidated statements of income, partners' equity, and cash
flows for the years then ended. Our audits also included the financial
statement schedule listed in the index at Item 14(a).These financial statements
are the responsibility of the Partnership's management. Our responsibility is
to express an opinion on these financial statements 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 financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Dakota Heartland
Health System at December 31, 1997 and 1996, and the results of its operations
and its cash flows for the years then ended in conformity with generally
accepted accounting principles. Also, in our opinion, the related financial
statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.


/s/ ERNST & YOUNG LLP
ERNST & YOUNG LLP

Houston, Texas
February 12, 1998


                                       70
<PAGE>   71



                         Dakota Heartland Health System

                          Consolidated Balance Sheets

<TABLE>
<CAPTION>


                                                                        DECEMBER 31
                                                                  1997             1996
                                                               -----------     -----------
<S>                                                            <C>             <C>
ASSETS
Current assets:
   Cash and cash equivalents                                   $ 7,276,675     $ 6,718,589
   Patient receivables, net of allowance for uncollectible
      accounts of $1,278,500 and $3,260,600 in 1997 and
       1996, respectively                                       14,374,894      16,929,466
   Supplies inventory                                            2,197,815       1,995,829
   Prepaid expenses and other current assets                     1,833,996       1,912,492
                                                               -----------     -----------

Total current assets                                            25,683,380      27,556,376

Property and equipment, net                                     60,663,177      58,034,774
Other assets:
   Investment in and advances to affiliates                      2,316,137       2,024,918
   Organizational costs, less accumulated amortization
     of $435,300 and $220,200 in 1997 and
     1996, respectively                                            640,186         855,282
   Other                                                           234,915         180,264
                                                               -----------    ------------
Total assets                                                   $89,537,795     $88,651,614
                                                               ===========     ===========

LIABILITIES AND PARTNERS' EQUITY
Current liabilities:
   Accounts payable                                            $ 5,017,075     $ 5,336,625
   Estimated third-party payor settlements                       2,905,822       2,125,946
   Accrued salaries and benefits                                 2,999,265       3,282,720
   Other current liabilities                                     2,923,616       2,280,017
                                                               -----------     -----------
Total current liabilities                                       13,845,778      13,025,308

Partners' equity                                                75,692,017      75,626,306
                                                               -----------     -----------
Total liabilities and partners' equity                         $89,537,795     $88,651,614
                                                               ===========     ===========

</TABLE>




See accompanying notes.


                                      71
<PAGE>   72



                         Dakota Heartland Health System

                       Consolidated Statements of Income

<TABLE>
<CAPTION>
                                                 YEAR ENDED DECEMBER 31
                                                  1997             1996
                                               ---------        ---------

Revenue:

<S>                                         <C>              <C>
   Net patient service revenue              $ 96,172,447     $103,008,100
   Other revenue                               3,754,498        3,598,743
                                            ------------     ------------
Net revenue                                   99,926,945      106,606,843

Expenses:
   Salaries and benefits                      36,509,074       36,722,276
   Professional fees                          12,351,437       15,084,913
   Supplies                                   17,218,273       16,868,015
   Depreciation and amortization               4,595,021        3,702,282
   Provision for uncollectible accounts        3,407,198        4,301,097
   Repairs and maintenance                     1,416,805        1,214,847
   Utilities                                   1,298,086        1,295,912
   Rent and leases                             1,244,227        1,618,966
   Property taxes                                993,731          800,288
   Other                                       3,085,405        2,927,245
                                            ------------     ------------
Total expenses                                82,119,257       84,535,841
                                            ============     ============
Net income                                  $ 17,807,688     $ 22,071,002
                                            ============     ============

</TABLE>




See accompanying notes.


                                      72

<PAGE>   73



                         Dakota Heartland Health System

                  Consolidated Statements of Partners' Equity


<TABLE>
<CAPTION>
                                           PARACELSUS         DAKOTA
                                            HEALTHCARE        MEDICAL
                                           CORPORATION        FOUNDATION            TOTAL
                                         ------------------------------------------------
<S>                                      <C>               <C>               <C>
Partners' equity at January 1, 1996      $ 48,144,648      $ 26,679,864      $ 74,824,512
   Net income                              12,139,051         9,931,951        22,071,002
   Partners' distributions                (11,698,064)       (9,571,144)      (21,269,208)
                                         ------------      ------------      ------------
Partners' equity at December 31, 1996      48,585,635        27,040,671        75,626,306
   Net income                               9,794,228         8,013,460        17,807,688
   Partners' distributions                 (9,758,087)       (7,983,890)      (17,741,977)
                                         ------------      ------------      ------------
Partners' equity at December 31, 1997    $ 48,621,776      $ 27,070,241      $ 75,692,017
                                         ============      ============      ============

</TABLE>




See accompanying notes.





                                       73
<PAGE>   74



                         Dakota Heartland Health System

                     Consolidated Statements of Cash Flows


<TABLE>
<CAPTION>
                                                                     YEAR ENDED DECEMBER 31
                                                                    1997              1996
                                                                ------------------------------
<S>                                                             <C>               <C>
OPERATING ACTIVITIES
Net income                                                      $ 17,807,688      $ 22,071,002
Adjustments to reconcile net income to net cash provided by
   operating activities:
      Depreciation and amortization                                4,595,021         3,702,282
      Loss (gain) on sale of property and equipment                   24,044          (353,663)
      Provision for uncollectible accounts                         3,407,198         4,301,097
      Minority interest                                                   --           103,072
      Changes in operating assets and liabilities:
         Patient receivables, net                                   (482,951)       (3,891,281)
         Supplies inventory                                         (201,986)         (393,043)
         Prepaid expenses and other current assets                  (291,179)         (909,473)
         Other assets                                                (54,651)         (159,321)
         Accounts payable                                           (319,550)       (7,043,391)
         Estimated third-party payor settlements                     779,876           117,770
         Accrued salaries and benefits                              (283,455)         (265,785)
         Other current liabilities                                   643,599           236,223
                                                                ------------      ------------
Net cash provided by operating activities                         25,623,654        17,515,489

INVESTING ACTIVITIES
Purchase of property and equipment                                (7,076,757)       (9,022,461)
Payment for organizational costs                                          --            (5,189)
Proceeds from sale of property and equipment                          44,385           750,000
Increase in investments and advances to affiliates                  (291,219)         (312,907)
                                                                ------------      ------------
Net cash used in investing activities                             (7,323,591)       (8,590,557)

FINANCING ACTIVITIES
Partners' distributions                                          (17,741,977)      (21,269,208)
                                                                ------------      ------------
Increase (decrease) in cash and cash equivalents                     558,086       (12,344,276)
Cash and cash equivalents at beginning of year                     6,718,589        19,062,865
                                                                ------------      ------------
Cash and cash equivalents at end of year                        $  7,276,675      $  6,718,589
                                                                ============      ============

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for taxes                                             $    579,743      $    601,763
                                                                ============      ============
</TABLE>


See accompanying notes.


                                      74
<PAGE>   75




                         Dakota Heartland Health System

                   Notes to Consolidated Financial Statements


                                December 31, 1997


1. ORGANIZATION AND ACCOUNTING POLICIES

On December 21, 1994, Dakota Heartland Health System (the "Partnership"), a
general partnership, was formed by a wholly-owned subsidiary of Champion
Healthcare Corporation ("Champion") that owned Heartland Medical Center, a
140-bed general acute facility in Fargo, North Dakota, and Dakota Medical
Foundation (the "Foundation"), a not-for-profit corporation that owned Dakota
Hospital, a 199-bed general acute care hospital also in Fargo, North Dakota.
Champion and the Foundation contributed certain assets and liabilities,
excluding long-term debt except capital leases, of their respective hospitals,
and Champion contributed an additional $20 million in cash, each in exchange
for 50% ownership in the Partnership. The Partnership then made a $20 million
cash distribution to the Foundation. On December 21, 1994, Champion entered
into an operating agreement with the Partnership to manage the combined
operations of the two hospitals. Champion will receive 55% of the net income
and distributable cash flow ("DCF") of the Partnership until such time as it
has recovered, on a cumulative basis, an additional $10 million of DCF in the
form of an "excess" distribution. In 1996, Paracelsus Healthcare Corporation
("Paracelsus") became the sole owner of Champion.

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of Dakota Heartland
Health System and Dakota Health Enterprises, a wholly-owned subsidiary of the
Partnership.

USE OF ESTIMATES

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and the disclosure
of contingent assets and liabilities at the date of the financial statements.
Estimates also affect the reported amounts of revenue and expenses during the
reporting period. Although estimates are considered to be fairly stated at the
time that the estimates are made, actual results could differ from those
estimates.

CASH AND CASH EQUIVALENTS

The Partnership considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents.

SUPPLIES INVENTORY

Supplies inventory is stated at the lower of cost or market, with cost
determined substantially on a first-in, first-out basis.




                                      75

<PAGE>   76

                         Dakota Heartland Health System

             Notes to Consolidated Financial Statements (continued)




1. ORGANIZATION AND ACCOUNTING POLICIES (CONTINUED)

PROPERTY AND EQUIPMENT

Property and equipment acquisitions are recorded at cost at the date of
receipt. Depreciation is provided using the straight-line method over the
estimated useful lives of the respective assets, ranging from 4 to 25 years.
Maintenance and repairs are charged to expense as incurred, while renewals and
improvements are capitalized.

INCOME TAXES

The Partnership's income is attributed to its partners for income tax purposes.
Accordingly, it has not accrued any liability for income taxes. An entity owned
by the Partnership has paid income taxes of $579,743 and $601,763 in 1997 and
1996, respectively.

RECLASSIFICATIONS

Certain reclassifications were made to the 1996 financial statements to conform
to 1997 presentation. The reclassifications had no effect on net income or
partners' equity as previously reported.

2. NET PATIENT SERVICE REVENUE

The Partnership has entered into agreements with third-party payors, including
the Medicare and Medicaid programs and managed care health plans.

Net patient service revenue is recorded at an estimated amount due from
patients and third-party payors for health care services provided, including
anticipated settlements under reimbursement agreements with third-party payors.
Final settlements under Medicare and Medicaid programs are subject to
administrative review and audit. The Partnership records adjustments, if any,
resulting from such review or audits during the period in which these
adjustments become known. Allowances for contractual adjustments under these
programs are netted in accounts receivable in the accompanying balance sheets.
It is management's opinion that adequate allowance has been provided for
possible adjustments that might result from final settlements under these
programs.

Revenues from the Medicare and Medicaid programs accounted for approximately
59% and 58% of the Partnership's gross patient service revenues for the years
ended December31, 1997 and 1996, respectively.



                                      76


<PAGE>   77

                         Dakota Heartland Health System

             Notes to Consolidated Financial Statements (continued)



2. NET PATIENT SERVICE REVENUE (CONTINUED)

Laws and regulations governing the Medicare and Medicaid programs are complex
and subject to interpretation. The Partnership believes that it is in
compliance with all applicable laws and regulations and is not aware of any
pending or threatened investigations involving allegations of potential
wrongdoing. While no such regulatory inquiries have been made, compliance with
such laws and regulations can be subject to future government review and
interpretation as well as significant regulatory action including fines,
penalties, and exclusion from the Medicare and Medicaid programs.

3. PROPERTY AND EQUIPMENT

A summary of property and equipment as of December 31 is as follows:

<TABLE>
<CAPTION>


                                                     1997                    1996
                                                ---------------        ---------------
<S>                                             <C>                    <C>
Land and land improvements                      $     4,422,702        $     3,877,436
Buildings and improvements                           37,982,088             31,364,052
Equipment                                            44,136,854             42,566,533
Construction-in-progress                              3,186,823              6,227,553
                                                ---------------        ---------------
                                                     89,728,467             84,035,574
Less accumulated depreciation                        29,065,290             26,000,800
                                                ---------------        ---------------
                                                $    60,663,177        $    58,034,774
                                                ===============        ===============
</TABLE>


4. INVESTMENTS IN AND ADVANCES TO AFFILIATES

The Partnership has an ownership interest in several entities. Investments in
these entities are recorded on the equity method. Investments in and advances
to affiliates consisted of the following at December 31:


<TABLE>
<CAPTION>
                                                     1997                    1996
                                                ---------------        ---------------
<S>                                             <C>                    <C>
Country Health, Inc.                            $       921,249        $       785,215
Dakota Day Surgery ("DDS")                              574,494                577,971
Dakota Outpatient Center ("DOC")                        478,562                441,175
Health Care Incinerators, Inc./Thom Linen               341,832                220,557
                                                ---------------        ---------------
                                                $     2,316,137        $     2,024,918
                                                ===============        ===============
</TABLE>



                                      77

<PAGE>   78


                         Dakota Heartland Health System

             Notes to Consolidated Financial Statements (continued)



4. INVESTMENTS IN AND ADVANCES TO AFFILIATES (CONTINUED)

The Partnership has a 50% interest in DOC, a general partnership which owns and
operates a medical and office building. As a general partner, the Partnership
is contingently liable on an outstanding note of DOC. As of December31, 1997,
the balance of the note was $1,931,695.

DOC also leases its real property to the Partnership under a noncancelable
ten-year net operating lease. As of December31, 1997, future minimum annual
lease payments are $102,540 for 1998. The Partnership incurred rental expense
of $102,540 in each of 1997 and 1996, related to the lease agreement.

The Partnership also has a 50% interest in DDS, a general partnership, which
provides outpatient surgical services. As a general partner, the Partnership is
contingently liable to cover any operating losses of DDS. In 1997 DDS had
operating income.

5. EMPLOYEE BENEFIT PLAN

The Dakota Heartland Health System Performance Plan (the "Plan") was adopted by
the Partnership (the "Plan Sponsor") effective April 1, 1995 and is a trusteed,
defined contribution plan. Participation in the Plan generally is available to
each employee who is at least 21 years old and after completion of one year of
service, with a minimum of 1,000 service hours annually.

Contributions consist of employee and employer contributions. Participants may
contribute from 1% to 15% of pretax annual compensation, as defined in the
Plan, up to a maximum of $9,500 in the 1997 Plan year. The Partnership expensed
$261,000 and $262,000 to the Plan in 1997 and 1996, respectively. Additional
amounts may be contributed at the option of the Partnership's board of
governors. Contributions are subject to certain limitations.

6. COMMITMENTS AND CONTINGENCIES

The Partnership has claims-made basis coverage for professional and
institutional liabilities and occurrence-based coverage for personnel liability
through a commercial carrier with limits of $1 million per occurrence and $3
million in aggregate per policy year. At December 31, 1997, the Partnership
could have some potential exposure on incidents that may have occurred for
which claims are made in the future. However, at this time, no accrual is
deemed necessary by management.




                                      78

<PAGE>   79


                         Dakota Heartland Health System

             Notes to Consolidated Financial Statements (continued)




6. COMMITMENTS AND CONTINGENCIES (CONTINUED)

On August 20, 1997, the Foundation exercised its right to require Paracelsus to
purchase the Foundation's 50% ownership interest in the Partnership. Paracelsus
has negotiated a purchase price of $64.5 million, inclusive of working capital,
and expects to complete the transaction by August 1998. If the purchase is not
completed within the allowable period, the Foundation can exercise various
options, including seeking remedies available at law against Paracelsus for
breach of its obligation.

7. CONCENTRATION OF CREDIT RISK

The Partnership grants credit without collateral to its patients, most of whom
are local residents and are insured under third-party payor agreements. Credit
risk on accounts receivable is limited because the majority of the receivable
balances are due from government agencies, commercial insurance companies, and
managed care organizations. The Partnership continually monitors and adjusts
its allowances associated with these receivable balances. Significant
concentrations of receivable balances due from payors at December 31, 1997 and
1996 include 33% and 26%, respectively, from the Medicare program, 9% and 13%,
respectively, from the Medicaid program, and 20% and 27% respectively, from the
Blue Cross/Blue Shield programs.

8. YEAR 2000 (UNAUDITED)

As a result of a computer conversion and purchase of computer hardware, the
Partnership expects that its critical data processing systems will be Year
2000-compliant during 1999. In addition, the Partnership has begun the process
of developing an approach relating to its significant vendors to determine the
extent to which the Partnership's systems may be vulnerable to third parties'
failure to remediate their own Year 2000 issues. Operating results could be
impacted if its equipment or the systems of third parties with whom the
Partnership transacts business are not compliant in a timely manner.



                                      79
<PAGE>   80
ITEM 9.     CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
             ACCOUNTING AND FINANCIAL DISCLOSURE

         None.

                                    PART III


ITEM 10.     DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         The information required by this Item is (i) incorporated herein by
reference from the Company's Proxy Statement to be filed by April 30, 1998 with
the Securities and Exchange Commission and (ii) as set forth under "Executive
Officers of the Registrant" in Part I of this Report.

ITEM 11.     EXECUTIVE COMPENSATION

         The information required by this Item is incorporated herein by
reference from the Company's Proxy Statement to be filed by April 30, 1998 with
the Securities and Exchange Commission.

ITEM 12.     SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The information required by this Item is incorporated herein by
reference from the Company's Proxy Statement to be filed by April 30, 1998 with
the Securities and Exchange Commission.

ITEM 13.     CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         The information required by this Item is incorporated herein by
reference from the Company's Proxy Statement to be filed by April 30, 1998 with
the Securities and Exchange Commission.

                                    PART IV

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

(a)(1) FINANCIAL STATEMENTS

         See Item 8 of this Report.

(a)(2) FINANCIAL STATEMENT SCHEDULE

         Schedule II - Valuation and Qualifying Accounts

         All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are not
required under the related instructions, are inapplicable or have been
disclosed in the consolidated financial statements and notes thereto and
therefore have been omitted.

(a)(3)  EXHIBITS

3.4 (a)       Amended and Restated Articles of Incorporation of Paracelsus.

3.5 (a)       Amended and Restated Bylaws of Paracelsus.




                                      80
<PAGE>   81





4.1 (a)       Indenture, dated August 16, 1996 between Paracelsus and
              AmSouth Bank of Alabama, as Trustee (including the form of
              certificate representing the 10% Senior Subordinated Notes due
              2006).

4.2 (b)       Shareholder Protection Rights Agreement between Paracelsus and
              ChaseMellon Shareholder Services, L.L.C, as Rights Agent.

4.5 (c)       Form of Warrant issued pursuant to Champion Series E Note
              Purchase Agreement, dated May 1, 1995, as amended.

4.6 (d)       Form of Warrant issued pursuant to Champion Series D Note and
              Stock Purchase Agreement dated December 31, 1993, as amended.

4.9 (e)       Certificate representing Common Stock.

10.1 (e)      Pooling Agreement, dated as of April 16, 1993 among PHC
              Funding Corp. II ("PFC II"), Sheffield Receivables Corporation
              and Bankers Trust Company, as trustee (the "Trustee").

10.2 (e)      Servicing Agreement, dated as of April 16, 1993, among
              PFC II, Paracelsus and the Trustee.

10.3 (e)      Guarantee, dated as of April 16, 1993, by Paracelsus in
              favor of PFC II.

10.4 (e)      Sale and Servicing Agreement between subsidiaries of
              Paracelsus and PFC II.

10.5 (e)      Subordinate Note by PFC II in favor of Hospitals.

10.8 (a)      $400 Million Reducing Revolving Credit Facility, dated as of
              August 16, 1996, among Paracelsus, Bank of America National Trust
              and Savings Association, as agent, and other lenders named
              therein (10.1).

10.9 (r)      First Amendment to Credit Agreement, dated as of April 14,
              1997, among Paracelsus, Bank America National Trust and Savings
              Association, as agent, and other lenders named therein.

10.10 (s)     Second Amendment to Credit Agreement, dated as of August 14,
              1997, among Paracelsus, Bank America National Trust and Savings
              Association, as agent, and other lenders named therein.

10.11 (s)     Third Amendment to Credit Agreement, dated as of April 14,
              1997, among Paracelsus, Bank America National Trust and Savings
              Association, as agent, and other lenders named therein.

10.14 (e)     Service and Consulting Agreement, dated as of July 4,
              1983, between Paracelsus and European Investors Inc. and
              Incofinas Limited.

10.16 (f)     The Restated Paracelsus Healthcare Corporation
              Supplemental Executive Retirement Plan.

10.17 (a)     Amendment No. 1 to the Supplemental Executive
              Retirement Plan.

10.19 (e)     Paracelsus Healthcare Corporation Annual Incentive Plan
              (10.17).

10.21 (g)     Facility Lease dated as of June 7, 1991, between Bell
              Atlantic Tricon Leasing Corporation and Chico Rehabilitation
              Hospital, Inc. (10.1).

10.22 (g)     Amendment to Lease dated June 30, 1994,  between  Tricon Capital
              and Chico Rehabilitation Hospital, Inc. (10.2).



                                      81
<PAGE>   82




10.23 (g)     Amendment to Lease dated June 30, 1994, between Tricon
              Capital and Beaumont Rehab Associates Limited Partnership (10.3).

10.25 (h)     Asset Purchase Agreement, dated as of March 29, 1996 between
              Paracelsus and FHP, Inc.

10.28 (i)     Amended and Restated Partnership Agreement of Dakota/Champion
              Partnership dated December 21, 1994.

10.29 (j)     Operating Agreement between Dakota/Champion Partnership and
              Champion, dated December 21, 1994.

10.31 (l)     Second Amended and Restated Credit Agreement, dated as of
              December 8, 1995, among Paracelsus, Bank of America National
              Trust and Savings Association, as agent, and other lenders named
              therein (10.1)

10.33 (f)     Restated Champion Healthcare Corporation Founders' Stock Option
              Plan.

10.34 (a)     License Agreement between Dr. Manfred George Krukemeyer and
              Paracelsus.

10.35 (n)     Asset Exchange Agreement dated November 9, 1995, by and between
              Champion Healthcare Holdings, Inc., CHC - Prattville, Inc. and
              CHC - Nursing Center, Inc. and West Jordan Hospital Corporation.

10.36 (a)     Registration Rights Agreement between Paracelsus and Park Hospital
              GmbH.

10.37 (a)     Voting Agreement between Park Hospital GmbH and Messrs. Miller and
              VanDevender.

10.38 (a)     Services Agreement between Paracelsus and Dr. Manfred G.
              Krukemeyer.

10.39 (a)     Insurance Agreement between Paracelsus and Dr. Manfred G.
              Krukemeyer.

10.40 (a)     Non-Compete Agreement between Paracelsus and Dr. Manfred G.
              Krukemeyer.

10.41 (a)     Shareholder Agreement between Paracelsus and Park Hospital GmbH,
              as guaranteed by Dr. Manfred G. Krukemeyer.

10.42 (a)     Dividend and Note Agreement between Paracelsus and Park Hospital
              GmbH.

10.43 (a)     Employment Agreement between Charles R. Miller and Paracelsus,
              including the Management Rights Agreement.

10.44 (a)     Employment Agreement between R.J. Messenger and Paracelsus,
              including the Management Rights Agreement.

10.45 (a)     Employment Agreement between James G. VanDevender and Paracelsus.

10.46 (a)     Employment Agreement between Ronald R. Patterson and Paracelsus.

10.47 (a)     Employment Agreement between Robert C. Joyner and Paracelsus.

10.48 (a)     Paracelsus 1996 Stock Incentive Plan.

10.49 (a)     Paracelsus Healthcare Corporation Executive Officer Performance
              Bonus Plan.


                                      82

<PAGE>   83


10.50 (a)     First Refusal Agreement among Park Hospital GmbH, Dr. Manfred G.
              Krukemeyer and Messrs. Messenger, Miller, VanDevender and
              Patterson.

10.51         Agreement between Robert C. Joyner and Paracelsus.

10.52 (o)     Subscription Agreement between Champion and James G.
              VanDevender dated February 10, 1990, as amended (10.3).

10.54 (a)     Registration Rights Agreement among Paracelsus and certain
              Champion Investors.

10.56 (a)     Indemnity and Insurance Coverage Agreement between Paracelsus
              and certain Champion and Paracelsus executive officers.

10.57 (p)     AmeriHealth Amended and Restated 1988 Non-Qualified Stock Option
              Plan.

10.58 (o)     Champion Employee Stock Option Plan dated December 31, 1991, as
              amended (10.14).

10.59 (o)     Champion Employee Stock Option Plan No. 2 dated May 29, 1992, as
              amended (10.15).

10.60 (o)     Champion Employee Stock Option Plan No. 3 dated September 1992, as
              amended (10.16).

10.61 (o)     Champion Employee Stock Option Plan No. 4, dated January 5, 1994,
              as amended (10.17).

10.62 (q)     Champion Healthcare Corporation Physicians Stock Option Plan(4.2).

10.63 (o)     Champion Selected Executive Stock Option Plan No. 5, dated May 25,
              1995 (4.12).

10.64 (o)     Champion Directors' Stock Option Plan, dated 1992.

10.65 (a)     Paracelsus' 6.51% Subordinated Notes Due 2006 (10.64).

10.66 (r)     Letter Agreement between R. J. Messenger and Paracelsus Healthcare
              Corporation dated April 11, 1997.

21.1          List of subsidiaries of Paracelsus.

23.1          Consent of Ernst & Young L.L.P.

27            Financial Data Schedule.

--------------------------
(a)  Incorporated by reference from Exhibit of the same number (or if otherwise
     noted, Exhibit number contained in parenthesis which refers to the exhibit
     number in such Quarterly Report) to the Company's Quarterly Report on Form
     10-Q for quarter ended September 30, 1996.

(b)  Incorporated by reference from Exhibit of the same number to the Company's
     Registration Statement on Form 8-A, filed on August 12, 1996.

(c)  Incorporated by reference from Exhibit 10.23(g) to Champion's Annual
     Report on Form 10-K for the year ended December 31, 1995.

(d)  Incorporated by reference from Exhibit 10.23(f) to Champion's Annual
     Report on Form 10-K for the year ended December 31, 1995.



                                      83
<PAGE>   84


(e)  Incorporated by reference from Exhibit of the same number (or if otherwise
     noted, Exhibit number contained in parenthesis which refers to the exhibit
     number in such Registration Statement) to the Registration Statement on
     Form S-1, Registration No. 33-67040, filed on August 5, 1993.

(f)  Incorporated by reference from Exhibit of the same number to the Company's
     Registration Statement on Form S-4, Registration No. 333-08521, filed on
     July 19, 1996.

(g)  Incorporated by reference from Exhibit of the same number (or if otherwise
     noted, Exhibit number contained in parenthesis which refers to the exhibit
     number in such Quarterly Report) to the Company's Quarterly Report on Form
     10-Q for the quarter ended June 30, 1994.

(h)  Incorporated by reference from Exhibit of the same number (or if otherwise
     noted, Exhibit number contained in parenthesis which refers to the exhibit
     number in such Quarterly Report) to the Company's Annual Report on Form
     10- K for the year ended September 30, 1995.

(i)  Incorporated by reference from Exhibit 10 to Champion's Current Report on
     Form 8-K, dated December 21, 1994.

(j)  Incorporated by reference from Exhibit 10.1 to Champion's Current Report on
     Form 8-K, dated January 5, 1995.

(k)  Incorporated by reference from Exhibit 10.1 to Champion's Current Report on
     Form 8-K, dated April 13, 1995.

(l)  Incorporated  by reference from Exhibit 4.1 to the Company's Current Report
     on Form 8-K, dated December 12, 1995.

(m)  Incorporated by reference from Exhibit 10.1 to Champion's Current Report on
     Form 8-K, dated April 15, 1996.

(n)  Incorporated by reference from Exhibit 10.1 to Champion's Current Report on
     Form 8-K, dated March 1, 1996.

(o)  Incorporated by reference from Exhibit of the same number (or if otherwise
     noted, Exhibit number contained in parenthesis which refers to the exhibit
     number in such Annual Report) to Champion's Annual Report for the year
     ended December 31, 1994.

(p)  Incorporated by reference from Exhibit 10.06 to AmeriHealth's Annual
     Report on Form 10K for the year ended December 31, 1992.

(q)  Incorporated by reference from Exhibit of the same number (or if otherwise
     noted, Exhibit number contained in parenthesis which refers to the exhibit
     number in such Registration Statement) to Champion's Registration
     Statement on Form S-8, filed on August 3, 1995.

(r)  Incorporated by reference from Exhibit of the same number to the Company's
     Quarterly Report on Form 10-Q for the quarter ended March 31, 1997.

(s)  Incorporated by reference from Exhibit of the same number to the Company's
     Quarterly Report on Form 10-Q for the quarter ended September 30, 1997.




                                      84
<PAGE>   85




(b) REPORTS ON FORM 8-K

     The Company filed a Current Report on Form 8-K, dated December 15, 1997,
     reporting, pursuant to Item 1 thereof, that there has been a change in
     beneficial ownership of 29,771,742 shares of common stock of Paracelsus
     Healthcare Corporation. Pursuant to Rule 13d-3 of the Securities Exchange
     Act of 1934, each of the following, Park-Hospital GmbH,
     Paracelsus-Kliniken-Deutschland GmbH, Dr. Heiner Meyer zu Losebeck and Mr.
     Peter Frommhold, is a beneficial owner of such shares. Dr. Manfred G.
     Krukemeyer is no longer a beneficial owner of these shares as defined
     under Rule 13d-3.





                                       85


<PAGE>   86

                       PARACELSUS HEALTHCARE CORPORATION
                SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
                                  ($ in 000's)

<TABLE>
<CAPTION>
                                           BALANCE AT      CHARGED TO
                                            BEGINNING       COSTS AND                                      BALANCE AT
                DESCRIPTION                  OF YEAR        EXPENSES       WRITE-OFFS        OTHER         END OF YEAR
                -----------                ----------      ----------      ----------        -----         -----------

<S>                                         <C>              <C>            <C>           <C>                 <C>
  Year ended December 31, 1997
     allowance for doubtful accounts.....    $36,469         46,606          (28,633)                          $54,442

  Year ended December 31, 1996
     Allowance for doubtful accounts.....     28,321         50,958(a)       (24,424)      (18,386)(b)          36,469

  Year ended December 31, 1995
     allowance for doubtful accounts.....     27,368         40,236(a)       (39,283)            -              28,321
</TABLE>


                         DAKOTA HEARTLAND HEALTH SYSTEM
                SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
                                  ($ in 000's)

<TABLE>
<CAPTION>
                                           BALANCE AT      CHARGED TO
                                            BEGINNING       COSTS AND                                      BALANCE AT
                DESCRIPTION                  OF YEAR        EXPENSES       WRITE-OFFS        OTHER         END OF YEAR
                -----------                ----------      ----------      ----------        -----         -----------

<S>                                         <C>              <C>            <C>              <C>              <C>
  Year ended December 31, 1997
     allowance for doubtful accounts.....    $3,261           3,407          (5,389)                          $1,279

  Year ended December 31, 1996
     Allowance for doubtful accounts.....     3,397           4,301          (4,437)                           3,261
</TABLE>

--------------------
(a)    Includes bad debt expenses of $12.6 million and $16.7 million for the
       years ended December 31, 1996 and 1995, respectively, related to the
       psychiatric hospitals which have been reclassified to discontinued
       operations.

(b)    Represents allowance for doubtful accounts balance of $36.1 million
       related to the psychiatric hospitals which have been reclassified to
       discontinued operations, net of $17.7 million acquired reserves from the
       acquisition of Champion.




                                      86
<PAGE>   87



                                   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 this 31st day of March, 1998.

                             PARACELSUS HEALTHCARE CORPORATION
                                        (Registrant)



                             By:    /s/ CHARLES R. MILLER
                                   --------------------------------------------
                                   Charles R. Miller
                                   President, Chief Operating Officer & Director

         Pursuant to the requirement of the Securities 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.


<TABLE>
<CAPTION>





                  SIGNATURE                                         TITLE                             DATE
----------------------------------------------   --------------------------------------------  --------------------

<S>                                              <C>                                           <C>
/s/ CHARLES R. MILLER                            President, Chief Operating Officer            March 31, 1998
----------------------------------------------   and Director
Charles R. Miller


/s/ JAMES G. VANDEVENDER                         Senior Executive Vice President,              March 31, 1998
----------------------------------------------   Chief Financial Officer and Director
James G. VanDevender


/s/ ROBERT M. STARLING                           Senior Vice President and Controller          March 31, 1998
----------------------------------------------
Robert M. Starling


/s/ CHRISTIAN A. LANGE                           Director                                      March 31, 1998
----------------------------------------------
Christian A. Lange


/s/ L. STANTON TUTTLE                            Director                                      March 31, 1998
----------------------------------------------
L. Stanton Tuttle


/s/ DARYL J. WHITE                               Director                                      March 31, 1998
----------------------------------------------
Daryl J. White






                                      87


</TABLE>
<PAGE>   88
                                   INDEX TO EXHIBITS

EXHIBITS                              DESCRIPTION
--------                              -----------
3.4 (a)       Amended and Restated Articles of Incorporation of Paracelsus.

3.5 (a)       Amended and Restated Bylaws of Paracelsus.

4.1 (a)       Indenture, dated August 16, 1996 between Paracelsus and
              AmSouth Bank of Alabama, as Trustee (including the form of
              certificate representing the 10% Senior Subordinated Notes due
              2006).

4.2 (b)       Shareholder Protection Rights Agreement between Paracelsus and
              ChaseMellon Shareholder Services, L.L.C, as Rights Agent.

4.5 (c)       Form of Warrant issued pursuant to Champion Series E Note
              Purchase Agreement, dated May 1, 1995, as amended.

4.6 (d)       Form of Warrant issued pursuant to Champion Series D Note and
              Stock Purchase Agreement dated December 31, 1993, as amended.

4.9 (e)       Certificate representing Common Stock.

10.1 (e)      Pooling Agreement, dated as of April 16, 1993 among PHC
              Funding Corp. II ("PFC II"), Sheffield Receivables Corporation
              and Bankers Trust Company, as trustee (the "Trustee").

10.2 (e)      Servicing Agreement, dated as of April 16, 1993, among
              PFC II, Paracelsus and the Trustee.

10.3 (e)      Guarantee, dated as of April 16, 1993, by Paracelsus in
              favor of PFC II.

10.4 (e)      Sale and Servicing Agreement between subsidiaries of
              Paracelsus and PFC II.

10.5 (e)      Subordinate Note by PFC II in favor of Hospitals.

10.8 (a)      $400 Million Reducing Revolving Credit Facility, dated as of
              August 16, 1996, among Paracelsus, Bank of America National Trust
              and Savings Association, as agent, and other lenders named
              therein (10.1).

10.9 (r)      First Amendment to Credit Agreement, dated as of April 14,
              1997, among Paracelsus, Bank America National Trust and Savings
              Association, as agent, and other lenders named therein.

10.10 (s)     Second Amendment to Credit Agreement, dated as of August 14,
              1997, among Paracelsus, Bank America National Trust and Savings
              Association, as agent, and other lenders named therein.

10.11 (s)     Third Amendment to Credit Agreement, dated as of April 14,
              1997, among Paracelsus, Bank America National Trust and Savings
              Association, as agent, and other lenders named therein.

10.14 (e)     Service and Consulting Agreement, dated as of July 4,
              1983, between Paracelsus and European Investors Inc. and
              Incofinas Limited.

10.16 (f)     The Restated Paracelsus Healthcare Corporation
              Supplemental Executive Retirement Plan.

10.17 (a)     Amendment No. 1 to the Supplemental Executive
              Retirement Plan.

10.19 (e)     Paracelsus Healthcare Corporation Annual Incentive Plan
              (10.17).

10.21 (g)     Facility Lease dated as of June 7, 1991, between Bell
              Atlantic Tricon Leasing Corporation and Chico Rehabilitation
              Hospital, Inc. (10.1).

10.22 (g)     Amendment to Lease dated June 30, 1994,  between  Tricon Capital
              and Chico Rehabilitation Hospital, Inc. (10.2).



<PAGE>   89




10.23 (g)     Amendment to Lease dated June 30, 1994, between Tricon
              Capital and Beaumont Rehab Associates Limited Partnership (10.3).

10.25 (h)     Asset Purchase Agreement, dated as of March 29, 1996 between
              Paracelsus and FHP, Inc.

10.28 (i)     Amended and Restated Partnership Agreement of Dakota/Champion
              Partnership dated December 21, 1994.

10.29 (j)     Operating Agreement between Dakota/Champion Partnership and
              Champion, dated December 21, 1994.

10.31 (l)     Second Amended and Restated Credit Agreement, dated as of
              December 8, 1995, among Paracelsus, Bank of America National
              Trust and Savings Association, as agent, and other lenders named
              therein (10.1)

10.33 (f)     Restated Champion Healthcare Corporation Founders' Stock Option
              Plan.

10.34 (a)     License Agreement between Dr. Manfred George Krukemeyer and
              Paracelsus.

10.35 (n)     Asset Exchange Agreement dated November 9, 1995, by and between
              Champion Healthcare Holdings, Inc., CHC - Prattville, Inc. and
              CHC - Nursing Center, Inc. and West Jordan Hospital Corporation.

10.36 (a)     Registration Rights Agreement between Paracelsus and Park Hospital
              GmbH.

10.37 (a)     Voting Agreement between Park Hospital GmbH and Messrs. Miller and
              VanDevender.

10.38 (a)     Services Agreement between Paracelsus and Dr. Manfred G.
              Krukemeyer.

10.39 (a)     Insurance Agreement between Paracelsus and Dr. Manfred G.
              Krukemeyer.

10.40 (a)     Non-Compete Agreement between Paracelsus and Dr. Manfred G.
              Krukemeyer.

10.41 (a)     Shareholder Agreement between Paracelsus and Park Hospital GmbH,
              as guaranteed by Dr. Manfred G. Krukemeyer.

10.42 (a)     Dividend and Note Agreement between Paracelsus and Park Hospital
              GmbH.

10.43 (a)     Employment Agreement between Charles R. Miller and Paracelsus,
              including the Management Rights Agreement.

10.44 (a)     Employment Agreement between R.J. Messenger and Paracelsus,
              including the Management Rights Agreement.

10.45 (a)     Employment Agreement between James G. VanDevender and Paracelsus.

10.46 (a)     Employment Agreement between Ronald R. Patterson and Paracelsus.

10.47 (a)     Employment Agreement between Robert C. Joyner and Paracelsus.

10.48 (a)     Paracelsus 1996 Stock Incentive Plan.

10.49 (a)     Paracelsus Healthcare Corporation Executive Officer Performance
              Bonus Plan.



<PAGE>   90


10.50 (a)     First Refusal Agreement among Park Hospital GmbH, Dr. Manfred G.
              Krukemeyer and Messrs. Messenger, Miller, VanDevender and
              Patterson.

10.51         Agreement between Robert C. Joyner and Paracelsus.

10.52 (o)     Subscription Agreement between Champion and James G.
              VanDevender dated February 10, 1990, as amended (10.3).

10.54 (a)     Registration Rights Agreement among Paracelsus and certain
              Champion Investors.

10.56 (a)     Indemnity and Insurance Coverage Agreement between Paracelsus
              and certain Champion and Paracelsus executive officers.

10.57 (p)     AmeriHealth Amended and Restated 1988 Non-Qualified Stock Option
              Plan.

10.58 (o)     Champion Employee Stock Option Plan dated December 31, 1991, as
              amended (10.14).

10.59 (o)     Champion Employee Stock Option Plan No. 2 dated May 29, 1992, as
              amended (10.15).

10.60 (o)     Champion Employee Stock Option Plan No. 3 dated September 1992, as
              amended (10.16).

10.61 (o)     Champion Employee Stock Option Plan No. 4, dated January 5, 1994,
              as amended (10.17).

10.62 (q)     Champion Healthcare Corporation Physicians Stock Option Plan(4.2).

10.63 (o)     Champion Selected Executive Stock Option Plan No. 5, dated May 25,
              1995 (4.12).

10.64 (o)     Champion Directors' Stock Option Plan, dated 1992.

10.65 (a)     Paracelsus' 6.51% Subordinated Notes Due 2006 (10.64).

10.66 (r)     Letter Agreement between R. J. Messenger and Paracelsus Healthcare
              Corporation dated April 11, 1997.

21.1          List of subsidiaries of Paracelsus.

23.1          Consent of Ernst & Young L.L.P.

27            Financial Data Schedule.

--------------------------
(a)  Incorporated by reference from Exhibit of the same number (or if otherwise
     noted, Exhibit number contained in parenthesis which refers to the exhibit
     number in such Quarterly Report) to the Company's Quarterly Report on Form
     10-Q for quarter ended September 30, 1996.

(b)  Incorporated by reference from Exhibit of the same number to the Company's
     Registration Statement on Form 8-A, filed on August 12, 1996.

(c)  Incorporated by reference from Exhibit 10.23(g) to Champion's Annual
     Report on Form 10-K for the year ended December 31, 1995.

(d)  Incorporated by reference from Exhibit 10.23(f) to Champion's Annual
     Report on Form 10-K for the year ended December 31, 1995.




<PAGE>   91


(e)  Incorporated by reference from Exhibit of the same number (or if otherwise
     noted, Exhibit number contained in parenthesis which refers to the exhibit
     number in such Registration Statement) to the Registration Statement on
     Form S-1, Registration No. 33-67040, filed on August 5, 1993.

(f)  Incorporated by reference from Exhibit of the same number to the Company's
     Registration Statement on Form S-4, Registration No. 333-08521, filed on
     July 19, 1996.

(g)  Incorporated by reference from Exhibit of the same number (or if otherwise
     noted, Exhibit number contained in parenthesis which refers to the exhibit
     number in such Quarterly Report) to the Company's Quarterly Report on Form
     10-Q for the quarter ended June 30, 1994.

(h)  Incorporated by reference from Exhibit of the same number (or if otherwise
     noted, Exhibit number contained in parenthesis which refers to the exhibit
     number in such Quarterly Report) to the Company's Annual Report on Form
     10- K for the year ended September 30, 1995.

(i)  Incorporated by reference from Exhibit 10 to Champion's Current Report on
     Form 8-K, dated December 21, 1994.

(j)  Incorporated by reference from Exhibit 10.1 to Champion's Current Report on
     Form 8-K, dated January 5, 1995.

(k)  Incorporated by reference from Exhibit 10.1 to Champion's Current Report on
     Form 8-K, dated April 13, 1995.

(l)  Incorporated  by reference from Exhibit 4.1 to the Company's Current Report
     on Form 8-K, dated December 12, 1995.

(m)  Incorporated by reference from Exhibit 10.1 to Champion's Current Report on
     Form 8-K, dated April 15, 1996.

(n)  Incorporated by reference from Exhibit 10.1 to Champion's Current Report on
     Form 8-K, dated March 1, 1996.

(o)  Incorporated by reference from Exhibit of the same number (or if otherwise
     noted, Exhibit number contained in parenthesis which refers to the exhibit
     number in such Annual Report) to Champion's Annual Report for the year
     ended December 31, 1994.

(p)  Incorporated by reference from Exhibit 10.06 to AmeriHealth's Annual
     Report on Form 10K for the year ended December 31, 1992.

(q)  Incorporated by reference from Exhibit of the same number (or if otherwise
     noted, Exhibit number contained in parenthesis which refers to the exhibit
     number in such Registration Statement) to Champion's Registration
     Statement on Form S-8, filed on August 3, 1995.

(r)  Incorporated by reference from Exhibit of the same number to the Company's
     Quarterly Report on Form 10-Q for the quarter ended March 31, 1997.

(s)  Incorporated by reference from Exhibit of the same number to the Company's
     Quarterly Report on Form 10-Q for the quarter ended September 30, 1997.