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

(Mark One)

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

        For the quarterly period ended June 30, 1997

                             OR

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

              Commission File No. 33-80987

             Merit Behavioral Care Corporation
 (Exact name of registrant as specified in its charter)

Delaware                                                    22-3236927
(State or other jurisdiction of                           (I.R.S. Employer
 incorporation or organization)                       Identification Number)

                             One Maynard Drive
                      Park Ridge, New Jersey 07656
                (Address of principal executive offices)

                                (201) 391-8700
                      (Registrant's telephone number,
                             including area code)

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the  preceding 12 months (or for such  shorter  period that the  registrant  was
required  to file  such  reports),  and  (2) has  been  subject  to such  filing
requirements for the past 90 days.

                          Yes..X...    No.......

As of July 31, 1997,  28,553,800  shares of the  registrant's  common stock, par
value $.01 per share, which is the only class of common stock of the registrant,
were outstanding.


<PAGE>



<TABLE>
<CAPTION>
                     MERIT BEHAVIORAL CARE CORPORATION

                             Table of Contents
                     Form 10-Q for the Quarterly Period
                            Ended June 30, 1997


<S>     <C>    <C>    <C>    <C>    <C>    <C>
PART I                     FINANCIAL INFORMATION                                                 PAGE

Item 1.                    Financial Statements (Unaudited)

                             Condensed Consolidated Balance Sheets at                               3
                             June 30, 1997 and September 30, 1996

                             Condensed Consolidated Statements of Operations for
                             the three  months  ended June 30, 1997 and June 30,
                             1996 and the nine months ended June 30, 1997
                             and June 30, 1996                                                       4

                             Condensed Consolidated Statements of
                             Cash Flows for the nine months ended
                             June 30, 1997 and June 30, 1996                                         5

                             Notes to Condensed Consolidated
                             Financial Statements                                                    6

Item 2.                    Management's Discussion and Analysis
                           of Financial Condition and Results of
                           Operations                                                                8

PART II                    OTHER INFORMATION

Item 1.                    Legal Proceedings                                                        11

Item 6.                    Exhibits and Reports on Form 8-K                                         11

</TABLE>

                                                         2

<PAGE>



<TABLE>
<CAPTION>
                           MERIT BEHAVIORAL CARE CORPORATION
                         CONDENSED CONSOLIDATED BALANCE SHEETS
                                       (UNAUDITED)
                                 (dollars in thousands)



<S>                                                                                    <C>                   <C>
                                                                                  June 30,         September 30,
         ASSETS                                                                     1997                1996
                                                                                ------------         ---------
Current Assets:
Cash and cash equivalents..............................................         $  53,176            $  47,375
Short-term marketable securities.......................................             4,111                  ---
Accounts receivable, net...............................................            33,853               28,383
Other current assets...................................................             6,530                4,777
                                                                               ----------          -----------
  Total current assets.................................................            97,670               80,535
                                                                               ----------          -----------
Property, plant and equipment, net.....................................            75,352               67,880
                                                                               ----------          -----------
Other Assets:
Goodwill and other intangibles, net....................................           145,218              162,849
Restricted cash and investments........................................             3,740                5,668
Deferred financing costs, net..........................................            10,368               11,362
Other assets...........................................................            19,873               16,507
                                                                               ----------          -----------
                                                                                  179,199              196,386
                                                                               ----------          -----------
Total assets...........................................................         $ 352,221            $ 344,801

         LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable.......................................................         $   7,182            $   5,888
Claims payable.........................................................            75,378               57,611
Deferred revenue.......................................................             6,545                6,577
Accrued interest.......................................................             2,172                5,008
Current portion of long-term debt......................................             3,000                  500
Other current liabilities..............................................             7,311               13,079
                                                                               ----------           ----------
  Total current liabilities............................................           101,588               88,663

Long-term debt.........................................................           256,500              253,500
Deferred income taxes..................................................            20,757               30,669
Other long-term liabilities............................................             1,847                1,451

Stockholders' Equity:
Common stock (40,000,000 shares authorized, $0.01 par
  value, 28,553,800 and 28,398,800 shares issued)......................               286                  284
Additional paid in capital.............................................            (1,412)              (9,756)
Retained deficit.......................................................           (21,295)             (14,435)
Notes receivable from officers.........................................            (6,050)              (5,470)
                                                                               -----------         ------------
                                                                                  (28,471)             (29,377)
Less common stock in treasury (21,000 shares)..........................               ---                 (105)
                                                                               -----------         ------------
  Total stockholders' equity...........................................           (28,471)             (29,482)
                                                                               -----------         ------------
Total liabilities and stockholders' equity.............................         $ 352,221            $ 344,801
                                                                                =========            ==========

See accompanying notes to condensed consolidated financial statements.

</TABLE>
                                                         3

<PAGE>

<TABLE>


                                         MERIT BEHAVIORAL CARE CORPORATION
<CAPTION>
                                  CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                                    (UNAUDITED)
                                              (dollars in thousands)




                                                                     Three months ended       Nine months ended
                                                                        June  30,                June 30,
                                                                  1997          1996             1997         1996
<S>     <C>    <C>    <C>    <C>    <C>    <C>
                                                              -----------  ------------     -----------  --------

Revenue..............................................          $ 143,762       $111,189        $405,130    $333,830
Expenses:
  Direct service costs...............................            116,564         86,419         327,739     262,710
  Selling, general and administrative................             17,366         17,313          49,739      47,328
  Amortization of intangibles........................              6,663          6,454          20,133      19,291
                                                               ----------   ------------     -----------  ---------
                                                                 140,593        110,186         397,611     329,329

Operating income.....................................              3,169          1,003           7,519       4,501
Other income (expense):
  Interest income and other..........................                823            681           2,368       2,019
  Interest expense...................................             (6,219)        (6,077)        (18,651)    (17,626)
  Merger costs.......................................                ---            ---             ---      (3,972)
                                                               ----------   ------------     -----------  ----------
                                                                  (5,396)        (5,396)        (16,283)    (19,579)
                                                              -----------   ------------     -----------  ----------

Loss  before income taxes  and cumulative effect of
  accounting change..................................             (2,227)        (4,393)         (8,764)    (15,078)
Benefit for income taxes.............................               (737)        (1,364)         (1,904)     (3,500)
                                                              -----------     -----------    -----------  ----------
Loss before cumulative effect of accounting change...             (1,490)        (3,029)         (6,860)    (11,578)
Cumulative effect of accounting change for deferred
 contract start-up costs, net of tax benefit of $757.                ---            ---             ---      (1,012)
                                                              -----------     -----------    -----------  ----------

Net loss.............................................          $  (1,490)      $ (3,029)       $ (6,860)   $(12,590)
                                                               ==========      ==========     ==========   =========



 See accompanying notes to condensed consolidated financial statements.

</TABLE>

                                                         4

<PAGE>

<TABLE>


<CAPTION>
                                         MERIT BEHAVIORAL CARE CORPORATION
                                  CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                                    (UNAUDITED)
                                              (dollars in thousands)

<S>     <C>    <C>    <C>    <C>    <C>    <C>
                                                                                  Nine months ended
                                                                                      June 30,
                                                                            1997                   1996
CASH FLOWS FROM OPERATING ACTIVITIES:                                      ------                 ------
Net loss .....................................................          $  (6,860)              $ (12,590)
Adjustments to reconcile net loss to net cash
  provided by operating activities:
  Cumulative effect of accounting change......................                ---                   1,012
  Depreciation and amortization...............................             29,228                  26,888
  Amortization of deferred financing costs....................              1,007                     841
  Deferred taxes..............................................             (2,341)                 (5,084)
Changes in operating assets and liabilities, net of the 
  effect of acquisitions:
  Accounts receivable.........................................             (5,470)                 (2,073)
  Other current assets........................................             (1,753)                   (252)
  Deferred contract start-up costs............................             (3,680)                 (3,310)
  Accounts payable and accrued liabilities....................             10,425                   5,451
                                                                         --------                 --------
Net cash provided by operating activities.....................             20,556                  10,883
                                                                         --------                 --------
CASH FLOWS FROM INVESTING ACTIVITIES:
  Purchases of property, plant and equipment..................            (16,965)                (15,838)
  (Purchases) sales of marketable securities..................             (4,111)                  1,143
  Long-term restrictions removed from (placed on) cash........              1,928                  (1,016)
  Investments in and advances to joint ventures...............             (1,750)                 (1,221)
  Repayments of advances from joint ventures..................                675                     300
  Cash used for acquisitions, contingent consideration, and
    related expenses, net of cash acquired....................                ---                 (11,058)
  Other.......................................................               (332)                   (909)
                                                                        ---------                ---------
  Net cash used for investing activities......................            (20,555)                (28,599)
                                                                        ---------                ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
  Proceeds from capital contribution..........................                ---                 114,980
  Proceeds from bridge loan...................................                ---                  75,000
  Proceeds from revolving credit facility.....................            134,500                 123,000
  Proceeds from senior term loans.............................                ---                 120,000
  Proceeds from sale of notes.................................                ---                 100,000
  Redemption of common stock..................................                ---                (254,144)
  Repayment of due to parent..................................                ---                 (70,813)
  Repayment of bridge loan....................................                ---                 (75,000)
  Repayment of revolving credit facility......................           (128,500)                (94,000)
  Repayment of senior term loans..............................               (500)                    ---
  Payment of financing costs..................................                ---                 (12,504)
  Other.......................................................                300                     110
  Net cash provided by financing activities ..................              5,800                  26,629
INCREASE  IN CASH AND CASH EQUIVALENTS................                      5,801                   8,913
  Cash and cash equivalents at beginning of period............             47,375                  29,531
                                                                        ---------               ----------
CASH AND CASH EQUIVALENTS AT END OF
  PERIOD......................................................           $ 53,176               $  38,444
                                                                        =========                =========
SUPPLEMENTAL DISCLOSURES OF CASH
  FLOW INFORMATION:
  Cash (received) paid for income taxes.......................           $   (151)              $   1,002
  Cash paid for interest......................................           $ 20,480               $  14,603

    See accompanying notes to condensed consolidated financial statements.
</TABLE>

                                                         5

<PAGE>


                         MERIT BEHAVIORAL CARE CORPORATION
               NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                    (UNAUDITED)
                             (dollars in thousands)




1.  BASIS OF PRESENTATION

The accompanying  unaudited interim condensed  consolidated financial statements
include the accounts of Merit  Behavioral Care  Corporation and its wholly-owned
subsidiaries  (the  "Company"),  and  have  been  prepared  in  accordance  with
generally accepted accounting  principles for interim financial  information and
with the instructions to Form 10-Q and Article 10 of Regulation S-X.

The  condensed  consolidated  balance  sheet at June 30, 1997 and the  condensed
consolidated  statements of operations and cash flows for all periods  presented
are unaudited and reflect all adjustments, consisting of normal recurring items,
which management considers necessary for a fair presentation.  Operating results
for fiscal 1997 interim periods are not necessarily  indicative of results to be
expected  for the entire  year.  The  condensed  consolidated  balance  sheet at
September  30, 1996 was derived from the  Company's  September  30, 1996 audited
financial  statements.  Certain  prior year  amounts have been  reclassified  to
conform with the current year's presentation.

Although the Company believes the accompanying disclosures are adequate, certain
information  and  disclosures  normally  included in the notes to the  financial
statements  have  been  condensed  or  omitted  as  permitted  by the  rules and
regulations  of  the  Securities  and  Exchange  Commission.   The  accompanying
unaudited financial  statements should be read in conjunction with the financial
statements  contained  in the  Annual  Report  on Form  10-K for the year  ended
September 30, 1996.

2.  CONTINGENCIES

In  October  1996,  a group of  eight  plaintiffs  purporting  to  represent  an
uncertified class of psychiatrists,  psychologists and social workers brought an
action under the federal  antitrust laws in the United States District Court for
the Southern District of New York (the "District Court") against nine behavioral
health  managed  care  organizations,   including  the  Company   (collectively,
"Defendants").  The complaint alleges that Defendants  violated section 1 of the
Sherman Act by engaging in a  conspiracy  to fix the prices at which  Defendants
purchase  services from mental  healthcare  providers  such as  plaintiffs.  The
complaint further alleges that Defendants  engaged in a group boycott to exclude
mental  healthcare  providers from Defendants'  networks in order to further the
goals of the alleged conspiracy.  The complaint also challenges the propriety of
Defendants' capitation arrangements with their respective customers, although it
is  unclear  from  the  complaint  whether  plaintiffs  allege  that  Defendants
unlawfully conspired to enter into capitation arrangements with their respective
customers.   The  complaint  seeks  treble  damages  against  Defendants  in  an
unspecified  amount  and a  permanent  injunction  prohibiting  Defendants  from
engaging in the alleged  conduct  which forms the basis of the  complaint,  plus
costs and attorneys' fees. In January 1997, Defendants filed a motion to dismiss
the complaint.  On July 21, 1997, a  court-appointed  magistrate  judge issued a
report and  recommendation  to the District Court  recommending that Defendants'
motion to dismiss the complaint  with  prejudice be granted.  On August 5, 1997,
plaintiffs filed objections to the magistrate judge's report and recommendation;
such  objections  have not yet been  heard.  The Company  intends to  vigorously
defend  itself in this  litigation.  No amounts are recorded on the books of the
Company in anticipation of a loss as a result of this contingency.

3.  SUBSEQUENT EVENT

On  July  14,  1997,  the  Company  entered  into a  definitive  agreement  (the
"Agreement")  to acquire all of the capital stock of CMG Health,  Inc.  ("CMG").
Pursuant to the Agreement,  the acquisition will be effected through a merger of
an  affiliate  of the  Company  with CMG, as a result of which CMG will become a
wholly owned subsidiary of the Company.

                                                         6

<PAGE>

                    MERIT BEHAVIORAL CARE CORPORATION
           NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                               (UNAUDITED)
                          (dollars in thousands)


The Agreement  provides  that holders of CMG's common and  preferred  stock will
receive, in the aggregate, at closing (1) approximately $51,500 in cash (subject
to certain  adjustments),  (2) 750,000 shares of MBC common stock and (3) rights
to receive  certain  additional cash and stock  consideration  based upon future
events and the  post-closing  financial  performance of CMG. The Chase Manhattan
Bank, the agent for the Company's existing senior credit facility, has committed
to provide the funding to make the cash payments required in connection with the
acquisition  (including  related  fees and  expenses).  The merger is subject to
certain  conditions,  including the expiration of antitrust  regulatory  waiting
periods and the funding of the financing arrangements.

                                                         7

<PAGE>



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

Results of Operations

Overview

The Company is one of the leading  behavioral  health  managed care companies in
the United  States,  arranging  for a full  spectrum  of  behavioral  healthcare
services on a nationwide basis.  Behavioral healthcare involves the treatment of
a variety of behavioral  health  conditions  such as emotional and mental health
problems,  substance abuse and other personal concerns that require  counseling,
outpatient therapy or more intensive  treatment  services.  The Company provides
managed behavioral  healthcare  services through a systematic  clinical approach
with the objective of diagnosing problems promptly and designing treatment plans
to ensure that patients  receive the  appropriate  level of care in an effective
and cost-efficient  manner. The Company manages behavioral  healthcare  programs
for  approximately  850 payors across all segments of the  healthcare  industry,
including  health  maintenance  organization  ("HMOs"),  Blue Cross Blue  Shield
organizations  and other  insurance  companies,  corporations  and labor unions,
Federal,  state and local  governmental  agencies,  and various  state  Medicaid
programs.

Three Months Ended June 30,  1997 Compared to Three Months Ended June 30, 1996

Revenue. Revenue increased by $32.6 million, or 29.3%, to $143.8 million for the
three months ended June 30, 1997 from $111.2  million for the three months ended
June 30, 1996. Of this increase, $22.2 million was attributable to the inclusion
of revenue from certain contracts that commenced during the prior fiscal year as
well as additional revenue from existing  customers  generated by an increase in
both the number of programs  managed by the Company on behalf of such  customers
and an  increase  in the number of  beneficiaries  enrolled  in such  customers'
programs; and $24.1 million was attributable to new customers commencing service
in the current  quarter,  a  significant  portion of which was derived  from the
Company's  contract  relating to the Civilian  Health and Medical Program of the
Uniformed Services ("Champus") for Champus Regions 7 and 8, under which services
commenced on April 1, 1997.  This revenue  increase  was  partially  offset by a
$13.7  million  decrease  in revenue as a result of the  termination  of certain
contracts,  $6.2  million  of which was due to  terminations  that  occurred  in
various  periods of the prior fiscal year.  Contract price  increases were not a
material factor in the increase in revenue.

Direct Service Costs. Direct service costs increased by $30.2 million, or 35.0%,
to $116.6  million for the three months  ended June 30, 1997 from $86.4  million
for the three  months ended June 30, 1996.  As a percentage  of revenue,  direct
service  costs  increased  from 77.7% in the prior  year  period to 81.1% in the
current year period.  The increase was  primarily due to the  anticipated  lower
than average direct profit margin earned on the Company's  contract  relating to
the State of Tennessee's  "TennCare  Partners Program" and a Medicaid program in
the Commonwealth of Pennsylvania.  Under the TennCare Partners Program, services
under  which  commenced  in the  fourth  quarter  of fiscal  1996,  the  Company
(together with a local Tennessee  partner)  provides mental health and substance
abuse  managed care  services to  approximately  500,000  Medicaid-eligible  and
uninsured  individuals  residing  in the  State  of  Tennessee.  In light of the
significance  of the  contract to the  Company's  overall  revenue  base and the
unusual  structure  of  the  TennCare  Partners  Program,  the  Company  expects
unfavorable year over year direct cost percentage  comparisons for the remainder
of fiscal  1997.  Furthermore,  on  February  1,  1997,  the  Company  commenced
providing  mental health and substance  abuse services to  approximately  40,000
Medicaid-eligible  beneficiaries  residing  in the  County  of  Delaware  of the
Commonwealth  of  Pennsylvania.  The direct  profit margin under such program is
contractually limited to an amount which is significantly lower than the average
direct profit margin of the Company's overall business.

Selling,   General   and   Administrative   Expenses.   Selling,   general   and
administrative expenses increased by $0.1 million, or 0.6%, to $17.4 million for
the three  months  ended June 30, 1997 from $17.3  million for the three  months
ended  June  30,  1996.  As  a  percentage  of  revenue,  selling,  general  and
administrative  expenses  decreased from 15.6% in the prior year period to 12.1%
in the current year period as a result of these expenses being  allocated over a
larger  revenue  base.  In  particular,  the TennCare  Partners and the Delaware
County programs  described above are large,  self-contained  programs  requiring
minimal incremental selling,  general and administrative expenses or operational
support  from the Company,  thereby  mitigating,  in large part,  the effects of
their lower than average direct service cost margins.

                                                         8

<PAGE>



Amortization  of  Intangibles.  Amortization  of  intangibles  increased by $0.2
million,  or 3.1%, to $6.7 million for the three months ended June 30, 1997 from
$6.5  million  for the three  months  ended  June 30,  1996.  The  increase  was
primarily  due  to  an  increase  in  amortization  of  goodwill  recognized  in
connection with the acquisition of ProPsych, Inc.

Other Income  (Expense).  For the three months ended June 30, 1997, other income
and expense  consisted of (i) interest  expense of $6.2 million  related to debt
incurred as a result of the merger of the Company with MDC Acquisition  Corp. on
October  6, 1995 (the  "Merger");  and (ii)  interest  and other  income of $0.8
million relating  primarily to investment  earnings on the Company's  short-term
investments and restricted cash and investment  balances.  Both interest expense
and interest income were relatively unchanged from the prior year period.

Income Taxes.  The Company  recorded a benefit for income taxes during the three
months ended June 30, 1997 based upon the Company's pre-tax loss in such period.

Nine Months Ended June 30, 1997 Compared to Nine Months Ended June 30, 1996

Revenue.  The Company's revenue increased by $71.3 million,  or 21.4%, to $405.1
million for the nine months ended June 30, 1997 from $333.8 million for the nine
months ended June 30, 1996. Of this increase,  $74.1 million was attributable to
the inclusion of revenue from certain  contracts that commenced during the prior
fiscal year as well as additional revenue from existing  customers  generated by
an increase  in both the number of programs  managed by the Company on behalf of
such customers and an increase in the number of  beneficiaries  enrolled in such
customers'  programs;  and  $39.1  million  was  attributable  to new  customers
commencing  service in the current nine month period.  This revenue increase was
partially  offset by a $41.9  million  decrease  in  revenue  as a result of the
termination of certain contracts, $28.7 million of which was due to terminations
that occurred in various periods of the prior fiscal year. Contract price 
increases were not a material factor in the increase in revenue.

Direct Service Costs. Direct service costs increased by $65.0 million, or 24.7%,
to $327.7  million for the nine months  ended June 30, 1997 from $262.7  million
for the nine months ended June 30,  1996.  As a  percentage  of revenue,  direct
service  costs  increased  from 78.7% in the prior  year  period to 80.9% in the
current year period.  The increase was due to the anticipated lower than average
direct  profit margin  earned on the TennCare  Partners and the Delaware  County
programs  described  above,  partly  offset  by a  year  over  year  decline  in
healthcare  utilization  in the Company's  overall  business.  In addition,  the
Delaware County program replaced a program under which beneficiaries  previously
received  their  mental  health  benefit  through  membership  in various  HMO's
servicing this area. Direct profit margins under contracts that the Company held
with certain of these HMO's,  which  terminated or membership in which decreased
substantially  as a result of this  program,  were higher than the direct profit
margins for the Delaware  County  carve-out  program and the  Company's  overall
average direct profit margins. Excluding the effect of the TennCare Partners and
the Delaware County contracts, however, the Company experienced a decline in the
direct  service  cost  percentage  as  a  result  of  overall  lower  healthcare
utilization  in the  current  nine month  period as  compared  to the prior year
period, due to the Company's continued development and deployment of alternative
treatment  programs  designed to achieve more  cost-effective  treatment and the
Company's  increased  focus on  clinical  care  techniques  directed at patients
requiring more  intensive  treatment  services.  Also  positively  impacting the
direct cost percentage was the effect of a nationwide recontracting program with
providers which began in the second quarter of fiscal 1996.

Selling,   General   and   Administrative   Expenses.   Selling,   general   and
administrative expenses increased by $2.4 million, or 5.1%, to $49.7 million for
the nine months ended June 30, 1997 from $47.3 million for the nine months ended
June 30,  1996.  The  increase  in total  selling,  general  and  administrative
expenses  was  primarily  attributable  to (i)  growth  in  marketing  and sales
administrative  staff,  corporate and regional  management  and support  systems
associated  with the higher sales  volume,  (ii)  expenses  associated  with the
expansion of both the  Company's  national  service  center  ("National  Service
Center") located in St. Louis,  Missouri, and the Company's headquarters located
in Park Ridge, New Jersey,  and (iii) expenses related to the planned deployment
of the Company's new information  systems. As a percentage of revenue,  selling,
general  and  administrative  expenses  decreased  from  14.2% in the prior year
period  to 12.3% in the  current  year  period  primarily  as a result  of these
expenses being  allocated  over a larger  revenue base. In particular,  as noted
above,  the TennCare  Partners and the Delaware County programs  require minimal
incremental selling,  general and administrative expenses or Company operational
support,  thereby  mitigating,  in large  part,  the effects of their lower than
average direct service cost margins described above.

                                                         9

<PAGE>



Amortization  of  Intangibles.  Amortization  of  intangibles  increased by $0.8
million,  or 4.1%, to $20.1 million for the nine months ended June 30, 1997 from
$19.3  million  for the nine  months  ended  June 30,  1996.  The  increase  was
primarily  due  to  an  increase  in  amortization  of  goodwill  recognized  in
connection with the acquisition of ProPsych, Inc.

Other Income  (Expense).  For the nine months ended June 30, 1997,  other income
and expense  consisted of (i) interest  expense of $18.7 million related to debt
incurred as a result of the Merger,  and (ii)  interest and other income of $2.4
million relating  primarily to investment  earnings on the Company's  short-term
investments  and  restricted  cash and investment  balances.  The year over year
increase in interest  expense of $1.0 million was primarily  attributable to the
full period  impact of (i) the  indebtedness  incurred on October 6, 1995 by the
Company in  connection  with the Merger;  and (ii) the  Company's 11 1/2% Senior
Subordinated  Notes due 2005 (the "Notes")  which bore interest at a higher rate
than the bridge financing  facility that the Notes replaced.  The year over year
increase in interest  income of $0.4 million was primarily  attributable to both
an  increase  in average  invested  cash  balances as compared to the prior year
period and interest earned on advances to certain joint ventures.

Income  Taxes.  The Company  recorded a benefit for income taxes during the nine
months ended June 30, 1997 based upon the Company's pre-tax loss in such period.

Liquidity and Capital Resources

General.  For the nine months ended June 30, 1997, operating activities provided
cash of $20.6  million,  investing  activities  used cash of $20.6  million  and
financing activities provided cash of $5.8 million,  resulting in a net increase
in cash  and cash  equivalents  of $5.8  million.  Investing  activities  in the
current nine month period consisted  principally of (i) capital  expenditures of
$17.0 million  related  primarily to the continued  development of the Company's
new information  systems and expansion of the Company's National Service Center;
and (ii) expenditures of $4.1 million for the purchase of short-term investments
made to satisfy contracts held by the Company.

Senior  Indebtedness.  As of June 30, 1997, $40.0 million of revolving loans and
$8.1 million of letters of credit were  outstanding  under the revolving  credit
facility of the Company's  Credit  Agreement with The Chase Manhattan Bank, N.A.
(the "Senior Credit Facility") and approximately $36.9 million was available for
future borrowing.

Adjusted EBITDA.  Adjusted EBITDA, a financial measure used in the Senior Credit
Facility and the  indenture for the Notes (the  "Indenture"),  increased by $2.7
million,  or 24.5%,  to $13.7  million for the three  months ended June 30, 1997
from $11.0 million for the three months ended June 30, 1996. For the nine months
ended June 30, 1997,  Adjusted  EBITDA  increased by $5.7 million , or 17.1%, to
$39.1 million from $33.4 million for the comparable period in the prior year.

Cash in Claims Funds and  Restricted  Cash. As of June 30, 1997, the Company had
total  cash  and  investment  balances  (including  cash  equivalents)  of $61.0
million,  of which  $41.1  million was  restricted  under  certain  contractual,
fiduciary and regulatory  requirements;  moreover,  of such amount, $3.7 million
was  classified  as a long-term  asset on the  Company's  balance  sheet.  Under
certain contracts,  the Company is required to establish segregated claims funds
into which a portion of its capitation fee is held until a  reconciliation  date
(which reconciliation  typically occurs annually).  Until that time, cash funded
under these  arrangements  is unavailable to the Company for purposes other than
the payment of claims.  In addition,  California and Illinois  state  regulatory
requirements restrict access to cash held by the Company's  subsidiaries in such
states.  As of June 30,  1997,  the Company  also held  surplus  cash  balances,
classified as cash and cash equivalents and short-term investments,  as required
by the contracts held by the Company  relating to Medicaid program for the State
of Iowa  and  the  TennCare  Partners  and  Delaware  County  Medicaid  programs
described above.

Availability of Cash. Prior to the Merger, the Company had funded its operations
primarily with cash generated from operations and through the funding of certain
acquisitions,  investments and other transactions by its former parent,  Merck &
Co., Inc. The Company currently and in the future expects to finance its capital
requirements through existing cash balances,  cash generated from operations and
borrowings  under the revolving  credit facility of the Senior Credit  Facility.
Based  upon the  current  level of cash flow  from  operations  and  anticipated
growth,  the Company  believes that  available  cash,  together  with  available
borrowings  under the revolving  credit facility and other sources of liquidity,
will

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be adequate to meet the Company's  anticipated  future  requirements for working
capital, capital expenditures,  and scheduled payments of principal and interest
on its indebtedness for the foreseeable future.

Acquisition  of CMG Health,  Inc. On July 14, 1997,  the Company  entered into a
definitive  agreement (the  "Agreement")  to acquire all of the capital stock of
CMG Health,  Inc.  ("CMG").  Pursuant to the Agreement,  the acquisition will be
effected  through a merger of an  affiliate of the Company with CMG, as a result
of which CMG will become a wholly owned subsidiary of the Company. The Agreement
provides that holders of CMG's common and preferred  stock will receive,  in the
aggregate,  at closing  (1)  approximately  $51.5  million in cash  (subject  to
certain  adjustments),  (2) 750,000 shares of MBC common stock and (3) rights to
receive certain additional cash and stock consideration based upon future events
and the post-closing financial performance of CMG. The Chase Manhattan Bank, the
agent for the  Company's  existing  senior  credit  facility,  has  committed to
provide the funding to make the cash payments  required in  connection  with the
acquisition  (including  related  fees and  expenses).  The merger is subject to
certain  conditions,  including the expiration of antitrust  regulatory  waiting
periods and the funding of the financing arrangements.

                         PART II.  OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

         In October 1996, a group of eight plaintiffs purporting to represent an
uncertified class of psychiatrists,  psychologists and social workers brought an
action under the federal  antitrust laws in the United States District Court for
the Southern District of New York (the "District Court") against nine behavioral
health  managed  care  organizations,   including  the  Company   (collectively,
"Defendants") entitled Edward M. Stephens, Jose A. Yaryura-Tobias, Judith Green,
Ph.D.,  Fugen Neziroglu,  Ph.D., Ona Robinson,  Ph.D.,  Laurie A. Baum,  C.S.W.,
Agnes Wohl, C.S.W., and The On-Step Institute For Mental Health Research,  Inc.,
individually and on behalf of all others similarly situated,  v. CMG Health, FHC
Options,  Inc., Foundation Health PsychCare Services,  Inc., Green Spring Health
Services, Inc., Human Affairs International,  Inc., Merit Behavioral Care Corp.,
MCC Behavioral Care Inc., United Behavioral Systems,  Inc., and Value Behavioral
Health, Inc., 96 Civ. 7798 (KMW). The complaint alleges that Defendants violated
section 1 of the Sherman Act by  engaging in a  conspiracy  to fix the prices at
which  Defendants  purchase  services from mental  healthcare  providers such as
plaintiffs.  The complaint  further alleges that  Defendants  engaged in a group
boycott to exclude  mental  healthcare  providers from  Defendants'  networks in
order to  further  the  goals of the  alleged  conspiracy.  The  complaint  also
challenges  the  propriety of  Defendants'  capitation  arrangements  with their
respective  customers,  although  it  is  unclear  from  the  complaint  whether
plaintiffs allege that Defendants  unlawfully conspired to enter into capitation
arrangements with their respective customers. The complaint seeks treble damages
against  Defendants  in  an  unspecified  amount  and  a  permanent   injunction
prohibiting  Defendants  from  engaging in the alleged  conduct  which forms the
basis of the  complaint,  plus  costs and  attorneys'  fees.  In  January  1997,
Defendants  filed a  motion  to  dismiss  the  complaint.  On July 21,  1997,  a
court-appointed  magistrate  judge  issued a report  and  recommendation  to the
District Court  recommending  that  Defendants'  motion to dismiss the complaint
with prejudice be granted. On August 5, 1997, plaintiffs filed objections to the
magistrate judge's report and recommendation;  such objections have not yet been
heard.  The Company  intends to  vigorously  defend  itself in this  litigation.
However,  there can be no assurance that the outcome of this  litigation will be
favorable to the Company.  An unfavorable  outcome could have a material adverse
effect on the Company.

ITEM 6.  EXHIBITS AND REPORTS ON FORM  8-K.

(a) Exhibits

         *27      Financial Data Schedule (electronic filing only).

                  *filed herewith

(b) Reports on Form 8-K

         No  reports on Form 8-K were filed  during the  quarter  for which this
report is being filed.

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                               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.

The signatory  hereby  acknowledges and adopts the typed form of his name in the
electronic filing of this document with the Securities and Exchange Commission.







Date: August 14, 1997                      Merit Behavioral Care Corporation



                                       By:      /s/ John A. Budnick III
                                          ___________________________________
                                          John A. Budnick III
                                          Executive Vice President
                                          and Chief Financial Officer
                                          (Principal Financial Officer,
                                           Accounting Officer and
                                           Duly Authorized Officer)


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