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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549


Form 10-K/ A

(Amendment No. 1)


|                                                |  |                                                                                             
|----------------------------------------------- |  | --------------------------------------------------------------------------------------------
|(Mark One)                                      |  |                                                                                             
|x                                               |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR
    15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|                                               
|For the fiscal year ended December 31,
    2003
|                                               
|OR                                             
|                                               
|o                                               |  | TRANSITION REPORT PURSUANT TO SECTION 13
    OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 1-9550

BEVERLY ENTERPRISES, INC.

(Exact name of Registrant as specified in its
charter)


|                                                                   |  |                                         
|------------------------------------------------------------------ |  | ----------------------------------------
|Delaware                                                           |  | 62-1691861                              
|(State or other jurisdiction of
    incorporation or organization) |  | (I.R.S. Employer
    Identification No.)

One Thousand Beverly Way

Fort Smith, Arkansas 72919


(Address of principal executive offices)


Registrants telephone number, including
area code: (479) 201-2000

Registrants website:
www.beverlycares.com

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

|                             |  |                                           |                         | 
|---------------------------- |  | ----------------------------------------- | ----------------------- | 
|Title of each class          |  | Name of each exchange on which registered
|                             |  |                                          
|Common Stock, $.10 par value |  |                                           | New York Stock Exchange | 
|                             |  |                                           | Pacific Stock Exchange  | 

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 þNoo

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.     o

Indicate by check mark if Registrant is an
accelerated filer (as defined in Exchange Act
Rule 12b-2).     Yes þ     No o

The aggregate market value of the voting and
non-voting common stock held by nonaffiliates of Registrant was
$368,035,217 as of June 30, 2003.

107,002,792

(Number of shares of common stock outstanding,
net of treasury shares, as of May 31, 2004)

Part III is incorporated by reference
from the Proxy Statement for the Annual Stockholders Meeting
held on May 20, 2004.



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|                                                                           |                                                                                                          |  |  |  |  |  |  | 
|-------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|EXPLANATORY NOTE                                                          
|FORWARD-LOOKING STATEMENTS                                                
|PART I                                                                    
|                                                                           | ITEM 1. BUSINESS.                                                                                       
|                                                                           | ITEM 2. PROPERTIES.                                                                                     
|                                                                           | ITEM 3. LEGAL PROCEEDINGS.                                                                              
|                                                                           | ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.                                            
|PART II                                                                   
|                                                                           | ITEM 5. MARKET FOR THE COMPANYS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.                         
|                                                                           | ITEM 6. SELECTED FINANCIAL DATA.                                                                        
|                                                                           | ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.          
|                                                                           | ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.                                    
|                                                                           | ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.                                       
|REPORT OF ERNST & YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
|                                                                           | ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.           
|                                                                           | ITEM 9A. CONTROLS AND PROCEDURES.                                                                       
|PART III                                                                  
|                                                                           | ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY.                                               
|                                                                           | ITEM 11. EXECUTIVE COMPENSATION.                                                                        
|                                                                           | ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
|                                                                           | ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.                                                
|                                                                           | ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.                                                        
|PART IV                                                                   
|                                                                           | ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.                               
|SIGNATURES                                                                
|Computation of Ratio of Earnings to Fixed Charges                         
|Consent of Ernst & Young                                                  
|CEO's Certification Pursuant to Section 302                               
|CFO's Certification Pursuant to Section 302                               
|CEO's Certification Pursuant to Section 906                               
|CFO's Certification Pursuant to Section 906                               



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EXPLANATORY NOTE

We are filing this Amendment No. 1 to our
Annual Report of Form 10-K/ A for the year ended
December 31, 2003 (the Form 10-K/ A) to
amend our Consolidated Financial Statements for the years ended
December 31, 2003, 2002 and 2001, to reflect
reclassifications to discontinued operations and to modify
related disclosures. Where considered appropriate, we have
updated other items and disclosures in this Form 10-K/ A.
We disposed of certain nursing facilities and a home medical
equipment business during the three months ended March 31,
2004, which have been reclassified to discontinued operations
for all periods presented in accordance with generally accepted
accounting principles and applicable Securities and Exchange
Commission (SEC) reporting requirements. This
document includes a Report of Ernst & Young LLP,
Independent Registered Public Accounting Firm, on the amended
Consolidated Financial Statements. The filing of this
Form 10-K/ A shall not be deemed an admission that the
original Form 10-K, when filed, knowingly included any
untrue statement of a material fact or omitted to state a
material fact necessary to make a statement not misleading.

In this report, when we use words such as
today, recently, current or
currently, or phrases such as as of the date
hereof, or as of the date of this report, we
are referring to June 14, 2004, the date we filed this
report with the SEC.




FORWARD-LOOKING STATEMENTS

References throughout this document to the
Company include Beverly Enterprises, Inc. and its wholly owned
subsidiaries. In accordance with the SEC Plain
English guidelines, this Annual Report on Form 10-K/
A has been written in the first person. In this document, the
words we, our, ours and
us refer only to Beverly Enterprises, Inc. and its
wholly owned subsidiaries and not to any other person.

This Annual Report on Form 10-K/ A, and
other information we provide from time to time, contains certain
statements that are not historical facts and may be
forward-looking statements within the meaning of United States
federal securities law. All statements regarding our expected
future financial position, results of operations or cash flows,
continued performance improvements, ability to service,
refinance, replace and comply with our debt obligations, ability
to finance growth opportunities, ability to control our patient
care liability costs, ability to respond to changes in
government regulations, ability to execute our three-year
strategic plan, 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.
These forward-looking statements reflect managements
beliefs and assumptions and are based on information currently
available to management. Forward-looking statements involve
known and unknown risks, uncertainties and other factors that
may cause our actual results, performance, achievements or
industry results to be materially different from any future
results, performance or achievements expressed or implied by us
in those statements. These risks, uncertainties and other
factors include, among others:



| |   |                                                                                                                                                                                                                                                                                                     
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | national and local economic conditions, including
    their effect on the availability and cost of labor, utilities
    and materials;                                                                                                                                                              
|
| |  | the effect of government regulations and changes
    in regulations governing the healthcare industry, including our
    compliance with such regulations;                                                                                                                                          
|
| |  | changes in Medicare and Medicaid payment levels
    and methodologies and the application of such methodologies by
    the government and its fiscal intermediaries;                                                                                                                                
|
| |  | the effects of adopting new accounting standards;                                                                                                                                                                                                                                                   
|
| |  | the ability to integrate acquisitions and realize
    synergies and accretion;                                                                                                                                                                                                                      
|
| |  | liabilities and other claims asserted against us,
    including patient care liabilities, as well as the resolution of
    lawsuits brought about by the announcement or settlement of
    government investigations and the announcement of increases in
    reserves for patient care liabilities;
|
| |  | our ability to predict future reserve levels for
    patient care and workers compensation liabilities;                                                                                                                                                                                            

1



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| |   |                                                                                                                                                                                     
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | our ability to obtain adequate insurance coverage
    with financially viable insurance carriers, as well as the
    ability of our insurance carriers to fulfill their obligations;
|
| |  | our ability to execute strategic divestitures in
    a timely manner at fair values;                                                                                                
|
| |  | our ability to improve our fundamental business
    processes and reduce costs throughout the organization;                                                                         
|
| |  | our ability to attract and retain qualified
    personnel;                                                                                                                          
|
| |  | the availability and terms of capital to fund
    acquisitions, capital improvements and ongoing operations;                                                                        
|
| |  | our ability to repurchase our stock and changes
    in the stock price after any such repurchases;                                                                                  
|
| |  | the competitive environment in which we operate;                                                                                                                                    
|
| |  | our ability to maintain and increase census
    (volume of residents) levels; and                                                                                                   
|
| |  | demographic changes.                                                                                                                                                                

See Item 1. Business for a discussion of
various governmental regulations and other operating factors
relating to the healthcare industry and the related risk
factors. You should carefully consider the risks described
herein before making any investment decisions in the Company.
These risks and uncertainties are not the only ones facing the
Company. There may be additional risks that we do not presently
know of or that we currently deem immaterial. If any of these
risks actually occur, our business, financial condition, results
of operations or cash flows could be materially and adversely
affected. In that case, the trading price of our common stock
could decline, and you may lose all or part of your investment.
Given these risks and uncertainties, we can give no assurances
that these forward-looking statements will, in fact, transpire
and, therefore, we caution investors not to place undue reliance
on them. We are not obligated to publicly update or revise any
forward-looking statements, whether as a result of new
information, future events or otherwise.

2



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PART I






|        |          
|------- | ---------
|ITEM 1. | BUSINESS.

General

2003 was an important transition year for
Beverly. Our improved financial and operating results validate
the strategic plan that has guided the turnaround during the
past three years. We strengthened our portfolio of nursing
facilities and continued to concentrate these operations in
strategic markets that provide attractive growth potential. We
also continued the profitable growth of our eldercare service
businesses, where margins are attractive and ongoing capital
requirements are lower. We further strengthened our financial
position by reducing on and off-balance sheet debt by a total of
$133.4 million. Our year-end cash position for 2003 was
$258.8 million, more than double the total at the end of
2002. We refinanced $325.0 million of debt to achieve lower
interest costs, extend maturities and provide increased
financial flexibility.

A major issue facing the nursing facility
industry is rising costs for patient care liabilities. We
believe we made significant progress during 2003 to contain this
issue. In late 2002, we identified facilities that represented a
disproportionately high share of those projected
costs  collectively approximately
50 percent  and we committed to a divestiture
program during 2003 and 2004. During 2003, we divested or closed
a total of 81 nursing facilities and seven assisted living
centers that represented 36 percent of those projected
costs. We used the net cash proceeds of these
divestitures  more than $200 million 
to reduce debt and strengthen our liquidity position.

We believe we have the strategic framework,
seasoned management team and financial resources to continue the
profitable growth of the Company.

Operations and Services

Our business consists principally of providing
healthcare services, primarily including the operation of
nursing facilities, assisted living centers, hospice and home
care centers, outpatient clinics and rehabilitation therapy
services. We are one of the largest operators of nursing
facilities in the United States. As of April 30, 2004, we
operated 368 nursing facilities with a total of 38,874 licensed
beds. Our nursing facilities are located in 23 states and
the District of Columbia and range in capacity from 24 to 355
licensed beds. (See Item 2. Properties.) As of
April 30, 2004, we also operated 19 assisted living centers
containing 526 units, 25 hospice and home care centers and
10 outpatient clinics, and we provided rehabilitation therapy
services in 35 states and the District of Columbia.

Our operations are currently organized into three
primary operating segments: Nursing Facilities, Aegis Therapies
and Home Care.

Nursing Facilities.Our Nursing Facilities operations provide long-term healthcare
and rehabilitation services through the operation of skilled
nursing facilities and assisted living centers and accounted for
approximately 92% of our revenues for the three months ended
March 31, 2004 and approximately 94% for the year ended
December 31, 2003. Our facilities provide residents with
routine long-term care services, including daily nursing,
dietary, social and recreational services and a full range of
pharmacy services and medical supplies. Our skilled nursing
staff also provides complex and intensive medical services to
residents with higher acuity needs outside the traditional
acute-care hospital setting. We have designed our assisted
living centers to provide residents with a greater degree of
independence while still offering routine services and, if
required, limited medical care.

Aegis Therapies.Our
Aegis operations provide rehabilitation therapy services under
contract to our nursing facilities, as well as 547 third-party
customers as of March 31, 2004, and accounted for
approximately 5% of our revenues for the three months ended
March 31, 2004 and approximately 4% as of December 31,
2003. Aegis offers occupational, physical and speech therapy
services designed to maximize function and independence, assist
in recovery from medical conditions and compensate for remaining
disabilities.

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Home Care.Our Home
Care operations primarily provide hospice services within our
nursing facilities, in facilities operated by other healthcare
providers and in patients homes and accounted for
approximately 2% of our revenues for the three months ended
March 31, 2004 and the year ended December 31, 2003.
Our hospice services include palliative care for terminally ill
patients, as well as pastoral, counseling and bereavement
services for the families of hospice patients.

In addition, we derived approximately 1% of our
revenues for the three months ended March 31, 2004 from
certain new business ventures, including pharmacy consulting
services, and the sale of procurement-related services.

Revenue Sources



| |         
| | --------
| | Overview

We receive payments for services provided to
patients from:



| |   |                                                                                                  
| | - | -------------------------------------------------------------------------------------------------
| |  | each of the states in which our facilities are
    located under the applicable Medicaid program;
|
| |  | the federal government under the Medicare program
    and the Department of Veterans Affairs; and
|
| |  | private and other payors, including commercial
    insurers and managed care payors.             

The following table sets forth for the periods
indicated:



| |   |                                                                                                                                                
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------
| |  | nursing facility patient days derived from the
    indicated sources of payment as a percentage of total nursing
    facility patient days; and
|
| |  | revenues derived from the indicated sources of
    payment as a percentage of total revenues.                                                  

|                    |                   |          |  |          |   |                   |  |          |   |         |  |          |   |  |  |    |   |  |  |    |   |  |  |    |  
|------------------- | ----------------- | -------- |  | -------- | - | ----------------- |  | -------- | - | ------- |  | -------- | - |  |  | -- | - |  |  | -- | - |  |  | -- | -
|                    |                   |          |  |          |   |                  
|                    |                   | Medicaid |  | Medicare |   | Private and Other
|                    |                   |          |  |          |   |                  
|                    |                   | Patient  |  |          |   | Patient           |  |          |   | Patient |  |         
|                    |                   | Days     |  | Revenues |   | Days              |  | Revenues |   | Days    |  | Revenues
|                    |                   |          |  |          |   |                   |  |          |   |         |  |         
|Three Months Ended: |                   |          |  |          |   |                   |  |          |   |         |  |          |   |  |  |    |   |  |  |    |   |  |  |   
|                    | March 31, 2004    |          |  | 71       | % |                   |  | 51       | % |         |  | 12       | % |  |  | 28 | % |  |  | 17 | % |  |  | 21 | %
|                    | March 31, 2003    |          |  | 71       | % |                   |  | 52       | % |         |  | 12       | % |  |  | 27 | % |  |  | 17 | % |  |  | 21 | %
|Years Ended:        |                   |          |  |          |   |                   |  |          |   |         |  |          |   |  |  |    |   |  |  |    |   |  |  |   
|                    | December 31, 2003 |          |  | 71       | % |                   |  | 53       | % |         |  | 12       | % |  |  | 26 | % |  |  | 17 | % |  |  | 21 | %
|                    | December 31, 2002 |          |  | 71       | % |                   |  | 53       | % |         |  | 11       | % |  |  | 27 | % |  |  | 18 | % |  |  | 20 | %
|                    | December 31, 2001 |          |  | 72       | % |                   |  | 55       | % |         |  | 10       | % |  |  | 26 | % |  |  | 18 | % |  |  | 19 | %

Changes in the mix of our patient population
among the Medicare, Medicaid and private categories can
significantly impact our revenues and profitability. In most
states, private patient care is the most profitable, and
Medicaid patient care is the least profitable. We receive
revenues by providing room and board, occupational, physical,
speech, respiratory and intravenous therapy, as well as sales of
pharmaceuticals and other services.



| |                                       
| | --------------------------------------
| | Reimbursement by Medicaid
    Programs

Medicaid programs currently exist in all of the
23 states, and the District of Columbia, in which we
operate nursing facilities. These programs differ in certain
respects from state to state, but they are all subject to
federally imposed requirements. At least 50% of the funds
available under these programs is provided by the federal
government under a matching program.

Currently, most state Medicaid programs use a
cost-based reimbursement system. This means that a facility is
reimbursed for the reasonable direct and indirect allowable
costs it incurs in providing routine patient care services (as
defined by the programs). These reasonable costs normally
include certain allowances for administrative and general costs,
as well as the costs of property and equipment (e.g.,
depreciation and

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interest, fair rental allowance or rental
expense). In addition, certain states provide for efficiency
incentives, subject to certain cost ceilings.


State Medicaid reimbursement programs vary as to
the level of allowable costs that are reimbursed to operators.
In some states, cost-based reimbursement is subject to
retrospective adjustment through cost report settlement. In
other states, reimbursements made to a facility that are
subsequently determined to be less than or in excess of
allowable costs may be adjusted through future reimbursements to
the facility and to other facilities owned by the same operator.
Still other states reimburse facilities based upon costs from a
prior base year, adjusted for inflation. More than 50% of the
states we currently operate in have enacted reimbursement
programs that are based on patient acuity versus traditional
cost-based methodologies. Many other states are actively
developing reimbursement systems based on patient acuity or that
follow a methodology similar to Medicares prospective
payment system (PPS). We are unable to estimate the
ultimate impact of any changes in state reimbursement programs
on our future consolidated financial position, results of
operations or cash flows.

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 done so 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 Balanced Budget Act of 1997 (the Budget
Act) broadened the states authority to develop their
own standards for setting payment rates. The law 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. Currently,
several states in which we have substantial operations are
experiencing deficits in their fiscal operating budgets. There
can be no assurance that these states, as well as other states
in which we operate, will not reduce payment rates.



| |                          
| | -------------------------
| | Reimbursement by Medicare

Healthcare system reform and concerns over rising
Medicare costs have been priorities for both the federal and
state governments. The Budget Act included numerous program
changes directed at balancing the federal budget. In addition to
the Medicaid changes described above, the legislation changed
Medicare policy in a number of ways, including the phase-in of
PPS for skilled nursing facilities. PPS reimburses a skilled
nursing facility based upon the acuity level of Medicare
patients. Acuity level is determined by classifying a patient
into one of 44 Resource Utilization Grouping (RUG)
categories, based on the nature of the patients condition
and services needed.

In 1999 and 2000, refinements were made to the
Budget Act. These refinements restored substantial Medicare
funding to skilled nursing facilities and other healthcare
providers originally eliminated by the Budget Act. A number of
the refinements made in 1999 and 2000 remain in place today,
including, among other things:



| |   |                                                                    
| | - | -------------------------------------------------------------------
| |  | a 20% add-on for 12 high acuity non-therapy RUG
    categories; and
|
| |  | a 6.7% add-on for all rehabilitation RUG
    categories.           

These add-ons are scheduled to expire when the
Centers for Medicare and Medicaid Services (CMS)
release their refinements to the current RUG payment system. It
is expected that these refinements will not be implemented until
at least October 1, 2005. We currently generate
approximately $35.6 million in annual revenues related to
these add-ons. We cannot predict when CMS will release its
refinements nor can we predict what their ultimate impact will
be on our operating results or cash flows, if any.

In addition, the 1999 and 2000 refinements to the
Budget Act included a three-year moratorium on two $1,500
Part B therapy caps, which expired on December 31,
2002. After several delays in implementation during 2003, the
annual caps of $1,590 for physical and speech therapy services
combined and $1,590 for occupational therapy services, which
were adjusted for inflation, were applied to services provided
during the

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period from September 1, 2003 through
December 8, 2003. On December 8, 2003, the Medicare
Prescription Drug, Improvement, and Modernization Act of 2003
(the Prescription Drug Bill) was signed into law and
included an additional two-year moratorium on the Part B therapy
caps until December 31, 2005.


The Prescription Drug Bill also requires payments
to skilled nursing facilities to be increased by 128% for
residents with AIDS, added a pilot program in certain states for
national and state criminal background checks for workers who
provide direct patient care in skilled nursing facilities, and
mandated that hospitals include new information about the
availability of skilled nursing facility care in notices of
discharge given to patients.

CMS implemented two increases in nursing facility
Medicare rates effective October 1, 2003. The first
increase of 3.26% was a cumulative correction for understated
market basket increases that CMS had relied on since 1998. The
second increase of 3.0%, which is applied to the Medicare rates
subsequent to being adjusted for the 3.26% increase above, was
an annual market basket increase for the federal fiscal year
beginning October 1, 2003. Based on our volume and mix of
Medicare patients during 2003, we estimate that these increases
will result in approximately $27.5 million of additional
annual revenues, including approximately $13.5 million for
the cumulative correction for understated market basket
increases and approximately $14.0 million for the annual
market basket increase.

On February 10, 2003, CMS published a
proposed rule to reduce by 30 percent the amount that
Medicare reimburses skilled nursing facilities and other
non-hospital providers for bad debts arising from uncollectible
Medicare coinsurance and deductibles. The proposal is to phase
in the reduction over a three-year period at 10 percent per
year. Based on our current volume of Medicare bad debts, this
proposed rule would reduce our revenues by $1.9 million,
$3.8 million and $5.7 million for the first, second
and third year, respectively. We cannot currently determine if
and when this rule will be implemented.

Government Regulation



| |                                        
| | ---------------------------------------
| | Survey, Certification and
    Licensure

Our nursing facilities, assisted living centers,
home health agencies and hospices are subject to state licensure
and certification requirements under the Medicare, Medicaid and
Veterans Administration programs. While regulations and
licensing requirements vary based upon provider type and from
state to state, they typically address, among other things,
administration and supervision, personnel qualifications,
physical plant specifications, nursing, rehabilitative therapy
and medical services and resident rights and responsibilities.
If we fail to comply with applicable licensing or certification
requirements, we may be subject to civil money penalties, loss
of licensure or termination of our participation in the
Medicare, Medicaid or Veterans Administration programs. Changes
in the laws or new interpretations of existing laws as applied
to our nursing facilities, assisted living centers or other
components of our healthcare businesses may have a significant
impact on our operations and costs of doing business.

In 1989, CMS published new survey and
certification regulations to implement the Medicare and Medicaid
provisions of the Omnibus Budget Reconciliation Act of 1987
(OBRA 1987). OBRA 1987 mandated enhanced quality of
care requirements for participation by skilled nursing
facilities under Medicare and nursing facilities under Medicaid.
After additional changes in the law, survey and certification
regulations became effective in October 1990. Final nursing
facility enforcement regulations were published in November 1994
and were revised significantly in March 1999. Among the
provisions that CMS has adopted are requirements that:



| |   |                                                                                                                                                        
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | surveys focus on residents outcomes;                                                                                                                  
|
| |  | all deviations from the participation
    requirements will be considered deficiencies, but all
    deficiencies will not constitute noncompliance; and
|
| |  | penalties will result for certain types of
    deficiencies.                                                                                           

6



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The regulations also identify remedies, as
alternatives to termination from participation, and specify the
categories of deficiencies for which these remedies will be
applied. These remedies include:



| |   |                                                                                                                                                                                                                                                                 
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | installation of temporary management;                                                                                                                                                                                                                           
|
| |  | denial of payment for new admissions;                                                                                                                                                                                                                           
|
| |  | denial of payment for all patients;                                                                                                                                                                                                                             
|
| |  | civil money penalties of $50 to $3,000 per
    day or per instance for deficiencies that do not put a resident
    in immediate jeopardy and $3,050 to $10,000 per day for
    deficiencies that have caused or are likely to cause serious
    injury or death;
|
| |  | closure of facility and/or transfer of patients
    in emergencies;                                                                                                                                                                                             
|
| |  | directed plans of correction; and                                                                                                                                                                                                                               
|
| |  | directed in-service training.                                                                                                                                                                                                                                   

In the ordinary course of our business, and like
other providers in the healthcare industry, we receive requests
for information from government agencies in connection with
their regulatory or investigational authority and notices of
deficiencies for failure to comply with various regulatory
requirements. We review such requests and notices and we believe
that we take appropriate corrective action. In most cases, with
respect to the notices, the facility or other provider 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 provider. These
adverse actions include:



| |   |                                                                                
| | - | -------------------------------------------------------------------------------
| |  | the imposition of fines;                                                       
|
| |  | temporary suspension of admission of new patients
    to the facility;         
|
| |  | decertification from participation in the
    Medicare or Medicaid programs; or
|
| |  | in extreme circumstances, revocation of a
    facilitys license.              

We have been subject to certain of these adverse
actions in the past and could be subject to adverse actions in
the future, which could result in significant penalties, as well
as adverse publicity. The results of current or future
enforcements or actions could have an adverse effect on our
operations or financial position.

In February 2000, as part of the settlement of an
investigation by the federal government into our allocation of
certain costs to the Medicare program, we entered into a
Corporate Integrity Agreement with the United States Department
of Justice and the Office of Inspector General (the
OIG). This agreement requires that we monitor our
compliance with the requirements of the federal healthcare
programs and addresses our obligations to ensure that we comply.
It includes our functional and training obligations, audit and
review requirements, recordkeeping and reporting requirements,
as well as penalties for breach or noncompliance of the
agreement. In April 2004, revisions were made to our Corporate
Integrity Agreement to extend the services of a quality monitor
to all of our nursing facilities and to reflect a modification
of the requirements under the agreement with respect to training
and education. We believe that we are generally in compliance
with the requirements of the Corporate Integrity Agreement and
file annual reports with the OIG documenting our compliance.
Failure to comply with the Corporate Integrity Agreement may
result in penalties or exclusion from the Medicare and Medicaid
programs.



| |                                        
| | ---------------------------------------
| | Nursing Facility Quality
    Initiative

In November 2002, CMS implemented Nursing Home
Compare, a national initiative to publicly report quality
measures to improve the quality of care of each Medicare and
Medicaid certified nursing facility. In January 2004, CMS
upgraded this program to include enhanced quality measures. This
report uses a set of quality indicators calculated from the
minimum data set assessments prepared by the nursing facilities
on each resident. The quality measures are intended to assist
consumers in evaluating nursing facilities, and to assist

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CMS in working with the nursing facility industry
to develop quality improvement programs where needed. We have
implemented an internal software program allowing each facility
access to their real-time CMS enhanced quality measures. This
enables the facility to compare their performance to local,
state and national averages along with the ability to analyze
which residents are included in each quality measure. Many of
our facilities were selected to participate in their individual
state Quality Improvement Organizations in a three-year nursing
home collaboration to improve these quality measures.


We developed and utilize a program called the
Beverly Quality System to help ensure quality care
is provided in all of our facilities. The program is comprised
of four elements: facility-based Quality Assurance and
Assessment Committees; Quality Councils; facility performance
assessments; and a performance improvement model. All elements
of the Beverly Quality System are addressed by a
multi-disciplinary team that includes regional and district
level business leaders and clinical consultants. Additional
consultative support is provided by designated Quality
Management Directors within the organization.

We have analyzed the revised CMS regulations with
respect to our programs and facilities, as well as compliance
data for the past year. Results of CMS surveys for the past year
determined that a significant majority of our nursing facilities
surveyed were in substantial compliance with CMS, and specific
state, requirements for participation. Our analysis shows that
our nursing facilities have improved their survey performance
year over year. Although we could be adversely affected if a
substantial portion of our programs or facilities were
eventually determined not to be in compliance with CMS
regulations, we believe our programs and facilities are
generally in compliance.



| |                                                     
| | ----------------------------------------------------
| | Regulations Governing Healthcare Fraud and
    Abuse

The Social Security Act and regulations of the
Department of Health and Human Services (HHS) state
that any entities or individuals who have been convicted of a
criminal offense related to the delivery of an item or service
under the Medicare or Medicaid programs or who 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 cannot participate in
the Medicare or Medicaid programs. Furthermore, any entities or
individuals who have been convicted of fraud, who have had their
licenses revoked or suspended, or who have failed to provide
services of adequate quality may be excluded from the Medicare
and Medicaid programs.

There are fraud and abuse
anti-kickback provisions of the Social Security Act (the
Antifraud Amendments) that make it a criminal felony
offense to knowingly and willfully offer, pay, solicit or
receive payment or any other remuneration in order to induce, or
in return for the receipt of, business for which reimbursement
is provided under government health programs, including Medicare
and Medicaid. In addition, violators can be subject to civil
penalties, as well as exclusion from government health programs.
The Antifraud Amendments have been broadly interpreted to make
payment of any kind, including many types of business and
financial arrangements among providers, and between providers
and beneficiaries, potentially illegal if any purpose of the
payment 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 subject to
increased regulatory scrutiny.

From time to time, HHS puts into effect
regulations describing or clarifying certain arrangements that
are not subject to enforcement action under the Social Security
Act (the Safe Harbors). The Safe Harbors described
in the regulations are narrow, leaving a wide range of economic
relationships, which many hospitals, physicians and other
healthcare providers consider to be legitimate business
arrangements, possibly subject to enforcement action under the
Antifraud Amendments. The Safe Harbor regulations do not intend
to comprehensively describe all lawful relationships between
healthcare providers and referral sources. The Safe Harbor
regulations state that just because an arrangement does not
qualify for Safe Harbor protection does not mean it violates the
Antifraud Amendments. However, a failure to meet all the
elements of a potentially applicable Safe Harbor may subject a
particular arrangement or relationship to increased regulatory
scrutiny.

In addition to the Antifraud Amendments,
Section 1877 of the Social Security Act, known as the
Stark Law, imposes restrictions on referrals between
physicians and certain entities with which the physicians have

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financial relationships. The Stark Law provides
that if a physician (or an immediate family member of a
physician) has a financial relationship with an entity that
provides certain designated health services, the physician may
not refer a Medicare or Medicaid patient to the entity for those
designated services, unless an exception applies. In addition,
the entity may not bill for services provided by that physician
unless an exception to the financial relationship exists.
Designated health services include certain services, such as
physical therapy, occupational therapy, outpatient prescription
drugs and home health. The types of financial relationships that
can trigger the referral and billing prohibitions include
ownership or investment interests, as well as compensation
arrangements. Penalties for violating the law are severe, and
include:




| |   |                                                                                                                                     
| | - | ------------------------------------------------------------------------------------------------------------------------------------
| |  | denial of payment for services provided;                                                                                            
|
| |  | civil money penalties of $15,000 for each item or
    service claimed;                                                              
|
| |  | refunds of any amounts collected;                                                                                                   
|
| |  | assessments of up to twice the amount claimed for
    each service;                                                                 
|
| |  | civil money penalties up to $100,000 for each
    arrangement or scheme designed to circumvent the Stark
    Laws prohibitions; and
|
| |  | exclusion from the Medicare and Medicaid programs.                                                                                  

Many states where we operate have laws similar to
the Antifraud Amendments and the Stark Law, but with broader
effect since they apply regardless of the source of payment for
care. These laws typically provide criminal and civil penalties,
as well as loss of licensure. The scope of these state laws is
broad and little precedent exists for their interpretation or
enforcement.

The Health Insurance Portability and
Accountability Act of 1996 (HIPAA) includes
comprehensive revisions or supplements to the Antifraud
Amendments. Under HIPAA, it is a federal criminal offense to
commit healthcare fraud. Healthcare fraud is defined as
knowingly and willfully executing or attempting to execute a
scheme or device to defraud any healthcare benefit
program. In addition, for the first time, HIPAA granted federal
enforcement officials 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 established that it is a
violation to pay or otherwise give anything of value to a
Medicare or Medicaid beneficiary if one knows or has reason to
know that the payment would be likely to influence such
beneficiary to order or receive services from a particular
provider or practitioner.

The Budget Act also contained a significant
number of new fraud and abuse provisions. For example, civil
money penalties may also be imposed for violations of the
Antifraud Amendments (previously, exclusion or criminal
prosecution were the only actions under the Antifraud
Amendments), as well as for contracting with an individual or
entity that a provider knows or should know is excluded from a
federal healthcare program. A person is subject to mandatory
exclusion from participation in federal healthcare programs upon
conviction for certain defined healthcare offenses. The Budget
Act provides a minimum ten-year period for exclusion from
participation in federal healthcare programs for providers
convicted of a prior healthcare offense. The Budget Act also
provides for civil money penalties of $50,000 and damages of not
more than three times the amount of payment received from the
prohibited activity.

In 1976, Congress established the OIG at HHS to
identify and eliminate fraud, abuse and waste in HHS programs
and to promote efficiencies 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 fraud
alerts encourage persons having

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information about potentially abusive practices
or transactions to report such information to the OIG. The OIG
has issued three fraud alerts targeting the skilled nursing
industry:




| |   |                                                                                                                                                                                                       
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | an August 1995 alert which relates to the
    provision of medical supplies to nursing facilities, fraudulent
    billing for medical supplies and equipment and fraudulent
    supplier transactions;
|
| |  | a May 1996 alert which focuses on the provision
    of fraudulent professional services to nursing facility
    residents; and                                                                        
|
| |  | a March 1998 alert which addresses the
    interrelationship between hospice services and the nursing
    facility industry, and potentially illegal practices and
    arrangements.                  

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 $11,000 for each claim and three
times the amount of damages, on entities and persons who
knowingly present or cause to be presented to the federal
government a false or fraudulent claim for payment. Also, the
statute allows private parties to bring qui tamwhistleblower lawsuits alleging false claims. Some states
have adopted similar whistleblower and/or false claims
provisions. The Social Security Act prohibits the knowing and
willful making of a false statement or misrepresentation of a
material fact with respect to the submission of a claim for
payment under government health programs (including the Medicare
and Medicaid programs). Violations of this provision are a
felony offense punishable by fines and imprisonment. Government
prosecutors are increasing their use of the Federal False Claims
Act to prosecute quality of care deficiencies in healthcare
facilities. Their theory behind this is that the submission of a
claim for services provided in a manner that falls short of
quality of care standards can constitute the submission of a
false claim.

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. From
time to time, we, like other healthcare providers, are required
to provide records to state or federal agencies to aid in such
investigations. It is possible that these entities could
initiate investigations in the future at facilities we operate
and that such investigations could result in significant
penalties, as well as adverse publicity.



| |                                                                                
| | -------------------------------------------------------------------------------
| | Regulation Governing the Privacy and
    Transmission of Healthcare Information

In addition to its antifraud provisions, HIPAA
also requires improved efficiency in healthcare delivery by
standardizing electronic data interchange and by protecting the
confidentiality and security of health data. More specifically,
HIPAA calls for:



| |   |                                                                                                                                             
| | - | --------------------------------------------------------------------------------------------------------------------------------------------
| |  | standardization of certain electronic patient
    health, administrative and financial data;                                                
|
| |  | unique health identifiers for employers, health
    plans and healthcare providers;                                                         
|
| |  | privacy standards protecting the privacy of
    individually identifiable health information; and                                           
|
| |  | security standards protecting the confidentiality
    and integrity of electronically held individually identifiable
    health information.

In August 2000, final regulations establishing
standards for electronic data transactions and code sets, as
required under HIPAA, were released. These standards are
designed to allow entities within the healthcare industry to
exchange medical, billing and other information and to process
transactions in a more timely and cost effective manner.
Modifications to the electronic data transactions and code sets
standards were issued on February 20, 2003, and further
modifications were released March 10, 2003. Subsequently,
on July 24, 2003 and September 23, 2003, Congress
granted extensions to providers whose Medicare and Medicaid
trading partners were not ready to implement these standards. We
are already complying with the transactions standards where
possible. We will begin operating in a compliant manner with the
remaining trading partners as they become ready.

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The HIPAA privacy standards are designed to
protect the privacy of certain individually identifiable health
information. The privacy standards have required us to make
certain updates to our policies and procedures and conduct
training for our employees surrounding these standards. We
believe we are compliant with the privacy standards.

We must comply with the HIPAA security standards
by April 21, 2005, with civil and criminal penalties for
noncompliance. We must comply with the employer identification
standard before May 23, 2005. We believe that we will be in
compliance with these standards as required.

HHS has estimated that implementation of the
electronic transactions and code sets, the privacy standards and
the security standards will cost the healthcare industry between
$1.8 billion and $6.3 billion over a five-year period.
We continue to evaluate and update our processes and procedures
to meet the requirements of the new standards; however, we
cannot assure you that all of the parties with whom we do
business will be in compliance with HIPAA. We do not believe our
ongoing implementation to comply with HIPAA will have a material
impact on our consolidated financial position, results of
operations or cash flows.

Competitive Conditions

Our nursing facilities compete primarily on a
local and regional basis with other long-term care providers,
some of whom may own as few as a single nursing facility. Our
primary national competitors include Manor Care, Inc., Kindred
Healthcare, Inc., Genesis HealthCare Corporation, Extendicare
Health Services, Inc. and Mariner Health Care, Inc. We also
compete with a variety of other companies in providing
rehabilitation therapy services, hospice services and assisted
living services.

Our ability to compete successfully varies from
location to location and depends on a number of factors, which
include:



| |   |                                                         
| | - | --------------------------------------------------------
| |  | the number of competitors in the local market;          
|
| |  | the types of services available;                        
|
| |  | quality of care;                                        
|
| |  | reputation, age and appearance of each
    facility; and
|
| |  | the cost of care in each locality.                      

In general, we seek to compete in each market by
establishing a reputation within the local community for quality
healthcare services, attractive and comfortable facilities, and
providing specialized healthcare. Increased competition in the
future could limit our ability to attract and retain residents
or to expand our business.

Employees and Labor Relations

At April 30, 2004, we had approximately
35,400 full and part-time employees.

Approximately 9% of our employees, employed in 71
of our nursing facilities, are represented by various labor
unions. Although our facilities have never experienced any
material work stoppages and we believe that our relations with
employees and labor organizations are generally good, we cannot
predict the effect continued union representation or
organizational activities will have on our future operations.

A national shortage of nurses and other trained
personnel and general inflationary pressures have required us to
adjust our wage and benefits packages in order to compete for
qualified personnel. For the three months ended March 31,
2004, labor costs accounted for approximately 54% of the
operating expenses of our Nursing Facilities segment, 92% of our
Aegis segment and 59% of our Home Care segment. We compete with
other healthcare providers to attract and retain qualified or
skilled personnel. We also compete with various industries for
lower-wage employees. We are not currently facing a staffing
shortage in all markets where we operate; however, in certain
markets with shortages of healthcare workers we have used
high-cost temporary help to supplement staffing levels. We are
addressing our staffing challenges through recruiting and
retention

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programs and training initiatives. However, these
programs and initiatives may not stabilize or improve our
ability to attract and retain these personnel. Our inability to
control labor availability and costs could have an adverse
effect on our future operating results.


Executive Officers

The following table sets forth the name, position
and age of each of our executive officers. Each executive
officer is elected or appointed by the Board of Directors. The
executive officers as of May 31, 2004, are as follows:

|                       |  |                                                                                    |  |     |    | 
|---------------------- |  | ---------------------------------------------------------------------------------- |  | --- | -- | 
|Name                   |  | Position                                                                           |  | Age
|                       |  |                                                                                    |  |    
|William R. Floyd       |  | Chairman of the Board, President, Chief Executive
    Officer and Director         |  |     | 59 | 
|Douglas J. Babb        |  | Executive Vice President, Chief Administrative
    and Legal Officer and Secretary |  |     | 52 | 
|David R. Devereaux     |  | Chief Operating Officer  Nursing
    Facilities                                   |  |     | 42 | 
|Jeffrey P. Freimark    |  | Executive Vice President, Chief Financial and
    Information Officer              |  |     | 49 | 
|Cindy H. Susienka      |  | Executive Vice President and
    President  Aegis Therapies and Home Care         |  |     | 44 | 
|Patrice K. Acosta      |  | Senior Vice President  Quality of Life
    Programs                               |  |     | 48 | 
|Pamela H. Daniels      |  | Senior Vice President, Controller and Chief
    Accounting Officer                 |  |     | 40 | 
|Lawrence Deans         |  | Senior Vice President  Human Resources                                            |  |     | 52 | 
|James M. Griffith      |  | Senior Vice President  Investor
    Relations and Corporate Communications        |  |     | 61 | 
|Patricia C. Kolling    |  | Senior Vice President  Compliance                                                 |  |     | 57 | 
|Andrea J. Ludington    |  | Senior Vice President  Professional
    Services                                  |  |     | 58 | 
|Blaise J. Mercadante   |  | Senior Vice President  Marketing and
    New Business Innovation                  |  |     | 50 | 
|Barbara R. Paul        |  | Senior Vice President and Chief Medical Officer                                    |  |     | 50 | 
|Harold A. Price        |  | Senior Vice President  Sales and
    Business Development                         |  |     | 54 | 
|Richard D. Skelly, Jr. |  | Senior Vice President and Treasurer                                                |  |     | 44 | 
|Chris W. Roussos       |  | President  Ceres Purchasing Solutions                                             |  |     | 39 | 

Mr. Floydjoined us in April 2000 as President
and Chief Operating Officer. He was elected Chief Executive
Officer in February 2001 and Chairman of the Board in December
2001. From 1996 to 1998, he was Chief Executive Officer of
Choice Hotels International, and from 1995 to 1996, he was Chief
Operating Officer of Taco Bell Corporation. He has been a
director since July 2000.

Mr. Babbjoined
us in April 2000 as Executive Vice President, General Counsel
and Secretary. He was named head of Government Relations in
January 2001 and Chief Administrative and Legal Officer in
October 2002. Mr. Babb was Senior Vice
President  Merchandise Business Unit for Burlington
Northern Santa Fe Corporation from 1997 to 1999.

Mr. Devereauxjoined us in August 1998 as Senior
Vice President  Operations for the Specialty Services
Division of the Nursing Facilities segment. He was elected
President of the corporations within the Nursing Facilities
segment in January 2001 and Chief Operating Officer in July 2001.

Mr. Freimarkjoined us in January 2002 as Executive
Vice President and Chief Financial Officer. He became head of
Information Technology in October 2002. From May 2001 to
January 4, 2002, he was Senior Executive Vice President and
Chief Financial Officer of OfficeMax, Inc. From March 1997 to
May 2001, he

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was with The Grand Union Company where he held
positions as Executive Vice President, Chief Financial Officer
and President and Chief Executive Officer.


Ms. Susienkajoined us in June 1998 as
President  Aegis Therapies and was elected
President  Home Care Services in March 2002. She was
elected Executive Vice President in December 2003.

Ms. Acostajoined us in October 1996 as Vice
President  Risk Management. She was elected Senior
Vice President  Professional Services in January 2001
and Senior Vice President  Quality of Life Programs
in October 2003.

Ms. Danielsjoined us in May 1988 as Audit
Coordinator. She was elected Vice President, Controller and
Chief Accounting Officer in October 1996 and Senior Vice
President in December 1999.

Mr. Deansjoined us in November 2003 as Senior
Vice President  Human Resources. From September 1999
to November 2003, he was Chief Human Resources Officer at Jones
Lang LaSalle. From February 1998 to June 1999, he was Vice
President  Human Resources of Alliant Foodservice,
Inc.

Mr. Griffithjoined us in November 1995 as Senior
Vice President  Investor Relations and Corporate
Communications.

Ms. Kollingjoined us in February 1989 as a
rehabilitation consultant. She was elected Vice
President  Rehabilitation in 1994, Vice
President  PPS in 1998 and Vice President 
Medicare Programs in 2000. She was elected Senior Vice
President  Compliance in October 2002.

Ms. Ludingtonjoined us in 1999 as Regional Director
of Professional Services. She was elected Senior Vice President
of Professional Services in 2004.

Mr. Mercadantejoined us in January 2002 as Senior
Vice President  Marketing and New Business
Innovation. From 1999 to 2002, he was President of Blazing
Insights Group, and from 1996 to 1999, he was Executive Vice
President  Marketing at Universal Studios.

Ms. Pauljoined
us in March 2004 as Chief Medical Officer. From 1999 to 2004,
she was director of the Quality Measurement and Health
Assessment Group for CMS at HHS.

Mr. Pricejoined us in August 2002 as Senior
Vice President  Sales and Business Development. Prior
to that, he worked with us on a consulting basis for
18 months. Before becoming a consultant, he was Vice
President  Strategic Relations and Business
Development for SelfCare, Inc. from 1999 to 2000.

Mr. Skellyjoined us in April 2002 as Senior Vice
President and Treasurer. From September 2001 to March 2002, he
served as Senior Vice President and Treasurer of OfficeMax, Inc.
From June 1997 to August 2001, he held various positions with
The Grand Union Company, including Acting Chief Financial
Officer and Treasurer.

Mr. Roussosjoined us in August 2001 as a
management designee of our former Matrix segment. He was elected
President of Matrix in February 2002 and President of Ceres
Purchasing Solutions in October 2002. From 2000 to 2001, he was
Division General Manager of American Homestar, and from 1996 to
2000, he was General Manager of Fleetwood Enterprises.

Risks Relating to Our Company



| |                                                                              
| | -----------------------------------------------------------------------------
| | Our substantial indebtedness could
    adversely affect our financial health.

We have a significant amount of indebtedness. At
March 31, 2004, we had total indebtedness on our
consolidated balance sheet of $562.6 million. On
March 31, 2004, our consolidated balance sheet also
included a liability of $58.4 million, representing the
present value of the remaining obligation we owe to the federal
government under a civil settlement agreement. In addition, at
March 31, 2004, we had $70.0 million of off-balance
sheet obligations. Our level of indebtedness has declined
significantly over the last two years. The reduction in these
obligations was primarily accomplished through the use of
proceeds from divestitures and cash generated from the
collection of accounts receivable. We expect to continue to
reduce our indebtedness

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through cash on hand, cash generated by
operations and proceeds from selected divestitures of
non-strategic assets.


Our substantial indebtedness could have important
consequences to you. For example, it could:



| |   |                                                                                                                                                                                                                                                                        
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | increase our vulnerability to general adverse
    economic and industry conditions;                                                                                                                                                                                    
|
| |  | require us to dedicate a substantial portion of
    our cash flow from operations to payments on our indebtedness,
    thereby reducing the availability of our cash flow to fund
    working capital, capital expenditures and other general
    corporate activities;
|
| |  | limit our flexibility in planning for, or
    reacting to, changes in our business and industry;                                                                                                                                                                       
|
| |  | place us at a competitive disadvantage compared
    to other less leveraged competitors;                                                                                                                                                                               
|
| |  | limit our ability to pursue business
    opportunities that may be in our interest; and                                                                                                                                                                                
|
| |  | limit our ability to borrow additional funds.                                                                                                                                                                                                                          

In addition, the indentures relating to our
publicly traded notes contain restrictive covenants and our
senior credit facility contains financial and other restrictive
covenants that limit our ability to engage in activities that
may be in our long-term best interest. Our failure to comply
with those covenants could result in an event of default, which,
if not cured or waived, could result in the acceleration of a
substantial amount of our debt.



| |                                                                                                                                                                                                             
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Despite current indebtedness levels, we and
    our subsidiaries may still be able to incur substantially more
    debt. This could further increase the risks associated with our
    substantial leverage.

We may be able to incur substantial additional
indebtedness in the future. The terms of our existing debt
instruments and the indentures relating to our public notes do
not fully prohibit us from doing so. As of March 31, 2004,
we were able to borrow up to $75.0 million of revolving
credit under our senior credit facility ($35.3 million of
which availability at March 31, 2004 was being used for
letters of credit). If new indebtedness is added to our current
debt levels, the related risks that we now face could increase.



| |                                                                                                                                                                                   
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | To service our indebtedness, we will
    require a significant amount of cash. Our ability to generate
    cash depends on many factors, some of which are beyond our
    control.

Our ability to make payments on and to refinance
our indebtedness and to fund planned capital expenditures will
depend on our ability to generate cash in the future. This, to a
certain extent, is subject to general economic, financial,
competitive, legislative, regulatory and other factors that are
beyond our control.

At March 31, 2004, we had cash and cash
equivalents totaling $230.2 million and availability under
our revolving credit facility of $39.7 million. We
currently anticipate that cash on hand, cash flows from
operations and availability under our banking arrangements will
be adequate to repay our debts due within one year of
$13.1 million, to make normal recurring annual capital
additions and improvements of $80.0 million, to make
operating lease and other contractual obligation payments, to
make selective acquisitions, including the purchase of
previously leased facilities, and to meet working capital
requirements for the twelve months ending March 31, 2005.

We cannot assure you, however, that our business
will generate sufficient cash flow from operations, that
currently anticipated cost savings and operating improvements
will be realized on schedule or that future borrowings will be
available in an amount sufficient to enable us to pay our
indebtedness or to fund our other liquidity needs. We may need
to refinance all or a portion of our indebtedness on or before
maturity. We cannot assure you that we will be able to refinance
any of our indebtedness on commercially reasonable terms or at
all.

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| |                                                                                                                                                         
| | --------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our reported earnings per share may be more
    volatile because of the contingent conversion provision of our
    2.75% convertible subordinated notes.

Holders of the convertible subordinated notes are
entitled to convert the notes into our common stock if the
closing sale price of our common stock for at least 20
consecutive trading days in the 30 consecutive trading day
period ending on the last day of the immediately preceding
fiscal quarter is more than 120% of the conversion price (or
$8.94 per share) in effect on that 30th trade day, among
other circumstances. Until this contingency or another
conversion contingency is met, the shares underlying the notes
are not included in the calculation of our basic or diluted
earnings per share. Should a conversion contingency be met,
diluted earnings per share is expected to decrease as a result
of the inclusion of the underlying shares in the diluted
earnings per share calculation. Volatility in our stock price
could cause this condition to be met in one quarter and not in a
subsequent quarter, increasing the volatility of our diluted
earnings per share. (See Part II 
Item 8  Note 9.)



| |                                                               
| | --------------------------------------------------------------
| | The price of our common stock may fluctuate
    significantly.

The price of our common stock has been, and is
likely to continue to be, highly volatile, which means that it
could decline substantially. The price of our common stock could
fluctuate significantly for the following reasons, among others:



| |   |                                                              
| | - | -------------------------------------------------------------
| |  | future announcements concerning us or our
    competitors;   
|
| |  | quarterly variations in operating results;                   
|
| |  | business acquisitions or divestitures;                       
|
| |  | changes in earnings estimates by analysts;                   
|
| |  | changes in third-party reimbursement practices;              
|
| |  | regulatory developments;                                     
|
| |  | changes in the number of outstanding
    shares; or          
|
| |  | fluctuations in the economy or general market
    conditions.

In addition, stock markets in general, and the
market for shares of healthcare stocks in particular, have
experienced extreme price and volume fluctuations in recent
years which have frequently been unrelated to the operating
performance of the affected companies. These broad market
fluctuations may adversely affect the market price of our common
stock. The market price of our common stock could decline below
its current price and the market price of our common stock may
fluctuate significantly in the future. These fluctuations may be
unrelated to our performance.

In the past, stockholders have often instituted
securities class action litigation after periods of volatility
in the market price of a companys securities. If a
stockholder files a securities class action lawsuit against us,
we would incur substantial legal fees and our managements
attention and resources would be diverted from operating our
business in order to respond to the litigation. (See
Item 3. Legal Proceedings.)



| |                                                                                                                                                                                   
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We rely on reimbursement from governmental
    programs for a majority of our revenues and we cannot assure you
    that reimbursement levels will not decrease in the
    future.

For the three months ended March, 31, 2004,
51%, 28% and 21% of our revenues were derived from Medicaid,
Medicare and private and other sources, respectively. Changes in
the reimbursement policies of the Medicare or Medicaid programs
as a result of budget cuts by federal and state governments or
other legislative and regulatory actions could have an adverse
effect on our consolidated financial position, results of
operations and cash flows.

We have experienced an increase in our state
Medicaid rates averaging 6.3% for the three months ended
March 31, 2004, over the same period in 2003, and 4.6%,
3.6% and 6.7% for the years ended December 31, 2003, 2002
and 2001, respectively. However, in the past, states have
curtailed their Medicaid payments as a

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result of budget considerations. Curtailments of
Medicaid funding by a state can affect long-term care providers
and/or other non-eldercare providers in that state. Currently,
several states in which we operate are experiencing deficits in
their fiscal operating budgets. There can be no assurance that
those states in which we operate that are experiencing budget
deficits, as well as other states in which we operate, will not
reduce payment rates.


The Budget Act broadened the states
authority 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 nursing 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.

In recent years, there have also been reductions
in payments to skilled nursing facilities under the Medicare
program. Although the Balanced Budget Refinement Act of 1999
(BBRA) and the Benefits Improvement and Protection
Act of 2000 (BIPA) reversed certain rate reductions
enacted under the Budget Act, some of these increases expired on
September 30, 2002, the so-called Medicare
cliff. While CMS announced two increases to skilled
nursing facility rates effective October 2003, and will continue
certain add-ons for high-acuity patients until CMS refines the
RUG system, there can be no assurances that payments from the
Medicare program will remain at levels comparable to present
levels or will, in the future, be sufficient to cover the costs
allocable to Medicare patients.

In addition, as required by the Budget Act, CMS
imposed annual limits per beneficiary of $1,590 for physical and
speech therapy services combined and $1,590 for occupational
therapy. These caps were applied to services provided during the
period from September 1, 2003 through December 8,
2003. Although Congress imposed a further moratorium from
December 8, 2003 through December 31, 2005 in the
provisions of the Prescription Drug Bill, there can be no
assurance that the caps will not go into effect on
January 1, 2006.

On February 10, 2003, CMS published a
proposed rule to reduce by 30 percent the amount that
Medicare reimburses skilled nursing facilities and other
non-hospital providers for bad debts arising from uncollectible
Medicare coinsurance and deductibles. The proposal is to phase
in the reduction over a three-year period at 10 percent per
year. Based on our current volume of Medicare bad debts, this
proposed rule would reduce our revenues by $1.9 million,
$3.8 million and $5.7 million for the first, second
and third year, respectively. We cannot currently determine if
and when this rule will be implemented.

Governmental payment programs are subject to
statutory and regulatory changes, retroactive rate adjustments,
administrative or executive orders and government funding
restrictions, all of which may materially decrease the rate of
government program payments to us for our services. Our
financial condition and results of operations may be adversely
affected by reductions in reimbursement levels and the
reimbursement process in general, which in the healthcare
industry is complex and can involve lengthy delays between the
time that revenue is recognized and the time that reimbursement
amounts are settled.



| |                                                                                                                   
| | ------------------------------------------------------------------------------------------------------------------
| | Our industry is heavily regulated by the
    government, which requires our compliance with a variety of
    laws.

The operation of our facilities and the services
we provide are subject to periodic inspection by governmental
authorities to ensure that we are complying with standards
established for continued licensure under state law and
certification for participation under the Medicare and Medicaid
programs. Additionally, in certain states, certificates of need
or other similar approvals are required for expansion of our
operations. We could be adversely affected if we are unable to
obtain these approvals, if the standards applicable to approvals
or the interpretation of those standards change and by possible
delays and expenses associated with obtaining approvals. Our
failure to obtain, retain or renew any required regulatory
approvals, licenses or certificates could prevent us from being
reimbursed for certain of our services.

In the ordinary course of our business, and like
other providers in the healthcare industry, we receive requests
for information from government agencies in connection with
their regulatory or investigational authority and notices of
deficiencies for failure to comply with various regulatory
requirements. We review all

16



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such notices and we believe that we take timely
and appropriate corrective action. In most cases, with respect
to these notices, the facility 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
include:




| |   |                                                                                
| | - | -------------------------------------------------------------------------------
| |  | the imposition of fines;                                                       
|
| |  | temporary suspension of payment for new patients
    to the facility;          
|
| |  | decertification from participation in the
    Medicare or Medicaid programs; or
|
| |  | in extreme circumstances, revocation of a
    facilitys license.              

We have been subject to certain of these adverse
actions in the past and could be subject to adverse actions in
the future which could result in significant penalties, as well
as adverse publicity. Any such penalties or adverse publicity
could have an adverse effect on our financial condition and
results of operations.



| |                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We face periodic reviews, audits and
    investigations under our contracts with federal and state
    government agencies, and these audits could have adverse
    findings that may negatively impact our business.

As a result of our participation in the Medicare
and Medicaid programs, we are subject to various governmental
reviews, audits and investigations to verify our compliance with
these programs and applicable laws and regulations. Private pay
sources also reserve the right to conduct audits. An adverse
review, audit or investigation could result in:



| |   |                                                                                                                         
| | - | ------------------------------------------------------------------------------------------------------------------------
| |  | refunding amounts we have been paid pursuant to
    the Medicare or Medicaid programs or from private payors;           
|
| |  | state or federal agencies imposing fines,
    penalties and other sanctions on us;                                      
|
| |  | loss of our right to participate in the Medicare
    or Medicaid programs or one or more private payor
    networks; and
|
| |  | damage to our reputation in various markets.                                                                            

Both federal and state government agencies have
heightened and coordinated civil and criminal enforcement
efforts as part of numerous ongoing investigations of healthcare
companies and, in particular, skilled nursing facilities. The
investigations include:



| |   |                                                       
| | - | ------------------------------------------------------
| |  | cost reporting and billing practices;                 
|
| |  | quality of care;                                      
|
| |  | financial relationships with referral
    sources; and
|
| |  | medical necessity of services provided.               

We also are subject to potential lawsuits under a
federal whistleblower statute designed to combat fraud and abuse
in the healthcare industry. These lawsuits can involve
significant monetary awards to private plaintiffs who
successfully bring these suits.



| |                                                                                                          
| | ---------------------------------------------------------------------------------------------------------
| | We are required to comply with laws
    governing the transmission and privacy of health
    information.

HIPAA requires us to comply with certain
standards for the exchange of individually identifiable health
information within our Company and with third parties, such as
payors, business associates and patients. These include
standards for common healthcare transactions, such as claims
information, plan eligibility, payment information and the use
of electronic signatures; unique identifiers for providers,
employers, and health plans; security; and privacy.

Sanctions for failing to comply with the HIPAA
health information practices provisions include criminal
penalties and civil sanctions. The security standards went into
effect in April 2003, with a compliance date in

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April 2005 for most covered entities. We cannot
assure you that all of the parties with whom we do business will
be in compliance with HIPAA. If we fail to comply with these
standards, we could be subject to criminal penalties and civil
sanctions, which could have an adverse effect on our financial
condition and results of operations.




| |                                                                     
| | --------------------------------------------------------------------
| | Healthcare reform legislation may adversely
    affect our business.

In recent years, there have been numerous
initiatives on the federal and state levels for comprehensive
reforms affecting the payment for and availability of healthcare
services. Aspects of certain of these healthcare initiatives,
such as reductions in funding of the Medicare and Medicaid
programs, potential changes in reimbursement regulations by CMS,
enhanced pressure to contain healthcare costs by Medicare,
Medicaid and other payors, greater state flexibility and
additional operational requirements, could adversely affect us.
There can be no assurance as to the ultimate content, timing or
effect of any healthcare reform legislation, nor is it possible
at this time to estimate the impact of potential legislation on
us. That impact may have an adverse effect on our financial
condition and results of operations.



| |                                                                                             
| | --------------------------------------------------------------------------------------------
| | We are subject to increasingly expensive
    and unpredictable patient care liability costs.

General and professional liability costs for the
long-term care industry have become increasingly expensive and
difficult to estimate. We and others have experienced
substantial increases in both the number of claims and lawsuits,
as well as the size of the typical claim and lawsuit. The
long-term care industry has previously experienced significant,
unexpected increases in estimated ultimate costs for claims in
certain states or areas. In Texas and Florida, for example, the
growth in patient care liability claims and lawsuits reached a
level where it was not possible for us to continue to operate
profitably and we disposed of all our facilities in Texas in
1996 and Florida in 2002.

We also have initiated several strategic and
tactical actions to mitigate the impact of these rising costs.
In late 2002, we identified those nursing facilities that
represented a disproportionately high share of projected patient
care liability costs. In early 2003, we began implementing a
strategy to divest, over a two-year period, properties that
accounted for approximately 50% of our annual patient care
liability costs projected at that time. We upgraded our risk
management and litigation functions, and adopted a more
coordinated and aggressive legal defense strategy. We began
using voluntary arbitration agreements in most of our nursing
facilities and improved communications with residents and their
families to resolve issues before they reach litigation. In
addition, we remain committed to continually improving the
quality of care we provide, adopting clinical performance
indicators to evaluate the care at each facility and including
quality care as a significant component of incentive
compensation at the facility, regional and corporate levels. If
patient care claims continue to increase in number and size, our
future financial condition and results of operations may be
adversely affected.



| |                                                                                                                                                                                                      
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Insurance coverage is becoming increasingly
    expensive and difficult to obtain for long-term care companies,
    and our insurance carriers could become insolvent and unable to
    reimburse us.

Primarily as a result of patient care liability
costs for long-term care providers, insurance companies are
ceasing to insure long-term care companies, or severely limiting
their capacity to write long-term care general and professional
liability insurance. In addition, in the wake of the
September 11, 2001 events, reduced overall insurance
capacity and increasing insurance company losses, the insurance
environment in general has become unstable, making it
increasingly difficult to obtain coverage for patient care
liabilities and certain other risks. When insurance coverage is
available, insurance carriers are typically requiring companies
to significantly increase their liability retention levels
and/or pay substantially higher premiums for reduced coverage.
This has been the case for most insurance coverages, including
workers compensation, employee healthcare and patient care
liability. We have experienced higher premiums and retention
levels in the past. Our insurance covering patient care
liability and workers compensation was renewed in the
second quarter of 2004 with retention levels remaining
consistent and premiums being generally the same or less than
the prior year. However, we cannot assure you that we will be
able to renew our insurance coverages in future years on terms
as favorable as those we currently have.

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We have purchased insurance for workers
compensation, property, casualty and other risks from numerous
insurance companies. In many cases, the policies provide
coverage for events occurring in specific time frames that may
only be determined in later years. We exercise care in selecting
companies from which we purchase insurance, including review of
published ratings by recognized rating agencies, advice from
national brokers and consultants and review of trade information
sources. There exists a risk that any of these insurance
companies may become insolvent and unable to fulfill their
obligation to defend, pay or reimburse us when that obligation
becomes due. Although we believe the companies we have purchased
insurance from are solvent, in light of the dramatic changes
occurring in the insurance industry in recent years, we cannot
assure you that they will remain solvent and able to fulfill
their obligations.



| |                                                                                                                                           
| | ------------------------------------------------------------------------------------------------------------------------------------------
| | State efforts to regulate the construction
    or expansion of healthcare providers could impair our ability to
    expand our operations.

Some states require healthcare providers
(including skilled nursing facilities, home health agencies,
hospices and assisted living centers) to obtain prior approval,
known as a certificate of need (a CON), for:



| |   |                                                                      
| | - | ---------------------------------------------------------------------
| |  | the purchase, construction or expansion of
    healthcare facilities;
|
| |  | capital expenditures exceeding a prescribed
    amount; or           
|
| |  | changes in services or bed capacity.                                 

To the extent that we are required to obtain a
CON or other similar approvals to expand our operations, either
by acquiring facilities or expanding or providing new services
or other changes, our expansion could be adversely affected by
our failure or inability to obtain the necessary approvals,
changes in the standards applicable to those approvals, and
possible delays and expenses associated with obtaining those
approvals. We cannot assure you that we will be able to obtain
CON approval for all future projects requiring this approval.



| |                                                                                                                                                                                                                                             
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our civil settlement agreement with the
    United States Government with respect to alleged violations of
    cost allocations under Medicare negatively impacts our cash
    flows and subjects us to a Corporate Integrity
    Agreement.

On February 3, 2000, we entered into a
series of separate agreements with the OIG of HHS. Under the
civil settlement agreement, we paid the federal government
$25.0 million during the first quarter of 2000 and agreed
to reimburse the federal government an additional
$145.0 million through withholdings from our biweekly
Medicare periodic interim payments in equal installments ending
in the first quarter of 2008. As of March 31, 2004, the
present value of the remaining obligation was
$58.4 million. As a result of such withholdings, our cash
flows from operations were negatively impacted by
$4.9 million for the three months ended March 31,
2004, and $18.1 million during the year ended
December 31, 2003, and are expected to be negatively
impacted at an annual rate of $18.1 million.

As part of this series of agreements, we entered
into a Corporate Integrity Agreement with the OIG. This
agreement requires that we monitor, on an ongoing basis, our
compliance with the requirements of the federal healthcare
programs. This agreement addresses our obligations to ensure
that we comply with the requirements of participation in the
federal healthcare programs. It also includes functional and
training obligations, audit and review requirements and record
keeping and reporting requirements. In 2002, certain revisions
were made to our Corporate Integrity Agreement to reflect a
permanent injunction requiring our nursing facilities in
California to conduct additional training programs and to hire
an independent quality monitor for our nursing facilities in
California, Arizona, Hawaii and Washington to assess our quality
care systems. By March 31, 2004, we had divested all of our
nursing facilities in Arizona, Washington and Hawaii and a
substantial portion of our nursing facilities in California. In
April 2004, additional revisions were made to our Corporate
Integrity Agreement to extend the services of the quality
monitor to all of our nursing facilities and to reflect a
modification of the requirements under the agreement with
respect to training and education. We believe that we are
generally in compliance with the requirements of our Corporate
Integrity Agreement and file annual reports with the OIG
documenting our compliance. If we fail to comply with our
Corporate Integrity Agreement, we may be subject to penalties or
exclusion from the Medicare and Medicaid programs, which could
have an adverse effect on our financial condition and results of
operations.

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| |                                           
| | ------------------------------------------
| | We are subject to material
    litigation.

We are, and may in the future be, subject to
litigation which, if determined adversely against us, could have
a material adverse effect on our business, financial condition
and results of operations. (See Item 3. Legal Proceedings.)



| |                                                                                                                                                                        
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we fail to cultivate new, or maintain
    existing, relationships with the physicians in the communities
    in which we operate, our patient base may
    decrease.

Our patient base depends in part upon the
admissions and referral practices of the physicians in the
communities in which we operate and our ability to cultivate and
maintain relationships with these physicians. Physicians
referring patients to our facilities are not our employees and
are free to refer their patients to other providers. If we are
unable to successfully cultivate and maintain strong
relationships with these physicians, our patient population may
decline, which, if significant, could have an adverse effect on
our financial condition and results of operations.



| |                                                                                                                                                                              
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Changes in the mix of our patient
    population among the Medicare, Medicaid and private categories
    may significantly affect our nursing revenues and
    profitability.

The sources and amounts of our patient revenues
are determined by a number of factors, including licensed bed
capacity and census of our nursing facilities, average length of
stay of our residents, the mix of our patients by payor type
(for example, Medicare versus Medicaid or private) and the
acuity level of our patients. Changes in the case mix of
patients, the mix of patients by payor type and payment
methodologies may significantly affect our profitability. In
particular, changes which increase the percentage of Medicaid
residents within our nursing facilities could have an adverse
effect on our financial condition and results of operations,
especially in states whose reimbursement levels are below our
operating costs.



| |                                                                                                                           
| | --------------------------------------------------------------------------------------------------------------------------
| | Certain trends in the healthcare industry
    are putting pressure on our ability to maintain nursing facility
    census.

Over the past decade, a number of trends have
developed that impact our census. These trends include:



| |   |                                                                                                                             
| | - | ----------------------------------------------------------------------------------------------------------------------------
| |  | overbuilding of nursing facilities in states that
    have eliminated the CON process for new construction;                 
|
| |  | creation of nursing facilities by acute-care
    hospitals to keep discharged patients within their complex;                
|
| |  | rapid growth of assisted living centers, which
    sometimes are more attractive to less medically complex
    patients; and
|
| |  | the availability of eldercare services delivered
    to the home.                                                           

The negative impact of these trends on nursing
facility census varies from facility to facility, from community
to community and from state to state, and if we are not
successful in responding to them, these trends could have an
adverse effect on our financial condition and results of
operations.

Available Information

Our website, www.beverlycares.com,
provides access, free of charge, to our SEC reports, including
our annual report on Form 10-K, quarterly reports on
Form 10-Q, current reports on Form 8-K, and amendments
to these reports, as soon as reasonably practicable. In
addition, our corporate governance guidelines, code of conduct,
code of ethics for senior financial officers, Audit and
Compliance Committee Charter and Nominating and Compensation
Committee Charter will be available on this website and in print
to any shareholder who request them.

You may read and copy any materials we file with
the SEC at the SECs Public Reference Room at
450 Fifth Street, NW, Washington, DC 20549. You may obtain
information on the operation of the Public Reference Room by
calling the SEC at 1-800-SEC-0330. The SEC maintains a website
that contains reports, proxy and information statements, and
other information regarding issuers that file electronically
with the SEC, including us, at http: //www.sec.gov.

20



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|        |            
|------- | -----------
|ITEM 2. | PROPERTIES.

On April 30, 2004, we operated 368 nursing
facilities, 19 assisted living centers, 25 hospice and home care
centers and 10 outpatient clinics in 25 states and the
District of Columbia. Most of our 96 leased nursing facilities
are subject to net leases which require us 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. Renewal options typically extend the
original terms of the leases by five to fifteen years. Many of
these leases also contain purchase options. We consider our
physical properties to be in good operating condition and
suitable for the purposes for which they are being used. Certain
of our nursing facilities and assisted living centers are
included in the collateral securing our obligations under
various debt agreements. (See Item 8. 
Note 9.)

The following is a summary of our nursing
facilities, assisted living centers, hospice and home care
centers and outpatient clinics at April 30, 2004:

|                     |  |                    |     |                |  |         |        |          |  |         |    |            |  |  |     |  |  |  |    |  |  |  |    | 
|-------------------- |  | ------------------ | --- | -------------- |  | ------- | ------ | -------- |  | ------- | -- | ---------- |  |  | --- |  |  |  | -- |  |  |  | -- | 
|                     |  |                    |     |                |  |         |        |          |  |        
|                     |  | Nursing Facilities |     |                |  |         |        |         
|                     |  |                    |     | Assisted       |  |         |        |         
|                     |  |                    |     | Living Centers |  | Hospice |        |         
|                     |  |                    |     | Total          |  |         |        | and Home |  |        
|                     |  |                    |     | Licensed       |  |         |        | Total    |  | Care    |    | Outpatient
|Location             |  | Number             |     | Beds           |  | Number  |        | Units    |  | Centers |    | Clinics   
|                     |  |                    |     |                |  |         |        |          |  |         |    |           
|Alabama              |  |                    | 14  |                |  |         | 1,669  |          |  |         |   |            |  |  |    |  |  |  |   |  |  |  |   | 
|Arkansas             |  |                    | 29  |                |  |         | 3,572  |          |  |         | 2  |            |  |  | 48  |  |  |  |   |  |  |  |   | 
|California           |  |                    | 25  |                |  |         | 2,405  |          |  |         |   |            |  |  |    |  |  |  | 2  |  |  |  |   | 
|District of Columbia |  |                    | 1   |                |  |         | 355    |          |  |         |   |            |  |  |    |  |  |  |   |  |  |  |   | 
|Georgia              |  |                    | 13  |                |  |         | 1,595  |          |  |         | 2  |            |  |  | 72  |  |  |  | 1  |  |  |  |   | 
|Illinois             |  |                    | 3   |                |  |         | 275    |          |  |         |   |            |  |  |    |  |  |  |   |  |  |  |   | 
|Indiana              |  |                    | 27  |                |  |         | 3,221  |          |  |         |   |            |  |  |    |  |  |  | 1  |  |  |  |   | 
|Iowa                 |  |                    |    |                |  |         |       |          |  |         |   |            |  |  |    |  |  |  | 1  |  |  |  |   | 
|Kansas               |  |                    | 19  |                |  |         | 1,175  |          |  |         |   |            |  |  |    |  |  |  |   |  |  |  |   | 
|Kentucky             |  |                    | 8   |                |  |         | 1,039  |          |  |         |   |            |  |  |    |  |  |  |   |  |  |  |   | 
|Maryland             |  |                    | 4   |                |  |         | 585    |          |  |         | 1  |            |  |  | 19  |  |  |  |   |  |  |  |   | 
|Massachusetts        |  |                    | 18  |                |  |         | 2,048  |          |  |         |   |            |  |  |    |  |  |  |   |  |  |  |   | 
|Minnesota            |  |                    | 29  |                |  |         | 2,353  |          |  |         | 1  |            |  |  | 16  |  |  |  |   |  |  |  |   | 
|Mississippi          |  |                    | 10  |                |  |         | 1,149  |          |  |         |   |            |  |  |    |  |  |  |   |  |  |  |   | 
|Missouri             |  |                    | 18  |                |  |         | 1,728  |          |  |         | 3  |            |  |  | 105 |  |  |  | 2  |  |  |  |   | 
|Nebraska             |  |                    | 24  |                |  |         | 2,045  |          |  |         | 1  |            |  |  | 19  |  |  |  | 3  |  |  |  |   | 
|New Jersey           |  |                    | 1   |                |  |         | 140    |          |  |         |   |            |  |  |    |  |  |  |   |  |  |  |   | 
|North Carolina       |  |                    | 10  |                |  |         | 1,278  |          |  |         |   |            |  |  |    |  |  |  | 1  |  |  |  | 10 | 
|Ohio                 |  |                    | 9   |                |  |         | 1,222  |          |  |         |   |            |  |  |    |  |  |  |   |  |  |  |   | 
|Pennsylvania         |  |                    | 42  |                |  |         | 4,769  |          |  |         | 3  |            |  |  | 72  |  |  |  | 8  |  |  |  |   | 
|South Dakota         |  |                    | 17  |                |  |         | 1,167  |          |  |         | 1  |            |  |  | 36  |  |  |  |   |  |  |  |   | 
|Tennessee            |  |                    | 5   |                |  |         | 555    |          |  |         | 2  |            |  |  | 55  |  |  |  |   |  |  |  |   | 
|Texas                |  |                    |    |                |  |         |       |          |  |         |   |            |  |  |    |  |  |  | 3  |  |  |  |   | 
|Virginia             |  |                    | 14  |                |  |         | 1,840  |          |  |         | 3  |            |  |  | 84  |  |  |  |   |  |  |  |   | 
|West Virginia        |  |                    | 3   |                |  |         | 310    |          |  |         |   |            |  |  |    |  |  |  |   |  |  |  |   | 
|Wisconsin            |  |                    | 25  |                |  |         | 2,379  |          |  |         |   |            |  |  |    |  |  |  | 3  |  |  |  |   | 
|                     |  |                    |     |                |  |         |        |          |  |         |    |            |  |  |     |  |  |  |    |  |  |  |    | 
|                     |  |                    | 368 |                |  |         | 38,874 |          |  |         | 19 |            |  |  | 526 |  |  |  | 25 |  |  |  | 10 | 
|                     |  |                    |     |                |  |         |        |          |  |         |    |            |  |  |     |  |  |  |    |  |  |  |    | 

|               |  |  |     |  |  |  |        |  |  |  |    |  |  |  |     |  |  |  |    |  |  |  |    | 
|-------------- |  |  | --- |  |  |  | ------ |  |  |  | -- |  |  |  | --- |  |  |  | -- |  |  |  | -- | 
|Classification |  |  |     |  |  |  |        |  |  |  |    | 
|               |  |  |     |  |  |  |        |  |  |  |    | 
|Owned          |  |  | 272 |  |  |  | 28,315 |  |  |  | 17 |  |  |  | 425 |  |  |  |   |  |  |  |   | 
|Leased         |  |  | 96  |  |  |  | 10,559 |  |  |  | 2  |  |  |  | 101 |  |  |  | 25 |  |  |  | 10 | 
|               |  |  |     |  |  |  |        |  |  |  |    |  |  |  |     |  |  |  |    |  |  |  |    | 
|               |  |  | 368 |  |  |  | 38,874 |  |  |  | 19 |  |  |  | 526 |  |  |  | 25 |  |  |  | 10 | 
|               |  |  |     |  |  |  |        |  |  |  |    |  |  |  |     |  |  |  |    |  |  |  |    | 

21



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|        |                   
|------- | ------------------
|ITEM 3. | LEGAL PROCEEDINGS.

(a) As previously reported, the following
derivative lawsuits have been filed in the state court of
Arkansas, as well as the federal district court in Arkansas,
assertedly on our behalf (collectively, the Derivative
Actions):



| |   |                                                                                                                                                                                                                                                                             
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Norman M. Lyons v. David R. Banks,
    et. al.,Case No. OT99-4041,
    was filed in the Chancery Court of Pulaski County, Arkansas
    (4th Division) on or about July 29, 1999, and the
    parties filed an Agreed Motion to Stay the proceedings on
    January 17, 2000;
|
| |  | Badger v. David R. Banks, et. al.,Case No. LR-C-99-881, was filed
    in the United States District Court for the Eastern District of
    Arkansas (Western Division) on November 30, 1999; and                                                                             
|
| |  | Richardson v. David R. Banks,
    et. al.,Case
    No. LR-C-99-826, was filed in the United States District
    Court for the Eastern District of Arkansas (Western Division) on
    November 4, 1999.                                                                      

The Derivative Actions each name our directors as
defendants, as well as the Company as a nominal defendant. The
Lyons action also names as defendants certain of our current and
former officers. The Derivative Actions each allege breach of
fiduciary duties to the Company and its stockholders as a result
of alleged conduct giving rise to the Class Action. The
Lyons and Richardson actions also assert claims for abuse of
control and constructive fraud arising from the same allegations
and the Richardson action also claims unjust enrichment.

The Badger and Richardson actions were ordered to
be consolidated as In re Beverly Enterprises, Inc. Derivative
Litigationand by agreed motion, plaintiffs filed an
amended, consolidated complaint on April 21, 2000.
Defendants filed a motion to dismiss the consolidated derivative
complaint and a motion to strike portions thereof on
July 21, 2000. The parties agreed to stay the consolidated
action pending the outcome of the motion to dismiss in a former
class action suit. In light of the dismissal of the former class
action suit, the Court entered a Scheduling Order dated
July 17, 2003, which set a trial date of March 29,
2004, for this case. Defendants filed a motion to renew their
motion to dismiss on December 17, 2003. Subsequently, the
trial date was postponed based on the mutual agreement of the
parties. The parties have agreed on a settlement in principle
for these actions, which provides that we will incorporate
various corporate governance practices that are consistent with
our policies. In addition, the directors and officers
liability insurance carriers, on behalf of the individual
defendants, will pay no more than $375,000 for plaintiffs
attorneys fees.

(b) On August 16, 2002, August 26,
2002, and September 26, 2002, respectively, Ernest
Baer v. Beverly Enterprises, Inc., et. al. (CIV.
No. 02-2190), Stanley V. Kensic v. Beverly Enterprises,
Inc., et. al. (CIV. No. 02-2193) and Charles
Krebs v. Beverly Enterprises, Inc., et. al. (CIV.
No. 02-2222) were filed in the United States District Court,
Western District of Arkansas, Fort Smith Division. These
cases were filed as purported securities fraud class actions
under Sections 10(b) and 20(a) of the Securities Exchange
Act of 1934 and Rule 10b-5.

These cases separately name Beverly Enterprises,
Inc. as a defendant along with various current officers and our
independent auditors. In all three cases, the purported class
period runs from October 16, 2000 to and including
July 19, 2002. Plaintiffs claim that the defendants, during
the purported class period, made multiple false and misleading
statements. In early March 2003, these cases were consolidated
as In re Beverly Enterprises, Inc. Securities Litigation.
On April 30, 2003, plaintiffs filed an amended complaint.
On May 30, 2003, the defendants filed a motion to dismiss
the amended complaint. Briefing on the motion to dismiss was
completed July 11, 2003. The court heard oral arguments on
the defendants motion on August 28, 2003. On
December 23, 2003, the court granted defendants
motions to dismiss with prejudice and denied plaintiffs
motion to amend the complaint. Plaintiffs filed a notice of
appeal on January 22, 2004. On April 2, 2004,
plaintiffs and defendants jointly moved to dismiss the appeal
with prejudice and on April 19, 2004, the court dismissed
the action.

(c) On October 31, 2002, a shareholder
derivative action entitled Paul Dunne and Helene Dunne,
derivatively on behalf of nominal defendant Beverly Enterprises,
Inc. v. Beryl F. Anthony, Jr., et. al. was
filed in the Circuit Court of Sebastian County, Arkansas,
Fort Smith Division (No. CIV-2002-1241). This case is

22



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purportedly brought derivatively on our behalf
against various current and former officers and directors. The
complaint alleges causes of action for breach of fiduciary duty
against the defendants based on: (1) allegations that defendants
failed to establish and maintain adequate accounting controls
such that we failed to record adequate reserves for patient care
liability costs; and (2) allegations that certain
defendants sold Company stock while purportedly in possession of
material non-public information. On May 16, 2003, two
additional derivative complaints (Holcombe v. Floyd,
et. al. and Flowers v. Floyd, et. al.)
were filed and subsequently transferred to the Circuit Court of
Sebastian County, Arkansas, Fort Smith Division and
consolidated with the Dunne action as Holcomb v. Beverly
Enterprises, Inc. The Dunnes were subsequently dismissed as
plaintiffs.


On June 9, 2003, pursuant to a stipulation
of the parties, the Court entered a Scheduling Order providing,
among other things, that plaintiffs will have thirty days from a
ruling on the motion to dismiss filed by defendants in the
related securities class action in federal court, In re
Beverly Enterprises, Inc. Securities Litigation(Case
No. 2:02 cv 2190), to file an amended complaint and that
defendants shall have thirty days thereafter to respond to the
complaint. The court entered a ruling on the defendants
motion to dismiss in the federal securities class action on
December 23, 2003, and the plaintiffs filed a notice of
appeal on January 22, 2004. In light of the
plaintiffs appeal, the parties agreed to a further stay of
this derivative action pending resolution of the appeal. The
dismissal of the appeal on April 19, 2004, described in
paragraph (b) above, began the thirty-day period for
plaintiffs to file an amended complaint in the derivative
action, which they declined to do. Defendants response to
the complaint is currently due on June 19, 2004. Due to the
preliminary state of this action, we are unable to assess the
probable outcome of the case and can give no assurance of the
ultimate impact on our financial position, results of operations
and cash flows.

(d) In 2002, we notified federal and
California healthcare regulatory authorities (Centers for
Medicare and Medicaid Services, Office of Inspector General, the
California Attorney Generals office and the California
Department of Health) of our intent to conduct an internal
investigation of past billing practices relating to MK Medical,
our former medical equipment business unit based in Fresno,
California. An independent accounting firm has reviewed MK
Medicals government payor billings since October 1,
1998, the date Beverly acquired the business unit. Deficiencies
identified by the accounting firm primarily relate to inadequate
documentation supporting Medicare and Medi-Cal claims for
reimbursement for drugs, wheelchairs, and other durable medical
equipment distributed by MK Medical. Specifically, the review
identified instances of missing or incomplete certificates of
medical necessity, treatment authorization requests,
prescriptions and other documentation MK Medical is required to
maintain in order to be entitled to reimbursement from
government payors. Based on the results of the accounting
firms review, we established a reserve in 2002, included
in Other accrued liabilities on the consolidated
balance sheets in the amount of $18.0 million to cover
potential overpayments from government payors for the period
from October 1, 1998 to 2002. We have advised regulatory
authorities of the results of the accounting firms review.
On September 15, 2003, we received a subpoena from the
United States Attorneys Office in Oakland, California,
requesting the production of additional documents relating to MK
Medicals operations and our review of MK Medicals
claims. We have produced documents in response to this subpoena
and continue to cooperate with the governments request for
information. Our liability with respect to this matter could
exceed the reserved amount, which continues to be our best
estimate of our exposure on this matter. We can give no
assurance of the final outcome of this matter or its impact on
our financial position, results of operations and cash flows.

(e) We are party to various legal matters
relating to patient care, including claims that our services
have resulted in injury or death to residents of our facilities.
Over the past few years, we have experienced an increasing trend
in the number and severity of the claims asserted against us. We
believe that there has been, and will continue to be, an
increase in governmental investigations of long-term care
providers. Adverse determinations in legal proceedings or
governmental investigations, whether currently asserted or
arising in the future, could have a material adverse effect on
us.

(f) There are various other lawsuits and
regulatory actions pending against us arising in the normal
course of business, some of which seek punitive damages that are
generally not covered by insurance. We do not believe that the
ultimate resolution of such other matters will have a material
adverse effect on our consolidated financial position, results
of operations or cash flows.

23



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##### Table of Contents








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

There were no matters submitted to a vote of our
security holders during the last quarter of our fiscal year
ended December 31, 2003.

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##### Table of Contents






PART II






|        |                                                                            
|------- | ---------------------------------------------------------------------------
|ITEM 5. | MARKET FOR THE COMPANYS COMMON EQUITY
    AND RELATED STOCKHOLDER MATTERS.

Our common stock is listed on the New York and
Pacific Stock Exchanges under the symbol BEV. The
table below sets forth, for the periods indicated, the range of
high and low sales prices of our common stock as reported on the
New York Stock Exchange composite tape.

|     |                                 |        |   |      |  |  |   |      | 
|---- | ------------------------------- | ------ | - | ---- |  |  | - | ---- | 
|     |                                 |       
|     |                                 | Prices
|     |                                 |       
|     |                                 | High   |   | Low 
|     |                                 |        |   |     
|2002 |                                 |        |   |      |  |  |   |     
|     | First Quarter                   |        | $ | 9.50 |  |  | $ | 5.66 | 
|     | Second Quarter                  |        |   | 9.18 |  |  |   | 6.95 | 
|     | Third Quarter                   |        |   | 7.95 |  |  |   | 1.90 | 
|     | Fourth Quarter                  |        |   | 3.89 |  |  |   | 1.60 | 
|2003 |                                 |        |   |      |  |  |   |     
|     | First Quarter                   |        | $ | 3.00 |  |  | $ | 1.63 | 
|     | Second Quarter                  |        |   | 4.30 |  |  |   | 1.80 | 
|     | Third Quarter                   |        |   | 6.99 |  |  |   | 3.71 | 
|     | Fourth Quarter                  |        |   | 8.60 |  |  |   | 5.06 | 
|2004 |                                 |        |   |      |  |  |   |     
|     | First Quarter                   |        | $ | 8.96 |  |  | $ | 5.84 | 
|     | Second Quarter (through June 8) |        |   | 8.85 |  |  |   | 5.83 | 

On May 31, 2004, there were 4,950 record
holders of our common stock.

We are subject to certain restrictions under our
long-term debt agreements related to the payment of cash
dividends on our common stock. We have not paid any cash
dividends on our common stock since 1987, and no future
dividends are currently planned. In deciding whether to propose
a dividend and determining the dividend amount, our Board of
Directors would take into account such matters as the
availability of funds for dividends, general business
conditions, our financial results, other capital requirements,
contractual, legal and regulatory restrictions on the payment of
dividends to our stockholders and such other factors as our
Board of Directors may deem relevant.

25



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##### Table of Contents








|        |                         
|------- | ------------------------
|ITEM 6. | SELECTED FINANCIAL DATA.

The following table of selected financial data
should be read along with our consolidated financial statements
and related notes for 2003, 2002 and 2001 included in
Item 8. Consolidated Financial Statements and Supplementary
Data.

|                                                                                                                                            |                                                                                                 |                                                                                               |                           |           |         |           |           |           |         |           |           |           |         |           |           |           |         |           |           |           |         |           |  
|------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------- | ------------------------- | --------- | ------- | --------- | --------- | --------- | ------- | --------- | --------- | --------- | ------- | --------- | --------- | --------- | ------- | --------- | --------- | --------- | ------- | --------- | -
|                                                                                                                                            |                                                                                                 |                                                                                              
|                                                                                                                                            |                                                                                                 | At or for the Years Ended December 31,                                                       
|                                                                                                                                            |                                                                                                 |                                                                                              
|                                                                                                                                            |                                                                                                 | 2003(1)                                                                                       |                           | 2002(1)   |         | 2001(1)   |           | 2000(1)   |         | 1999(1)  
|                                                                                                                                            |                                                                                                 |                                                                                               |                           |           |         |           |           |           |         |          
|                                                                                                                                            |                                                                                                 |                                                                                              
|                                                                                                                                            |                                                                                                 | (Dollars in thousands, except per share data)                                                
|Consolidated Statement of Operations
    Data:                                                                                              |                                                                                                 |                                                                                               |                           |           |         |           |           |           |         |           |           |           |         |           |           |           |         |           |           |          
|Revenues                                                                                                                                    |                                                                                                 | $                                                                                             | 1,979,759                 |           |         | $         | 1,941,313 |           |         | $         | 2,127,795 |           |         | $         | 2,062,229 |           |         | $         | 1,945,404 |          
|Costs and expenses:                                                                                                                         |                                                                                                 |                                                                                               |                           |           |         |           |           |           |         |           |           |           |         |           |           |           |         |           |           |          
|                                                                                                                                            | Wages and related                                                                               |                                                                                               |                           | 1,178,926 |         |           |           | 1,168,789 |         |           |           | 1,300,527 |         |           |           | 1,274,071 |         |           |           | 1,230,574 |        
|                                                                                                                                            | Provision for insurance and related items                                                       |                                                                                               |                           | 125,871   |         |           |           | 93,657    |         |           |           | 82,286    |         |           |           | 107,258   |         |           |           | 78,740    |        
|                                                                                                                                            | Other operating and administrative                                                              |                                                                                               |                           | 524,785   |         |           |           | 513,789   |         |           |           | 560,424   |         |           |           | 590,364   |         |           |           | 519,445   |        
|                                                                                                                                            | Depreciation and amortization                                                                   |                                                                                               |                           | 59,318    |         |           |           | 65,927    |         |           |           | 66,952    |         |           |           | 73,919    |         |           |           | 74,679    |        
|                                                                                                                                            | Florida insurance reserve adjustment                                                            |                                                                                               |                           |          |         |           |           | 22,179    |         |           |           |          |         |           |           |          |         |           |           |          |        
|                                                                                                                                            | Special charge and adjustment related to
    California investigation settlement                |                                                                                               |                           | (925      | )       |           |           | 6,300     |         |           |           |          |         |           |           |          |         |           |           |          |        
|                                                                                                                                            | Special charges and adjustments related to
    settlements of federal government investigations |                                                                                               |                           |          |         |           |           | (9,441    | )       |           |           | 77,495    |         |           |           |          |         |           |           | 202,447   |        
|                                                                                                                                            | Asset impairments, workforce reductions and other
    unusual items                             |                                                                                               |                           | 5,596     |         |           |           | 54,829    |         |           |           | 182,028   |         |           |           | 16,895    |         |           |           | 23,177    |        
|                                                                                                                                            | Year 2000 remediation                                                                           |                                                                                               |                           |          |         |           |           |          |         |           |           |          |         |           |           |          |         |           |           | 12,402    |        
|                                                                                                                                            |                                                                                                 |                                                                                               |                           |           |         |           |           |           |         |           |           |           |         |           |           |           |         |           |           |          
|                                                                                                                                            |                                                                                                 |                                                                                               | Total costs and expenses  |           |         | 1,893,571 |           |           |         | 1,916,029 |           |           |         | 2,269,712 |           |           |         | 2,062,507 |           |           |         | 2,141,464 |  
|                                                                                                                                            |                                                                                                 |                                                                                               |                           |           |         |           |           |           |         |           |           |           |         |           |           |           |         |           |           |          
|Income (loss) before other income (expenses)                                                                                                |                                                                                                 |                                                                                               | 86,188                    |           |         |           | 25,284    |           |         |           | (141,917  | )         |         |           | (278      | )         |         |           | (196,060  | )        
|                                                                                                                                            | Other income (expenses):                                                                        |                                                                                               |                           |           |         |           |           |           |         |           |           |           |         |           |           |           |         |           |           |           |        
|                                                                                                                                            |                                                                                                 | Interest expense                                                                              |                           |           | (63,904 | )         |           |           | (63,226 | )         |           |           | (75,035 | )         |           |           | (75,678 | )         |           |           | (69,011 | )        
|                                                                                                                                            |                                                                                                 | Costs related to early extinguishments of debt                                                |                           |           | (6,634  | )         |           |           |        |           |           |           |        |           |           |           | (354    | )         |           |           | (619    | )        
|                                                                                                                                            |                                                                                                 | Interest income                                                                               |                           |           | 5,365   |           |           |           | 4,690   |           |           |           | 2,916   |           |           |           | 2,485   |           |           |           | 4,198   |          
|                                                                                                                                            |                                                                                                 | Net gains (losses) on dispositions                                                            |                           |           | 422     |           |           |           | 2,149   |           |           |           | 696     |           |           |           | 2,433   |           |           |           | (4,007  | )        
|                                                                                                                                            |                                                                                                 | Gains on sales of equity investments                                                          |                           |           | 6,686   |           |           |           |        |           |           |           | 256     |           |           |           | 1,477   |           |           |           |        |          
|                                                                                                                                            |                                                                                                 |                                                                                               |                           |           |         |           |           |           |         |           |           |           |         |           |           |           |         |           |           |          
|                                                                                                                                            |                                                                                                 |                                                                                               | Total other expenses, net |           |         | (58,065   | )         |           |         | (56,387   | )         |           |         | (71,167   | )         |           |         | (69,637   | )         |           |         | (69,439   | )
|                                                                                                                                            |                                                                                                 |                                                                                               |                           |           |         |           |           |           |         |           |           |           |         |           |           |           |         |           |           |          
|Income (loss) before provision for income taxes,
    discontinued operations and cumulative effect of change in
    accounting for goodwill |                                                                                                 |                                                                                               | 28,123                    |           |         |           | (31,103   | )         |         |           | (213,084  | )         |         |           | (69,915   | )         |         |           | (265,499  | )        
|Provision for (benefit from) income taxes                                                                                                   |                                                                                                 |                                                                                               | 5,069                     |           |         |           | 6,085     |           |         |           | 60,132    |           |         |           | (25,450   | )         |         |           | (100,185  | )        
|                                                                                                                                            |                                                                                                 |                                                                                               |                           |           |         |           |           |           |         |           |           |           |         |           |           |           |         |           |           |          
|Income (loss) before discontinued operations and
    cumulative effect of change in accounting for goodwill                                 |                                                                                                 |                                                                                               | 23,054                    |           |         |           | (37,188   | )         |         |           | (273,216  | )         |         |           | (44,465   | )         |         |           | (165,314  | )        
|Discontinued operations, net of taxes of
    2003  $3,378; 2002  $0; 2001 
    $1,256; 2000  $3,188; and 1999  $21,106                 |                                                                                                 |                                                                                               | 57,414                    |           |         |           | (31,731   | )         |         |           | (28,056   | )         |         |           | (10,037   | )         |         |           | 30,667    |          
|Cumulative effect of change in accounting for
    goodwill, net of income taxes of $0(2)                                                    |                                                                                                 |                                                                                               |                          |           |         |           | (77,171   | )         |         |           |          |           |         |           |          |           |         |           |          |          
|                                                                                                                                            |                                                                                                 |                                                                                               |                           |           |         |           |           |           |         |           |           |           |         |           |           |           |         |           |           |          
|Net income (loss)                                                                                                                           |                                                                                                 | $                                                                                             | 80,468                    |           |         | $         | (146,090  | )         |         | $         | (301,272  | )         |         | $         | (54,502   | )         |         | $         | (134,647  | )        
|                                                                                                                                            |                                                                                                 |                                                                                               |                           |           |         |           |           |           |         |           |           |           |         |           |           |           |         |           |           |          
|Basic and diluted net income (loss) per share of
    common stock:                                                                          |                                                                                                 |                                                                                               |                           |           |         |           |           |           |         |           |           |           |         |           |           |           |         |           |           |          
|                                                                                                                                            |                                                                                                 | Before discontinued operations and cumulative
    effect of change in accounting for goodwill |                           | $         | 0.22    |           |           | $         | (0.36   | )         |           | $         | (2.63   | )         |           | $         | (0.43   | )         |           | $         | (1.61   | )        
|                                                                                                                                            |                                                                                                 | Discontinued operations, net of taxes                                                         |                           |           | 0.53    |           |           |           | (0.29   | )         |           |           | (0.27   | )         |           |           | (0.10   | )         |           |           | 0.30    |          
|                                                                                                                                            |                                                                                                 | Cumulative effect of change in accounting for
    goodwill, net of taxes                      |                           |           |        |           |           |           | (0.74   | )         |           |           |        |           |           |           |        |           |           |           |        |          
|                                                                                                                                            |                                                                                                 |                                                                                               |                           |           |         |           |           |           |         |           |           |           |         |           |           |           |         |           |           |          
|                                                                                                                                            |                                                                                                 | Net income (loss) per share of common stock                                                   |                           | $         | 0.75    |           |           | $         | (1.39   | )         |           | $         | (2.90   | )         |           | $         | (0.53   | )         |           | $         | (1.31   | )        
|                                                                                                                                            |                                                                                                 |                                                                                               |                           |           |         |           |           |           |         |           |           |           |         |           |           |           |         |           |           |          
|                                                                                                                                            |                                                                                                 | Shares used to compute basic net income (loss)
    per share                                  |                           |           | 106,582 |           |           |           | 104,726 |           |           |           | 104,037 |           |           |           | 102,452 |           |           |           | 102,491 |          
|                                                                                                                                            |                                                                                                 |                                                                                               |                           |           |         |           |           |           |         |           |           |           |         |           |           |           |         |           |           |          
|                                                                                                                                            |                                                                                                 | Shares used to compute diluted net income (loss)
    per share                                |                           |           | 106,920 |           |           |           | 104,726 |           |           |           | 104,037 |           |           |           | 102,452 |           |           |           | 102,491 |          
|                                                                                                                                            |                                                                                                 |                                                                                               |                           |           |         |           |           |           |         |           |           |           |         |           |           |           |         |           |           |          
|Other Financial Data:                                                                                                                       |                                                                                                 |                                                                                               |                           |           |         |           |           |           |         |           |           |           |         |           |           |           |         |           |           |          
|Cash flow from operations                                                                                                                   |                                                                                                 | $                                                                                             | 69,861                    |           |         | $         | 116,633   |           |         | $         | 220,897   |           |         | $         | 37,010    |           |         | $         | 189,141   |          
|Capital expenditures                                                                                                                        |                                                                                                 |                                                                                               | 43,984                    |           |         |           | 100,103   |           |         |           | 89,401    |           |         |           | 76,027    |           |         |           | 95,414    |          
|Consolidated Balance Sheet Data:                                                                                                            |                                                                                                 |                                                                                               |                           |           |         |           |           |           |         |           |           |           |         |           |           |           |         |           |           |          
|Total assets                                                                                                                                |                                                                                                 | $                                                                                             | 1,346,421                 |           |         | $         | 1,349,895 |           |         | $         | 1,681,070 |           |         | $         | 1,875,993 |           |         | $         | 1,982,880 |          
|Current portion of long-term debt                                                                                                           |                                                                                                 |                                                                                               | 13,354                    |           |         |           | 41,463    |           |         |           | 64,231    |           |         |           | 227,111   |           |         |           | 34,052    |          
|Long-term debt, excluding current portion                                                                                                   |                                                                                                 |                                                                                               | 552,873                   |           |         |           | 588,714   |           |         |           | 677,442   |           |         |           | 564,247   |           |         |           | 746,164   |          
|Total stockholders equity                                                                                                                  |                                                                                                 |                                                                                               | 238,186                   |           |         |           | 153,472   |           |         |           | 296,497   |           |         |           | 583,993   |           |         |           | 641,124   |          
|Other Data:                                                                                                                                 |                                                                                                 |                                                                                               |                           |           |         |           |           |           |         |           |           |           |         |           |           |           |         |           |           |          
|Average occupancy(3)                                                                                                                        |                                                                                                 |                                                                                               | 88.2                      | %         |         |           | 87.9      | %         |         |           | 86.6      | %         |         |           | 86.5      | %         |         |           | 86.7      | %        



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The operations of Matrix, MK Medical, Care Focus,
    84 nursing facilities and seven assisted living centers have
    been reclassified as discontinued operations for all periods
    presented, including four nursing facilities and a home medical
    equipment business disposed of during the three months ended
    March 31, 2004, since they met the applicable criteria
    under Statement of Financial Accounting Standards No. 144,
    Accounting for the Impairment or Disposal of Long-Lived Assets.
|   
|(2) | Includes a $77.2 million goodwill impairment
    charge relating to the 2002 adoption of Statement of Financial
    Accounting Standards No. 142, Goodwill and Other Intangible
    Assets.                                                                                                                                                                                                                                                                                                                           
|   
|(3) | Calculated by dividing the nursing
    facilities actual patient days by available patient days
    from continuing operations. Available patient days are
    calculated by multiplying total calendar days by the number of
    beds that are operationally ready for use.                                                                                                                                                                                                                                         

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|        |                                                                                           
|------- | ------------------------------------------------------------------------------------------
|ITEM 7. | MANAGEMENTS DISCUSSION AND ANALYSIS OF
    FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

General

Our business consists principally of providing
healthcare services, including the operation of nursing
facilities, assisted living centers, hospice and home care
centers, outpatient clinics and rehabilitation therapy services.
We are one of the largest operators of nursing facilities in the
United States. As of April 30, 2004, we operated 368
nursing facilities with a total of 38,874 licensed beds. Our
nursing facilities are located in 23 states and the
District of Columbia and range in capacity from 24 to 355
licensed beds. As of April 30, 2004, we also operated 19
assisted living centers containing 526 units, 25 hospice
and home care centers, and 10 outpatient clinics. Our operations
also include rehabilitation therapy services in 35 states
and the District of Columbia.

Operations and Services

Our operations are currently organized into three
primary operating segments: Nursing Facilities, Aegis Therapies
and Home Care.

Nursing Facilities.Our Nursing Facilities operations provide long-term
healthcare and rehabilitation services through the operation of
skilled nursing facilities and assisted living centers and
accounted for approximately 92% of our revenues for the three
months ended March 31, 2004 and approximately 94% for the
year ended December 31, 2003. Our facilities provide
residents with routine long-term care services, including daily
nursing, dietary, social and recreational services and a full
range of pharmacy services and medical supplies. Our skilled
nursing staff also provides complex and intensive medical
services to residents with higher acuity needs outside the
traditional acute-care hospital setting. We have designed our
assisted living centers to provide residents with a greater
degree of independence while still offering routine services
and, if required, limited medical care.

Aegis Therapies.Our
Aegis operations provide rehabilitation therapy services under
contract to our nursing facilities, as well as 547 third-party
customers as of March 31, 2004, and accounted for
approximately 5% of our revenues for the three months ended
March 31, 2004 and approximately 4% as of December 31,
2003. Aegis offers occupational, physical and speech therapy
services designed to maximize function and independence, assist
in recovery from medical conditions and compensate for remaining
disabilities.

Home Care.Our Home
Care operations primarily provide hospice services within our
nursing facilities, in facilities operated by other healthcare
providers and in patients homes and accounted for
approximately 2% of our revenues for the three months ended
March 31, 2004 and the year ended December 31, 2003.
Our hospice services include palliative care for terminally ill
patients, as well as pastoral, counseling and bereavement
services for the families of hospice patients.

In addition, we derived approximately 1% of our
revenues for the three months ended March 31, 2004 from
certain new business ventures, including pharmacy consulting
services, and the sale of procurement-related services.

Governmental Regulation

We are subject to extensive regulation by
federal, state and local agencies. Each of our facilities must
comply with regulations regarding staffing levels, patient care
standards, occupational health and safety, patient
confidentiality, billing and reimbursement, as well as
environmental and biological hazards, among others.
Additionally, government agencies have steadily increased their
enforcement activity in this industry over the past several
years, particularly with respect to large for-profit,
multi-facility providers like us. This regulatory environment
may force us to expend considerable resources to ensure
compliance and respond to inspections, investigations or other
enforcement actions. We believe the government will continue
aggressive enforcement in the future.

27



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##### Table of Contents



On February 3, 2000, we entered into a
series of separate agreements with the Office of Inspector
General (OIG) of the Department of Health and Human
Services (HHS). Under the civil settlement
agreement, we paid the federal government $25.0 million
during the first quarter of 2000 and agreed to reimburse the
federal government an additional $145.0 million through
withholdings from our biweekly Medicare periodic interim
payments in equal installments ending in the first quarter of
2008. As of March 31, 2004, the present value of the
remaining obligation was $58.4 million. As a result of such
withholdings, our cash flows from operations were negatively
impacted by $4.9 million for the three months ended
March 31, 2004, and $18.1 million during the year
ended December 31, 2003, and are expected to be negatively
impacted at an annual rate of $18.1 million.

As part of this series of agreements, we entered
into a Corporate Integrity Agreement with the OIG. This
agreement requires that we monitor, on an ongoing basis, our
compliance with the requirements of the federal healthcare
programs. This agreement addresses our obligations to ensure
that we comply with the requirements of participation in the
federal healthcare programs. It also includes functional and
training obligations, audit and review requirements and record
keeping and reporting requirements. In 2002, certain revisions
were made to our Corporate Integrity Agreement to reflect a
permanent injunction requiring our nursing facilities in
California to conduct additional training programs and to hire
an independent quality monitor for our nursing facilities in
California, Arizona, Hawaii and Washington to assess our quality
care systems. By March 31, 2004, we had divested all of our
nursing facilities in Arizona, Washington and Hawaii and a
substantial portion of our nursing facilities in California. In
April 2004, additional revisions were made to our Corporate
Integrity Agreement to extend the services of the quality
monitor to all of our nursing facilities and to reflect a
modification of the requirements under the agreement with
respect to training and education.

In the ordinary course of business, we
periodically receive notices of deficiencies for allegations of
failure to comply with various regulatory requirements. We
review all such notices and believe we take timely and
appropriate corrective action. In most cases, the facility and
the government will agree upon steps to be taken to bring the
facility into compliance with regulatory requirements. In some
cases or upon repeat violations, the government may take a
number of adverse actions against the facility or us, including
imposition of fines, temporary suspension of admission of new
patients, decertification from participation in Medicare or
Medicaid programs and licensure revocation. (See Item 1.
Business.)

Critical Accounting Policies

The accompanying consolidated financial
statements have been prepared in conformity with
U.S. generally accepted accounting principles. The
accounting policies discussed below are considered by management
to be critical to an understanding of our financial statements
because their application requires significant judgment and
reliance on estimations of matters that are inherently
uncertain. Certain risks related to these critical accounting
policies are described in the following paragraphs.



| |                                                                                  
| | ---------------------------------------------------------------------------------
| | Revenue Recognition, Accounts Receivable
    and Allowances for Doubtful Accounts

Our revenues are derived primarily from providing
long-term healthcare services. Approximately 80% of our current
revenues is derived from federal and state healthcare programs
(primarily Medicare and Medicaid). As discussed more fully in
Item 8  Note 1, we record revenues when
services are provided at standard charges adjusted to amounts
estimated to be received under governmental programs or other
third-party contractual arrangements based on contractual terms
and historical experience.

All providers participating in the Medicare and
Medicaid programs are required to meet certain financial cost
reporting requirements. Federal and state regulations generally
require the submission of annual cost reports covering revenues,
costs and expenses associated with the services provided to
Medicare beneficiaries and Medicaid recipients. Annual cost
reports are subject to routine audits and retroactive
adjustments. These audits often require several years to reach
the final determination of amounts due to, or by, us under these
programs.

As adjustments to recorded revenues become known
or as cost reporting years are no longer subject to audits,
reviews or investigations, the amounts of our revenues and
receivables are revised. Our revenues are

28



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##### Table of Contents



reported at their estimated net realizable
amounts, and we believe adequate provision has been made to
reflect any adjustments that could result from audits of cost
reports. However, due to the complexity of the laws and
regulations governing the Medicare and Medicaid programs, there
is at least a possibility that recorded estimates will change by
a material amount in the near term. Changes in estimates related
to third party receivables resulted in an increase in revenues
of approximately $8.7 million and $745,000 for the years
ended December 31, 2003 and 2002, respectively, and a
decrease in revenues of approximately $2.0 million for the
year ended December 31, 2001.


Compliance with laws and regulations governing
the Medicare and Medicaid programs is subject to government
review and interpretation, as well as significant regulatory
action including fines, penalties, and possible exclusion from
the Medicare and Medicaid programs. In addition, under the
Medicare program, if the federal government makes a formal
demand for reimbursement, even related to contested items,
payment must be made for those items before the provider is
given an opportunity to appeal and resolve the issue.

We record bad debt expense monthly as a
percentage of revenue reflecting our historical experience. Each
quarter we adjust the allowance for doubtful accounts according
to the aging and payor mix of the receivables. These adjustments
are based on our weighted average collection experience by payor
type, and recognize the relative risk depending on the source of
the expected payment. Private pay accounts usually represent our
highest collectibility risk. In addition, specific accounts that
are determined to be uncollectible (due to bankruptcy,
insufficient documentation, lack of third-party coverage or
financial resources and the like) are fully reserved when such
determinations are made. We write-off uncollectible accounts
receivable after all collection efforts have been exhausted and
we determine they will not be collected. If circumstances change
(including, but not limited to: economic downturn; higher than
expected defaults or denials; reduced collections; and changes
in our payor mix), our estimates of the recoverability of our
receivables could be reduced by a material amount.

Our provisions for bad debts represented 1.1%,
2.9% and 2.1% of revenues from continuing operations for the
years ended December 31, 2003, 2002 and 2001, respectively.
Our allowance for doubtful accounts represented approximately
17% and 20% of patient accounts receivable at December 31,
2003 and 2002, respectively. Our allowance for doubtful accounts
represented 127% and 121% of accounts over 180 days old as
of December 31, 2003 and 2002, respectively. Accounts
receivable for our Nursing Facilities segment have continued to
decline in 2003, our aging of receivables has improved and our
cash collections continue to be in line with, or ahead of, our
generated revenues. These factors have led to a decrease in our
provision for bad debts and a reduction in our allowance for
doubtful accounts in 2003. We believe adequate provision has
been made for receivables that may prove to be uncollectible.



| |                                                     
| | ----------------------------------------------------
| | Patient Care Liability and Other Insurance
    Risks

General and professional liability costs for the
long-term healthcare industry have become increasingly expensive
and difficult to estimate. In addition, insurance coverage for
patient care liability and certain other risks, for nursing
facilities specifically and companies in general, has become
increasingly difficult to obtain. When obtained, insurance
carriers are often requiring companies to significantly increase
their liability retention levels and pay substantially higher
premiums for reduced terms of coverage. The majority of our
workers compensation and auto liability risks are insured
through loss-sensitive insurance policies with affiliated and
unaffiliated insurance companies. For our general and
professional liabilities, we are responsible for the first
dollar of each claim, up to a self-insurance limit determined by
the individual policies, subject to aggregate limits in certain
prior policy years.

We have purchased insurance for workers
compensation, property, casualty and other risks from numerous
insurance companies. In many cases, the policies provide
coverage for events occurring in specific time frames that may
only be determined in later years. We evaluate our purchased
insurance coverage for risk transfer and believe our
occurrence-based insurance policies have sufficiently
transferred the risk of loss to the insurance carriers we
utilize. As a result, we do not recognize a liability in our
consolidated financial statements for amounts covered by
insurance.

29



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##### Table of Contents



We exercise care in selecting companies from
which we purchase insurance, including review of published
ratings by recognized rating agencies, advice from national
brokers and consultants and review of trade information sources.
There exists a risk that any of these insurance companies may
become insolvent and unable to fulfill their obligation to
defend, pay or reimburse us when that obligation becomes due. In
several prior policy years, losses exceed our self-insurance
aggregate limits. For claims relating to these years, our
insurers have assumed a more significant role in handling the
claims or related obligations and settlements. As a result, it
is more difficult to estimate potential losses in those years.
However, we expect any losses in those years to be covered by
our insurers. Although we believe the companies we have
purchased insurance from are solvent, in light of the dramatic
changes occurring in the insurance industry in recent years, we
cannot assure you that they will remain solvent and able to
fulfill their obligations.

Our liabilities for general, professional and
workers compensation risks are estimated by our
independent actuaries twice a year using the most recent trends
of claims, settlements and other relevant data. On an
undiscounted basis, these liabilities totaled
$203.7 million at December 31, 2003. On our financial
statements, these liabilities are discounted at 10% to their
present value using actuarially determined loss payment timing
patterns. The discount rate is based upon our best estimate of
the incremental borrowing rate that would be required to fund
these liabilities with uncollateralized debt. A reduction in the
discount rate by one-half of a percentage point would have
resulted in an additional pre-tax charge of $1.8 million
for the year ended December 31, 2003. Based on information
provided by our independent actuaries, we estimate our range of
discounted exposure for these liabilities to be
$152.5 million to $179.4 million. At December 31,
2003, our recorded reserves for these liabilities totaled
$159.9 million. We believe adequate provision has been made
in the financial statements for liabilities that may arise out
of patient care and other services.



| |                  
| | -----------------
| | Asset Impairments

We recorded pre-tax asset impairment charges from
continuing operations of $2.1 million, $49.9 million
and $98.9 million for the years ended December 31,
2003, 2002 and 2001, respectively. We also recorded impairments
of goodwill of $77.2 million in 2002 as the cumulative
effect of an accounting change in accordance with Statement of
Financial Accounting Standards No. 142, Goodwill and
Other Intangible Assets(SFAS No. 142). We evaluate our
long-lived assets for impairment whenever indicators of
impairment exist, in accordance with Statement of Financial
Accounting Standards No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets(SFAS No. 144). These indicators of
impairment can include, but are not limited to, the following:



| |   |                                                                   
| | - | ------------------------------------------------------------------
| |  | a history of operating losses, with expected
    future losses;   
|
| |  | changes in the regulatory environment affecting
    reimbursement;
|
| |  | decreases in cash flows or cash flow deficiencies;                
|
| |  | changes in the way an asset is used in the
    business; and      
|
| |  | commitment to a plan to sell or otherwise dispose
    of an asset.

During 2003, a history of operating losses, with
expected future losses, and cash flow deficiencies led to
impairments on three facilities in our Nursing Facilities
segment. During 2002, changes in the regulatory environment
affecting Medicare reimbursement led to a long-lived asset
impairment analysis on our Nursing Facilities segment. During
2001, continuing operating losses in several of our lines of
business, including certain outpatient clinics, our managed care
contracting entity, certain Home Care businesses and a few of
our nursing facilities, led to impairment analyses on these
assets.

These impairment analyses included:



| |   |                                                                                                                                                                                                              
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | estimating the undiscounted cash flows to be
    generated by each clinic, unit, facility or property, primarily
    over the remaining life of the primary asset; and                                       
|
| |  | reducing the carrying value of the asset to the
    estimated fair value when the total estimated undiscounted cash
    flows was less than the carrying value of the clinic, unit,
    facility or property.

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In estimating the undiscounted cash flows for our
nursing facilities, we primarily used our internally prepared
budgets and forecast information, with certain probability
adjustments, including, but not limited to, the following items:
Medicare and Medicaid funding; overhead costs; capital
expenditures; and patient care liability costs. In order to
estimate the fair values of the nursing facilities, we used a
discounted cash flow approach, supplemented by public resource
information on valuations of nursing facility sales transactions
by region of the country. Where the estimated undiscounted cash
flows were negative, we estimated the fair values based on
discounted public resource information, sales values or
estimated salvage values. For other lines of business that lack
significant property investments, we discounted the next five
years of expected cash flows. A substantial decline in the
estimated future cash flows for these facilities or businesses
could materially change the estimated fair values of these
assets, possibly resulting in an additional impairment.

In July 2001, SFAS No. 142 was issued,
which established new rules on the accounting for goodwill and
other intangible assets. In accordance with this standard, we
performed the initial screening for potential impairments of our
indefinite-lived intangible assets by reporting unit as of
January 1, 2002. We determined the estimated fair values of
each reporting unit using discounted cash flow analyses, along
with independent source data related to recent transactions.
Based on this determination, we identified potential goodwill
impairments at our former Matrix segment and at Care Focus, a
former reporting unit within our Home Care segment. We engaged a
qualified, independent valuation group to determine the
estimated fair values of each of these reporting units. Their
analysis was completed in the fourth quarter of 2002, and led to
the recording of goodwill impairment charges as the cumulative
effect of an accounting change of $77.2 million as of
January 1, 2002, including $70.6 million for Matrix
and $6.6 million for Care Focus. The outpatient therapy
clinic operations and the managed care network of Matrix were
sold during January 2003. The Care Focus unit was sold in June
2003. Based on our annual assessments of all reporting units as
of October 1, 2003 and 2002, no additional impairments of
goodwill were identified.

Off-Balance Sheet Arrangements

At March 31, 2004, we had an off-balance
sheet financing arrangement of $70.0 million of medium-term
notes (Medium-Term Notes). These notes are
obligations of Beverly Funding Corporation (BFC), a
non-consolidated bankruptcy remote, qualifying special purpose
entity. BFC was formed to acquire, own, hold, and otherwise
administer certain accounts receivable originated and sold to it
by certain of our operating subsidiaries through
February 29, 2004, and to issue beneficial interests in
those receivables. Under the terms of the arrangement, certain
of our wholly owned operating subsidiaries (groups of nursing
facilities within each state that we operate), which are
separate legal entities, sold Medicaid and Veterans
Administration accounts receivable to Beverly Health and
Rehabilitation Services, Inc. (BHRS), one of our
wholly owned operating subsidiaries. BFC then purchased these
receivables under a revolving sales structure from BHRS at a
discount of 1%. BFC received its funding from: (1) the
issuance of debt to third-party investors; and
(2) investments made in BFC by us. At March 31, 2004
and December 31, 2003, BFC held $22.2 million and
$76.1 million, respectively, of accounts receivable. The
decrease in accounts receivable held by BFC in 2004 from 2003 is
due to BFC ceasing to purchase receivables from BHRS on
March 1, 2004 in accordance with its Medium-Term Notes
agreement. In addition to accounts receivable, BFC also had
$80.4 million of cash at March 31, 2004. The
Medium-Term Notes mature in 2005; however, according to the
provisions of the notes, principal payments on these obligations
are calculated based on quarterly collections of the underlying
receivables. It is expected that the Medium-Term Notes will be
repaid by BFC on June 15, 2004. (See
Item 8.  Note 1.)

The Medium-Term Notes were issued in June and
July 1999 to third-party investors. The proceeds were used to
redeem $40.0 million of then outstanding medium-term notes
issued by BFC in 1994 that were nearing maturity and to purchase
additional eligible receivables from BHRS. In addition, we
increased our investment in BFC, allowing BFC to purchase
additional eligible receivables to serve as excess collateral
for the new Medium-Term Notes. Under the terms of the
arrangement, BFC is required to maintain receivables and/or cash
in excess of the outstanding balance of the Medium-Term Notes
based on a calculated formula included in the Master Sale and
Servicing Agreement among BHRS, BFC and Beverly Enterprises, Inc.

BHRS recognizes a loss at the time the
receivables are sold to BFC equal to the 1% discount and this
loss is included in Other operating and administrative
costs and expenses and in Net cash provided by

31



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##### Table of Contents



operating activities in our consolidated
financial statements. BHRS provides invoicing and collection
services related to the purchased receivables for a market-based
servicing fee. Neither the loss on sale of receivables nor the
servicing fee revenue is material to the Companys results
of operations or cash flows.


Prior to June 1999, BFCs assets,
liabilities and operating results were consolidated with us.
However, in June 1999 in connection with the redemption of
previously issued medium-term notes, and issuance of the
Medium-Term Notes in June and July 1999, the Master Sale and
Servicing Agreement was amended so that BFC met the definition
of a qualifying special purpose entity as defined in Statement
of Financial Accounting Standards No. 125, Accounting
for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities.Specifically, BFC was no
longer permitted to hold or purchase receivables that originated
prior to January 1, 1997 (a condition that prevented it
from becoming a qualifying special purpose entity prior to June
1999). We continually evaluate the organizational structure and
operations of BFC to ensure that it remains legally isolated
from us and each of our operating subsidiaries and that it
maintains its status as a qualifying special purpose entity and,
thereby, remains deconsolidated.

Our investment in BFC of $32.2 million and
$31.3 million at March 31, 2004 and December 31,
2003, respectively, has been recorded as a current asset in our
consolidated balance sheet. The investment is recorded at its
estimated fair value and is subject to periodic review for other
than temporary impairment. The fair value is determined by
discounting the expected future cash flows of the underlying
receivables purchased and held by BFC at discount rates that
reflect the projected payment terms and the credit risk of the
receivables. We regularly update our fair value analysis for
changes in timing and amount of expected future collections of
the receivables. The carrying value of our investment is written
down when the analysis indicates that the investment is other
than temporarily impaired. Our total investments in BFC have
been adjusted from their initial value of $35.0 million due
to cumulative credit losses incurred by BFC associated with the
purchased receivables since June 1999. We believe the carrying
value of our asset will be fully realized upon the maturity and
repayment of the Medium-Term Notes and collection of the excess
receivables. We monitor this off-balance sheet obligation
throughout the year and believe the obligation and any related
assets should not be included in our consolidated financial
statements under current generally accepted accounting
principles.

As of March 31, 2004 and December 31,
2003, we were contingently liable for approximately
$13.1 million of long-term debt maturing on various dates
through 2019, as well as annual interest on that debt. These
contingent liabilities principally arose from previous sales of
nursing facilities and assisted living centers. We also
guarantee certain third-party operating leases. Those guarantees
arose from our dispositions of leased facilities and the
underlying leases have $46.6 million of minimum rental
commitments remaining through the initial lease terms. In
accordance with the FASBs Interpretation No. 45,
Guarantors Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of
Others, we have recorded approximately $531,000, included in
Other accrued liabilities on the condensed
consolidated balance sheets, as the estimated fair value of our
guarantees.

Operating Results



| |                 
| | ----------------
| | Reclassification

Results of operations for the years ended
December 31, 2003, 2002 and 2001 reflect asset dispositions
during 2003 and for the three months ended March 31, 2004,
as discontinued operations. The following discussions of
2003 Compared to 2002 and 2002
Compared to 2001 reflect this reclassification.



| |                      
| | ---------------------
| | 2003 Compared to 2002



| |                                                  
| | -------------------------------------------------
| | Results of Operations  Continuing
    Operations

We reported net income from continuing operations
for the year ended December 31, 2003 of $23.1 million,
compared to a net loss from continuing operations of
$37.2 million for the year ended

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December 31, 2002. Net income from
continuing operations for 2003 included special pre-tax charges
totaling $4.7 million, primarily including:




| |   |                                                                                                                                                                              
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | $2.1 million for asset impairments,
    primarily related to three nursing facilities;                                                                                       
|
| |  | $2.5 million for workforce reductions (see
    below);                                                                                                                       
|
| |  | $1.9 million for exit costs associated with
    our divestiture strategy; net of                                                                                             
|
| |  | $1.0 million reversal of previously recorded
    exit costs and $447,000 primarily resulting from the settlement
    of a previously impaired asset above carrying value; and
|
| |  | the reversal of $925,000 of costs originally
    accrued for the California investigation settlement.                                                                        

The $2.5 million for workforce reductions
primarily relates to 67 associates who were notified during 2003
that their positions would be eliminated, and included the
following:



| |   |                                                                                                                                                                                                                                   
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | $2.8 million of cash expenses,
    $1.8 million of which was paid during the year ended
    December 31, 2003; and                                                                                                                
|
| |  | non-cash expenses of approximately $84,000
    related to the issuance of 108,230 shares under our Stock
    Grant Plan (the Stock Grant Plan), less
    approximately $400,000 due to the cancellation of restricted
    stock.

We estimate the annual cost savings of this
operational reorganization to be approximately
$5.0 million. The following table summarizes activity in
our estimated workforce reduction and exit costs for the years
ended December 31 (in thousands):

|                          |                                    |            |       |            |   |            |       |            |   |            |       |            |   |   |        |         |   |   |       |         |   |   |        |        |  
|------------------------- | ---------------------------------- | ---------- | ----- | ---------- | - | ---------- | ----- | ---------- | - | ---------- | ----- | ---------- | - | - | ------ | ------- | - | - | ----- | ------- | - | - | ------ | ------ | -
|                          |                                    |            |       |            |   |           
|                          |                                    | 2003       |       | 2002       |   | 2001      
|                          |                                    |            |       |            |   |           
|                          |                                    | Workforce  |       |            |   | Workforce  |       |            |   | Workforce  |       |           
|                          |                                    | Reductions |       | Exit Costs |   | Reductions |       | Exit Costs |   | Reductions |       | Exit Costs
|                          |                                    |            |       |            |   |            |       |            |   |            |       |           
|Balance beginning of year |                                    | $          | 5,418 |            |   | $          | 4,991 |            |   | $          | 7,631 |            |   | $ | 15,030 |         |   | $ | 4,151 |         |   | $ | 5,208  |       
|                          | Charged to continuing operations   |            |       | 2,902      |   |            |       | 887        |   |            |       | 8,454      |   |   |        |        |   |   |       | 23,118  |   |   |        | 18,165 |  
|                          | Charged to discontinued operations |            |       |           |   |            |       | 24,828     |   |            |       |           |   |   |        | 2,633   |   |   |       |        |   |   |        |       |  
|                          | Cash payments                      |            |       | (4,896     | ) |            |       | (22,579    | ) |            |       | (9,074     | ) |   |        | (10,313 | ) |   |       | (15,448 | ) |   |        | (8,343 | )
|                          | Stock transactions                 |            |       |           |   |            |       |           |   |            |       | (1,008     | ) |   |        |        |   |   |       | (4,158  | ) |   |        |       |  
|                          | Reversals                          |            |       | (395       | ) |            |       | (857       | ) |            |       | (585       | ) |   |        | (2,359  | ) |   |       | (32     | ) |   |        |       |  
|                          |                                    |            |       |            |   |            |       |            |   |            |       |            |   |   |        |         |   |   |       |         |   |   |        |       
|Balance end of year       |                                    | $          | 3,029 |            |   | $          | 7,270 |            |   | $          | 5,418 |            |   | $ | 4,991  |         |   | $ | 7,631 |         |   | $ | 15,030 |       
|                          |                                    |            |       |            |   |            |       |            |   |            |       |            |   |   |        |         |   |   |       |         |   |   |        |       

Net loss from continuing operations for 2002
included pre-tax charges totaling $73.9 million, including
$54.8 million for asset impairments, exit costs and
workforce reductions, $22.2 million for the Florida
insurance reserve adjustment, $6.3 million for the
California investigation settlement, offset by a decrease of
$9.4 million in reserves established in connection with
previous settlements of Federal government investigations. (See
2002 Compared to 2001.)



| |                                                   
| | --------------------------------------------------
| | Costs Related to Early Extinguishments of
    Debt

During the fourth quarter of 2003, we entered
into a $210.0 million senior credit facility and issued
$115.0 million of 2.75% convertible subordinated
notes. The net proceeds from these transactions were used to pay
off our 9% senior notes and certain mortgages, bonds and
other debt obligations. In conjunction with these transactions,
we wrote off $3.9 million of deferred financing costs
related to our former credit facility, the 9% senior notes
and the other debt obligations. We also paid a prepayment
premium of $2.7 million related to the early extinguishment
of the 9% senior notes.

33



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##### Table of Contents





| |                                  
| | ---------------------------------
| | Gain on Sale of Equity Investment

During the fourth quarter of 2003, we sold all of
our holdings in a publicly traded equity security that was
acquired in 1995. This investment had been accounted for as
available for sale, with all changes in fair value being
recorded as comprehensive income. In conjunction with the sale
of the investment, we reversed the accumulated comprehensive
income and recognized a pre-tax gain of $6.7 million.



| |         
| | --------
| | Revenues

We reported revenues of $1,979.8 million
during the year ended December 31, 2003, compared to
$1,941.3 million for the same period in 2002. Approximately
94% and 95% of our revenues for the years ended
December 31, 2003 and 2002, respectively, were derived from
services provided by our Nursing Facilities segment. The
increase in revenues of $38.5 million for the year ended
December 31, 2003, as compared to the same period in 2002,
is due to the following:



| |   |                                                                                                                                                                                                 
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | an increase of $44.4 million from facilities
    we operated during each of the years ended December 31,
    2003 and 2002 (same facility operations);                                        
|
| |  | an increase of $22.9 million from growth in
    Aegis external therapy business;                                                                                                               
|
| |  | an increase of $15.5 million due to a
    facility acquisition, the opening of a newly constructed
    facility and three hospice and home care centers, and two
    start-up businesses; net of
|
| |  | a decrease of $44.3 million due to
    dispositions during 2002 not reported as discontinued operations.                                                                                        

The increase in revenues of $44.4 million
from same facility operations for the year ended
December 31, 2003, as compared to the same period in 2002,
was primarily due to the following:



| |   |                                                                                                                                                                                                                                                                                                                                                                                   
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | $56.3 million due to an increase in Medicaid
    and private payment rates;                                                                                                                                                                                                                                                                                                       
|
| |  | $9.2 million due to a positive shift in our
    patient mix primarily from private to Medicare;                                                                                                                                                                                                                                                                                   
|
| |  | $6.1 million adjustment related to favorable
    prior year cost report settlements;                                                                                                                                                                                                                                                                                              
|
| |  | $7.0 million due to an increase in average
    daily census in our Home Care segment;                                                                                                                                                                                                                                                                                             
|
| |  | partially offset by a decrease of
    $13.6 million in Medicare payment rates. Effective
    October 1, 2002, certain Medicare add-on payments were
    eliminated when the federal government did not pass legislation
    to restore the funding. The impact of these eliminations was
    partially offset by a 6.26% increase in Medicare rates effective
    October 1, 2003;
|
| |  | a decrease of $12.0 million due to a decline
    in same facility census; and                                                                                                                                                                                                                                                                                                     
|
| |  | $8.6 million due to a decrease in various
    other items.                                                                                                                                                                                                                                                                                                                        



| |                   
| | ------------------
| | Costs and Expenses

We reported costs and expenses of
$1,893.6 million during the year ended December 31,
2003, compared to $1,916.0 million for the same period in
2002. Excluding special pre-tax charges of $4.7 million in
2003 and $73.9 million in 2002, discussed above, our costs
and expenses increased $46.8 million, consisting of the
following:



| |   |                                                                                                                                                                                             
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | an increase of $75.3 million in same
    facility operations;                                                                                                                               
|
| |  | an increase of $12.0 million due to a
    facility acquisition, and the opening of a newly constructed
    facility and three hospice and home care centers and two
    start-up businesses;
|
| |  | partially offset by a decrease of
    $40.5 million due to dispositions during 2002 not reported
    as discontinued operations.                                                            

34



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##### Table of Contents



The increase in costs and expenses of
$75.3 million from same facility operations for the year
ended December 31, 2003, as compared to the same period in
2002, was due primarily to the following:



| |   |                                                                                                                                                                                                                                                                                     
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | $51.9 million of additional wages and
    related expenses primarily due to an increase in our weighted
    average wage rate, an increase in nursing hours per patient day
    and an increase in associate incentives;                                                            
|
| |  | $32.2 million increase in our provision for
    insurance and related items, as discussed below;                                                                                                                                                                                    
|
| |  | $5.4 million due to an increase in
    contracted services, primarily due to outsourcing certain
    housekeeping, laundry and dietary services in our Nursing
    Facilities segment;                                                                                              
|
| |  | partially offset by an $18.2 million
    decrease in our provision for reserves on accounts and notes
    receivable due to improvements in the timing and amount of
    collections, as well as the collection of certain accounts that
    had previously been fully reserved; and
|
| |  | $3.7 million decrease in depreciation and
    amortization expense due to the impact of asset impairments
    recorded in the fourth quarter of 2002.                                                                                                                               

Our provision for insurance and related items for
continuing operations increased during 2003, as compared to
2002, primarily due to the following:



| |   |                                                                                                                                                                                                                                                    
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | an increase in fixed premiums and related costs
    for general and professional liabilities, directors and
    officers insurance and workers compensation;                                                                                    
|
| |  | 2002 accruals for patient care liability costs
    were low due to aggregate limits on our insurance policies in
    place for a portion of 2002. Such aggregate limits were reached
    during 2001 due to the sale of our Florida facilities; and
|
| |  | an increase in the actuarial projection of
    patient care liability claims.                                                                                                                                                                      

We adjust our accruals for prior policy-year
patient care and workers compensation liabilities and our
accrual of expected losses for the current year based primarily
on actuarial studies conducted twice per year. Adjustments to
premiums and other costs are recorded as incurred.



| |             
| | ------------
| | Income Taxes

We recorded a provision for income taxes,
including $5.1 million from continuing operations and
$3.4 million from discontinued operations for the year
ended December 31, 2003, primarily related to state income
taxes. We decreased our valuation allowance on our deferred tax
assets by $30.1 million during 2003 to $169.1 million
as of December 31, 2003. This valuation allowance is
required under the guidance of Statement of Financial Accounting
Standards No. 109, Accounting for Income Taxes(SFAS No. 109) due to our historical
operating performance and our reported cumulative net losses.
Our realization of the deferred tax benefits, primarily
associated with our net operating losses, is dependent upon our
achieving sufficient future pre-tax income. Under federal income
tax regulations, we have up to 20 years to generate
sufficient taxable income to realize the deferred benefits.
However, given the size of our pre-tax losses in prior years, a
valuation allowance was considered to be appropriate under the
more stringent accounting standards for the realization of these
deferred tax benefits, which is contingent upon future income in
the near term.

At December 31, 2003, for income tax
purposes, we had federal net operating loss carryforwards of
$93.2 million which expire in years 2018 through 2023;
general business tax credit carryforwards of $37.7 million
which expire in years 2006 through 2023; and alternative minimum
tax credit carryforwards of $21.3 million which do not
expire. Future tax benefits associated with these carryforwards
are not recorded in our 2003 and 2002 consolidated financial
statements as a result of the valuation allowance recorded in
2001.



| |                                                    
| | ---------------------------------------------------
| | Results of Operations  Discontinued
    Operations

The results of operations of disposed facilities,
clinics and other assets during 2003 and for the three months
ended March 31, 2004, as well as the results of operations
of held-for-sale assets, have been reported as discontinued
operations for all periods presented in the consolidated
statements of operations. A summary

35



---



##### Table of Contents



of discontinued operations by operating segment
for the years ended December 31 is as follows (in
thousands):


|                                       |  |        |        |      |  |            |        |       |  |        |         |      |  |            |         |       |  |   |        |   |  |   |         |   |  |   |         |   |  |   |         |  
|-------------------------------------- |  | ------ | ------ | ---- |  | ---------- | ------ | ----- |  | ------ | ------- | ---- |  | ---------- | ------- | ----- |  | - | ------ | - |  | - | ------- | - |  | - | ------- | - |  | - | ------- | -
|                                       |  |        |        |     
|                                       |  | 2003   |        | 2002
|                                       |  |        |        |     
|                                       |  |        |        | Home |  | Nursing    |        |       |  |        |         | Home |  | Nursing    |         |      
|                                       |  | Matrix |        | Care |  | Facilities |        | Total |  | Matrix |         | Care |  | Facilities |         | Total
|                                       |  |        |        |      |  |            |        |       |  |        |         |      |  |            |         |      
|Revenues(1)                            |  | $      | 18,550 |      |  | $          | 20,395 |       |  | $      | 338,181 |      |  | $          | 377,126 |       |  | $ | 86,109 |   |  | $ | 20,894  |   |  | $ | 471,151 |   |  | $ | 578,154 |  
|                                       |  |        |        |      |  |            |        |       |  |        |         |      |  |            |         |       |  |   |        |   |  |   |         |   |  |   |         |   |  |   |         |  
|Operating income (loss)(1)(2)          |  | $      | 749    |      |  | $          | (2,446 | )     |  | $      | 62      |      |  | $          | (1,635  | )     |  | $ | 810    |   |  | $ | (31,057 | ) |  | $ | 29,575  |   |  | $ | (672    | )
|Gain (loss) on sales and exit costs    |  |        | 11,120 |      |  |            | 1,557  |       |  |        | 67,113  |      |  |            | 79,790  |       |  |   | (1,001 | ) |  |   | (1,257  | ) |  |   | (114    | ) |  |   | (2,372  | )
|Impairments and other unusual items(3) |  |        |       |      |  |            | (540   | )     |  |        | (16,823 | )    |  |            | (17,363 | )     |  |   | 230    |   |  |   | (4,239  | ) |  |   | (24,678 | ) |  |   | (28,687 | )
|                                       |  |        |        |      |  |            |        |       |  |        |         |      |  |            |         |       |  |   |        |   |  |   |         |   |  |   |         |   |  |   |         |  
|Pre-tax income (loss)                  |  | $      | 11,869 |      |  | $          | (1,429 | )     |  | $      | 50,352  |      |  |            | 60,792  |       |  | $ | 39     |   |  | $ | (36,553 | ) |  | $ | 4,783   |   |  |   | (31,731 | )
|                                       |  |        |        |      |  |            |        |       |  |        |         |      |  |            |         |       |  |   |        |   |  |   |         |   |  |   |         |   |  |   |         |  
|Provision for state income taxes       |  |        |        |      |  |            |        |       |  |        |         |      |  |            | 3,378   |       |  |   |        |   |  |   |         |   |  |   |         |   |  |   |        |  
|                                       |  |        |        |      |  |            |        |       |  |        |         |      |  |            |         |       |  |   |        |   |  |   |         |   |  |   |         |   |  |   |         |  
|Discontinued operations, net of taxes  |  |        |        |      |  |            |        |       |  |        |         |      |  | $          | 57,414  |       |  |   |        |   |  |   |         |   |  |   |         |   |  | $ | (31,731 | )
|                                       |  |        |        |      |  |            |        |       |  |        |         |      |  |            |         |       |  |   |        |   |  |   |         |   |  |   |         |   |  |   |         |  



---



|    |                                                                                                                                                                                                                                                                                                                                                                                         
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Includes an adjustment of $18.0 million in
    2002 for estimated overpayments to MK Medical by government
    payors. MK Medical was part of our Home Care segment.                                                                                                                                                                                                                    
|   
|(2) | Includes net interest expense of
    $2.2 million and $3.5 million for 2003 and 2002,
    respectively. Also includes depreciation and amortization of
    $10.3 million and $23.0 million for 2003 and 2002,
    respectively.                                                                                                                                                         
|   
|(3) | Includes an accrual in 2003 for the purchase of
    incremental patient care liability insurance on disposed nursing
    facilities. Includes an accrual of $1.0 million in 2002 for
    legal and related fees associated with the MK Medical estimated
    overpayment issue, and asset impairment charges related to
    certain nursing facilities and our MK Medical business unit.

We recognized net gains on sales of
$67.1 million in discontinued operations related to
divestitures of certain nursing facilities and assisted living
centers during the year ended December 31, 2003. During
2002, we recognized asset impairment charges on certain of these
divested facilities, amounting to $24.7 million. These
impairments were precipitated by an estimated decline in future
cash flows, primarily associated with Medicare funding
reductions. Of the divested nursing facilities that incurred
impairment charges in 2002, we recognized net losses on sales of
$5.3 million.



| |                                           
| | ------------------------------------------
| | Cumulative Effect of Accounting
    Change

See 2002 Compared to 2001 for
a discussion of the cumulative effect of a change in accounting
for goodwill recorded in 2002 as a result of adopting
SFAS No. 142. In accordance with
SFAS No. 142, we completed our annual impairment
assessment of all of our indefinite-lived intangible assets,
including goodwill, as of October 1, 2003 with no
additional impairment identified.



| |                      
| | ---------------------
| | 2002 Compared to 2001



| |                                                  
| | -------------------------------------------------
| | Results of Operations  Continuing
    Operations

We reported a net loss from continuing operations
of $37.2 million for the year ended December 31, 2002,
compared to a net loss from continuing operations of
$273.2 million for the year ended December 31, 2001.
The net loss from continuing operations for 2002 included
special pre-tax charges totaling $73.9 million, including:



| |   |                                                                                                                                                              
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | $54.8 million for asset impairments,
    workforce reductions and other unusual items;                                                                       
|
| |  | $22.2 million for the Florida insurance
    reserve adjustment (See Costs and Expenses);                                                                   
|
| |  | $6.3 million for the California
    investigation settlement and related costs;                                                                              
|
| |  | partially offset by a decrease of
    $9.4 million in reserves established in conjunction with
    previous settlements of federal government investigations.

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##### Table of Contents



The $54.8 million for asset impairments,
workforce reductions and other unusual items includes the
following:



| |   |                                                                                                                                                                       
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | $49.9 million write-down of property and
    equipment on certain assets of the Nursing Facilities segment;                                                           
|
| |  | $8.5 million of workforce reductions (see
    below); and                                                                                                             
|
| |  | $3.0 million adjustment to asset impairments
    and approximately $600,000 reversal of workforce reduction
    charges recorded in 2001, which were no longer needed.

The net loss from continuing operations for 2001
included special pre-tax charges totaling $259.5 million,
primarily including $155.7 million for asset impairments
and exit costs, $24.2 million for workforce reductions and
$77.5 million related to a settlement with the federal
government to resolve open reimbursement issues under the former
cost-reimbursement system for Medicare. The asset impairment and
exit costs, which are included in the consolidated statements of
operations caption Asset impairments, workforce reductions
and other unusual items, relate to:



| |   |                                                                                                                                                                                                                                                                                                                                                  
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | $75.1 million write-down of Florida
    facilities and $55.1 million of Florida exit and other
    costs related to a formal plan initiated by management to pursue
    the sale of our nursing facility operations in Florida. These
    assets were included in the total assets of the Nursing
    Facilities segment as of December 31, 2001;
|
| |  | write-down of goodwill of $5.8 million, and
    recording of closing and other costs of $2.8 million on
    under-performing Home Care businesses. These assets were
    included in the total assets of the Home Care segment as of
    December 31, 2001;                                                                                      
|
| |  | write-down of property and equipment of
    $5.2 million, and goodwill and other intangibles of
    $600,000 on certain under-performing nursing facilities. These
    assets were included in the total assets of the Nursing
    Facilities segment as of December 31, 2001;                                                                   
|
| |  | write-off of abandoned projects and investments
    totaling $7.8 million; and                                                                                                                                                                                                                                                                   
|
| |  | $3.3 million related to the termination of a
    lease in Indiana and the write-off of the net book value of the
    related assets.                                                                                                                                                                                                             

We recorded a special pre-tax charge of
$8.5 million during 2002 for workforce reductions which
were primarily the result of a continuing operational
reorganization required to support the implementation of our
three-year strategic plan. During 2002, we notified 133
employees that their positions would be eliminated. The charge
included the following:



| |   |                                                                                                                                                                
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | $8.0 million of cash expenses,
    $2.8 million and $4.1 million of which was paid during
    the years ended December 31, 2003 and 2002,
    respectively; and
|
| |  | non-cash expenses of approximately $500,000
    related to the issuance of 124,212 shares under our Stock
    Grant Plan.                                      

We estimate the annual cost savings of this
operational reorganization to be approximately
$11.2 million.

During 2001, we recorded special pre-tax charges
totaling $24.2 million for workforce reductions and related
costs, of which $23.1 million related to severance and
other employment agreements for approximately 240 employees who
were notified in 2001 that their positions would be eliminated,
including:



| |   |                                                                                                                                                                              
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | $18.0 million of cash expenses, $271,000,
    $4.9 million and $11.3 million of which was paid
    during the years ended December 31, 2003, 2002 and 2001,
    respectively;
|
| |  | non-cash expenses of $4.5 million related to
    the issuance of 545,542 shares under the Stock Grant
    Plan; and                                                          
|
| |  | non-cash expenses of $600,000 related to other
    long-term incentive agreements.                                                                                           

37



---



##### Table of Contents



We estimated the annual costs savings of this
operational reorganization to be approximately
$14.0 million. Much of this savings was realized in 2001,
since the majority of the workforce reductions took place in the
first quarter. These estimated savings are net of the additional
costs we incurred to increase the operations and clinical staff
at the facility and district level. Approximately $600,000 of
these workforce reduction charges in 2001 were reversed during
2002.

On February 4, 2002, we made a settlement
offer to the federal government to resolve open reimbursement
issues under the former cost-reimbursement system for Medicare.
For accounting purposes, this settlement offer was required to
be recorded in our operating results for the year ended
December 31, 2001, and resulted in a pre-tax charge of
$77.5 million which is included in the caption
Special charges and adjustment related to settlements of
federal government investigations. This charge included a
$35.0 million cash settlement and the write-off of
$81.5 million of related cost report receivables, offset by
a $39.0 million reserve established in 1999 for related
issues. This matter was settled with CMS in the fourth quarter
of 2002, and required no increase in accruals previously
recorded.



| |         
| | --------
| | Revenues

We reported revenues of $1,941.3 million
during the year ended December 31, 2002, compared to
$2,127.8 million for the same period in 2001. Approximately
95% and 97% of our revenues for each of the years ended
December 31, 2002 and 2001, respectively, were derived from
services provided by our Nursing Facilities segment. The
decrease in revenues of $186.5 million for the year ended
December 31, 2002, as compared to the same period in 2001,
consists of the following:



| |   |                                                                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | a decrease of $321.2 million due to
    dispositions, primarily related to our Florida facilities;                                                                              
|
| |  | partially offset by an increase of
    $96.0 million from facilities we operated during each of
    the years ended December 31, 2002 and 2001 (same
    facility operations);
|
| |  | an increase of $35.6 million from growth in
    Aegis external therapy business; and                                                                                           
|
| |  | an increase of $3.1 million due to
    acquisitions and openings of newly-constructed facilities.                                                                               

The increase in revenues of $96.0 million
from same facility operations for the year ended
December 31, 2002, as compared to the same period in 2001,
was primarily due to the following:



| |   |                                                                                              
| | - | ---------------------------------------------------------------------------------------------
| |  | $67.8 million due to an increase in
    Medicaid, Medicare and private payment rates;        
|
| |  | $8.3 million due to an increase in Medicare
    Part B revenues;                             
|
| |  | $16.4 million due to a positive shift in our
    patient mix;                                
|
| |  | partially offset by a decrease of
    $14.2 million due to a decline in same facility census.



| |                   
| | ------------------
| | Costs and Expenses

We reported costs and expenses of
$1,916.0 million during the year ended December 31,
2002, compared to $2,269.7 million for the same period in
2001. Excluding special pre-tax charges of $73.9 million in
2002 and $259.5 in 2001, discussed above, our costs and expenses
decreased $168.0 million, consisting of the following:



| |   |                                                                                                  
| | - | -------------------------------------------------------------------------------------------------
| |  | a decrease of $272.0 million due to
    dispositions primarily related to our Florida facilities;
|
| |  | partially offset by an increase of
    $96.6 million in same facility operations; and            
|
| |  | an increase of $7.4 million due to
    acquisitions and openings of newly constructed facilities.

The increase in costs and expenses of
$96.6 million from same facility operations for the year
ended December 31, 2002, as compared to the same period in
2001, was due primarily to the following:



| |   |                                                                                                                                                                                     
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | $29.3 million of additional wages and
    related expenses, primarily due to an increase in our weighted
    average wage rate and an increase in nursing hours per patient
    day;
|
| |  | $28.1 million additional provision for
    reserves on accounts and notes receivable;                                                                                               

38



---



##### Table of Contents





| |   |                                                                                                                                                                                            
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | $20.4 million due to an increase in
    contracted services, primarily due to outsourcing certain
    housekeeping, laundry and dietary services in our Nursing
    Facilities segment; and
|
| |  | $11.4 million increase in our provision for
    insurance and related claims, as discussed below.                                                                                          

Our provision for insurance and related items
increased in 2002 over 2001 primarily due to rising patient care
liability costs. Based on the results of our 2002 mid-year
actuarial study completed in mid-July, we recorded a pre-tax
charge of $43.3 million to increase our reserves for prior
policy-year patient care liability costs, including
$22.2 million related to our previously operated Florida
facilities and $21.1 million related to same facility
operations.



| |                            
| | ---------------------------
| | Interest Income and Expense

Interest income increased to $4.7 million
for the year ended December 31, 2002, as compared to
$2.9 million for the same period in 2001 primarily due to
certain notes receivable accepted as partial consideration for
the sale of our Florida facilities. Interest expense decreased
to $63.2 million for the year ended December 31, 2002,
as compared to $75.0 million for the same period in 2001.
This was primarily due to the reduction of debt using the net
proceeds from the sale of our Florida facilities in January 2002.



| |             
| | ------------
| | Income Taxes

We recorded a provision for income taxes of
$6.1 million for the year ended December 31, 2002,
primarily related to state income taxes. We increased our
valuation allowance on our deferred tax assets by
$45.5 million during 2002 to $199.2 million as of
December 31, 2002. This valuation allowance is required
under the guidance of SFAS No. 109 due to our
historical operating performance and our reported cumulative net
losses.



| |                                                    
| | ---------------------------------------------------
| | Results of Operations  Discontinued
    Operations

The results of operations of disposed facilities,
clinics and other assets in the three months ended
March 31, 2004, as well as the results of operations of
held-for-sale assets, have been reported as discontinued
operations for all periods presented in the consolidated
statements of operations. A summary of the discontinued
operations by operating segment for the years ended
December 31 is as follows (in thousands):

|                                        |  |        |        |      |  |            |         |       |  |        |         |      |  |            |         |       |  |   |         |   |  |   |         |   |  |   |         |   |  |   |         |  
|--------------------------------------- |  | ------ | ------ | ---- |  | ---------- | ------- | ----- |  | ------ | ------- | ---- |  | ---------- | ------- | ----- |  | - | ------- | - |  | - | ------- | - |  | - | ------- | - |  | - | ------- | -
|                                        |  |        |        |     
|                                        |  | 2002   |        | 2001
|                                        |  |        |        |     
|                                        |  |        |        | Home |  | Nursing    |         |       |  |        |         | Home |  | Nursing    |         |      
|                                        |  | Matrix |        | Care |  | Facilities |         | Total |  | Matrix |         | Care |  | Facilities |         | Total
|                                        |  |        |        |      |  |            |         |       |  |        |         |      |  |            |         |      
|Revenues(1)                             |  | $      | 86,109 |      |  | $          | 20,894  |       |  | $      | 471,151 |      |  | $          | 578,154 |       |  | $ | 90,907  |   |  | $ | 52,714  |   |  | $ | 460,684 |   |  | $ | 604,305 |  
|                                        |  |        |        |      |  |            |         |       |  |        |         |      |  |            |         |       |  |   |         |   |  |   |         |   |  |   |         |   |  |   |         |  
|Operating income (loss)(1)(2)           |  | $      | 810    |      |  | $          | (31,057 | )     |  | $      | 29,575  |      |  | $          | (672    | )     |  | $ | (8,652  | ) |  | $ | (13,366 | ) |  | $ | 51,292  |   |  | $ | 29,274  |  
|Loss on sales and exit costs            |  |        | (1,001 | )    |  |            | (1,257  | )     |  |        | (114    | )    |  |            | (2,372  | )     |  |   |        |   |  |   |        |   |  |   |        |   |  |   |        |  
|Impairments and other unusual items (3) |  |        | 230    |      |  |            | (4,239  | )     |  |        | (24,678 | )    |  |            | (28,687 | )     |  |   | (32,482 | ) |  |   | (18,760 | ) |  |   | (4,832  | ) |  |   | (56,074 | )
|                                        |  |        |        |      |  |            |         |       |  |        |         |      |  |            |         |       |  |   |         |   |  |   |         |   |  |   |         |   |  |   |         |  
|Pre-tax income (loss)                   |  | $      | 39     |      |  | $          | (36,553 | )     |  | $      | 4,783   |      |  |            | (31,731 | )     |  | $ | (41,134 | ) |  | $ | (32,126 | ) |  | $ | 46,460  |   |  |   | (26,800 | )
|                                        |  |        |        |      |  |            |         |       |  |        |         |      |  |            |         |       |  |   |         |   |  |   |         |   |  |   |         |   |  |   |         |  
|Provision for income taxes              |  |        |        |      |  |            |         |       |  |        |         |      |  |            |        |       |  |   |         |   |  |   |         |   |  |   |         |   |  |   | 1,256   |  
|                                        |  |        |        |      |  |            |         |       |  |        |         |      |  |            |         |       |  |   |         |   |  |   |         |   |  |   |         |   |  |   |         |  
|Discontinued operations, net of taxes   |  |        |        |      |  |            |         |       |  |        |         |      |  | $          | (31,731 | )     |  |   |         |   |  |   |         |   |  |   |         |   |  | $ | (28,056 | )
|                                        |  |        |        |      |  |            |         |       |  |        |         |      |  |            |         |       |  |   |         |   |  |   |         |   |  |   |         |   |  |   |         |  



---



|    |                                                                                                                                                                                                                                                                                                    
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Includes an adjustment of $18.0 million in
    2002 for estimated overpayments to MK Medical by government
    payors. MK Medical was part of our Home Care segment.                                                                                                                               
|   
|(2) | Includes net interest expense of
    $3.5 million and $4.2 million for 2002 and 2001,
    respectively and depreciation and amortization of
    $23.0 million and $26.0 million for 2002 and 2001,
    respectively.                                                                               
|   
|(3) | Includes an accrual of $1.0 million in 2002
    for legal and related fees associated with the MK Medical
    estimated overpayment issue, and asset impairment charges in
    2002 and 2001 related to certain nursing facilities, our former
    Matrix segment and our MK Medical business unit.

39



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##### Table of Contents





| |                                           
| | ------------------------------------------
| | Cumulative Effect of Accounting
    Change

In July 2001, the Financial Accounting Standards
Board issued SFAS No. 142, which established new rules
on the accounting for goodwill and other intangible assets.
Under SFAS No. 142, goodwill and intangible assets
with indefinite lives are no longer amortized; however, they are
subject to annual impairment tests as prescribed by the
Statement. Intangible assets with definite lives will continue
to be amortized over their estimated useful lives. With respect
to our goodwill and intangible assets, SFAS No. 142
was effective for us beginning January 1, 2002. For 2001,
our goodwill and operating rights amortization was
$3.9 million and $252,000, respectively, net of income
taxes, or $0.04 per share diluted.

We completed the impairment assessment of our
indefinite-lived intangible assets, other than goodwill, during
the first quarter of 2002, with no impairment identified.
SFAS No. 142 described a two-step process for testing
goodwill for impairment. The first step is a screen for
potential impairment, while the second step measures the amount
of the impairment, if any. Upon completion of the first step of
the goodwill impairment test for all of our reporting units,
results indicated that goodwill appeared to be impaired for our
former Matrix and Home Care Services  Care Focus
reporting units. We subjected the goodwill at these reporting
units to step two under SFAS No. 142.

We engaged a qualified, independent third-party
to determine the estimated fair value of these two reporting
units. Their valuation was completed during the fourth quarter
of 2002, and the resulting impairment losses amounted to
$70.6 million for Matrix and $6.6 million for Home
Care Services  Care Focus. As required by
SFAS No. 142, these impairment losses were recorded in
the 2002 consolidated statement of operations as the cumulative
effect of a change in accounting for goodwill as of
January 1, 2002.

Liquidity and Capital Resources

At March 31, 2004, we had
$230.2 million in cash and cash equivalents. We anticipate
that $42.4 million of this cash balance, while not legally
restricted, will be utilized primarily to fund certain general
and professional liabilities and workers compensation
claims and expenses. At March 31, 2004, we had
$39.7 million of unused commitments under our
$75.0 million revolving credit facility, with utilization
being for standby letters of credit primarily in support of
certain insurance programs, security deposits, and debt or
guaranteed debt obligations. At March 31, 2004, we had
positive working capital of $139.6 million reflected on our
condensed consolidated balance sheet. Our cash flows consisted
of the following for the three months ended March 31 (in
thousands):

|                                                         |  |      |         |      |  |   |         |  
|-------------------------------------------------------- |  | ---- | ------- | ---- |  | - | ------- | -
|                                                         |  | 2004 |         | 2003
|                                                         |  |      |         |     
|Net cash provided by (used for) operating
    activities |  | $    | (36,572 | )    |  | $ | 11,358  |  
|Net cash provided by investing activities                |  |      | 11,726  |      |  |   | 18,572  |  
|Net cash used for financing activities                   |  |      | (3,742  | )    |  |   | (23,256 | )
|                                                         |  |      |         |      |  |   |         |  
|Net increase (decrease) in cash and cash
    equivalents |  | $    | (28,588 | )    |  | $ | 6,674   |  
|                                                         |  |      |         |      |  |   |         |  

For the three months ended March 31, 2004,
proceeds from dispositions and collections on notes receivable
totaling $26.0 million were primarily used to fund capital
expenditures of $9.8 million and to pay down debt of
$3.6 million. Net cash provided by (used for) operating
activities, under the direct method, for the three months ended
March 31, consists of the following (in thousands):

|                                                         |  |      |          |      |  |   |          |  
|-------------------------------------------------------- |  | ---- | -------- | ---- |  | - | -------- | -
|                                                         |  | 2004 |          | 2003
|                                                         |  |      |          |     
|Cash paid to suppliers and employees                     |  | $    | (504,580 | )    |  | $ | (564,084 | )
|Interest paid                                            |  |      | (5,218   | )    |  |   | (14,633  | )
|Income taxes (paid) refunds received                     |  |      | (2,450   | )    |  |   | 1,146    |  
|Cash received from patients and third-party payors       |  |      | 474,108  |      |  |   | 587,717  |  
|Interest received                                        |  |      | 1,568    |      |  |   | 1,212    |  
|                                                         |  |      |          |      |  |   |          |  
|Net cash provided by (used for) operating
    activities |  | $    | (36,572  | )    |  | $ | 11,358   |  
|                                                         |  |      |          |      |  |   |          |  

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For the three months ended March 31, 2004,
the $36.6 million net cash used by operating activities was
not caused by operational issues, but was primarily due to a
$53.6 million increase in accounts receivable, principally
resulting from BFC ceasing to purchase receivables from us.
According to the provisions of BFCs $70.0 million
Medium-Term Notes, BFC ceased its daily purchases of accounts
receivable from BHRS on March 1, 2004, and will accumulate
cash collected on previously purchased receivables in order to
make the principal payments on its Medium-Term Notes, which
begin in the second quarter of 2004. Based on current collection
trends, it is expected that the Medium-Term Notes will be repaid
by BFC on June 15, 2004. Collections of BFC receivables
that are in excess of the $70.0 million of Medium-Term
Notes are expected to be paid to the Company in cash to redeem
our investment in BFC during the second quarter of 2004. When
the Medium-Term Notes are repaid, BFC will no longer have
third-party beneficial owners and is expected to be consolidated
with us as of June 2004, in accordance with
SFAS No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of
Liabilities.

With the termination of daily purchases of
receivables by BFC from BHRS, accounts receivable on our
condensed consolidated balance sheet have increased and have
resulted in a use of cash from operating activities on our
condensed consolidated statement of cash flows for the first
quarter of 2004. These receivables will be collected from the
applicable governmental agencies to relieve the aging, but the
timing of collections will be longer than when they were being
purchased daily by BFC.

At December 31, 2003, we had
$258.8 million in cash and cash equivalents. We anticipated
that $29.9 million of this cash balance, while not legally
restricted, would be utilized primarily to fund certain general
and professional liabilities and workers compensation
claims and expenses. At December 31, 2003, we had
$33.7 million of unused commitments under our
$75.0 million revolving credit facility, with utilization
being for standby letters of credit primarily in support of
certain insurance programs, security deposits, and debt or
guaranteed debt obligations. At December 31, 2003, we had
positive working capital of $101.5 million reflected on our
consolidated balance sheet. Our cash flows consisted of the
following for the years ended December 31 (in thousands):

|                                                         |  |      |          |      |  |      |          |   |  |   |         |  
|-------------------------------------------------------- |  | ---- | -------- | ---- |  | ---- | -------- | - |  | - | ------- | -
|                                                         |  | 2003 |          | 2002 |  | 2001
|                                                         |  |      |          |      |  |     
|Net cash provided by operating activities                |  | $    | 69,861   |      |  | $    | 116,633  |   |  | $ | 220,897 |  
|Net cash provided by (used for) investing
    activities |  |      | 219,188  |      |  |      | 62,335   |   |  |   | (86,654 | )
|Net cash used for financing activities                   |  |      | (145,679 | )    |  |      | (152,866 | ) |  |   | (70,808 | )
|                                                         |  |      |          |      |  |      |          |   |  |   |         |  
|Net increase in cash and cash equivalents                |  | $    | 143,370  |      |  | $    | 26,102   |   |  | $ | 63,435  |  
|                                                         |  |      |          |      |  |      |          |   |  |   |         |  

Net cash provided by operating activities, under
the direct method, for the years ended December 31,
consists of the following (in thousands):

|                                                   |  |      |            |      |  |      |            |   |  |   |            |  
|-------------------------------------------------- |  | ---- | ---------- | ---- |  | ---- | ---------- | - |  | - | ---------- | -
|                                                   |  | 2003 |            | 2002 |  | 2001
|                                                   |  |      |            |      |  |     
|Cash received from patients and third-party payors |  | $    | 2,342,917  |      |  | $    | 2,527,363  |   |  | $ | 2,728,577  |  
|Income taxes (paid) refunds received               |  |      | 7,656      |      |  |      | 3,705      |   |  |   | (6,299     | )
|Interest received                                  |  |      | 5,524      |      |  |      | 4,749      |   |  |   | 3,077      |  
|Cash paid to suppliers and employees               |  |      | (2,218,526 | )    |  |      | (2,353,526 | ) |  |   | (2,428,100 | )
|Interest paid                                      |  |      | (67,710    | )    |  |      | (65,658    | ) |  |   | (76,358    | )
|                                                   |  |      |            |      |  |      |            |   |  |   |            |  
|Net cash provided by operating activities          |  | $    | 69,861     |      |  | $    | 116,633    |   |  | $ | 220,897    |  
|                                                   |  |      |            |      |  |      |            |   |  |   |            |  

The decrease in net cash provided by operating
activities of $46.8 million in 2003 from 2002 was primarily
related to a reduction in Medicare funding, an increase in our
insurance and related payments, as well as a decrease in our
incremental cash collections on patient accounts receivable. Our
Nursing Facilities patient accounts receivable have continued to
decline throughout 2003 and our cash collections on these
accounts receivable continue to be in line with, or ahead of,
our generated revenues. However, during 2002 our cash
collections were significantly higher than our generated
revenues due to collections of old patient balances. Having
substantially completed these collection efforts during 2002,
our incremental cash collections returned to a more normalized
amount in 2003. In addition, our patient accounts receivable
increased during 2003 due

41



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to certain Medicaid rate increases for which we
will not receive payment until 2004. These factors have resulted
in a year over year decline in the cash generated from accounts
receivable.


In 2002, we completed a full evaluation of our
nursing facility portfolio, which included the identification of
non-strategic facilities and facilities that account for a
disproportionately high share of projected patient care
liability costs. As a result of this analysis, we have divested
a significant portion of our nursing facility capacity. During
the year ended December 31, 2003, we sold, closed or
terminated the leases on 81 nursing facilities, seven assisted
living centers, and one managed facility, of which 72 nursing
facilities and six assisted living centers were part of this
divestiture strategy. We received net cash proceeds of
$275.0 million from the sales of these nursing facilities,
our former Matrix outpatient therapy clinics and managed care
network, certain assets of our Home Care segment and other
assets. These net proceeds were primarily used to:



| |   |                                                                
| | - | ---------------------------------------------------------------
| |  | repay approximately $84.0 million of
    long-term debt;       
|
| |  | pay off $69.5 million of off-balance sheet
    lease financing;
|
| |  | fund capital expenditures totaling
    $44.0 million; and      
|
| |  | increase our cash on hand.                                     

During October 2003, we entered into a new
$210.0 million senior credit facility (the Credit
Facility). The Credit Facility consists of a five-year
$135.0 million term loan facility and a four-year
$75.0 million revolving credit facility. The revolving
credit facility is available for general corporate purposes and
up to $55.0 million for the issuance of letters of credit.
The term loan facility is fully drawn and as of March 31,
2004, we were utilizing $35.3 million of the revolving
credit facility for letters of credit. The Credit Facility
currently bears interest at the prime lending rate plus 2.25%,
or the Eurodollar rate plus 3.25%, at our option. The Credit
Facility is secured by mortgages on certain nursing facilities,
has a security interest in certain patient accounts receivable,
is guaranteed by substantially all of our present and future
subsidiaries and imposes on us certain financial tests and
restrictive covenants.

Concurrent with the Credit Facility transaction,
we issued through a public offering $115.0 million of
2.75% convertible subordinated notes due 2033 (the
Convertible Notes). The Convertible Notes are
subordinated in right of payment to all of our existing and
future senior debt. The Convertible Notes are convertible into
shares of our common stock at an initial conversion price of
$7.45 per share, at the option of the holder when certain
conditions are met prior to maturity. As of December 31,
2003, none of the conversion conditions had been met and
therefore, the common shares into which the Convertible Notes
may be converted were not included in the calculation of our
diluted earnings per share. Assuming the Convertible Notes had
been converted into shares of our common stock effective
January 1, 2003, our diluted net income per share for the
year ended December 31, 2003 would have been reduced by
$0.09 per share to $0.66 per share diluted, based on a
total number of shares outstanding of approximately 122,352,000.

The net proceeds from these refinancing
transactions were used as follows:



| |   |                                                                                                                                    
| | - | -----------------------------------------------------------------------------------------------------------------------------------
| |  | to redeem all $180.0 million of our
    outstanding 9% Senior Notes due 2006 and to pay the
    applicable premium of $2.7 million;
|
| |  | to redeem $31.0 million of our industrial
    development revenue and first mortgage bonds;                                        
|
| |  | to repay $18.6 million of our mortgage
    obligations; and                                                                        
|
| |  | to pay transaction fees and expenses and for
    general corporate purposes.                                                       

These transactions enabled us to extend principal
maturities, invest significantly more capital expenditures for
future growth and reduce our weighted average interest rate by
approximately two percentage points (or approximately
$11.0 million in annual interest expense).

In November 2003, the Board of Directors
authorized a stock repurchase program whereby we may repurchase,
from time to time on the open market, up to $20.0 million
of our outstanding common stock, effective December 1, 2003
and remaining in effect for one year. No shares have been
repurchased under this authorization and any such repurchases
will occur during open trading windows, if at all.

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We expect the successful completion of our
divestiture strategy, while resulting in a significant reduction
in our revenues, will reduce our patient care liability costs,
reduce outstanding debt and strengthen the nursing facility
portfolio going forward. We expect to continue the
implementation of initiatives to improve our fundamental
business processes and reduce costs throughout the organization.
We can give no assurance that we will be able to execute the
divestiture strategy in a timely manner at fair values or that
we will be able to fully implement planned initiatives to reduce
costs.

We currently anticipate that cash on hand, cash
flows from operations and availability under our banking
arrangements will be adequate to repay our debts due within one
year of $13.1 million, to make capital additions and
improvements of approximately $80.0 million, to make
operating lease and other contractual obligation payments, to
make selective acquisitions, including the potential purchase of
Hospice USA, LLC and the purchase of previously leased
facilities, and to meet working capital requirements for the
twelve months ending March 31, 2005. If cash flows from
operations or availability under our existing banking
arrangements fall below expectations, we may be required to
utilize cash on hand, delay capital expenditures, dispose of
certain assets, issue additional debt securities, or consider
other alternatives to improve liquidity.

Our ability to make payments on and to refinance
our indebtedness and to fund planned capital expenditures and
research and development efforts will depend on our ability to
generate cash in the future. This, to a certain extent, is
subject to general economic, financial, competitive,
legislative, regulatory and other factors that are beyond our
control. However, based on our current level of operations and
anticipated cost savings and operating improvements, we believe
our cash flows from operations, available cash and cash
equivalents and available borrowings will be adequate to meet
our future liquidity needs for at least the next few years.

We cannot assure you, however, that our business
will generate sufficient cash flow from operations, that
currently anticipated cost savings and operating improvements
will be realized on schedule or that future borrowings will be
available to us in an amount sufficient to enable us to pay our
indebtedness or to fund our other liquidity needs. We may need
to refinance all or a portion of our indebtedness on or before
maturity. We cannot assure you that we will be able to refinance
any of our indebtedness on commercially reasonable terms or at
all. (See Item 1.  Business  Risk
Relating to our Company  To service our indebtedness,
we will require a significant amount of cash. Our ability to
generate cash depends on many factors, some of which are beyond
our control.)

Obligations and Commitments

As of March 31, 2004, we have off-balance
sheet debt guarantees of $13.1 million that primarily arose
from our sales of nursing facilities. We also guarantee certain
third-party operating leases. Those guarantees arose from our
dispositions of leased facilities, and the underlying leases
have $46.6 million of minimum rental commitments remaining
through the initial lease terms, with the latest termination
date being February 2019. We have recorded approximately
$531,000, included in Other accrued liabilities on
the consolidated balance sheet, as the estimated fair value of
2003 guarantees in accordance with the FASBs
Interpretation No. 45, Guarantors Accounting and
Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others.

43



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##### Table of Contents



A summary of our long-term contractual
obligations and commitments in future years as of
December 31, 2003, including principal and interest, is
shown below (in thousands):

|                                          |                               |                        |         |           |  |           |        |           |  |            |         |         |  |   |         |         |  |   |         |         | 
|----------------------------------------- | ----------------------------- | ---------------------- | ------- | --------- |  | --------- | ------ | --------- |  | ---------- | ------- | ------- |  | - | ------- | ------- |  | - | ------- | ------- | 
|                                          |                               |                       
|                                          |                               | Payments Due by Period
|                                          |                               |                       
|                                          |                               | Total                  |         | 2004      |  | 2005-2006 |        | 2007-2008 |  | After 2008
|                                          |                               |                        |         |           |  |           |        |           |  |           
|Contractual obligations:                  |                               |                        |         |           |  |           |        |           |  |            |         |         |  |   |         |         |  |   |         |        
|Long-term debt(a)                         |                               | $                      | 854,131 |           |  | $         | 50,722 |           |  | $          | 101,288 |         |  | $ | 226,920 |         |  | $ | 475,201 |        
|Capital lease obligations                 |                               |                        | 7,626   |           |  |           | 887    |           |  |            | 1,215   |         |  |   | 901     |         |  |   | 4,623   |        
|Operating leases                          |                               |                        | 134,002 |           |  |           | 43,504 |           |  |            | 50,201  |         |  |   | 20,164  |         |  |   | 20,133  |        
|Federal government settlement obligations |                               |                        | 73,894  |           |  |           | 18,125 |           |  |            | 36,250  |         |  |   | 19,519  |         |  |   |        |        
|Data processing agreement                 |                               |                        | 8,073   |           |  |           | 2,437  |           |  |            | 4,874   |         |  |   | 762     |         |  |   |        |        
|                                          |                               |                        |         |           |  |           |        |           |  |            |         |         |  |   |         |         |  |   |         |        
|                                          | Total contractual obligations |                        | $       | 1,077,726 |  |           | $      | 115,675   |  |            | $       | 193,828 |  |   | $       | 268,266 |  |   | $       | 499,957 | 
|                                          |                               |                        |         |           |  |           |        |           |  |            |         |         |  |   |         |         |  |   |         |        

|                              |                              |           |        |                                            |  |           |        |           |  |            |   |   |  |   |       |       |  |   |        |        | 
|----------------------------- | ---------------------------- | --------- | ------ | ------------------------------------------ |  | --------- | ------ | --------- |  | ---------- | - | - |  | - | ----- | ----- |  | - | ------ | ------ | 
|                              |                              |           |        |                                           
|                              |                              | Total     |        | Amount of Commitment Expiration Per Period
|                              |                              | Amounts   |        |                                           
|                              |                              | Committed |        | 2004                                       |  | 2005-2006 |        | 2007-2008 |  | After 2008
|                              |                              |           |        |                                            |  |           |        |           |  |           
|Other commercial commitments: |                              |           |        |                                            |  |           |        |           |  |            |   |   |  |   |       |       |  |   |        |       
|Letters of credit             |                              | $         | 41,266 |                                            |  | $         | 41,266 |           |  | $          |  |   |  | $ |      |       |  | $ |       |       
|Guarantees                    |                              |           | 13,083 |                                            |  |           | 345    |           |  |            |  |   |  |   | 2,508 |       |  |   | 10,230 |       
|Other commercial commitments  |                              |           | 403    |                                            |  |           | 403    |           |  |            |  |   |  |   |      |       |  |   |       |       
|                              |                              |           |        |                                            |  |           |        |           |  |            |   |   |  |   |       |       |  |   |        |       
|                              | Total commercial commitments |           | $      | 54,752                                     |  |           | $      | 42,014    |  |            | $ |  |  |   | $     | 2,508 |  |   | $      | 10,230 | 
|                              |                              |           |        |                                            |  |           |        |           |  |            |   |   |  |   |       |       |  |   |        |       



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|    |  |                                                                                                                       
|--- |  | ----------------------------------------------------------------------------------------------------------------------
|(a) |  | For variable-rate debt, we estimated future
    interest payments based on published forward yield curve
    analyses.

These obligations and commitments do not include
$70.0 million of Medium-Term Notes due March 2005, which
are off-balance sheet obligations of BFC. (See
Item 8  Note 1.)

During 2003, we acquired six leased properties
(649 beds) and our corporate office building, which had been
subject to our off-balance sheet lease arrangement, for cash of
$69.5 million. These acquisitions were in accordance with
the 2003 amendments to our former senior credit facility and our
off-balance sheet lease arrangement. These acquisitions were
primarily funded with the proceeds from the sale of nursing
facilities, outpatient therapy clinics and Care Focus.

44



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|         |                                                                
|-------- | ---------------------------------------------------------------
|ITEM 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
    MARKET RISK.

We are exposed to market risk because we utilize
financial instruments. The market risks inherent in these
instruments are attributable to the potential loss from adverse
changes in the general level of United States interest rates. We
manage our interest rate risk exposure by maintaining a mix of
fixed and variable rates for debt and notes receivable. The
following table provides information regarding our market
sensitive financial instruments and constitutes a
forward-looking statement.

|                                   |                       |                         |   |        |   |              |   |              |   |      |   |            |   |       |   |        |   |      |   |        |   |  |   |         |   |  |   |         |  |  |   |         |  |  |   |         | 
|---------------------------------- | --------------------- | ----------------------- | - | ------ | - | ------------ | - | ------------ | - | ---- | - | ---------- | - | ----- | - | ------ | - | ---- | - | ------ | - |  | - | ------- | - |  | - | ------- |  |  | - | ------- |  |  | - | ------- | 
|                                   |                       |                         |   |        |   |              |   |             
|                                   |                       | Expected Maturity Dates |   |        |   | Fair Value   |   | Fair Value  
|                                   |                       |                         |   |        |   | December 31, |   | December 31,
|                                   |                       | 2004                    |   | 2005   |   | 2006         |   | 2007         |   | 2008 |   | Thereafter |   | Total |   | 2003   |   | 2002
|                                   |                       |                         |   |        |   |              |   |              |   |      |   |            |   |       |   |        |   |     
|                                   |                       |                        
|                                   |                       | (Dollars in thousands) 
|Total long-term debt(1):           |                       |                         |   |        |   |              |   |              |   |      |   |            |   |       |   |        |   |      |   |        |   |  |   |         |   |  |   |         |  |  |   |         |  |  |   |        
|                                   | Fixed rate            |                         | $ | 11,743 |   |              | $ | 11,786       |   |      | $ | 9,567      |   |       | $ | 15,423 |   |      | $ | 8,994  |   |  | $ | 371,914 |   |  | $ | 429,427 |  |  | $ | 503,923 |  |  | $ | 578,282 | 
|                                   | Average interest rate |                         |   | 7.53   | % |              |   | 7.53         | % |      |   | 7.55       | % |       |   | 7.55   | % |      |   | 7.55   | % |  |   | 7.55    | % |  |   |         |  |  |   |         |  |  |   |         | 
|                                   | Variable rate         |                         | $ | 1,611  |   |              | $ | 1,635        |   |      | $ | 1,663      |   |       | $ | 33,759 |   |      | $ | 97,581 |   |  | $ | 551     |   |  | $ | 136,800 |  |  | $ | 136,800 |  |  | $ | 7,375   | 
|                                   | Average interest rate |                         |   | 4.43   | % |              |   | 5.54         | % |      |   | 6.64       | % |       |   | 7.46   | % |      |   | 8.04   | % |  |   | 7.83    | % |  |   |         |  |  |   |         |  |  |   |         | 
|Total notes receivable:            |                       |                         |   |        |   |              |   |              |   |      |   |            |   |       |   |        |   |      |   |        |   |  |   |         |   |  |   |         |  |  |   |         |  |  |   |        
|                                   | Fixed rate            |                         | $ | 14,378 |   |              | $ | 650          |   |      | $ | 402        |   |       | $ | 13,766 |   |      | $ | 291    |   |  | $ | 3,299   |   |  | $ | 32,786  |  |  | $ | 27,459  |  |  | $ | 24,548  | 
|                                   | Average interest rate |                         |   | 10.88  | % |              |   | 8.39         | % |      |   | 9.16       | % |       |   | 9.98   | % |      |   | 9.07   | % |  |   | 8.71    | % |  |   |         |  |  |   |         |  |  |   |         | 
|                                   | Variable rate         |                         | $ | 37     |   |              | $ | 39           |   |      | $ | 41         |   |       | $ | 43     |   |      | $ | 46     |   |  | $ | 208     |   |  | $ | 414     |  |  | $ | 414     |  |  | $ | 449     | 
|                                   | Average interest rate |                         |   | 5.00   | % |              |   | 5.00         | % |      |   | 5.00       | % |       |   | 5.00   | % |      |   | 5.00   | % |  |   | 5.00    | % |  |   |         |  |  |   |         |  |  |   |         | 
|Off-balance sheet obligations (2): |                       |                         |   |        |   |              |   |              |   |      |   |            |   |       |   |        |   |      |   |        |   |  |   |         |   |  |   |         |  |  |   |         |  |  |   |        
|                                   | Variable rate         |                         | $ | 70,000 |   |              | $ |             |   |      | $ |           |   |       | $ |       |   |      | $ |       |   |  | $ |        |   |  | $ | 70,000  |  |  | $ | 70,000  |  |  | $ | 139,456 | 
|                                   | Average interest      |                         |   | 1.87   | % |              |   |             |   |      |   |           |   |       |   |       |   |      |   |       |   |  |   |        |   |  |   |         |  |  |   |         |  |  |   |         | 



---



|    |                                                                                                                                                                                                                                                                                                                              
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | See Item 8-Note 9 for a discussion of
    our 2003 refinancing. For variable-rate debt, we estimated
    future interest payments based on published forward yield curve
    analyses.                                                                                                                                       
|   
|(2) | Our off-balance sheet lease obligation of
    $69.5 million was satisfied in June 2003 when we acquired
    the remaining leased properties and our corporate office
    building, which had been subject to this arrangement. We expect
    the $70.0 million of Medium-Term Notes will be paid by BFC
    on June 15, 2004.

45



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##### Table of Contents






ITEM 8. CONSOLIDATED FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA.

|                                                                               |  |      |    | 
|------------------------------------------------------------------------------ |  | ---- | -- | 
|                                                                               |  | Page
|                                                                               |  |     
|Report of Ernst & Young LLP, Independent
    Registered Public Accounting Firm |  |      | 47 | 
|Consolidated Balance Sheets                                                    |  |      | 48 | 
|Consolidated Statements of Operations                                          |  |      | 49 | 
|Consolidated Statements of Stockholders
    Equity                            |  |      | 50 | 
|Consolidated Statements of Cash Flows                                          |  |      | 51 | 
|Notes to Consolidated Financial Statements                                     |  |      | 52 | 
|Supplementary Data (Unaudited) 
    Quarterly Financial Data                  |  |      | 84 | 

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##### Table of Contents






REPORT OF ERNST & YOUNG
LLP,

INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM


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, 2003 and 2002, and the related consolidated
statements of operations, stockholders equity, and cash
flows for each of the three years in the period ended
December 31, 2003. Our audits also included the financial
statement schedule listed in the Index at Item 15(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 the
standards of the Public Company Accounting Oversight Board
(United States). 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, 2003 and 2002, and the
consolidated results of its operations and its cash flows for
each of the three years in the period ended December 31,
2003, in conformity with U.S. 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.

As discussed in Note 1 to the consolidated
financial statements, in 2002 the Company changed its method of
accounting for goodwill.



| |                      
| | ---------------------
| | -S- ERNST & YOUNG LLP

Little Rock, Arkansas

June 4, 2004, except for Note 15,
paragraph 1


as to which the
date is June 9, 2004


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BEVERLY ENTERPRISES, INC.

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)


|                                         |                                                                                                               |                            |           |          |         |   |           |          |         | 
|---------------------------------------- | ------------------------------------------------------------------------------------------------------------- | -------------------------- | --------- | -------- | ------- | - | --------- | -------- | ------- | 
|                                         |                                                                                                               |                           
|                                         |                                                                                                               | December 31,              
|                                         |                                                                                                               |                           
|                                         |                                                                                                               | 2003                       |           | 2002    
|                                         |                                                                                                               |                            |           |         
|ASSETS                                  
|                                        
|Current assets:                          |                                                                                                               |                            |           |          |         |   |           |         
|                                         | Cash and cash equivalents                                                                                     |                            | $         | 258,815  |         |   | $         | 115,445  |        
|                                         | Accounts receivable  patient, less
    allowance for doubtful accounts: 2003  $30,048;
    2002  $43,189   |                            |           | 149,108  |         |   |           | 169,100  |        
|                                         | Accounts receivable  non-patient, less
    allowance for doubtful accounts: 2003  $1,567;
    2002  $1,347 |                            |           | 15,527   |         |   |           | 6,799    |        
|                                         | Notes receivable, less allowance for doubtful
    notes: 2003  $3,336; 2002  $6,038                         |                            |           | 13,724   |         |   |           | 10,388   |        
|                                         | Operating supplies                                                                                            |                            |           | 10,425   |         |   |           | 13,980   |        
|                                         | Assets held for sale                                                                                          |                            |           | 3,498    |         |   |           | 36,418   |        
|                                         | Investment in Beverly Funding Corporation                                                                     |                            |           | 31,342   |         |   |           |         |        
|                                         | Prepaid expenses and other                                                                                    |                            |           | 33,377   |         |   |           | 23,577   |        
|                                         |                                                                                                               |                            |           |          |         |   |           |         
|                                         |                                                                                                               | Total current assets       |           |          | 515,816 |   |           |          | 375,707 | 
|Property and equipment, net              |                                                                                                               |                            | 694,220   |          |         |   | 789,283   |         
|Other assets:                            |                                                                                                               |                            |           |          |         |   |           |         
|                                         | Goodwill, net                                                                                                 |                            |           | 57,102   |         |   |           | 63,377   |        
|                                         | Other, less allowance for doubtful accounts and
    notes: 2003  $2,120; 2002  $1,853                       |                            |           | 79,283   |         |   |           | 121,528  |        
|                                         |                                                                                                               |                            |           |          |         |   |           |         
|                                         |                                                                                                               | Total other assets         |           |          | 136,385 |   |           |          | 184,905 | 
|                                         |                                                                                                               |                            |           |          |         |   |           |         
|                                         |                                                                                                               | $                          | 1,346,421 |          |         | $ | 1,349,895 |         
|                                         |                                                                                                               |                            |           |          |         |   |           |         
|                                        
|LIABILITIES AND STOCKHOLDERS
    EQUITY
|                                        
|Current liabilities:                     |                                                                                                               |                            |           |          |         |   |           |         
|                                         | Accounts payable                                                                                              |                            | $         | 67,572   |         |   | $         | 65,546   |        
|                                         | Accrued wages and related liabilities                                                                         |                            |           | 116,717  |         |   |           | 98,206   |        
|                                         | Accrued interest                                                                                              |                            |           | 6,896    |         |   |           | 12,783   |        
|                                         | General and professional liabilities                                                                          |                            |           | 93,736   |         |   |           | 77,025   |        
|                                         | Federal government settlement obligations                                                                     |                            |           | 13,125   |         |   |           | 11,915   |        
|                                         | Liabilities held for sale                                                                                     |                            |           | 672      |         |   |           | 3,239    |        
|                                         | Other accrued liabilities                                                                                     |                            |           | 102,289  |         |   |           | 107,241  |        
|                                         | Current portion of long-term debt                                                                             |                            |           | 13,354   |         |   |           | 41,463   |        
|                                         |                                                                                                               |                            |           |          |         |   |           |         
|                                         |                                                                                                               | Total current liabilities  |           |          | 414,361 |   |           |          | 417,418 | 
|Long-term debt                           |                                                                                                               |                            | 552,873   |          |         |   | 588,714   |         
|Other liabilities and deferred items     |                                                                                                               |                            | 141,001   |          |         |   | 190,291   |         
|Commitments and contingencies            |                                                                                                               |                            |           |          |         |   |           |         
|Stockholders equity:                    |                                                                                                               |                            |           |          |         |   |           |         
|                                         | Preferred stock, shares authorized: 25,000,000                                                                |                            |           |         |         |   |           |         |        
|                                         | Common stock, shares issued: 2003 
    115,594,806; 2002  113,249,341                                       |                            |           | 11,559   |         |   |           | 11,325   |        
|                                         | Additional paid-in capital                                                                                    |                            |           | 895,950  |         |   |           | 891,782  |        
|                                         | Accumulated deficit                                                                                           |                            |           | (560,825 | )       |   |           | (641,293 | )      
|                                         | Accumulated other comprehensive income                                                                        |                            |           |         |         |   |           | 517      |        
|                                         | Treasury stock, at cost: 2003 
    8,283,316; 2002  8,391,546                                               |                            |           | (108,498 | )       |   |           | (108,859 | )      
|                                         |                                                                                                               |                            |           |          |         |   |           |         
|                                         |                                                                                                               | Total stockholders equity |           |          | 238,186 |   |           |          | 153,472 | 
|                                         |                                                                                                               |                            |           |          |         |   |           |         
|                                         |                                                                                                               | $                          | 1,346,421 |          |         | $ | 1,349,895 |         
|                                         |                                                                                                               |                            |           |          |         |   |           |         

See accompanying notes.

48



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##### Table of Contents



BEVERLY ENTERPRISES, INC.

CONSOLIDATED STATEMENTS OF
OPERATIONS

(In thousands, except per share
amounts)


|                                                                                                                                            |                                                                                               |                                                                                               |                           |            |         |            |           |           |         |           |           |           |         |           |  
|------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------- | ------------------------- | ---------- | ------- | ---------- | --------- | --------- | ------- | --------- | --------- | --------- | ------- | --------- | -
|                                                                                                                                            |                                                                                               |                                                                                              
|                                                                                                                                            |                                                                                               | Years Ended December 31,                                                                     
|                                                                                                                                            |                                                                                               |                                                                                              
|                                                                                                                                            |                                                                                               | 2003                                                                                          |                           | 2002       |         | 2001      
|                                                                                                                                            |                                                                                               |                                                                                               |                           |            |         |           
|                                                                                                                                            |                                                                                               | (Restated)                                                                                    |                           | (Restated) |         | (Restated)
|Revenues                                                                                                                                    |                                                                                               | $                                                                                             | 1,979,759                 |            |         | $          | 1,941,313 |           |         | $         | 2,127,795 |          
|Costs and expenses:                                                                                                                         |                                                                                               |                                                                                               |                           |            |         |            |           |           |         |           |           |          
|                                                                                                                                            | Wages and related                                                                             |                                                                                               |                           | 1,178,926  |         |            |           | 1,168,789 |         |           |           | 1,300,527 |        
|                                                                                                                                            | Provision for insurance and related items                                                     |                                                                                               |                           | 125,871    |         |            |           | 93,657    |         |           |           | 82,286    |        
|                                                                                                                                            | Other operating and administrative                                                            |                                                                                               |                           | 524,785    |         |            |           | 513,789   |         |           |           | 560,424   |        
|                                                                                                                                            | Depreciation and amortization                                                                 |                                                                                               |                           | 59,318     |         |            |           | 65,927    |         |           |           | 66,952    |        
|                                                                                                                                            | Florida insurance reserve adjustment                                                          |                                                                                               |                           |           |         |            |           | 22,179    |         |           |           |          |        
|                                                                                                                                            | Special charge and adjustment related to
    California investigation settlement              |                                                                                               |                           | (925       | )       |            |           | 6,300     |         |           |           |          |        
|                                                                                                                                            | Special charge and adjustment related to
    settlements of federal government investigations |                                                                                               |                           |           |         |            |           | (9,441    | )       |           |           | 77,495    |        
|                                                                                                                                            | Asset impairments, workforce reductions and other
    unusual items                           |                                                                                               |                           | 5,596      |         |            |           | 54,829    |         |           |           | 182,028   |        
|                                                                                                                                            |                                                                                               |                                                                                               |                           |            |         |            |           |           |         |           |           |          
|                                                                                                                                            |                                                                                               |                                                                                               | Total costs and expenses  |            |         | 1,893,571  |           |           |         | 1,916,029 |           |           |         | 2,269,712 |  
|                                                                                                                                            |                                                                                               |                                                                                               |                           |            |         |            |           |           |         |           |           |          
|Income (loss) before other income (expenses)                                                                                                |                                                                                               |                                                                                               | 86,188                    |            |         |            | 25,284    |           |         |           | (141,917  | )        
|                                                                                                                                            | Other income (expenses):                                                                      |                                                                                               |                           |            |         |            |           |           |         |           |           |           |        
|                                                                                                                                            |                                                                                               | Interest expense                                                                              |                           |            | (63,904 | )          |           |           | (63,226 | )         |           |           | (75,035 | )        
|                                                                                                                                            |                                                                                               | Costs related to early extinguishments of debt                                                |                           |            | (6,634  | )          |           |           |        |           |           |           |        |          
|                                                                                                                                            |                                                                                               | Interest income                                                                               |                           |            | 5,365   |            |           |           | 4,690   |           |           |           | 2,916   |          
|                                                                                                                                            |                                                                                               | Net gains on dispositions                                                                     |                           |            | 422     |            |           |           | 2,149   |           |           |           | 696     |          
|                                                                                                                                            |                                                                                               | Gains on sales of equity investments                                                          |                           |            | 6,686   |            |           |           |        |           |           |           | 256     |          
|                                                                                                                                            |                                                                                               |                                                                                               |                           |            |         |            |           |           |         |           |           |          
|                                                                                                                                            |                                                                                               |                                                                                               | Total other expenses, net |            |         | (58,065    | )         |           |         | (56,387   | )         |           |         | (71,167   | )
|                                                                                                                                            |                                                                                               |                                                                                               |                           |            |         |            |           |           |         |           |           |          
|Income (loss) before provision for income taxes,
    discontinued operations and cumulative effect of change in
    accounting for goodwill |                                                                                               |                                                                                               | 28,123                    |            |         |            | (31,103   | )         |         |           | (213,084  | )        
|Provision for income taxes                                                                                                                  |                                                                                               |                                                                                               | 5,069                     |            |         |            | 6,085     |           |         |           | 60,132    |          
|                                                                                                                                            |                                                                                               |                                                                                               |                           |            |         |            |           |           |         |           |           |          
|Income (loss) before discontinued operations and
    cumulative effect of change in accounting for goodwill                                 |                                                                                               |                                                                                               | 23,054                    |            |         |            | (37,188   | )         |         |           | (273,216  | )        
|Discontinued operations, net of taxes:
    2003  $3,378; 2002  $0; 2001 
    $1,256                                                      |                                                                                               |                                                                                               | 57,414                    |            |         |            | (31,731   | )         |         |           | (28,056   | )        
|Cumulative effect of change in accounting for
    goodwill, net of income taxes of $0                                                       |                                                                                               |                                                                                               |                          |            |         |            | (77,171   | )         |         |           |          |          
|                                                                                                                                            |                                                                                               |                                                                                               |                           |            |         |            |           |           |         |           |           |          
|Net income (loss)                                                                                                                           |                                                                                               | $                                                                                             | 80,468                    |            |         | $          | (146,090  | )         |         | $         | (301,272  | )        
|                                                                                                                                            |                                                                                               |                                                                                               |                           |            |         |            |           |           |         |           |           |          
|Net income (loss) per share of common stock:                                                                                                |                                                                                               |                                                                                               |                           |            |         |            |           |           |         |           |           |          
|                                                                                                                                            | Basic and diluted:                                                                            |                                                                                               |                           |            |         |            |           |           |         |           |           |           |        
|                                                                                                                                            |                                                                                               | Before discontinued operations and cumulative
    effect of change in accounting for goodwill |                           | $          | 0.22    |            |           | $         | (0.36   | )         |           | $         | (2.63   | )        
|                                                                                                                                            |                                                                                               | Discontinued operations, net of taxes                                                         |                           |            | 0.53    |            |           |           | (0.29   | )         |           |           | (0.27   | )        
|                                                                                                                                            |                                                                                               | Cumulative effect of change in accounting for
    goodwill, net of taxes                      |                           |            |        |            |           |           | (0.74   | )         |           |           |        |          
|                                                                                                                                            |                                                                                               |                                                                                               |                           |            |         |            |           |           |         |           |           |          
|                                                                                                                                            |                                                                                               | Net income (loss) per share of common stock                                                   |                           | $          | 0.75    |            |           | $         | (1.39   | )         |           | $         | (2.90   | )        
|                                                                                                                                            |                                                                                               |                                                                                               |                           |            |         |            |           |           |         |           |           |          
|                                                                                                                                            |                                                                                               | Shares used to compute basic net income (loss)
    per share                                  |                           |            | 106,582 |            |           |           | 104,726 |           |           |           | 104,037 |          
|                                                                                                                                            |                                                                                               |                                                                                               |                           |            |         |            |           |           |         |           |           |          
|                                                                                                                                            |                                                                                               | Shares used to compute diluted net income (loss)
    per share                                |                           |            | 106,920 |            |           |           | 104,726 |           |           |           | 104,037 |          
|                                                                                                                                            |                                                                                               |                                                                                               |                           |            |         |            |           |           |         |           |           |          

See accompanying notes.

49



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##### Table of Contents



BEVERLY ENTERPRISES, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS
EQUITY

(Dollars in thousands)


|                              |                                                                                  |                                                                                 |        |            |   |             |         |               |   |          |          |       |          |   |       |   |        |   |          |       |   |   |         |          |          |  
|----------------------------- | -------------------------------------------------------------------------------- | ------------------------------------------------------------------------------- | ------ | ---------- | - | ----------- | ------- | ------------- | - | -------- | -------- | ----- | -------- | - | ----- | - | ------ | - | -------- | ----- | - | - | ------- | -------- | -------- | -
|                              |                                                                                  |                                                                                 |        |            |   |             |         | Accumulated   |   |          |          |      
|                              |                                                                                  |                                                                                 |        |            |   |             |         | Other         |   |          |          |      
|                              |                                                                                  |                                                                                 |        | Additional |   |             |         | Comprehensive |   |          |          |      
|                              |                                                                                  | Common                                                                          |        | Paid-in    |   | Accumulated |         | Income        |   | Treasury |          |      
|                              |                                                                                  | Stock                                                                           |        | Capital    |   | Deficit     |         | (Loss)        |   | Stock    |          | Total
|                              |                                                                                  |                                                                                 |        |            |   |             |         |               |   |          |          |      
|Balances at January 1, 2001   |                                                                                  | $                                                                               | 11,282 |            |   | $           | 876,981 |               |   | $        | (193,931 | )     |          | $ | 718   |   |        | $ | (111,057 | )     |   | $ | 583,993 |         
|                              | Employee stock transactions related to
    5,495 shares of common stock, net     |                                                                                 |        | (1         | ) |             |         | 8,456         |   |          |          |      |          |   |       |  |        |   |          |      |   |   |         | 8,455    |         
|                              | Reissuance of 545,542 shares of common stock
    from treasury                   |                                                                                 |        |           |   |             |         | 2,231         |   |          |          |      |          |   |       |  |        |   |          | 1,779 |   |   |         | 4,010    |         
|                              | Comprehensive income (loss):                                                     |                                                                                 |        |            |   |             |         |               |   |          |          |       |          |   |       |   |        |   |          |       |   |   |         |          |         
|                              |                                                                                  | Foreign currency translation adjustments, net of
    income tax benefit of $222 |        |            |  |             |         |               |  |          |          |       |         |   |       |   | (330   | ) |          |       |  |   |         |          | (330     | )
|                              |                                                                                  | Unrealized gains on securities, net of income
    taxes of $1,104               |        |            |  |             |         |               |  |          |          |       |         |   |       |   | 1,641  |   |          |       |  |   |         |          | 1,641    |  
|                              |                                                                                  | Net loss                                                                        |        |            |  |             |         |               |  |          |          |       | (301,272 | ) |       |   |       |   |          |       |  |   |         |          | (301,272 | )
|                              |                                                                                  |                                                                                 |        |            |   |             |         |               |   |          |          |       |          |   |       |   |        |   |          |       |   |   |         |         
|                              | Total comprehensive loss                                                         |                                                                                 |        |            |   |             |         |               |   |          |          |       |          |   |       |   |        |   |          |       |   |   |         | (299,961 | )       
|                              |                                                                                  |                                                                                 |        |            |   |             |         |               |   |          |          |       |          |   |       |   |        |   |          |       |   |   |         |         
|Balances at December 31, 2001 |                                                                                  |                                                                                 | 11,281 |            |   |             | 887,668 |               |   |          | (495,203 | )     |          |   | 2,029 |   |        |   | (109,278 | )     |   |   | 296,497 |         
|                              | Employee stock transactions related to
    436,038 shares of common stock, net   |                                                                                 |        | 44         |   |             |         | 3,680         |   |          |          |      |          |   |       |  |        |   |          |      |   |   |         | 3,724    |         
|                              | Reissuance of 124,212 shares of common stock
    from treasury                   |                                                                                 |        |           |   |             |         | 434           |   |          |          |      |          |   |       |  |        |   |          | 419   |   |   |         | 853      |         
|                              | Comprehensive loss:                                                              |                                                                                 |        |            |   |             |         |               |   |          |          |       |          |   |       |   |        |   |          |       |   |   |         |          |         
|                              |                                                                                  | Unrealized losses on securities, net of income
    taxes of $0                  |        |            |  |             |         |               |  |          |          |       |         |   |       |   | (1,464 | ) |          |       |  |   |         |          | (1,464   | )
|                              |                                                                                  | Foreign currency translation adjustments, net of
    income taxes of $0         |        |            |  |             |         |               |  |          |          |       |         |   |       |   | (48    | ) |          |       |  |   |         |          | (48      | )
|                              |                                                                                  | Net loss                                                                        |        |            |  |             |         |               |  |          |          |       | (146,090 | ) |       |   |       |   |          |       |  |   |         |          | (146,090 | )
|                              |                                                                                  |                                                                                 |        |            |   |             |         |               |   |          |          |       |          |   |       |   |        |   |          |       |   |   |         |         
|                              | Total comprehensive loss                                                         |                                                                                 |        |            |   |             |         |               |   |          |          |       |          |   |       |   |        |   |          |       |   |   |         | (147,602 | )       
|                              |                                                                                  |                                                                                 |        |            |   |             |         |               |   |          |          |       |          |   |       |   |        |   |          |       |   |   |         |         
|Balances at December 31, 2002 |                                                                                  |                                                                                 | 11,325 |            |   |             | 891,782 |               |   |          | (641,293 | )     |          |   | 517   |   |        |   | (108,859 | )     |   |   | 153,472 |         
|                              | Employee stock transactions related to
    2,345,465 shares of common stock, net |                                                                                 |        | 234        |   |             |         | 4,274         |   |          |          |      |          |   |       |  |        |   |          |      |   |   |         | 4,508    |         
|                              | Reissuance of 108,230 shares of common stock
    from treasury                   |                                                                                 |        |           |   |             |         | (106          | ) |          |          |      |          |   |       |  |        |   |          | 361   |   |   |         | 255      |         
|                              | Comprehensive income (loss):                                                     |                                                                                 |        |            |   |             |         |               |   |          |          |       |          |   |       |   |        |   |          |       |   |   |         |          |         
|                              |                                                                                  | Unrealized losses on securities, net of income
    taxes of $0                  |        |            |  |             |         |               |  |          |          |       |         |   |       |   | (512   | ) |          |       |  |   |         |          | (512     | )
|                              |                                                                                  | Foreign currency translation adjustments, net of
    income taxes of $0         |        |            |  |             |         |               |  |          |          |       |         |   |       |   | (5     | ) |          |       |  |   |         |          | (5       | )
|                              |                                                                                  | Net income                                                                      |        |            |  |             |         |               |  |          |          |       | 80,468   |   |       |   |       |   |          |       |  |   |         |          | 80,468   |  
|                              |                                                                                  |                                                                                 |        |            |   |             |         |               |   |          |          |       |          |   |       |   |        |   |          |       |   |   |         |         
|                              | Total comprehensive income                                                       |                                                                                 |        |            |   |             |         |               |   |          |          |       |          |   |       |   |        |   |          |       |   |   |         | 79,951   |         
|                              |                                                                                  |                                                                                 |        |            |   |             |         |               |   |          |          |       |          |   |       |   |        |   |          |       |   |   |         |         
|Balances at December 31, 2003 |                                                                                  | $                                                                               | 11,559 |            |   | $           | 895,950 |               |   | $        | (560,825 | )     |          | $ |      |   |        | $ | (108,498 | )     |   | $ | 238,186 |         
|                              |                                                                                  |                                                                                 |        |            |   |             |         |               |   |          |          |       |          |   |       |   |        |   |          |       |   |   |         |         

See accompanying notes.

50



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##### Table of Contents



BEVERLY ENTERPRISES, INC.

CONSOLIDATED STATEMENTS OF CASH
FLOWS

(In thousands)


|                                                |                                                                                                                                     |                                                                                               |                                             |                                                          |         |         |          |          |        |         |          |          |         |        |         |  
|----------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------- | ------------------------------------------- | -------------------------------------------------------- | ------- | ------- | -------- | -------- | ------ | ------- | -------- | -------- | ------- | ------ | ------- | -
|                                                |                                                                                                                                     |                                                                                              
|                                                |                                                                                                                                     | Years Ended December 31,                                                                     
|                                                |                                                                                                                                     |                                                                                              
|                                                |                                                                                                                                     | 2003                                                                                          |                                             | 2002                                                     |         | 2001   
|                                                |                                                                                                                                     |                                                                                               |                                             |                                                          |         |        
|Cash flows from operating activities:           |                                                                                                                                     |                                                                                               |                                             |                                                          |         |         |          |          |        |         |          |         
|                                                | Net income (loss)                                                                                                                   |                                                                                               | $                                           | 80,468                                                   |         |         | $        | (146,090 | )      |         | $        | (301,272 | )      
|                                                | Adjustments to reconcile net income (loss) to net
    cash provided by operating activities, including discontinued
    operations: |                                                                                               |                                             |                                                          |         |         |          |          |        |         |          |          |        
|                                                |                                                                                                                                     | Depreciation and amortization                                                                 |                                             |                                                          | 69,663  |         |          |          | 88,943 |         |          |          | 93,001  |       
|                                                |                                                                                                                                     | Provision for reserves on patient, notes and
    other receivables, net                       |                                             |                                                          | 21,605  |         |          |          | 55,570 |         |          |          | 44,251  |       
|                                                |                                                                                                                                     | Amortization of deferred financing costs                                                      |                                             |                                                          | 4,474   |         |          |          | 3,096  |         |          |          | 4,051   |       
|                                                |                                                                                                                                     | Florida insurance reserve adjustment                                                          |                                             |                                                          |        |         |          |          | 22,179 |         |          |          |        |       
|                                                |                                                                                                                                     | Special charge and adjustment related to
    California investigation settlement              |                                             |                                                          | (925    | )       |          |          | 6,300  |         |          |          |        |       
|                                                |                                                                                                                                     | Special charge and adjustment related to
    settlements of federal government investigations |                                             |                                                          |        |         |          |          | (9,441 | )       |          |          | 77,495  |       
|                                                |                                                                                                                                     | Asset impairments, workforce reductions and other
    unusual items                           |                                             |                                                          | 7,459   |         |          |          | 85,773 |         |          |          | 238,102 |       
|                                                |                                                                                                                                     | Costs related to early extinguishments of debt                                                |                                             |                                                          | 6,634   |         |          |          |        |         |          |          |         |       
|                                                |                                                                                                                                     | Cumulative effect of change in accounting for
    goodwill                                    |                                             |                                                          |        |         |          |          | 77,171 |         |          |          |        |       
|                                                |                                                                                                                                     | Gains on dispositions of facilities and other
    assets, net                                 |                                             |                                                          | (81,508 | )       |          |          | (1,855 | )       |          |          | (568    | )     
|                                                |                                                                                                                                     | Deferred income taxes                                                                         |                                             |                                                          |        |         |          |          |       |         |          |          | 54,901  |       
|                                                |                                                                                                                                     | Insurance related accounts                                                                    |                                             |                                                          | (32,727 | )       |          |          | 8,411  |         |          |          | 11,830  |       
|                                                |                                                                                                                                     | Changes in operating assets and liabilities, net
    of acquisitions and dispositions:        |                                             |                                                          |         |         |          |          |        |         |          |          |         |       
|                                                |                                                                                                                                     |                                                                                               | Accounts receivable  patient               |                                                          |         | (13,968 | )        |          |        | 7,896   |          |          |         | (3,523 | )      
|                                                |                                                                                                                                     |                                                                                               | Operating supplies                          |                                                          |         | 1,467   |          |          |        | 3,081   |          |          |         | 567    |        
|                                                |                                                                                                                                     |                                                                                               | Prepaid expenses and other receivables      |                                                          |         | (2,502  | )        |          |        | 988     |          |          |         | 728    |        
|                                                |                                                                                                                                     |                                                                                               | Accounts payable and other accrued expenses |                                                          |         | 117     |          |          |        | (85,335 | )        |          |         | 8,846  |        
|                                                |                                                                                                                                     |                                                                                               | Income taxes payable                        |                                                          |         | 16,103  |          |          |        | 9,790   |          |          |         | 188    |        
|                                                |                                                                                                                                     |                                                                                               | Other, net                                  |                                                          |         | (6,499  | )        |          |        | (9,844  | )        |          |         | (7,700 | )      
|                                                |                                                                                                                                     |                                                                                               |                                             |                                                          |         |         |          |          |        |         |          |         
|                                                |                                                                                                                                     |                                                                                               |                                             | Total adjustments                                        |         |         | (10,607  | )        |        |         | 262,723  |          |         |        | 522,169 |  
|                                                |                                                                                                                                     |                                                                                               |                                             |                                                          |         |         |          |          |        |         |          |         
|                                                |                                                                                                                                     |                                                                                               |                                             | Net cash provided by operating activities                |         |         | 69,861   |          |        |         | 116,633  |          |         |        | 220,897 |  
|Cash flows from investing activities:           |                                                                                                                                     |                                                                                               |                                             |                                                          |         |         |          |          |        |         |          |         
|                                                | Capital expenditures                                                                                                                |                                                                                               |                                             | (43,984                                                  | )       |         |          | (100,103 | )      |         |          | (89,401  | )      
|                                                | Proceeds from dispositions of facilities and
    other assets, net                                                                  |                                                                                               |                                             | 275,039                                                  |         |         |          | 169,471  |        |         |          | 20,795   |        
|                                                | Collections on notes receivable                                                                                                     |                                                                                               |                                             | 8,689                                                    |         |         |          | 1,616    |        |         |          | 238      |        
|                                                | Payments for designated funds, net                                                                                                  |                                                                                               |                                             | (5,183                                                   | )       |         |          | (260     | )      |         |          | (8,950   | )      
|                                                | Other, net                                                                                                                          |                                                                                               |                                             | (15,373                                                  | )       |         |          | (8,389   | )      |         |          | (9,336   | )      
|                                                |                                                                                                                                     |                                                                                               |                                             |                                                          |         |         |          |          |        |         |          |         
|                                                |                                                                                                                                     |                                                                                               |                                             | Net cash provided by (used for) investing
    activities |         |         | 219,188  |          |        |         | 62,335   |          |         |        | (86,654 | )
|Cash flows from financing activities:           |                                                                                                                                     |                                                                                               |                                             |                                                          |         |         |          |          |        |         |          |         
|                                                | Revolver borrowings                                                                                                                 |                                                                                               |                                             |                                                         |         |         |          |         |        |         |          | 442,000  |        
|                                                | Repayments of revolver borrowings                                                                                                   |                                                                                               |                                             |                                                         |         |         |          |         |        |         |          | (606,000 | )      
|                                                | Proceeds from issuance of long-term debt                                                                                            |                                                                                               |                                             | 250,000                                                  |         |         |          | 5,000    |        |         |          | 205,248  |        
|                                                | Repayments of long-term debt                                                                                                        |                                                                                               |                                             | (313,352                                                 | )       |         |          | (116,496 | )      |         |          | (106,150 | )      
|                                                | Repayments of off-balance sheet financing                                                                                           |                                                                                               |                                             | (69,456                                                  | )       |         |          | (42,901  | )      |         |          |         |        
|                                                | Proceeds from exercise of stock options                                                                                             |                                                                                               |                                             | 1,108                                                    |         |         |          | 1,699    |        |         |          | 3,648    |        
|                                                | Deferred financing and other costs                                                                                                  |                                                                                               |                                             | (13,979                                                  | )       |         |          | (168     | )      |         |          | (9,554   | )      
|                                                |                                                                                                                                     |                                                                                               |                                             |                                                          |         |         |          |          |        |         |          |         
|                                                |                                                                                                                                     |                                                                                               |                                             | Net cash used for financing activities                   |         |         | (145,679 | )        |        |         | (152,866 | )        |         |        | (70,808 | )
|                                                |                                                                                                                                     |                                                                                               |                                             |                                                          |         |         |          |          |        |         |          |         
|Net increase in cash and cash equivalents       |                                                                                                                                     |                                                                                               | 143,370                                     |                                                          |         |         | 26,102   |          |        |         | 63,435   |         
|Cash and cash equivalents at beginning of year  |                                                                                                                                     |                                                                                               | 115,445                                     |                                                          |         |         | 89,343   |          |        |         | 25,908   |         
|                                                |                                                                                                                                     |                                                                                               |                                             |                                                          |         |         |          |          |        |         |          |         
|Cash and cash equivalents at end of year        |                                                                                                                                     | $                                                                                             | 258,815                                     |                                                          |         | $       | 115,445  |          |        | $       | 89,343   |         
|                                                |                                                                                                                                     |                                                                                               |                                             |                                                          |         |         |          |          |        |         |          |         
|Supplemental schedule of cash flow information: |                                                                                                                                     |                                                                                               |                                             |                                                          |         |         |          |          |        |         |          |         
|                                                | Cash paid (received) during the year for:                                                                                           |                                                                                               |                                             |                                                          |         |         |          |          |        |         |          |          |        
|                                                |                                                                                                                                     | Interest, net of amounts capitalized                                                          |                                             | $                                                        | 67,710  |         |          | $        | 65,658 |         |          | $        | 76,358  |       
|                                                |                                                                                                                                     | Income tax payments (refunds), net                                                            |                                             |                                                          | (7,656  | )       |          |          | (3,705 | )       |          |          | 6,299   |       

See accompanying notes.

51



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##### Table of Contents



BEVERLY ENTERPRISES, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS

Years ended December 31, 2003, 2002 and
2001




|   |                                               
|-- | ----------------------------------------------
|1. | Summary of Significant Accounting
    Policies



| |                      
| | ---------------------
| | Basis of Presentation

References herein to the Company include Beverly
Enterprises, Inc. and its wholly owned subsidiaries.

On December 31, 2003, we operated
373 nursing facilities, 20 assisted living centers,
23 hospice and home care centers and 10 outpatient
clinics in 26 states and the District of Columbia. Our
operations also include rehabilitation therapy services in
36 states and the District of Columbia. Our consolidated
financial statements include the accounts of the Company and all
of its wholly owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated.



| |            
| | -----------
| | Restatement

The accompanying consolidated financial
statements have been restated to report facilities, clinics and
other assets which have been sold, closed or classified as
held-for-sale during the three months ended March 31, 2004
as discontinued operations.



| |                 
| | ----------------
| | Use of Estimates

Generally accepted accounting principles require
management to make estimates and assumptions when preparing
financial statements that affect:



| |   |                                                                                                
| | - | -----------------------------------------------------------------------------------------------
| |  | the reported amounts of assets and liabilities at
    the date of the financial statements; and
|
| |  | the reported amounts of revenues and expenses
    during the reporting period.                 

They also require management to make estimates
and assumptions regarding contingent assets and liabilities at
the date of the financial statements. 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, Net

Property and equipment is stated at the lower of
carrying value or fair value, or where appropriate, the present
value of the related capital lease obligations less accumulated
amortization. Depreciation and amortization are computed using
the straight-line method over the estimated useful lives of the
assets.



| |                  
| | -----------------
| | Intangible Assets

Following is a summary of our goodwill and other
indefinite-lived intangible assets, included in Other
assets, and related accumulated amortization, at
December 31 (in thousands):

|                                         |  |            |        |              |  |                |        |      |  |      |        |      |  |   |        |  |  |   |        |  |  |   |        | 
|---------------------------------------- |  | ---------- | ------ | ------------ |  | -------------- | ------ | ---- |  | ---- | ------ | ---- |  | - | ------ |  |  | - | ------ |  |  | - | ------ | 
|                                         |  |            |        |              |  |                |        |      |  |     
|                                         |  |            |        | Accumulated  |  |               
|                                         |  | Cost Basis |        | Amortization |  | Carrying Value
|                                         |  |            |        |              |  |               
|                                         |  | 2003       |        | 2002         |  | 2003           |        | 2002 |  | 2003 |        | 2002
|                                         |  |            |        |              |  |                |        |      |  |      |        |     
|Goodwill                                 |  | $          | 78,609 |              |  | $              | 87,895 |      |  | $    | 21,507 |      |  | $ | 24,518 |  |  | $ | 57,102 |  |  | $ | 63,377 | 
|Other indefinite-lived intangible assets |  |            | 9,546  |              |  |                | 11,368 |      |  |      | 4,547  |      |  |   | 5,376  |  |  |   | 4,999  |  |  |   | 5,992  | 
|                                         |  |            |        |              |  |                |        |      |  |      |        |      |  |   |        |  |  |   |        |  |  |   |        | 
|                                         |  | $          | 88,155 |              |  | $              | 99,263 |      |  | $    | 26,054 |      |  | $ | 29,894 |  |  | $ | 62,101 |  |  | $ | 69,369 | 
|                                         |  |            |        |              |  |                |        |      |  |      |        |      |  |   |        |  |  |   |        |  |  |   |        | 

52



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##### Table of Contents



BEVERLY ENTERPRISES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Years ended December 31, 2003, 2002 and
2001




|   |                                                             
|-- | ------------------------------------------------------------
|1. | Summary of Significant Accounting
    Policies  (Continued)

In July 2001, Statement of Financial Accounting
Standards No. 142, Goodwill and Other Intangible Assets(SFAS No. 142) was issued, which
established new rules on the accounting for goodwill and other
intangible assets. Under SFAS No. 142, goodwill and
intangible assets with indefinite lives are no longer amortized;
however, they are subject to annual impairment tests as
prescribed by the Statement. Intangible assets with definite
lives continue to be amortized over their estimated useful
lives. With respect to our goodwill and intangible assets,
SFAS No. 142 was effective for us beginning
January 1, 2002. For 2001, our goodwill and operating
rights amortization was $3.9 million and $252,000,
respectively, net of income taxes, or $0.04 per share
diluted.

In accordance with this standard, we performed
the initial screening for potential impairments of our
indefinite-lived intangible assets by reporting unit as of
January 1, 2002. We determined the estimated fair values of
each reporting unit using discounted cash flow analyses, along
with independent source data related to recent transactions.
Based on this determination, we identified potential goodwill
impairments at our former Matrix and Home Care
Services  Care Focus reporting units.

We engaged a qualified independent valuation
group to determine the estimated fair values of each of these
reporting units. Their valuation analysis was completed in the
fourth quarter of 2002, and led to the recording of a cumulative
effect of a change in accounting for goodwill of
$77.2 million as of January 1, 2002, including
$70.6 million for Matrix and $6.6 million for Care
Focus. In accordance with SFAS No. 142, we test
goodwill for impairment on an annual basis as of October 1
for each of our reporting units. We also test goodwill for
impairment, between annual tests, if an event occurs that would
more likely than not reduce the fair value of a reporting unit
below its carrying amount. Based on the October 1, 2003 and
2002 analyses, no additional impairments of goodwill or other
indefinite-lived intangibles were identified.

Following is a summary of our finite-lived
intangible assets and related accumulated amortization, by major
classification, which are included in Other assets
at December 31 (in thousands):

|                              |  |            |       |              |  |                |       |      |  |      |     |      |  |   |       |  |  |   |       |  |  |   |       | 
|----------------------------- |  | ---------- | ----- | ------------ |  | -------------- | ----- | ---- |  | ---- | --- | ---- |  | - | ----- |  |  | - | ----- |  |  | - | ----- | 
|                              |  |            |       |              |  |                |       |      |  |     
|                              |  |            |       | Accumulated  |  |               
|                              |  | Cost Basis |       | Amortization |  | Carrying Value
|                              |  |            |       |              |  |               
|                              |  | 2003       |       | 2002         |  | 2003           |       | 2002 |  | 2003 |     | 2002
|                              |  |            |       |              |  |                |       |      |  |      |     |     
|Operating rights and licenses |  | $          | 1,801 |              |  | $              | 2,161 |      |  | $    | 203 |      |  | $ | 114   |  |  | $ | 1,598 |  |  | $ | 2,047 | 
|Leasehold interests           |  |            | 439   |              |  |                | 2,134 |      |  |      | 389 |      |  |   | 2,053 |  |  |   | 50    |  |  |   | 81    | 
|                              |  |            |       |              |  |                |       |      |  |      |     |      |  |   |       |  |  |   |       |  |  |   |       | 
|                              |  | $          | 2,240 |              |  | $              | 4,295 |      |  | $    | 592 |      |  | $ | 2,167 |  |  | $ | 1,648 |  |  | $ | 2,128 | 
|                              |  |            |       |              |  |                |       |      |  |      |     |      |  |   |       |  |  |   |       |  |  |   |       | 

The weighted-average amortization period for
these intangibles is approximately 15 years, including
16 years for operating rights and licenses and 6 years
for leasehold interests. Amortization expense related to these
intangibles for the years ended December 31, 2003, 2002 and
2001 was approximately $100,000, $300,000 and $400,000,
respectively. Our estimated aggregate annual amortization
expense for these intangibles for each of the next five years is
approximately $100,000.

On an ongoing basis, we review the carrying value
of our finite-lived intangibles in light of any events or
circumstances that indicate they may be impaired or that the
amortization period may need to be adjusted and make any
necessary adjustments. As of December 31, 2003, we do not
believe there are any indications that the carrying values, or
the useful lives, of these assets need to be adjusted. We have
no residual values assigned to our finite-lived intangible
assets.

53



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BEVERLY ENTERPRISES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Years ended December 31, 2003, 2002 and
2001




|   |                                                             
|-- | ------------------------------------------------------------
|1. | Summary of Significant Accounting
    Policies  (Continued)



| |                                
| | -------------------------------
| | Impairment of Long-Lived Assets

In August 2001, the FASB issued Statement of
Financial Accounting Standards No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets(SFAS No. 144), which addresses
financial accounting and reporting for the impairment of
long-lived assets (other than goodwill and indefinite-lived
intangibles). SFAS No. 144 supersedes 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) and
Accounting Principles Board Opinion No. 30, Reporting
the Results of Operations  Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual
and Infrequently Occurring Events and Transactions.We
adopted the provisions of SFAS No. 144 in 2002.
Similar to SFAS No. 121, SFAS No. 144
requires impairment losses to be recognized for long-lived
assets used in operations when indicators of impairment are
present and the estimated undiscounted cash flows are not
sufficient to recover the assets carrying amounts. The
impairment loss is measured by comparing the estimated fair
value of the asset, usually based on discounted cash flows, to
its carrying amount. In accordance with SFAS No. 144,
we assess the need for an impairment write-down when such
indicators of impairment are present. (See Note 5.)



| |                        
| | -----------------------
| | Discontinued Operations

SFAS No. 144 also addresses the
accounting for and disclosure of long-lived assets to be
disposed of by sale. Under SFAS No. 144, when a
long-lived asset or group of assets (disposal group) meets
certain criteria set forth in the Statement, including a
commitment by the Company to a plan to sell the long-lived asset
(disposal group) within one-year:



| |   |                                                                                                                                                                                                                           
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the long-lived asset (disposal group) will be
    measured and reported at the lower of its carrying value or fair
    value less costs to sell and classified as held for sale on the
    consolidated balance sheet; and
|
| |  | the related operations of the long-lived asset
    (disposal group) will be reported as discontinued operations in
    the consolidated statement of operations, with all comparable
    periods restated.                

SFAS No. 144 also addresses the
accounting for and disclosure surrounding the disposal of
long-lived assets. Our consolidated statements of operations
have been restated for all periods presented to report as
discontinued operations 80 nursing facilities, seven
assisted living centers, our Matrix outpatient therapy clinics,
our Care Focus business unit and certain business units of our
Home Care segment which were disposed of during the year ended
December 31, 2003 and four nursing facilities and a home
medical equipment business disposed of during the three months
ended March 31, 2004. At December 31, 2002, our former
Matrix segment and our MK Medical business unit met the criteria
set forth in SFAS No. 144 to be classified as held for
sale and reported in discontinued operations. At
December 31, 2003, the remaining assets and liabilities of
our former Matrix segment are classified as held for sale. (See
Note 6.)



| |                              
| | -----------------------------
| | Transfers of Financial Assets

The Company has an agreement to sell, on an
ongoing basis, certain of its patient accounts receivable
through a revolving sales structure and retains servicing
responsibilities for the transferred receivables. The Company
accounts for the transfers of receivables as sales in accordance
with Statement of Financial Accounting Standards No. 140,
Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities(SFAS No. 140). Accordingly, the
related patient accounts receivable are not included in our
consolidated balance sheets.

During 2003, 2002 and 2001, the Company, through
its wholly owned subsidiary Beverly Health and Rehabilitation
Services, Inc. (BHRS), sold on a revolving basis
certain Medicaid and Veterans Administra-

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##### Table of Contents



BEVERLY ENTERPRISES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Years ended December 31, 2003, 2002 and
2001




|   |                                                             
|-- | ------------------------------------------------------------
|1. | Summary of Significant Accounting
    Policies  (Continued)

tion (VA) patient accounts receivable
to a non-consolidated bankruptcy remote, qualifying special
purpose entity (QSPE), Beverly Funding Corporation
(BFC) at a discount of 1%. These daily transactions
constitute true sales of receivables for which BFC bears the
risk of collection.

Activities related to the revolving sales
structure with BFC were as follows for the years ended
December 31 (in thousands):

|                            |  |      |         |      |  |      |         |   |  |   |         |  
|--------------------------- |  | ---- | ------- | ---- |  | ---- | ------- | - |  | - | ------- | -
|                            |  | 2003 |         | 2002 |  | 2001
|                            |  |      |         |      |  |     
|New receivables sold        |  | $    | 824,475 |      |  | $    | 867,772 |   |  | $ | 801,707 |  
|Cash collections remitted   |  |      | 830,457 |      |  |      | 857,731 |   |  |   | 818,168 |  
|Fees received for servicing |  |      | 2,142   |      |  |      | 2,119   |   |  |   | 2,085   |  
|Loss on sale of receivables |  |      | (8,245  | )    |  |      | (8,678  | ) |  |   | (8,017  | )

BHRS provides invoicing and collection services
related to the receivables for a market-based servicing fee.
BHRS recognizes a loss for the 1% discount at the time of sale
which is included in Other operating and administrative
costs and expenses and in Net cash provided by
operating activities in our consolidated financial
statements.

BFC has $70.0 million of medium-term notes
(the Medium-Term Notes), which are collateralized by
outstanding Medicaid and VA patient accounts receivable
purchased from BHRS. BFC is required to maintain receivables
and/or a cash balance in excess of the outstanding balance of
the Medium-Term Notes, based on a calculated formula in the
Master Sale and Servicing Agreement. Based on ongoing reviews of
BFCs operations, the Company believes that BFC meets the
criteria set forth in SFAS No. 140, and related
interpretive guidance, to be a QSPE. Therefore, the assets and
liabilities of BFC are not consolidated with Beverly
Enterprises, Inc. At December 31, 2003, BFC had total
assets of approximately $108.5 million, substantially all
of which are pledged as collateral for the Medium-Term Notes.
The assets of BFC cannot be used to satisfy claims of the
Company or any of its subsidiaries. The Medium-Term Notes
currently mature in March 2005; however, according to the
provisions of the notes, principal payments on these
obligations, calculated based on quarterly collections of the
underlying receivables, begin in the second quarter of 2004.
Based on current collection trends, it is expected that these
obligations will be paid off on June 15, 2004.

At December 31, 2003, our investment in BFC
of $31.3 million has been recorded as a current asset in
our consolidated balance sheet. The investment is recorded at
its estimated fair value and is subject to periodic review for
other than temporary impairment. The fair value is determined by
discounting the expected future cash flows of the underlying
receivables purchased and held by BFC at discount rates that
reflect the projected payment terms and the credit risk of the
receivables. We regularly update our fair value analysis for
changes in timing and amount of expected future collections of
the receivables. The carrying value of our investment is written
down when the analysis indicates that the investment is other
than temporarily impaired. Our total investments in BFC have
been adjusted from their initial value of $35.0 million due
to cumulative credit losses incurred by BFC associated with the
purchased receivables since June 1999. We believe the carrying
value of our asset will be fully realized upon the maturity and
repayment of the Medium-Term Notes and collection of the excess
receivables. We monitor this off-balance sheet obligation
throughout the year and believe the obligation and any related
assets should not be included in our consolidated financial
statements under current generally accepted accounting
principles.

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##### Table of Contents



BEVERLY ENTERPRISES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Years ended December 31, 2003, 2002 and
2001




|   |                                                             
|-- | ------------------------------------------------------------
|1. | Summary of Significant Accounting
    Policies  (Continued)



| |          
| | ---------
| | Insurance

We record our provisions for insurance based
primarily on independent actuarial valuations using the most
recent trends of claims, settlements and other relevant data.
Premiums and other costs for our insurance programs are recorded
as incurred. See Note 2 for a discussion of our insurance
liabilities and related items.



| |                   
| | ------------------
| | Earnings Per Share

The following table sets forth the calculation of
basic and diluted earnings per share for the years ended
December 31 (in thousands, except per share data):

|             |                                                                                                           |                          |   |         |     |      |   |          |   |  |   |          |   | 
|------------ | --------------------------------------------------------------------------------------------------------- | ------------------------ | - | ------- | --- | ---- | - | -------- | - |  | - | -------- | - | 
|             |                                                                                                           |                         
|             |                                                                                                           | Years Ended December 31,
|             |                                                                                                           |                         
|             |                                                                                                           | 2003                     |   | 2002    |     | 2001
|             |                                                                                                           |                          |   |         |     |     
|Numerator:   |                                                                                                           |                          |   |         |     |      |   |          |   |  |   |         
|             | Numerator for basic and diluted net income (loss)
    per share                                           |                          | $ | 80,468  |     |      | $ | (146,090 | ) |  | $ | (301,272 | )
|             |                                                                                                           |                          |   |         |     |      |   |          |   |  |   |         
|Denominator: |                                                                                                           |                          |   |         |     |      |   |          |   |  |   |         
|             | Denominator for basic net income (loss) per
    share  weighted average shares                           |                          |   | 106,582 |     |      |   | 104,726  |   |  |   | 104,037  |  
|             | Effect of dilutive securities:                                                                            |                          |   |         |     |      |   |          |   |  |   |          |  
|             |                                                                                                           | Employee stock options   |   |         | 338 |      |   |          |  |  |   |          |  | 
|             |                                                                                                           |                          |   |         |     |      |   |          |   |  |   |         
|             | Denominator for diluted net income (loss) per
    share  weighted average shares and assumed conversions |                          |   | 106,920 |     |      |   | 104,726  |   |  |   | 104,037  |  
|             |                                                                                                           |                          |   |         |     |      |   |          |   |  |   |         
|             | Basic and diluted net income (loss) per share                                                             |                          | $ | 0.75    |     |      | $ | (1.39    | ) |  | $ | (2.90    | )
|             |                                                                                                           |                          |   |         |     |      |   |          |   |  |   |         

Diluted earnings per share does not include the
impact of 4.0 million, 8.9 million and
5.8 million of employee stock options outstanding for the
years ended December 31, 2003, 2002 and 2001, respectively,
because their effect would have been antidilutive.



| |                   
| | ------------------
| | Stock-Based Awards

On December 31, 2002, the FASB issued
Statement of Financial Accounting Standards No. 148,
Accounting for Stock-Based Compensation 
Transition and Disclosure(SFAS No. 148). SFAS No. 148
amends Statement of Financial Accounting Standards No. 123,
Accounting for Stock-Based Compensation(SFAS No. 123) to provide alternative
methods of transition for an entity that changes to the fair
value method of accounting for stock-based employee
compensation. In addition, SFAS No. 148 amends the
disclosure provisions of SFAS No. 123 and Accounting
Principles Board Opinion No. 28, Interim Financial
Reporting(APB 28) to require expanded
disclosure of the effects of an entitys accounting policy
with respect to stock-based employee compensation on reported
net income and earnings per share in annual and interim
financial statements and allows companies to continue to use the
intrinsic value method of APB 25.

We continue to use the intrinsic value method to
account for our stock options. Accordingly, we do not recognize
compensation expense for our stock option grants, which are
issued at fair market value on the date of grant. However, we
recognize compensation expense for our restricted stock grants
at the fair market value of our common stock on the date of
grant over the respective vesting periods on a straight-line
basis. See Note 11 for the pro forma effects on our
reported net income (loss) and diluted net income (loss) per
share if

56



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##### Table of Contents



BEVERLY ENTERPRISES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Years ended December 31, 2003, 2002 and
2001




|   |                                                             
|-- | ------------------------------------------------------------
|1. | Summary of Significant Accounting
    Policies  (Continued)

we recognized compensation expense on all
stock-based awards using estimated fair values over the vesting
periods and other disclosures required by SFAS No. 148.



| |         
| | --------
| | Revenues

Our revenues are derived primarily from providing
long-term healthcare services. Approximately 80% of our revenues
is derived from federal (Medicare) and state (Medicaid) medical
assistance programs. Approximately 56% and 57% of our net
patient accounts receivable at December 31, 2003 and 2002,
respectively, are due from such programs. We record revenues
when services are provided at standard charges adjusted to
amounts estimated to be received under governmental programs and
other third-party contractual arrangements based on contractual
terms and historical experience. These revenues and receivables
are reported at their estimated net realizable amounts and are
subject to audit and retroactive adjustment.

Retroactive adjustments are estimated in the
recording of revenues in the period the related services are
rendered. These amounts are adjusted in future periods as
adjustments become known or as cost reporting years are no
longer subject to audits, reviews or investigations. Due to the
complexity of the laws and regulations governing the Medicare
and Medicaid programs, there is at least a possibility that
recorded estimates will change by a material amount in the near
term. See Note 4 for a discussion of a settlement with the
federal government related to Medicare cost reimbursement issues
and Note 10 for the estimated potential overpayment from
government programs resulting from an internal investigation of
our former MK Medical business unit. Excluding these items,
changes in estimates related to third-party receivables resulted
in an increase in revenues of approximately $8.7 million
and $745,000 for the years ended December 31, 2003 and
2002, respectively, and a decrease in revenues of approximately
$2.0 million for the year ended December 31, 2001.

Compliance with laws and regulations governing
the Medicare and Medicaid programs is subject to government
review and interpretation, as well as significant regulatory
action including fines, penalties and possible exclusion from
the Medicare and Medicaid programs. In addition, under the
Medicare program, if the federal government makes a formal
demand for reimbursement, even related to contested items,
payment must be made for those items before the provider is
given an opportunity to appeal and resolve the issue.



| |                                                 
| | ------------------------------------------------
| | Receivables and Concentration of Credit
    Risk

We have significant accounts receivable and notes
receivable whose collectibility or realizability is dependent
upon the performance of certain governmental programs, primarily
Medicare and Medicaid. These receivables represent our only
concentration of credit risk. We do not believe there are
significant credit risks associated with these governmental
programs. We believe that an adequate provision, based on
historical experience, has been made for the possibility of a
portion of these and other receivables becoming uncollectible
and we continually monitor and adjust these allowances as
necessary. In establishing our estimate of uncollectible
accounts and notes, we consider our historical collection
experience, the aging of the account, and the payor
classification, as well as the collateral value for notes
receivable. Private pay accounts usually represent our highest
collectibility risk. We write-off uncollectible accounts and
notes receivable after all collection efforts have been
exhausted and we determine they will not be collected. Our
allowance for doubtful accounts represented approximately 17%
and 20% of patient accounts receivable at December 31, 2003
and 2002, respectively. Certain interest-bearing notes
receivable are placed on a nonaccrual basis when uncertainty
arises as to the collectibility of principal or interest. Notes
receivable of $6.7 million and $9.5 million at
December 31, 2003 and 2002, respectively, were on a
nonaccrual basis and specific collectibility allowances of
$3.7 million and $6.9 million, respectively, have been
recorded on these nonaccrual notes.

57



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##### Table of Contents



BEVERLY ENTERPRISES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Years ended December 31, 2003, 2002 and
2001




|   |                                                             
|-- | ------------------------------------------------------------
|1. | Summary of Significant Accounting
    Policies  (Continued)



| |             
| | ------------
| | Income Taxes

We follow the liability method in accounting for
income taxes. The liability method requires deferred tax assets
and liabilities to be 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. Due to
uncertainties surrounding the generation of sufficient future
income in the near term necessary to realize certain deferred
tax benefits, primarily relating to net operating loss
carryforwards, we have established a full valuation allowance on
our net deferred tax assets. (See Note 12.)



| |                            
| | ---------------------------
| | Comprehensive Income (Loss)

During the fourth quarter of 2003, we sold all of
our holdings in a publicly traded equity security that was
acquired in 1995 for gross proceeds of $8.5 million. This
investment had been accounted for as available for sale, with
all changes in fair value being recorded as comprehensive
income. In conjunction with the sale of the investment, we
reversed accumulated comprehensive income, net of income taxes,
of $512,000 and recognized a pre-tax gain of $6.7 million.
Comprehensive income (loss) for 2002 includes charges and
credits to stockholders equity not included in net loss.
Accumulated other comprehensive income, net of income taxes, of
$517,000 at December 31, 2002, primarily consisted of net
unrealized gains on available-for-sale securities of $512,000.

During the year ended December 31, 2000, we
transferred one of our equity securities from the
available-for-sale category to the trading category. During
2001, this security was sold and we recognized a pre-tax gain of
$256,000 included in Gains on sales of equity
investments on the consolidated statements of operations.



| |      
| | -----
| | Other

Certain prior year amounts have been reclassified
to conform with the 2003 financial statement presentation.
Assets and liabilities held for sale are reported based on their
status as of the balance sheet date.



|   |          
|-- | ---------
|2. | Insurance

General and professional liability costs for the
long-term care industry have become increasingly expensive and
difficult to estimate. In addition, insurance coverage for
patient care liability and certain other risks, for nursing
facilities specifically and companies in general, has become
increasingly difficult to obtain. When obtained, insurance
carriers are often requiring companies to significantly increase
their liability retention levels and/or pay substantially higher
premiums for reduced coverage. We exercise care in selecting
companies from which we purchase insurance, including review of
published ratings by recognized rating agencies, advice from
national brokers and consultants and review of trade information
sources. There exists a risk that any of these insurance
companies may become insolvent and unable to fulfill their
obligation to defend, pay or reimburse us when that obligation
becomes due. Although we believe the companies we have purchased
insurance from are solvent, in light of the dramatic changes
occurring in the insurance industry in recent years, we cannot
be assured that they will remain solvent and able to fulfill
their obligations.

We believe that adequate provision has been made
in the financial statements for liabilities that may arise out
of patient care and related services provided to date. These
provisions are based primarily upon the results of independent
actuarial valuations, prepared by actuaries with long-term care
industry experience. These independent valuations are formally
prepared twice a year using the most recent trends of claims,
settlements and other relevant data. In addition to the
actuarial estimate of retained losses, our provision for
insurance

58



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##### Table of Contents



BEVERLY ENTERPRISES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Years ended December 31, 2003, 2002 and
2001




|   |                        
|-- | -----------------------
|2. | Insurance  (Continued)

includes accruals for insurance premiums and
related costs for the coverage period and our estimate of any
experience adjustments to premiums. The following table
summarizes our provisions for insurance and related items,
including the Florida insurance reserve adjustment in 2002, for
the years ended December 31 (in thousands):

|                                                     |                                      |      |         |         |  |      |         |        |  |   |         |        | 
|---------------------------------------------------- | ------------------------------------ | ---- | ------- | ------- |  | ---- | ------- | ------ |  | - | ------- | ------ | 
|                                                     |                                      | 2003 |         | 2002    |  | 2001
|                                                     |                                      |      |         |         |  |     
|General and professional liability:                  |                                      |      |         |         |  |      |         |        |  |   |         |       
|                                                     | Continuing operations                |      | $       | 68,009  |  |      | $       | 46,774 |  |   | $       | 39,148 | 
|                                                     | Florida insurance reserve adjustment |      |         |        |  |      |         | 22,179 |  |   |         |       | 
|                                                     | Discontinued operations              |      |         | 38,650  |  |      |         | 23,603 |  |   |         | 11,069 | 
|                                                     |                                      |      |         |         |  |      |         |        |  |   |         |       
|                                                     |                                      | $    | 106,659 |         |  | $    | 92,556  |        |  | $ | 50,217  |       
|                                                     |                                      |      |         |         |  |      |         |        |  |   |         |       
|Workers compensation:                               |                                      |      |         |         |  |      |         |        |  |   |         |       
|                                                     | Continuing operations                |      | $       | 44,060  |  |      | $       | 38,995 |  |   | $       | 37,875 | 
|                                                     | Discontinued operations              |      |         | 7,801   |  |      |         | 8,899  |  |   |         | 7,528  | 
|                                                     |                                      |      |         |         |  |      |         |        |  |   |         |       
|                                                     |                                      | $    | 51,861  |         |  | $    | 47,894  |        |  | $ | 45,403  |       
|                                                     |                                      |      |         |         |  |      |         |        |  |   |         |       
|Other insurance:                                     |                                      |      |         |         |  |      |         |        |  |   |         |       
|                                                     | Continuing operations                |      | $       | 13,802  |  |      | $       | 7,888  |  |   | $       | 5,263  | 
|                                                     | Discontinued operations              |      |         | 553     |  |      |         | 833    |  |   |         | 678    | 
|                                                     |                                      |      |         |         |  |      |         |        |  |   |         |       
|                                                     |                                      | $    | 14,355  |         |  | $    | 8,721   |        |  | $ | 5,941   |       
|                                                     |                                      |      |         |         |  |      |         |        |  |   |         |       
|Total provision for insurance and related
    items: |                                      |      |         |         |  |      |         |        |  |   |         |       
|                                                     | Continuing operations                |      | $       | 125,871 |  |      | $       | 93,657 |  |   | $       | 82,286 | 
|                                                     | Florida insurance reserve adjustment |      |         |        |  |      |         | 22,179 |  |   |         |       | 
|                                                     | Discontinued operations              |      |         | 47,004  |  |      |         | 33,335 |  |   |         | 19,275 | 
|                                                     |                                      |      |         |         |  |      |         |        |  |   |         |       
|                                                     |                                      | $    | 172,875 |         |  | $    | 149,171 |        |  | $ | 101,561 |       
|                                                     |                                      |      |         |         |  |      |         |        |  |   |         |       



---



|    |                                                                                                                                     
|--- | ------------------------------------------------------------------------------------------------------------------------------------
|(1) | Includes an accrual in 2003 for the purchase of
    incremental patient care liability insurance on divested nursing
    facilities.

Based on the results of the 2002 mid-year
actuarial study, performed by our independent actuaries, we
recorded a pre-tax charge of $43.3 million related to an
increase in our reserves for prior policy year patient care
liability costs, including $22.2 million attributable to
our previously operated Florida facilities. We completed the
sale of our Florida facilities in January 2002; however, we are
liable for patient care liability claims and other costs for
those facilities through the date of sale, subject to insurance.

We insure certain of our auto liability, general
liability, professional liability and workers compensation
risks through various types of loss sensitive insurance policies
with affiliated and unaffiliated insurance companies. For our
general and professional liabilities, we are typically
responsible for the first dollar of each claim, up to a
self-insurance limit determined by the individual policies,
subject to aggregate limits for certain policy years. In several
prior policy years, losses exceed our self-insurance aggregate
limits. For claims relating to these years, our insurers have
assumed a more significant role in handling the claims or
related obligations and settlements. As a result, it is more
difficult to estimate potential losses in these years. However,
we expect any losses in those years to be covered by our
insurers. The liabilities for incurred losses retained by
Beverly and not covered by insurance are estimated by the
independent actuaries and are discounted on our financial
statements at 10% to their present value using actuarially
determined loss payment timing patterns. The

59



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##### Table of Contents



BEVERLY ENTERPRISES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Years ended December 31, 2003, 2002 and
2001




|   |                        
|-- | -----------------------
|2. | Insurance  (Continued)

discount rate is based upon our best estimate of
the incremental borrowing rate that would be required to fund
these liabilities with uncollateralized debt. A reduction in the
discount rate by one-half of a percentage point would have
resulted in an additional pre-tax charge of approximately
$1.8 million for the year ended December 31, 2003.

The discounted insurance liabilities are included
in the consolidated balance sheet captions as follows at
December 31 (in thousands):

|                                      |  |      |         |      |  |   |         | 
|------------------------------------- |  | ---- | ------- | ---- |  | - | ------- | 
|                                      |  | 2003 |         | 2002
|                                      |  |      |         |     
|Accrued wages and related liabilities |  | $    | 2,528   |      |  | $ | 2,574   | 
|General and professional liabilities  |  |      | 93,736  |      |  |   | 77,025  | 
|Other accrued liabilities             |  |      | 10,678  |      |  |   | 8,142   | 
|Other liabilities and deferred items  |  |      | 52,954  |      |  |   | 102,418 | 
|                                      |  |      |         |      |  |   |         | 
|                                      |  | $    | 159,896 |      |  | $ | 190,159 | 
|                                      |  |      |         |      |  |   |         | 

On an undiscounted basis, total retained
liabilities as of December 31, 2003 and 2002 were
approximately $203.7 million and $224.2 million,
respectively. As of December 31, 2003, approximately
$11.8 million in funds (the Beverly Indemnity
funds) are restricted for the payment of insured claims
and included in Prepaid expenses and other on our
consolidated balance sheet. In addition, we anticipate that
approximately $29.9 million of our existing cash at
December 31, 2003, while not legally restricted, will be
utilized primarily to fund certain workers compensation,
general and professional liability claims and expenses. We do
not expect to use this cash for other purposes.



|   |                                                          
|-- | ---------------------------------------------------------
|3. | California Investigation Settlement and
    Related Costs

On August 1, 2002, the Company and the State
of California reached an agreement on the settlement of an
investigation by the Attorney Generals office and the
District Attorney of Santa Barbara County of patient care
issues in several California nursing facilities. In accordance
with the terms of the settlement agreement, Beverly
Enterprises  California, Inc. entered a plea of
nolo contendereto two felony charges under
Californias Elder Abuse statute and paid a fine of $54,000
related to the plea. In addition, Beverly
Enterprises  California, Inc. reimbursed the Attorney
General and the Santa Barbara County District Attorney
$533,000 for the costs of their investigations and paid a
$2.0 million civil penalty in four equal, quarterly
installments of $500,000.

A Permanent Injunction (Permanent
Injunction) was entered requiring nursing facilities in
California, operated by subsidiaries of the Company, to comply
with all applicable laws and regulations and conduct certain
training and education programs. The Company recorded a pre-tax
charge against earnings of $6.3 million during the second
quarter of 2002 to reflect the terms of the settlement and
related costs. During the second quarter of 2003, approximately
$925,000 of the reserves related to this settlement were
reversed when it was determined they were no longer required.

Certain revisions were made to our Corporate
Integrity Agreement in conjunction with the Permanent Injunction
requiring:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | additional training for clinical associates,
    contractors and agents who perform services in our California
    nursing facilities; and                                                                                                                                                                                                                                                                                                                      
|
| |  | hiring an independent quality monitor to assess
    the effectiveness, reliability and thoroughness of our quality
    care systems and our response to quality of care issues in our
    nursing facilities in California, Arizona, Hawaii and
    Washington. By March 31, 2004, we had divested all of our
    nursing facilities in Arizona, Washington and Hawaii and a
    substantial portion of our nursing facilities in California.
    (See Note 15.)

60



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BEVERLY ENTERPRISES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Years ended December 31, 2003, 2002 and
2001




|   |                                                                                     
|-- | ------------------------------------------------------------------------------------
|4. | Special Charge and Adjustment Related to
    Settlements with the Federal Government

Effective October 15, 2002, we entered into
a settlement agreement with the Centers for Medicare and
Medicaid Services (CMS), which resolved certain
reimbursement issues relating to: (1) costs of services
provided to Medicare patients during 1996 through 1998 under the
federal governments former cost-reimbursement system;
(2) co-payments due from Medicare beneficiaries, who were
also eligible for Medicaid, for the years 1996 through 2000; and
(3) all outstanding issues from our Allocation
Investigations (see Note 10). Under the terms of the
settlement agreement, we paid CMS $35.0 million in November
2002.

Because the issues related to this matter arose
prior to December 31, 2001 and an offer to settle was made
prior to releasing our 2001 consolidated financial statements,
we reflected a pre-tax charge related to this matter of
$77.5 million in our 2001 results of operations, including:



| |   |                                                                                                                                                  
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------
| |  | $35.0 million related to the cash payment to
    CMS, which was made in November 2002;                                                           
|
| |  | $81.5 million related to the write-off of
    Medicare cost report receivables for 1996 through 1998 and
    co-payment issues for 1999 and 2000;
|
| |  | partially offset by $39.0 million in
    reserves established in conjunction with the Allocation
    Investigations (see Note 10).               

In connection with the final settlement with CMS
in 2002, we were able to revise the amount of legal fees and
other costs we originally expected to incur in conjunction with
these settlements. Accordingly, legal and related fees accrued
for these matters in prior years were reduced by
$9.4 million during 2002.

The present value of our remaining obligation
under the Civil Settlement Agreement (see Note 10) is
included in the consolidated balance sheet captions as follows
at December 31 (in thousands):

|                                          |  |      |        |      |  |   |        | 
|----------------------------------------- |  | ---- | ------ | ---- |  | - | ------ | 
|                                          |  | 2003 |        | 2002
|                                          |  |      |        |     
|Federal government settlement obligations |  | $    | 13,125 |      |  | $ | 11,915 | 
|Other liabilities and deferred items      |  |      | 48,763 |      |  |   | 61,976 | 
|                                          |  |      |        |      |  |   |        | 
|                                          |  | $    | 61,888 |      |  | $ | 73,891 | 
|                                          |  |      |        |      |  |   |        | 



|   |                                                                    
|-- | -------------------------------------------------------------------
|5. | Asset Impairments, Workforce Reductions and
    Other Unusual Items

We recorded pre-tax charges for asset
impairments, workforce reductions and other unusual items as
follows for the years ended December 31 (in thousands):

|                                          |  |      |       |      |  |      |        |   |  |   |         | 
|----------------------------------------- |  | ---- | ----- | ---- |  | ---- | ------ | - |  | - | ------- | 
|                                          |  | 2003 |       | 2002 |  | 2001
|                                          |  |      |       |      |  |     
|Asset impairments                         |  | $    | 2,076 |      |  | $    | 49,927 |   |  | $ | 98,894  | 
|Workforce reductions                      |  |      | 2,507 |      |  |      | 7,869  |   |  |   | 24,236  | 
|Other unusual items, including exit costs |  |      | 1,410 |      |  |      |       |   |  |   | 58,898  | 
|Adjustment of previously recorded charges |  |      | (397  | )    |  |      | (2,967 | ) |  |   |        | 
|                                          |  |      |       |      |  |      |        |   |  |   |         | 
|                                          |  | $    | 5,596 |      |  | $    | 54,829 |   |  | $ | 182,028 | 
|                                          |  |      |       |      |  |      |        |   |  |   |         | 



| |                  
| | -----------------
| | Asset Impairments

During 2003, we recorded asset impairments of
$2.1 million primarily related to the write-down of
property and equipment on three nursing facilities included in
the Nursing Facilities segment, utilizing the same method
described below for 2002. These facilities had a history of
operating losses with expected future losses and cash flow
deficiencies.

61



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BEVERLY ENTERPRISES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Years ended December 31, 2003, 2002 and
2001




|   |                                                                                  
|-- | ---------------------------------------------------------------------------------
|5. | Asset Impairments, Workforce Reductions and
    Other Unusual Items  (Continued)

During 2002, we recorded asset impairments of
$49.9 million relating to the write-down of property and
equipment on certain assets of the Nursing Facilities segment.
The October 1, 2002 elimination of certain funding under
the Medicare program affected the cash flows, and therefore the
fair values, of each of our nursing facilities. This event led
to an impairment assessment on each of our nursing facilities,
including:



| |   |                                                                                                                                                                                                                                                                              
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | estimating the undiscounted cash flows to be
    generated by each of the facilities over the remaining life of
    the primary asset; and                                                                                                                                   
|
| |  | reducing the carrying value of the asset to the
    estimated fair value when the total estimated undiscounted
    future cash flows was less than the current book value of the
    long-lived assets (excluding goodwill and other indefinite-lived
    intangible assets).

In estimating the undiscounted cash flows for the
2002 impairment assessment, we primarily used our internally
prepared budgets and forecast information, with certain
probability adjustments, including, but not limited to, the
following items: Medicare and Medicaid funding; overhead costs;
capital expenditures; and patient care liability costs. In order
to estimate the fair values of the nursing facilities, we used a
discounted cash flow approach, supplemented by public resource
information on valuations of nursing facility sales transactions
by region of the country. Where the estimated undiscounted cash
flows were negative, we estimated the fair values based on
discounted public resource information, sales values or
estimated salvage values. A substantial change in the estimated
future cash flows for these facilities could materially change
the estimated fair values of these assets, possibly resulting in
an additional impairment.

During 2001, we recorded asset impairments of
$98.9 million, primarily including:



| |   |                                                                                                                                                                                                                                                                               
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | $75.1 million write-down of Florida
    facilities, as discussed below. These assets were included in
    the total assets of the Nursing Facilities segment as of
    December 31, 2001;                                                                                     
|
| |  | write-down of goodwill of $5.8 million and
    other assets of $1.1 million on under-performing Home Care
    businesses. These assets were included in the total assets of
    the Home Care segment as of December 31, 2001;                                                
|
| |  | write-down of property and equipment of
    $5.2 million, and goodwill and other intangibles of
    $600,000 on certain under-performing nursing facilities. These
    assets were included in the total assets of the Nursing
    Facilities segment as of December 31, 2001;
|
| |  | write-off of abandoned projects and investments
    totaling $7.8 million; and                                                                                                                                                                                                
|
| |  | $3.3 million related to the termination of a
    lease in Indiana, including the write-off of net book value of
    the related assets.                                                                                                                                       

The asset impairment analyses on our
under-performing units and facilities in 2001 included:



| |   |                                                                                                                                                                               
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | estimating the undiscounted cash flows to be
    generated by each unit or facility, primarily over the weighted
    average remaining life of the assets; and                
|
| |  | reducing the carrying value of the assets to the
    estimated fair value when the total undiscounted cash flows was
    less than the carrying value of the unit or facility.

In order to estimate the fair values of the unit,
facility or property for the 2001 impairment assessment, we used
a discounted cash flow approach. For the nursing facilities, we
discounted the estimated future cash flows over the remaining
life of the primary asset. For the Home Care businesses that
lacked significant property investments, we discounted the next
10 years of expected cash flows. Cash flows for all lines
of business were estimated using historical results, without an
inflation factor, and adjusted for known trends.

62



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BEVERLY ENTERPRISES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Years ended December 31, 2003, 2002 and
2001




|   |                                                                                  
|-- | ---------------------------------------------------------------------------------
|5. | Asset Impairments, Workforce Reductions and
    Other Unusual Items  (Continued)

Those cash flows were discounted at our weighted
average cost of capital. A one percent change in the discount
rate would not have had a material impact on the impairment
calculations. Where the cash flows were negative, we estimated
the fair values based on our knowledge of recent or pending
sales of comparable businesses.

During 2001, a formal plan was initiated by
management to pursue the sale of our nursing home operations in
Florida, which included 49 nursing facilities and four assisted
living centers (the Florida facilities). The plan
included the pursuit of the sale of one additional nursing
facility in Florida and certain other assets which would be sold
in separate transactions. The decision to sell these properties
was made primarily due to the disproportionately high patient
care liability costs that we had been incurring in the state of
Florida. Accordingly, the property and equipment, identifiable
intangibles and operating supplies of our Florida nursing home
operations were considered assets held for sale. Management
estimated the fair value less selling costs of such assets and
took special pre-tax charges in 2001 totaling $75.1 million
to write-down the Florida assets. Effective December 1,
2001, we entered into a lease agreement on the Florida
facilities with Florida Health Care Properties and we closed the
real estate sale in January 2002, with no further gain or loss.
Annualized revenues for the Florida facilities were
approximately $288.0 million. During the year ended
December 31, 2001, our Florida nursing home operations
recorded pre-tax income of approximately $600,000.



| |                     
| | --------------------
| | Workforce Reductions

During 2003, we recorded $2.5 million for
workforce reductions primarily relating to 67 associates who
were notified during 2003 that their positions would be
eliminated, and included the following:



| |   |                                                                                                                                                                                                                                   
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | $2.8 million of cash expenses,
    $1.8 million of which was paid during the year ended
    December 31, 2003; and                                                                                                                
|
| |  | non-cash expenses of approximately $84,000
    related to the issuance of 108,230 shares under our Stock
    Grant Plan (the Stock Grant Plan), less
    approximately $400,000 due to the cancellation of restricted
    stock.

During 2002, we recorded $7.9 million for
workforce reductions, which included a charge of approximately
$8.5 million for 133 associates who were notified in 2002
that their positions would be eliminated, net of a $600,000
reversal of workforce reduction charges recorded in 2001 which
were no longer needed. The $8.5 million pre-tax charges
included the following:



| |   |                                                                                                                                                            
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | $8.0 million of cash expenses, approximately
    $2.8 million and $4.1 million of which was paid during
    the years ended December 31, 2003 and 2002; and
|
| |  | non-cash expenses of $500,000 related to the
    issuance of 124,212 shares under our Stock Grant Plan.                                                    

In January 2001, we implemented a new three-year
strategic plan and operationally reorganized our business. As a
result of this operational reorganization, we recorded special
pre-tax charges totaling approximately $24.2 million during
2001. Approximately $23.1 million of these pre-tax charges
related to severance and other employment agreements for
approximately 240 associates who were notified in 2001 that
their positions would be eliminated, including:



| |   |                                                                                                                                                                                            
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | $18.0 million of cash expenses,
    approximately $271,000, $4.9 million and $11.3 million
    of which was paid during the years ended December 31, 2003,
    2002 and 2001, respectively;

63



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BEVERLY ENTERPRISES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Years ended December 31, 2003, 2002 and
2001




|   |                                                                                  
|-- | ---------------------------------------------------------------------------------
|5. | Asset Impairments, Workforce Reductions and
    Other Unusual Items  (Continued)



| |   |                                                                                                                    
| | - | -------------------------------------------------------------------------------------------------------------------
| |  | non-cash expenses of $4.5 million related to
    the issuance of 545,542 shares under our Stock Grant
    Plan; and
|
| |  | non-cash expenses of $600,000 related to other
    long-term incentive agreements.                                 



| |                    
| | -------------------
| | Other Unusual Items

During 2001, in conjunction with the sale of our
Florida facilities, we recorded special pre-tax charges totaling
$55.1 million for certain exit and other costs. These costs
related to severance agreements, termination payments on certain
contracts and various other items.

The following table summarizes activity in our
estimated workforce reduction and exit costs for the years ended
December 31 (in thousands):

|                          |                                    |            |       |            |   |            |       |            |   |            |       |            |   |   |        |         |   |   |       |         |   |   |        |        |  
|------------------------- | ---------------------------------- | ---------- | ----- | ---------- | - | ---------- | ----- | ---------- | - | ---------- | ----- | ---------- | - | - | ------ | ------- | - | - | ----- | ------- | - | - | ------ | ------ | -
|                          |                                    |            |       |            |   |           
|                          |                                    | 2003       |       | 2002       |   | 2001      
|                          |                                    |            |       |            |   |           
|                          |                                    | Workforce  |       |            |   | Workforce  |       |            |   | Workforce  |       |           
|                          |                                    | Reductions |       | Exit Costs |   | Reductions |       | Exit Costs |   | Reductions |       | Exit Costs
|                          |                                    |            |       |            |   |            |       |            |   |            |       |           
|Balance beginning of year |                                    | $          | 5,418 |            |   | $          | 4,991 |            |   | $          | 7,631 |            |   | $ | 15,030 |         |   | $ | 4,151 |         |   | $ | 5,208  |       
|                          | Charged to continuing operations   |            |       | 2,902      |   |            |       | 887        |   |            |       | 8,454      |   |   |        |        |   |   |       | 23,118  |   |   |        | 18,165 |  
|                          | Charged to discontinued operations |            |       |           |   |            |       | 24,828     |   |            |       |           |   |   |        | 2,633   |   |   |       |        |   |   |        |       |  
|                          | Cash payments                      |            |       | (4,896     | ) |            |       | (22,579    | ) |            |       | (9,074     | ) |   |        | (10,313 | ) |   |       | (15,448 | ) |   |        | (8,343 | )
|                          | Stock transactions                 |            |       |           |   |            |       |           |   |            |       | (1,008     | ) |   |        |        |   |   |       | (4,158  | ) |   |        |       |  
|                          | Reversals                          |            |       | (395       | ) |            |       | (857       | ) |            |       | (585       | ) |   |        | (2,359  | ) |   |       | (32     | ) |   |        |       |  
|                          |                                    |            |       |            |   |            |       |            |   |            |       |            |   |   |        |         |   |   |       |         |   |   |        |       
|Balance end of year       |                                    | $          | 3,029 |            |   | $          | 7,270 |            |   | $          | 5,418 |            |   | $ | 4,991  |         |   | $ | 7,631 |         |   | $ | 15,030 |       
|                          |                                    |            |       |            |   |            |       |            |   |            |       |            |   |   |        |         |   |   |       |         |   |   |        |       



|   |                        
|-- | -----------------------
|6. | Discontinued Operations

During the fourth quarter of 2002, a formal plan
was approved by our Board of Directors to pursue the sale of our
Matrix segment and MK Medical business unit. The decision
to sell these non-strategic assets was made primarily to allow
us to further reduce our debt level and to reinvest in
facilities, technology and other business opportunities
consistent with our strategic objectives.

During 2002, in accordance with
SFAS No. 144, the assets and liabilities of our former
Matrix segment, the assets of our MK Medical business unit, and
certain non-strategic assets of our Nursing Facilities Segment
were reclassified to the corresponding held for sale
asset and liability line items in the 2002 consolidated balance
sheet. The outpatient therapy clinics and managed care network
of Matrix, the MK Medical business unit, and certain
non-strategic assets of our Nursing Facilities segment were sold
during 2003. We continue to actively market the remaining Matrix
assets and expect to dispose of them within the next six months.

64



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BEVERLY ENTERPRISES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Years ended December 31, 2003, 2002 and
2001




|   |                                          
|-- | -----------------------------------------
|6. | Discontinued
    Operations  (Continued)

A summary of the asset and liability line items
from which the reclassifications have been made at
December 31, is as follows (in thousands):

|                                  |                            |        |       |        |  |         |        |         |  |       |       |       |  |   |       |       |  |   |        |        | 
|--------------------------------- | -------------------------- | ------ | ----- | ------ |  | ------- | ------ | ------- |  | ----- | ----- | ----- |  | - | ----- | ----- |  | - | ------ | ------ | 
|                                  |                            |        |       |       
|                                  |                            | 2003   |       | 2002  
|                                  |                            |        |       |       
|                                  |                            |        |       |        |  | MK      |        |        
|                                  |                            | Matrix |       | Matrix |  | Medical |        | Nursing |  | Total
|                                  |                            |        |       |        |  |         |        |         |  |      
|Current assets:                   |                            | $      | 2,042 |        |  | $       | 13,711 |         |  | $     | 923   |       |  | $ |      |       |  | $ | 14,634 |       
|Property and equipment, net       |                            |        | 1,100 |        |  |         | 6,588  |         |  |       | 1,183 |       |  |   | 6,696 |       |  |   | 14,467 |       
|Goodwill                          |                            |        | 332   |        |  |         | 3,713  |         |  |       |      |       |  |   |      |       |  |   | 3,713  |       
|Other assets                      |                            |        | 24    |        |  |         | 3,531  |         |  |       | 73    |       |  |   |      |       |  |   | 3,604  |       
|                                  |                            |        |       |        |  |         |        |         |  |       |       |       |  |   |       |       |  |   |        |       
|                                  | Total assets held for sale |        | $     | 3,498  |  |         | $      | 27,543  |  |       | $     | 2,179 |  |   | $     | 6,696 |  |   | $      | 36,418 | 
|                                  |                            |        |       |        |  |         |        |         |  |       |       |       |  |   |       |       |  |   |        |       
|Current liabilities held for sale |                            | $      | 672   |        |  | $       | 3,239  |         |  | $     |      |       |  | $ |      |       |  | $ | 3,239  |       
|                                  |                            |        |       |        |  |         |        |         |  |       |       |       |  |   |       |       |  |   |        |       

The following facilities, clinics and other
assets disposed of during the year ended December 31, 2003,
are reflected as discontinued operations in the accompanying
consolidated statements of operations:



| |   |                                                                                                                                                                                                               
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 80 nursing facilities (9,468 beds), seven
    assisted living centers (278 units) and certain other
    assets for cash proceeds totaling approximately
    $223.8 million and a $4.0 million note receivable;
|
| |  | the outpatient rehabilitation clinic operations
    and the managed care network of our former Matrix segment for
    cash proceeds of $36.0 million; and                                                     
|
| |  | the Care Focus and MK Medical business units and
    certain other assets of our Home Care segment for cash proceeds
    totaling $11.0 million and a $1.0 million note
    receivable.                       

The following facilities and business disposed of
during the three months ended March 31, 2004, are reflected
as discontinued operations in the accompanying consolidated
statements of operations:



| |   |                                                                                                    
| | - | ---------------------------------------------------------------------------------------------------
| |  | four nursing facilities (353 beds) for cash
    proceeds totaling $8.4 million; and                
|
| |  | a home medical equipment business of our Home
    Care segment for cash proceeds totaling $165,000.

The results of operations of disposed facilities,
clinics and other assets during the three months ended
March 31, 2004, and the year ended December 31, 2003,
as well as the results of operations of the held-for-sale
assets, have been reported as discontinued operations for all
periods presented in the accompanying consolidated statements of
operations. Also included in discontinued operations are gains
and losses on sales,

65



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BEVERLY ENTERPRISES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Years ended December 31, 2003, 2002 and
2001




|   |                                          
|-- | -----------------------------------------
|6. | Discontinued
    Operations  (Continued)

additional impairments and exit costs relative to
these facilities, clinics and other assets. A summary of the
discontinued operations by operating segment for the years ended
December 31 is as follows (in thousands):

|                                        |  |        |        |      |  |            |        |       |  |        |         |      |  |            |         |       |  |   |        |   |  |   |         |   |  |   |         |   |  |   |         |  
|--------------------------------------- |  | ------ | ------ | ---- |  | ---------- | ------ | ----- |  | ------ | ------- | ---- |  | ---------- | ------- | ----- |  | - | ------ | - |  | - | ------- | - |  | - | ------- | - |  | - | ------- | -
|                                        |  |        |        |     
|                                        |  | 2003   |        | 2002
|                                        |  |        |        |     
|                                        |  |        |        | Home |  | Nursing    |        |       |  |        |         | Home |  | Nursing    |         |      
|                                        |  | Matrix |        | Care |  | Facilities |        | Total |  | Matrix |         | Care |  | Facilities |         | Total
|                                        |  |        |        |      |  |            |        |       |  |        |         |      |  |            |         |      
|Revenues(1)                             |  | $      | 18,550 |      |  | $          | 20,395 |       |  | $      | 338,181 |      |  | $          | 377,126 |       |  | $ | 86,109 |   |  | $ | 20,894  |   |  | $ | 471,151 |   |  | $ | 578,154 |  
|                                        |  |        |        |      |  |            |        |       |  |        |         |      |  |            |         |       |  |   |        |   |  |   |         |   |  |   |         |   |  |   |         |  
|Operating income (loss)(1)(2)           |  | $      | 749    |      |  | $          | (2,446 | )     |  | $      | 62      |      |  | $          | (1,635  | )     |  | $ | 810    |   |  | $ | (31,057 | ) |  | $ | 29,575  |   |  | $ | (672    | )
|Gain (loss) on sales and exit costs     |  |        | 11,120 |      |  |            | 1,557  |       |  |        | 67,113  |      |  |            | 79,790  |       |  |   | (1,001 | ) |  |   | (1,257  | ) |  |   | (114    | ) |  |   | (2,372  | )
|Impairments and other unusual items (3) |  |        |       |      |  |            | (540   | )     |  |        | (16,823 | )    |  |            | (17,363 | )     |  |   | 230    |   |  |   | (4,239  | ) |  |   | (24,678 | ) |  |   | (28,687 | )
|                                        |  |        |        |      |  |            |        |       |  |        |         |      |  |            |         |       |  |   |        |   |  |   |         |   |  |   |         |   |  |   |         |  
|Pre-tax income (loss)                   |  | $      | 11,869 |      |  | $          | (1,429 | )     |  | $      | 50,352  |      |  |            | 60,792  |       |  | $ | 39     |   |  | $ | (36,553 | ) |  | $ | 4,783   |   |  |   | (31,731 | )
|                                        |  |        |        |      |  |            |        |       |  |        |         |      |  |            |         |       |  |   |        |   |  |   |         |   |  |   |         |   |  |   |         |  
|Provision for state income taxes        |  |        |        |      |  |            |        |       |  |        |         |      |  |            | 3,378   |       |  |   |        |   |  |   |         |   |  |   |         |   |  |   |        |  
|                                        |  |        |        |      |  |            |        |       |  |        |         |      |  |            |         |       |  |   |        |   |  |   |         |   |  |   |         |   |  |   |         |  
|Discontinued operations, net of taxes   |  |        |        |      |  |            |        |       |  |        |         |      |  | $          | 57,414  |       |  |   |        |   |  |   |         |   |  |   |         |   |  | $ | (31,731 | )
|                                        |  |        |        |      |  |            |        |       |  |        |         |      |  |            |         |       |  |   |        |   |  |   |         |   |  |   |         |   |  |   |         |  

|                                      |  |        |         |      |  |            |         |       |  |   |         |   |  |   |         |  
|------------------------------------- |  | ------ | ------- | ---- |  | ---------- | ------- | ----- |  | - | ------- | - |  | - | ------- | -
|                                      |  |       
|                                      |  | 2001  
|                                      |  |       
|                                      |  |        |         | Home |  | Nursing    |         |      
|                                      |  | Matrix |         | Care |  | Facilities |         | Total
|                                      |  |        |         |      |  |            |         |      
|Revenues                              |  | $      | 90,907  |      |  | $          | 52,714  |       |  | $ | 460,684 |   |  | $ | 604,305 |  
|                                      |  |        |         |      |  |            |         |       |  |   |         |   |  |   |         |  
|Operating income (loss)(2)            |  | $      | (8,652  | )    |  | $          | (13,366 | )     |  | $ | 51,292  |   |  | $ | 29,274  |  
|Gain (loss) on sale and exit costs    |  |        |        |      |  |            |        |       |  |   |        |   |  |   |        |  
|Impairments and other unusual items   |  |        | (32,482 | )    |  |            | (18,760 | )     |  |   | (4,832  | ) |  |   | (56,074 | )
|                                      |  |        |         |      |  |            |         |       |  |   |         |   |  |   |         |  
|Pre-tax income (loss)                 |  | $      | (41,134 | )    |  | $          | (32,126 | )     |  | $ | 46,460  |   |  |   | (26,800 | )
|                                      |  |        |         |      |  |            |         |       |  |   |         |   |  |   |         |  
|Provision for income taxes            |  |        |         |      |  |            |         |       |  |   |         |   |  |   | 1,256   |  
|                                      |  |        |         |      |  |            |         |       |  |   |         |   |  |   |         |  
|Discontinued operations, net of taxes |  |        |         |      |  |            |         |       |  |   |         |   |  | $ | (28,056 | )
|                                      |  |        |         |      |  |            |         |       |  |   |         |   |  |   |         |  



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                         
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Includes an adjustment of $18.0 million in
    2002 for estimated overpayments to MK Medical by government
    payors. MK Medical was part of our Home Care segment. (See
    Note 10.)                                                                                                                                                                                                                                                 
|   
|(2) | Includes net interest expense of
    $2.2 million, $3.5 million and $4.2 million for
    2003, 2002 and 2001, respectively. Also includes depreciation
    and amortization of $10.3 million, $23.0 million and
    $26.0 million for 2003, 2002 and 2001, respectively.                                                                                                                                                                
|   
|(3) | Includes an accrual in 2003 for the purchase of
    incremental patient care liability insurance on divested nursing
    facilities. Includes an accrual of $1.0 million in 2002 for
    legal and related fees associated with the MK Medical
    estimated overpayment issue, and asset impairment charges in
    2002 and 2001 related to certain nursing facilities, our former
    Matrix segment and our MK Medical business unit.

We recognized net gains on sales of
$67.1 million related to divestitures of certain nursing
facilities and assisted living centers during the year ended
December 31, 2003. During 2002, we recognized asset
impairment charges on certain of these divested facilities,
amounting to $24.7 million. These impairments were
precipitated by an estimated decline in future cash flows,
primarily associated with Medicare funding reductions. Of the
divested nursing facilities that incurred impairment charges in
2002, we recognized net losses on sales of $5.3 million.



|   |                              
|-- | -----------------------------
|7. | Acquisitions and Dispositions

During the year ended December 31, 2003, we
acquired the remaining six leased properties (649 beds) and our
corporate office building, which had been subject to our
off-balance sheet lease arrangement, for cash of
$69.5 million. These acquisitions were in accordance with
amendments made in 2003 to our former credit facility and our
off-balance sheet lease arrangement. The acquisitions were
primarily funded with the proceeds

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BEVERLY ENTERPRISES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Years ended December 31, 2003, 2002 and
2001




|   |                                                
|-- | -----------------------------------------------
|7. | Acquisitions and
    Dispositions  (Continued)

from the sales of nursing facilities, our
outpatient rehabilitation clinics and Care Focus. We also
entered into an operating lease on a nursing facility (140 beds)
and purchased certain other assets for cash of approximately
$400,000 plus closing and other costs. Excluding discontinued
operations during 2003 (see Note 6), we closed one nursing
facility (94 beds), sold one non-operational nursing facility
(120 beds) and certain other assets for $7.6 million,
including cash and a $4.1 million note receivable. We
recognized net pre-tax gains of $400,000 during the year ended
December 31, 2003, included in Net gains on
dispositions on the consolidated statements of operations,
as a result of these disposal activities. These dispositions did
not meet the criteria in SFAS No. 144 to be included
in discontinued operations.

During the year ended December 31, 2002, we
sold, closed or terminated the leases on 69 nursing facilities
(8,132 beds), four assisted living centers (315 units),
four home care centers, 10 outpatient clinics and certain other
assets for cash proceeds of approximately $170.9 million
and notes receivable of approximately $21.7 million. In
December 2001, we leased to another operator 49 nursing
facilities (6,129 beds) and four assisted living centers, all of
which were located in Florida (see Note 5). Excluding the
Florida properties, which had been written down to net
realizable value in 2001, we recognized net pre-tax gains of
$2.1 million during the year ended December 31, 2002,
included in Net gains on dispositions on the
consolidated statements of operations, as a result of these
disposal activities. The majority of these disposed assets were
classified as held for sale at December 31, 2001 and,
therefore, did not meet the criteria for classification as
discontinued operations.

During the year ended December 31, 2001, we
acquired one nursing facility (185 beds), eight previously
leased nursing facilities (903 beds) and certain other assets
for cash of approximately $3.7 million, assumed debt of
approximately $18.4 million, security deposits of $200,000
and incurred closing and other costs of approximately $300,000.
These acquisitions were accounted for as purchases. Also during
such period, we sold, closed or terminated the leases on 18
nursing facilities (1,768 beds), one assisted living center
(12 units), three outpatient therapy clinics, one home care
center and certain other assets for cash proceeds of
approximately $20.4 million and a note receivable of
approximately $3.9 million. We did not operate three of the
nursing facilities (355 beds) which had been leased to other
nursing home operators. We recognized net pre-tax gains of
$700,000 during the year ended December 31, 2001, included
in Net gains on dispositions on the consolidated
statements of operations, as a result of these dispositions. In
addition, we terminated the lease on one nursing facility (223
beds) in Indiana and recorded a pre-tax charge of approximately
$3.3 million which was included in the consolidated
statements of operations caption Asset impairments,
workforce reductions and other unusual items.

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BEVERLY ENTERPRISES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Years ended December 31, 2003, 2002 and
2001




|   |                       
|-- | ----------------------
|8. | Property and Equipment

A summary of property and equipment and related
accumulated depreciation and amortization, by major
classification, at December 31 is as follows (in thousands):

|                                               |  |       |           |       |  |        |           |      |  |      |           |      |  |   |           |  |  |   |        |  |  |   |        | 
|---------------------------------------------- |  | ----- | --------- | ----- |  | ------ | --------- | ---- |  | ---- | --------- | ---- |  | - | --------- |  |  | - | ------ |  |  | - | ------ | 
|                                               |  |       |           |       |  |       
|                                               |  | Total |           | Owned |  | Leased
|                                               |  |       |           |       |  |       
|                                               |  | 2003  |           | 2002  |  | 2003   |           | 2002 |  | 2003 |           | 2002
|                                               |  |       |           |       |  |        |           |      |  |      |           |     
|Land, buildings and improvements               |  | $     | 1,038,702 |       |  | $      | 1,153,084 |      |  | $    | 1,029,657 |      |  | $ | 1,138,054 |  |  | $ | 9,045  |  |  | $ | 15,030 | 
|Furniture and equipment                        |  |       | 241,412   |       |  |        | 301,604   |      |  |      | 239,071   |      |  |   | 298,244   |  |  |   | 2,341  |  |  |   | 3,360  | 
|Construction in progress                       |  |       | 8,091     |       |  |        | 6,974     |      |  |      | 8,091     |      |  |   | 6,974     |  |  |   |       |  |  |   |       | 
|                                               |  |       |           |       |  |        |           |      |  |      |           |      |  |   |           |  |  |   |        |  |  |   |        | 
|                                               |  |       | 1,288,205 |       |  |        | 1,461,662 |      |  |      | 1,276,819 |      |  |   | 1,443,272 |  |  |   | 11,386 |  |  |   | 18,390 | 
|Less accumulated depreciation and amortization |  |       | 593,985   |       |  |        | 672,379   |      |  |      | 585,995   |      |  |   | 659,746   |  |  |   | 7,990  |  |  |   | 12,633 | 
|                                               |  |       |           |       |  |        |           |      |  |      |           |      |  |   |           |  |  |   |        |  |  |   |        | 
|                                               |  | $     | 694,220   |       |  | $      | 789,283   |      |  | $    | 690,824   |      |  | $ | 783,526   |  |  | $ | 3,396  |  |  | $ | 5,757  | 
|                                               |  |       |           |       |  |        |           |      |  |      |           |      |  |   |           |  |  |   |        |  |  |   |        | 

We record 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; furniture and
equipment  5 to 15 years. Capital leased 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, 2003, 2002 and 2001 was $61.9 million,
$77.7 million and $76.3 million, respectively,
including depreciation and amortization expense on discontinued
operations of $10.0 million, $19.7 million and
$18.4 million, respectively.

Capitalized software costs of $53.4 million
and $53.6 million at December 31, 2003 and 2002,
respectively, net of accumulated amortization of
$28.4 million and $30.8 million, respectively, are
included in the accompanying consolidated balance sheet caption
Other assets. Amortization expense related to
capitalized software costs for the years ended December 31,
2003, 2002 and 2001 was $8.0 million, $10.3 million
and $8.6 million, respectively, including amortization
expense on discontinued operations of $337,000,
$2.4 million and $1.8 million, respectively.

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BEVERLY ENTERPRISES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Years ended December 31, 2003, 2002 and
2001




|   |               
|-- | --------------
|9. | Long-term Debt

Long-term debt consists of the following at
December 31 (in thousands):

|                                                                                                                                                                                                                                                                                   |  |      |         |      |  |   |         | 
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ------- | ---- |  | - | ------- | 
|                                                                                                                                                                                                                                                                                   |  | 2003 |         | 2002
|                                                                                                                                                                                                                                                                                   |  |      |         |     
|Revolving credit facility                                                                                                                                                                                                                                                          |  | $    |        |      |  | $ |        | 
|9 5/8% Senior Notes due April 15,
    2009, unsecured                                                                                                                                                                                                                              |  |      | 200,000 |      |  |   | 200,000 | 
|9% Senior Notes due February 15, 2006,
    unsecured, prepaid December 1, 2003                                                                                                                                                                                                     |  |      |        |      |  |   | 180,000 | 
|Term Loan due October 22, 2008 secured by
    first priority liens on 79 nursing facilities (9,157 beds) with
    a carrying value of $190,816 at December 31, 2003                                                                                                                |  |      | 134,662 |      |  |   |        | 
|2.75% Convertible Subordinated Notes due
    November 1, 2033, unsecured                                                                                                                                                                                                           |  |      | 115,000 |      |  |   |        | 
|Notes and mortgages, less imputed interest; due
    in installments through the year 2031, at effective interest
    rates of 4.75% to 12.50%, a portion of which is secured by
    property, equipment and other assets with a carrying value of
    $85,416 at December 31, 2003 |  |      | 63,584  |      |  |   | 133,554 | 
|Industrial development revenue bonds, due in
    installments through the year 2013, at effective interest rates
    of 4.98% to 10.00%, a portion of which is secured by property
    and other assets with a carrying value of $58,475 at
    December 31, 2003                  |  |      | 48,565  |      |  |   | 78,530  | 
|8.750% First Mortgage Bonds due July 1,
    2008, prepaid November 26, 2003                                                                                                                                                                                                        |  |      |        |      |  |   | 11,041  | 
|8.625% First Mortgage Bonds due October 1,
    2008, prepaid November 26, 2003                                                                                                                                                                                                     |  |      |        |      |  |   | 17,900  | 
|                                                                                                                                                                                                                                                                                   |  |      |         |      |  |   |         | 
|                                                                                                                                                                                                                                                                                   |  |      | 561,811 |      |  |   | 621,025 | 
|Present value of capital lease obligations, less
    imputed interest: 2003  $3,210; 2002 
    $6,977; at effective interest rates of 6.62% to 13.89%                                                                                                                            |  |      | 4,416   |      |  |   | 9,152   | 
|                                                                                                                                                                                                                                                                                   |  |      |         |      |  |   |         | 
|                                                                                                                                                                                                                                                                                   |  |      | 566,227 |      |  |   | 630,177 | 
|Less amounts due within one year                                                                                                                                                                                                                                                   |  |      | 13,354  |      |  |   | 41,463  | 
|                                                                                                                                                                                                                                                                                   |  |      |         |      |  |   |         | 
|                                                                                                                                                                                                                                                                                   |  | $    | 552,873 |      |  | $ | 588,714 | 
|                                                                                                                                                                                                                                                                                   |  |      |         |      |  |   |         | 

During October 2003, we entered into a new
$210.0 million senior credit facility (the Credit
Facility). The Credit Facility consists of a five-year
$135.0 million term loan facility and a four-year
$75.0 million revolving credit facility. The revolving
credit facility will be available for general corporate purposes
and up to $55.0 million for the issuance of letters of
credit. The term loan facility is fully drawn and we are
utilizing $41.3 million of the revolving credit facility
for letters of credit at December 31, 2003. The Credit
Facility currently bears interest at the prime lending rate plus
2.25%, or the Eurodollar rate plus 3.25%, at our option. These
rates may be adjusted quarterly based on the senior secured
leverage ratio calculation. The revolving credit facility is
secured by first priority liens on 79 nursing facilities (5,950
beds) with an aggregate carrying value of $111.3 million at
December 31, 2003, has a security interest in certain
patient accounts receivable, is guaranteed by substantially all
of our present and future subsidiaries and imposes on us certain
financial tests and restrictive covenants.

Concurrently with the Credit Facility
transaction, we issued through a public offering
$115.0 million of 2.75% convertible subordinated notes
due 2033 (the Convertible Notes). The Convertible
Notes are subordinated in right of payment to all of our
existing and future senior debt. The Convertible Notes are

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BEVERLY ENTERPRISES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Years ended December 31, 2003, 2002 and
2001




|   |                                 
|-- | --------------------------------
|9. | Long-term
    Debt  (Continued)

convertible into shares of our common stock at an
initial conversion price of $7.45 per share, at the option
of the holder, if any of the following conditions are met:



| |   |                                                                                                                                                                                                                                                                                                                                                
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | during any fiscal quarter, if the market price of
    our common stock is at least $8.94 for at least
    20 consecutive trading days during the 30 consecutive
    trading day period ending on the last day of the preceding
    fiscal quarter;                                                                                             
|
| |  | during the five business day period following any
    10 consecutive trading day period in which (a) the trading
    price of a note for each day of such period is less than 105% of
    the conversion value and (b) the conversion value for each
    day of such period is less than 95% of the principal amount of a
    Convertible Note;
|
| |  | if we call the Convertible Notes for
    redemption; or                                                                                                                                                                                                                                                                                        
|
| |  | upon the occurrence of certain corporate
    transactions specified in the agreement.                                                                                                                                                                                                                                                          

As of December 31, 2003, none of the
conversion conditions had been met and therefore, the common
shares into which the Convertible Notes may be converted were
not included in the calculation of our diluted earnings per
share. Assuming the Convertible Notes had been converted into
shares of our common stock effective January 1, 2003, our
unaudited pro forma diluted net income per share for the year
ended December 31, 2003, would have been reduced by
$0.09 per share to $0.66 per share diluted, based on a
total number of shares outstanding of approximately 122,352,000.

The net proceeds from these transactions were
used as follows:



| |   |                                                                                                                                    
| | - | -----------------------------------------------------------------------------------------------------------------------------------
| |  | to redeem all $180.0 million of our
    outstanding 9% Senior Notes due 2006 and to pay the
    applicable premium of $2.7 million;
|
| |  | to redeem $31.0 million of our industrial
    development revenue and first mortgage bonds;                                        
|
| |  | to repay $18.6 million of our mortgage
    obligations; and                                                                        
|
| |  | to pay transaction fees and expenses, and for
    general corporate purposes.                                                      

The 9 5/8% Senior Notes are unsecured
obligations guaranteed by substantially all of our present and
future subsidiaries (the Subsidiary Guarantors) and
impose on us certain restrictive covenants. Separate financial
statements of the Subsidiary Guarantors are not considered to be
material to holders of our 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 material
assets separate from its investments in its subsidiaries.

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BEVERLY ENTERPRISES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Years ended December 31, 2003, 2002 and
2001




|   |                                 
|-- | --------------------------------
|9. | Long-term
    Debt  (Continued)

Maturities and sinking fund requirements of
long-term debt, including capital leases, for the years ended
December 31 are estimated as follows (in thousands):

|                                                   |  |      |        |      |  |      |        |      |  |      |        |            |  |       |        |   |  |   |         |   |  |   |         |   |  |   |         |  
|-------------------------------------------------- |  | ---- | ------ | ---- |  | ---- | ------ | ---- |  | ---- | ------ | ---------- |  | ----- | ------ | - |  | - | ------- | - |  | - | ------- | - |  | - | ------- | -
|                                                   |  | 2004 |        | 2005 |  | 2006 |        | 2007 |  | 2008 |        | Thereafter |  | Total
|                                                   |  |      |        |      |  |      |        |      |  |      |        |            |  |      
|Future minimum lease payments                      |  | $    | 887    |      |  | $    | 712    |      |  | $    | 503    |            |  | $     | 461    |   |  | $ | 440     |   |  | $ | 4,623   |   |  | $ | 7,626   |  
|Less interest                                      |  |      | (375   | )    |  |      | (335   | )    |  |      | (304   | )          |  |       | (288   | ) |  |   | (273    | ) |  |   | (1,635  | ) |  |   | (3,210  | )
|                                                   |  |      |        |      |  |      |        |      |  |      |        |            |  |       |        |   |  |   |         |   |  |   |         |   |  |   |         |  
|Net present value of future minimum lease payments |  |      | 512    |      |  |      | 377    |      |  |      | 199    |            |  |       | 173    |   |  |   | 167     |   |  |   | 2,988   |   |  |   | 4,416   |  
|Notes, mortgages and bonds                         |  |      | 12,842 |      |  |      | 13,044 |      |  |      | 11,031 |            |  |       | 49,009 |   |  |   | 106,408 |   |  |   | 369,477 |   |  |   | 561,811 |  
|                                                   |  |      |        |      |  |      |        |      |  |      |        |            |  |       |        |   |  |   |         |   |  |   |         |   |  |   |         |  
|                                                   |  | $    | 13,354 |      |  | $    | 13,421 |      |  | $    | 11,230 |            |  | $     | 49,182 |   |  | $ | 106,575 |   |  | $ | 372,465 |   |  | $ | 566,227 |  
|                                                   |  |      |        |      |  |      |        |      |  |      |        |            |  |       |        |   |  |   |         |   |  |   |         |   |  |   |         |  

Most of our capital leases, as well as our
operating leases, have original terms from ten to fifteen years
and contain at least one renewal option (which could extend the
terms of the leases by five to fifteen years), purchase options,
escalation clauses and provisions for payments by us of real
estate taxes, insurance and maintenance costs.



|    |                              
|--- | -----------------------------
|10. | Commitments and Contingencies

Our future minimum rental commitments required by
all noncancelable operating leases with initial or remaining
terms in excess of one year as of December 31, 2003, are
estimated as follows (in thousands):

|             |  |   |         | 
|------------ |  | - | ------- | 
|Year Ending  |  |  
|December 31, |  |  
|             |  |  
|2004         |  | $ | 43,504  | 
|2005         |  |   | 33,927  | 
|2006         |  |   | 16,274  | 
|2007         |  |   | 10,517  | 
|2008         |  |   | 9,647   | 
|Thereafter   |  |   | 20,133  | 
|             |  |   |         | 
|             |  | $ | 134,002 | 
|             |  |   |         | 

Our total future minimum rental commitments are
net of approximately $5.1 million of minimum sublease
rental income due in the future under noncancelable subleases.
The following table summarizes certain information relative to
our operating leases, including operating leases for
discontinued operations, for the years ended December 31
(in thousands):

|                                                                   |  |      |        |      |  |      |        |  |  |   |         | 
|------------------------------------------------------------------ |  | ---- | ------ | ---- |  | ---- | ------ |  |  | - | ------- | 
|                                                                   |  | 2003 |        | 2002 |  | 2001
|                                                                   |  |      |        |      |  |     
|Rent expense, net of sublease rent income                          |  | $    | 70,132 |      |  | $    | 87,852 |  |  | $ | 106,814 | 
|Sublease rent income                                               |  |      | 1,143  |      |  |      | 2,036  |  |  |   | 2,248   | 
|Estimated contingent rent expense, based
    primarily on revenues |  |      | 1,000  |      |  |      | 2,000  |  |  |   | 7,000   | 

Our management information systems data
processing functions have been outsourced under an agreement
which was renegotiated during 2002 and expires in 2007. Our
future minimum commitments as of December 31, 2003, under
this agreement are estimated as follows: 2004 
$2.4 million; 2005  $2.4 million;
2006  $2.5 million; 2007  $762,000.
We incurred approximately $2.3 million, $2.9 million
and $3.4 million under this agreement during the years
ended December 31, 2003, 2002 and 2001, respectively.

71



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BEVERLY ENTERPRISES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Years ended December 31, 2003, 2002 and
2001




10. Commitments and
Contingencies  (Continued)


We are contingently liable for approximately
$13.1 million of long-term debt maturing on various dates
through 2019, as well as annual interest. These contingent
liabilities principally arose from our sale of nursing
facilities and assisted living centers. We operate two
facilities related to approximately $2.8 million of the
principal amount for which we are contingently liable, pursuant
to long-term agreements accounted for as operating leases. We
guarantee certain third-party operating leases. These guarantees
arose from our dispositions of leased facilities and the
underlying leases have approximately $46.6 million of
minimum rental commitments remaining through the initial lease
terms, with the latest termination date being February 2019. In
accordance with the FASBs Interpretation No. 45,
Guarantors Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of
Others(FIN 45), we have recorded
approximately $531,000, included in Other accrued
liabilities on the consolidated balance sheet, as the
estimated fair value of 2003 guarantees.

In 2002, we notified federal and California
healthcare regulatory authorities (CMS, Office of Inspector
General (the OIG), the California Attorney
Generals office and the California Department of Health)
of our intent to conduct an internal investigation of past
billing practices relating to MK Medical, our former medical
equipment business unit based in Fresno, California. An
independent accounting firm has reviewed MK Medicals
government payor billings since October 1, 1998, the date
Beverly acquired the business unit. Deficiencies identified by
the accounting firm primarily relate to inadequate documentation
supporting Medicare and Medi-Cal claims for reimbursement for
drugs, wheelchairs, and other durable medical equipment
distributed by MK Medical. Specifically, the review identified
instances of missing or incomplete certificates of medical
necessity, treatment authorization requests, prescriptions and
other documentation MK Medical is required to maintain in order
to be entitled to reimbursement from government payors. Based on
the results of the accounting firms review, we established
a reserve in 2002, included in Other accrued
liabilities on the consolidated balance sheets in the
amount of $18.0 million to cover potential overpayments
from government payors for the period from October 1, 1998
to 2002. We have advised regulatory authorities of the results
of the accounting firms review. On September 15,
2003, we received a subpoena from the United States
Attorneys Office in Oakland, California, requesting the
production of additional documents relating to MK Medicals
operations and our review of MK Medicals claims. We have
produced documents in response to this subpoena and continue to
cooperate with the governments request for information.
Our liability with respect to this matter could exceed the
reserved amount, which continues to be our best estimate of our
exposure on this matter. We can give no assurance of the final
outcome of this matter or its impact on our financial position,
results of operations and cash flows.

On February 3, 2000, we entered into a
series of separate agreements with the U.S. Department of
Justice and the OIG. These agreements settled the federal
governments investigations of the Company relating to our
allocation to the Medicare program of certain nursing labor
costs in our skilled nursing facilities from 1990 to 1998 (the
Allocation Investigations).

Under the Civil Settlement Agreement, we paid the
federal government $25.0 million during 2000 and are
reimbursing the federal government an additional
$145.0 million through withholdings from our biweekly
Medicare periodic interim payments in equal installments through
the first quarter of 2008. The present value of the remaining
obligation included as liabilities on our consolidated balance
sheets was $61.9 million and $73.9 million at
December 31, 2003 and 2002, respectively. In addition, we
agreed to resubmit certain Medicare filings to reflect reduced
labor costs allocated to the Medicare program. The adjustments
for these resubmitted filings were part of the settlement
agreement with CMS. (See Note 4.)

Under the Corporate Integrity Agreement, we are
required to monitor, on an ongoing basis, our compliance with
the requirements of the federal healthcare programs. This
agreement addresses our

72



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##### Table of Contents



BEVERLY ENTERPRISES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Years ended December 31, 2003, 2002 and
2001




10. Commitments and
Contingencies  (Continued)


obligations to ensure that we comply with the
requirements for participation in the federal healthcare
programs. It also includes functional and training obligations,
audit and review requirements, recordkeeping and reporting
requirements, as well as penalties for breach or noncompliance
of the agreement. We believe that we are generally in compliance
with the requirements of the Corporate Integrity Agreement.

On October 31, 2002, a shareholder
derivative action entitled Paul Dunne and Helene Dunne,
derivatively on behalf of nominal defendant Beverly Enterprises,
Inc. v. Beryl F. Anthony, Jr., et. al. was
filed in the Circuit Court of Sebastian County, Arkansas,
Fort Smith Division (No. CIV-2002-1241). This case was
purportedly brought derivatively on behalf of the Company
against various current and former officers and directors. The
complaint alleges causes of action for breach of fiduciary duty
against the defendants based on: (1) allegations that
defendants failed to establish and maintain adequate accounting
controls such that the Company failed to record adequate
reserves for patient care liability costs; and
(2) allegations that certain defendants sold Company stock
while purportedly in possession of material non-public
information.

On May 16, 2003, two additional derivative
complaints (Holcombe v. Floyd, et. al. and
Flowers v. Floyd, et. al.) were filed and
subsequently transferred to the Circuit Court of Sebastian
County, Arkansas, Fort Smith Division and consolidated with
the Dunne action as Holcomb v. Beverly Enterprises,
Inc. The Dunnes were subsequently dismissed as plaintiffs.
On June 9, 2003, pursuant to a stipulation of the parties,
the Court entered a scheduling order providing, among other
things, that plaintiffs will have thirty days from a ruling on
the motion to dismiss filed by defendants in the related
securities class action in federal court, In re Beverly
Enterprises, Inc. Securities Litigation(Case No. 2:02
cv 2190), to file an amended complaint and that defendants shall
have thirty days thereafter to respond to the complaint. The
court entered a ruling on the defendants motion to dismiss
in the federal securities class action on December 23,
2003, and the plaintiffs filed a notice of appeal on
January 22, 2004. In light of the plaintiffs appeal,
the parties have agreed to a further stay of this derivative
action pending resolution of the appeal. The dismissal of the
appeal on April 19, 2004, described in paragraph below,
began the thirty-day period for plaintiffs to file an amended
complaint in the derivative action, which they declined to do.
Defendants response to the complaint is currently due on
June 19, 2004. Due to the preliminary state of this action,
we are unable to assess the probable outcome of the case and can
give no assurance of the ultimate impact on our financial
position, results of operations and cash flows.

On August 16, 2002, August 26, 2002,
and September 26, 2002, respectively, Ernest
Baer v. Beverly Enterprises, Inc., et. al. (CIV.
No. 02-2190), Stanley V. Kensic v. Beverly
Enterprises, Inc., et. al. (CIV. No. 02-2193) and
Charles Krebs v. Beverly Enterprises, Inc., et. al.
(CIV. No. 02-2222) were filed in the United States District
Court, Western District of Arkansas, Fort Smith Division.
These cases were filed as purported securities fraud class
actions under Sections 10(b) and 20(a) of the Securities
Exchange Act of 1934 and Rule 10b-5 promulgated thereunder.

These cases separately name Beverly Enterprises,
Inc. as a defendant along with various current officers and our
independent auditors. In all three cases, the purported class
period runs from October 16, 2000 to and including
July 19, 2002. Plaintiffs claim that the defendants, during
the purported class period, made multiple false and misleading
statements. In early March 2003, these cases were consolidated
as In re Beverly Enterprises, Inc. Securities Litigation.
On April 30, 2003, plaintiffs filed an amended complaint.
On May 30, 2003, the defendants filed a motion to dismiss
the amended complaint. Briefing on the motion to dismiss was
completed July 11, 2003. The court heard oral arguments on
the defendants motion on August 28, 2003. On
December 23, 2003, the court granted defendants
motions to dismiss with prejudice and denied plaintiffs
motion to amend the complaint. Plaintiffs filed a notice of
appeal on January 22, 2004. On April 2, 2004,

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##### Table of Contents



BEVERLY ENTERPRISES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Years ended December 31, 2003, 2002 and
2001




10. Commitments and
Contingencies  (Continued)


plaintiffs and defendants jointly moved to
dismiss the appeal with prejudice and on April 19, 2004,
the court dismissed the action.

In addition, since July 29, 1999, several
derivative lawsuits have been filed in the state courts of
Arkansas, California and Delaware, as well as the federal
district court in Arkansas, assertedly on behalf of the Company
(collectively, the Derivative Actions). The parties
have agreed on a settlement in principle for these actions,
which provides that we will incorporate various corporate
governance practices that are consistent with our policies. In
addition, the directors and officers liability insurance
carriers, on behalf of the individual defendants, will pay no
more than $375,000 for plaintiffs attorneys fees.

We are party to various legal matters relating to
patient care, including claims that our services have resulted
in injury or death to residents of our facilities. We have
experienced an increasing trend in the number and severity of
the claims asserted against us. (See Note 2.) We believe
that there has been, and will continue to be, an increase in
governmental investigations of long-term care providers. Adverse
determinations in legal proceedings or governmental
investigations, whether currently asserted or arising in the
future, could have a material adverse effect on us.

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. We do not believe that the
ultimate resolution of such other matters will have a material
adverse effect on our consolidated financial position, results
of operations or cash flows.



|    |                     
|--- | --------------------
|11. | Stockholders Equity

We have 300,000,000 shares of authorized
$.10 par value common stock. We are subject to certain
restrictions under our long-term debt agreements related to the
payment of cash dividends on, and the repurchase of, our common
stock. During 2003 and 2002, we did not pay any cash dividends
on, or repurchase any of, our common stock. We have
25,000,000 shares of authorized $1 par value preferred
stock, all of which remains 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 November 2003, the Board of Directors
authorized a stock repurchase program whereby we may repurchase,
from time to time on the open market, up to $20.0 million
of our outstanding common stock, effective December 1, 2003
and remaining in effect for one year. As of December 31,
2003, no shares had been repurchased under this authorization
and any such repurchases will occur during open trading windows,
if at all.

In April 2003, we issued 2.5 million shares
of restricted stock to certain officers and other employees.
These shares vest one-third per year over the three years
following the grant date. These restricted stock grants were
made, along with certain cash incentives, as part of a program
designed to retain key associates. If these additional shares
had been issued prior to January 1, 2003, there would have
been no material impact on the Companys net income per
share for the year ended December 31, 2003. We recognize
compensation expense for our restricted stock grants at the fair
market value of our common stock on the date of grant, amortized
over the respective vesting periods on a straight-line basis.
The total charges to our consolidated statements of operations
for the years ended December 31, 2003, 2002 and 2001
related to restricted stock grants were approximately
$1.8 million, $1.3 million and $1.7 million,
respectively.

In January 2001, we filed a registration
statement under Form S-8 with the Securities and Exchange
Commission registering 1,174,500 shares of our common
stock. These shares were previously repurchased by the Company
and held in treasury. They may be issued under the Beverly
Enterprises, Inc. Stock Grant Plan

74



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##### Table of Contents



BEVERLY ENTERPRISES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Years ended December 31, 2003, 2002 and
2001




11. Stockholders Equity 
(Continued)


(the Stock Grant Plan) to holders of
restricted stock who, by virtue of the terms of their employment
contracts, severance agreements or other similar arrangements,
are entitled to the immediate vesting of their restricted stock.
In conjunction with ongoing operational reorganizations (as
discussed in Note 5), 777,984 shares of our common
stock under the Stock Grant Plan have been issued to various
officers in exchange for shares of restricted stock held by
them, which have been cancelled. Pre-tax workforce reduction
charges of $84,000, $500,000 and $4.5 million were recorded
in 2003, 2002 and 2001, respectively, in connection with the
issuance of these shares.

During 1997, the New Beverly 1997 Long-Term
Incentive Plan was approved (the 1997 Long-Term Incentive
Plan). The plan became effective December 3, 1997 and
remains in effect until December 31, 2006, subject to early
termination by the Board of Directors. 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 1997 Long-Term Incentive Plan was originally
authorized to issue 10,000,000 shares of our common stock,
subject to certain adjustments, in the form of nonqualified
stock options, incentive stock options, stock appreciation
rights, restricted stock, restricted stock units, performance
awards, bonus stock and other stock unit awards. In May 2001,
our stockholders approved an amendment to this plan which
authorized the issuance of an additional 5,000,000 shares.

In general, nonqualified and incentive stock
options must be granted at a purchase price equal to the fair
market value of our common stock on the date of grant. Options
issued at fair market value do not currently require the
recording of compensation expense upon issuance. 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. The issuance of restricted stock and
other stock awards usually require the recognition of
compensation expense measured by the fair value of the stock on
the date of grant.

During 1997, the New Beverly Non-Employee
Directors Stock Option Plan was approved (the Non-Employee
Directors Stock Option Plan). The plan became effective
December 3, 1997 and remains in effect until
December 31, 2007, subject to early termination by the
Board of Directors. We have 450,000 shares of our 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 March 28, 2001, to provide that each
non-employee director be granted an option to
purchase 11,000 shares of our common stock on
June 1 of each year until the plan is terminated, subject
to the availability of shares. These options are granted at a
purchase price equal to the fair market value of our common
stock on the date of grant, become exercisable one year after
the date of grant and expire 10 years after the date of
grant.

75



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##### Table of Contents



BEVERLY ENTERPRISES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Years ended December 31, 2003, 2002 and
2001




11. Stockholders Equity 
(Continued)


The following table summarizes stock option and
restricted stock data relative to our long-term incentive plans
for the years ended December 31:

|                                                  |           |           |           |           |   |           |      |           |  |           |           |            |   |   |      |      |  |  |           |            |   |   |      |      | 
|------------------------------------------------- | --------- | --------- | --------- | --------- | - | --------- | ---- | --------- |  | --------- | --------- | ---------- | - | - | ---- | ---- |  |  | --------- | ---------- | - | - | ---- | ---- | 
|                                                  |           |           |           |           |   |          
|                                                  |           | 2003      |           | 2002      |   | 2001     
|                                                  |           |           |           |           |   |          
|                                                  |           |           |           | Weighted- |   |           |      | Weighted- |  |           |           | Weighted- 
|                                                  |           |           |           | Average   |   |           |      | Average   |  |           |           | Average   
|                                                  |           | Number of |           | Exercise  |   | Number of |      | Exercise  |  | Number of |           | Exercise  
|                                                  |           | Shares    |           | Price     |   | Shares    |      | Price     |  | Shares    |           | Price     
|                                                  |           |           |           |           |   |           |      |           |  |           |           |           
|Options outstanding at beginning of year          |           |           | 8,882,635 |           |   | $         | 6.62 |           |  |           | 5,808,260 |            |   | $ | 6.46 |      |  |  | 3,790,326 |            |   | $ | 5.02 |     
|Changes during the year:                          |           |           |           |           |   |           |      |           |  |           |           |            |   |   |      |      |  |  |           |            |   |   |      |     
|                                                  | Granted   |           |           | 103,000   |   |           |      | 3.96      |  |           |           | 4,749,460  |   |   |      | 6.43 |  |  |           | 3,914,323  |   |   |      | 7.77 | 
|                                                  | Exercised |           |           | (234,850  | ) |           |      | 5.37      |  |           |           | (512,612   | ) |   |      | 3.72 |  |  |           | (943,608   | ) |   |      | 3.93 | 
|                                                  | Cancelled |           |           | (970,582  | ) |           |      | 5.98      |  |           |           | (1,162,473 | ) |   |      | 6.30 |  |  |           | (952,781   | ) |   |      | 8.59 | 
|                                                  |           |           |           |           |   |           |      |           |  |           |           |            |   |   |      |      |  |  |           |            |   |   |      |     
|Options outstanding at end of year                |           |           | 7,780,203 |           |   |           | 6.70 |           |  |           | 8,882,635 |            |   |   | 6.62 |      |  |  | 5,808,260 |            |   |   | 6.46 |     
|                                                  |           |           |           |           |   |           |      |           |  |           |           |            |   |   |      |      |  |  |           |            |   |   |      |     
|Options exercisable at end of year                |           |           | 3,580,102 |           |   |           | 6.86 |           |  |           | 2,274,231 |            |   |   | 7.09 |      |  |  | 1,289,677 |            |   |   | 7.19 |     
|                                                  |           |           |           |           |   |           |      |           |  |           |           |            |   |   |      |      |  |  |           |            |   |   |      |     
|Options available for grant at end of year        |           |           | 1,967,432 |           |   |           |      |           |  |           | 2,933,703 |            |   |   |      |      |  |  | 6,465,204 |            |   |   |      |     
|                                                  |           |           |           |           |   |           |      |           |  |           |           |            |   |   |      |      |  |  |           |            |   |   |      |     
|                                                 
|Restricted stock outstanding at beginning of year |           |           | 1,122,402 |           |   |           |      |           |  |           | 1,290,572 |            |   |   |      |      |  |  | 2,354,873 |            |   |   |      |     
|Changes during the year:                          |           |           |           |           |   |           |      |           |  |           |           |            |   |   |      |      |  |  |           |            |   |   |      |     
|                                                  | Granted   |           |           | 2,503,125 |   |           |      |           |  |           |           | 175,000    |   |   |      |      |  |  |           | 205,360    |   |   |      |      | 
|                                                  | Vested    |           |           | (131,550  | ) |           |      |           |  |           |           | (112,684   | ) |   |      |      |  |  |           | (75,709    | ) |   |      |      | 
|                                                  | Forfeited |           |           | (352,971  | ) |           |      |           |  |           |           | (230,486   | ) |   |      |      |  |  |           | (1,193,952 | ) |   |      |      | 
|                                                  |           |           |           |           |   |           |      |           |  |           |           |            |   |   |      |      |  |  |           |            |   |   |      |     
|Restricted stock outstanding at end of year       |           |           | 3,141,006 |           |   |           |      |           |  |           | 1,122,402 |            |   |   |      |      |  |  | 1,290,572 |            |   |   |      |     
|                                                  |           |           |           |           |   |           |      |           |  |           |           |            |   |   |      |      |  |  |           |            |   |   |      |     

Exercise prices for options outstanding as of
December 31, 2003, ranged from $2.33 to $14.38. The
weighted-average remaining contractual life of these options is
approximately seven years. The following table provides certain
information with respect to stock options outstanding and
exercisable at December 31, 2003:

|                         |  |                     |           |                     |  |                  |       |             |  |           |      |  |  |  |           |  |  |   |       | 
|------------------------ |  | ------------------- | --------- | ------------------- |  | ---------------- | ----- | ----------- |  | --------- | ---- |  |  |  | --------- |  |  | - | ----- | 
|                         |  |                     |           |                    
|                         |  | Options Outstanding |           | Options Exercisable
|                         |  |                     |           |                    
|                         |  |                     |           | Weighted-           |  | Weighted-        |       |             |  | Weighted-
|                         |  |                     |           | Average             |  | Average          |       |             |  | Average  
|                         |  | Options             |           | Exercise            |  | Remaining        |       | Options     |  | Exercise 
|Range of Exercise Prices |  | Outstanding         |           | Price               |  | Contractual Life |       | Exercisable |  | Price    
|                         |  |                     |           |                     |  |                  |       |             |  |          
|$ 2.33  $ 6.85          |  |                     | 3,782,276 |                     |  | $                | 5.20  |             |  |           | 7.53 |  |  |  | 1,521,893 |  |  | $ | 4.71  | 
|$ 7.00  $ 9.80          |  |                     | 3,582,592 |                     |  |                  | 7.73  |             |  |           | 7.26 |  |  |  | 1,655,000 |  |  |   | 7.68  | 
|$10.46  $11.76          |  |                     | 364,710   |                     |  |                  | 11.29 |             |  |           | 7.28 |  |  |  | 352,584   |  |  |   | 11.29 | 
|$12.88  $14.38          |  |                     | 50,625    |                     |  |                  | 13.58 |             |  |           | 4.17 |  |  |  | 50,625    |  |  |   | 13.58 | 
|                         |  |                     |           |                     |  |                  |       |             |  |           |      |  |  |  |           |  |  |   |       | 
|$ 2.33  $14.38          |  |                     | 7,780,203 |                     |  |                  | 6.70  |             |  |           | 7.39 |  |  |  | 3,580,102 |  |  |   | 6.86  | 
|                         |  |                     |           |                     |  |                  |       |             |  |           |      |  |  |  |           |  |  |   |       | 

SFAS No. 148, issued on
December 31, 2002, provides companies alternative methods
of transitioning to SFAS No. 123s fair value
method of accounting for stock-based employee compensation, and
amends certain

76



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##### Table of Contents



BEVERLY ENTERPRISES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Years ended December 31, 2003, 2002 and
2001




11. Stockholders Equity 
(Continued)


disclosure requirements. SFAS No. 148
does not mandate fair value accounting for stock-based employee
compensation, but does require all companies to meet the
disclosure provisions. We currently do not recognize
compensation expense for our stock option grants, which are
issued at fair market value on the date of grant, and are
accounted for under the intrinsic value method. We are in
compliance with the current accounting rules surrounding
stock-based compensation.

On March 31, 2004, the Financial Accounting
Standards Board (FASB) issued an Exposure Draft,
Share-Based Payment, which is a proposed amendment to
SFAS No. 123. The Exposure Draft would require all
share-based payments to employees, including grants of employee
stock options, to be expensed in the statements of income based
on their fair values. Public comments on the Exposure Draft are
due by June 30, 2004, and the FASB expects the new standard
will be effective beginning in 2005.

Pro forma information regarding net income (loss)
and diluted net income (loss) per share has been determined as
if we accounted for our stock option grants under the fair
market value method described in SFAS No. 123. The
fair market value of our 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, 2003, 2002 and 2001, respectively:



| |   |                                                                                                 
| | - | ------------------------------------------------------------------------------------------------
| |  | risk-free interest rates of 3.0%, 4.8% and 4.3%;                                                
|
| |  | volatility factors of the expected market price
    of our common stock of .81, .74 and .59; and
|
| |  | expected option lives of five years.                                                            

We do not currently pay cash dividends on our
common stock and no future dividends are currently planned. The
weighted-average assumptions resulted in a weighted average
estimated fair market value of options granted during 2003, 2002
and 2001 of $2.61 per share, $3.55 per share and
$4.25 per share, respectively.

The Black-Scholes option valuation model was
developed for use in estimating the fair market value of traded
options that 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 our stock options have
characteristics significantly different from those of traded
options, and because changes in the subjective input assumptions
can materially affect the fair market value estimates, in
managements opinion, the existing models do not
necessarily provide a reliable single measure of the fair market
value of our stock options.

77



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##### Table of Contents



BEVERLY ENTERPRISES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Years ended December 31, 2003, 2002 and
2001




11. Stockholders Equity 
(Continued)


For purposes of pro forma disclosures, the
estimated fair market value of all outstanding stock options is
amortized to expense over their respective vesting periods. The
pro forma effects are not necessarily indicative of the effects
on future years. The following table summarized our pro forma
net income (loss) and diluted net income (loss) per share,
assuming we accounted for our stock option grants in accordance
with SFAS No. 123, for the years ended
December 31 (in thousands, except per share amounts):

|                                              |  |      |        |      |  |      |          |   |  |   |          |  
|--------------------------------------------- |  | ---- | ------ | ---- |  | ---- | -------- | - |  | - | -------- | -
|                                              |  | 2003 |        | 2002 |  | 2001
|                                              |  |      |        |      |  |     
|Reported net income (loss)(a)                 |  | $    | 80,468 |      |  | $    | (146,090 | ) |  | $ | (301,272 | )
|Stock option compensation expense             |  |      | 6,865  |      |  |      | 6,218    |   |  |   | 2,708    |  
|                                              |  |      |        |      |  |      |          |   |  |   |          |  
|Pro forma net income (loss)                   |  | $    | 73,603 |      |  | $    | (152,308 | ) |  | $ | (303,980 | )
|                                              |  |      |        |      |  |      |          |   |  |   |          |  
|Reported diluted net income (loss) per share  |  | $    | 0.75   |      |  | $    | (1.39    | ) |  | $ | (2.90    | )
|                                              |  |      |        |      |  |      |          |   |  |   |          |  
|Pro forma diluted net income (loss) per share |  | $    | 0.69   |      |  | $    | (1.45    | ) |  | $ | (2.92    | )
|                                              |  |      |        |      |  |      |          |   |  |   |          |  



---



|    |  |                                                                                                                                                                                                                                          
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) |  | Includes total charges to our consolidated
    statements of operations related to restricted stock grants of
    $1.8 million, $1.3 million and $1.7 million for
    the years ended December 31, 2003, 2002 and 2001,
    respectively.

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 our common stock at the current market price
through payroll deductions. Effective January 1, 2003, we
eliminated our matching contributions to this plan. Each
participant specifies the amount to be withheld from earnings
per pay period, subject to certain limitations. During 2002 and
2001 we matched 15% of each participants contribution. The
total charges to our consolidated statements of operations for
the years ended December 31, 2002 and 2001 related to this
plan were approximately $300,000 and $500,000, respectively.



|    |             
|--- | ------------
|12. | Income Taxes

The provision for (benefit from) income taxes,
including taxes allocated to discontinued operations of
$3.4 million in 2003 and $1.3 million in 2001,
consists of the following for the years ended December 31
(in thousands):

|         |          |      |       |         |   |      |       |        |   |   |        |        |  
|-------- | -------- | ---- | ----- | ------- | - | ---- | ----- | ------ | - | - | ------ | ------ | -
|         |          | 2003 |       | 2002    |   | 2001
|         |          |      |       |         |   |     
|Federal: |          |      |       |         |   |      |       |        |   |   |        |       
|         | Current  |      | $     | (11,122 | ) |      | $     | (8,345 | ) |   | $      | 1,487  |  
|         | Deferred |      |       | 12,702  |   |      |       | 10,447 |   |   |        | 56,831 |  
|State:   |          |      |       |         |   |      |       |        |   |   |        |       
|         | Current  |      |       | 6,867   |   |      |       | 3,835  |   |   |        | 5,000  |  
|         | Deferred |      |       |        |   |      |       | 148    |   |   |        | (1,930 | )
|         |          |      |       |         |   |      |       |        |   |   |        |       
|         |          | $    | 8,447 |         |   | $    | 6,085 |        |   | $ | 61,388 |       
|         |          |      |       |         |   |      |       |        |   |   |        |       

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BEVERLY ENTERPRISES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Years ended December 31, 2003, 2002 and
2001




|    |                               
|--- | ------------------------------
|12. | Income
    Taxes  (Continued)

A reconciliation of our income tax provision
(benefit), including taxes allocated to discontinued operations
computed at the statutory federal income tax rate to our actual
provision for (benefit from) income taxes is summarized as
follows for the years ended December 31 (in thousands):

|                                           |  |      |         |      |  |      |         |   |  |   |         |  
|------------------------------------------ |  | ---- | ------- | ---- |  | ---- | ------- | - |  | - | ------- | -
|                                           |  | 2003 |         | 2002 |  | 2001
|                                           |  |      |         |      |  |     
|Tax (benefit) at statutory rate            |  | $    | 31,121  |      |  | $    | (49,002 | ) |  | $ | (83,959 | )
|General business tax credits               |  |      | (968    | )    |  |      | (2,090  | ) |  |   | (5,987  | )
|State tax provision (benefit), net         |  |      | 8,423   |      |  |      | 2,593   |   |  |   | (10,666 | )
|Impairment charges                         |  |      |        |      |  |      | 12,685  |   |  |   | 7,090   |  
|Increase (decrease) in valuation allowance |  |      | (30,141 | )    |  |      | 45,520  |   |  |   | 153,697 |  
|Other                                      |  |      | 12      |      |  |      | (3,621  | ) |  |   | 1,213   |  
|                                           |  |      |         |      |  |      |         |   |  |   |         |  
|                                           |  | $    | 8,447   |      |  | $    | 6,085   |   |  | $ | 61,388  |  
|                                           |  |      |         |      |  |      |         |   |  |   |         |  

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 our deferred tax assets and
liabilities at December 31, 2003 and 2002 are as follows
(in thousands):

|                                             |         |                           |         |                   |        |       |        |           |        |   |         |          |         |   |         |   |         | 
|-------------------------------------------- | ------- | ------------------------- | ------- | ----------------- | ------ | ----- | ------ | --------- | ------ | - | ------- | -------- | ------- | - | ------- | - | ------- | 
|                                             |         |                           |         |                  
|                                             |         | December 31, 2003         |         | December 31, 2002
|                                             |         |                           |         |                  
|                                             |         | Asset                     |         | Liability         |        | Asset |        | Liability
|                                             |         |                           |         |                   |        |       |        |          
|Insurance reserves                           |         | $                         | 70,838  |                   |        | $     |       |           |        | $ | 79,071  |          |         | $ |        |  
|General business tax credit carryforwards    |         |                           | 37,708  |                   |        |       |       |           |        |   | 28,742  |          |         |   |        |  
|Alternative minimum tax credit carryforwards |         |                           | 21,279  |                   |        |       |       |           |        |   | 19,124  |          |         |   |        |  
|Provision for dispositions                   |         |                           | 3,539   |                   |        |       | 16,016 |           |        |   | 66,768  |          |         |   | 8,387   |  
|Provision for Medicare repayment             |         |                           | 26,574  |                   |        |       |       |           |        |   | 31,735  |          |         |   |        |  
|Depreciation and amortization                |         |                           | 21,572  |                   |        |       | 55,687 |           |        |   | 28,399  |          |         |   | 113,228 |  
|Operating supplies                           |         |                           |        |                   |        |       | 9,538  |           |        |   |        |          |         |   | 11,489  |  
|Federal net operating loss carryforwards     |         |                           | 34,183  |                   |        |       |       |           |        |   | 55,659  |          |         |   |        |  
|Other                                        |         |                           | 29,767  |                   |        |       | 18,440 |           |        |   | 29,279  |          |         |   | 17,051  |  
|                                             |         |                           |         |                   |        |       |        |           |        |   |         |          |         |   |         |  
|                                             |         |                           | 245,460 |                   |        |       | 99,681 |           |        |   | 338,777 |          |         |   | 150,155 |  
|Valuation allowances:                        |         |                           |         |                   |        |       |        |           |        |   |         |          |         |   |         |  
|                                             | Federal |                           |         | (155,692          | )      |       |        |          |        |   |         | (179,625 | )       |   |         |  |        
|                                             | State   |                           |         | (13,384           | )      |       |        |          |        |   |         | (19,592  | )       |   |         |  |        
|                                             |         |                           |         |                   |        |       |        |           |        |   |         |          |         |   |         |  
|                                             |         | Net deferred tax balances |         | $                 | 76,384 |       |        | $         | 99,681 |   |         | $        | 139,560 |   |         | $ | 150,155 | 
|                                             |         |                           |         |                   |        |       |        |           |        |   |         |          |         |   |         |  

At December 31, 2003, for federal income tax
purposes, we had federal net operating loss carryforwards of
$93.2 million that expire in years 2018 through 2023;
general business tax credit carryforwards of $37.7 million
that expire in years 2006 through 2023; and alternative minimum
tax credit carryforwards of $21.3 million that do not
expire. Under the guidance of SFAS No. 109, based upon
our operating results in recent years, our reported cumulative
losses, and the inherent uncertainty associated with the
realization of future income in the near term, we have provided
a valuation allowance on our net deferred tax assets as of
December 31, 2003 and 2002.

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BEVERLY ENTERPRISES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Years ended December 31, 2003, 2002 and
2001




|    |                                     
|--- | ------------------------------------
|13. | Fair Values of Financial Instruments

Financial Accounting Standards Statement
No. 107, Disclosures about Fair Value of Financial
Instruments, (SFAS No. 107) 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 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. SFAS No. 107 excludes certain financial
instruments and all nonfinancial instruments from its disclosure
requirements. Accordingly, the aggregate fair value amounts
presented do not represent our underlying value.

The carrying amounts and estimated fair values of
our financial instruments at December 31, 2003 and 2002 are
as follows (in thousands):

|                                                               |  |          |         |       |  |          |         |       |  |   |         |  |  |   |         | 
|-------------------------------------------------------------- |  | -------- | ------- | ----- |  | -------- | ------- | ----- |  | - | ------- |  |  | - | ------- | 
|                                                               |  |          |         |      
|                                                               |  | 2003     |         | 2002 
|                                                               |  |          |         |      
|                                                               |  | Carrying |         | Fair  |  | Carrying |         | Fair 
|                                                               |  | Amount   |         | Value |  | Amount   |         | Value
|                                                               |  |          |         |       |  |          |         |      
|Cash and cash equivalents                                      |  | $        | 258,815 |       |  | $        | 258,815 |       |  | $ | 115,445 |  |  | $ | 115,445 | 
|Notes receivable, net (including current portion)              |  |          | 27,873  |       |  |          | 27,873  |       |  |   | 24,997  |  |  |   | 24,997  | 
|Beverly Indemnity funds                                        |  |          | 11,809  |       |  |          | 11,809  |       |  |   | 2,809   |  |  |   | 2,809   | 
|Long-term debt (including current portion)                     |  |          | 566,227 |       |  |          | 640,723 |       |  |   | 630,177 |  |  |   | 585,657 | 
|Federal government settlements (including current
    portion) |  |          | 61,888  |       |  |          | 61,888  |       |  |   | 73,891  |  |  |   | 73,891  | 

At December 31, 2003 and 2002, we had
outstanding defeased long-term debt with aggregate carrying
values of $6.3 million and $4.6 million, respectively.
The fair value of such defeased debt was approximately
$6.4 million and $4.6 million at December 31,
2003 and 2002, respectively. The fair value was estimated using
discounted cash flow analyses, based on our incremental
borrowing rates for similar types of borrowing arrangements.

In order to consummate certain dispositions and
other transactions, we have agreed to guarantee the debt assumed
or acquired by the purchaser or the performance under a lease,
by the lessee. In accordance with FIN 45, we have recorded
approximately $531,000, included in Other accrued
liabilities on the 2003 consolidated balance sheet, as the
estimated fair value of 2003 guarantees.

We used the following methods and assumptions in
estimating our 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. For fixed-rate notes, the fair values
are estimated using discounted cash flow analyses, using
interest rates currently being offered for loans with similar
terms to borrowers of similar credit quality.

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BEVERLY ENTERPRISES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Years ended December 31, 2003, 2002 and
2001




|    |                                                       
|--- | ------------------------------------------------------
|13. | Fair Values of Financial
    Instruments  (Continued)



| |                        
| | -----------------------
| | Beverly Indemnity Funds

The carrying amount reported in the consolidated
balance sheets for the Beverly Indemnity funds approximates its
fair value and is included in the consolidated balance sheet
caption Prepaid expenses and other.



| |                                               
| | ----------------------------------------------
| | Long-term Debt (Including Current
    Portion)

The carrying amounts of our variable-rate
borrowings approximate their fair values. The fair values of the
remaining long-term debt are estimated using discounted cash
flow analyses, based on our incremental borrowing rates for
similar types of borrowing arrangements.



| |                                                               
| | --------------------------------------------------------------
| | Federal Government Settlements (Including
    Current Portion)

The present value of our obligations to the
federal government resulting from the settlements of the
Allocation Investigations is included in the consolidated
balance sheet captions Federal government settlement
obligations and Other liabilities and deferred
items. These obligations are non-interest bearing, and as
such, were imputed at their approximate fair market rate of 9%
for accounting purposes. The carrying amounts of these
obligations approximate their fair values.



|    |                    
|--- | -------------------
|14. | Segment Information

Statement of Financial Accounting Standards
No. 131, Disclosures about Segments of an Enterprise and
Related Information,provides 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

Our operations are currently organized into three
primary segments:



| |   |                                                                                                                                                        
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Nursing Facilities,which provide long-term healthcare through the operation of
    skilled nursing homes and assisted living centers;                  
|
| |  | Aegis Therapies,which provides rehabilitation therapy services under contract to
    our nursing facilities and third-party nursing
    facilities; and
|
| |  | Home Care,which
    primarily provides hospice services.                                                                                               



| |                                                             
| | ------------------------------------------------------------
| | 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). We evaluate financial
performance and allocate resources primarily based on income or
loss from operations before income taxes, excluding any unusual
items.



| |                                                               
| | --------------------------------------------------------------
| | Factors Management Used to Identify Our
    Operating Segments

Our operating segments are strategic business
units that offer different services within the healthcare
continuum. Business in each operating segment is conducted by
one or more entities. The entities comprising each operating
segment also have separate boards of directors or managers.

81



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BEVERLY ENTERPRISES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Years ended December 31, 2003, 2002 and
2001




|    |                                      
|--- | -------------------------------------
|14. | Segment
    Information  (Continued)

The following table summarizes certain
information for each of our operating segments (in thousands):

|                             |                                  |            |   |           |  |           |   |              |  |       |   |               |   |  |   |          |   |  |   |           |   |  |   |         |  
|---------------------------- | -------------------------------- | ---------- | - | --------- |  | --------- | - | ------------ |  | ----- | - | ------------- | - |  | - | -------- | - |  | - | --------- | - |  | - | ------- | -
|                             |                                  | Nursing    |   |           |  |           |   |              |  |       |   | Discontinued 
|                             |                                  | Facilities |   | Aegis(1)  |  | Home Care |   | All Other(2) |  | Total |   | Operations(3)
|                             |                                  |            |   |           |  |           |   |              |  |       |   |              
|Year ended December 31, 2003 |                                  |            |   |           |  |           |   |              |  |       |   |               |   |  |   |          |   |  |   |           |   |  |   |        
|                             | Revenues from external customers |            | $ | 1,857,030 |  |           | $ | 77,007       |  |       | $ | 39,164        |   |  | $ | 6,558    |   |  | $ | 1,979,759 |   |  | $ | 377,126 |  
|                             | Intercompany revenues            |            |   | 1,121     |  |           |   | 153,140      |  |       |   |              |   |  |   | 1,322    |   |  |   | 155,583   |   |  |   |        |  
|                             | Interest income                  |            |   | 2,941     |  |           |   | 25           |  |       |   | 1             |   |  |   | 2,398    |   |  |   | 5,365     |   |  |   | 159     |  
|                             | Interest expense                 |            |   | 12,231    |  |           |   |             |  |       |   | 8             |   |  |   | 51,665   |   |  |   | 63,904    |   |  |   | 2,394   |  
|                             | Depreciation and amortization    |            |   | 50,233    |  |           |   | 831          |  |       |   | 547           |   |  |   | 7,707    |   |  |   | 59,318    |   |  |   | 10,345  |  
|                             | Pre-tax income (loss)            |            |   | 61,655    |  |           |   | 46,892       |  |       |   | 5,030         |   |  |   | (85,454  | ) |  |   | 28,123    |   |  |   | 60,792  |  
|                             | Goodwill                         |            |   | 45,272    |  |           |   |             |  |       |   | 11,723        |   |  |   | 107      |   |  |   | 57,102    |   |  |   | 332     |  
|                             | Total assets                     |            |   | 953,244   |  |           |   | 21,015       |  |       |   | 22,577        |   |  |   | 346,087  |   |  |   | 1,342,923 |   |  |   | 3,498   |  
|                             | Capital expenditures             |            |   | 28,892    |  |           |   | 1,434        |  |       |   | 387           |   |  |   | 9,785    |   |  |   | 40,498    |   |  |   | 3,486   |  
|Year ended December 31, 2002 |                                  |            |   |           |  |           |   |              |  |       |   |               |   |  |   |          |   |  |   |           |   |  |   |        
|                             | Revenues from external customers |            | $ | 1,852,479 |  |           | $ | 52,871       |  |       | $ | 34,315        |   |  | $ | 1,648    |   |  | $ | 1,941,313 |   |  | $ | 578,154 |  
|                             | Intercompany revenues            |            |   |          |  |           |   | 154,306      |  |       |   |              |   |  |   | 626      |   |  |   | 154,932   |   |  |   |        |  
|                             | Interest income                  |            |   | 1,567     |  |           |   | 42           |  |       |   | 13            |   |  |   | 3,068    |   |  |   | 4,690     |   |  |   | 59      |  
|                             | Interest expense                 |            |   | 13,387    |  |           |   |             |  |       |   | 23            |   |  |   | 49,816   |   |  |   | 63,226    |   |  |   | 3,603   |  
|                             | Depreciation and amortization    |            |   | 57,284    |  |           |   | 710          |  |       |   | 724           |   |  |   | 7,209    |   |  |   | 65,927    |   |  |   | 23,018  |  
|                             | Pre-tax income (loss)            |            |   | 105,994   |  |           |   | 35,569       |  |       |   | (1,633        | ) |  |   | (171,033 | ) |  |   | (31,103   | ) |  |   | (31,731 | )
|                             | Goodwill                         |            |   | 44,808    |  |           |   |             |  |       |   | 11,724        |   |  |   | (159     | ) |  |   | 56,373    |   |  |   | 7,004   |  
|                             | Total assets                     |            |   | 918,298   |  |           |   | 15,966       |  |       |   | 20,873        |   |  |   | 137,907  |   |  |   | 1,093,044 |   |  |   | 256,851 |  
|                             | Capital expenditures             |            |   | 77,952    |  |           |   | 1,676        |  |       |   | 258           |   |  |   | 7,778    |   |  |   | 87,664    |   |  |   | 12,439  |  
|Year ended December 31, 2001 |                                  |            |   |           |  |           |   |              |  |       |   |               |   |  |   |          |   |  |   |           |   |  |   |        
|                             | Revenues from external customers |            | $ | 2,063,698 |  |           | $ | 17,366       |  |       | $ | 45,389        |   |  | $ | 1,342    |   |  | $ | 2,127,795 |   |  | $ | 604,305 |  
|                             | Intercompany revenues            |            |   |          |  |           |   | 170,705      |  |       |   |              |   |  |   | 11,360   |   |  |   | 182,065   |   |  |   |        |  
|                             | Interest income                  |            |   | 127       |  |           |   | 4            |  |       |   |              |   |  |   | 2,785    |   |  |   | 2,916     |   |  |   | 161     |  
|                             | Interest expense                 |            |   | 21,608    |  |           |   |             |  |       |   | 74            |   |  |   | 53,354   |   |  |   | 75,036    |   |  |   | 4,337   |  
|                             | Depreciation and amortization    |            |   | 58,286    |  |           |   | 278          |  |       |   | 1,472         |   |  |   | 6,916    |   |  |   | 66,952    |   |  |   | 26,050  |  
|                             | Pre-tax income (loss)            |            |   | 64,845    |  |           |   | 48,322       |  |       |   | (425          | ) |  |   | (325,826 | ) |  |   | (213,084  | ) |  |   | (26,800 | )
|                             | Goodwill                         |            |   | 28,550    |  |           |   |             |  |       |   | 13,397        |   |  |   | (223     | ) |  |   | 41,724    |   |  |   | 103,160 |  
|                             | Total assets                     |            |   | 1,113,194 |  |           |   | 8,575        |  |       |   | 30,442        |   |  |   | 141,481  |   |  |   | 1,293,692 |   |  |   | 387,378 |  
|                             | Capital expenditures             |            |   | 65,908    |  |           |   | 1,200        |  |       |   | 118           |   |  |   | 3,127    |   |  |   | 70,353    |   |  |   | 19,048  |  



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Pre-tax income includes profit on intercompany
    revenues which is eliminated in All Other.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   
|(2) | Consists of the operations of our corporate
    headquarters and related overhead, as well as certain
    non-operating revenues and expenses. These amounts also include
    special pre-tax charges and adjustments totaling approximately
    $4.7 million, $73.9 million and $259.5 million
    for 2003, 2002 and 2001, respectively. These pre-tax charges
    primarily related to asset impairments, workforce reductions and
    other unusual items, special charges and adjustments related to
    federal government investigation settlements and increasing
    reserves for patient care liability costs in 2002.
|   
|(3) | The results of operations of 2003 disposed
    facilities, clinics and other assets as well as dispositions
    during the three months ended March 31, 2004 have been
    reported as discontinued operations, for all periods presented.
    Pre-tax income (loss) includes net gains on sales, exit costs,
    asset impairments and other unusual items of $62.4 million
    for 2003; net losses on sales, exit costs, asset impairments and
    other unusual items of $31.1 million in 2002; and
    $56.1 million of asset impairments and other unusual items
    in 2001. (See Note 6.)                               

82



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BEVERLY ENTERPRISES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Years ended December 31, 2003, 2002 and
2001




|    |                  
|--- | -----------------
|15. | Subsequent Events

On June 9, 2004, we commenced a cash tender
offer to purchase any and all of our $200.0 million in
aggregate principal amount of 9 5/8% senior notes due
2009 at an offer price of $1,190 per $1,000 principal amount
tendered, plus accrued and unpaid interest, and a solicitation
of consents to amend the indenture under which the
9 5/8% senior notes were issued. The consummation of
the tender offer is conditioned upon, among other things, the
consummation of our private placement of up to
$225.0 million senior subordinated notes due 2014 on terms
acceptable to us. The tender offer is scheduled to expire on
July 8, 2004, unless extended or earlier terminated. We
intend to use the net proceeds of the $225.0 million senior
subordinated notes offering, together with cash on hand, to
purchase the 9 5/8% senior notes validly tendered
pursuant to the tender offer.

On May 27, 2004, we signed a definitive
agreement to purchase the assets of Hospice USA, LLC, a
privately held company providing hospice services in
Mississippi, Alabama and Tennessee, for cash of approximately
$77.0 million. Hospice USA, LLC currently operates 18
hospice agencies and has an additional 16 agencies under
development. The transaction is subject to customary conditions,
including normal licensure and government approvals, and is
expected to close in late July.

The results of operations of the following
facilities and business disposed of during the three months
ended March 31, 2004 are reflected as discontinued
operations for all periods presented in the accompanying
consolidated statements of operations:



| |   |                                                                                                    
| | - | ---------------------------------------------------------------------------------------------------
| |  | four nursing facilities (353 beds) for cash
    proceeds totaling $8.4 million; and                
|
| |  | a home medical equipment business of our Home
    Care segment for cash proceeds totaling $165,000.

In April 2004, revisions were made to our
Corporate Integrity Agreement to extend the services of the
quality monitor to all of our nursing facilities and to reflect
a modification of the requirements under the agreement with
respect to training and education. We believe that we are
generally in compliance with the requirements of our Corporate
Integrity Agreement and file annual reports with the OIG
documenting our compliance. If we fail to comply with our
Corporate Integrity Agreement, we may be subject to penalties or
exclusion from the Medicare and Medicaid programs, which could
have an adverse effect on our financial condition and results of
operations.

83



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BEVERLY ENTERPRISES, INC.

SUPPLEMENTARY DATA (Unaudited)

QUARTERLY FINANCIAL DATA


(In thousands, except per share
data)


The following is a summary of our quarterly
results of operations for the years ended December 31, 2003
and 2002:

|                                                                                                                               |                    |                                                                                  |         |      |      |     |         |      |      |       |         |      |      |     |         |      |      |     |           |       |      |   |         |      |       |   |         |      |       |   |         |      |      |   |         |      |       |   |           |   |       |  
|------------------------------------------------------------------------------------------------------------------------------ | ------------------ | -------------------------------------------------------------------------------- | ------- | ---- | ---- | --- | ------- | ---- | ---- | ----- | ------- | ---- | ---- | --- | ------- | ---- | ---- | --- | --------- | ----- | ---- | - | ------- | ---- | ----- | - | ------- | ---- | ----- | - | ------- | ---- | ---- | - | ------- | ---- | ----- | - | --------- | - | ----- | -
|                                                                                                                               |                    |                                                                                  |         |     
|                                                                                                                               |                    | 2003                                                                             |         | 2002
|                                                                                                                               |                    |                                                                                  |         |     
|                                                                                                                               |                    | 1st                                                                              |         | 2nd  |      | 3rd |         | 4th  |      | Total |         | 1st  |      | 2nd |         | 3rd  |      | 4th |           | Total
|                                                                                                                               |                    |                                                                                  |         |      |      |     |         |      |      |       |         |      |      |     |         |      |      |     |           |      
|Revenues                                                                                                                       |                    | $                                                                                | 476,233 |      |      | $   | 485,333 |      |      | $     | 502,607 |      |      | $   | 515,586 |      |      | $   | 1,979,759 |       |      | $ | 472,600 |      |       | $ | 495,750 |      |       | $ | 487,027 |      |      | $ | 485,936 |      |       | $ | 1,941,313 |  
|                                                                                                                               |                    |                                                                                  |         |      |      |     |         |      |      |       |         |      |      |     |         |      |      |     |           |       |      |   |         |      |       |   |         |      |       |   |         |      |      |   |         |      |       |   |           |  
|Income (loss) before provision for income taxes,
    discontinued operations and cumulative effect of change in
    accounting |                    | $                                                                                | 1,393   |      |      | $   | 5,529   |      |      | $     | 8,797   |      |      | $   | 12,404  |      |      | $   | 28,123    |       |      | $ | 13,946  |      |       | $ | (18,212 | )    |       | $ | 16,130  |      |      | $ | (42,967 | )    |       | $ | (31,103   | )
|Provision for income taxes                                                                                                     |                    |                                                                                  | 1,236   |      |      |     | 1,201   |      |      |       | 1,853   |      |      |     | 779     |      |      |     | 5,069     |       |      |   | 1,079   |      |       |   | 1,331   |      |       |   | 1,021   |      |      |   | 2,654   |      |       |   | 6,085     |  
|                                                                                                                               |                    |                                                                                  |         |      |      |     |         |      |      |       |         |      |      |     |         |      |      |     |           |       |      |   |         |      |       |   |         |      |       |   |         |      |      |   |         |      |       |   |           |  
|Income (loss) before discontinued operations and
    cumulative effect of change in accounting                                 |                    |                                                                                  | 157     |      |      |     | 4,328   |      |      |       | 6,944   |      |      |     | 11,625  |      |      |     | 23,054    |       |      |   | 12,867  |      |       |   | (19,543 | )    |       |   | 15,109  |      |      |   | (45,621 | )    |       |   | (37,188   | )
|Discontinued operations, net of taxes                                                                                          |                    |                                                                                  | 12,031  |      |      |     | 13,163  |      |      |       | 3,039   |      |      |     | 29,181  |      |      |     | 57,414    |       |      |   | 7,637   |      |       |   | 5,529   |      |       |   | 469     |      |      |   | (45,366 | )    |       |   | (31,731   | )
|Cumulative effect of change in accounting, net of
    taxes                                                                    |                    |                                                                                  |        |      |      |     |        |      |      |       |        |      |      |     |        |      |      |     |          |       |      |   | (77,171 | )    |       |   |        |      |       |   |        |      |      |   |        |      |       |   | (77,171   | )
|                                                                                                                               |                    |                                                                                  |         |      |      |     |         |      |      |       |         |      |      |     |         |      |      |     |           |       |      |   |         |      |       |   |         |      |       |   |         |      |      |   |         |      |       |   |           |  
|Net income (loss)                                                                                                              |                    | $                                                                                | 12,188  |      |      | $   | 17,491  |      |      | $     | 9,983   |      |      | $   | 40,806  |      |      | $   | 80,468    |       |      | $ | (56,667 | )    |       | $ | (14,014 | )    |       | $ | 15,578  |      |      | $ | (90,987 | )    |       | $ | (146,090  | )
|                                                                                                                               |                    |                                                                                  |         |      |      |     |         |      |      |       |         |      |      |     |         |      |      |     |           |       |      |   |         |      |       |   |         |      |       |   |         |      |      |   |         |      |       |   |           |  
|Income (loss) per share of common stock:                                                                                       |                    |                                                                                  |         |      |      |     |         |      |      |       |         |      |      |     |         |      |      |     |           |       |      |   |         |      |       |   |         |      |       |   |         |      |      |   |         |      |       |   |           |  
|                                                                                                                               | Basic and diluted: |                                                                                  |         |      |      |     |         |      |      |       |         |      |      |     |         |      |      |     |           |       |      |   |         |      |       |   |         |      |       |   |         |      |      |   |         |      |       |   |           |   |      
|                                                                                                                               |                    | Before discontinued operations and cumulative
    effect of change in accounting |         | $    |     |     |         | $    | 0.04 |       |         | $    | 0.06 |     |         | $    | 0.11 |     |           | $     | 0.22 |   |         | $    | 0.12  |   |         | $    | (0.19 | ) |         | $    | 0.14 |   |         | $    | (0.44 | ) |           | $ | (0.36 | )
|                                                                                                                               |                    | Discontinued operations, net of taxes                                            |         |      | 0.12 |     |         |      | 0.12 |       |         |      | 0.03 |     |         |      | 0.27 |     |           |       | 0.53 |   |         |      | 0.08  |   |         |      | 0.06  |   |         |      | 0.01 |   |         |      | (0.43 | ) |           |   | (0.29 | )
|                                                                                                                               |                    | Cumulative effect of change in accounting, net of
    taxes                      |         |      |     |     |         |      |     |       |         |      |     |     |         |      |     |     |           |       |     |   |         |      | (0.74 | ) |         |      |      |   |         |      |     |   |         |      |      |   |           |   | (0.74 | )
|                                                                                                                               |                    |                                                                                  |         |      |      |     |         |      |      |       |         |      |      |     |         |      |      |     |           |       |      |   |         |      |       |   |         |      |       |   |         |      |      |   |         |      |       |   |           |  
|                                                                                                                               |                    | Net income (loss)                                                                |         | $    | 0.12 |     |         | $    | 0.16 |       |         | $    | 0.09 |     |         | $    | 0.38 |     |           | $     | 0.75 |   |         | $    | (0.54 | ) |         | $    | (0.13 | ) |         | $    | 0.15 |   |         | $    | (0.87 | ) |           | $ | (1.39 | )
|                                                                                                                               |                    |                                                                                  |         |      |      |     |         |      |      |       |         |      |      |     |         |      |      |     |           |       |      |   |         |      |       |   |         |      |       |   |         |      |      |   |         |      |       |   |           |  
|Shares used to compute basic net income (loss)
    per share amounts                                                           |                    |                                                                                  | 104,743 |      |      |     | 107,156 |      |      |       | 107,142 |      |      |     | 107,201 |      |      |     | 106,582   |       |      |   | 104,441 |      |       |   | 104,731 |      |       |   | 104,865 |      |      |   | 104,861 |      |       |   | 104,726   |  
|                                                                                                                               |                    |                                                                                  |         |      |      |     |         |      |      |       |         |      |      |     |         |      |      |     |           |       |      |   |         |      |       |   |         |      |       |   |         |      |      |   |         |      |       |   |           |  
|Shares used to compute diluted net income (loss)
    per share amounts                                                         |                    |                                                                                  | 104,743 |      |      |     | 107,161 |      |      |       | 107,600 |      |      |     | 108,089 |      |      |     | 106,920   |       |      |   | 105,466 |      |       |   | 104,731 |      |       |   | 104,937 |      |      |   | 104,861 |      |       |   | 104,726   |  
|                                                                                                                               |                    |                                                                                  |         |      |      |     |         |      |      |       |         |      |      |     |         |      |      |     |           |       |      |   |         |      |       |   |         |      |       |   |         |      |      |   |         |      |       |   |           |  
|Common stock price range:                                                                                                      |                    |                                                                                  |         |      |      |     |         |      |      |       |         |      |      |     |         |      |      |     |           |       |      |   |         |      |       |   |         |      |       |   |         |      |      |   |         |      |       |   |           |  
|                                                                                                                               | High               |                                                                                  | $       | 3.00 |      |     | $       | 4.30 |      |       | $       | 6.99 |      |     | $       | 8.60 |      |     |           |       |      |   | $       | 9.50 |       |   | $       | 9.18 |       |   | $       | 7.95 |      |   | $       | 3.89 |       |   |           |   |      
|                                                                                                                               | Low                |                                                                                  | $       | 1.63 |      |     | $       | 1.80 |      |       | $       | 3.71 |      |     | $       | 5.06 |      |     |           |       |      |   | $       | 5.66 |       |   | $       | 6.95 |       |   | $       | 1.90 |      |   | $       | 1.60 |       |   |           |   |      

We recorded provisions for income taxes,
including taxes allocated to discontinued operations, at 9.5%
and 4% for the years ended December 31, 2003 and 2002,
respectively, primarily due to state income taxes.

The operations of Matrix, MK Medical, Care Focus,
84 nursing facilities, seven assisted living centers and certain
other assets, including four nursing facilities and a home
medical equipment business disposed of during the three months
ended March 31, 2004, have been reported as discontinued
operations for all periods presented since they met the criteria
under SFAS No. 144 and therefore, the results above
differ from amounts previously reported in our Form 10-Qs.
In addition, we recorded a cumulative effect for the change in
accounting for goodwill as of January 1, 2002, which had
not been included in the first quarter 2002 Form 10-Q.

84



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

None.






|         |                         
|-------- | ------------------------
|ITEM 9A. | CONTROLS AND PROCEDURES.

The Company maintains disclosure controls and
procedures which are designed to ensure that information
required to be disclosed in the Companys Exchange Act
reports is recorded, processed, summarized and reported within
the time periods specified in the SECs rules and forms.
Such information is accumulated and communicated to the
Companys management, including its Chief Executive Officer
and Chief Financial Officer, as appropriate, to allow timely
decisions regarding required disclosure. In designing and
evaluating the disclosure controls and procedures, the
Companys management recognizes that any controls and
procedures, no matter how well designed and operated, can
provide only reasonable assurance of achieving the desired
control objectives, and the Companys management is
required to apply its judgment in evaluating the cost-benefit
relationship of possible controls and procedures.

As required by SEC Rule 13a-15(b), the
Company has carried out an evaluation as of December 31,
2003, the end of the period covered by this report, under the
supervision and with the participation of the Companys
management, including the Companys Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the design
and operation of the Companys disclosure controls and
procedures. Based upon their evaluation and subject to the
foregoing, the Chief Executive Officer and Chief Financial
Officer concluded that the Companys disclosure controls
and procedures were effective at the reasonable assurance level.

There has been no change in the Companys
internal controls over financial reporting during the
Companys fourth fiscal quarter ended December 31,
2003, that has materially affected, or is reasonably likely to
materially affect, the Companys internal controls over
financial reporting.

85



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PART III






|         |                                                     
|-------- | ----------------------------------------------------
|ITEM 10. | DIRECTORS AND EXECUTIVE OFFICERS OF THE
    COMPANY.

The information contained in our proxy with
respect to directors, executive officers, code of ethics, audit
committee and audit committee financial experts is incorporated
herein by reference from our definitive proxy statement for the
Annual Stockholders Meeting held on May 20, 2004, filed
pursuant to Regulation 14a.






|         |                        
|-------- | -----------------------
|ITEM 11. | EXECUTIVE COMPENSATION.

Incorporated herein by reference from our
definitive proxy statement for the Annual Stockholders Meeting
held on May 20, 2004, filed pursuant to Regulation 14A.






|         |                                                                                                    
|-------- | ---------------------------------------------------------------------------------------------------
|ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
    OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.

Incorporated herein by reference from our
definitive proxy statement for the Annual Stockholders Meeting
held on May 20, 2004, filed pursuant to Regulation 14A.






|         |                                                    
|-------- | ---------------------------------------------------
|ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED
    TRANSACTIONS.

Incorporated herein by reference from our
definitive proxy statement for the Annual Stockholders Meeting
held on May 20, 2004, filed pursuant to Regulation 14A.






|         |                                            
|-------- | -------------------------------------------
|ITEM 14. | PRINCIPAL ACCOUNTANT FEES AND
    SERVICES.

Incorporated herein by reference from our
definitive proxy statement for the Annual Stockholders Meeting
held on May 20, 2004, filed pursuant to Regulation 14A.

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PART IV






|         |                                                                     
|-------- | --------------------------------------------------------------------
|ITEM 15. | 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

On December 22, 2003, we filed a report on
Form 8-K under Item 9, which included a press release
announcing that Larry Deans has joined the Company as Senior
Vice President  Human Resources.

On December 15, 2003, we filed a report on
Form 8-K under Item 9, which included a press release
announcing the election of Cindy Susienka as Executive Vice
President and the election of Steve Brigance as Senior Vice
President  Litigation and Assistant Chief Legal
Officer.

On December 3, 2003, we filed a report on
Form 8-K under Item 9, which included a press release
announcing the sale of 21 skilled nursing operations in
California, Washington and Arizona.

On November 13, 2003, we filed a
Form 8-K under Items 9 and 12, which included a press
release announcing our operating results for the 2003 third
quarter. We also announced that our Board of Directors has
authorized us to purchase up to $20.0 million of
outstanding shares of our common stock, effective
December 1, 2003 and remaining in effect for one year.

On November 4, 2003, we filed a report on
Form 8-K under Item 9, which included a press release
announcing the all-cash sale of nine skilled nursing operations
in Southern California.

On October 23, 2003, we filed a report on
Form 8-K including a press release dated October 17,
2003, announcing that the underwriters of our previously
announced public offering of $100.0 million principal
amount of 2.75% Convertible Subordinated Notes due 2033
(the Notes) had exercised their over-allotment
option in full to purchase an additional $15.0 million in
principal amount of the Notes. Also included was a press release
dated October 22, 2003, announcing that, as a result of our
sale of an additional $15.0 million in principal amount of
the Notes to cover over-allotments, we had decided to reduce the
$150.0 million term loan portion of our new senior credit
facility to $135.0 million.

On October 17, 2003, we filed a report on
Form 8-K under Items 5, 7 and 9, announcing our
agreement to sell $100.0 million of 2.75% Convertible
Subordinated Notes due 2033 pursuant to the previously announced
public offering. The underwriting agreement relating to the
Notes, the Prospectus Supplement and a press release all dated
October 16, 2003, were also included in the Form 8-K.

On October 14, 2003, we filed a report on
Form 8-K under Items 5, 7 and 9, announcing the
appointment of The Bank of New York as trustee in connection
with our proposed offering of $100.0 million of convertible
subordinated notes. A copy of the T-1 and a press release dated
October 13, 2003, were also included in the Form 8-K.

On October 2, 2003, we filed a report on
Form 8-K under Item 9, which included a press release
announcing the all-cash sale of 12 skilled nursing
operations and one assisted living center in Southern California.

87



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| |             
| | ------------
| | (c) Exhibits

See the accompanying index to exhibits referenced
in Item 15(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 15(a)1 and 2, above.

88



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BEVERLY ENTERPRISES, INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND

FINANCIAL STATEMENT SCHEDULES


(Item 15(a))


|   |  |                                                                                                                           |  |      |    | 
|-- |  | ------------------------------------------------------------------------------------------------------------------------- |  | ---- | -- | 
|   |  |                                                                                                                           |  | Page
|   |  |                                                                                                                           |  |     
|1. |  | Consolidated financial statements:                                                                                        |  |      |    | 
|   |  | Report of Ernst & Young LLP, Independent
    Registered Public Accounting Firm                                            |  |      | 47 | 
|   |  | Consolidated Balance Sheets at December 31,
    2003 and 2002                                                             |  |      | 48 | 
|   |  | Consolidated Statements of Operations for each of
    the three years in the period ended December 31, 2003               |  |      | 49 | 
|   |  | Consolidated Statements of Stockholders
    Equity for each of the three years in the period ended
    December 31, 2003 |  |      | 50 | 
|   |  | Consolidated Statements of Cash Flows for each of
    the three years in the period ended December 31, 2003               |  |      | 51 | 
|   |  | Notes to Consolidated Financial Statements                                                                                |  |      | 52 | 
|   |  | Supplementary Data (Unaudited) 
    Quarterly Financial Data                                                             |  |      | 84 | 
|  
|2. |  | Consolidated financial statement schedule for
    each of the three years in the period ended December 31,
    2003:      |  |      |    | 
|   |  | Schedule II  Valuation and
    Qualifying Accounts                                                                       |  |      | 90 | 



| |                                                                                                                                               
| | ----------------------------------------------------------------------------------------------------------------------------------------------
| | All other schedules are omitted because they are
    either not applicable or the items do not meet 
     the various disclosure requirements.

89



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BEVERLY ENTERPRISES, INC.

SCHEDULE II  VALUATION AND
QUALIFYING ACCOUNTS

Years ended December 31, 2003, 2002 and
2001


(In thousands)


|                              |                                            |                                 |        |            |        |              |        |                  |        |       |         |            |         |       |        |   |        |   |       |         |        |   |        |         |        |  
|----------------------------- | ------------------------------------------ | ------------------------------- | ------ | ---------- | ------ | ------------ | ------ | ---------------- | ------ | ----- | ------- | ---------- | ------- | ----- | ------ | - | ------ | - | ----- | ------- | ------ | - | ------ | ------- | ------ | -
|                              |                                            |                                 |        |            |        |              |        | Due to           |        |       |         |           
|                              |                                            |                                 |        | Charged    |        |              |        | Acquisitions,    |        |       |         |           
|                              |                                            | Balance at                      |        | (Credited) |        |              |        | Dispositions and |        |       |         | Balance at
|                              |                                            | Beginning                       |        | to         |        | (Write-offs) |        | Discontinued     |        |       |         | End of    
|Description                   |                                            | of Year                         |        | Operations |        | Recoveries   |        | Operations       |        | Other |         | Year      
|                              |                                            |                                 |        |            |        |              |        |                  |        |       |         |           
|Year ended December 31, 2003: |                                            |                                 |        |            |        |              |        |                  |        |       |         |            |         |       |        |   |        |   |       |         |        |   |        |        
|                              | Allowance for doubtful accounts:           |                                 |        |            |        |              |        |                  |        |       |         |            |         |       |        |   |        |   |       |         |        |   |        |         |       
|                              |                                            | Account receivable  patient    |        | $          | 43,189 |              |        | $                | 22,515 |       |         | $          | (30,287 | )     |        | $ | (3,478 | ) |       | $       | (1,891 | ) |        | $       | 30,048 |  
|                              |                                            | Account receivable  nonpatient |        |            | 1,477  |              |        |                  | 228    |       |         |            | (20     | )     |        |   | (4     | ) |       |         | 16     |   |        |         | 1,697  | *
|                              |                                            | Notes receivable                |        |            | 7,761  |              |        |                  | (1,138 | )     |         |            | (4,085  | )     |        |   | 682    |   |       |         | 2,106  |   |        |         | 5,326  |  
|                              |                                            |                                 |        |            |        |              |        |                  |        |       |         |            |         |       |        |   |        |   |       |         |        |   |        |        
|                              |                                            | $                               | 52,427 |            |        | $            | 21,605 |                  |        | $     | (34,392 | )          |         | $     | (2,800 | ) |        | $ | 231   |         |        | $ | 37,071 |        
|                              |                                            |                                 |        |            |        |              |        |                  |        |       |         |            |         |       |        |   |        |   |       |         |        |   |        |        
|                              | Valuation allowance on deferred tax assets |                                 | $      | 199,217    |        |              | $      | (30,141          | )      |       | $       |           |         |       | $      |  |        |   | $     |        |        |   | $      | 169,076 |       
|                              |                                            |                                 |        |            |        |              |        |                  |        |       |         |            |         |       |        |   |        |   |       |         |        |   |        |        
|Year ended December 31, 2002: |                                            |                                 |        |            |        |              |        |                  |        |       |         |            |         |       |        |   |        |   |       |         |        |   |        |        
|                              | Allowance for doubtful accounts:           |                                 |        |            |        |              |        |                  |        |       |         |            |         |       |        |   |        |   |       |         |        |   |        |         |       
|                              |                                            | Account receivable  patient    |        | $          | 51,400 |              |        | $                | 53,692 |       |         | $          | (59,385 | )     |        | $ | (4,207 | ) |       | $       | 1,689  |   |        | $       | 43,189 |  
|                              |                                            | Account receivable  nonpatient |        |            | 1,074  |              |        |                  | 866    |       |         |            | (615    | )     |        |   | (14    | ) |       |         | 166    |   |        |         | 1,477  | *
|                              |                                            | Notes receivable                |        |            | 4,941  |              |        |                  | 1,012  |       |         |            | (39     | )     |        |   | 181    |   |       |         | 1,666  |   |        |         | 7,761  |  
|                              |                                            |                                 |        |            |        |              |        |                  |        |       |         |            |         |       |        |   |        |   |       |         |        |   |        |        
|                              |                                            | $                               | 57,415 |            |        | $            | 55,570 |                  |        | $     | (60,039 | )          |         | $     | (4,040 | ) |        | $ | 3,521 |         |        | $ | 52,427 |        
|                              |                                            |                                 |        |            |        |              |        |                  |        |       |         |            |         |       |        |   |        |   |       |         |        |   |        |        
|                              | Valuation allowance on deferred tax assets |                                 | $      | 153,697    |        |              | $      | 45,520           |        |       | $       |           |         |       | $      |  |        |   | $     |        |        |   | $      | 199,217 |       
|                              |                                            |                                 |        |            |        |              |        |                  |        |       |         |            |         |       |        |   |        |   |       |         |        |   |        |        
|Year ended December 31, 2001: |                                            |                                 |        |            |        |              |        |                  |        |       |         |            |         |       |        |   |        |   |       |         |        |   |        |        
|                              | Allowance for doubtful accounts:           |                                 |        |            |        |              |        |                  |        |       |         |            |         |       |        |   |        |   |       |         |        |   |        |         |       
|                              |                                            | Account receivable  patient    |        | $          | 91,636 |              |        | $                | 43,658 |       |         | $          | (95,214 | ) (A) |        | $ | 4,022  |   |       | $       | 7,298  |   |        | $       | 51,400 |  
|                              |                                            | Account receivable  nonpatient |        |            | 1,372  |              |        |                  | 89     |       |         |            | (477    | )     |        |   |       |   |       |         | 90     |   |        |         | 1,074  | *
|                              |                                            | Notes receivable                |        |            | 3,573  |              |        |                  | 504    |       |         |            | 93      |       |        |   | 107    |   |       |         | 664    |   |        |         | 4,941  |  
|                              |                                            |                                 |        |            |        |              |        |                  |        |       |         |            |         |       |        |   |        |   |       |         |        |   |        |        
|                              |                                            | $                               | 96,581 |            |        | $            | 44,251 |                  |        | $     | (95,598 | )          |         | $     | 4,129  |   |        | $ | 8,052 |         |        | $ | 57,415 |        
|                              |                                            |                                 |        |            |        |              |        |                  |        |       |         |            |         |       |        |   |        |   |       |         |        |   |        |        
|                              | Valuation allowance on deferred tax assets |                                 | $      |           |        |              | $      | 52,100           |        |       | $       |           |         |       | $      |  |        |   | $     | 101,597 | (B)    |   | $      | 153,697 |       
|                              |                                            |                                 |        |            |        |              |        |                  |        |       |         |            |         |       |        |   |        |   |       |         |        |   |        |        



---



|    |  |                                                                                                                                                                                                    
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(A) |  | Includes the write-off of $39.0 million of
    Medicare cost report related receivables against a related
    reserve established in conjunction with the OIG settlement (see
    Item 8  Note 4).
|   
|(B) |  | Represents a full valuation allowance on our net
    deferred tax assets.                                                                                                                          



|  |                                                                                     
|- | ------------------------------------------------------------------------------------
|* | Includes amounts classified in long-term other
    assets as well as current assets.

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##### Table of Contents



BEVERLY ENTERPRISES, INC.

INDEX TO EXHIBITS

(ITEM 15(a)(3))


|        |    |     |  |             |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|------- | -- | --- |  | ----------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |     |  |            
|Number  |    |     |  | Description
|        |    |     |  |            
|        | 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 April 25, 2001,
    between Beverly Enterprises, Inc., and The Bank of New York, as
    Trustee, with respect to Beverly Enterprises, Inc.s
    9 5/8% Senior Notes due 2009 (incorporated by
    reference to Exhibit 4.3 to Beverly Enterprises,
    Inc.s Annual Report on Form 10-K for the year ended
    December 31, 2001)                                                                                                                                                                   
|        | 4  | .2  |  |            |  | 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  | .3  |  |            |  | First Amendment and Restatement, dated as of
    June 1, 1999, of Trust Indenture, dated as of
    December 1, 1994, from Beverly Funding Corporation, as
    Issuer, to The Chase Manhattan Bank, as Trustee (incorporated by
    reference to Exhibit 10.2 to Beverly Enterprises,
    Inc.s Quarterly Report on Form 10-Q for the quarter
    ended September 30, 1999)                                                                                                                                                  
|        | 4  | .4  |  |            |  | 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))                                                                                                                                                                                                                                                                     
|        | 4  | .5  |  |            |  | Series Supplement, dated as of June 1,
    1999, by and between Beverly Funding Corporation and The Chase
    Manhattan Bank (1999-1 Series Supplement)
    (incorporated by reference to Exhibit 10.3 to Beverly
    Enterprises, Inc.s Quarterly Report on Form 10-Q for
    the quarter ended September 30, 1999)                                                                                                                                                                                                      
|        | 4  | .6  |  |            |  | First Amendment, dated as of July 14, 1999,
    to the 1999-1 Series Supplement (incorporated by reference
    to Exhibit 10.4 to Beverly Enterprises, Inc.s
    Quarterly Report on Form 10-Q for the quarter ended
    September 30, 1999). 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 10.1 to Beverly
    Enterprises, Inc.s Annual Report on Form 10-K for the
    year ended December 31, 2001)                                                                                                                                                                                                                                                                                                                       
|        | 10 | .2* |  |            |  | 1997 Long-Term Incentive Plan, as amended and
    restated as of June 1, 2001 (the 1997 LTIP)
    (incorporated by reference to Exhibit 10.2 to Beverly
    Enterprises, Inc.s Annual Report on Form 10-K for the
    year ended December 31, 2001)                                                                                                                                                                                                                                                                       

91



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|        |    |      |  |             |  |                                                                                                                                                                                                                                                                                                              
|------- | -- | ---- |  | ----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |      |  |            
|Number  |    |      |  | Description
|        |    |      |  |            
|        | 10 | .3*  |  |            |  | Beverly Enterprises, Inc. Non-Employee
    Directors Stock Option Plan, as amended and restated as of
    June 1, 2001 (the Directors Option Plan)
    (incorporated by reference to Exhibit 10.3 to Beverly
    Enterprises, Inc.s Annual Report on Form 10-K for the
    year ended December 31, 2001)
|        | 10 | .4*  |  |            |  | Beverly Enterprises, Inc. Stock Grant Plan
    (incorporated by reference to Exhibit 10.6 to Beverly
    Enterprises, Inc.s Annual Report on Form 10-K for the
    year ended December 31, 2000)                                                                                                            
|        | 10 | .5*  |  |            |  | 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 | .6*  |  |            |  | Form of the Beverly Enterprises, Inc. Executive
    Life Insurance Plan Split Dollar Agreement (incorporated by
    reference to Exhibit 10.8 to Beverly Enterprises,
    Inc.s Annual Report on Form 10-K for the year ended
    December 31, 2000)                                                        
|        | 10 | .7*  |  |            |  | 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 | .8*  |  |            |  | 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 | .9*  |  |            |  | 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 | .10* |  |            |  | 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 | .11* |  |            |  | 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 | .12* |  |            |  | 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 | .13* |  |            |  | 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 | .14* |  |            |  | 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 | .15* |  |            |  | 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 | .16* |  |            |  | 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 | .17* |  |            |  | 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)                                                             

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|        |    |      |  |             |  |                                                                                                                                                                                                                                                                                                        
|------- | -- | ---- |  | ----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |      |  |            
|Number  |    |      |  | Description
|        |    |      |  |            
|        | 10 | .18* |  |            |  | 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 | .19* |  |            |  | Beverly Enterprises, Inc. Amended and Restated
    Supplemental Executive Retirement Plan effective as of
    April 1, 2000 (incorporated by reference to
    Exhibit 10.21 to Beverly Enterprises, Inc.s Annual
    Report on Form 10-K for the year ended December 31,
    2000)                    
|        | 10 | .20* |  |            |  | Amendment Number One to the Beverly Enterprises,
    Inc. Supplemental Executive Retirement Plan (incorporated by
    reference to Exhibit 10.5 to Beverly Enterprises,
    Inc.s Quarterly Report on Form 10-Q for the quarter
    ended June 30, 2002)                                              
|        | 10 | .21* |  |            |  | Beverly Enterprises, Inc. Amended and Restated
    Executive Deferred Compensation Plan effective July 1, 2000
    (incorporated by reference to Exhibit 10.22 to Beverly
    Enterprises, Inc.s Annual Report on Form 10-K for the
    year ended December 31, 2000)                                 
|        | 10 | .22* |  |            |  | Beverly Enterprises, Inc. Executive Deferred
    Compensation Plan effective December 31, 2002 (incorporated
    by reference to Exhibit 10.22 to Beverly Enterprises,
    Inc.s Annual Report on Form 10-K for the year ended
    December 31, 2002)                                                 
|        | 10 | .23* |  |            |  | 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 | .24* |  |            |  | 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 | .25* |  |            |  | 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 | .26* |  |            |  | 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 | .27* |  |            |  | 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 | .28* |  |            |  | 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 | .29* |  |            |  | 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 | .30* |  |            |  | Severance Agreement and Release of Claims between
    Beverly Enterprises, Inc. and David R. Banks (incorporated by
    reference to Exhibit 10.28 to Beverly Enterprises,
    Inc.s Annual Report on Form 10-K for the year ended
    December 31, 2001)                                             

93



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|        |    |      |  |             |  |                                                                                                                                                                                                                                                                                                                               
|------- | -- | ---- |  | ----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |      |  |            
|Number  |    |      |  | Description
|        |    |      |  |            
|        | 10 | .31* |  |            |  | Employment Contract, made as of April 10,
    2000, between Beverly Enterprises, Inc. and William R. Floyd
    (incorporated by reference to Exhibit 10.31 to Beverly
    Enterprises, Inc.s Annual Report on Form 10-K for the
    year ended December 31, 2000)                                                            
|        | 10 | .32* |  |            |  | Employment Contract, made as of December 6,
    2001, between Beverly Enterprises, Inc. and William R. Floyd
    (incorporated by reference to Exhibit 10.32 to Beverly
    Enterprises, Inc.s Annual Report on Form 10-K for the
    year ended December 31, 2002)                                                          
|        | 10 | .33* |  |            |  | Employment and Severance Agreement, made as of
    June 1, 2001, between Beverly Enterprises, Inc. and David
    R. Devereaux (incorporated by reference to Exhibit 10.33 to
    Beverly Enterprises, Inc.s Annual Report on Form 10-K
    for the year ended December 31, 2002)                                             
|        | 10 | .34* |  |            |  | Severance Agreement and Release of Claims made as
    of October 5, 2002, between Beverly Enterprises, Inc. and
    Bobby W. Stephens (incorporated by reference to
    Exhibit 10.34 to Beverly Enterprises, Inc.s Annual
    Report on Form 10-K for the year ended December 31,
    2002)                                 
|        | 10 | .35* |  |            |  | Employment Contract, made as of April 1,
    2000, between Beverly Enterprises, Inc. and Douglas J. Babb
    (incorporated by reference to Exhibit 10.35 to Beverly
    Enterprises, Inc.s Annual Report on Form 10-K for the
    year ended December 31, 2002)                                                              
|        | 10 | .36* |  |            |  | Severance Agreement and Release of Claims made as
    of October 11, 2002, between Beverly Enterprises, Inc. and
    Michael J. Matheny (incorporated by reference to
    Exhibit 10.36 to Beverly Enterprises, Inc.s Annual
    Report on Form 10-K for the year ended December 31,
    2002)                               
|        | 10 | .37* |  |            |  | Severance Agreement and Release of Claims made as
    of December 31, 2001, between Beverly Enterprises, Inc. and
    T. Jerald Moore (incorporated by reference to Exhibit 10.37
    to Beverly Enterprises, Inc.s Annual Report on
    Form 10-K for the year ended December 31, 2002)                                     
|        | 10 | .38* |  |            |  | Employment Agreement, dated February 15,
    2001 between Beverly Enterprises, Inc. and William A. Mathies
    (incorporated by reference to Exhibit 10.1 to Beverly
    Enterprises, Inc.s Quarterly Report on Form 10-Q for
    the quarter ended June 30, 2001)                                                           
|        | 10 | .39* |  |            |  | 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 | .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))                                                   
|        | 10 | .41* |  |            |  | Retention Stock Option Agreement, effective as of
    June 1, 2001, between Beverly Enterprises, Inc. and David
    R. Devereaux (incorporated by reference to Exhibit 10.1 to
    Beverly Enterprises, Inc.s Quarterly Report on
    Form 10-Q for the quarter ended September 30, 2002)                                    
|        | 10 | .42* |  |            |  | Description of Non-Employee Directors Group Term
    Life Insurance Plan (incorporated by reference to
    Exhibit 10.4 to Beverly Enterprises, Inc.s Quarterly
    Report on Form 10-Q for the quarter ended June 30,
    2002)                                                                                             

94



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|        |    |      |  |             |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|------- | -- | ---- |  | ----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |      |  |            
|Number  |    |      |  | Description
|        |    |      |  |            
|        | 10 | .43* |  |            |  | Performance based Stock Option Award to Jeffrey
    P. Freimark pursuant to Process Improvement Team Awards Program
    (incorporated by reference to Exhibit 10.6 to Beverly
    Enterprises, Inc.s Quarterly Report on Form 10-Q for
    the quarter ended June 30, 2002)                                                                                                                                                                                                                                                                                                                                                                                                          
|        | 10 | .44* |  |            |  | Performance based Stock Option Award to L.
    Darlene Burch pursuant to Process Improvement Team Awards
    Program (incorporated by reference to Exhibit 10.7 to
    Beverly Enterprises, Inc.s Quarterly Report on
    Form 10-Q for the quarter ended June 30, 2002)                                                                                                                                                                                                                                                                                                                                                                                                             
|        | 10 | .45* |  |            |  | Description of Long Term Disability Policy for
    William R. Floyd (incorporated by reference to Exhibit 10.8
    to Beverly Enterprises, Inc.s Quarterly Report on
    Form 10-Q for the quarter ended June 30, 2002)                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|        | 10 | .46* |  |            |  | Employment Agreement, made as of
    December 31, 2001, between Beverly Enterprises, Inc. and
    Jeffrey P. Freimark (incorporated by reference to
    Exhibit 10.9 to Beverly Enterprises, Inc.s Quarterly
    Report on Form 10-Q for the quarter ended June 30,
    2002)                                                                                                                                                                                                                                                                                                                                                                                                        
|        | 10 | .47* |  |            |  | Demand Promissory Note, made as of April 1,
    2002, by Richard D. Skelly, Jr. for the benefit of Beverly
    Enterprises, Inc. (incorporated by reference to
    Exhibit 10.10 to Beverly Enterprises, Inc.s Quarterly
    Report on Form 10-Q for the quarter ended June 30,
    2002)                                                                                                                                                                                                                                                                                                                                                                                            
|        | 10 | .48  |  |            |  | 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 | .49  |  |            |  | 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)
|        | 10 | .50  |  |            |  | Agreement to Sale of Nursing Home Properties,
    dated as of July 13, 2001, among Beverly Enterprises
    Florida, Inc., Beverly Health and Rehabilitation Services, Inc.,
    Beverly Savana Cay Manor, Inc., Vantage Healthcare Corporation,
    Peterson Health Care, Inc. and NMC of Florida, LLC (the
    Florida Sale Agreement) (incorporated by reference
    to Exhibit 10.36 to Beverly Enterprises, Inc.s Annual
    Report on Form 10-K for the year ended December 31,
    2001)                                                                                                                                                                                     
|        | 10 | .51  |  |            |  | First Amendment to Florida Sale Agreement, dated
    as of August 30, 2001 (incorporated by reference to
    Exhibit 10.37 to Beverly Enterprises, Inc.s Annual
    Report on Form 10-K for the year ended December 31,
    2001)                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|        | 10 | .52  |  |            |  | Second Amendment to Florida Sale Agreement, dated
    as of October 29, 2001 (incorporated by reference to
    Exhibit 10.38 to Beverly Enterprises, Inc.s Annual
    Report on Form 10-K for the year ended December 31,
    2001)                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|        | 10 | .53  |  |            |  | Amendment No. 5 to Amended and Restated
    Participation Agreement, dated as of December 20, 2002
    (incorporated by reference to Exhibit 10.59 to Beverly
    Enterprises, Inc.s Annual Report on Form 10-K for the
    year ended December 31, 2002)                                                                                                                                                                                                                                                                                                                                                                                                                            

95



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|        |    |     |  |             |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|------- | -- | --- |  | ----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |     |  |            
|Number  |    |     |  | Description
|        |    |     |  |            
|        | 10 | .54 |  |            |  | Amendment No. 6 to Amended and Restated
    Participation Agreement, dated as of February 28, 2003
    (incorporated by reference to Exhibit 10.60 to Beverly
    Enterprises, Inc.s Annual Report on Form 10-K for the
    year ended December 31, 2002) [Note: Confidential treatment
    has been requested for portions of this document.]                                                                                                                                                                                       
|        | 10 | .55 |  |            |  | Master Services Agreement, dated as of
    September 18, 1997, by and between Alltel Information
    Services, Inc. and Beverly Enterprises, Inc. (incorporated by
    reference to Exhibit 10.41 to Beverly Enterprises,
    Inc.s Annual Report on Form 10-K for the year ended
    December 31, 1999)                                                                                                                                                                                                                             
|        | 10 | .56 |  |            |  | Fifth Amendment to Master Services Agreement,
    dated as of January 1, 2003, by and between Alltel
    Information Services, Inc. and Beverly Enterprises, Inc.
    (incorporated by reference to Exhibit 10.62 to Beverly
    Enterprises, Inc.s Annual Report on Form 10-K for the
    year ended December 31, 2002).                                                                                                                                                                                                            
|        | 10 | .57 |  |            |  | Amendment No. 3 to the Credit Agreement,
    dated as of December 20, 2002 (incorporated by reference to
    Exhibit 10.65 to Beverly Enterprises, Inc.s Annual
    Report on Form 10-K for the year ended December 31,
    2002).                                                                                                                                                                                                                                                                                                   
|        | 10 | .58 |  |            |  | Amendment No. 4 to the Credit Agreement,
    dated as of February 28, 2003 (incorporated by reference to
    Exhibit 10.66 to Beverly Enterprises, Inc.s Annual
    Report on Form 10-K for the year ended December 31,
    2002) [Note: Confidential treatment has been requested for
    portions of this document.]                                                                                                                                                                                                               
|        | 10 | .59 |  |            |  | Corporate Integrity Agreement between the Office
    of Inspector General of the Department of Health and Human
    Services and Beverly Enterprises, Inc. (incorporated by
    reference to Exhibit 10.43 to Beverly Enterprises,
    Inc.s Annual Report on Form 10-K for the year ended
    December 31, 1999)                                                                                                                                                                                                                    
|        | 10 | .60 |  |            |  | Plea Agreement (incorporated by reference to
    Exhibit 10.44 to Beverly Enterprises, Inc.s Annual
    Report on Form 10-K for the year ended December 31,
    1999)                                                                                                                                                                                                                                                                                                                                                                
|        | 10 | .61 |  |            |  | Addendum to Plea Agreement (incorporated by
    reference to Exhibit 10.45 to Beverly Enterprises,
    Inc.s Annual Report on Form 10-K for the year ended
    December 31, 1999)                                                                                                                                                                                                                                                                                                                                                    
|        | 10 | .62 |  |            |  | Settlement Agreement between the United States of
    America, Beverly Enterprises, Inc. and Domenic Todarello
    (incorporated by reference to Exhibit 10.46 to Beverly
    Enterprises, Inc.s Annual Report on Form 10-K for the
    year ended December 31, 1999)                                                                                                                                                                                                                                                                
|        | 10 | .63 |  |            |  | Agreement Regarding the Operations of Beverly
    Enterprises  California, Inc. (incorporated by
    reference to Exhibit 10.47 to Beverly Enterprises,
    Inc.s Annual Report on Form 10-K for the year ended
    December 31, 1999)                                                                                                                                                                                                                                                                                              
|        | 10 | .64 |  |            |  | Settlement Agreement, effective October 15,
    2002, between the Centers for Medicare and Medicaid Services,
    United States Department of Health and Human Services and
    Beverly Enterprises, Inc. (incorporated by reference to
    Exhibit 10.2 to Beverly Enterprises, Inc.s Quarterly
    Report on Form 10-Q for the quarter ended
    September 30, 2002)                                                                                                                                                               
|        | 10 | .65 |  |            |  | Permanent Injunction and Final Judgment, entered
    on August 1, 2002, in People of the State of
    California v. Beverly Enterprises, Inc.; Beverly Health and
    Rehabilitation Services, Inc.; Beverly Enterprises 
    California, Inc.; and Beverly Healthcare  California,
    Inc., Superior Court of the State of California For the County
    of Santa Barbara (incorporated by reference to
    Exhibit 10.1 to Beverly Enterprises, Inc.s Quarterly
    Report on Form 10-Q for the quarter ended June 30,
    2002)

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##### Table of Contents



|        |    |      |  |             |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|------- | -- | ---- |  | ----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |      |  |            
|Number  |    |      |  | Description
|        |    |      |  |            
|        | 10 | .66  |  |            |  | Waiver of Constitutional Rights and Plea Form and
    Court Finding and Order, dated August 1, 2002, in The
    People of California v. Beverly Enterprises 
    California, Inc., Superior Court of the State of California For
    the County of Santa Barbara (S.C. No. 1094923)
    (incorporated by reference to Exhibit 10.2 to Beverly
    Enterprises, Inc.s Quarterly Report on Form 10-Q for
    the quarter ended June 30, 2002)                                         
|        | 10 | .67  |  |            |  | Investigation Conclusion letter dated
    August 1, 2002, from the State of California Department of
    Justice (incorporated by reference to Exhibit 10.3 to
    Beverly Enterprises, Inc.s Quarterly Report on
    Form 10-Q for the quarter ended June 30, 2002)                                                                                                                                                                                                                 
|        | 10 | .68  |  |            |  | Loan Agreement, dated as of December 24,
    2002, between Beverly Enterprises  Washington, Inc.
    and Bank of America, N.A. (incorporated by reference to
    Exhibit 10.76 to Beverly Enterprises, Inc.s Annual
    Report on Form 10-K for the year ended December 31,
    2002)                                                                                                                                                                                               
|        | 10 | .69  |  |            |  | Guaranty, dated December 24, 2002, between
    Beverly Enterprises, Inc. and Bank of America, N.A.
    (incorporated by reference to Exhibit 10.77 to Beverly
    Enterprises, Inc.s Annual Report on Form 10-K for the
    year ended December 31, 2002)                                                                                                                                                                                                                            
|        | 10 | .70  |  |            |  | Credit Agreement, dated as of October 22,
    2003, (the Credit Agreement) among Beverly
    Enterprises, Inc., Lehman Brothers Inc., Lehman Commercial Paper
    Inc., Bank of Montreal and General Electric Capital Corporation
    [Note: Confidential treatment has been requested for portions of
    this document.] (incorporated by reference to Exhibit 10.1
    to Beverly Enterprises, Inc.s Quarterly Report on
    Form 10-Q for the quarter ended September 30, 2003)
|        | 10 | .71  |  |            |  | Guaranty and Collateral Agreement (incorporated
    by reference to Exhibit 10.1 to Beverly Enterprises,
    Inc.s Quarterly Report on Form 10-Q for the quarter
    ended September 30, 2003)                                                                                                                                                                                                                                                                                       
|        | 12 | .1  |  |            |  | Computation of Ratio of Earnings to Fixed Charges                                                                                                                                                                                                                                                                                                                                                                                                                                     
|        | 21 | .1 |  |            |  | Subsidiaries of Registrant                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|        | 23 | .1  |  |            |  | Consent of Ernst & Young LLP,
    Independent Registered Public Accounting Firm                                                                                                                                                                                                                                                                                                                                                                                                       
|        | 31 | .1  |  |            |  | Rule 13a-14(a)/15d-14(a) Certification of
    Chief Executive Officer                                                                                                                                                                                                                                                                                                                                                                                                                 
|        | 31 | .2  |  |            |  | Rule 13a-14(a)/15d-14(a) Certification of
    Chief Financial Officer                                                                                                                                                                                                                                                                                                                                                                                                                 
|        | 32 | .1  |  |            |  | Section 1350 Certification of Chief Executive
    Officer                                                                                                                                                                                                                                                                                                                                                                                                                             
|        | 32 | .2  |  |            |  | Section 1350 Certification of Chief Financial
    Officer                                                                                                                                                                                                                                                                                                                                                                                                                             



---



| |   |                                                                                                                                                                            
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | * | Exhibits 10.1 through 10.47 are management
    contracts, compensatory plans, contracts and arrangements in
    which any director or named executive officer participates.



| |   |                
| | - | ---------------
| |  | Filed herewith.



| |                     
| | --------------------
| |  Previously filed.

97



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##### Table of Contents






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: June 14, 2004

| |     |                     
| | --- | --------------------
| | By: | /s/ WILLIAM R. FLOYD

| |                                     
| | ------------------------------------
| |                                     
| | William R. Floyd                    
| | Chairman of the Board, President,   
| | 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:

|                                           |  |                                                                            |  |               |  | 
|------------------------------------------ |  | -------------------------------------------------------------------------- |  | ------------- |  | 
|/s/ WILLIAM R. FLOYDWilliam R. Floyd       |  | Chairman of the Board,
    President, Chief Executive Officer and Director |  | June 14, 2004
|                                          
|/s/ JEFFREY P. FREIMARKJeffrey P. Freimark |  | Executive Vice President,
    Chief Financial and
    Information Officer  |  | June 14, 2004
|                                          
|/s/ PAMELA H. DANIELSPamela H. Daniels     |  | Senior Vice President,
    Controller and Chief
    Accounting Officer     |  | June 14, 2004
|                                          
|* John D. Fowler, Jr.                      |  | Director                                                                   |  | June 14, 2004
|                                          
|* John P. Howe, III                        |  | Director                                                                   |  | June 14, 2004
|                                          
|*James W. McLane                           |  | Director                                                                   |  | June 14, 2004
|                                          
|*Ivan R. Sabel                             |  | Director                                                                   |  | June 14, 2004
|                                          
|*Donald L. Seeley                          |  | Director                                                                   |  | June 14, 2004
|                                          
|*Marilyn R. Seymann                        |  | Director                                                                   |  | June 14, 2004
|                                          
|*By:                                       |  | /s/ JOHN G. ARENAJohn G. ArenaAttorney-in-Fact                             |  |               |  | 

98