<PAGE>   1
 
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                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                   FORM 10-K
(MARK ONE)
      [X]      ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
               EXCHANGE ACT OF 1934 (FEE REQUIRED)
 
                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
 
                                       OR
 
      [ ]      TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
               SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
 
                         COMMISSION FILE NUMBER: 1-9550
 
                           BEVERLY ENTERPRISES, INC.
             (Exact name of Registrant as specified in its charter)
 
<TABLE>
<S>                                            <C>
                  DELAWARE                                      62-1691861
       (State or other jurisdiction of                       (I.R.S. Employer
       incorporation or organization)                       Identification No.)
       5111 ROGERS AVENUE, SUITE 40-A
            FORT SMITH, ARKANSAS                                72919-0155
  (Address of principal executive offices)                      (Zip Code)
</TABLE>
 
       Registrant's telephone number, including area code: (501) 452-6712
 
          Securities registered pursuant to Section 12(b) of the Act:
 
<TABLE>
<CAPTION>
                                                           NAME OF EACH EXCHANGE
             TITLE OF EACH CLASS                            ON WHICH REGISTERED
             -------------------                           ---------------------
<C>                                            <S>
        Common Stock, $.10 par value                        New York Stock Exchange
                                                            Pacific Stock Exchange
    9% Senior Notes due February 15, 2006                   New York Stock Exchange
</TABLE>
 
        Securities registered pursuant to Section 12(g) of the Act: NONE
     INDICATE BY CHECK MARK WHETHER 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 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.  [X]
 
     THE AGGREGATE MARKET VALUE OF THE VOTING STOCK HELD BY NONAFFILIATES OF
REGISTRANT WAS $526,153,242 AS OF FEBRUARY 26, 1999.
 
                                  102,493,655
  (NUMBER OF SHARES OF COMMON STOCK OUTSTANDING, NET OF TREASURY SHARES, AS OF
                               FEBRUARY 26, 1999)
 
     PART III IS INCORPORATED BY REFERENCE FROM THE PROXY STATEMENT FOR THE
ANNUAL MEETING OF STOCKHOLDERS TO BE HELD ON MAY 27, 1999.
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<PAGE>   2
 
                                     PART I
 
ITEM 1. BUSINESS.
 
GENERAL
 
     References herein to the Company include Beverly Enterprises, Inc. and its
wholly-owned subsidiaries.
 
     Beverly Enterprises, Inc. (formerly known as New Beverly Holdings, Inc.),
which was incorporated on April 15, 1997 ("New Beverly"), is the successor to
the former Beverly Enterprises, Inc., which was incorporated on February 27,
1987 ("Old Beverly"), as the result of a tax-free reorganization completed
December 3, 1997 (the "Reorganization") in order to facilitate the merger of
Pharmacy Corporation of America ("PCA") with Capstone Pharmacy Services, Inc.
("Capstone") (the "Merger"). References to Beverly Enterprises, Inc., or the
Company, prior to December 3, 1997 means the predecessor corporation, Old
Beverly. References to Beverly Enterprises, Inc., or the Company, on or after
December 3, 1997 means New Beverly, and New Beverly is treated for accounting
purposes as the continuing reporting entity with respect to the historical and
future operations of the Company. See "Part II, Item 8 -- Note 3 of Notes to
Consolidated Financial Statements" for additional information.
 
     The business of the Company consists principally of providing healthcare
services, including the operation of nursing facilities, rehabilitation therapy
services, assisted living centers, home care centers and outpatient clinics. In
addition, prior to June 30, 1998, the Company operated acute long-term
transitional hospitals and, prior to the Merger, institutional and mail service
pharmacies.
 
     The Company is one of the largest operators of nursing facilities in the
United States. At January 31, 1999, the Company operated 561 nursing facilities
with 62,171 licensed beds. The facilities are located in 29 states and the
District of Columbia, and range in capacity from 20 to 355 beds. At January 31,
1999, the Company also operated 36 assisted living centers containing 1,039
units, 194 outpatient clinics, and 75 home care centers. The Company's
facilities had average occupancy of 88.7%, 88.9% and 87.4% during the years
ended December 31, 1998, 1997 and 1996, respectively. See "Item 2. Properties."
 
     This Annual Report on Form 10-K, and other information provided by the
Company from time to time, contains certain "forward-looking" statements as that
term is defined by the Private Securities Litigation Reform Act of 1995. All
statements regarding the Company's expected future financial position, results
of operations, cash flows, continued performance improvements, ability to
service its debt obligations, ability to finance growth opportunities, response
to changes in government regulations, and similar statements including, without
limitation, those containing words such as "believes," "anticipates," "expects,"
"intends," "estimates," "plans," and other similar expressions are
forward-looking statements. Forward-looking statements involve known and unknown
risks and uncertainties that may cause the Company's actual results in future
periods to differ materially from those projected or contemplated in the
forward-looking statements as a result of, but not limited to, the following
factors: national and local economic conditions; the effect of government
regulation and changes in regulations governing the healthcare industry,
including the Company's compliance with such regulations; changes in Medicare
and Medicaid payment levels; liabilities and other claims asserted against the
Company, including the outcome of the federal government investigation (see
"Item 3. Legal Proceedings"); the ability to attract and retain qualified
personnel; the availability and terms of capital to fund acquisitions and
capital improvements; the competitive environment in which the Company operates;
demographic changes; the ability of the Company and its significant vendors,
suppliers and payors to timely locate and correct all relevant computer codes
and identify and remediate date-sensitive embedded chips prior to the year 2000;
and the availability and cost of labor and materials. Given these risks and
uncertainties, the Company can give no assurances that these forward-looking
statements will, in fact, transpire and, therefore, cautions investors not to
place undue reliance on them.
 
     Healthcare service providers, such as the Company, operate in an industry
that is subject to significant changes from business combinations, new strategic
alliances, legislative reform, aggressive marketing practices by competitors and
market pressures. In this environment, the Company is frequently contacted by,
and
 
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<PAGE>   3
 
otherwise engages in discussions with, other healthcare companies and financial
advisors regarding possible strategic alliances, joint ventures, business
combinations and other financial alternatives.
 
OPERATIONS
 
     The Company is currently organized into two operating segments, which
support the Company's delivery of vertically integrated services to the
long-term healthcare market. These operating segments include: (i) Beverly
Healthcare, which provides long-term healthcare through the operation of nursing
facilities and assisted living centers; and (ii) Beverly Care Alliance, which
operates outpatient clinics, home care centers and a rehabilitation services
business. Business in each operating segment is conducted by one or more
corporations headed by a president who also is a senior officer of the Company
and reports directly to the President of the Company. The corporations
comprising each of the two operating segments also have separate boards of
directors consisting of four senior executives of the Company and the president
of the segment. See "Part II, Item 8 -- Note 10 of Notes to Consolidated
Financial Statements" for additional information.
 
     Beverly Healthcare's nursing facilities provide residents with routine
long-term care services, including daily dietary, social and recreational
services and a full range of pharmacy services and medical supplies. Beverly
Healthcare's highly skilled staff also offers complex and intensive medical
services to patients with higher acuity disorders outside the traditional acute
care hospital setting. In addition, Beverly Healthcare provides assisted living
services. Approximately 90%, 80% and 82% of the Company's total net operating
revenues for the years ended December 31, 1998, 1997 and 1996, respectively,
were derived from services provided by Beverly Healthcare.
 
     Beverly Care Alliance offers industrial rehabilitation, outpatient clinics,
acute hospital therapy contracts, management/consulting rehabilitation programs
and home care services within the Company's network of facilities and to other
healthcare providers. Approximately 7%, 2% and 2% of the Company's total net
operating revenues for the years ended December 31, 1998, 1997 and 1996,
respectively, were derived from services provided by Beverly Care Alliance.
 
GOVERNMENTAL REGULATION AND REIMBURSEMENT
 
     The Company's nursing facilities are subject to compliance with various
federal, state and local healthcare statutes and regulations. Compliance with
state licensing requirements imposed upon all healthcare facilities is a
prerequisite for the operation of the facilities and for participation in
government-sponsored healthcare funding programs, such as Medicaid and Medicare.
Medicaid is a medical assistance program for the indigent, operated by
individual states with the financial participation of the federal government.
Medicare is a health insurance program for the aged and certain other
chronically disabled individuals, operated by the federal government. Changes in
the reimbursement policies of such funding programs as a result of budget cuts
by federal and state governments or other legislative and regulatory actions
could have a material adverse effect on the Company's consolidated financial
position, results of operations and cash flows.
 
     The Company receives payments for services rendered to patients from (a)
each of the states in which its nursing facilities are located under the
Medicaid program; (b) the federal government under the Medicare program; and (c)
private payors, including commercial insurers, managed care payors and Veterans
Administration ("VA"). The following table sets forth: (i) patient days derived
from the indicated sources of payment as a percentage of total patient days,
(ii) room and board revenues derived from the indicated
 
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<PAGE>   4
 
sources of payment as a percentage of net operating revenues, and (iii)
ancillary and other revenues derived from all sources of payment as a percentage
of net operating revenues, for the periods indicated:
 
<TABLE>
<CAPTION>
                                      MEDICAID             MEDICARE          PRIVATE AND VA
                                 ------------------   ------------------   ------------------
                                           ROOM AND             ROOM AND             ROOM AND
                                 PATIENT    BOARD     PATIENT    BOARD     PATIENT    BOARD     ANCILLARY AND
                                  DAYS     REVENUES    DAYS     REVENUES    DAYS     REVENUES   OTHER REVENUES
                                 -------   --------   -------   --------   -------   --------   --------------
<S>                              <C>       <C>        <C>       <C>        <C>       <C>        <C>
Year ended:
  December 31, 1998............    69%        46%       11%        13%       20%        18%           23%
  December 31, 1997............    68%        40%       12%        12%       20%        16%           32%
  December 31, 1996............    69%        42%       12%        12%       19%        14%           32%
</TABLE>
 
     Consistent with the long-term care industry in general, changes in the mix
of the Company's patient population among the Medicaid, Medicare and private
categories can significantly affect revenues and profitability. In most states,
private patients are the most profitable, and Medicaid patients are the least
profitable.
 
     Ancillary revenues are derived from providing services to residents beyond
room, board and custodial care and include occupational, physical, speech,
respiratory and intravenous ("IV") therapy, as well as sales of pharmaceuticals
and other services. Such services are currently provided primarily to Medicare
and private pay patients, consistent with the trend in healthcare of providing a
broader range of services in a lower cost setting, such as the Company's nursing
facilities.
 
     Medicaid programs are currently in existence in all of the states in which
the Company operates nursing facilities. While these programs differ in certain
respects from state to state, they are all subject to federally-imposed
requirements, and at least 50% of the funds available under these programs is
provided by the federal government under a matching program.
 
     The Medicaid and Medicare programs each contain specific requirements which
must be adhered to by healthcare facilities in order to qualify under the
programs. Currently, most state Medicaid programs utilize a cost-based
reimbursement system for nursing facilities which reimburses facilities for the
reasonable direct and indirect allowable costs incurred in providing routine
patient care services (as defined by the programs) plus, in certain states,
efficiency incentives or a return on equity, subject to certain cost ceilings.
These costs normally include allowances for administrative and general costs as
well as the costs of property and equipment (e.g. depreciation and interest,
fair rental allowance or rental expense). In some states, cost-based
reimbursement is subject to retrospective adjustment through cost report
settlement. In other states, payments made to a facility on an interim basis
that are subsequently determined to be less than or in excess of allowable costs
may be adjusted through future payments to the affected facility and to other
facilities owned by the same owner. State Medicaid reimbursement programs vary
as to the methodology used to determine the level of allowable costs which are
reimbursed to operators.
 
     Arkansas and California provide for reimbursement at a flat daily rate, as
determined by the responsible state agency. Several states in which the Company
currently operates have enacted payment mechanisms which are based on patient
acuity versus traditional cost-based methodologies. Many other states are
actively developing similar payment systems. The Company is unable to estimate
the ultimate impact of these changes in payment mechanisms on the Company's
future consolidated financial position, results of operations, or cash flows.
 
     Healthcare system reform and concerns over rising Medicare and Medicaid
costs continue to be high priorities for both the federal and state governments.
In August 1997, the President signed into law the Balanced Budget Act of 1997
(the "1997 Act") in which Congress included numerous program changes directed at
balancing the federal budget. The legislation changes Medicare and Medicaid
policy in a number of ways, including: (i) the phase in of a Medicare
prospective payment system ("PPS") for skilled nursing facilities effective July
1, 1998 (see below); (ii) establishment of limitations on Part B therapy charges
per beneficiary per year; (iii) a 10% reduction in Part B therapy costs for the
period from January 1, 1998 through July 1, 1998, at which time reimbursement
for these services will be based on fee schedules established by the Health Care
Financing Administration ("HCFA") of the Department of Health and Human Services
 
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<PAGE>   5
 
("HHS"); (iv) development of new Medicare and Medicaid health plan options; (v)
creation of additional safeguards against healthcare fraud and abuse; and (vi)
repeal of the Medicaid "Boren Amendment" payment standard. The legislation
includes new opportunities for providers to focus further on patient outcomes by
creating alternative patient delivery structures. The Company currently
estimates a decrease in its 1999 net operating revenues of approximately
$70,000,000 related to the impact of PPS and estimates a decrease in its 1999
net operating revenues of approximately $30,000,000 related to the impact of
Part B therapy cost reductions, including the establishment of beneficiary
limits. Future federal budget legislation and federal and state regulatory
changes may negatively impact the Company.
 
     PPS, which became effective for the Company on January 1, 1999,
significantly changes the manner in which its skilled nursing facilities are
paid for inpatient services provided to Medicare beneficiaries. PPS will be
phased in over a three year period. In year one (1999 for the Company), Medicare
PPS rates will be based 75% on 1995 facility-specific Medicare costs (as
adjusted for inflation) and 25% will be federally-determined based upon the
acuity level of Medicare patients served in the Company's skilled nursing
facilities. In year two, Medicare PPS rates will be based 50% on 1995
facility-specific costs (as adjusted for inflation) and 50% on the
federally-determined acuity-adjusted rate. In year three, Medicare PPS rates
will be based 25% on 1995 facility-specific costs (as adjusted for inflation)
and 75% on the federally-determined acuity-adjusted rate. In year four and
thereafter, Medicare PPS rates will be based entirely on the
federally-determined acuity-adjusted rate.
 
     The Company has analyzed its 1995 facility-specific costs, as well as the
current acuity level of Medicare patients in its skilled nursing facilities. In
addition, the Company has identified the significant changes in its
facility-specific costs since 1995 to determine the major reasons for such
changes. Based on such analyses, the Company has implemented facility-specific
plans to deliver care to Medicare patients at a lower cost and in a manner
consistent with PPS requirements. Such plans resulted in material changes in
staffing in the Company's skilled nursing facilities, primarily in the area of
rehabilitation services. Such staffing changes also resulted in a fourth quarter
1998 charge of approximately $2,500,000. The Company has also determined that
other cost reductions can be achieved in its skilled nursing facilities. If the
Company is unable to carry out its facility-specific plans to reduce the cost of
care to Medicare patients, PPS could have a material adverse effect on the
Company's consolidated financial position and results of operations.
 
     PPS also imposes significant documentation requirements on skilled nursing
facilities to demonstrate the acuity level of Medicare patients and other
factors which will directly impact billing and payment rates to the Company, as
well as compliance with PPS rules and regulations. The Company has implemented
new and enhanced information systems to help ensure compliance with PPS.
Company-wide training on PPS and other 1997 Act provisions has been conducted.
As a result of these and other preparations, the Company believes it will be
positioned to operate effectively under PPS.
 
     In addition to the requirements to be met by the Company's facilities for
annual licensure renewal, the Company's healthcare facilities are subject to
annual surveys and inspections in order to be certified for participation in the
Medicare and Medicaid programs. In order to maintain their operator's licenses
and their certification for participation in Medicare and Medicaid programs, the
nursing facilities must meet certain statutory and administrative requirements.
These requirements relate to the condition of the facilities and the adequacy
and condition of the equipment used therein, the quality and adequacy of
personnel, and the quality of medical care. Such requirements are subject to
change. There can be no assurance that, in the future, the Company will be able
to maintain such licenses for its facilities or that the Company will not be
required to expend significant sums in order to do so.
 
     HCFA adopted survey, certification and enforcement procedures by
regulations effective July 1, 1995 to implement the Medicare and Medicaid
provisions of the Omnibus Budget Reconciliation Act of 1987 ("OBRA 1987")
governing survey, certification and enforcement of the requirements for contract
participation by skilled nursing facilities under Medicare and nursing
facilities under Medicaid. Among the provisions that HCFA has adopted are
requirements that (i) surveys focus on residents' outcomes; (ii) all deviations
from the participation requirements will be considered deficiencies, but all
deficiencies will not constitute noncompliance; and (iii) certain types of
deficiencies must result in the imposition of a sanction. The
 
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<PAGE>   6
 
regulations also identify alternative remedies and specify the categories of
deficiencies for which they will be applied. These remedies include: temporary
management; denial of payment for new admissions; denial of payment for all
residents; civil money penalties of $50 to $10,000 per day of violation; closure
of facility and/or transfer of residents in emergencies; directed plans of
correction; and directed in service training. The regulations also specify under
what circumstances alternative enforcement remedies or termination, or both,
will be imposed on facilities which are not in compliance with the participation
requirements. The Company has undertaken an analysis of the procedures with
respect to its programs and facilities covered by the final HCFA regulations.
Results of HCFA surveys for the past year have determined that the Company
continues to improve its regulatory compliance record. The Company's facilities
that are cited with deficiencies are cited less frequently than other
proprietary, chain facilities. Although the Company could be adversely affected
if a substantial portion of its programs or facilities were eventually
determined not to be in compliance with the HCFA regulations, the Company
believes its programs and facilities are generally in compliance.
 
     The Company has a Quality Management ("QM") program to help ensure that
high quality care is provided in each of its nursing and outpatient facilities.
The Company's nationwide QM network of healthcare professionals includes
physician medical directors, registered nurses, dieticians, social workers and
other specialists who work in conjunction with regional and facility based QM
professionals. Facility based QM is structured through the Company's Quality
Assessment and Assurance Committee. With a philosophy of quality improvement,
Company-wide clinical indicators are utilized as a database to set goals and
monitor thresholds in critical areas directly related to the delivery of
healthcare related services. These internal evaluations are used by local
quality improvement teams, which include QM advisors, to identify and correct
possible problems. The Senior Vice President of QM reports directly to the
President of the Company and the QM Committee of the Company's Board of
Directors.
 
     The Company believes that its facilities are in substantial compliance with
currently applicable Medicaid and Medicare conditions of participation. In the
ordinary course of its business, however, the Company receives notices of
deficiencies for failure to comply with various regulatory requirements. The
Company reviews such notices and takes appropriate corrective action. In most
cases, the Company and the reviewing agency will agree upon the steps to be
taken to bring the facility into compliance with regulatory requirements. In
some cases or upon repeat violations, the reviewing agency may take a number of
adverse actions against a facility. These adverse actions can include the
imposition of fines, temporary suspension of admission of new patients to the
facility, decertification from participation in the Medicaid or Medicare
programs and, in extreme circumstances, revocation of a facility's license.
 
     The Social Security Act and regulations of HHS provide for exclusion of
providers and related persons from participation in the Medicare and Medicaid
programs if they have been convicted of a criminal offense related to the
delivery of an item or service under either of these programs or if they have
been convicted, under state or federal law, of a criminal offense relating to
neglect or abuse of residents in connection with the delivery of a healthcare
item or service. Furthermore, individuals or entities and their affiliates may
be excluded from the Medicare and Medicaid programs under certain circumstances
including conviction relating to fraud, license revocation or suspension, or
failure to furnish services of adequate quality.
 
     The "fraud and abuse" anti-kickback provisions of the Social Security Act
(presently codified in Section 1128B(b) of the Social Security Act, hereinafter
the "Antifraud Amendments") make it a criminal felony offense to knowingly and
willfully offer, pay, solicit or receive remuneration in order to induce
business for which reimbursement is provided under government health programs,
including Medicare and Medicaid. The Antifraud Amendments have been broadly
interpreted to make remuneration of any kind, including many types of business
and financial arrangements among providers, potentially illegal if any purpose
of the remuneration or financial arrangement is to induce a referral.
Accordingly, joint ventures, space and equipment rentals, management and
personal services contracts, and certain investment arrangements among providers
may be suspect.
 
     In 1991, HHS promulgated regulations which describe certain arrangements
that would not be subject to enforcement action under the Social Security Act
(the "Safe Harbors"). The Safe Harbors described in the regulations are narrow,
leaving unprotected a wide range of economic relationships that many hospitals,
 
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<PAGE>   7
 
physicians and other healthcare providers consider to be legitimate business
arrangements not prohibited by the Antifraud Amendments. The regulations do not
purport to describe comprehensively all lawful relationships between healthcare
providers and referral sources, and clearly provide that arrangements that do
not qualify for Safe Harbor protection are not automatically deemed to violate
the Antifraud Amendments. Thus, skilled nursing facilities and other healthcare
providers having arrangements or relationships that do not fall within a Safe
Harbor may not be required to alter them in order to ensure compliance with the
Social Security Act provisions. Although failure to qualify for a Safe Harbor
may subject a particular arrangement or relationship to increased regulatory
scrutiny, the fact that a particular relationship or arrangement does not fall
within one of the Safe Harbors does not, in and of itself, mean the relationship
or arrangement is unlawful. In 1993, HHS published proposed regulations for
comment in the Federal Register establishing additional Safe Harbors.
Additionally, in 1994, HHS published a proposed rule aimed at clarifying the
existing Safe Harbors. As of January 1, 1999, these regulations had not been
adopted in final form. The Company cannot predict the final form that these
regulations and rules will take or their effect, if any, on the Company's
business.
 
     In addition to the Antifraud Amendments, Section 1877 of the Social
Security Act (known as the "Stark Law") imposes restrictions on financial
relationships between physicians and certain entities. The Stark Law provides
that if a physician (or an immediate family member of a physician) has a
financial relationship with an entity that furnishes certain designated health
services, the physician may not refer a Medicare or Medicaid patient to the
entity, and the entity may not bill for services provided unless an exception to
the financial relationship exists. Designated health services include certain
services furnished by the Company, such as physical therapy, occupational
therapy, prescription drugs and home health. The types of financial
relationships that can trigger the referral and billing prohibitions are broad
and include ownership or investment interests, as well as compensation
arrangements. Penalties for violating the law are severe, including denial of
payment for services furnished pursuant to prohibited referrals, civil monetary
penalties of $15,000 for each item claimed, assessments equal to 200% of the
dollar value of each such service provided, and exclusion from the Medicare and
Medicaid programs.
 
     On August 14, 1995, final regulations were published interpreting the
original provisions of the Stark Law that became effective January 1, 1992.
These provisions relate to entities that furnish clinical laboratory services,
commonly referred to as "Stark I." Expanded restrictions as applied to the
additional designated health services (referred to as "Stark II") became
effective as of January 1, 1995. Proposed regulations implementing Stark II were
published on January 9, 1998. The Company cannot predict the final form that
such regulations will take or the effect that Stark II or the regulations
promulgated thereunder will have on the Company.
 
     Many states in which the Company operates also have laws that prohibit
payments to physicians for patient referrals with statutory language similar to
the Antifraud Amendments, but with broader effect since they apply regardless of
the source of payment for care. These statutes typically provide criminal and
civil penalties, as well as loss of licensure. Many states also have passed
legislation similar to Stark, but with broader effect, since the legislation
applies regardless of the source of payment for care. The scope of these state
laws is broad and little precedent exists for their interpretation or
enforcement.
 
     On August 21, 1996, President Clinton signed significant new federal health
reform legislation known as the Health Insurance Portability and Accountability
Act of 1996 ("HIPAA"). The new law includes comprehensive and far-reaching
revisions or supplements to the Antifraud Amendments. Under HIPAA, healthcare
fraud, now defined as knowingly and willfully executing or attempting to execute
a "scheme or device" to defraud any healthcare benefit program, is made a
federal criminal offense. In addition, for the first time, federal enforcement
officials will have the ability to exclude from the Medicare and Medicaid
programs any investors, officers and managing employees associated with business
entities that have committed healthcare fraud, even if the investor, officer or
employee had no actual knowledge of the fraud. HIPAA also establishes a new
violation for the payment of inducements to Medicare or Medicaid beneficiaries
in order to influence those beneficiaries to order or receive services from a
particular provider or practitioner. Most of the provisions of HIPAA became
effective January 1, 1997. HIPAA was followed by the 1997 Act. The 1997 Act also
contained a significant number of new fraud and abuse provisions. For example,
civil monetary penalties ("CMP") may now be imposed for violations of the
anti-kickback provisions of the Medicare and Medicaid
                                        6
<PAGE>   8
 
statute (previously, exclusion or criminal prosecution were the only actions
under the anti-kickback statute), as well as contracting with an individual or
entity that the provider knows or should know is excluded from a federal
healthcare program. The 1997 Act provides for CMP of $50,000 and damages of not
more than three times the amount of remuneration in the prohibited activity.
 
     In 1976, Congress established the Office of Inspector General ("OIG") at
HHS to identify and eliminate fraud, abuse and waste in HHS programs and to
promote efficiency and economy in HHS departmental operations. The OIG carries
out this mission through a nationwide program of audits, investigations and
inspections. In order to provide guidance to healthcare providers on ways to
engage in legitimate business practices and avoid scrutiny under the fraud and
abuse statutes, the OIG has from time to time issued "fraud alerts" identifying
segments of the healthcare industry and particular practices that are vulnerable
to abuse. The OIG has issued three fraud alerts targeting the skilled nursing
industry: an August 1995 alert relating to the provision of medical supplies to
nursing facilities, the fraudulent billing for medical supplies and equipment
and fraudulent supplier transactions; a May 1996 alert focusing on the provision
of fraudulent professional services to nursing facility residents; and a March
1998 alert addressing the interrelationship between hospice services and the
nursing home industry, and potentially illegal practices and arrangements. The
fraud alerts encourage persons having information about potentially abusive
practices or transactions to report such information to the OIG.
 
     In addition to laws addressing referral relationships, several federal laws
impose criminal and civil sanctions for fraudulent and abusive billing
practices. The federal False Claims Act imposes sanctions, consisting of
monetary penalties of up to $10,000 for each claim and treble damages, on
entities and persons who knowingly present or cause to be presented a false or
fraudulent claim for payment to the United States. Section 1128B(a) of the
Social Security Act prohibits the knowingly and willful making of a false
statement or representation of a material fact in relation to the submission of
a claim for payment under government health programs (including the Medicare and
Medicaid programs). Violations of this provision constitute felony offenses
punishable by fines and imprisonment. The new HIPAA provisions establish
criminal penalties for fraud, theft, embezzlement, and the making of false
statements in relation to healthcare benefits programs (which includes private,
as well as government programs). Government prosecutors are increasing their use
of the federal False Claims Act to prosecute quality of care deficiencies in
nursing facilities and other healthcare facilities under the theory that the
submission of reimbursement claims for services provided in a manner which falls
short of quality of care standards can constitute the submission of a false
claim in violation of the federal False Claims Act.
 
     A joint federal/state initiative, Operation Restore Trust, was created in
1995 to apply to nursing homes, home health agencies, and suppliers of medical
equipment to these providers in five states: New York, Florida, California,
Illinois and Texas. The program was subsequently expanded to hospices in these
states as well. The program is designed to focus audit and law enforcement
efforts on geographic areas and provider types receiving large concentrations of
Medicare and Medicaid funds. According to HHS statistics, the targeted states
account for nearly 40% of all Medicare and Medicaid beneficiaries. Under
Operation Restore Trust, the OIG and HCFA have undertaken a variety of
activities to address fraud and abuse by nursing homes, home health providers
and medical equipment suppliers. These activities include financial audits,
creation of a Fraud and Waste Report Hotline, and increased investigations and
enforcement activity.
 
     On May 20, 1997, HHS announced that Operation Restore Trust would be
expanded during the next two years to include twelve additional states (Arizona,
Colorado, Georgia, Louisiana, Massachusetts, Missouri, New Jersey, Ohio,
Pennsylvania, Tennessee, Virginia and Washington), as well as several other
types of healthcare services. Over the longer term, it is anticipated that
Operation Restore Trust investigative techniques will be used in all 50 states,
and will be applied throughout the Medicare and Medicaid programs.
 
     In addition to increasing the resources devoted to investigating
allegations of fraud and abuse in the Medicare and Medicaid programs, federal
and state regulatory and law enforcement authorities are taking an increasingly
strict view of the requirements imposed on healthcare providers by the Social
Security Act and Medicare and Medicaid regulations. Although the Company
believes that it is in material compliance with such laws, a determination that
the Company has violated such laws, or even the public announcement that
 
                                        7
<PAGE>   9
 
the Company was being investigated concerning possible violations, could have a
material adverse effect on the Company. See "Item 3. Legal Proceedings."
 
     The Nursing Home Resident Protection Amendments of 1999, which were signed
into law on March 25, 1999 and amend Section 1919(c)(2) of the Social Security
Act, are designed to protect Medicaid patients living in nursing facilities that
decide to withdraw from the Medicaid program. Under the amended version of
Section 1919(c)(2), a nursing facility is required to continue providing care to
residents currently qualifying for assistance under the Medicaid program, as
well as residents who may qualify under Medicaid in the future, even if the
facility decides to withdraw from the Medicaid program. In addition, if a
nursing facility decides to stop admitting Medicaid patients to its facility, it
must also notify any existing residents not currently relying on assistance from
the Medicaid program that they could potentially be denied services from the
facility if they eventually need to rely on Medicaid.
 
     While federal regulations do not provide states with grounds to curtail
funding of their Medicaid cost reimbursement programs due to state budget
deficiencies, states have nevertheless curtailed funding in such circumstances
in the past. No assurance can be given that states will not do so in the future
or that the future funding of Medicaid programs will remain at levels comparable
to the present levels. The United States Supreme Court ruled in 1990 that
healthcare providers could use the Boren Amendment to require states to comply
with their legal obligation to adequately fund Medicaid programs. The 1997 Act
repeals the Boren Amendment and authorizes states to develop their own standards
for setting payment rates. It requires each state to use a public process for
establishing proposed rates whereby the methodologies and justifications used
for setting such rates are available for public review and comment. This
requires facilities to become more involved in the rate setting process since
failure to do so may interfere with a facility's ability to challenge rates
later.
 
COMPETITION
 
     The long-term care industry is highly competitive. The Company's
competitive position varies from facility to facility, from community to
community and from state to state. Some of the significant competitive factors
for the placing of patients in a nursing facility include quality of care,
reputation, physical appearance of facilities, services offered, family
preferences, location, physician services and price. The Company's operations
compete with services provided by nursing facilities, acute care hospitals,
subacute facilities, transitional hospitals, rehabilitation facilities, hospices
and home healthcare centers. The Company also competes with a number of
tax-exempt nonprofit organizations which can finance acquisitions and capital
expenditures on a tax-exempt basis or receive charitable contributions
unavailable to the Company. There can be no assurance that the Company will not
encounter increased competition which could adversely affect its business,
results of operations or financial condition.
 
EMPLOYEES
 
     At December 31, 1998, the Company had approximately 73,000 employees. The
Company is subject to both federal minimum wage and applicable federal and state
wage and hour laws and maintains various employee benefit plans.
 
     In recent years, the Company has experienced increases in its labor costs
primarily due to higher wages and greater benefits required to attract and
retain qualified personnel, increased staffing levels in its nursing facilities
due to greater patient acuity and the hiring of therapists on staff. The
Company's ability to control costs, including its wages and related expenses
which continue to rise and represent the largest component of the Company's
operating and administrative expenses, will significantly impact its future
operating results. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Operating Results."
 
     In the past, the healthcare industry, including the Company's long-term
care facilities, has experienced a shortage of nurses to staff healthcare
operations, and, more recently, the healthcare industry has experienced a
shortage of therapists. The Company is not currently experiencing a nursing or
therapist shortage, but it competes with other healthcare providers for nursing
and therapist personnel. However, it is becoming more
                                        8
<PAGE>   10
 
difficult to attract and retain certain other nursing home personnel, such as
certified nursing assistants and nurses' aides, for whom the Company competes
with other service industries. A nursing, therapist or nurse's aide shortage
could force the Company to pay even higher salaries and make greater use of
higher cost temporary personnel. A lack of qualified personnel might also
require the Company to reduce its census or admit patients requiring a lower
level of care, both of which could adversely affect operating results.
 
     Approximately 100 of the Company's facilities, or 8% of the Company's
employees, are represented by various labor unions. Certain labor unions have
publicly stated that they are concentrating their organizing efforts within the
long-term healthcare industry. The Company, being one of the largest employers
within the long-term healthcare industry, has been the target of a "corporate
campaign" by two AFL-CIO affiliated unions attempting to organize certain of the
Company's facilities. Although the Company has never experienced any material
work stoppages and believes that its relations with its employees are generally
good, the Company cannot predict the effect continued union representation or
organizational activities will have on the Company's future activities. There
can be no assurance that continued union representation and organizational
activities will not result in material work stoppages, which could have a
material adverse effect on the Company's operations.
 
     Excessive litigation is a tactic common to "corporate campaigns" and one
that is being employed against the Company. There have been several proceedings
against facilities operated by the Company before the National Labor Relations
Board ("NLRB"). These proceedings consolidate individual cases from separate
facilities, and certain of these proceedings are currently pending before the
NLRB. The Company is vigorously defending these proceedings. The Company
believes, based on advice of its general counsel, that many of these cases are
without merit, and further, it is the Company's belief that the NLRB-related
proceedings, individually and in the aggregate, are not material to the
Company's consolidated financial position, results of operations, or cash flows.
 
ITEM 2. PROPERTIES.
 
     At January 31, 1999, the Company operated 561 nursing facilities, 36
assisted living centers, 194 outpatient clinics and 75 home care centers in 33
states and the District of Columbia. Most of the Company's 190 leased nursing
facilities are subject to "net" leases which require the Company to pay all
taxes, insurance and maintenance costs. Most of these leases have original terms
from ten to fifteen years and contain at least one renewal option, which could
extend the original term of the leases by five to fifteen years. Many of these
leases also contain purchase options. The Company considers its physical
properties to be in good operating condition and suitable for the purposes for
which they are being used. Certain of the nursing facilities and assisted living
centers owned by the Company are included in the collateral securing the
obligations under its various debt agreements. See "Part II, Item 8 -- Note 5 of
Notes to Consolidated Financial Statements."
 
                                        9
<PAGE>   11
 
     The following is a summary of the Company's nursing facilities, assisted
living centers, outpatient clinics and home care centers at January 31, 1999:
 
<TABLE>
<CAPTION>
                                      NURSING              ASSISTED                    HOME
                                     FACILITIES         LIVING CENTERS   OUTPATIENT    CARE
                               ----------------------   --------------    CLINICS     CENTERS
                                            TOTAL                TOTAL   ----------   -------
                               NUMBER   LICENSED BEDS   NUMBER   UNITS     NUMBER     NUMBER
                               ------   -------------   ------   -----   ----------   -------
<S>                            <C>      <C>             <C>      <C>     <C>          <C>
LOCATION
Alabama......................    21         2,725         --        --       --         --
Arizona......................     3           480         --        --       --         --
Arkansas.....................    36         4,256          4        80        1          2
California...................    69         7,423          2       113       36         20
Colorado.....................    --            --         --        --       17         --
Delaware.....................    --            --         --        --        4         --
District of Columbia.........     1           355         --        --       --         --
Florida......................    51         6,311          5       311       --         --
Georgia......................    18         2,147          3        72       24          2
Hawaii.......................     2           396         --        --       --         --
Illinois.....................     3           275         --        --       --         --
Indiana......................    26         3,817          1        16       --          1
Kansas.......................    32         2,059          3        39       --         --
Kentucky.....................     8         1,039         --        --       --         --
Maryland.....................     4           585          1        16       12         --
Massachusetts................    24         2,402         --        --       --         --
Michigan.....................     2           206         --        --       --         --
Minnesota....................    35         3,041          3        33       --         --
Mississippi..................    21         2,466         --        --       --         --
Missouri.....................    29         3,038          3       101       --          1
Nebraska.....................    24         2,161          1        16       --          4
Nevada.......................    --            --         --        --       --          1
New Jersey...................     1           120         --        --       --         --
North Carolina...............    11         1,398          1        16       11         31
Ohio.........................    12         1,433         --        --        4         --
Pennsylvania.................    42         4,791          3        53        9          4
South Carolina...............     3           302         --        --       15         --
South Dakota.................    17         1,232          1        36       --         --
Tennessee....................     7           948          2        57       --          6
Texas........................    --            --         --        --       49          2
Virginia.....................    16         2,113          3        80       --         --
Washington...................    10         1,000         --        --       12         --
West Virginia................     3           310         --        --       --         --
Wisconsin....................    30         3,342         --        --       --          1
                                ---        ------         --     -----      ---         --
                                561        62,171         36     1,039      194         75
                                ===        ======         ==     =====      ===         ==
CLASSIFICATION
Owned........................   369        40,315         31       815       --         --
Leased.......................   190        21,721          5       224      194         75
Managed......................     2           135         --        --       --         --
                                ---        ------         --     -----      ---         --
                                561        62,171         36     1,039      194         75
                                ===        ======         ==     =====      ===         ==
</TABLE>
 
                                       10
<PAGE>   12
 
ITEM 3. LEGAL PROCEEDINGS.
 
     On March 4, 1998, a jury in California returned a verdict of $95,100,000
against a nursing facility operated by a subsidiary of the Company. The verdict,
which was based on findings of fraud as well as negligence and abuse, consisted
of $365,580 in compensatory damages and $94,700,000 in punitive damages. At a
post-trial hearing on June 3, 1998, the trial judge reduced the compensatory
damages to $125,000 and reduced the punitive damages to $3,000,000. The Company
believes that these reduced damages are excessive and has appealed on this
basis. The plaintiff has cross-appealed. The Company intends to aggressively
pursue all appellate remedies available.
 
     The Company is the subject of a federal government investigation relating
to the allocation to the Medicare program of certain nursing labor costs in its
skilled nursing facilities from 1990 to 1997. The federal government has not
disclosed the origin of this investigation or its intended scope. The
investigation is being conducted by the Office of Inspector General of the
Department of Health and Human Services and by the Department of Justice. The
Company has received subpoenas and has provided substantial information
voluntarily. The Company's independent auditors, Ernst & Young LLP, also
received a subpoena relating to its evaluation of the Company's internal
controls. In addition, the Company has been notified that a federal grand jury
in San Francisco is currently investigating practices which are the subject of
the above civil investigation. Two former employees of the Company have received
letters from the United States Attorney for the Northern District of California
indicating they are targets of the grand jury investigation. To date, four
current employees of the Company have served as witnesses before the grand jury.
The Company has cooperated with the United States Attorney's office in its
investigation. In addition, the Company's current Medicare fiscal intermediary,
Blue Cross of California, is examining cost reports of the Company's facilities
with respect to the areas that are the focus of the government investigation.
 
     Skilled nursing facilities are required to allocate nursing labor costs to
Medicare-certified units on an equitable basis. The Company has relied on a
variety of internal and external processes and practices that are designed to
ensure compliance with this requirement. The Company believes that its cost
reporting policies and procedures are consistent with government regulations and
reflect industry norms for determination of these cost allocations. While it is
not possible to predict the outcome of this investigation, a determination that
the Company has violated these regulations could have a material adverse effect
on the Company's consolidated financial position and results of operations,
which could include the payment of fines and penalties and exclusion from
participation in the Medicare and Medicaid programs. See "Item 1. Business --
Governmental Regulation and Reimbursement".
 
     On October 2, 1998, a purported class action lawsuit was filed in the
United States District Court for the Eastern District of Arkansas by Jack
Kushner against the Company and certain of its officers. The class action
lawsuit alleges, among other things, that the Company and certain of its
officers committed violations of the federal securities laws by materially
inflating the Company's revenues and earnings through practices that are the
subject of the federal government investigation (see above) and disseminating
false and misleading statements concerning compliance with Medicare regulations.
The class action lawsuit seeks damages, costs and expenses. The Company intends
to aggressively pursue all defenses available to it.
 
     There are various other lawsuits and regulatory actions pending against the
Company arising in the normal course of business, some of which seek punitive
damages that are generally not covered by insurance. The Company does not
believe that the ultimate resolution of such other matters will have a material
adverse effect on the Company's consolidated financial position or results of
operations.
 
                                       11
<PAGE>   13
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
 
     No matters were submitted to a vote of the Company's security holders
during the last quarter of its fiscal year ended December 31, 1998.
 
EXECUTIVE OFFICERS AND DIRECTORS
 
     The table below sets forth, as to each executive officer and director of
the Company, such person's name, positions with the Company and age. Each
executive officer and director of the Company holds office until a successor is
elected, or until the earliest of death, resignation or removal. Each executive
officer is elected or appointed by the Board of Directors. The information below
is given as of March 18, 1999.
 
<TABLE>
<CAPTION>
                      NAME                                           POSITION                      AGE
                      ----                                           --------                      ---
<S>                                               <C>                                              <C>
David R. Banks(1)...............................  Chairman of the Board, Chief Executive Officer
                                                  and Director                                     62
Boyd W. Hendrickson(1)..........................  President, Chief Operating Officer and Director  54
William A. Mathies..............................  Executive Vice President and
                                                  President -- Beverly Healthcare                  39
T. Jerald Moore.................................  Executive Vice President                         58
Robert W. Pommerville...........................  Executive Vice President, General Counsel and
                                                    Secretary                                      58
Bobby W. Stephens...............................  Executive Vice President -- Asset Management     54
Scott M. Tabakin................................  Executive Vice President and Chief Financial
                                                  Officer                                          40
Mark D. Wortley.................................  Executive Vice President and
                                                  President -- Beverly Care Alliance               43
Philip W. Small.................................  Executive Vice President -- Strategic Planning
                                                  and Operations Support                           42
Schuyler Hollingsworth, Jr. ....................  Senior Vice President and Treasurer              52
Pamela H. Daniels...............................  Vice President, Controller and Chief Accounting
                                                    Officer                                        35
Beryl F. Anthony, Jr.(1)(3)(5)..................  Director                                         61
Carolyne K. Davis, R.N., Ph.D.(1)(4)*...........  Director                                         67
James R. Greene(2)(3)(4)........................  Director                                         77
Edith E. Holiday(2)(4)(5).......................  Director                                         47
Jon E.M. Jacoby(1)(2)...........................  Director                                         60
Risa J. Lavizzo-Mourey, M.D.(3)(4)*.............  Director                                         44
Marilyn R. Seymann(2)(4)(5).....................  Director                                         56
</TABLE>
 
---------------
 
(1) Member of the Executive Committee.
 
(2) Member of the Audit Committee.
 
(3) Member of the Compensation Committee.
 
(4) Member of the Quality Management Committee.
 
(5) Member of the Nominating Committee.
 
 *  Dr. Davis and Dr. Lavizzo-Mourey were made honorary members of the Audit
    Committee to deal with the oversight of the OIG investigation. In February
    1999, the Board formed a separate Litigation and Compliance Committee which
    now has oversight of the OIG investigation.
 
     Mr. Banks has been a director of the Company since 1979 and has served as
Chief Executive Officer since May 1989 and Chairman of the Board since March
1990. Mr. Banks was President of the Company from 1979 to September 1995. Mr.
Banks is a director of Nationwide Health Properties, Inc., Ralston Purina
Company, and trustee for Occidental College. Mr. Banks also serves as a director
of PharMerica, Inc., a major supplier of institutional pharmacy services to the
Company.
 
                                       12
<PAGE>   14
 
     Mr. Hendrickson joined the Company in 1988 as a Division President. He was
elected Vice President of Marketing in May 1989, Executive Vice President of
Operations and Marketing in February 1990, President of the corporations within
Beverly Healthcare in January 1995 and President, Chief Operating Officer and a
director of the Company in September 1995. He is a director of PharMerica, Inc.
and Superior Financial Corp.
 
     Mr. Mathies joined the Company in 1981 as an Administrator in training. He
was an Administrator until 1986 at which time he became a Regional Manager. In
1988, Mr. Mathies was elected Vice President of Operations for the California
region and was elected Executive Vice President of the Company and President of
the corporations within Beverly Healthcare in September 1995.
 
     Mr. Moore joined the Company as Executive Vice President in December 1992
and served as President of the corporations within Beverly Specialty Hospitals
from June 1996 to June 1998. Mr. Moore was employed at Aetna Life and Casualty
from 1963 to 1992 and was elected Senior Vice President in 1990.
 
     Mr. Pommerville first joined the Company in 1970 and left in 1976. He
rejoined the Company as Vice President and General Counsel in 1984 and was
elected Secretary in February 1990, Senior Vice President in March 1990 and
Executive Vice President in February 1995.
 
     Mr. Stephens joined the Company as a staff accountant in 1969. He was
elected Assistant Vice President in 1978, Vice President of the Company and
President of the Company's Central Division in 1980, and Executive Vice
President in February 1990. Mr. Stephens is a director of City National Bank in
Fort Smith, Arkansas, Beverly Japan Corporation, and Harbortown Properties, Inc.
 
     Mr. Tabakin joined the Company in October 1992 as Vice President,
Controller and Chief Accounting Officer. He was elected Senior Vice President in
May 1995, Acting Chief Financial Officer in September 1995 and Executive Vice
President and Chief Financial Officer in October 1996. From 1980 to 1992, Mr.
Tabakin was with Ernst & Young LLP.
 
     Mr. Wortley joined the Company as Senior Vice President and President of
the corporations within Beverly Care Alliance in September 1994 and was elected
Executive Vice President in February 1996. From 1988 to 1994, Mr. Wortley was an
officer of Therapy Management Innovations.
 
     Mr. Small joined the Company in January 1986 as Reimbursement Manager, was
promoted to Division Controller in September 1986 and Director of Finance for
the California Region in 1989. He was elected Vice President -- Reimbursement in
September 1990, Senior Vice President -- Finance in 1995 and Executive Vice
President -- Strategic Planning and Operations Support in August 1998.
 
     Mr. Hollingsworth joined the Company in June 1985 as Assistant Treasurer.
He was elected Treasurer in 1988, Vice President in 1990 and Senior Vice
President in March 1992. Mr. Hollingsworth is a director of Sparks Regional
Medical Center.
 
     Ms. Daniels joined the Company in May 1988 as Audit Coordinator. She was
promoted to Financial Reporting Senior Manager in 1991 and Director of Financial
Reporting in 1992. She was elected Vice President, Controller and Chief
Accounting Officer in October 1996. From 1985 to 1988, Ms. Daniels was with
Price Waterhouse LLP.
 
     Mr. Anthony served as a member of the United States Congress and was
Chairman of the Democratic Congressional Campaign Committee from 1987 through
1990. In 1993, he became a partner in the Winston & Strawn law firm. He has been
a director of the Company since January 1993.
 
     Dr. Davis is currently a part-time scholar in residence at the Sloan Health
Management Program at Cornell University, Ithaca, New York. She served as
Administrator of the Health Care Financing Administration of the U.S. Department
of Health and Human Services from 1981 to 1985. She was a director of the
Company from 1985 to 1989 and served as consultant and advisor to the Company's
Board of Directors from 1989 to 1997. She was a national and international
health care advisor to Ernst & Young LLP from 1985 to 1997. She is a member of
the Institute of Medicine and the National Academy of Science, a trustee for the
University of Pennsylvania Medical Center, a member of the board of directors
for Georgetown University, a
 
                                       13
<PAGE>   15
 
director of Beckman Coulter, Inc., The Prudential Insurance Company of America,
Inc., Pharmaceutical Marketing Services, Inc. and MiniMed, Inc. She has been a
director of the Company since December 1997.
 
     Mr. Greene's principal occupation has been that of a director and
consultant to various U.S. and international businesses since 1986. He is a
director of Buck Engineering Company and Bank Leumi. He has been a director of
the Company since January 1991.
 
     Ms. Holiday is an attorney. She served as White House Liaison for the
Cabinet and all federal agencies during the Bush administration. Prior to that,
Ms. Holiday served as General Counsel of the U.S. Treasury Department, as well
as its Assistant Secretary of Treasury for Public Affairs and Public Liaison.
She is a director of Amerada Hess Corporation, Hercules Incorporated and H.J.
Heinz Company and a director or trustee of various investment companies in the
Franklin Templeton Group of Funds. She has been a director of the Company since
March 1995.
 
     Mr. Jacoby is Executive Vice President, Chief Financial Officer and a
director of Stephens Group, Inc. Mr. Jacoby has held the indicated positions
with Stephens Group, Inc. since 1986, and prior to that time, served as Manager
of the Corporate Finance Department and Assistant to the President of Stephens
Inc. Mr. Jacoby is a director of Power-One, Inc. and Delta and Pine Land
Company, Inc. He has been a director of the Company since February 1987.
 
     Dr. Lavizzo-Mourey is Director of the Institute of Aging, Chief of the
Division of Geriatric Medicine, Associate Executive Vice President for health
policy and Professor of Medicine at the University of Pennsylvania. She is a
director of Managed Care Solutions, Inc. and Hanger Orthopedic Group, Inc. She
has been a director of the Company since March 1995.
 
     Ms. Seymann is President and Chief Executive Officer of M One, Inc., a
management and information systems consulting firm specializing in the financial
services industry. She is a director of Community First Bankshares, Inc. and
True North Communications, Inc. She has been a director of the Company since
March 1995.
 
     During 1998, there were six meetings of the Board of Directors. Each
director attended 75% or more of the meetings of the Board and committees on
which he or she served.
 
     In 1998, directors, other than Mr. Banks and Mr. Hendrickson, received a
retainer fee of $25,000 for serving on the Board and an additional fee of $1,000
for each Board or committee meeting attended. The chairperson of each committee
received an additional $1,000 for each committee meeting attended. Such fees can
be deferred, at the option of the director, as provided for under the
Non-Employee Director Deferred Compensation Plan (discussed below). Mr. Banks,
the Company's current Chairman of the Board and Chief Executive Officer, and Mr.
Hendrickson, the Company's current President and Chief Operating Officer,
received no additional cash compensation for serving on the Board or its
committees.
 
     During 1997, the Beverly Enterprises, Inc. Non-Employee Director Deferred
Compensation Plan was approved. Such plan provides each nonemployee director the
opportunity to receive awards equivalent to shares of Common Stock ("deferred
share units") and to defer receipt of compensation for services rendered to the
Company. There are three types of contributions available under the plan. First,
nonemployee directors can defer all or part of retainer and meeting fees to a
pre-tax deferred compensation account with two investment options. The first
investment option is a cash account which is credited with interest, and the
second investment option is a deferred share unit account, with each unit having
a value equivalent to one share of Common Stock. The second type of contribution
is a Company matching contribution whereby the Company matches 25% of the amount
of fees deferred, to the extent the deferral is in the deferred share unit
account. Third, as a replacement for the prior benefits under the retirement
plan for outside directors, each nonemployee director receives a grant of 675
deferred share units each year which is automatically credited to the deferred
share unit account. Distributions under the plan will commence upon retirement,
termination, death or disability and will be made in shares of Common Stock
unless the Board of Directors approves payment in cash.
 
                                       14
<PAGE>   16
 
     During 1997, the New Beverly Non-Employee Directors Stock Option Plan (the
"Non-Employee Directors Stock Option Plan") was approved. Such plan became
effective December 3, 1997 and will remain in effect until December 31, 2007,
subject to early termination by the Board of Directors. Such plan replaced the
Nonemployee Directors' Plan entered into in 1994. There are 300,000 shares of
the Company's $.10 par value common stock ("Common Stock") authorized for
issuance, subject to certain adjustments, under the Non-Employee Directors Stock
Option Plan. The Non-Employee Directors Stock Option Plan was amended by the
Board of Directors on December 11, 1997 to provide that 3,375 stock options be
granted to each nonemployee director on June 1 of each year until the plan is
terminated, subject to the availability of shares. Stock option grants have been
made since 1994 to each of the nonemployee directors. Such stock options are
granted at a purchase price equal to fair market value on the date of grant,
become exercisable one year after date of grant and expire ten years after date
of grant.
 
                                       15
<PAGE>   17
 
                                    PART II
 
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
 
     The Company's Common Stock is listed on the New York and Pacific Stock
Exchanges. The table below sets forth, for the periods indicated, the range of
high and low sales prices of the Common Stock as reported on the New York Stock
Exchange composite tape.
 
<TABLE>
<CAPTION>
                                                                    PRICES
                                                              -------------------
                                                                HIGH       LOW
                                                                ----       ---
<S>                                                           <C>        <C>
1997
  First Quarter.............................................  $ 16 1/8   $ 12 1/4
  Second Quarter............................................    16 7/8     13 1/8
  Third Quarter.............................................    17 1/2     14 9/16
  Fourth Quarter............................................    17 1/2     12 1/8(1)
1998
  First Quarter.............................................  $ 15 9/16  $ 12 1/4
  Second Quarter............................................    16 1/4     13 1/2
  Third Quarter.............................................    14 13/16    7 3/8
  Fourth Quarter............................................     8 1/8      5 1/4
1999
  First Quarter (through March 18)..........................  $  6 15/16 $  4 1/2
</TABLE>
 
---------------
 
(1) After the effect of the Reorganization on December 3, 1997 (as discussed
    herein).
 
     The Company is subject to certain restrictions under its long-term debt
agreements related to the payment of cash dividends on its Common Stock. During
1998 and 1997, no cash dividends were paid on the Company's Common Stock and no
future dividends are currently planned.
 
     At March 18, 1999, there were 5,585 record holders of the Common Stock.
 
EMPLOYEE STOCK PURCHASE PLAN
 
     The Beverly Enterprises 1988 Employee Stock Purchase Plan (as amended and
restated) enables all full-time employees having completed one year of
continuous service to purchase shares of Common Stock at the current market
price through payroll deductions. The Company makes contributions in the amount
of 30% of the participant's contribution. Each participant specifies the amount
to be withheld from earnings per two-week pay period, subject to certain
limitations. The total charge to the Company's statement of operations for the
year ended December 31, 1998 related to this plan was approximately $2,435,000.
At December 31, 1998, there were approximately 4,800 participants in the plan.
 
     Merrill Lynch & Co., Merrill Lynch World Headquarters, North Tower, World
Financial Center, New York, New York 10281, was appointed broker to open and
maintain an account in each participant's name and to purchase shares of Common
Stock on the New York Stock Exchange for each participant.
 
                                       16
<PAGE>   18
 
ITEM 6. SELECTED FINANCIAL DATA.
 
     The following table of selected financial data should be read in
conjunction with the Company's consolidated financial statements and related
notes thereto for 1998, 1997 and 1996 included elsewhere in this Annual Report
on Form 10-K.
 
<TABLE>
<CAPTION>
                                                                 AT OR FOR THE YEARS ENDED DECEMBER 31,
                                                 ----------------------------------------------------------------------
                                                     1998         1997(1)          1996          1995          1994
                                                 ------------   ------------   ------------   -----------   -----------
                                                             (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                              <C>            <C>            <C>            <C>           <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Net operating revenues.........................  $  2,812,232   $  3,217,099   $  3,267,189   $ 3,228,553   $ 2,969,239
Interest income................................        10,708         13,201         13,839        14,228        14,578
                                                 ------------   ------------   ------------   -----------   -----------
        Total revenues.........................     2,822,940      3,230,300      3,281,028     3,242,781     2,983,817
Costs and expenses:
  Operating and administrative.................     2,633,135      2,888,021      2,958,942     2,960,832     2,715,496
  Interest.....................................        65,938         82,713         91,111        84,245        64,792
  Depreciation and amortization................        93,722        107,060        105,468       103,581        88,734
  Workforce reductions, asset impairments,
    transaction costs and other unusual
    items......................................        69,443         44,000             --       100,277            --
  Year 2000 remediation........................         9,719             --             --            --            --
  Investigation costs..........................         1,865             --             --            --            --
                                                 ------------   ------------   ------------   -----------   -----------
        Total costs and expenses...............     2,873,822      3,121,794      3,155,521     3,248,935     2,869,022
                                                 ------------   ------------   ------------   -----------   -----------
Income (loss) before provision for (benefit
  from) income taxes, extraordinary charge and
  cumulative effect of change in accounting for
  start-up costs...............................       (50,882)       108,506        125,507        (6,154)      114,795
Provision for (benefit from) income taxes......       (25,936)        49,913         73,481         1,969        37,882
Extraordinary charge, net of income tax benefit
  of $1,057 in 1998, $1,099 in 1996 and $1,188
  in 1994......................................        (1,660)            --         (1,726)           --        (2,412)
Cumulative effect of change in accounting for
  start-up costs, net of income tax benefit of
  $2,811.......................................        (4,415)            --             --            --            --
                                                 ------------   ------------   ------------   -----------   -----------
Net income (loss)..............................  $    (31,021)  $     58,593   $     50,300   $    (8,123)  $    74,501
                                                 ============   ============   ============   ===========   ===========
Net income (loss) applicable to common
  shares.......................................  $    (31,021)  $     58,593   $     50,300   $   (14,998)  $    66,251
                                                 ============   ============   ============   ===========   ===========
Diluted income (loss) per share of common
  stock:
  Before extraordinary charge and cumulative
    effect of change in accounting for start-up
    costs......................................  $       (.24)  $        .57   $        .50   $      (.16)  $       .78
  Extraordinary charge.........................          (.02)            --           (.01)           --          (.02)
  Cumulative effect of change in accounting for
    start-up costs.............................          (.04)            --             --            --            --
                                                 ------------   ------------   ------------   -----------   -----------
  Net income (loss)............................  $       (.30)  $        .57   $        .49   $      (.16)  $       .76
                                                 ============   ============   ============   ===========   ===========
  Shares used to compute per share amounts.....   103,762,000    103,422,000    110,726,000    92,233,000    98,016,000
CONSOLIDATED BALANCE SHEET DATA:
Total assets...................................  $  2,160,511   $  2,073,469   $  2,525,082   $ 2,506,461   $ 2,322,578
Current portion of long-term obligations.......  $     27,773   $     31,551   $     38,826   $    84,639   $    60,199
Long-term obligations, excluding current
  portion......................................  $    878,270   $    686,941   $  1,106,256   $ 1,066,909   $   918,018
Stockholders' equity...........................  $    776,206   $    862,505   $    861,095   $   820,333   $   827,244
OTHER DATA:
Average occupancy percentage(2)................          88.7%          88.9%          87.4%         88.1%         88.5%
Number of nursing home beds....................        62,293         63,552         71,204        75,669        78,058
</TABLE>
 
---------------
 
(1) Amounts for 1997 include the operations of PCA up until the effective date
    of the Merger (as discussed herein).
 
(2) Average occupancy percentage for 1998 and 1997 was based on operational
    beds, and for all periods prior to 1997, such percentage was based on
    licensed beds. Average occupancy percentage for 1998 and 1997 based on
    licensed beds was 86.9% and 87.1%, respectively.
 
                                       17
<PAGE>   19
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS.
 
GENERAL
 
  GOVERNMENTAL REGULATION AND REIMBURSEMENT
 
     Healthcare system reform and concerns over rising Medicare and Medicaid
costs continue to be high priorities for both the federal and state governments.
In August 1997, the President signed into law the Balanced Budget Act of 1997
(the "1997 Act") in which Congress included numerous program changes directed at
balancing the federal budget. The legislation changes Medicare and Medicaid
policy in a number of ways, including: (i) the phase in of a Medicare
prospective payment system ("PPS") for skilled nursing facilities effective July
1, 1998 (see below); (ii) establishment of limitations on Part B therapy charges
per beneficiary per year; (iii) a 10% reduction in Part B therapy costs for the
period from January 1, 1998 through July 1, 1998, at which time reimbursement
for these services will be based on fee schedules established by the Health Care
Financing Administration ("HCFA") of the Department of Health and Human Services
("HHS"); (iv) development of new Medicare and Medicaid health plan options; (v)
creation of additional safeguards against healthcare fraud and abuse; and (vi)
repeal of the Medicaid "Boren Amendment" payment standard. The legislation
includes new opportunities for providers to focus further on patient outcomes by
creating alternative patient delivery structures. The Company currently
estimates a decrease in its 1999 net operating revenues of approximately
$70,000,000 related to the impact of PPS and estimates a decrease in its 1999
net operating revenues of approximately $30,000,000 related to the impact of
Part B therapy cost reductions, including the establishment of beneficiary
limits. Future federal budget legislation and federal and state regulatory
changes may negatively impact the Company.
 
     PPS, which became effective for the Company on January 1, 1999,
significantly changes the manner in which its skilled nursing facilities are
paid for inpatient services provided to Medicare beneficiaries. PPS will be
phased in over a three year period. In year one (1999 for the Company), Medicare
PPS rates will be based 75% on 1995 facility-specific Medicare costs (as
adjusted for inflation) and 25% will be federally-determined based upon the
acuity level of Medicare patients served in the Company's skilled nursing
facilities. In year two, Medicare PPS rates will be based 50% on 1995
facility-specific costs (as adjusted for inflation) and 50% on the
federally-determined acuity-adjusted rate. In year three, Medicare PPS rates
will be based 25% on 1995 facility-specific costs (as adjusted for inflation)
and 75% on the federally-determined acuity-adjusted rate. In year four and
thereafter, Medicare PPS rates will be based entirely on the
federally-determined acuity-adjusted rate.
 
     The Company has analyzed its 1995 facility-specific costs, as well as the
current acuity level of Medicare patients in its skilled nursing facilities. In
addition, the Company has identified the significant changes in its
facility-specific costs since 1995 to determine the major reasons for such
changes. Based on such analyses, the Company has implemented facility-specific
plans to deliver care to Medicare patients at a lower cost and in a manner
consistent with PPS requirements. Such plans resulted in material changes in
staffing in the Company's skilled nursing facilities, primarily in the area of
rehabilitation services. Such staffing changes also resulted in a fourth quarter
1998 charge of approximately $2,500,000 (See "-- Operating Results"). The
Company has also determined that other cost reductions can be achieved in its
skilled nursing facilities. If the Company is unable to carry out its
facility-specific plans to reduce the cost of care to Medicare patients, PPS
could have a material adverse effect on the Company's consolidated financial
position and results of operations.
 
     PPS also imposes significant documentation requirements on skilled nursing
facilities to demonstrate the acuity level of Medicare patients and other
factors which will directly impact billing and payment rates to the Company, as
well as compliance with PPS rules and regulations. The Company has implemented
new and enhanced information systems to help ensure compliance with PPS.
Company-wide training on PPS and other 1997 Act provisions has been conducted.
As a result of these and other preparations, the Company believes it will be
positioned to operate effectively under PPS.
 
     The Company's future operating performance will continue to be affected by
the issues facing the long-term healthcare industry as a whole, including the
maintenance of occupancy, its ability to continue to expand
                                       18
<PAGE>   20
 
higher margin businesses, the availability of nursing, therapy and other
personnel, the adequacy of funding of governmental reimbursement programs, the
demand for nursing home care and the nature of any healthcare reform measures
that may be taken by the federal government, as discussed above, as well as by
any state governments. The Company's ability to control costs, including its
wages and related expenses which continue to rise and represent the largest
component of the Company's operating and administrative expenses, will also
significantly impact its future operating results.
 
YEAR 2000 REMEDIATION
 
  GENERAL
 
     Computer programs and embedded chips that utilize a two digit year in their
processing logic may interpret the year "00" as the year 1900 rather than the
year 2000. This could result in system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary inability
to process transactions, send invoices, or engage in similar normal business
activities. The Company is addressing its own processing logic issues, as well
as those of third parties, which may impact the Company through the year 2000
Project (the "Y2K Project").
 
     In 1996, the Company began a major systems initiative to upgrade or replace
all of its integrated financial application software to facilitate the adoption
of a new standard chart of accounts. As part of that major initiative, the
Company took the necessary steps to upgrade or replace the applications with
year 2000 compliant releases of the software whenever possible. For those
purchased software applications where the year 2000 release was not available at
that time, the upgrades to the compliant releases are being addressed as part of
the Y2K Project. The Company has not postponed any of its other information
technology projects as a result of the Y2K Project.
 
  Y2K PROJECT
 
     The Company's Y2K Project is divided into four major components: technology
infrastructure; applications software; third party vendors, suppliers and major
customers; and business unit operating equipment. The phases of the Y2K Project
that are common to all components include: inventory of date-dependent hardware,
software, and operating equipment; assessment of identified items to determine
current year 2000 compliance status; repair or replacement of material
non-compliant items; testing of material items for compliance; and development
of contingency plans for each operating unit.
 
     The technology infrastructure component and the applications software
component, together, comprise all of the Company's hardware and systems
software, as well as all electronic interfaces with external parties. The
testing phase for these components is divided into two distinct types of
testing, each with its own timetable. The initial phase of year 2000 testing is
ongoing as hardware and software is remediated, upgraded, or replaced; and upon
successful completion of this phase of testing, the application is moved back
into the production environment. The second phase of year 2000 testing will
occur after the applications have been remediated, upgraded, or replaced, and
have been successfully tested and put back into production. At that time, year
2000 compliance testing will be done in a parallel operating environment in
which the internal system clock will be set forward in time to cross over the
century time boundary. The remediation, upgrade, replacement, and initial
testing of all mission critical mainframe hardware and software was
approximately 83% complete as of December 31, 1998, with the remaining mission
critical applications expected to be completed by the second quarter of 1999.
The trans-century compliance testing began during the first quarter of 1999 and
is scheduled to be completed by the end of the second quarter of 1999.
 
     The third party vendors, suppliers and major customers component of the Y2K
Project includes the process of identifying and prioritizing critical vendors,
suppliers and customers, and communicating with them about their plans and
progress in addressing the year 2000 problem. The Company has completed the
inventory phase of this component of the Y2K Project and has initiated formal
communications with all of the vendors, suppliers, and customers identified as
critical to the Company's operations and initiated follow-up inquiries during
the fourth quarter of 1998 with any that did not respond to the first
communication. Detailed evaluations of the responses for the most critical third
parties were initiated during the fourth quarter of 1998.
 
                                       19
<PAGE>   21
 
Based on the data obtained and the detailed evaluations being performed,
contingency planning began in the fourth quarter of 1998 and will continue
throughout 1999. The Company has no means of ensuring that third parties will be
year 2000 ready. The inability of third parties to complete their year 2000
resolution process in a timely manner could materially impact the Company. The
Company cannot determine the effect of non-compliance by third parties.
 
     For the business unit operating equipment component of the Y2K Project, the
inventories of each individual operating unit were completed during the third
quarter of 1998, and the data has been compiled and summarized by major
operating category, including: medical devices and equipment; environmental
systems; security systems; telecommunication and office equipment. The Company
is utilizing external resources to test critical equipment impacted by the year
2000 problem, retrofit or replace equipment where necessary, and certify year
2000 compliance of all material date-sensitive equipment. The Company estimates
that all such remediation and testing will be completed by the third quarter of
1999.
 
  COSTS
 
     The Company has, and will continue to, utilize both internal and external
resources to reprogram or replace, test, and implement the software and
operating equipment for year 2000 modifications. The total cost of the Company's
Y2K Project is estimated at approximately $41,000,000 and is being funded
through operating cash flows. The total amount expended on the Y2K Project
through December 31, 1998 was approximately $11,000,000 ($10,000,000 expensed
and $1,000,000 capitalized for new systems and equipment), related to the
activities completed to date for all components and phases of the Y2K Project.
Of the total remaining Y2K Project costs, $13,000,000 is attributable to the
purchase of new hardware, software and operating equipment, which will be
capitalized. The remaining $17,000,000 relates to remediation of hardware,
software, and operating equipment, and will be expensed as incurred.
 
  RISKS
 
     The failure to correct a material year 2000 problem could result in
significant disruptions in, or failures of, normal business activities. Due to
the general uncertainty inherent in the year 2000 problem, due in part to the
uncertainty of the year 2000 readiness of third party vendors, suppliers and
customers, the Company is unable to determine at this time if it will be
impacted by year 2000 disruptions or failures, or whether the consequences of
such year 2000 disruptions or failures will have a material impact on the
Company's consolidated financial position, results of operations or cash flows.
The Company believes that, with the completion of all phases of each component
of the Y2K Project as scheduled, the possibility of significant disruptions of
normal operations should be significantly reduced. However, in the event that
the Company fails to complete the remaining phases of any component of the Y2K
Project, a possible worst case scenario might be that the Company would be
unable to provide uninterrupted service to its patients, invoice customers, or
collect payments. In addition, due to the Company's dependence on Medicare and
Medicaid revenue sources, disruptions in the processing and payment of Medicare
or Medicaid claims could also materially adversely affect the Company. The
General Accounting Office has reported that HCFA, which runs Medicare, is behind
schedule in taking steps to deal with the year 2000 issue, and that it is highly
unlikely that all of the Medicare systems will be compliant in time to ensure
the delivery of uninterrupted benefits and services into the year 2000. The
Company does not know at this time whether there will in fact be a disruption of
Medicare or Medicaid reimbursements and is, therefore, unable to determine the
impact on the Company, its operations or cash flows. In addition, the Company
could be subject to litigation for equipment shutdown or failure to properly
date business records. The amount of potential liability and lost revenue cannot
be reasonably estimated at this time.
 
     The Company is in the process of developing contingency plans for certain
critical applications and will continue development of such plans for all other
applications throughout 1999. These contingency plans involve, among other
actions, manual workarounds, increasing inventories, and adjusting staffing.
 
     The dates on which the Company believes the Y2K Project will be completed
are based on management's best estimates, which were derived utilizing
assumptions of future events, including the continued
 
                                       20
<PAGE>   22
 
availability of certain resources, third party modification plans, and other
factors. However, there can be no assurance that these estimates will be
achieved, or that there will not be a delay in, or increased costs associated
with, the implementation of the Y2K Project. Specific factors that could cause
differences between the estimates and actual results include, but are not
limited to, the availability and cost of personnel trained in these areas, the
ability to locate and correct all relevant computer codes, timely responses to
and corrections by third parties, and similar uncertainties.
 
OPERATING RESULTS
 
  1998 COMPARED TO 1997
 
  RESULTS OF OPERATIONS
 
     Operating results for 1997 included the operations of Pharmacy Corporation
of America ("PCA") up until the effective date of the Merger (as discussed
herein). Net loss was $31,021,000 for the year ended December 31, 1998, as
compared to net income of $58,593,000 for the same period in 1997. Net loss for
1998 included a pre-tax charge of approximately $69,400,000 for workforce
reductions, impaired long-lived assets and other unusual items (as discussed
herein). In addition, net loss for 1998 included a $1,660,000 extraordinary
charge, net of income taxes, related to the write-off of unamortized deferred
financing costs associated with the repayment of certain debt instruments, as
well as certain bond refundings, and a cumulative effect adjustment of
$4,415,000, net of income taxes, related to the adoption of SOP 98-5 (as defined
below). Net income for 1997 included a pre-tax charge of $44,000,000 relating to
the December 3, 1997 Reorganization (as discussed herein).
 
     In preparing for the January 1, 1999 implementation of the new Medicare
Prospective Payment System ("PPS"), as well as responding to other legislative
and regulatory changes, the Company reorganized its therapy operations, analyzed
its businesses for impairment issues and implemented new care-delivery and
tracking software. These initiatives, among others, resulted in a fourth quarter
1998 pre-tax charge of approximately $69,400,000, including $3,800,000 for
workforce reductions, $58,700,000 for asset impairments and $6,900,000 for
various other items.
 
     During the fourth quarter of 1998, the Company reorganized all employed
therapy associates into a newly formed subsidiary, Beverly Rehabilitation, Inc.
("Bev Rehab"), in order to create a more consolidated, strategic approach to
managing the Company's rehabilitation business under PPS. The Company believes
that this reorganization should allow for a more cost-effective and efficient
therapy staff. Bev Rehab also may facilitate the development of additional
rehabilitation business outside the Company. The Company accrued approximately
$2,500,000 related to the termination of 835 therapy associates in conjunction
with this reorganization. Substantially all of the terminated therapy associates
will receive their severance packages and leave the Company during the first
quarter of 1999. In addition, the Company's home care and outpatient therapy
units underwent the consolidation and relocation of certain services, including
billing and collections, which resulted in a workforce reduction charge of
approximately $1,300,000 associated with the termination of 236 associates. Of
these 236 associates, 74 associates had been paid and left the Company by
December 31, 1998. The Company paid approximately $233,000 to these 74
associates during the year ended December 31, 1998. The remaining 162 terminated
home care and outpatient therapy associates will receive their severance
packages and leave the Company during the first quarter of 1999.
 
     Statement of Financial Accounting Standards No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of"
("SFAS No. 121") requires impairment losses to be recognized for long-lived
assets used in operations when indicators of impairment are present and the
undiscounted cash flows are not sufficient to recover the assets' carrying
amounts. The impairment loss is measured by comparing the fair value of the
asset to its carrying amount. SFAS No. 121 also requires that long-lived assets
held for disposal be carried at the lower of carrying value or fair value less
costs to sell, once management has committed the organization to a plan of
disposal.
 
     As previously reported, the Company estimated that the impact of PPS on its
1999 net operating revenues would be a decrease of approximately $70,000,000, as
compared to 1998 Medicare Part A revenues, and the additional decrease related
to Part B therapy limitations and per beneficiary caps would be
                                       21
<PAGE>   23
 
approximately $30,000,000. These significant regulatory changes were an
indicator to management that the carrying values of certain of its nursing
facilities may not be fully recoverable. In addition, there were certain assets
that had 1998 operating losses, and anticipated future operating losses, which
led management to believe that these assets were impaired. Accordingly,
management estimated the undiscounted future cash flows to be generated by each
facility and reduced the carrying value to its estimate of fair value, resulting
in an impairment charge of approximately $9,000,000. Management calculated the
fair values of the impaired facilities by using the present value of estimated
future cash flows, or its best estimate of what such facility, or similar
facilities in that state, would sell for in the open market. Management believes
it has the knowledge to make such estimates of open market sales prices based on
the volume of facilities the Company has purchased and sold in previous years.
 
     Also during the fourth quarter of 1998, management identified nine nursing
facilities with an aggregate carrying value of approximately $14,000,000 which
needed to be replaced in order to increase operating efficiencies, attract
additional census or upgrade the nursing home environment. Management committed
to a plan to construct new facilities to replace these buildings and reduced the
carrying values of these facilities to their estimated salvage values. These
assets are included in the total assets of the Company's Beverly Healthcare
segment. In addition, management committed to a plan to dispose of 24 home care
centers and nine outpatient clinics which had 1998 and expected future period
operating losses. These businesses had an aggregate carrying value of
approximately $16,500,000 and were written down to their fair value less costs
to sell. These assets generated pre-tax losses for the Company of approximately
$5,100,000 during the year ended December 31, 1998. Substantially all of these
assets were purchased during 1998. The Company expects to dispose of these
assets during 1999. These assets are included in the total assets of the
Company's Beverly Care Alliance segment. The Company incurred a charge of
approximately $30,300,000 related to these replacements, closings and planned
disposals. These assets are included in the consolidated balance sheet captions
"Property and equipment, net" and "Goodwill, net."
 
     In addition to the workforce reduction and the SFAS No. 121 charges, the
Company recorded a fourth quarter 1998 impairment charge for other long-lived
assets of approximately $19,400,000 primarily related to the write-off of
software and software development costs. In conjunction with the implementation
of business process changes, and the need for enhanced data-gathering and
reporting required to operate effectively under PPS, the Company installed new
clinical software in each of its nursing homes during late-1998, which made
obsolete the previously employed software. In addition, certain of the Company's
other ongoing software development projects were abandoned or written down due
to obsolescence, feasibility or cost recovery issues.
 
     In April 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position 98-5,
"Reporting on the Costs of Start-Up Activities" ("SOP 98-5"), which provides
guidance on the financial reporting of start-up and organization costs. SOP 98-5
requires costs of start-up activities and organization costs to be expensed as
incurred. Prior to 1998, the Company capitalized start-up costs in connection
with the opening of new facilities and businesses. The Company adopted the
provisions of SOP 98-5 in its financial statements for the year ended December
31, 1998. The effect of adopting SOP 98-5 was to decrease the Company's pre-tax
loss from continuing operations in 1998 by approximately $1,000,000 and to
record a charge for the cumulative effect of an accounting change, as of January
1, 1998, of $4,415,000, net of income taxes, or $0.04 per share, to expense
costs that had previously been capitalized.
 
  INCOME TAXES
 
     The Company had an annual effective tax rate of 51% for the year ended
December 31, 1998, compared to an annual effective tax rate of 46% for the same
period in 1997. The annual effective tax rate in 1998 was different than the
federal statutory rate primarily due to the impact of the sale of American
Transitional Hospitals, Inc. ("ATH"), the benefit of certain tax credits and the
pre-tax charge of $69,400,000 (as discussed above) which reduced the Company's
pre-tax income to a level where the impact of permanent tax differences and
state income taxes had a more significant impact on the effective tax rate. The
annual effective tax rate in 1997 was different than the federal statutory rate
primarily due to the impact of nondeductible transaction costs associated with
the Reorganization. At December 31, 1998, the Company had federal net
                                       22
<PAGE>   24
 
operating loss carryforwards of $50,989,000 for income tax purposes which expire
in 2018. At December 31, 1998, the Company had general business tax credit
carryforwards of $5,270,000 for income tax purposes which expire in years 2008
through 2014. For financial reporting purposes, the federal net operating loss
carryforwards and the general business tax credit carryforwards have been
utilized to offset existing net taxable temporary differences reversing during
the carryforward periods.
 
  NET OPERATING REVENUES
 
     The Company reported net operating revenues of $2,812,232,000 during the
year ended December 31, 1998 compared to $3,217,099,000 for the same period in
1997. Approximately 90% and 80% of the Company's total net operating revenues
for the years ended December 31, 1998 and 1997, respectively, were derived from
services provided by the Company's Beverly Healthcare segment. The decrease in
net operating revenues of approximately $404,900,000 for the year ended December
31, 1998, as compared to the same period in 1997, consists of the following: a
decrease of approximately $599,900,000 due to the disposition of, or lease
terminations on, 26 nursing facilities and ATH in 1998 and 68 nursing facilities
and PCA in 1997; partially offset by an increase of approximately $155,100,000
due to the acquisitions of nursing facilities and outpatient, home care and
hospice businesses during 1998 and 1997; and an increase of approximately
$39,900,000 due to facilities which the Company operated during each of the
years ended December 31, 1998 and 1997 ("same facility operations").
 
     The decrease in net operating revenues of approximately $599,900,000 for
1998, as compared to the same period in 1997, resulting from dispositions and
lease terminations that occurred during the years ended December 31, 1998 and
1997 are described below. During the year ended December 31, 1998, the Company
sold or terminated the leases on 26 nursing facilities (3,203 beds) and certain
other assets for cash proceeds of approximately $52,500,000 (approximately
$35,600,000 of which was included in accounts receivable-nonpatient at December
31, 1998), notes receivable of approximately $21,300,000, assumed debt of
approximately $4,600,000 and closing and other costs of approximately
$2,300,000. The Company did not operate seven of these nursing facilities (893
beds) which were leased to other nursing home operators in prior year
transactions. The Company recognized net pre-tax gains, which were included in
net operating revenues, during the year ended December 31, 1998 of approximately
$17,900,000 as a result of these dispositions. During the year ended December
31, 1997, the Company sold or terminated the leases on 68 nursing facilities
(8,314 beds) and certain other assets for cash proceeds of approximately
$146,800,000. The Company recognized net pre-tax gains, which were included in
net operating revenues, during the year ended December 31, 1997 of approximately
$19,900,000 as a result of these dispositions. The operations of these
facilities and certain other assets were immaterial to the Company's
consolidated financial position and results of operations.
 
     In June 1998, the Company completed the sale of its ATH subsidiary to
Select Medical Corporation for cash of approximately $65,300,000 and assumed
debt of approximately $2,400,000. Prior to the sale, ATH operated 15
transitional hospitals (743 beds) in eight states which addressed the needs of
patients requiring intense therapy regimens, but not necessarily the breadth of
services provided within traditional acute care hospitals. The Company
recognized a pre-tax gain, which was included in net operating revenues, of
approximately $16,000,000 during the year ended December 31, 1998 as a result of
this disposition. The operations of ATH were immaterial to the Company's
consolidated financial position and results of operations.
 
     On December 3, 1997, the Company completed the merger of PCA with Capstone
Pharmacy Services, Inc. (the "Merger"). As a result of the Merger, the Company
received approximately $281,000,000 of cash as partial repayment for PCA's
intercompany debt, with a charge to the Company's retained earnings of
approximately $45,100,000 for the remaining intercompany balance which was not
repaid. Pursuant to the Reorganization, each of the Company's stockholders of
record at the close of business on December 3, 1997 received .4551 shares of
PharMerica, Inc.'s common stock for each share of the Company's Common Stock
held. The conversion ratio was based on a total of 109,873,230 outstanding
shares of the Company's Common Stock at the close of business on December 3,
1997 divided into the 50,000,000 shares issued by PharMerica, Inc.
 
                                       23
<PAGE>   25
 
     In connection with the Reorganization, the Company incurred $44,000,000 of
transaction costs related to the restructuring, repayment or renegotiating of
substantially all of the Company's outstanding debt instruments, as well as the
renegotiating or making of certain payments, primarily in the form of
accelerated vesting of stock-based awards, under various employment agreements
with officers of the Company. Such amounts were funded with a portion of the
$281,000,000 proceeds received as partial repayment of PCA's intercompany debt,
as discussed above. Included in the $44,000,000 of transaction costs were
approximately $18,000,000 of non-cash expenses related to various long-term
incentive agreements.
 
     At the date of the Merger, PCA had total assets of approximately
$489,200,000, total liabilities of approximately $368,000,000 and total
stockholder's equity of approximately $121,200,000. Total net operating revenues
for PCA for the years ended December 31, 1997 and 1996 were approximately
$564,200,000 and $516,400,000, respectively. Total net operating revenues for
PCA for the year ended December 31, 1997 represent the operations of PCA prior
to the Merger.
 
     The increase in net operating revenues of approximately $155,100,000 for
1998, as compared to the same period in 1997, resulting from acquisitions which
occurred during the years ended December 31, 1998 and 1997 are described below.
During the year ended December 31, 1998, the Company purchased 111 outpatient
clinics, 50 home care centers, eight nursing facilities (823 beds), one assisted
living center (48 units), two previously leased nursing facilities (228 beds)
and certain other assets for cash of approximately $163,200,000, acquired debt
of approximately $8,000,000 and closing and other costs of approximately
$7,000,000. During the year ended December 31, 1997, the Company purchased six
previously leased nursing facilities (758 beds) and certain other assets
including, among other things, 14 institutional pharmacies and 40 outpatient
clinics, for cash of approximately $60,800,000 and closing and other costs of
approximately $9,500,000. The acquisitions of such facilities and certain other
assets were accounted for as purchases. The operations of these facilities and
certain other assets were immaterial to the Company's consolidated financial
position and results of operations.
 
     The increase in net operating revenues of approximately $39,900,000 for
same facility operations for the year ended December 31, 1998, as compared to
the same period in 1997, was due to the following: approximately $92,300,000 due
to increases in room and board rates and approximately $6,100,000 due to various
other items; partially offset by approximately $30,400,000 decrease in ancillary
revenues due to a decline in the Company's Medicare census and, to a lesser
extent, as a result of hiring therapists on staff as opposed to contracting for
their services; approximately $19,900,000 due to a decrease in same facility
occupancy to 89.3% for the year ended December 31, 1998, as compared to 90.1%
for the same period in 1997; and approximately $8,200,000 due to a shift in the
Company's patient mix. The Company's Medicare, private and Medicaid census for
same facility operations was 10%, 20% and 69%, respectively, for the year ended
December 31, 1998, as compared to 12%, 19% and 68%, respectively, for the same
period in 1997.
 
  OPERATING AND ADMINISTRATIVE EXPENSES
 
     The Company reported operating and administrative expenses of
$2,633,135,000 during the year ended December 31, 1998 compared to
$2,888,021,000 for the same period in 1997. The decrease of approximately
$254,900,000 consists of the following: a decrease of approximately $534,700,000
due to dispositions; partially offset by an increase of approximately
$141,400,000 due to acquisitions; and an increase of approximately $138,400,000
due to same facility operations. (See above for a discussion of dispositions and
acquisitions).
 
     The increase in operating and administrative expenses of approximately
$138,400,000 for same facility operations for the year ended December 31, 1998,
as compared to the same period in 1997, was due to the following: approximately
$66,500,000 due to an increase in the provision for insurance and related items;
approximately $61,400,000 due to increased wages and related expenses
principally due to higher wages and greater benefits required to attract and
retain qualified personnel and the hiring of therapists on staff as opposed to
contracting for their services; approximately $32,900,000 due to increases in
purchased ancillary products, nursing supplies and other variable costs; and
approximately $13,300,000 due to various other items. These increases in
operating and administrative expenses were partially offset by approximately
$35,700,000
 
                                       24
<PAGE>   26
 
due to a decrease in contracted therapy expenses as a result of hiring
therapists on staff as opposed to contracting for their services.
 
     On December 31, 1998, Beverly Indemnity, Ltd., a wholly-owned subsidiary of
the Company, completed a risk transfer of substantially all of its pre-May 1998
auto liability, general liability and workers' compensation claims liability to
a third party insurer effected through a loss portfolio transfer valued as of
December 31, 1998. In exchange for a premium of approximately $116,000,000 (paid
primarily from restricted cash and investments), the Company acquired
reinsurance of approximately $180,000,000 to insure such auto liability, general
liability and workers' compensation losses. In addition, in exchange for a
premium of approximately $4,000,000, the Company acquired excess coverage of
approximately $20,000,000 for general liability losses. Based upon estimates and
analyses by its outside actuaries, the Company believes that the risk of such
liabilities exceeding the aggregate limit is remote, although there can be no
assurance that such liabilities will not exceed the aggregate limit. The
Company's provision for insurance and related items increased approximately
$82,200,000 during the fourth quarter of 1998 primarily as a result of this
transaction.
 
  INTEREST EXPENSE, NET
 
     Net interest expense decreased approximately $14,300,000 to $55,230,000 for
the year ended December 31, 1998, as compared to $69,512,000 for the same period
in 1997 primarily due to the conversion of the Company's 5 1/2% convertible
subordinated debentures to Common Stock in the third quarter of 1997, as well as
the repayments of the Company's 7 5/8% convertible subordinated debentures, the
8 3/4% Notes and certain other notes and mortgages during the fourth quarter of
1997 with the proceeds from the PCA transaction.
 
  DEPRECIATION AND AMORTIZATION
 
     Depreciation and amortization expense decreased approximately $13,300,000
to $93,722,000 for the year ended December 31, 1998, as compared to $107,060,000
for the same period in 1997. Such decrease was affected by the following:
approximately $25,900,000 decrease due to the dispositions of, or lease
terminations on, certain nursing facilities, ATH and PCA; partially offset by an
increase of approximately $12,600,000 due to acquisitions, as well as capital
additions and improvements.
 
  NEW ACCOUNTING STANDARDS
 
     In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use" ("SOP 98-1"), which is required to be adopted by the Company in
the first quarter of 1999. SOP 98-1 provides guidance on accounting for the
costs of computer software developed or obtained for internal use. The Company
does not expect the adoption of SOP 98-1 to have a material effect on its
consolidated financial position or results of operations.
 
  1997 COMPARED TO 1996
 
  RESULTS OF OPERATIONS
 
     Operating results for 1997 included the operations of PCA up until the
effective date of the Merger (as discussed above). Net income was $58,593,000
for the year ended December 31, 1997, as compared to net income of $50,300,000
for the same period in 1996. Net income for 1997 included a pre-tax charge of
$44,000,000 relating to the December 3, 1997 Reorganization (as discussed
above). Net income for 1996 included a $1,726,000 extraordinary charge, net of
income taxes, related to the write-off of unamortized deferred financing costs
related to certain refinanced debt.
 
  INCOME TAXES
 
     The Company had an annual effective tax rate of 46% for the year ended
December 31, 1997, compared to an annual effective tax rate of 59% for the same
period in 1996. The annual effective tax rate in 1997 was different than the
federal statutory rate primarily due to the impact of nondeductible transaction
costs
 
                                       25
<PAGE>   27
 
associated with the Reorganization. The annual effective tax rate in 1996 was
different than the federal statutory rate primarily due to the impact of
nondeductible goodwill associated with the sale of the Company's MedView
Services unit ("MedView").
 
  NET OPERATING REVENUES
 
     The Company reported net operating revenues of $3,217,099,000 during the
year ended December 31, 1997 compared to $3,267,189,000 for the same period in
1996. Approximately 80% and 82% of the Company's total net operating revenues
for the years ended December 31, 1997 and 1996, respectively, were derived from
services provided by the Company's Beverly Healthcare segment. Approximately 15%
and 13% of the Company's total net operating revenues for the years ended
December 31, 1997 and 1996, respectively, were derived from services provided by
the Company's PCA segment. The decrease in net operating revenues of
approximately $50,100,000 for the year ended December 31, 1997, as compared to
the same period in 1996, consists of the following: a decrease of approximately
$246,500,000 due to the disposition of, or lease terminations on, 68 nursing
facilities in 1997 and 83 nursing facilities and MedView in 1996; partially
offset by an increase of approximately $100,300,000 due to facilities which the
Company operated during each of the years ended December 31, 1997 and 1996
("same facility operations"); an increase of approximately $57,800,000 due to
the acquisitions of nursing facilities, outpatient and hospice businesses during
1997 and 1996; and an increase of approximately $38,300,000 due to the
operations of PCA.
 
     The decrease in net operating revenues of approximately $246,500,000 for
1997, as compared to the same period in 1996, resulting from dispositions and
lease terminations that occurred during the year ended December 31, 1996 are
described below. (See above for discussion of 1997 dispositions). During the
year ended December 31, 1996, the Company sold or terminated the leases on 83
nursing facilities (5,230 beds) and certain other assets for cash proceeds of
approximately $36,700,000 and approximately $4,200,000 of notes receivable. The
Company recognized net pre-tax gains, which were included in net operating
revenues, during the year ended December 31, 1996 of approximately $6,300,000 as
a result of these dispositions. The operations of these facilities and certain
other assets were immaterial to the Company's consolidated financial position
and results of operations.
 
     In November 1996, the Company sold its MedView unit for cash of
approximately $89,700,000 (approximately $2,200,000 of which was included in
accounts receivable-nonpatient at December 31, 1996). Prior to the sale, MedView
provided a full range of managed care services to the workers' compensation
market. It also offered case management and injury reporting and tracking
services. The Company recognized a pre-tax gain, which was included in net
operating revenues, of approximately $14,700,000 during the year ended December
31, 1996 as a result of this disposition. The operations of MedView were
immaterial to the Company's consolidated financial position and results of
operations.
 
     The increase in net operating revenues of approximately $100,300,000 for
same facility operations for the year ended December 31, 1997, as compared to
the same period in 1996, was due to the following: approximately $103,200,000
due to increases in room and board rates and approximately $11,800,000 due
primarily to increases in ancillary revenues and various other items. These
increases in net operating revenues were partially offset by approximately
$9,300,000 due to a decrease in same facility occupancy to 89.8% for the year
ended December 31, 1997, as compared to 90.3% for the same period in 1996 and
approximately $5,400,000 due to one less calendar day for the year ended
December 31, 1997, as compared to the same period in 1996.
 
     The increase in net operating revenues of approximately $57,800,000 for
1997, as compared to the same period in 1996, resulting from acquisitions which
occurred during the year ended December 31, 1996 are described below. (See above
for discussion of 1997 acquisitions). During the year ended December 31, 1996,
the Company acquired 22 nursing facilities (2,138 beds) (15 of such facilities
(1,747 beds) were previously leased), one previously managed nursing facility
(180 beds) and certain other assets including, among other things, pharmacy,
hospice and outpatient businesses, for cash of approximately $80,800,000,
acquired debt of approximately $7,500,000, closing and other costs of
approximately $7,000,000, reduction in receivables of approximately $4,800,000
and security and other deposits of approximately $1,900,000. The Company did not
 
                                       26
<PAGE>   28
 
operate three of these nursing facilities which had been subleased to other
nursing home operators in prior year transactions. The acquisitions of these
facilities and certain other assets were accounted for as purchases. The
operations of these facilities and certain other assets were immaterial to the
Company's consolidated financial position and results of operations.
 
  OPERATING AND ADMINISTRATIVE EXPENSES
 
     The Company reported operating and administrative expenses of
$2,888,021,000 during the year ended December 31, 1997 compared to
$2,958,942,000 for the same period in 1996. The decrease of approximately
$70,900,000 consists of the following: a decrease of approximately $215,900,000
due to dispositions; partially offset by an increase of approximately
$77,600,000 due to same facility operations; an increase of approximately
$51,500,000 due to acquisitions; and an increase of approximately $15,900,000
due to the operations of PCA. (See above for a discussion of dispositions and
acquisitions).
 
     The increase in operating and administrative expenses of approximately
$77,600,000 for same facility operations for the year ended December 31, 1997,
as compared to the same period in 1996, was due to the following: approximately
$66,000,000 due to increased wages and related expenses principally due to
higher wages and greater benefits required to attract and retain qualified
personnel, the hiring of therapists on staff as opposed to contracting for their
services and increased staffing levels in the Company's nursing facilities to
cover increased patient acuity; approximately $18,200,000 due primarily to
increases in purchased ancillary products; approximately $14,300,000 due to
increases in nursing supplies and other variable costs; and approximately
$7,800,000 due to various other items. These increases in operating and
administrative expenses were partially offset by approximately $20,700,000 due
to a decrease in contracted therapy expenses as a result of hiring therapists on
staff as opposed to contracting for their services and approximately $8,000,000
due to a decrease in insurance-related expenses primarily due to a reduction in
loss payments for the Company's workers' compensation claims liability.
 
  INTEREST EXPENSE, NET
 
     Net interest expense decreased approximately $7,800,000 to $69,512,000 for
the year ended December 31, 1997, as compared to $77,272,000 for the same period
in 1996 primarily due to repayments of the term loan and revolver borrowings
under the Company's 1994 Credit Agreement, the term loan under the Company's
1992 Credit Facility and the Nippon Term Loan during late 1996 with the proceeds
from a new credit facility, as well as the redemption of the Company's 5 1/2%
convertible subordinated debentures in the third quarter of 1997 and the debt
repayments made during the fourth quarter of 1997 with the proceeds from the
Merger (as discussed above).
 
  DEPRECIATION AND AMORTIZATION
 
     Depreciation and amortization expense increased approximately $1,600,000 to
$107,060,000 for the year ended December 31, 1997, as compared to $105,468,000
for the same period in 1996. Such increase was affected by the following:
approximately $9,900,000 increase primarily due to capital additions and
improvements, as well as acquisitions; partially offset by a decrease of
approximately $8,300,000 related to the disposition of, or lease terminations
on, certain nursing facilities and MedView.
 
LIQUIDITY AND CAPITAL RESOURCES
 
     At December 31, 1998, the Company had approximately $17,300,000 in cash and
cash equivalents and net working capital of approximately $338,800,000. The
Company anticipates that approximately $4,000,000 of its existing cash at
December 31, 1998, while not legally restricted, will be utilized primarily to
fund certain workers' compensation and general liability claims and expenses,
and the Company does not expect to use such cash for other purposes. The Company
had approximately $93,800,000 of unused commitments under its Revolver/Letter of
Credit Facility as of December 31, 1998.
 
     Net cash provided by operating activities for the year ended December 31,
1998 decreased approximately $137,400,000 to $6,800,000 as compared to
$144,200,000 for 1997, primarily due to an increase in accounts
                                       27
<PAGE>   29
 
receivable-patient. This increase was primarily the result of changes in certain
Medicare documentation requirements which has lengthened the billing period for
these and other related receivables. Net cash used for investing activities and
net cash provided by financing activities were approximately $230,600,000 and
$135,800,000, respectively, for the year ended December 31, 1998. The Company
received net cash proceeds of approximately $82,100,000 from the dispositions of
facilities and other assets and approximately $9,500,000 from the issuance of
long-term obligations. Such net cash proceeds, along with cash generated from
operations, net borrowings of approximately $251,000,000 under its
Revolver/Letter of Credit Facility and cash on hand, were used to fund
acquisitions of approximately $163,000,000, to fund capital expenditures
totaling approximately $150,500,000, to repay approximately $70,900,000 of
long-term obligations and to repurchase shares of Common Stock for approximately
$56,800,000.
 
     During 1998, the Company entered into promissory notes totaling
approximately $9,500,000 in conjunction with the construction or renovation of
certain nursing facilities. Such debt instruments bear interest at rates ranging
from 7.29% to 8.75%, require monthly installments of principal and interest, and
are secured by mortgage interests in the real property and security interests in
the personal property of the nursing facilities.
 
     The Company has a $125,000,000 financing arrangement available for the
construction of certain facilities. The Company will lease the facilities, under
operating leases with the creditor, upon completion of construction. The Company
will have the option to purchase these facilities at the end of the initial
lease terms. Total construction advances under the financing arrangement as of
December 31, 1998 were approximately $54,000,000.
 
     In June 1996, the Company announced that its Board of Directors had
authorized a stock repurchase program whereby the Company may repurchase, from
time to time on the open market, up to a total of 10,000,000 shares of its
outstanding Common Stock. In December 1997, the Company repurchased 4,000,000
shares of its Common Stock through an accelerated stock repurchase transaction
at a cost of approximately $56,100,000 (approximately $5,700,000 of which was
paid during 1998). During 1998, the Company repurchased 3,000,000 shares of its
Common Stock, through a similar transaction, and approximately 900,000 shares on
the open market at a total cost of approximately $51,100,000. The repurchases
were financed primarily through borrowings under the Company's Revolver/Letter
of Credit Facility. On June 2, 1998, the Company announced that its Board of
Directors had authorized an increase in its stock repurchase program. The
Company may repurchase from time to time on the open market, up to an additional
10,000,000 shares of its outstanding Common Stock. Since June 1996, the Company
has repurchased approximately 10,200,000 shares of its outstanding Common Stock
under the stock repurchase program. The Company is subject to certain
restrictions under its credit arrangements related to the repurchase of its
outstanding Common Stock.
 
     The Company believes that its existing cash and cash equivalents, working
capital from operations, borrowings under its banking arrangements, issuance of
certain debt securities and refinancings of certain existing indebtedness will
be adequate to repay its debts due within one year of approximately $27,800,000,
to make normal recurring capital additions and improvements of approximately
$102,000,000, to make selective acquisitions, including the purchase of
previously leased facilities, to construct new facilities, and to meet working
capital requirements for the twelve months ending December 31, 1999.
 
     Any settlement of the federal government investigation could result in a
substantial additional liability for the Company. The timing and amount of such
ultimate liability cannot, at this time, be reasonably estimated; however, it is
possible that the ultimate resolution of this investigation could have a
material adverse effect on the Company's consolidated financial position,
results of operations and cash flows. See "Item 3. Legal Proceedings."
 
     As of December 31, 1998, the Company had total indebtedness of
approximately $906,000,000 and total stockholders' equity of approximately
$776,200,000. The ability of the Company to satisfy its long-term obligations
will be dependent upon its future performance, which will be subject to
prevailing economic conditions and to financial, business and other factors
beyond the Company's control, such as federal and state healthcare reform. In
addition, healthcare service providers, such as the Company, operate in an
industry that is currently subject to significant changes from business
combinations, new strategic alliances, legislative
                                       28
<PAGE>   30
 
reform, increased regulatory oversight, aggressive marketing practices by
competitors and market pressures. In this environment, the Company is frequently
contacted by, and otherwise engages in discussions with, other healthcare
companies and financial advisors regarding possible strategic alliances, joint
ventures, business combinations and other financial alternatives. The terms of
substantially all of the Company's debt instruments require the Company to repay
or refinance indebtedness under such debt instruments in the event of a change
of control. There can be no assurance that the Company will have the financial
resources to repay such indebtedness upon a change of control.
 
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
 
     The Company is exposed to market risk because it utilizes financial
instruments. The market risks inherent in these instruments are represented by
the potential loss due to adverse changes in the general level of U.S. interest
rates. The Company manages its interest rate risk exposure by maintaining a mix
of fixed and variable rates for debt and notes receivable. The following table
provides information regarding the Company's market sensitive financial
instruments and constitutes a forward-looking statement.
 
<TABLE>
<CAPTION>
                                                                                                    FAIR VALUE
                                                                                                    JANUARY 1,
EXPECTED MATURITY DATES   1999      2000       2001      2002      2003     THEREAFTER    TOTAL        1999
-----------------------  -------   -------   --------   -------   -------   ----------   --------   ----------
                                                        (DOLLARS IN THOUSANDS)
<S>                      <C>       <C>       <C>        <C>       <C>       <C>          <C>        <C>
Total long-term obligations:
  Fixed Rate...........  $27,129   $28,867   $ 23,851   $21,561   $28,491    $430,181    $560,080    $585,394
  Average Interest
    Rate...............     8.32%     8.21%      8.39%     8.16%     8.42%       8.85%
  Variable Rate........  $   644   $40,657   $266,775   $23,799   $   920    $ 13,168    $345,963    $344,060
  Average Interest
    Rate...............     5.91%     5.58%      6.07%     5.61%     5.86%       5.81%
Total notes receivable:
  Fixed Rate...........  $20,616   $12,257   $  5,728   $   425   $ 3,724    $    890    $ 43,640    $ 43,600
  Average Interest
    Rate...............     9.53%    10.07%     10.73%     9.50%     9.13%      10.28%
  Variable Rate........  $    42   $    51   $     53   $    59   $    64    $    933    $  1,202    $  1,300
  Average Interest
    Rate...............     8.75%     8.75%      8.75%     8.75%     8.75%       8.75%
</TABLE>
 
                                       29
<PAGE>   31
 
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
 
<TABLE>
<CAPTION>
                                                              PAGE
                                                              ----
<S>                                                           <C>
Report of Ernst & Young LLP, Independent Auditors...........   31
Consolidated Balance Sheets.................................   32
Consolidated Statements of Operations.......................   33
Consolidated Statements of Stockholders' Equity.............   34
Consolidated Statements of Cash Flows.......................   35
Notes to Consolidated Financial Statements..................   36
Supplementary Data (Unaudited) -- Quarterly Financial
  Data......................................................   58
</TABLE>
 
                                       30
<PAGE>   32
 
               REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
 
The Board of Directors and Stockholders
Beverly Enterprises, Inc.
 
     We have audited the accompanying consolidated balance sheets of Beverly
Enterprises, Inc. as of December 31, 1998 and 1997, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended December 31, 1998. Our audits also included the
financial statement schedule listed in the Index at Item 14(a). These financial
statements and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
 
     We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
 
     In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Beverly Enterprises, Inc. at December 31, 1998 and 1997, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1998, in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly, in all material respects, the information set forth
therein.
 
                                     /s/ ERNST & YOUNG LLP
 
Little Rock, Arkansas
February 3, 1999
 
                                       31
<PAGE>   33
 
                           BEVERLY ENTERPRISES, INC.
 
                          CONSOLIDATED BALANCE SHEETS
                             (DOLLARS IN THOUSANDS)
 
                                     ASSETS
 
<TABLE>
<CAPTION>
                                                                   DECEMBER 31,
                                                              -----------------------
                                                                 1998         1997
                                                              ----------   ----------
<S>                                                           <C>          <C>
Current assets:
  Cash and cash equivalents.................................  $   17,278   $  105,230
  Accounts receivable -- patient, less allowance for
     doubtful accounts:
     1998 -- $21,764; 1997 -- $17,879.......................     463,822      384,833
  Accounts receivable -- nonpatient, less allowance for
     doubtful accounts:
     1998 -- $441; 1997 -- $626.............................      85,585       14,400
  Notes receivable..........................................      21,075        4,409
  Operating supplies........................................      32,133       30,439
  Deferred income taxes.....................................      56,512       27,304
  Prepaid expenses and other................................      19,565       59,703
                                                              ----------   ----------
          Total current assets..............................     695,970      626,318
Property and equipment, net.................................   1,120,315    1,158,329
Other assets:
  Notes receivable, less allowance for doubtful notes:
     1998 -- $2,921; 1997 -- $2,917.........................      21,263       20,564
  Designated and restricted funds...........................       4,029       64,233
  Goodwill, net.............................................     217,066       99,280
  Other, net................................................     101,868      104,745
                                                              ----------   ----------
          Total other assets................................     344,226      288,822
                                                              ----------   ----------
                                                              $2,160,511   $2,073,469
                                                              ==========   ==========
 
                        LIABILITIES AND STOCKHOLDERS' EQUITY
 
Current liabilities:
  Accounts payable..........................................  $   85,533   $   75,791
  Accrued wages and related liabilities.....................      96,092      123,146
  Accrued interest..........................................      12,783       15,108
  Other accrued liabilities.................................     134,975       98,421
  Current portion of long-term obligations..................      27,773       31,551
                                                              ----------   ----------
          Total current liabilities.........................     357,156      344,017
Long-term obligations.......................................     878,270      686,941
Deferred income taxes payable...............................     114,962      111,388
Other liabilities and deferred items........................      33,917       68,618
Commitments and contingencies
Stockholders' equity:
  Preferred stock, shares authorized: 25,000,000............          --           --
  Common stock, shares issued: 1998 -- 110,275,714; 1997 --
     109,890,205............................................      11,028       10,989
  Additional paid-in capital................................     876,383      874,335
  Retained earnings (deficit)...............................      (4,782)      26,239
  Accumulated other comprehensive income....................         760        1,332
  Treasury stock, at cost: 1998 -- 7,886,800 shares;
     1997 -- 4,000,000 shares...............................    (107,183)     (50,390)
                                                              ----------   ----------
          Total stockholders' equity........................     776,206      862,505
                                                              ----------   ----------
                                                              $2,160,511   $2,073,469
                                                              ==========   ==========
</TABLE>
 
                            See accompanying notes.
 
                                       32
<PAGE>   34
 
                           BEVERLY ENTERPRISES, INC.
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                                                                 YEARS ENDED DECEMBER 31,
                                                           ------------------------------------
                                                              1998         1997         1996
                                                           ----------   ----------   ----------
<S>                                                        <C>          <C>          <C>
Net operating revenues...................................  $2,812,232   $3,217,099   $3,267,189
Interest income..........................................      10,708       13,201       13,839
                                                           ----------   ----------   ----------
          Total revenues.................................   2,822,940    3,230,300    3,281,028
Costs and expenses:
  Operating and administrative:
     Wages and related...................................   1,664,741    1,713,224    1,749,855
     Provision for insurance and related items...........     154,267       87,780       95,807
     Other...............................................     814,127    1,087,017    1,113,280
  Interest...............................................      65,938       82,713       91,111
  Depreciation and amortization..........................      93,722      107,060      105,468
  Workforce reductions, asset impairments, transaction
     costs and other unusual items.......................      69,443       44,000           --
  Year 2000 remediation..................................       9,719           --           --
  Investigation costs....................................       1,865           --           --
                                                           ----------   ----------   ----------
          Total costs and expenses.......................   2,873,822    3,121,794    3,155,521
                                                           ----------   ----------   ----------
Income (loss) before provision for (benefit from) income
  taxes, extraordinary charge and cumulative effect of
  change in accounting for start-up costs................     (50,882)     108,506      125,507
Provision for (benefit from) income taxes................     (25,936)      49,913       73,481
                                                           ----------   ----------   ----------
Income (loss) before extraordinary charge and cumulative
  effect of change in accounting for start-up costs......     (24,946)      58,593       52,026
Extraordinary charge, net of income tax benefit of $1,057
  in 1998 and $1,099 in 1996.............................      (1,660)          --       (1,726)
Cumulative effect of change in accounting for start-up
  costs, net of income tax benefit of $2,811.............      (4,415)          --           --
                                                           ----------   ----------   ----------
Net income (loss)........................................  $  (31,021)  $   58,593   $   50,300
                                                           ==========   ==========   ==========
Income (loss) per share of common stock:
  Basic:
     Before extraordinary charge and cumulative effect of
       change in accounting for start-up costs...........  $     (.24)  $      .57   $      .53
     Extraordinary charge................................        (.02)          --         (.02)
     Cumulative effect of change in accounting for
       start-up costs....................................        (.04)          --           --
                                                           ----------   ----------   ----------
     Net income (loss)...................................  $     (.30)  $      .57   $      .51
                                                           ==========   ==========   ==========
     Shares used to compute per share amounts............     103,762      102,060       98,574
                                                           ==========   ==========   ==========
  Diluted:
     Before extraordinary charge and cumulative effect of
       change in accounting for start-up costs...........  $     (.24)  $      .57   $      .50
     Extraordinary charge................................        (.02)          --         (.01)
     Cumulative effect of change in accounting for
       start-up costs....................................        (.04)          --           --
                                                           ----------   ----------   ----------
     Net income (loss)...................................  $     (.30)  $      .57   $      .49
                                                           ==========   ==========   ==========
     Shares used to compute per share amounts............     103,762      103,422      110,726
                                                           ==========   ==========   ==========
</TABLE>
 
                            See accompanying notes.
 
                                       33
<PAGE>   35
 
                           BEVERLY ENTERPRISES, INC.
 
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                             (DOLLARS IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                                                      ACCUMULATED
                                                            ADDITIONAL   RETAINED        OTHER
                                      PREFERRED   COMMON     PAID-IN     EARNINGS    COMPREHENSIVE   TREASURY
                                        STOCK      STOCK     CAPITAL     (DEFICIT)      INCOME         STOCK       TOTAL
                                      ---------   -------   ----------   ---------   -------------   ---------   ---------
<S>                                   <C>         <C>       <C>          <C>         <C>             <C>         <C>
Balances at January 1, 1996.........   $    --    $10,262    $766,549    $  83,657    $        --    $ (40,135)  $ 820,333
  Employee stock transactions,
    net.............................        --       181        8,123           --             --           --       8,304
  Purchase of 1,451,200 shares of
    common stock for treasury.......        --        --           --           --             --      (17,842)    (17,842)
  Net income and total comprehensive
    income..........................        --        --           --       50,300             --           --      50,300
                                       -------    -------    --------    ---------    -----------    ---------   ---------
Balances at December 31, 1996.......        --    10,443      774,672      133,957             --      (57,977)    861,095
  Employee stock transactions,
    net.............................        --        54       21,314           --             --           --      21,368
  Purchase of 4,850,700 shares of
    common stock for treasury.......        --        --           --           --             --      (62,729)    (62,729)
  Cancellation and retirement of
    6,274,108 shares of common stock
    held in treasury................        --      (627)     (69,689)          --             --       70,316          --
  Disposition of PCA................        --        --           --     (121,230)            --           --    (121,230)
  Forgiveness of PCA intercompany
    balance.........................        --        --           --      (45,081)            --           --     (45,081)
  Conversion of 5 1/2% Debentures
    into common stock...............        --     1,119      147,991           --             --           --     149,110
  Conversion of 7 5/8% Debentures
    into common stock...............        --        --           47           --             --           --          47
  Comprehensive income:
    Unrealized gains on securities,
      net of income taxes of $896...        --        --           --           --          1,332           --       1,332
    Net income......................        --        --           --       58,593             --           --      58,593
                                                                                                                 ---------
  Total comprehensive income........        --        --           --           --             --           --      59,925
                                       -------    -------    --------    ---------    -----------    ---------   ---------
Balances at December 31, 1997.......        --    10,989      874,335       26,239          1,332      (50,390)    862,505
  Employee stock transactions,
    net.............................        --        39        2,048           --             --           --       2,087
  Purchase of 3,886,800 shares of
    common stock for treasury.......        --        --           --           --             --      (51,120)    (51,120)
  Settlement of amounts due from
    1997 purchase of 4,000,000
    shares of common stock for
    treasury........................        --        --           --           --             --       (5,673)     (5,673)
  Comprehensive income (loss):
    Unrealized gains on securities,
      net of income taxes of $795...        --        --           --           --          1,183           --       1,183
    Adjustment to unrealized gains
      on securities, net of income
      tax benefit of $1,180.........        --        --           --           --         (1,755)          --      (1,755)
    Net loss........................        --        --           --      (31,021)            --           --     (31,021)
                                                                                                                 ---------
  Total comprehensive loss..........        --        --           --           --             --           --     (31,593)
                                       -------    -------    --------    ---------    -----------    ---------   ---------
Balances at December 31, 1998.......   $    --    $11,028    $876,383    $  (4,782)   $       760    $(107,183)  $ 776,206
                                       =======    =======    ========    =========    ===========    =========   =========
</TABLE>
 
                            See accompanying notes.
 
                                       34
<PAGE>   36
 
                           BEVERLY ENTERPRISES, INC.
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                                     YEARS ENDED DECEMBER 31,
                                                              ---------------------------------------
                                                                 1998          1997          1996
                                                              -----------   -----------   -----------
<S>                                                           <C>           <C>           <C>
Cash flows from operating activities:
  Net income (loss).........................................  $   (31,021)  $    58,593   $    50,300
  Adjustments to reconcile net income (loss) to net cash
    provided by operating activities:
    Depreciation and amortization...........................       93,722       107,060       105,468
    Provision for reserves on patient, notes and other
      receivables, net......................................       25,249        34,341        28,544
    Amortization of deferred financing costs................        2,336         3,163         3,210
    Workforce reductions, asset impairments, transaction
      costs and other unusual items.........................       69,443        44,000            --
    Extraordinary charge....................................        2,717            --         2,825
    Cumulative effect of change in accounting for start-up
      costs.................................................        7,226            --            --
    Gains on dispositions of facilities and other assets,
      net...................................................      (33,853)      (19,901)      (20,951)
    Deferred taxes..........................................      (28,105)       20,247        33,765
    Insurance related accounts..............................       39,587       (25,432)      (22,336)
    Changes in operating assets and liabilities, net of
      acquisitions and dispositions:
      Accounts receivable --  patient.......................     (132,199)      (46,639)      (25,851)
      Operating supplies....................................       (1,239)       (3,911)        3,226
      Prepaid expenses and other receivables................          240       (18,749)          771
      Accounts payable and other accrued expenses...........       24,945         3,377       (53,029)
      Income taxes payable..................................      (27,729)       (7,305)       26,711
      Other, net............................................       (4,530)       (4,640)          527
                                                              -----------   -----------   -----------
         Total adjustments..................................       37,810        85,611        82,880
                                                              -----------   -----------   -----------
         Net cash provided by operating activities..........        6,789       144,204       133,180
Cash flows from investing activities:
  Capital expenditures......................................     (150,451)     (133,087)     (136,442)
  Payments for acquisitions, net of cash acquired...........     (162,969)      (61,567)      (80,981)
  Proceeds from dispositions of facilities and other
    assets..................................................       82,119       421,412       121,660
  Collections on notes receivable and REMIC investment......        6,089        32,273        12,809
  Other, net................................................       (5,374)      (28,178)       (8,547)
                                                              -----------   -----------   -----------
         Net cash provided by (used for) investing
           activities.......................................     (230,586)      230,853       (91,501)
Cash flows from financing activities:
  Revolver borrowings.......................................    1,328,000     1,604,000     1,308,000
  Repayments of Revolver borrowings.........................   (1,077,000)   (1,745,000)   (1,230,000)
  Proceeds from issuance of long-term obligations...........        9,495        31,137       228,862
  Repayments of long-term obligations.......................      (70,878)     (166,369)     (318,447)
  Purchase of common stock for treasury.....................      (56,793)      (65,126)      (15,445)
  Proceeds from exercise of stock options...................        3,092         5,401         3,620
  Deferred financing costs..................................         (730)       (1,251)       (7,560)
  Dividends paid on preferred stock.........................           --            --          (688)
  Proceeds from designated funds, net.......................          659        (2,380)        3,437
                                                              -----------   -----------   -----------
         Net cash provided by (used for) financing
           activities.......................................      135,845      (339,588)      (28,221)
                                                              -----------   -----------   -----------
Net increase (decrease) in cash and cash equivalents........      (87,952)       35,469        13,458
Cash and cash equivalents at beginning of year..............      105,230        69,761        56,303
                                                              -----------   -----------   -----------
Cash and cash equivalents at end of year....................  $    17,278   $   105,230   $    69,761
                                                              ===========   ===========   ===========
Supplemental schedule of cash flow information:
  Cash paid during the year for:
    Interest (net of amount capitalized)....................  $    65,927   $    81,411   $    81,193
    Income taxes (net of refunds)...........................       26,030        36,971        11,906
</TABLE>
 
                            See accompanying notes.
 
                                       35
<PAGE>   37
 
                           BEVERLY ENTERPRISES, INC.
 
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
  Basis of Presentation
 
     References herein to the Company include Beverly Enterprises, Inc. and its
wholly-owned subsidiaries.
 
     Beverly Enterprises, Inc. (formerly known as New Beverly Holdings, Inc.),
which was incorporated on April 15, 1997 ("New Beverly"), is the successor to
the former Beverly Enterprises, Inc., which was incorporated on February 27,
1987 ("Old Beverly"), as the result of a tax-free reorganization completed
December 3, 1997 (the "Reorganization") in order to facilitate the merger of
Pharmacy Corporation of America ("PCA") with Capstone Pharmacy Services, Inc.
("Capstone") (the "Merger"). References to Beverly Enterprises, Inc., or the
Company, prior to December 3, 1997 means the predecessor corporation, Old
Beverly. References to Beverly Enterprises, Inc., or the Company, on or after
December 3, 1997 means New Beverly, and New Beverly is treated for accounting
purposes as the continuing reporting entity with respect to the historical and
future operations of the Company. See Note 3 for additional information.
 
     The Company provides healthcare services in 33 states and the District of
Columbia. Its operations include nursing facilities, rehabilitation therapy
services, assisted living centers, home care centers and outpatient clinics. In
addition, prior to June 30, 1998, the Company operated acute long-term
transitional hospitals and, prior to the Merger, institutional and mail service
pharmacies. The consolidated financial statements of the Company include the
accounts of the Company and all of its wholly-owned subsidiaries. All
significant intercompany accounts and transactions have been eliminated.
 
  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 and Cash Equivalents
 
     Cash and cash equivalents include time deposits and certificates of deposit
with original maturities of three months or less.
 
  Property and Equipment
 
     Property and equipment is stated at cost less accumulated depreciation or,
where appropriate, the present value of the related capital lease obligations
less accumulated amortization. Depreciation and amortization are computed by the
straight-line method over the estimated useful lives of the assets.
 
  Intangible Assets
 
     Goodwill (stated at cost less accumulated amortization of $25,547,000 in
1998 and $21,610,000 in 1997) is being amortized over 40 years using the
straight-line method. Operating and leasehold rights and licenses, which are
included in the consolidated balance sheet caption "Other, net," (stated at cost
less accumulated amortization of $18,307,000 in 1998 and $17,442,000 in 1997)
are being amortized over the lives of the related assets (principally 40 years)
and leases (principally 10 to 15 years), using the straight-line method.
 
     On an ongoing basis, the Company reviews the carrying value of its
intangible assets in light of any events or circumstances that indicate they may
be impaired or that the amortization period may need to be adjusted. If such
circumstances suggest the intangible value cannot be recovered, calculated based
on undiscounted
 
                                       36
<PAGE>   38
                           BEVERLY ENTERPRISES, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
cash flows over the remaining amortization period, the carrying value of the
intangible will be reduced by such shortfall. As of December 31, 1998, the
Company does not believe there is any indication that the carrying value or the
amortization period of its intangibles needs to be adjusted; however, certain
adjustments were made to the carrying value of the Company's intangibles during
1998. See Note 2.
 
  Impairment of Long-Lived Assets
 
     In March 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of," ("SFAS No. 121")
which requires impairment losses to be recognized for long-lived assets used in
operations when indicators of impairment are present and the undiscounted cash
flows are not sufficient to recover the assets' carrying amounts. The impairment
loss is measured by comparing the fair value of the asset to its carrying
amount. In accordance with SFAS No. 121, the Company assesses the need for an
impairment write-down when such indicators of impairment are present. See Note
2.
 
  Insurance
 
     On December 31, 1998, Beverly Indemnity, Ltd., a wholly-owned subsidiary of
the Company, completed a risk transfer of substantially all of its pre-May 1998
auto liability, general liability and workers' compensation claims liability to
a third party insurer effected through a loss portfolio transfer ("LPT") valued
as of December 31, 1998. In exchange for a premium of approximately $116,000,000
(paid primarily from restricted cash and investments), the Company acquired
reinsurance of approximately $180,000,000 to insure such auto liability, general
liability and workers' compensation losses. In addition, in exchange for a
premium of approximately $4,000,000, the Company acquired excess coverage of
approximately $20,000,000 for general liability losses. Based upon estimates and
analyses by its outside actuaries, the Company believes that the risk of such
liabilities exceeding the aggregate limit is remote, although there can be no
assurance that such liabilities will not exceed the aggregate limit. The
Company's provision for insurance and related items increased approximately
$82,200,000 during the fourth quarter of 1998 primarily as a result of this
transaction.
 
     Prior to the LPT, and for periods not covered by the LPT, the Company
insures the majority of its auto liability, general liability and workers'
compensation risks through insurance policies with third parties, some of which
are subject to reinsurance agreements between the insurer and Beverly Indemnity,
Ltd. The liabilities for estimated incurred losses not covered by third party
insurance are discounted at 10% to their present value based on expected loss
payment patterns determined by independent actuaries. Had the discount rate been
reduced by one-half of a percentage point, the Company would have incurred a
pre-tax charge of approximately $200,000 for the year ended December 31, 1998.
The discounted insurance liabilities are included in the consolidated balance
sheet captions as follows (in thousands):
 
<TABLE>
<CAPTION>
                                                               1998      1997
                                                              -------   -------
<S>                                                           <C>       <C>
Accrued wages and related liabilities.......................  $    --   $28,484
Other accrued liabilities...................................       --     6,874
Other liabilities and deferred items........................   18,151    50,366
                                                              -------   -------
                                                              $18,151   $85,724
                                                              =======   =======
</TABLE>
 
     On an undiscounted basis, the total insurance liabilities as of December
31, 1998 and 1997 were $22,800,000 and $111,200,000, respectively. As of
December 31, 1998, the Company had deposited approximately $1,600,000 in funds
(the "Beverly Indemnity funds") that are restricted for the payment of insured
claims. In addition, the Company anticipates that approximately $4,000,000 of
its existing cash at
 
                                       37
<PAGE>   39
                           BEVERLY ENTERPRISES, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
December 31, 1998, while not legally restricted, will be utilized primarily to
fund certain workers' compensation and general liability claims and expenses,
and the Company does not expect to use such cash for other purposes.
 
     During 1998, the Company purchased traditional indemnity insurance coverage
for its 1998 workers' compensation and auto liabilities. During 1997, the
Company transferred a portion of its liabilities for workers' compensation and
general liability related to certain of its sold nursing facilities to a
third-party indemnity insurance company and purchased traditional indemnity
insurance coverage for its 1997 workers' compensation and auto liabilities.
 
  Stock Based Awards
 
     In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," ("SFAS No. 123") which encourages, but does not require,
companies to recognize compensation expense for stock-based awards based on
their fair value on the date of grant. The Company has elected to continue to
account for its stock-based awards in accordance with Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees," and,
accordingly, recognizes no compensation expense for its stock option grants
which are issued at market value on the date of grant. See Note 7 for the pro
forma effects on the Company's reported net income (loss) and diluted earnings
per share assuming the election had been made to recognize compensation expense
on stock-based awards in accordance with SFAS No. 123.
 
  Revenues
 
     The Company's revenues are derived primarily from providing long-term
healthcare services. Approximately 74%, 74% and 75% of the Company's net
operating revenues for 1998, 1997 and 1996, respectively, were derived from
funds under federal and state medical assistance programs, and approximately 62%
and 68% of the Company's net patient accounts receivable at December 31, 1998
and 1997, respectively, are due from such programs. The Company accrues for
revenues when services are provided at standard charges adjusted to amounts
estimated to be received under governmental programs and other third-party
contractual arrangements. These revenues and receivables are reported at their
estimated net realizable amounts and are subject to audit and retroactive
adjustment. Provisions for estimated third-party payor settlements are provided
in the period the related services are rendered and are adjusted in the period
of settlement. Changes in estimates related to third party receivables resulted
in the recording of approximately $10,900,000, $8,900,000 and $10,900,000 of net
operating revenues for the years ended December 31, 1998, 1997 and 1996,
respectively.
 
     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; however, as disclosed in
Note 6, the Company is the subject of an investigation involving allegations of
potential wrongdoing. Compliance with such laws and regulations is subject to
government review and interpretation, as well as significant regulatory action
including fines, penalties, and exclusion from the Medicare and Medicaid
programs.
 
  Concentration of Credit Risk
 
     The Company has significant accounts receivable, notes receivable and other
assets whose collectibility or realizability is dependent upon the performance
of certain governmental programs, primarily Medicaid and Medicare. These
receivables and other assets represent the only concentration of credit risk for
the Company.
 
                                       38
<PAGE>   40
                           BEVERLY ENTERPRISES, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
The Company does not believe there are significant credit risks associated with
these governmental programs. The Company believes that an adequate provision has
been made for the possibility of these receivables and other assets proving
uncollectible and continually monitors and adjusts these allowances as
necessary.
 
  Income Taxes
 
     The Company follows the liability method in accounting for income taxes.
The liability method provides that deferred tax assets and liabilities are
recorded at currently enacted tax rates based on the difference between the tax
basis of assets and liabilities and their carrying amounts for financial
reporting purposes, referred to as temporary differences.
 
  Earnings per Share
 
     In 1997, the Company adopted Statement of Financial Accounting Standards
No. 128, "Earnings per Share" ("SFAS No. 128"). SFAS No. 128 replaced the
calculation of primary and fully diluted earnings per share with basic and
diluted earnings per share. Unlike primary earnings per share, basic earnings
per share excludes any dilutive effects of options, warrants and convertible
securities. Diluted earnings per share is similar to the previously reported
fully diluted earnings per share. Earnings per share amounts for all periods
have been presented to conform with the requirements of SFAS No. 128.
 
     The following table sets forth the computation of basic and diluted income
(loss) per share for the years ended December 31 (in thousands):
 
<TABLE>
<CAPTION>
                                                         1998       1997       1996
                                                       --------   --------   --------
<S>                                                    <C>        <C>        <C>
NUMERATOR:
  Numerator for basic income (loss) per share from
     continuing operations...........................  $(24,946)  $ 58,593   $ 52,026
  Effect of dilutive securities:
     5 1/2% Debentures, net of income taxes..........        --         --      3,420
                                                       --------   --------   --------
  Numerator for diluted income (loss) per share from
     continuing operations...........................  $(24,946)  $ 58,593   $ 55,446
                                                       ========   ========   ========
DENOMINATOR:
  Denominator for basic income (loss) per
     share -- weighted average shares................   103,762    102,060     98,574
  Effect of dilutive securities:
     Employee stock options..........................        --      1,236        899
     Performance shares..............................        --        126         --
     5 1/2% Debentures...............................        --         --     11,253
                                                       --------   --------   --------
  Dilutive potential common shares...................        --      1,362     12,152
                                                       --------   --------   --------
  Denominator for diluted income (loss) per share --
     adjusted weighted average shares and assumed
     conversions.....................................   103,762    103,422    110,726
                                                       ========   ========   ========
Basic income (loss) per share........................  $  (0.24)  $   0.57   $   0.53
                                                       ========   ========   ========
Diluted income (loss) per share......................  $  (0.24)  $   0.57   $   0.50
                                                       ========   ========   ========
</TABLE>
 
                                       39
<PAGE>   41
                           BEVERLY ENTERPRISES, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
  New Accounting Standards
 
     In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS
No. 130"), which requires the presentation of comprehensive income in a
company's financial statement disclosures. Comprehensive income includes net
income (loss), as well as charges and credits directly to stockholders' equity
which are excluded from net income (loss). Accumulated other comprehensive
income, net of income taxes, consists of unrealized gains on securities of
approximately $760,000 and $1,332,000 at December 31, 1998 and 1997,
respectively.
 
     In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS No. 131"), which provides revised
disclosure guidelines for segments of a company based on a management approach
to defining operating segments. See Note 10 for additional information.
 
     In April 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position 98-5,
"Reporting on the Costs of Start-Up Activities" ("SOP 98-5"), which provides
guidance on the financial reporting of start-up and organization costs. SOP 98-5
requires costs of start-up activities and organization costs to be expensed as
incurred. Prior to 1998, the Company capitalized start-up costs in connection
with the opening of new facilities and businesses. The Company adopted the
provisions of SOP 98-5 in its financial statements for the year ended December
31, 1998. The effect of adopting SOP 98-5 was to decrease the Company's pre-tax
loss from continuing operations in 1998 by approximately $1,000,000 and to
record a charge for the cumulative effect of an accounting change, as of January
1, 1998, of $4,415,000, net of income taxes, or $0.04 per share, to expense
costs that had previously been capitalized.
 
     In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use" ("SOP 98-1"), which is required to be adopted by the Company in
the first quarter of 1999. SOP 98-1 provides guidance on accounting for the
costs of computer software developed or obtained for internal use. The Company
does not expect the adoption of SOP 98-1 to have a material effect on its
consolidated financial position or results of operations.
 
  Other
 
     Certain prior year amounts have been reclassified to conform with the 1998
presentation.
 
2. WORKFORCE REDUCTIONS, ASSET IMPAIRMENTS AND OTHER UNUSUAL ITEMS
 
     In preparing for the January 1, 1999 implementation of the new Medicare
Prospective Payment System ("PPS"), as well as responding to other legislative
and regulatory changes, the Company reorganized its therapy operations, analyzed
its businesses for impairment issues and implemented new care-delivery and
tracking software. These initiatives, among others, resulted in a fourth quarter
1998 pre-tax charge of approximately $69,400,000, including $3,800,000 for
workforce reductions, $58,700,000 for asset impairments and $6,900,000 for
various other items.
 
     During the fourth quarter of 1998, the Company reorganized all employed
therapy associates into a newly formed subsidiary, Beverly Rehabilitation, Inc.
("Bev Rehab"), in order to create a more consolidated, strategic approach to
managing the Company's rehabilitation business under PPS. The Company believes
that this reorganization should allow for a more cost-effective and efficient
therapy staff. Bev Rehab also may facilitate the development of additional
rehabilitation business outside the Company. The Company accrued
 
                                       40
<PAGE>   42
                           BEVERLY ENTERPRISES, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
2. WORKFORCE REDUCTIONS, ASSET IMPAIRMENTS AND OTHER UNUSUAL
ITEMS -- (CONTINUED)
approximately $2,500,000 related to the termination of 835 therapy associates in
conjunction with this reorganization. Substantially all of the terminated
therapy associates will receive their severance packages and leave the Company
during the first quarter of 1999. In addition, the Company's home care and
outpatient therapy units underwent the consolidation and relocation of certain
services, including billing and collections, which resulted in a workforce
reduction charge of approximately $1,300,000 associated with the termination of
236 associates. Of these 236 associates, 74 associates had been paid and left
the Company by December 31, 1998. The Company paid approximately $233,000 to
these 74 associates during the year ended December 31, 1998. The remaining 162
terminated home care and outpatient therapy associates will receive their
severance packages and leave the Company during the first quarter of 1999.
 
     SFAS No. 121 requires impairment losses to be recognized for long-lived
assets used in operations when indicators of impairment are present and the
undiscounted cash flows are not sufficient to recover the assets' carrying
amounts. The impairment loss is measured by comparing the fair value of the
asset to its carrying amount. SFAS No. 121 also requires that long-lived assets
held for disposal be carried at the lower of carrying value or fair value less
costs to sell, once management has committed the organization to a plan of
disposal.
 
     As previously reported, the Company estimated that the impact of PPS on its
1999 net operating revenues would be a decrease of approximately $70,000,000, as
compared to 1998 Medicare Part A revenues, and the additional decrease related
to Part B therapy limitations and per beneficiary caps would be approximately
$30,000,000. These significant regulatory changes were an indicator to
management that the carrying values of certain of its nursing facilities may not
be fully recoverable. In addition, there were certain assets that had 1998
operating losses, and anticipated future operating losses, which led management
to believe that these assets were impaired. Accordingly, management estimated
the undiscounted future cash flows to be generated by each facility and reduced
the carrying value to its estimate of fair value, resulting in an impairment
charge of approximately $9,000,000. Management calculated the fair values of the
impaired facilities by using the present value of estimated future cash flows,
or its best estimate of what such facility, or similar facilities in that state,
would sell for in the open market. Management believes it has the knowledge to
make such estimates of open market sales prices based on the volume of
facilities the Company has purchased and sold in previous years. There were no
material impairment adjustments recorded during the years ended December 31,
1997 and 1996.
 
     Also during the fourth quarter of 1998, management identified nine nursing
facilities with an aggregate carrying value of approximately $14,000,000 which
needed to be replaced in order to increase operating efficiencies, attract
additional census or upgrade the nursing home environment. Management committed
to a plan to construct new facilities to replace these buildings and reduced the
carrying values of these facilities to their estimated salvage values. These
assets are included in the total assets of Beverly Healthcare (See Note 10). In
addition, management committed to a plan to dispose of 24 home care centers and
nine outpatient clinics which had 1998 and expected future period operating
losses. These businesses had an aggregate carrying value of approximately
$16,500,000 and were written down to their fair value less costs to sell. These
assets generated pre-tax losses for the Company of approximately $5,100,000
during the year ended December 31, 1998. Substantially all of these assets were
purchased during 1998. The Company expects to dispose of these assets during
1999. These assets are included in the total assets of Beverly Care Alliance
(See Note 10). The Company incurred a charge of approximately $30,300,000
related to these replacements, closings and planned disposals. These assets are
included in the consolidated balance sheet captions "Property and equipment,
net" and "Goodwill, net."
 
     In addition to the workforce reduction and the SFAS No. 121 charges, the
Company recorded a fourth quarter 1998 impairment charge for other long-lived
assets of approximately $19,400,000 primarily related to the write-off of
software and software development costs. In conjunction with the implementation
of business
                                       41
<PAGE>   43
                           BEVERLY ENTERPRISES, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
2. WORKFORCE REDUCTIONS, ASSET IMPAIRMENTS AND OTHER UNUSUAL
ITEMS -- (CONTINUED)
process changes, and the need for enhanced data-gathering and reporting required
to operate effectively under PPS, the Company installed new clinical software in
each of its nursing homes during late-1998, which made obsolete the previously
employed software. In addition, certain of the Company's other ongoing software
development projects were abandoned or written down due to obsolescence,
feasibility or cost recovery issues.
 
3. ACQUISITIONS AND DISPOSITIONS
 
     During the year ended December 31, 1998, the Company purchased 111
outpatient clinics, 50 home care centers, eight nursing facilities (823 beds),
one assisted living center (48 units), two previously leased nursing facilities
(228 beds) and certain other assets for cash of approximately $163,200,000,
acquired debt of approximately $8,000,000 and closing and other costs of
approximately $7,000,000. The acquisitions of such facilities and other assets
were accounted for as purchases and resulted in the Company recording goodwill
of approximately $143,000,000. Also, during such period, the Company sold or
terminated the leases on 26 nursing facilities (3,203 beds) and certain other
assets for cash proceeds of approximately $52,500,000 (approximately $35,600,000
of which was included in accounts receivable-nonpatient at December 31, 1998),
notes receivable of approximately $21,300,000, assumed debt of approximately
$4,600,000 and closing and other costs of approximately $2,300,000. The Company
did not operate seven of these nursing facilities (893 beds) which were leased
to other nursing home operators in prior year transactions. The Company
recognized net pre-tax gains, which were included in net operating revenues,
during the year ended December 31, 1998 of approximately $17,900,000 as a result
of these dispositions. The operations of these facilities and certain other
assets were immaterial to the Company's consolidated financial position and
results of operations.
 
     In June 1998, the Company completed the sale of its American Transitional
Hospitals, Inc. ("ATH") subsidiary to Select Medical Corporation for cash of
approximately $65,300,000 and assumed debt of approximately $2,400,000. Prior to
the sale, ATH operated 15 transitional hospitals (743 beds) in eight states
which addressed the needs of patients requiring intense therapy regimens, but
not necessarily the breadth of services provided within traditional acute care
hospitals. The Company recognized a pre-tax gain, which was included in net
operating revenues, of approximately $16,000,000 during the year ended December
31, 1998 as a result of this disposition. The operations of ATH were immaterial
to the Company's consolidated financial position and results of operations.
 
     During the year ended December 31, 1997, the Company purchased six
previously leased nursing facilities (758 beds) and certain other assets
including, among other things, 14 institutional pharmacies and 40 outpatient
clinics, for cash of approximately $60,800,000 and closing and other costs of
approximately $9,500,000. The acquisitions of such facilities and other assets
were accounted for as purchases. Also during such period, the Company sold or
terminated the leases on 68 nursing facilities (8,314 beds) and certain other
assets for cash proceeds of approximately $146,800,000. The Company recognized
net pre-tax gains, which were included in net operating revenues, during the
year ended December 31, 1997 of approximately $19,900,000 as a result of these
dispositions. The operations of these facilities and certain other assets were
immaterial to the Company's consolidated financial position and results of
operations.
 
     On December 3, 1997, the Company completed the Merger of PCA with Capstone.
As a result of the Merger, the Company received approximately $281,000,000 of
cash as partial repayment for PCA's intercompany debt, with a charge to the
Company's retained earnings of approximately $45,100,000 for the remaining
intercompany balance which was not repaid. Pursuant to the Reorganization, each
of the Company's stockholders of record at the close of business on December 3,
1997 received .4551 shares of PharMerica, Inc.'s common stock for each share of
the Company's Common Stock held. The conversion ratio
 
                                       42
<PAGE>   44
                           BEVERLY ENTERPRISES, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
3. ACQUISITIONS AND DISPOSITIONS -- (CONTINUED)
was based on a total of 109,873,230 outstanding shares of the Company's Common
Stock at the close of business on December 3, 1997 divided into the 50,000,000
shares issued by PharMerica, Inc.
 
     In connection with the Reorganization, the Company incurred $44,000,000 of
transaction costs related to the restructuring, repayment or renegotiating of
substantially all of the Company's outstanding debt instruments, as well as the
renegotiating or making of certain payments, primarily in the form of
accelerated vesting of stock-based awards, under various employment agreements
with officers of the Company. Such amounts were funded with a portion of the
$281,000,000 proceeds received as partial repayment of PCA's intercompany debt,
as discussed above. Included in the $44,000,000 of transaction costs were
approximately $18,000,000 of non-cash expenses related to various long-term
incentive agreements.
 
     At the date of the Merger, PCA had total assets of approximately
$489,200,000, total liabilities of approximately $368,000,000 and total
stockholder's equity of approximately $121,200,000. Total net operating revenues
for PCA for the years ended December 31, 1997 and 1996 were approximately
$564,200,000 and $516,400,000, respectively. Total net operating revenues for
PCA for the year ended December 31, 1997 represent the operations of PCA prior
to the Merger.
 
     During the year ended December 31, 1996, the Company acquired 22 nursing
facilities (2,138 beds) (15 of such facilities (1,747 beds) were previously
leased), one previously managed nursing facility (180 beds) and certain other
assets including, among other things, pharmacy, hospice and outpatient
businesses, for cash of approximately $80,000,000, acquired debt of
approximately $7,500,000, closing and other costs of approximately $7,000,000,
reduction in receivables of approximately $4,800,000 and security and other
deposits of approximately $1,900,000. The acquisitions of such facilities and
other assets were accounted for as purchases. The Company did not operate three
of these nursing facilities which had been subleased to other nursing home
operators in prior year transactions. Also during such period, the Company sold
or terminated the leases on 83 nursing facilities (5,230 beds) (including the
three nursing facilities which were not operated by the Company, as mentioned
above) and certain other assets for cash proceeds of approximately $36,700,000
and approximately $4,200,000 of notes receivable. The Company recognized net
pre-tax gains, which were included in net operating revenues, during the year
ended December 31, 1996 of approximately $6,300,000 as a result of these
dispositions. The operations of these facilities and certain other assets were
immaterial to the Company's consolidated financial position and results of
operations.
 
     In November 1996, the Company sold its MedView Services unit ("MedView")
for cash of approximately $89,700,000 (approximately $2,200,000 of which was
included in accounts receivable-nonpatient at December 31, 1996). Prior to the
sale, MedView provided a full range of managed care services to the workers'
compensation market. It also offered case management and injury reporting and
tracking services. The Company recognized a pre-tax gain, which was included in
net operating revenues, of approximately $14,700,000 during the year ended
December 31, 1996 as a result of this disposition. The operations of MedView
were immaterial to the Company's consolidated financial position and results of
operations.
 
                                       43
<PAGE>   45
                           BEVERLY ENTERPRISES, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
4. PROPERTY AND EQUIPMENT
 
     Following is a summary of property and equipment and related accumulated
depreciation and amortization, by major classification, at December 31 (in
thousands):
 
<TABLE>
<CAPTION>
                                     TOTAL                     OWNED                 LEASED
                            -----------------------   -----------------------   -----------------
                               1998         1997         1998         1997       1998      1997
                            ----------   ----------   ----------   ----------   -------   -------
<S>                         <C>          <C>          <C>          <C>          <C>       <C>
Land, buildings and
  improvements............  $1,433,170   $1,437,334   $1,393,839   $1,395,859   $39,331   $41,475
Furniture and equipment...     350,410      329,222      344,484      324,309     5,926     4,913
Construction in
  progress................      31,057       30,607       31,057       30,607        --        --
                            ----------   ----------   ----------   ----------   -------   -------
                             1,814,637    1,797,163    1,769,380    1,750,775    45,257    46,388
Less accumulated
  depreciation and
  amortization............     694,322      638,834      662,281      606,541    32,041    32,293
                            ----------   ----------   ----------   ----------   -------   -------
                            $1,120,315   $1,158,329   $1,107,099   $1,144,234   $13,216   $14,095
                            ==========   ==========   ==========   ==========   =======   =======
</TABLE>
 
     The Company provides depreciation and amortization using the straight-line
method over the following estimated useful lives: land improvements -- 5 to 15
years; buildings -- 35 to 40 years; building improvements -- 5 to 20 years;
leasehold improvements -- 5 to 20 years or term of lease, if less; furniture and
equipment -- 5 to 15 years. Capitalized lease assets are amortized over the
remaining initial terms of the leases.
 
     Depreciation and amortization expense related to property and equipment,
including the amortization of assets under capital lease obligations, for the
years ended December 31, 1998, 1997 and 1996 was $81,722,000, $87,286,000 and
$85,221,000, respectively.
 
                                       44
<PAGE>   46
                           BEVERLY ENTERPRISES, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
5. LONG-TERM OBLIGATIONS
 
     Long-term obligations consist of the following at December 31 (dollars in
thousands):
 
<TABLE>
<CAPTION>
                                                                1998       1997
                                                              --------   --------
<S>                                                           <C>        <C>
Credit Agreement due December 31, 2001......................  $266,000   $ 15,000
9% Senior Notes due February 15, 2006, unsecured............   180,000    180,000
Notes and mortgages, less imputed interest: 1998 -- $92,
  1997 -- $203; due in installments through the year 2031,
  at effective interest rates of 5.57% to 12.50%, a portion
  of which is secured by property, equipment and other
  assets with a net book value of $182,681 at December 31,
  1998......................................................   167,268    170,738
Industrial development revenue bonds, less imputed interest:
  1998 -- $13,
  1997 -- $19; due in installments through the year 2013, at
  effective interest rates of 4.00% to 10.49%, a portion of
  which is secured by property and other assets with a net
  book value of $193,527 at December 31, 1998...............   169,306    188,711
Term Loan under the GE Capital Facility.....................     5,471     10,505
8 3/4% First Mortgage Bonds due July 1, 2008, secured by
  first mortgages on eight nursing facilities with an
  aggregate net book value of $17,180 at December 31,
  1998......................................................    14,219     18,750
8 5/8% First Mortgage Bonds due October 1, 2008, secured by
  first mortgages on 10 nursing facilities with an aggregate
  net book value of $27,833 at December 31, 1998............    21,540     28,195
7 3/4% Note due in quarterly installments through June 1,
  2001 (repaid in July 1998)................................        --     21,437
Series 1995 Bonds due June 2005, at an interest rate of
  6.88% with respect to $7,000 and 7.24% with respect to
  $18,000, secured by a letter of credit....................    25,000     25,000
Medium Term Notes due June 15, 2000, at an interest rate
  based on LIBOR, as defined, plus .35%, secured by eligible
  receivables of selected nursing facilities of $56,793 at
  December 31, 1998, which cannot be used to satisfy claims
  of the Company or any of its subsidiaries other than
  Beverly Funding Corporation...............................    40,000     40,000
                                                              --------   --------
                                                               888,804    698,336
Present value of capital lease obligations, less imputed
  interest: 1998 -- $419, 1997 -- $456, at effective
  interest rates of 5.94% to 13.00%.........................    17,239     20,156
                                                              --------   --------
                                                               906,043    718,492
Less amounts due within one year............................    27,773     31,551
                                                              --------   --------
                                                              $878,270   $686,941
                                                              ========   ========
</TABLE>
 
     During 1998, the Company entered into promissory notes totaling
approximately $9,500,000 in conjunction with the construction or renovation of
certain nursing facilities. Such debt instruments bear interest at rates ranging
from 7.29% to 8.75%, require monthly installments of principal and interest, and
are secured by mortgage interests in the real property and security interests in
the personal property of the nursing facilities. In addition, the Company
incurred a $1,660,000 extraordinary charge, net of income taxes, in 1998 related
to the write-off of unamortized deferred financing costs associated with the
repayment of certain debt instruments, as well as certain bond refundings.
 
     The Company has a $375,000,000 Credit Agreement (the "Credit Agreement")
which provides for a Revolver/Letter of Credit Facility (the "Revolver/LOC
Facility"). At December 31, 1998, the Company had approximately $15,200,000 of
outstanding letters of credit under the Revolver/LOC Facility. Borrowings
 
                                       45
<PAGE>   47
                           BEVERLY ENTERPRISES, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
5. LONG-TERM OBLIGATIONS -- (CONTINUED)
under the Credit Agreement bear interest at adjusted LIBOR plus .875%, the Prime
Rate, as defined, or the adjusted CD rate, as defined, plus 1%, at the Company's
option. Such interest rates may be adjusted quarterly based on certain financial
ratio calculations. The Company pays certain commitment fees and commissions
with respect to the Revolver/LOC Facility and had approximately $93,800,000 of
unused commitments under such facility at December 31, 1998. The Credit
Agreement is guaranteed by substantially all of the Company's present and future
subsidiaries (collectively, the "Subsidiary Guarantors") and imposes on the
Company certain financial tests and restrictive covenants.
 
     The Company has $180,000,000 of 9% Senior Notes due February 15, 2006 (the
"Senior Notes") which were sold through a public offering (the "Senior Notes
offering"). The Senior Notes are unsecured obligations guaranteed by the
Subsidiary Guarantors and impose on the Company certain restrictive covenants.
Separate financial statements of the Subsidiary Guarantors are not considered to
be material to holders of the Senior Notes since the guaranty of each of the
Subsidiary Guarantors is joint and several and full and unconditional (except
that liability thereunder is limited to an aggregate amount equal to the largest
amount that would not render its obligations thereunder subject to avoidance
under Section 548 of the Bankruptcy Code of 1978, as amended, or any comparable
provisions of applicable state law), and Beverly Enterprises, Inc., the parent,
has no operations or assets separate from its investment in its subsidiaries.
 
     Maturities and sinking fund requirements of long-term obligations,
including capital leases, for the years ended December 31 are as follows (in
thousands):
 
<TABLE>
<CAPTION>
                          1999      2000       2001      2002      2003     THEREAFTER    TOTAL
                         -------   -------   --------   -------   -------   ----------   --------
<S>                      <C>       <C>       <C>        <C>       <C>       <C>          <C>
Future minimum lease
  payments.............  $ 3,129   $ 2,755   $  2,561   $ 2,616   $ 1,965    $ 18,934    $ 31,960
Less interest..........    1,584     1,443      1,327     1,201     1,081       8,085      14,721
                         -------   -------   --------   -------   -------    --------    --------
Net present value of
  future minimum lease
  payments.............    1,545     1,312      1,234     1,415       884      10,849      17,239
Notes, mortgages and
  bonds................   26,228    68,212    289,392    43,945    28,527     432,500     888,804
                         -------   -------   --------   -------   -------    --------    --------
                         $27,773   $69,524   $290,626   $45,360   $29,411    $443,349    $906,043
                         =======   =======   ========   =======   =======    ========    ========
</TABLE>
 
     Many of the capital and operating leases contain at least one renewal
option (which could extend the term of the leases by five to fifteen years),
purchase options, escalation clauses and provisions for payments by the Company
of real estate taxes, insurance and maintenance costs.
 
     The industrial development revenue bonds were originally issued prior to
1985 primarily for the construction or acquisition of nursing facilities. Bond
reserve funds are included in designated funds. These funds are invested
primarily in certificates of deposit and in United States government securities
and are carried at cost, which approximates market value. Net capitalized
interest relating to construction was not material in 1998, 1997, or 1996.
 
                                       46
<PAGE>   48
                           BEVERLY ENTERPRISES, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
6. COMMITMENTS AND CONTINGENCIES
 
     The future minimum rental commitments required by all noncancelable
operating leases with initial or remaining terms in excess of one year as of
December 31, 1998, are as follows (in thousands):
 
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31,
------------
<S>                                                            <C>
1999........................................................   $ 76,472
2000........................................................     56,256
2001........................................................     43,095
2002........................................................     33,583
2003........................................................     19,041
Thereafter..................................................     54,017
                                                               --------
                                                               $282,464
                                                               ========
</TABLE>
 
     Total future minimum rental commitments are net of approximately
$17,863,000 of minimum sublease rental income due in the future under
noncancelable subleases. Rent expense on operating leases, net of sublease
rental income, for the years ended December 31 was as follows:
1998 -- $113,762,000; 1997 -- $114,694,000; 1996 -- $116,718,000. Sublease rent
income was approximately $6,772,000, $5,638,000 and $4,595,000 for the years
ended December 31, 1998, 1997 and 1996, respectively. Contingent rent expense,
based primarily on revenues, was approximately $17,000,000, $18,000,000 and
$18,000,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
 
     The Company has a $125,000,000 financing arrangement available for the
construction of certain facilities. The Company will lease the facilities, under
operating leases with the creditor, upon completion of construction. The Company
will have the option to purchase these facilities at the end of the initial
lease terms. Total construction advances under the financing arrangement as of
December 31, 1998 were approximately $54,000,000.
 
     In 1992, the Company entered into an agreement to outsource its management
information systems functions for a period of seven years, with an option to
renew based on mutual agreement among the parties. Such agreement was
renegotiated during 1997 to allow the Company to bring the programming functions
under its direct control but continue to outsource the data processing functions
and to extend the term of the agreement. The future minimum commitments as of
December 31, 1998 required under such agreement are as follows:
1999 -- $4,033,000; 2000 -- $3,944,000; 2001 -- $3,859,000; 2002 -- $2,849,000.
The Company incurred approximately $5,673,000, $4,498,000 and $8,711,000 under
such agreement during the years ended December 31, 1998, 1997 and 1996,
respectively.
 
     The Company is contingently liable for approximately $76,520,000 of
long-term obligations maturing on various dates through 2019, as well as annual
interest and letter of credit fees of approximately $7,027,000. Such contingent
liabilities principally arose from the Company's sale of nursing facilities and
retirement living centers. The Company operates the facilities related to
approximately $25,795,000 of the principal amount for which it is contingently
liable, pursuant to long-term agreements accounted for as operating leases. In
addition, the Company is contingently liable for various operating leases that
were assumed by purchasers and are secured by the rights thereto.
 
     Approximately 100 of the Company's facilities, or 8% of the Company's
employees, are represented by various labor unions. Certain labor unions have
publicly stated that they are concentrating their organizing efforts within the
long-term healthcare industry. The Company, being one of the largest employers
within the long-term healthcare industry, has been the target of a "corporate
campaign" by two AFL-CIO affiliated unions attempting to organize certain of the
Company's facilities. Although the Company has never
                                       47
<PAGE>   49
                           BEVERLY ENTERPRISES, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
6. COMMITMENTS AND CONTINGENCIES -- (CONTINUED)
experienced any material work stoppages and believes that its relations with its
employees are generally good, the Company cannot predict the effect continued
union representation or organizational activities will have on the Company's
future activities. There can be no assurance that continued union representation
and organizational activities will not result in material work stoppages, which
could have a material adverse effect on the Company's operations.
 
     On March 4, 1998, a jury in California returned a verdict of $95,100,000
against a nursing facility operated by a subsidiary of the Company. The verdict,
which was based on findings of fraud as well as negligence and abuse, consisted
of $365,580 in compensatory damages and $94,700,000 in punitive damages. At a
post-trial hearing on June 3, 1998, the trial judge reduced the compensatory
damages to $125,000 and reduced the punitive damages to $3,000,000. The Company
believes that these reduced damages are excessive and has appealed on this
basis. The plaintiff has cross-appealed. The Company intends to aggressively
pursue all appellate remedies available.
 
     The Company is the subject of a federal government investigation relating
to the allocation to the Medicare program of certain nursing labor costs in its
skilled nursing facilities from 1990 to 1997. The federal government has not
disclosed the origin of this investigation or its intended scope. The
investigation is being conducted by the Office of Inspector General of the
Department of Health and Human Services and by the Department of Justice. The
Company has received subpoenas and has provided substantial information
voluntarily. The Company's independent auditors, Ernst & Young LLP, also
received a subpoena relating to its evaluation of the Company's internal
controls. In addition, the Company has been notified that a federal grand jury
in San Francisco is currently investigating practices which are the subject of
the above civil investigation. Two former employees of the Company have received
letters from the United States Attorney for the Northern District of California
indicating they are targets of the grand jury investigation. To date, four
current employees of the Company have served as witnesses before the grand jury.
The Company has cooperated with the United States Attorney's office in its
investigation. In addition, the Company's current Medicare fiscal intermediary,
Blue Cross of California, is examining cost reports of the Company's facilities
with respect to the areas that are the focus of the government investigation.
 
     Skilled nursing facilities are required to allocate nursing labor costs to
Medicare-certified units on an equitable basis. The Company has relied on a
variety of internal and external processes and practices that are designed to
ensure compliance with this requirement. The Company believes that its cost
reporting policies and procedures are consistent with government regulations and
reflect industry norms for determination of these cost allocations. While it is
not possible to predict the outcome of this investigation, a determination that
the Company has violated these regulations could have a material adverse effect
on the Company's consolidated financial position and results of operations,
which could include the payment of fines and penalties and exclusion from
participation in the Medicare and Medicaid programs.
 
     On October 2, 1998, a purported class action lawsuit was filed in the
United States District Court for the Eastern District of Arkansas by Jack
Kushner against the Company and certain of its officers. The class action
lawsuit alleges, among other things, that the Company and certain of its
officers committed violations of the federal securities laws by materially
inflating the Company's revenues and earnings through practices that are the
subject of the federal government investigation (see above) and disseminating
false and misleading statements concerning compliance with Medicare regulations.
The class action lawsuit seeks damages, costs and expenses. The Company intends
to aggressively pursue all defenses available to it.
 
     There are various other lawsuits and regulatory actions pending against the
Company arising in the normal course of business, some of which seek punitive
damages that are generally not covered by insurance. The Company does not
believe that the ultimate resolution of such other matters will have a material
adverse effect on the Company's consolidated financial position or results of
operations.
                                       48
<PAGE>   50
                           BEVERLY ENTERPRISES, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
7. STOCKHOLDERS' EQUITY
 
     The Company had 300,000,000 shares of authorized $.10 par value common
stock ("Common Stock") at December 31, 1998 and 1997. The Company is subject to
certain restrictions under its long-term debt agreements related to the payment
of cash dividends on its Common Stock. The Company had 25,000,000 shares of
authorized $1 par value preferred stock at December 31, 1998 and 1997, all of
which remain unissued. The Board of Directors has authority, without further
stockholder action, to set rights, privileges and preferences for any unissued
shares of preferred stock.
 
     In June 1996, the Company announced that its Board of Directors had
authorized a stock repurchase program whereby the Company may repurchase, from
time to time on the open market, up to a total of 10,000,000 shares of its
outstanding Common Stock. In December 1997, the Company repurchased 4,000,000
shares of its Common Stock through an accelerated stock repurchase transaction
at a cost of approximately $56,100,000 (approximately $5,700,000 of which was
paid during 1998). During 1998, the Company repurchased 3,000,000 shares of its
Common Stock, through a similar transaction, and approximately 900,000 shares on
the open market at a total cost of approximately $51,100,000. The repurchases
were financed primarily through borrowings under the Company's Revolver/LOC
Facility. On June 2, 1998, the Company announced that its Board of Directors had
authorized an increase in its stock repurchase program. The Company may
repurchase from time to time on the open market, up to an additional 10,000,000
shares of its outstanding Common Stock. Since June 1996, the Company has
repurchased approximately 10,200,000 shares of its outstanding Common Stock
under the stock repurchase program. The Company is subject to certain
restrictions under its credit arrangements related to the repurchase of its
outstanding Common Stock.
 
     During 1997, the New Beverly 1997 Long-Term Incentive Plan was approved
(the "1997 Long-Term Incentive Plan"). Such plan became effective December 3,
1997 and will remain in effect until December 31, 2006, subject to early
termination by the Board of Directors. Such plan replaced the 1996 Long-Term
Incentive Plan, the 1993 Incentive Stock Plan and the 1985 Nonqualified Stock
Option Plan. The Compensation Committee of the Board of Directors (the
"Committee") is responsible for administering the 1997 Long-Term Incentive Plan
and has complete discretion in determining the number of shares or units to be
granted, in setting performance goals and in applying other restrictions to
awards, as needed, under the plan. The Company has 10,000,000 shares of Common
Stock authorized for issuance, subject to certain adjustments, under the 1997
Long-Term Incentive Plan in the form of nonqualified stock options, incentive
stock options, stock appreciation rights, restricted stock, performance awards,
bonus stock and other stock unit awards. Except for options granted upon the
assumption of, or in substitution for, options of another company in which the
Company participates in a corporate transaction or the options affected by the
Reorganization (as discussed below), nonqualified and incentive stock options
must be granted at a purchase price equal to the market price on the date of
grant. Options shall be exercisable at such times and be subject to such
restrictions and conditions as the Committee shall determine and expire no later
than 10 years from the grant date. Stock appreciation rights may be granted
alone, in tandem with an option or in addition to an option. Stock appreciation
rights shall be exercisable at such times and be subject to such restrictions
and conditions as the Committee shall determine and expire no later than 10
years from the grant date. Restricted stock awards are outright stock grants
which have a minimum vesting period of one year for performance-based awards and
three years for other awards. Performance awards, bonus stock and other stock
unit awards may be granted based on the achievement of certain performance or
other goals and will carry certain restrictions, as defined.
 
     During 1997, the New Beverly Non-Employee Directors Stock Option Plan was
approved (the "Non-Employee Directors Stock Option Plan"). Such plan became
effective December 3, 1997 and will remain in effect until December 31, 2007,
subject to early termination by the Board of Directors. Such plan replaced the
Nonemployee Directors' Plan. The Company has 300,000 shares of Common Stock
authorized for issuance,
 
                                       49
<PAGE>   51
                           BEVERLY ENTERPRISES, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
7. STOCKHOLDERS' EQUITY -- (CONTINUED)
subject to certain adjustments, under the Non-Employee Directors Stock Option
Plan. The Non-Employee Directors Stock Option Plan was amended by the Board of
Directors on December 11, 1997 to provide that each nonemployee director be
granted an option to purchase 3,375 shares of the Company's Common Stock on June
1 of each year until the plan is terminated, subject to the availability of
shares. Such options are granted at a purchase price equal to fair market value
on the date of grant, become exercisable one year after date of grant and expire
10 years after date of grant.
 
     The following table summarizes stock option, restricted stock and other
stock units data relative to the Company's long-term incentive plans for the
years ended December 31:
 
<TABLE>
<CAPTION>
                                                  1998                     1997                    1996
                                         ----------------------   ----------------------   ---------------------
                                                      WEIGHTED-                WEIGHTED-               WEIGHTED-
                                                       AVERAGE                  AVERAGE                 AVERAGE
                                           NUMBER     EXERCISE      NUMBER     EXERCISE     NUMBER     EXERCISE
                                         OF SHARES      PRICE     OF SHARES      PRICE     OF SHARES     PRICE
                                         ----------   ---------   ----------   ---------   ---------   ---------
<S>                                      <C>          <C>         <C>          <C>         <C>         <C>
Options outstanding at beginning of
  year.................................   6,561,903     $9.29      4,908,727    $10.55     4,394,382    $ 9.02
Changes during the year:
  Granted..............................   3,341,994      8.81      2,944,522     10.87     1,696,500     12.38
  Exercised............................    (428,069)     6.89     (1,047,423)     8.06      (833,587)     5.41
  Cancelled............................  (1,312,263)     9.42       (243,923)    14.64      (348,568)    12.39
                                         ----------               ----------               ---------
Options outstanding at end of year.....   8,163,565      9.20      6,561,903      9.29     4,908,727     10.55
                                         ==========               ==========               =========
Options exercisable at end of year.....   3,761,259      8.50      5,073,903      8.23     2,560,209      8.75
                                         ==========               ==========               =========
Options available for grant at end of
  year.................................   1,701,426                3,738,097               3,052,403
                                         ==========               ==========               =========
Restricted stock outstanding at
  beginning of year....................          --                  145,200                 306,052
Changes during the year:
  Granted..............................          --                   10,500                  29,000
  Vested...............................          --                 (134,711)               (148,352)
  Forfeited............................          --                  (20,989)                (41,500)
                                         ----------               ----------               ---------
Restricted stock outstanding at end of
  year.................................          --                       --                 145,200
                                         ==========               ==========               =========
Phantom units outstanding at beginning
  of year..............................          --                   76,769                  90,942
Changes during the year:
  Granted..............................          --                       --                      --
  Vested...............................          --                  (76,316)                 (6,982)
  Cancelled............................          --                     (453)                 (7,191)
                                         ----------               ----------               ---------
Phantom units outstanding at end of
  year.................................          --                       --                  76,769
                                         ==========               ==========               =========
Performance shares outstanding at
  beginning of year....................          --                  992,000                      --
Changes during the year:
  Granted..............................          --                   16,000               1,040,000
  Vested...............................          --                 (759,389)                     --
  Cancelled............................          --                 (248,611)                (48,000)
                                         ----------               ----------               ---------
Performance shares outstanding at end
  of year..............................          --                       --                 992,000
                                         ==========               ==========               =========
</TABLE>
 
                                       50
<PAGE>   52
                           BEVERLY ENTERPRISES, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
7. STOCKHOLDERS' EQUITY -- (CONTINUED)
     Exercise prices for options outstanding as of December 31, 1998 ranged from
$3.24 to $16.06. The weighted-average remaining contractual life of these
options is eight years. The following table provides certain information with
respect to stock options outstanding at December 31, 1998:
 
<TABLE>
<CAPTION>
                                              OPTIONS OUTSTANDING
                                -----------------------------------------------       OPTIONS EXERCISABLE
                                                                  WEIGHTED-       ----------------------------
                                                WEIGHTED-          AVERAGE                        WEIGHTED-
                                  OPTIONS        AVERAGE          REMAINING         OPTIONS        AVERAGE
RANGE OF EXERCISE PRICES        OUTSTANDING   EXERCISE PRICE   CONTRACTUAL LIFE   EXERCISABLE   EXERCISE PRICE
------------------------        -----------   --------------   ----------------   -----------   --------------
<S>                             <C>           <C>              <C>                <C>           <C>
$ 3.24-$ 6.50.................   3,143,678        $ 5.73             7.87            920,091        $ 3.85
$ 7.13-$10.00.................   1,888,575          9.14             7.45          1,724,460          9.20
$10.19-$13.81.................   2,188,833         12.05             8.06          1,116,708         11.25
$14.00-$16.06.................     942,479         14.26             9.17                 --            --
                                 ---------                                         ---------
$ 3.24-$16.06.................   8,163,565        $ 9.20             7.98          3,761,259        $ 8.50
                                 =========                                         =========
</TABLE>
 
     As a result of the Reorganization (as discussed herein), immediately prior
to the Distribution, (i) each option to purchase the Company's Common Stock then
outstanding became fully vested and exercisable, (ii) all restrictions on
outstanding restricted shares lapsed and became fully vested, (iii) each
outstanding award of phantom units became fully vested, and (iv) each
outstanding performance share became fully vested. The Company incurred expenses
of approximately $18,000,000 as it related to these stock-based awards, which
was included in the $44,000,000 of transaction costs. In addition, all options
outstanding immediately after the Distribution were cancelled and replaced with
new options issued by the Company under the 1997 Long-Term Incentive Plan. Such
options are exercisable upon the same terms and conditions (except that all
options are 100% vested) as under the applicable option agreement issued
thereunder, except that (i) the number of shares for which such options may be
converted, and (ii) the option exercise price per share of such options were
adjusted to take into account the effect of the Reorganization.
 
     The Company recognizes compensation expense for its restricted stock
grants, performance share grants (when the performance targets are achieved) and
other stock unit awards. The Company did not incur any charges related to these
stock-based awards during the year ended December 31, 1998. The total charges to
the Company's consolidated statements of operations for the years ended December
31, 1997 and 1996 related to these stock-based awards were approximately
$19,767,000 and $509,000, respectively. The total charges for 1997 included
approximately $18,000,000 related to the impact of the Reorganization on the
Company's stock-based awards (as discussed above), which was included in the
$44,000,000 of transaction costs.
 
     Pro forma information regarding net income and earnings per share is
required by SFAS No. 123, and has been determined as if the Company had
accounted for its 1998, 1997 and 1996 stock option and performance share grants
under the fair value method as prescribed by such statement. The fair value for
stock options was estimated at the date of grant using a Black-Scholes option
pricing model with the following weighted-average assumptions for the years
ended December 31, 1998, 1997 and 1996, respectively: risk-free interest rates
of 5.0%, 5.9% and 6.5%; volatility factors of the expected market price of the
Company's Common Stock of .41, .35 and .34; and weighted-average expected option
lives of 10 years, 8 years and 10 years. The Company does not currently pay cash
dividends on its Common Stock and no future dividends are currently planned.
Such weighted-average assumptions resulted in a weighted average fair value of
options granted during 1998, 1997 and 1996 of $5.35 per share, $7.84 per share
and $7.30 per share, respectively. The fair value of the performance share
grants was based on the market value of the Company's Common Stock on the date
of grant.
 
                                       51
<PAGE>   53
                           BEVERLY ENTERPRISES, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
7. STOCKHOLDERS' EQUITY -- (CONTINUED)
     The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's 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 estimates, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its stock options.
 
     For purposes of pro forma disclosures, the estimated fair value of the
stock options and performance shares is amortized to expense over their
respective vesting periods. The pro forma effects on reported net income (loss)
and diluted earnings per share assuming the Company had elected to account for
its stock option and performance share grants in accordance with SFAS No. 123
for the years ended December 31, 1998, 1997 and 1996 would have been a net loss
of $32,202,000 or $.31 per share, net income of $47,244,000 or $.46 per share
and net income of $48,964,000 or $.49 per share, respectively. The pro forma
amounts for 1997 reflect the impact of the Reorganization on the Company's
outstanding stock options (as discussed above). Such pro forma effects are not
necessarily indicative of the effect on future years.
 
     The Beverly Enterprises 1988 Employee Stock Purchase Plan (as amended and
restated) enables all full-time employees having completed one year of
continuous service to purchase shares of Common Stock at the current market
price through payroll deductions. The Company makes contributions in the amount
of 30% of the participant's contribution. Each participant specifies the amount
to be withheld from earnings per two-week pay period, subject to certain
limitations. The total charges to the Company's consolidated statements of
operations for the years ended December 31, 1998, 1997 and 1996 related to this
plan were approximately $2,435,000, $2,449,000 and $2,258,000, respectively.
 
8. INCOME TAXES
 
     The provision for (benefit from) taxes on income (loss) before
extraordinary charge and cumulative effect of change in accounting for start-up
costs (see Note 1) consists of the following for the years ended December 31 (in
thousands):
 
<TABLE>
<CAPTION>
                                                           1998      1997      1996
                                                         --------   -------   -------
<S>                                                      <C>        <C>       <C>
Federal:
  Current..............................................  $     --   $22,997   $31,615
  Deferred.............................................   (28,227)   20,404    29,466
State:
  Current..............................................     2,169     6,669     8,101
  Deferred.............................................       122      (157)    4,299
                                                         --------   -------   -------
                                                         $(25,936)  $49,913   $73,481
                                                         ========   =======   =======
</TABLE>
 
     The Company had an annual effective tax rate of 51% for the year ended
December 31, 1998, compared to annual effective tax rates of 46% and 59% for the
years ended December 31, 1997 and 1996, respectively. The annual effective tax
rate in 1998 was different than the federal statutory rate primarily due to the
impact of the sale of ATH (see Note 3), the benefit of certain tax credits, and
the pre-tax charge of approximately $69,400,000 (see Note 2) which reduced the
Company's pre-tax income to a level where the impact of permanent tax
differences and state income taxes had a more significant impact on the
effective tax rate. The annual effective tax rate in 1997 was different than the
federal statutory rate primarily due to the impact of nondeductible transaction
costs associated with the Reorganization (see Note 3). The annual effective tax
rate
 
                                       52
<PAGE>   54
                           BEVERLY ENTERPRISES, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
8. INCOME TAXES -- (CONTINUED)
in 1996 was different than the federal statutory rate primarily due to the
impact of nondeductible goodwill associated with the MedView disposition (see
Note 3).
 
     A reconciliation of the provision for (benefit from) income taxes, computed
at the statutory rate, to the Company's annual effective tax rate is summarized
as follows (dollars in thousands):
 
<TABLE>
<CAPTION>
                                               1998            1997            1996
                                          --------------   -------------   -------------
                                           AMOUNT     %    AMOUNT     %    AMOUNT     %
                                          --------   ---   -------   ---   -------   ---
<S>                                       <C>        <C>   <C>       <C>   <C>       <C>
Tax (benefit) at statutory rate.........  $(17,809)  35    $37,977   35    $43,927   35
General business tax credits............    (2,315)   5         --   --         --   --
State tax provision, net................     1,489   (3)     4,233    4      8,060    6
Nondeductible amortization of
  intangibles...........................       (74)  --      1,702    2     20,881   17
Sale of ATH.............................    (6,867)  13         --   --         --   --
Effect of Reorganization and Merger.....        --   --      5,618    5         --   --
Other...................................      (360)   1        383   --        613    1
                                          --------   --    -------   --    -------   --
                                          $(25,936)  51    $49,913   46    $73,481   59
                                          ========   ==    =======   ==    =======   ==
</TABLE>
 
     Deferred income taxes reflect the impact of temporary differences between
the carrying amounts of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. The tax effects of temporary
differences giving rise to the Company's deferred tax assets and liabilities at
December 31, 1998 and 1997 are as follows (in thousands):
 
<TABLE>
<CAPTION>
                                              DECEMBER 31, 1998      DECEMBER 31, 1997
                                             --------------------   --------------------
                                              ASSET     LIABILITY    ASSET     LIABILITY
                                             --------   ---------   --------   ---------
<S>                                          <C>        <C>         <C>        <C>
Insurance reserves.........................  $ 11,988   $     --    $ 36,104   $     --
General business tax credit
  carryforwards............................     5,270         --          --         --
Alternative minimum tax credit
  carryforwards............................    16,568         --      13,969         --
Provision for dispositions.................    37,805      3,152      32,591      5,776
Depreciation and amortization..............    12,711    136,096          29    140,062
Operating supplies.........................        --     13,241          --     12,907
Federal net operating loss carryforwards...    17,846         --          --         --
Other......................................    22,728     30,877      18,304     26,336
                                             --------   --------    --------   --------
                                             $124,916   $183,366    $100,997   $185,081
                                             ========   ========    ========   ========
</TABLE>
 
     At December 31, 1998, the Company had federal net operating loss
carryforwards of $50,989,000 for income tax purposes which expire in 2018. At
December 31, 1998, the Company had general business tax credit carryforwards of
$5,270,000 for income tax purposes which expire in years 2008 through 2014. For
financial reporting purposes, the federal net operating loss carryforwards and
the general business tax credit carryforwards have been utilized to offset
existing net taxable temporary differences reversing during the carryforward
periods.
 
9. FAIR VALUES OF FINANCIAL INSTRUMENTS
 
     Financial Accounting Standards Statement No. 107, "Disclosures about Fair
Value of Financial Instruments" requires disclosure of fair value information
about financial instruments, whether or not recognized in the balance sheet, for
which it is practicable to estimate that value. In cases where quoted market
prices are not available, fair values are based on estimates using present value
or other valuation
 
                                       53
<PAGE>   55
                           BEVERLY ENTERPRISES, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
9. FAIR VALUES OF FINANCIAL INSTRUMENTS -- (CONTINUED)
techniques. Those techniques are significantly affected by the assumptions used,
including the discount rate and estimates of future cash flows. In that regard,
the derived fair value estimates cannot be substantiated by comparison to
independent markets and, in many cases, could not be realized in immediate
settlement of the instrument. Statement No. 107 excludes certain financial
instruments and all nonfinancial instruments from its disclosure requirements.
Accordingly, the aggregate fair value amounts presented do not represent the
underlying value of the Company. The following methods and assumptions were used
by the Company in estimating its fair value disclosures for financial
instruments:
 
  Cash and Cash Equivalents
 
     The carrying amount reported in the consolidated balance sheets for cash
and cash equivalents approximates its fair value.
 
  Notes Receivable, Net (Including Current Portion)
 
     For variable-rate notes that reprice frequently and with no significant
change in credit risk, fair values are based on carrying values. The fair values
for fixed-rate notes are estimated using discounted cash flow analyses, using
interest rates currently being offered for loans with similar terms to borrowers
of similar credit quality.
 
  Beverly Indemnity Funds
 
     The fair value of the Beverly Indemnity funds is based on information
obtained from the trustee and the manager of such funds. These funds are
invested primarily in United States government securities with maturity dates
ranging primarily from one to five years. The carrying amount of these funds is
included in the consolidated balance sheet captions "Prepaid expenses and other"
and "Designated and restricted funds" based on when the corresponding claims are
expected to be paid. During the fourth quarter of 1998, Beverly Indemnity, Ltd.
completed a risk transfer of substantially all of its pre-May 1998 auto
liability, general liability and workers' compensation claims liability to a
third party insurer effected through a loss portfolio transfer (see Note 1)
which resulted in the sale of securities with a book value of approximately
$61,600,000. Also during 1998, various other securities were sold with a book
value of approximately $33,700,000. Beverly Indemnity, Ltd. received gross
proceeds of approximately $98,000,000 from the sale of these securities and
recognized gross gains on the sales of these securities of approximately
$3,000,000. In addition, an adjustment was recorded to unrealized gains on
securities of $1,755,000, net of income taxes, for gains on sales of securities
included in net income.
 
  Long-term Obligations (Including Current Portion)
 
     The carrying amounts of the Company's variable-rate borrowings approximate
their fair values. The fair values of the remaining long-term obligations are
estimated using discounted cash flow analyses, based on the Company's
incremental borrowing rates for similar types of borrowing arrangements.
 
                                       54
<PAGE>   56
                           BEVERLY ENTERPRISES, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
9. FAIR VALUES OF FINANCIAL INSTRUMENTS -- (CONTINUED)
     The carrying amounts and estimated fair values of the Company's financial
instruments at December 31, 1998 and 1997 are as follows (in thousands):
 
<TABLE>
<CAPTION>
                                                      1998                  1997
                                               -------------------   -------------------
                                               CARRYING     FAIR     CARRYING     FAIR
                                                AMOUNT     VALUE      AMOUNT     VALUE
                                               --------   --------   --------   --------
<S>                                            <C>        <C>        <C>        <C>
Cash and cash equivalents....................  $ 17,278   $ 17,278   $105,230   $105,230
Notes receivable, net (including current
  portion)...................................    42,338     44,900     24,973     26,400
Beverly Indemnity funds......................     1,600      1,600     80,804     80,804
Long-term obligations (including current
  portion)...................................   906,043    929,454    718,492    746,439
</TABLE>
 
     During 1998, the Company defeased long-term obligations with an aggregate
carrying value of $5,740,000. The fair values of such long-term obligations are
estimated using discounted cash flow analyses, based on the Company's
incremental borrowing rates for similar types of borrowing arrangements, and
were approximately $5,819,000 at December 31, 1998.
 
     In order to consummate certain dispositions and other transactions, the
Company has agreed to guarantee the debt assumed or acquired by the purchaser or
the performance under a lease, by the lessor. It is not practicable to estimate
the fair value of the Company's off-balance sheet guarantees (See Note 6). The
Company does not charge a fee for entering into such agreements and contracting
with a financial institution to estimate such amounts could not be done without
incurring excessive costs. In addition, unlike the Company, a financial
institution would not be in a position to assume the underlying obligations and
operate the nursing facilities collateralizing the obligations, which would
significantly impact the calculation of the fair value of such off-balance sheet
guarantees.
 
10. SEGMENT INFORMATION
 
     In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS No. 131"). SFAS No. 131 provides
revised disclosure guidelines for segments of a company based on a management
approach to defining operating segments.
 
  Description of the Types of Services from which each Operating Segment Derives
its Revenues
 
     At December 31, 1998, the Company was organized into two operating
segments, which support the Company's delivery of vertically integrated services
to the long-term healthcare market. These operating segments included: (i)
Beverly Healthcare, which provides long-term healthcare through the operation of
nursing facilities and assisted living centers; and (ii) Beverly Care Alliance,
which operates outpatient clinics, home care centers and a rehabilitation
services business.
 
     At December 31, 1997, in addition to the two operating segments mentioned
above, the Company owned Beverly Specialty Hospitals, which operated the
Company's transitional hospitals. In June 1998, the Company completed the sale
of this segment to Select Medical Corporation (see Note 3). At December 31,
1996, in addition to the three operating segments mentioned above, the Company
owned PCA, which operated the Company's institutional and mail service pharmacy
businesses. In December 1997, the Company completed the Merger of PCA with
Capstone (see Note 3).
 
                                       55
<PAGE>   57
                           BEVERLY ENTERPRISES, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
10. SEGMENT INFORMATION -- (CONTINUED)
  Measurement of Segment Income or Loss and Segment Assets
 
     The accounting policies of the operating segments are the same as those
described in the summary of significant accounting policies (see Note 1). The
Company evaluates performance and allocates resources based on income or loss
from operations before income taxes, excluding any unusual items.
 
  Factors Management Used to Identify the Company's Operating Segments
 
     The Company's operating segments are strategic business units that offer
different services within the long-term healthcare continuum. Business in each
operating segment is conducted by one or more corporations headed by a president
who also is a senior officer of the Company and reports directly to the
President of the Company. The corporations comprising each operating segment
also have separate boards of directors consisting of four senior executives of
the Company and the president of the segment.
 
                                       56
<PAGE>   58
                           BEVERLY ENTERPRISES, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
10. SEGMENT INFORMATION -- (CONTINUED)
     The following table summarizes certain information for each of the
Company's operating segments (in thousands):
 
<TABLE>
<CAPTION>
                                               BEVERLY     BEVERLY     PHARMACY
                                   BEVERLY       CARE     SPECIALTY   CORPORATION
                                  HEALTHCARE   ALLIANCE   HOSPITALS   OF AMERICA    ALL OTHER(1)     TOTALS
                                  ----------   --------   ---------   -----------   ------------   ----------
<S>                               <C>          <C>        <C>         <C>           <C>            <C>
Year ended December 31, 1998
  Revenues from external
     customers..................  $2,531,496   $192,627    $61,775           --      $  26,334     $2,812,232
  Intercompany revenues.........          --     13,518        539           --         10,682         24,739
  Interest income...............         410        160          3           --         10,135         10,708
  Interest expense..............      29,359        108         93           --         36,378         65,938
  Depreciation and
     amortization...............      78,269      8,662      1,578           --          5,213         93,722
  Pre-tax income (loss).........     165,707      6,878       (670)          --       (222,797)       (50,882)
  Total assets..................   1,526,091    303,913         --           --        330,507      2,160,511
  Capital expenditures..........      87,209     15,149      4,937           --         43,156        150,451
Year ended December 31, 1997
  Revenues from external
     customers..................  $2,583,758   $ 60,103    $99,783     $472,861      $     594     $3,217,099
  Intercompany revenues.........          --     15,643      1,708       91,338         10,269        118,958
  Interest income...............         302         --          3          125         12,771         13,201
  Interest expense..............      32,264         19        275       14,965         35,190         82,713
  Depreciation and
     amortization...............      77,162      3,402      2,517       18,281          5,698        107,060
  Pre-tax income (loss).........     173,363      2,801        819       33,450       (101,927)       108,506
  Total assets..................   1,504,437    101,364     48,964           --        418,704      2,073,469
  Capital expenditures..........      90,699      6,468      5,198       11,725         18,997        133,087
Year ended December 31, 1996
  Revenues from external
     customers..................  $2,678,025   $ 65,516    $80,363     $434,238      $   9,047     $3,267,189
  Intercompany revenues.........          --     15,314      1,269       82,162          9,957        108,702
  Interest income...............         603         54         19          177         12,986         13,839
  Interest expense..............      32,230         --        219       16,000         42,662         91,111
  Depreciation and
     amortization...............      77,169      4,108      2,437       16,385          5,369        105,468
  Pre-tax income (loss).........     164,463      3,718     (1,576)      21,215        (62,313)       125,507
  Total assets..................   1,580,162     53,202     41,440      449,086        401,192      2,525,082
  Capital expenditures..........      97,807      6,294      2,769       10,895         18,677        136,442
</TABLE>
 
---------------
 
(1) All Other consists of the operations of the Company's corporate headquarters
    and related overhead.
 
                                       57
<PAGE>   59
 
                           BEVERLY ENTERPRISES, INC.
 
                         SUPPLEMENTARY DATA (UNAUDITED)
                            QUARTERLY FINANCIAL DATA
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
 
     The following is a summary of the quarterly results of operations for the
years ended December 31, 1998 and 1997.
<TABLE>
<CAPTION>
                                                                    1998
                                           -------------------------------------------------------
                                             1ST        2ND        3RD         4TH        TOTAL
                                           --------   --------   --------   ---------   ----------
<S>                                        <C>        <C>        <C>        <C>         <C>
Total revenues...........................  $697,427   $717,648   $700,635   $ 707,230   $2,822,940
                                           ========   ========   ========   =========   ==========
Income (loss) before provision for
 (benefit from) income taxes,
 extraordinary charge and cumulative
 effect of change in accounting for
 start-up costs..........................  $ 29,099   $ 31,803   $ 32,822   $(144,606)  $  (50,882)
Provision for (benefit from) income
 taxes...................................    11,058     10,258     11,487     (58,739)     (25,936)
                                           --------   --------   --------   ---------   ----------
Income (loss) before extraordinary charge
 and cumulative effect of change in
 accounting for start-up costs...........    18,041     21,545     21,335     (85,867)     (24,946)
Extraordinary charge.....................        --         --         --      (1,660)      (1,660)
Cumulative effect of change in accounting
 for start-up costs......................    (4,415)        --         --          --       (4,415)
                                           --------   --------   --------   ---------   ----------
Net income (loss)........................  $ 13,626   $ 21,545   $ 21,335   $ (87,527)  $  (31,021)
                                           ========   ========   ========   =========   ==========
Income (loss) per share of common stock:
Basic:
 Before extraordinary charge and
   cumulative effect of change in
   accounting for start-up costs.........  $    .17   $    .21   $    .21   $    (.84)  $     (.24)
 Extraordinary charge....................        --         --         --        (.02)        (.02)
 Cumulative effect of change in
   accounting for start-up costs.........      (.04)        --         --          --         (.04)
                                           --------   --------   --------   ---------   ----------
 Net income (loss).......................  $    .13   $    .21   $    .21   $    (.86)  $     (.30)
                                           ========   ========   ========   =========   ==========
 Shares used to compute per share
   amounts...............................   106,006    103,682    103,019     102,389      103,762
                                           ========   ========   ========   =========   ==========
Diluted:
 Before extraordinary charge and
   cumulative effect of change in
   accounting for start-up costs.........  $    .17   $    .20   $    .21   $    (.84)  $     (.24)
 Extraordinary charge....................        --         --         --        (.02)        (.02)
 Cumulative effect of change in
   accounting for start-up costs.........      (.04)        --         --          --         (.04)
                                           --------   --------   --------   ---------   ----------
 Net income (loss).......................  $    .13   $    .20   $    .21   $    (.86)  $     (.30)
                                           ========   ========   ========   =========   ==========
 Shares used to compute per share
   amounts...............................   107,479    105,112    103,610     102,389      103,762
                                           ========   ========   ========   =========   ==========
Common stock price range:
 High....................................  $  15.56   $  16.25   $  14.81   $    8.13
 Low.....................................  $  12.25   $  13.50   $   7.38   $    5.25
 
<CAPTION>
                                                                    1997
                                           ------------------------------------------------------
                                             1ST        2ND        3RD        4TH        TOTAL
                                           --------   --------   --------   --------   ----------
<S>                                        <C>        <C>        <C>        <C>        <C>
Total revenues...........................  $820,281   $820,664   $807,926   $781,429   $3,230,300
                                           ========   ========   ========   ========   ==========
Income (loss) before provision for
 (benefit from) income taxes,
 extraordinary charge and cumulative
 effect of change in accounting for
 start-up costs..........................  $ 30,772   $ 34,950   $ 45,222   $ (2,438)  $  108,506
Provision for (benefit from) income
 taxes...................................    12,309     13,980     18,089      5,535       49,913
                                           --------   --------   --------   --------   ----------
Income (loss) before extraordinary charge
 and cumulative effect of change in
 accounting for start-up costs...........    18,463     20,970     27,133     (7,973)      58,593
Extraordinary charge.....................        --         --         --         --           --
Cumulative effect of change in accounting
 for start-up costs......................        --         --         --         --           --
                                           --------   --------   --------   --------   ----------
Net income (loss)........................  $ 18,463   $ 20,970   $ 27,133   $ (7,973)  $   58,593
                                           ========   ========   ========   ========   ==========
Income (loss) per share of common stock:
Basic:
 Before extraordinary charge and
   cumulative effect of change in
   accounting for start-up costs.........  $    .19   $    .21   $    .26   $   (.07)  $      .57
 Extraordinary charge....................        --         --         --         --           --
 Cumulative effect of change in
   accounting for start-up costs.........        --         --         --         --           --
                                           --------   --------   --------   --------   ----------
 Net income (loss).......................  $    .19   $    .21   $    .26   $   (.07)  $      .57
                                           ========   ========   ========   ========   ==========
 Shares used to compute per share
   amounts...............................    98,144     97,736    103,508    108,719      102,060
                                           ========   ========   ========   ========   ==========
Diluted:
 Before extraordinary charge and
   cumulative effect of change in
   accounting for start-up costs.........  $    .18   $    .20   $    .26   $   (.07)  $      .57
 Extraordinary charge....................        --         --         --         --           --
 Cumulative effect of change in
   accounting for start-up costs.........        --         --         --         --           --
                                           --------   --------   --------   --------   ----------
 Net income (loss).......................  $    .18   $    .20   $    .26   $   (.07)  $      .57
                                           ========   ========   ========   ========   ==========
 Shares used to compute per share
   amounts...............................   110,386    109,993    107,751    108,719      103,422
                                           ========   ========   ========   ========   ==========
Common stock price range:
 High....................................  $  16.13   $  16.88   $  17.50   $  17.50
 Low.....................................  $  12.25   $  13.13   $  14.56   $  12.13(1)
</TABLE>
 
---------------
 
(1) After the effect of the Reorganization on December 3, 1997 (as discussed
    herein).
 
     The Company had an annual effective tax rate of 51% for the year ended
December 31, 1998 compared to an annual effective tax rate of 46% for the year
ended December 31, 1997. The annual effective tax rate in 1998 was different
than the federal statutory rate primarily due to the impact of the sale of ATH
(see Note 3), the benefit of certain tax credits, and the $69,400,000 pre-tax
charge (see Note 2) which reduced the Company's pre-tax income to a level where
the impact of permanent tax differences and state income taxes had a significant
impact on the effective tax rate. In addition, the annual effective tax rate in
1997 was different than the federal statutory rate primarily due to the impact
of nondeductible transaction costs associated with the Reorganization (as
discussed herein).
 
     Results of operations for the first quarter of 1998 have been restated for
the cumulative effect of a change in accounting for start-up costs resulting
from the adoption of SOP 98-5 (see Note 1). The adoption of SOP 98-5 did not
have a significant impact on previously reported results from continuing
operations and, therefore, such results have not been restated.
 
                                       58
<PAGE>   60
 
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE.
 
     None.
 
                                    PART III
 
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY.
 
     Incorporated herein by reference from the Company's definitive proxy
statement for the Annual Meeting of Stockholders to be held on May 27, 1999, to
be filed pursuant to Regulation 14A.
 
ITEM 11. EXECUTIVE COMPENSATION.
 
     Incorporated herein by reference from the Company's definitive proxy
statement for the Annual Meeting of Stockholders to be held on May 27, 1999, to
be filed pursuant to Regulation 14A.
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
 
     Incorporated herein by reference from the Company's definitive proxy
statement for the Annual Meeting of Stockholders to be held on May 27, 1999, to
be filed pursuant to Regulation 14A.
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
 
     Jon E.M. Jacoby, a director, serves as Executive Vice President, Chief
Financial Officer and director of Stephens Group, Inc. During the years ended
December 31, 1998, 1997 and 1996, the Company used Stephens Group, Inc., or its
affiliates, for investment banking services.
 
                                    PART IV
 
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
 
  (a) 1 and 2. The Consolidated Financial Statements and Consolidated Financial
Statement Schedule
 
     The consolidated financial statements and consolidated financial statement
schedule listed in the accompanying index to consolidated financial statements
and financial statement schedules are filed as part of this annual report.
 
     3. Exhibits
 
     The exhibits listed in the accompanying index to exhibits are incorporated
by reference herein or are filed as part of this annual report.
 
  (b) Reports on Form 8-K
 
     No reports on Form 8-K were filed by the Company during the quarter ended
December 31, 1998.
 
  (c) Exhibits
 
     See the accompanying index to exhibits referenced in Item 14(a)(3) above
for a list of exhibits incorporated herein by reference or filed as part of this
annual report.
 
  (d) Financial Statement Schedule
 
     See the accompanying index to consolidated financial statements and
financial statement schedules referenced in Item 14(a)1 and 2, above.
 
                                       59
<PAGE>   61
 
                           BEVERLY ENTERPRISES, INC.
 
                 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND
                         FINANCIAL STATEMENT SCHEDULES
                                  (ITEM 14(A))
 
<TABLE>
<CAPTION>
                                                               PAGE
                                                               ----
<S>                                                            <C>
1. Consolidated financial statements:
     Report of Ernst & Young LLP, Independent Auditors......    31
     Consolidated Balance Sheets at December 31, 1998 and
      1997..................................................    32
     Consolidated Statements of Operations for each of the
      three years in the period ended December 31, 1998.....    33
     Consolidated Statements of Stockholders' Equity for
      each of the three years in the period ended December
      31, 1998..............................................    34
     Consolidated Statements of Cash Flows for each of the
      three years in the period ended December 31, 1998.....    35
     Notes to Consolidated Financial Statements.............    36
     Supplementary Data (Unaudited) -- Quarterly Financial
      Data..................................................    58
2. Consolidated financial statement schedule for each of the
   three years in the period ended December 31, 1998:
     II -- Valuation and Qualifying Accounts................    61
</TABLE>
 
     All other schedules are omitted because they are either not applicable or
the items do not exceed the various disclosure levels.
 
                                       60
<PAGE>   62
 
                           BEVERLY ENTERPRISES, INC.
 
                SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                 CHARGED                     DUE TO
                                   BALANCE AT   (CREDITED)                ACQUISITIONS            BALANCE
                                   BEGINNING        TO                        AND                 AT END
DESCRIPTION                         OF YEAR     OPERATIONS   WRITE-OFFS   DISPOSITIONS   OTHER    OF YEAR
-----------                        ----------   ----------   ----------   ------------   ------   -------
<S>                                <C>          <C>          <C>          <C>            <C>      <C>
Year ended December 31, 1998:
  Allowance for doubtful
     accounts:
     Accounts
       receivable -- patient.....   $17,879      $25,549      $(19,807)     $(1,857)     $   --   $21,764
     Accounts receivable --
       nonpatient................       862          (90)          (13)         (82)         --       677*
     Notes receivable............     2,917         (210)          (66)          --         280     2,921
                                    -------      -------      --------      -------      ------   -------
                                    $21,658      $25,249      $(19,886)     $(1,939)     $  280   $25,362
                                    =======      =======      ========      =======      ======   =======
Year ended December 31, 1997:
  Allowance for doubtful
     accounts:
     Accounts
       receivable -- patient.....   $25,618      $35,343      $(34,858)     $(8,224)     $   --   $17,879
     Accounts receivable --
       nonpatient................       637          209          (218)          --         234       862*
     Notes receivable............     4,951       (1,211)         (306)      (1,453)        936     2,917
                                    -------      -------      --------      -------      ------   -------
                                    $31,206      $34,341      $(35,382)     $(9,677)     $1,170   $21,658
                                    =======      =======      ========      =======      ======   =======
Year ended December 31, 1996:
  Allowance for doubtful
     accounts:
     Accounts
       receivable -- patient.....   $22,860      $28,637      $(29,163)     $ 2,555      $  729   $25,618
     Accounts receivable --
       nonpatient................       813           56          (223)          --          (9)      637*
     Notes receivable............     4,953         (149)         (257)          24         380     4,951
                                    -------      -------      --------      -------      ------   -------
                                    $28,626      $28,544      $(29,643)     $ 2,579      $1,100   $31,206
                                    =======      =======      ========      =======      ======   =======
</TABLE>
 
---------------
 
* Includes amounts classified in long-term other assets as well as current
  assets.
 
                                       61
<PAGE>   63
 
                           BEVERLY ENTERPRISES, INC.
 
                               INDEX TO EXHIBITS
                                (ITEM 14(A)(3))
 
<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                  DESCRIPTION
        -------                                  -----------
<C>                      <S>
          3.1            -- Form of Restated Certificate of Incorporation of New
                            Beverly Holdings, Inc. (incorporated by reference to
                            Exhibit 3.1 to Beverly Enterprises, Inc.'s Annual Report
                            on Form 10-K for the year ended December 31, 1997)
          3.2            -- Form of Certificate of Amendment of Certificate of
                            Incorporation of New Beverly Holdings Inc., changing its
                            name to Beverly Enterprises, Inc. (incorporated by
                            reference to Exhibit 3.2 to Beverly Enterprises, Inc.'s
                            Annual Report on Form 10-K for the year ended December
                            31, 1997)
          3.3            -- By-Laws of Beverly Enterprises, Inc. (incorporated by
                            reference to Exhibit 3.4 to Beverly Enterprises, Inc.'s
                            Registration Statement on Form S-1 filed on June 4, 1997
                            (File No. 333-28521))
          4.1            -- Indenture dated as of February 1, 1996 between Beverly
                            Enterprises, Inc. and Chemical Bank, as Trustee, with
                            respect to Beverly Enterprises, Inc.'s 9% Senior Notes
                            due February 15, 2006 (the "9% Indenture") (incorporated
                            by reference to Exhibit 4.1 to Beverly Enterprises,
                            Inc.'s Annual Report on Form 10-K for the year ended
                            December 31, 1995)
          4.2            -- Form of Supplemental Indenture No. 2 to the 9% Indenture
                            dated as of November 19, 1997 (incorporated by reference
                            to Exhibit 4.2 to Beverly Enterprises, Inc.'s
                            Registration Statement on Form S-4 filed on September 8,
                            1997 (File No. 333-35137))
          4.3            -- Indenture dated as of April 1, 1993 (the "First Mortgage
                            Bond Indenture"), among Beverly Enterprises, Inc.,
                            Delaware Trust Company, as Corporate Trustee, and Richard
                            N. Smith, as Individual Trustee, with respect to First
                            Mortgage Bonds (incorporated by reference to Exhibit 4.1
                            to Beverly Enterprises, Inc.'s Quarterly Report on Form
                            10-Q for the quarter ended March 31, 1993)
          4.4            -- First Supplemental Indenture dated as of April 1, 1993 to
                            the First Mortgage Bond Indenture, with respect to 8 3/4%
                            First Mortgage Bonds due 2008 (incorporated by reference
                            to Exhibit 4.2 to Beverly Enterprises, Inc.'s Quarterly
                            Report on Form 10-Q for the quarter ended March 31, 1993)
          4.5            -- Second Supplemental Indenture dated as of July 1, 1993 to
                            the First Mortgage Bond Indenture, with respect to 8 5/8%
                            First Mortgage Bonds due 2008 (replaces Exhibit 4.1 to
                            Beverly Enterprises, Inc.'s Current Report on Form 8-K
                            dated July 15, 1993) (incorporated by reference to
                            Exhibit 4.15 to Beverly Enterprises, Inc.'s Quarterly
                            Report on Form 10-Q for the quarter ended June 30, 1993)
          4.6            -- Trust Indenture dated as of December 1, 1994 from Beverly
                            Funding Corporation, as Issuer, to Chemical Bank, as
                            Trustee (the "Chemical Indenture") (incorporated by
                            reference to Exhibit 10.45 to Beverly Enterprises, Inc.'s
                            Registration Statement on Form S-4 filed on February 13,
                            1995 (File No.33-57663))
</TABLE>
 
                                       62
<PAGE>   64
 
<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                  DESCRIPTION
        -------                                  -----------
<C>                      <S>
          4.7            -- Series Supplement dated as of December 1, 1994 to the
                            Chemical Indenture (incorporated by reference to Exhibit
                            10.46 to Beverly Enterprises, Inc.'s Registration
                            Statement on Form S-4 filed on February 13, 1995 (File
                            No. 33-57663))
                         In accordance with item 601(b)(4)(iii) of Regulation S-K,
                            certain instruments pertaining to Beverly Enterprises,
                            Inc.'s long-term obligations have not been filed; copies
                            thereof will be furnished to the Securities and Exchange
                            Commission upon request.
         10.1*           -- Beverly Enterprises, Inc. Annual Incentive Plan
                            (incorporated by reference to Exhibit 10.4 to Beverly
                            Enterprises, Inc.'s Registration Statement on Form S-4
                            filed on February 13, 1995 (File No. 33-57663))
         10.2*           -- New Beverly Holdings, Inc. 1997 Long-Term Incentive Plan
                            (the "1997 LTIP") (incorporated by reference to Exhibit
                            4.1 to Beverly Enterprises, Inc.'s Registration Statement
                            on Form S-8 filed on December 8, 1997 (File No.
                            333-41669))
         10.3*           -- Amendment No. 1 to the 1997 LTIP dated as of December 3,
                            1997 (incorporated by reference to Exhibit 10.3 to
                            Beverly Enterprises, Inc.'s Annual Report on Form 10-K
                            for the year ended December 31, 1997)
         10.4*           -- New Beverly Holdings, Inc. Non-Employee Directors' Stock
                            Option Plan (the "Directors' Option Plan") (incorporated
                            by reference to Exhibit 4.1 to Beverly Enterprises,
                            Inc.'s Registration Statement on Form S-8 filed on
                            December 12, 1997 (File No. 333-42131))
         10.5*           -- Amendment No. 1 to the Directors' Option Plan dated as of
                            December 3, 1997 (incorporated by reference to Exhibit
                            10.5 to Beverly Enterprises, Inc.'s Annual Report on Form
                            10-K for the year ended December 31, 1997)
         10.6*           -- Executive Medical Reimbursement Plan (incorporated by
                            reference to Exhibit 10.5 to Beverly Enterprises, Inc.'s
                            Annual Report on Form 10-K for the year ended December
                            31, 1987)
         10.7*           -- Amended and Restated Beverly Enterprises, Inc. Executive
                            Life Insurance Plan and Summary Plan Description (the
                            "Executive Life Plan") (incorporated by reference to
                            Exhibit 10.7 to Beverly Enterprises, Inc.'s Annual Report
                            on Form 10-K for the year ended December 31, 1993)
         10.8*           -- Amendment No. 1, effective September 29, 1994, to the
                            Executive Life Plan (incorporated by reference to Exhibit
                            10.10 to Beverly Enterprises, Inc.'s Registration
                            Statement on Form S-4 filed on February 13, 1995 (File
                            No. 33-57663))
         10.9*           -- Executive Physicals Policy (incorporated by reference to
                            Exhibit 10.8 to Beverly Enterprises, Inc.'s Quarterly
                            Report on Form 10-Q for the quarter ended June 30, 1993)
         10.10*          -- Amended and Restated Deferred Compensation Plan effective
                            July 18, 1991 (incorporated by reference to Exhibit 10.6
                            to Beverly Enterprises, Inc.'s Annual Report on Form 10-K
                            for the year ended December 31, 1991)
         10.11*          -- Amendment No. 1, effective September 29, 1994, to the
                            Deferred Compensation Plan (incorporated by reference to
                            Exhibit 10.13 to Beverly Enterprises, Inc.'s Registration
                            Statement on Form S-4 filed on February 13, 1995 (File
                            No. 33-57663))
</TABLE>
 
                                       63
<PAGE>   65
 
<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                  DESCRIPTION
        -------                                  -----------
<C>                      <S>
         10.12*          -- Executive Retirement Plan (incorporated by reference to
                            Exhibit 10.9 to Beverly Enterprises, Inc.'s Annual Report
                            on Form 10-K for the year ended December 31, 1987)
         10.13*          -- Amendment No. 1, effective as of July 1, 1991, to the
                            Executive Retirement Plan (incorporated by reference to
                            Exhibit 10.8 to Beverly Enterprises, Inc.'s Annual Report
                            on Form 10-K for the year ended December 31, 1991)
         10.14*          -- Amendment No. 2, effective as of December 12, 1991, to
                            the Executive Retirement Plan (incorporated by reference
                            to Exhibit 10.9 to Beverly Enterprises, Inc.'s Annual
                            Report on Form 10-K for the year ended December 31, 1991)
         10.15*          -- Amendment No. 3, effective as of July 31, 1992, to the
                            Executive Retirement Plan (incorporated by reference to
                            Exhibit 10.10 to Beverly Enterprises, Inc.'s Annual
                            Report on Form 10-K for the year ended December 31, 1992)
         10.16*          -- Amendment No. 4, effective as of January 1, 1993, to the
                            Executive Retirement Plan (incorporated by reference to
                            Exhibit 10.18 to Beverly Enterprises, Inc.'s Annual
                            Report on Form 10-K for the year ended December 31, 1994)
         10.17*          -- Amendment No. 5, effective as of September 29, 1994, to
                            the Executive Retirement Plan (incorporated by reference
                            to Exhibit 10.19 to Beverly Enterprises, Inc.'s Annual
                            Report on Form 10-K for the year ended December 31, 1994)
         10.18*          -- Amendment No. 6, effective as of January 1, 1996, to the
                            Executive Retirement Plan (incorporated by reference to
                            Exhibit 10.18 to Beverly Enterprises, Inc.'s Annual
                            Report on Form 10-K for the year ended December 31, 1997)
         10.19*          -- Amendment No. 7, effective as of September 1, 1997, to
                            the Executive Retirement Plan (incorporated by reference
                            to Exhibit 10.19 to Beverly Enterprises, Inc.'s Annual
                            Report on Form 10-K for the year ended December 31, 1997)
         10.20*          -- Amendment No. 8, dated as of December 11, 1997, to the
                            Executive Retirement Plan, changing its name to the
                            "Executive SavingsPlus Plan" (incorporated by reference
                            to Exhibit 10.20 to Beverly Enterprises, Inc.'s Annual
                            Report on Form 10-K for the year ended December 31, 1997)
         10.21*          -- Beverly Enterprises, Inc.'s Supplemental Executive
                            Retirement Plan effective as of January 1, 1998
                            (incorporated by reference to Exhibit 10.21 to Beverly
                            Enterprises, Inc.'s Annual Report on Form 10-K for the
                            year ended December 31, 1997)
         10.22*          -- Beverly Enterprises, Inc.'s Executive Deferred
                            Compensation Plan (incorporated by reference to Exhibit
                            4.1 to Beverly Enterprises, Inc.'s Registration Statement
                            on Form S-8 filed on December 5, 1997 (File No.
                            333-41673))
         10.23*          -- Amendment No. 1 to the Executive Deferred Compensation
                            Plan made as of December 11, 1997 (incorporated by
                            reference to Exhibit 10.23 to Beverly Enterprises, Inc.'s
                            Annual Report on Form 10-K for the year ended December
                            31, 1997)
         10.24*          -- Amendment No. 2 to the Executive Deferred Compensation
                            Plan made as of December 11, 1997 (incorporated by
                            reference to Exhibit 10.24 to Beverly Enterprises, Inc.'s
                            Annual Report on Form 10-K for the year ended December
                            31, 1997)
         10.25*          -- Beverly Enterprises, Inc. Non-Employee Director Deferred
                            Compensation Plan (the "Directors' Plan") (incorporated
                            by reference to Exhibit 10.1 to Beverly Enterprises,
                            Inc.'s Quarterly Report on Form 10-Q for the quarter
                            ended June 30, 1997)
</TABLE>
 
                                       64
<PAGE>   66
 
<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                  DESCRIPTION
        -------                                  -----------
<C>                      <S>
         10.26*          -- Amendment No. 1, effective as of December 3, 1997, to the
                            Directors' Plan (incorporated by reference to Exhibit
                            10.26 to Beverly Enterprises, Inc.'s Annual Report on
                            Form 10-K for the year ended December 31, 1997)
         10.27*          -- Beverly Enterprises, Inc.'s Supplemental Long-Term
                            Disability Plan (incorporated by reference to Exhibit
                            10.24 to Beverly Enterprises, Inc.'s Annual Report on
                            Form 10-K for the year ended December 31, 1996)
         10.28*          -- Form of Indemnification Agreement between Beverly
                            Enterprises, Inc. and its officers, directors and certain
                            of its employees (incorporated by reference to Exhibit
                            19.14 to Beverly Enterprises, Inc.'s Quarterly Report on
                            Form 10-Q for the quarter ended June 30, 1987)
         10.29*          -- Form of request by Beverly Enterprises, Inc. to certain
                            of its officers or directors relating to indemnification
                            rights (incorporated by reference to Exhibit 19.5 to
                            Beverly Enterprises, Inc.'s Quarterly Report on Form 10-Q
                            for the quarter ended September 30, 1987)
         10.30*          -- Form of request by Beverly Enterprises, Inc. to certain
                            of its officers or employees relating to indemnification
                            rights (incorporated by reference to Exhibit 19.6 to
                            Beverly Enterprises, Inc.'s Quarterly Report on Form 10-Q
                            for the quarter ended September 30, 1987)
         10.31*          -- Agreement dated December 29, 1986 between Beverly
                            Enterprises, Inc. and Stephens Inc. (incorporated by
                            reference to Exhibit 10.20 to Beverly Enterprises, Inc.'s
                            Registration Statement on Form S-1 filed on January 18,
                            1990 (File No. 33-33052))
         10.32*          -- Employment Contract, made as of August 22, 1997, between
                            New Beverly Holdings, Inc. and David R. Banks
                            (incorporated by reference to Exhibit 10.17 to Amendment
                            No. 2 to Beverly Enterprises, Inc.'s Registration
                            Statement on Form S-1 filed on September 22, 1997 (File
                            No. 333-28521))
         10.33*          -- Form of Employment Contract, made as of August 22, 1997,
                            between New Beverly Holdings, Inc. and certain of its
                            officers (incorporated by reference to Exhibit 10.20 to
                            Amendment No. 2 to Beverly Enterprises, Inc.'s
                            Registration Statement on Form S-1 filed on September 22,
                            1997 (File No. 333-28521))
         10.34*          -- Executive Stock Option Agreement, effective as of
                            February 19, 1998, between Beverly Enterprises, Inc. and
                            David R. Banks (incorporated by reference to Exhibit 10.1
                            to Beverly Enterprises, Inc.'s Quarterly Report on Form
                            10-Q for the quarter ended March 31, 1998)
         10.35           -- Master Lease Document -- General Terms and Conditions
                            dated December 30, 1985 for Leases between Beverly
                            California Corporation and various subsidiaries thereof
                            as lessees and Beverly Investment Properties, Inc. as
                            lessor (incorporated by reference to Exhibit 10.12 to
                            Beverly California Corporation's Annual Report on Form
                            10-K for the year ended December 31, 1985)
         10.36           -- Agreement dated as of December 29, 1986 among Beverly
                            California Corporation, Beverly Enterprises -- Texas,
                            Inc., Stephens Inc. and Real Properties, Inc.
                            (incorporated by reference to Exhibit 28 to Beverly
                            California Corporation's Current Report on Form 8-K dated
                            December 30, 1986) and letter agreement dated as of July
                            31, 1987 among Beverly Enterprises, Inc., Beverly
                            California Corporation, Beverly Enterprises -- Texas,
                            Inc. and Stephens Inc. with reference thereto
                            (incorporated by reference to Exhibit 19.13 to Beverly
                            Enterprises, Inc.'s Quarterly Report on Form 10-Q for the
                            quarter ended June 30, 1987)
</TABLE>
 
                                       65
<PAGE>   67
 
<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                  DESCRIPTION
        -------                                  -----------
<C>                      <S>
         10.37           -- Participation Agreement, dated as of August 28, 1998,
                            among Vantage Healthcare Corporation, Petersen Health
                            Care, Inc., Beverly Savana Cay Manor, Inc., Beverly
                            Enterprises -- Georgia, Inc., Beverly
                            Enterprises -- California, Inc., Beverly Health and
                            Rehabilitation Services, Inc., Beverly
                            Enterprises -- Arkansas, Inc., Beverly
                            Enterprises -- Florida, Inc. and Beverly
                            Enterprises -- Washington, Inc. as Lessees and Structural
                            Guarantors; Beverly Enterprises, Inc. as Representative,
                            Construction Agent and Parent Guarantor; Bank of Montreal
                            Global Capital Solutions, Inc. as Agent Lessor and
                            Lessor; The Long-Term Credit Bank of Japan, LTD., Los
                            Angeles Agency, Bank of America National Trust and
                            Savings Association and Bank of Montreal, as Lenders; The
                            Long-Term Credit Bank of Japan, LTD., Los Angeles Agency
                            as Arranger; and Bank of Montreal as Co-Arranger and
                            Syndication Agent and Administrative Agent for the
                            Lenders with respect to the Lease Financing of New
                            Headquarters for Beverly Enterprises, Inc., Assisted
                            Living and Nursing Facilities for Beverly Enterprises,
                            Inc.
         10.38           -- Amended and Restated Credit Agreement, dated as of April
                            30, 1998, among Beverly Enterprises, Inc., the Banks
                            listed therein and Morgan Guaranty Trust Company of New
                            York, as Issuing Bank and Agent
         10.39           -- Data Processing Agreement, dated as of August 1, 1992, by
                            and between Systematics Telecommunications Services, Inc.
                            and Beverly California Corporation (incorporated by
                            reference to Exhibit 10 to Beverly Enterprises, Inc.'s
                            Quarterly Report on Form 10-Q for the quarter ended June
                            30, 1992)
         10.40           -- Form of Irrevocable Trust Agreement for the Beverly
                            Enterprises, Inc. Executive Benefits Plan (incorporated
                            by reference to Exhibit 10.55 to Beverly Enterprises,
                            Inc.'s Registration Statement of Form S-4 filed on
                            February 13, 1995 (File No. 33-57663))
         21.1            -- Subsidiaries of Registrant
         23.1            -- Consent of Ernst & Young LLP, Independent Auditors
         27.1            -- Financial Data Schedule for the year ended December 31,
                            1998
</TABLE>
 
---------------
 
*  Exhibits 10.1 through 10.34 are the management contracts, compensatory plans,
   contracts and arrangements in which any director or named executive officer
   participates.
 
                                       66
<PAGE>   68
 
                                   SIGNATURES
 
     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
 
                                            BEVERLY ENTERPRISES, INC.
                                            Registrant
 
Dated: March 25, 1999                       By:     /s/ DAVID R. BANKS
                                              ----------------------------------
                                                        David R. Banks
                                                 Chairman of the Board, Chief
                                                Executive Officer and Director
 
     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of Registrant
and in the capacities and on the dates indicated:
 
<TABLE>
<C>                                                    <S>                              <C>
 
                 /s/ DAVID R. BANKS                    Chairman of the Board, Chief     March 25, 1999
-----------------------------------------------------    Executive Officer and
                   David R. Banks                        Director
 
               /s/ BOYD W. HENDRICKSON                 President, Chief Operating       March 25, 1999
-----------------------------------------------------    Officer and Director
                 Boyd W. Hendrickson
 
                /s/ SCOTT M. TABAKIN                   Executive Vice President and     March 25, 1999
-----------------------------------------------------    Chief Financial Officer
                  Scott M. Tabakin
 
                /s/ PAMELA H. DANIELS                  Vice President, Controller and   March 25, 1999
-----------------------------------------------------    Chief Accounting Officer
                  Pamela H. Daniels
 
              /s/ BERYL F. ANTHONY, JR.                Director                         March 25, 1999
-----------------------------------------------------
                Beryl F. Anthony, Jr.
 
                /s/ CAROLYNE K. DAVIS                  Director                         March 25, 1999
-----------------------------------------------------
                  Carolyne K. Davis
 
                 /s/ JAMES R. GREENE                   Director                         March 25, 1999
-----------------------------------------------------
                   James R. Greene
 
                /s/ EDITH E. HOLIDAY                   Director                         March 25, 1999
-----------------------------------------------------
                  Edith E. Holiday
 
                                                       Director                         March 25, 1999
-----------------------------------------------------
                  Jon E. M. Jacoby
 
                                                       Director                         March 25, 1999
-----------------------------------------------------
               Risa J. Lavizzo-Mourey
 
               /s/ MARILYN R. SEYMANN                  Director                         March 25, 1999
-----------------------------------------------------
                 Marilyn R. Seymann
</TABLE>
 
                                       67
<PAGE>   69
 
                           BEVERLY ENTERPRISES, INC.
 
                               INDEX TO EXHIBITS
 
<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                  DESCRIPTION
        -------                                  -----------
<C>                      <S>
          3.1            -- Form of Restated Certificate of Incorporation of New
                            Beverly Holdings, Inc. (incorporated by reference to
                            Exhibit 3.1 to Beverly Enterprises, Inc.'s Annual Report
                            on Form 10-K for the year ended December 31, 1997)
          3.2            -- Form of Certificate of Amendment of Certificate of
                            Incorporation of New Beverly Holdings Inc., changing its
                            name to Beverly Enterprises, Inc. (incorporated by
                            reference to Exhibit 3.2 to Beverly Enterprises, Inc.'s
                            Annual Report on Form 10-K for the year ended December
                            31, 1997)
          3.3            -- By-Laws of Beverly Enterprises, Inc. (incorporated by
                            reference to Exhibit 3.4 to Beverly Enterprises, Inc.'s
                            Registration Statement on Form S-1 filed on June 4, 1997
                            (File No. 333-28521))
          4.1            -- Indenture dated as of February 1, 1996 between Beverly
                            Enterprises, Inc. and Chemical Bank, as Trustee, with
                            respect to Beverly Enterprises, Inc.'s 9% Senior Notes
                            due February 15, 2006 (the "9% Indenture") (incorporated
                            by reference to Exhibit 4.1 to Beverly Enterprises,
                            Inc.'s Annual Report on Form 10-K for the year ended
                            December 31, 1995)
          4.2            -- Form of Supplemental Indenture No. 2 to the 9% Indenture
                            dated as of November 19, 1997 (incorporated by reference
                            to Exhibit 4.2 to Beverly Enterprises, Inc.'s
                            Registration Statement on Form S-4 filed on September 8,
                            1997 (File No. 333-35137))
          4.3            -- Indenture dated as of April 1, 1993 (the "First Mortgage
                            Bond Indenture"), among Beverly Enterprises, Inc.,
                            Delaware Trust Company, as Corporate Trustee, and Richard
                            N. Smith, as Individual Trustee, with respect to First
                            Mortgage Bonds (incorporated by reference to Exhibit 4.1
                            to Beverly Enterprises, Inc.'s Quarterly Report on Form
                            10-Q for the quarter ended March 31, 1993)
          4.4            -- First Supplemental Indenture dated as of April 1, 1993 to
                            the First Mortgage Bond Indenture, with respect to 8 3/4%
                            First Mortgage Bonds due 2008 (incorporated by reference
                            to Exhibit 4.2 to Beverly Enterprises, Inc.'s Quarterly
                            Report on Form 10-Q for the quarter ended March 31, 1993)
          4.5            -- Second Supplemental Indenture dated as of July 1, 1993 to
                            the First Mortgage Bond Indenture, with respect to 8 5/8%
                            First Mortgage Bonds due 2008 (replaces Exhibit 4.1 to
                            Beverly Enterprises, Inc.'s Current Report on Form 8-K
                            dated July 15, 1993) (incorporated by reference to
                            Exhibit 4.15 to Beverly Enterprises, Inc.'s Quarterly
                            Report on Form 10-Q for the quarter ended June 30, 1993)
          4.6            -- Trust Indenture dated as of December 1, 1994 from Beverly
                            Funding Corporation, as Issuer, to Chemical Bank, as
                            Trustee (the "Chemical Indenture") (incorporated by
                            reference to Exhibit 10.45 to Beverly Enterprises, Inc.'s
                            Registration Statement on Form S-4 filed on February 13,
                            1995 (File No. 33-57663))
          4.7            -- Series Supplement dated as of December 1, 1994 to the
                            Chemical Indenture (incorporated by reference to Exhibit
                            10.46 to Beverly Enterprises, Inc.'s Registration
                            Statement on Form S-4 filed on February 13, 1995 (File
                            No. 33-57663))
                         In accordance with item 601(b)(4)(iii) of Regulation S-K,
                            certain instruments pertaining to Beverly Enterprises,
                            Inc.'s long-term obligations have not been filed; copies
                            thereof will be furnished to the Securities and Exchange
                            Commission upon request.
</TABLE>
<PAGE>   70
 
<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                  DESCRIPTION
        -------                                  -----------
<C>                      <S>
         10.1*           -- Beverly Enterprises, Inc. Annual Incentive Plan
                            (incorporated by reference to Exhibit 10.4 to Beverly
                            Enterprises, Inc.'s Registration Statement on Form S-4
                            filed on February 13, 1995 (File No. 33-57663))
         10.2*           -- New Beverly Holdings, Inc. 1997 Long-Term Incentive Plan
                            (the "1997 LTIP") (incorporated by reference to Exhibit
                            4.1 to Beverly Enterprises, Inc.'s Registration Statement
                            on Form S-8 filed on December 8, 1997 (File No.
                            333-41669))
         10.3*           -- Amendment No. 1 to the 1997 LTIP dated as of December 3,
                            1997 (incorporated by reference to Exhibit 10.3 to
                            Beverly Enterprises, Inc.'s Annual Report on Form 10-K
                            for the year ended December 31, 1997)
         10.4*           -- New Beverly Holdings, Inc. Non-Employee Directors' Stock
                            Option Plan (the "Directors' Option Plan") (incorporated
                            by reference to Exhibit 4.1 to Beverly Enterprises,
                            Inc.'s Registration Statement on Form S-8 filed on
                            December 12, 1997 (File No. 333-42131))
         10.5*           -- Amendment No. 1 to the Directors' Option Plan dated as of
                            December 3, 1997 (incorporated by reference to Exhibit
                            10.5 to Beverly Enterprises, Inc.'s Annual Report on Form
                            10-K for the year ended December 31, 1997)
         10.6*           -- Executive Medical Reimbursement Plan (incorporated by
                            reference to Exhibit 10.5 to Beverly Enterprises, Inc.'s
                            Annual Report on Form 10-K for the year ended December
                            31, 1987)
         10.7*           -- Amended and Restated Beverly Enterprises, Inc. Executive
                            Life Insurance Plan and Summary Plan Description (the
                            "Executive Life Plan") (incorporated by reference to
                            Exhibit 10.7 to Beverly Enterprises, Inc.'s Annual Report
                            on Form 10-K for the year ended December 31, 1993)
         10.8*           -- Amendment No. 1, effective September 29, 1994, to the
                            Executive Life Plan (incorporated by reference to Exhibit
                            10.10 to Beverly Enterprises, Inc.'s Registration
                            Statement on Form S-4 filed on February 13, 1995 (File
                            No. 33-57663))
         10.9*           -- Executive Physicals Policy (incorporated by reference to
                            Exhibit 10.8 to Beverly Enterprises, Inc.'s Quarterly
                            Report on Form 10-Q for the quarter ended June 30, 1993)
         10.10*          -- Amended and Restated Deferred Compensation Plan effective
                            July 18, 1991 (incorporated by reference to Exhibit 10.6
                            to Beverly Enterprises, Inc.'s Annual Report on Form 10-K
                            for the year ended December 31, 1991)
         10.11*          -- Amendment No. 1, effective September 29, 1994, to the
                            Deferred Compensation Plan (incorporated by reference to
                            Exhibit 10.13 to Beverly Enterprises, Inc.'s Registration
                            Statement on Form S-4 filed on February 13, 1995 (File
                            No. 33-57663))
         10.12*          -- Executive Retirement Plan (incorporated by reference to
                            Exhibit 10.9 to Beverly Enterprises, Inc.'s Annual Report
                            on Form 10-K for the year ended December 31, 1987)
         10.13*          -- Amendment No. 1, effective as of July 1, 1991, to the
                            Executive Retirement Plan (incorporated by reference to
                            Exhibit 10.8 to Beverly Enterprises, Inc.'s Annual Report
                            on Form 10-K for the year ended December 31, 1991)
         10.14*          -- Amendment No. 2, effective as of December 12, 1991, to
                            the Executive Retirement Plan (incorporated by reference
                            to Exhibit 10.9 to Beverly Enterprises, Inc.'s Annual
                            Report on Form 10-K for the year ended December 31, 1991)
</TABLE>
<PAGE>   71
 
<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                  DESCRIPTION
        -------                                  -----------
<C>                      <S>
         10.15*          -- Amendment No. 3, effective as of July 31, 1992, to the
                            Executive Retirement Plan (incorporated by reference to
                            Exhibit 10.10 to Beverly Enterprises, Inc.'s Annual
                            Report on Form 10-K for the year ended December 31, 1992)
         10.16*          -- Amendment No. 4, effective as of January 1, 1993, to the
                            Executive Retirement Plan (incorporated by reference to
                            Exhibit 10.18 to Beverly Enterprises, Inc.'s Annual
                            Report on Form 10-K for the year ended December 31, 1994)
         10.17*          -- Amendment No. 5, effective as of September 29, 1994, to
                            the Executive Retirement Plan (incorporated by reference
                            to Exhibit 10.19 to Beverly Enterprises, Inc.'s Annual
                            Report on Form 10-K for the year ended December 31, 1994)
         10.18*          -- Amendment No. 6, effective as of January 1, 1996, to the
                            Executive Retirement Plan (incorporated by reference to
                            Exhibit 10.18 to Beverly Enterprises, Inc.'s Annual
                            Report on Form 10-K for the year ended December 31, 1997)
         10.19*          -- Amendment No. 7, effective as of September 1, 1997, to
                            the Executive Retirement Plan (incorporated by reference
                            to Exhibit 10.19 to Beverly Enterprises, Inc.'s Annual
                            Report on Form 10-K for the year ended December 31, 1997)
         10.20*          -- Amendment No. 8, dated as of December 11, 1997, to the
                            Executive Retirement Plan, changing its name to the
                            "Executive SavingsPlus Plan" (incorporated by reference
                            to Exhibit 10.20 to Beverly Enterprises, Inc.'s Annual
                            Report on Form 10-K for the year ended December 31, 1997)
         10.21*          -- Beverly Enterprises, Inc.'s Supplemental Executive
                            Retirement Plan effective as of January 1, 1998
                            (incorporated by reference to Exhibit 10.21 to Beverly
                            Enterprises, Inc.'s Annual Report on Form 10-K for the
                            year ended December 31, 1997)
         10.22*          -- Beverly Enterprises, Inc.'s Executive Deferred
                            Compensation Plan (incorporated by reference to Exhibit
                            4.1 to Beverly Enterprises, Inc.'s Registration Statement
                            on Form S-8 filed on December 5, 1997 (File No.
                            333-41673))
         10.23*          -- Amendment No. 1 to the Executive Deferred Compensation
                            Plan made as of December 11, 1997 (incorporated by
                            reference to Exhibit 10.23 to Beverly Enterprises, Inc.'s
                            Annual Report on Form 10-K for the year ended December
                            31, 1997)
         10.24*          -- Amendment No. 2 to the Executive Deferred Compensation
                            Plan made as of December 11, 1997 (incorporated by
                            reference to Exhibit 10.24 to Beverly Enterprises, Inc.'s
                            Annual Report on Form 10-K for the year ended December
                            31, 1997)
         10.25*          -- Beverly Enterprises, Inc. Non-Employee Director Deferred
                            Compensation Plan (the "Directors' Plan") (incorporated
                            by reference to Exhibit 10.1 to Beverly Enterprises,
                            Inc.'s Quarterly Report on Form 10-Q for the quarter
                            ended June 30, 1997)
         10.26*          -- Amendment No. 1, effective as of December 3, 1997, to the
                            Directors' Plan (incorporated by reference to Exhibit
                            10.26 to Beverly Enterprises, Inc.'s Annual Report on
                            Form 10-K for the year ended December 31, 1997)
         10.27*          -- Beverly Enterprises, Inc.'s Supplemental Long-Term
                            Disability Plan (incorporated by reference to Exhibit
                            10.24 to Beverly Enterprises, Inc.'s Annual Report on
                            Form 10-K for the year ended December 31, 1996)
         10.28*          -- Form of Indemnification Agreement between Beverly
                            Enterprises, Inc. and its officers, directors and certain
                            of its employees (incorporated by reference to Exhibit
                            19.14 to Beverly Enterprises, Inc.'s Quarterly Report on
                            Form 10-Q for the quarter ended June 30, 1987)
</TABLE>
<PAGE>   72
 
<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                  DESCRIPTION
        -------                                  -----------
<C>                      <S>
         10.29*          -- Form of request by Beverly Enterprises, Inc. to certain
                            of its officers or directors relating to indemnification
                            rights (incorporated by reference to Exhibit 19.5 to
                            Beverly Enterprises, Inc.'s Quarterly Report on Form 10-Q
                            for the quarter ended September 30, 1987)
         10.30*          -- Form of request by Beverly Enterprises, Inc. to certain
                            of its officers or employees relating to indemnification
                            rights (incorporated by reference to Exhibit 19.6 to
                            Beverly Enterprises, Inc.'s Quarterly Report on Form 10-Q
                            for the quarter ended September 30, 1987)
         10.31*          -- Agreement dated December 29, 1986 between Beverly
                            Enterprises, Inc. and Stephens Inc. (incorporated by
                            reference to Exhibit 10.20 to Beverly Enterprises, Inc.'s
                            Registration Statement on Form S-1 filed on January 18,
                            1990 (File No. 33-33052))
         10.32*          -- Employment Contract, made as of August 22, 1997, between
                            New Beverly Holdings, Inc. and David R. Banks
                            (incorporated by reference to Exhibit 10.17 to Amendment
                            No. 2 to Beverly Enterprises, Inc.'s Registration
                            Statement on Form S-1 filed on September 22, 1997 (File
                            No. 333-28521))
         10.33*          -- Form of Employment Contract, made as of August 22, 1997,
                            between New Beverly Holdings, Inc. and certain of its
                            officers (incorporated by reference to Exhibit 10.20 to
                            Amendment No. 2 to Beverly Enterprises, Inc.'s
                            Registration Statement on Form S-1 filed on September 22,
                            1997 (File No. 333-28521))
         10.34*          -- Executive Stock Option Agreement, effective as of
                            February 19, 1998, between Beverly Enterprises, Inc. and
                            David R. Banks (incorporated by reference to Exhibit 10.1
                            to Beverly Enterprises, Inc.'s Quarterly Report on Form
                            10-Q for the quarter ended March 31, 1998)
         10.35           -- Master Lease Document -- General Terms and Conditions
                            dated December 30, 1985 for Leases between Beverly
                            California Corporation and various subsidiaries thereof
                            as lessees and Beverly Investment Properties, Inc. as
                            lessor (incorporated by reference to Exhibit 10.12 to
                            Beverly California Corporation's Annual Report on Form
                            10-K for the year ended December 31, 1985)
         10.36           -- Agreement dated as of December 29, 1986 among Beverly
                            California Corporation, Beverly Enterprises -- Texas,
                            Inc., Stephens Inc. and Real Properties, Inc.
                            (incorporated by reference to Exhibit 28 to Beverly
                            California Corporation's Current Report on Form 8-K dated
                            December 30, 1986) and letter agreement dated as of July
                            31, 1987 among Beverly Enterprises, Inc., Beverly
                            California Corporation, Beverly Enterprises -- Texas,
                            Inc. and Stephens Inc. with reference thereto
                            (incorporated by reference to Exhibit 19.13 to Beverly
                            Enterprises, Inc.'s Quarterly Report on Form 10-Q for the
                            quarter ended June 30, 1987)
</TABLE>
<PAGE>   73
 
<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                  DESCRIPTION
        -------                                  -----------
<C>                      <S>
         10.37           -- Participation Agreement, dated as of August 28, 1998,
                            among Vantage Healthcare Corporation, Petersen Health
                            Care, Inc., Beverly Savana Cay Manor, Inc., Beverly
                            Enterprises -- Georgia, Inc., Beverly
                            Enterprises -- California, Inc., Beverly Health and
                            Rehabilitation Services, Inc., Beverly
                            Enterprises -- Arkansas, Inc., Beverly
                            Enterprises -- Florida, Inc. and Beverly
                            Enterprises -- Washington, Inc. as Lessees and Structural
                            Guarantors; Beverly Enterprises, Inc. as Representative,
                            Construction Agent and Parent Guarantor; Bank of Montreal
                            Global Capital Solutions, Inc. as Agent Lessor and
                            Lessor; The Long-Term Credit Bank of Japan, LTD., Los
                            Angeles Agency, Bank of America National Trust and
                            Savings Association and Bank of Montreal, as Lenders; The
                            Long-Term Credit Bank of Japan, LTD., Los Angeles Agency
                            as Arranger; and Bank of Montreal as Co-Arranger and
                            Syndication Agent and Administrative Agent for the
                            Lenders with respect to the Lease Financing of New
                            Headquarters for Beverly Enterprises, Inc., Assisted
                            Living and Nursing Facilities for Beverly Enterprises,
                            Inc.
         10.38           -- Amended and Restated Credit Agreement, dated as of April
                            30, 1998, among Beverly Enterprises, Inc., the Banks
                            listed therein and Morgan Guaranty Trust Company of New
                            York, as Issuing Bank and Agent
         10.39           -- Data Processing Agreement, dated as of August 1, 1992, by
                            and between Systematics Telecommunications Services, Inc.
                            and Beverly California Corporation (incorporated by
                            reference to Exhibit 10 to Beverly Enterprises, Inc.'s
                            Quarterly Report on Form 10-Q for the quarter ended June
                            30, 1992)
         10.40           -- Form of Irrevocable Trust Agreement for the Beverly
                            Enterprises, Inc. Executive Benefits Plan (incorporated
                            by reference to Exhibit 10.55 to Beverly Enterprises,
                            Inc.'s Registration Statement of Form S-4 filed on
                            February 13, 1995 (File No. 33-57663))
         21.1            -- Subsidiaries of Registrant
         23.1            -- Consent of Ernst & Young LLP, Independent Auditors
         27.1            -- Financial Data Schedule for the year ended December 31,
                            1998
</TABLE>
 
---------------
 
*  Exhibits 10.1 through 10.34 are the management contracts, compensatory plans,
   contracts and arrangements in which any director or named executive officer
   participates.