FORM 10-K
                       SECURITIES AND EXCHANGE COMMISSION
                              Washington, DC 20549

|X|   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
      ACT OF 1934 (NO FEE REQUIRED)
      For the fiscal year ended December 31, 1997
                                       OR
|_|   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
      For the transition period from ___________ to ___________

                           Commission File No. 0-28752

                          KAPSON SENIOR QUARTERS CORP.
             ------------------------------------------------------
             (Exact name of registrant as specified in its charter)

                Delaware                              11-3323503
     -------------------------------       --------------------------------
     (State or other jurisdiction of       (I.R.S. Employer Identification)
      incorporation or organization)

      125 Froehlich Farm Boulevard
            Woodbury, New York                          11797
----------------------------------------              ----------
(Address of principal executive offices)              (Zip Code)

                                 (516) 921-8900
              ----------------------------------------------------
              (Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

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

                     Common Stock, par value $.01 per share
                     --------------------------------------
                                (Title of Class)

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

                                Yes |_|    No |X|

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.|_|

Aggregate market value of voting stock held by non-affiliates of registrant as
of March 1, 1998: $51,004,062.50

Number of shares of Common Stock outstanding as of March 1, 1998: 7,750,000

Number of shares of Preferred Stock outstanding as of March 1, 1998: 2,400,000

                       DOCUMENTS INCORPORATED BY REFERENCE

                                      None.
<PAGE>

                          KAPSON SENIOR QUARTERS CORP.
                           ANNUAL REPORT ON FORM 10-K
              ----------------------------------------------------

                                TABLE OF CONTENTS

Item No.                                                                    Page
--------                                                                    ----

Part I

         1.  Business .........................................................4
         2.  Properties.......................................................15
         3.  Legal Proceedings................................................16
         4.  Submission of Matters to a Vote of
               Security Holders...............................................16

Part II

         5.  Market for Registrant's Common Equity
               and Related Stockholder Matters................................17
         6.  Selected Consolidated Financial Data.............................17
         7.  Management's Discussion and Analysis
                of Financial Condition and Results of Operations..............20
         8.  Financial Statements and Supplementary Data......................28
         9.  Changes in and Disagreements with
               Accountants on Accounting and Financial Disclosure.............28

Part III

         10. Directors and Executive Officers of the
               Registrant.....................................................28
         11. Executive Compensation...........................................32
         12. Security Ownership of Certain Beneficial
               Owners and Management..........................................39
         13. Certain Relationships and Related
               Transactions...................................................41

Part IV

         14. Exhibits, Financial Statement Schedules, and
               Reports on Form 8-K............................................46

Signatures....................................................................50
<PAGE>

Exhibit Index.................................................................51
<PAGE>

                                     PART I

ITEM 1. BUSINESS.

Recent Developments

         On March 2, 1998, Prometheus Acquisition Corp., a Delaware corporation
(the "Offeror"), a wholly owned subsidiary of Prometheus Senior Quarters, LLC, a
Delaware limited liability company ("Parent"), and an affiliate of Lazard Freres
Real Estate Investors, L.L.C., a Delaware limited liability company ("LFREI"),
commenced a tender offer, disclosed in a Tender Offer Statement on Schedule
14D-1, dated March 2, 1998 (the "Schedule 14D-1"), to purchase all of the
outstanding shares of common stock, par value $.01 per share (the "Common
Stock"), of Kapson Senior Quarters Corp. (the "Company") at a price of $14.50
per share, net to the seller in cash, without interest (the "Common Stock Offer
Price"), and all of the outstanding shares of $2.00 Convertible Exchangeable
Preferred Stock, par value $.01 per share (the "Preferred Stock" and, together
with the Common Stock, the "Shares"), of the Company at a price of $27.93 per
share, net to the seller in cash, without interest (the "Preferred Stock Offer
Price"), upon the terms and subject to the conditions set forth in the Offeror's
Offer to Purchase, dated March 2, 1998 (the "Offer to Purchase"), and the
related Letter of Transmittal (which, together with the Offer to Purchase,
constitute the "Offer"). The Offer is conditioned upon, among other things,
there being validly tendered and not withdrawn prior to the expiration date of
the Offer that number of shares of Common Stock representing at least a majority
of the outstanding shares of Common Stock on a fully diluted basis, and for the
purpose of the satisfaction of such condition, the tender of each share of
Preferred Stock will be deemed to be the tender of 1.92604 shares of Common
Stock.

         The Offer is being made pursuant to an Amended and Restated Agreement
and Plan of Merger, dated as of February 23, 1998 (the "Merger Agreement"),
among the Company, Parent and the Offeror, pursuant to which, following the
consummation of the Offer and the satisfaction or waiver of certain conditions
set forth in the Merger Agreement and in accordance with the General Corporation
Law of the State of Delaware (the "DGCL"), the Offeror will be merged with and
into the Company (the "Merger" and, together with the Offer, the "Transaction"),
the separate corporate existence of the Offeror will cease and the Company will
continue as the surviving corporation following the Merger (the "Surviving
Corporation"). At the effective time of the Merger (the "Effective Time"), each
outstanding Share (other than Shares held in the treasury of the Company, Shares
owned by any subsidiary of the Company, Shares owned by the Offeror or Parent or
Shares with respect to which appraisal rights are properly exercised under the
DGCL) will be converted into and represent the right to receive, in the case of
the Common Stock, the Common Stock Offer Price, and in the case of the Preferred
Stock, the Preferred Stock Offer Price, in each case in cash without interest.

         In connection with the execution of the Merger Agreement, Parent
entered into a Second Amended and Restated Stockholders Agreement, dated as of
February 23, 1998 (the "Stockholder Agreement"), with Glenn Kaplan, Wayne L.
Kaplan and Evan A. Kaplan (the "Kaplans"), directors and executive officers of
the Company who collectively beneficially own approximately 54% of the
outstanding Common Stock, who agreed, among other things, to tender all shares
of Common Stock beneficially owned by them in the Offer and to grant Parent an
irrevocable option, subject to the terms and conditions of the Stockholder
Agreement, to purchase these shares of Common Stock at the Common Stock Offer
Price.


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<PAGE>

         The Transaction represents the restructuring of an earlier agreement
among the parties relating to the acquisition of the Company.

General

         Kapson Senior Quarters Corp. is a leading provider of assisted living
services in the northeastern region of the United States, and has owned, managed
and/or operated assisted living facilities since 1972. Assisted living
facilities provide a residential alternative for elderly senior citizens who
need or desire assistance with their activities of daily living and certain home
health care services in a non-institutional environment. The Company's
facilities are designed to provide premium accommodations and a comprehensive,
bundled package of standard services for a single monthly fee.

         The Company, directly or through controlled subsidiaries, owns (in
whole or in part), manages and/or operates 23 assisted living facilities with an
aggregate of 2,521 units located in New York, New Jersey, Connecticut,
Pennsylvania and California. In addition, the Company currently has under
construction or pre-construction development a total of 27 assisted living
facilities with an expected aggregate of 3,208 units in its current markets as
well as in North Carolina, South Carolina and Virginia. The Company's
fully-stabilized facilities (i.e., facilities that have been in operation for at
least twelve months) have operated at an average occupancy rate of 97% for the
past five calendar years.

         The Company completed its initial public offering (the "Initial Public
Offering") of 3,550,000 shares of Common Stock in October 1996. Subsequent
thereto, the Company significantly expanded its business and entered into a
number of negotiations relating to the acquisition and development of additional
assisted living facilities. These negotiations led to: the Company's purchase of
the 50% interest in Senior Quarters at East Northport not previously owned by
the Company; long-term operating leases of Senior Quarters at Cranford and
Senior Quarters at Chestnut Hill; a joint venture to develop six assisted living
facilities over an 18-month period in North Carolina and South Carolina; the
purchase of a 51% interest in a 90-unit senior residence in Albany, New York;
assumption of the management of a 186-unit facility in Liverpool, New York; a
joint venture agreement to construct a 48-unit adjacent residence for an
Extended Care Program; and the purchase in September 1997 of a 126-unit facility
in Lynbrook, New York that the Company had previously managed. In addition, the
Company increased its facilities under development to over 30 sites.

         The Company's operating philosophy is to provide services and care
which meet the individual needs of its residents, and to enhance their physical
and mental well-being, thereby allowing them to live longer and to "age in
place." These facilities offer, on a 24-hour basis, personal, supportive and
home health care services appropriate for their residents in a home-like
setting, which allow residents to maintain their independence and quality of
life. Furthermore, many of the Company's facilities, through its Extended Care
Program, also offer additional specialized care and services to residents in the
beginning stages of Alzheimer's disease, dementia and other cognitive
impairments. At December 31, 1997, the average monthly fee for standard services
at the Company's facilities was approximately $2,700 per unit. The average age
of residents at the Company's facilities is approximately 85, and the average
length of stay is 24 months.

         The Company's primary focus is the northeastern United States, where it
intends to maintain its position as a leading assisted living provider. The
Company also will seek to develop or acquire facilities in other areas of the
United States in which it believes it will be able to create a sizable presence.
The Company believes that by concentrating or "clustering" its facilities in
target areas with desirable


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<PAGE>

demographics, it can increase the efficiency of its management resources and
achieve broad economies of scale.

         The Kaplan family has an extensive background in real estate and
assisted living. In 1932, the grandfather of the Kaplans founded a family-owned
commercial real estate enterprise and made a number of subsequent investments in
hotel and hospitality properties. This enterprise opened its first assisted
living facility in 1972 and a second assisted living facility was opened two
years later. Thereafter, the assisted living facilities were expanded, a third
facility was opened and land for future projects was purchased. In 1985, The
Kapson Group, a New York general partnership among the Kaplans and the
predecessor of the Company, acquired one of these assisted living facilities.
Since that time, The Kapson Group has focused strictly on its assisted living
business and built an executive management team with experience and expertise in
the financing, acquisition, development, management and operation of assisted
living facilities.

         Although the Company has an ownership interest in most of its
facilities, in order to comply with applicable New York law and regulations
prohibiting the operation of adult-care facilities by a publicly traded
corporation, most of the Company's licensed New York facilities are operated by
the Kaplans individually or as a partnership. The licensed operators have site
control over most of the Company's New York facilities, and have personal
liability for operating these facilities. With respect to such facilities, the
Kaplans have engaged a wholly owned subsidiary of the Company to manage the
day-to-day operations of the facilities.

         The Company was incorporated in Delaware on June 7, 1996 in order to
consolidate and expand the assisted living business of The Kapson Group, which
was effected at the time of the Initial Public Offering.

The Assisted Living Industry

         The long-term care industry encompasses a wide continuum of services
and residential arrangements for elderly senior citizens. Skilled nursing
facilities provide the highest level of care and are designed for elderly senior
citizens who need chronic nursing and medical attention and are not able to live
on their own. Further, skilled nursing facilities tend to be one of the most
expensive alternatives while providing elderly senior citizens with limited
independence and a diminished quality of life. On the other end of the continuum
is home-based care, which typically is provided in an individual's private
residence. While this alternative allows the elderly individual to "age in
place" in his or her home and, in certain instances, can provide most of the
services available at a skilled nursing facility, it does not foster any sense
of community or the ability to participate in group activities.

         Assisted living facilities generally are designed to fill the gap in
the middle of this continuum. Assisted living facilities have been described by
the Assisted Living Federation of America ("ALFA") as providing a special
combination of housing and personal, supportive and home health care services
designed to respond to the individual needs of those who need or desire help
with their activities of daily living, including personal care and household
management. According to ALFA, residents of assisted living facilities are
generally in their eighties. Services in an assisted living facility are
generally available 24 hours a day to meet the scheduled and unscheduled needs
of residents, thereby promoting maximum dignity and independence.


                                        6
<PAGE>

         The assisted living industry is highly fragmented, with only
approximately 5% of the industry's beds represented by the top 30 industry
participants based on 1995 studies. However, the Company believes that
substantial industry consolidation is underway. At present, the industry is
characterized by participants who operate only a limited number of facilities
and who frequently can offer only basic assistance with a limited number of
activities of daily living. The Company believes that it is characterized by the
following: (i) the ability to offer premium accommodations and a comprehensive
bundle of standard services for a single inclusive monthly fee; (ii)
sophisticated, professional management structures and highly trained employees;
(iii) a cost-efficient, user-specific prototype facility; (iv) experience in
providing home health care services; and (v) the proven ability to operate in a
highly regulated environment such as that in the State of New York.

The Company's Assisted Living Services

         The Company's facilities provide services and care which are designed
to meet the individual needs of its residents, enhance their physical and mental
well-being and promote a supportive, independent and home-like setting. Most of
the Company's facilities are primarily designed as premium facilities at which
residents receive a comprehensive, bundled package of standard services for a
single monthly fee.

         Tailored Care Plan. A primary element of the Company's strategy is the
concept of "tailored" care to meet each resident's specific needs. The
customizing of services to meet a resident's needs commences with the admissions
process, during which the resident, his or her family and physician and the
facility's medical director and management staff discuss the resident's needs
and develop a plan for his or her care. If recommended by the resident's
physician, additional home health care or medical services may be provided at
the facility by a home health care services agency. The care plan is reviewed
and modified on a regular basis.

         Extended Care Program. The Company is implementing its Extended Care
Program at substantially all of its new facilities and is near completion of the
construction of special wings at two of its existing facilities, which will add
a total of 90 units dedicated to participants in the program. The program is
designed to accept residents in the beginning stages of Alzheimer's disease,
dementia and other cognitive impairments and to enhance their opportunity to
"age in place." This program, which is provided at an additional cost, includes
special services such as: personal care aides specifically trained to help
seniors with declining cognitive functioning; separate activity areas; special
activities for cognitive and behavioral problems, including ones that encourage
artistic outlets for creative expression; additional assistance with bathing,
personal hygiene and dressing; a high staff-to-resident ratio; either a separate
dining room or separate dining times; and special living arrangements. The
Company intends to continue to expand its Extended Care Program to many of its
other current facilities and to offer the program at all new facilities.
Currently, the Company has implemented its Extended Care Program at the
following facilities: Senior Quarters at Centereach I, Senior Quarters at
Cranford, Chestnut Hill Residence, Senior Quarters at East Northport, Senior
Quarters at Albany Shaker, Senior Quarters at Briarcliff Manor, Senior Quarters
at Montville, Senior Quarters at Jamesburg and Senior Quarters at Glen Riddle.

         Service and Care Package. The Company's facilities typically charge a
single monthly fee which includes a large package of services and amenities. The
Company believes that this fee is larger than that of typical providers of
assisted living services and that such a fee is viable because: (i) the
Company's facilities are designed as premium facilities; (ii) the Company's
basic package includes services that typical assisted living providers charge
for on an "as-needed" basis; (iii) the overall quality of its services is high;


                                        7
<PAGE>

and (iv) the long tenure of its staff which, because of its low turnover,
becomes well known and trusted by the facility's residents and their families.
At December 31, 1997, the average monthly fee for standard services at the
Company's facilities was approximately $2,700 per unit. Among other things, the
Company believes that this fee structure distinguishes the Company from other
assisted living providers, enhances the home-like environment of its facilities
and makes it easier for the Company to predict operating expenses at any given
facility and, therefore, increases profitability at its facilities.

Operations of the Company's Facilities

         Corporate. Over the past 25 years the Company has provided centralized
management services to each of its facilities, including the development of
operating procedures, recruiting and training, financial accounting services, a
licensing facilitator and legal support systems. As part of the Company's
training procedures, new staff train at existing facilities to observe methods
of administration, cash management, personal care assistance, housekeeping,
maintenance, security, medication management, food preparation, nutrition
planning, supervision of recreational activities and other operational elements.

         Facility. The operational staff at each of the Company's assisted
living facilities generally consists of an administrator, who has overall
responsibility for the operation of the facility (subject, however, to the
control of the licensed operator, where applicable), a wellness director, a
recreation director, a case manager or social worker and an assistant
administrator. At least one personal care aide is on duty 24 hours per day to
respond to emergencies, and scheduled 24-hour assisted living services are
available to residents. Each facility has a kitchen staff, a housekeeping staff
and a maintenance staff. The Company's assisted living facilities have on
average 70 to 80 full-time or part-time employees depending on the size of the
facility and the extent of assisted living services provided in that facility.

         The Company's facilities place emphasis on diet and nutrition, as well
as preparing attractively presented healthy meals which can be enjoyed by the
residents. The Company's food service program is led by a nutritionist, who
prepares all menus and recipes for each facility. The menus and recipes are
reviewed and changed based on consultation with nutritional experts, input from
the residents and applicable law and regulations. Under certain circumstances,
the Company also provides special meals for residents who require special diets.

         Employees. The Company emphasizes maximizing each employee's potential
through support and training. The Company experiences low turnover in the staff
at both its central office and its facilities and, consequently, it is able to
promote from within. Management personnel are trained in the areas of
supervision and management skills. At the facility level, key personnel such as
administrators will generally have received approximately eight months training
at the Company's central office and one of the Company's facilities prior to the
opening of the facility. Other key personnel, such as medical directors, case
managers or recreational directors will generally have received approximately
four months training at one of the Company's facilities prior to assuming duties
at a new facility. In addition, the administrators of each facility conduct
monthly in-service training sessions relating to various practical areas of
care-giving at the facility. These monthly training sessions cover policies and
procedures of all facets of facility operations, including special areas such as
state and social service regulations, quality assurance, fire, safety disaster
procedures and resident care. In addition, hourly employees are trained in the
Company's philosophy of assisted living, motivational sessions and practical
how-to areas of dealing with residents. The Company believes that the long
tenure of its operational staff is due to the advancement opportunities that
arise out of the Company's rapid growth.


                                        8
<PAGE>

         Transition Team. In order to manage its growth more effectively, the
Company dispatches a transition team to each new facility that offers its
permanent staff back-up assistance and technical and other advice with respect
to all aspects of the operation of the new facility, such as budgets, policies,
procedures and systems, activities for the elderly, administration and provision
of specific assisted living services, food service, wellness monitoring,
maintenance and other operational areas. Depending on the size and nature of the
new facility, a transition team generally consists of two to eight persons who
are department heads of other facilities. The team is typically on site prior to
and through the new facility's opening date and remains there for a week at a
time during the new facility's first two months of operation.

         Quality Control. The Company ensures the quality of its services
through frequent, thorough reviews. The administrator of each facility conducts
a "walk-through" inspection every day and the department heads hold frequent
staff meetings to discuss issues concerning the operation of the facility. The
Vice President of Operations conducts a regular site review on an unannounced
basis. The Company also uses outside inspectors to examine the facility from the
viewpoint of the family member of a prospective resident and to report their
impressions to Company management.

Growth Strategy

         The Company's growth strategy for the next three to five years will
focus on (i) the development of new assisted living facilities; (ii) the
acquisition and conversion of existing facilities; (iii) the expansion of its
ancillary services, including home health care services and its Extended Care
Program; and (iv) maintaining its focus on cost-efficient facilities management.
The Company's primary focus is the northeastern United States where it intends
to maintain its position as a leading assisted living provider. The Company also
will seek to develop or acquire facilities in other areas of the United States
in which it believes it will be able to create a sizable presence. The Company
believes that by concentrating or "clustering" its facilities in target areas
with desirable demographics, it can increase the efficiency of its management
resources and achieve broad economies of scale.

         The Company will seek to realize future growth primarily through the
construction of new facilities and through the acquisition of other assisted
living providers and existing facilities. The Company intends to pursue the
conversion of buildings employed for other uses on a selective basis, thereby
increasing its universe of potential development activities. Additionally, the
Company will selectively enter into management contracts to manage facilities.

         The Company's experience with real estate developers and lenders has
led it to believe that the "Senior Quarters" trademark and the Company's
established reputation in the assisted living industry increase its development
and acquisition opportunities and that its participation in a project generally
lends that project credibility with the potential financing sources, local
governing bodies and communities and potential residents. Further, through its
activities as a leading developer and operator of assisted living facilities in
the northeastern United States and management's activities in numerous industry
associations, the Company has generated numerous contacts through which it is
able to identify possible development and acquisition opportunities.

         The Kaplans own and operate a New York licensed home care services
agency, which offers home care services in some of the Company's New York
facilities. It is intended that the ownership and responsibility for the
operation of the home care agency shall be transferred to the Company. The
Company intends to provide such services through the Kaplans' agency in all of
its New York facilities


                                        9
<PAGE>

until such time as the Company receives regulatory approval to own and operate
the home care agency. In addition, the Company intends to offer its Extended
Care Program to residents suffering from cognitive impairments at many of its
existing facilities and all of its new facilities. The Company believes not only
that these ancillary services will enable the Company to attract additional
residents and enable residents to stay at the Company's assisted living
facilities longer, but also that its provision of such services will increase as
its growth strategy is implemented.

         The Company's growth strategy also emphasizes continued cost-efficient
management at its assisted living facilities. This includes the use of the
Company's new facility prototype, the balancing of increases in costs with
increases in assisted living fees and the maximization of occupancy rates. In
addition, due to its size and number of facilities, the Company is able to take
advantage of volume purchases of supplies from vendors with whom it has an
established relationship, thereby reducing operating expenses. The Company
maintains an aggressive facility maintenance program which helps not only to
attract and retain residents but also to avoid costly replacements and repairs.

Development of New Facilities

         Prototype Facility. Through its quarter of a century of industry
experience, the Company has developed a prototype facility floor plan with more
efficient and flexible multi-purpose common areas and residential unit layout.
The design of this prototype has enabled the Company to reduce the square
footage required by 25% without adversely impacting the quality of its services
and facilities. The prototype facility contains 125 units with a capacity for up
to 200 residents, includes studios, one-bedroom and two-bedroom units and spans
82,000 square feet.

         Development Process. The development of a facility begins with the
zoning process, which the Company has significant experience at managing. Local
zoning board members are strongly encouraged to visit the Company's existing
facilities on both an escorted and a "drop-in" basis and to discuss with the
Company's senior management any concerns that may arise so that they may be
addressed well in advance of zoning board meetings. While the Company has
developed a prototype for its facilities, this plan is extremely flexible with
respect to the exterior facade, which can be tailored to blend into the
surrounding community. The construction of the Company's new facilities is
typically undertaken by a select group of general contractors with whom the
Company works or intends to work on a continuing basis. All contractors are
required to submit performance and payment bonds in favor of the Company.
Several bids are solicited for each project and the winning bidder is brought
into the planning process in its initial stages. The intensive involvement of
the general contractor at such an early stage has resulted in most of the
Company's existing projects being completed on time and within budget.

Development Status

         Development Status. The Company currently has a total of 27 assisted
living facilities under construction or pre-construction development. The
pre-construction period, which involves zoning, site assessment and financing,
typically takes between six and twelve months, while the actual construction of
facilities on average requires twelve months. The Company is also in the
preliminary stage of discussions to develop an additional ten facilities or
sites. In considering a prospective site for development, the Company generally
considers such factors as a potential market's demographics, the number of
existing long-term care facilities (including those owned or managed by the
Company) in the area and the income level of the target population. Preliminary
development activities include due diligence activities (including


                                       10
<PAGE>

the evaluation of environmental and geo-technical matters), the preparation of
architectural and engineering plans and the negotiation of definitive agreements
regarding the acquisition of the site and the financing of the development.
There can be no assurance that the Company will ultimately be able to or elect
to acquire and develop any of these sites.

Acquisition and Conversion of Facilities

         Acquisition Criteria. Driven by the assisted living industry's current
fragmentation and ongoing consolidation, the Company believes that there are a
large number of acquisition opportunities available. Through its extensive
experience in the assisted living industry and its development and acquisition
team, the Company continually seeks to acquire other assisted living facilities
inside and outside of its targeted markets. In evaluating potential
acquisitions, the Company reviews and considers: (i) locations; (ii) its ability
to cluster with existing facilities; (iii) the demographics of the area; (iv)
the current and projected revenues and cash flows of the facilities; and (v) the
Company's ability to increase bottom-line profitability through enhanced
services (including home health care), operational efficiencies and capital
improvements.

         Acquisition Process. Through its experience in developing and operating
assisted living facilities and management's participation in industry
associations, the Company has generated numerous contacts through which it is
able to identify possible acquisitions. The Company is regularly contacted by
other operators, industry participants and groups, as well as lenders and banks
associated and unassociated with the Company. The Company believes that it is
chosen over others due to its recognition as an experienced operator and its
ability to operate effectively in highly regulated states. Management intends to
pursue single and portfolio acquisitions of assisted living facilities where the
Company believes it can add increased value to the existing operations. Further,
the Company will seek to acquire independent living facilities where there is an
opportunity to reposition the existing operation into a Senior Quarters assisted
living facility.

         Conversions of Existing Facilities Used for Other Purposes. The Company
has extensive experience with the conversion of existing buildings into assisted
living facilities, which it believes expands its universe of potential
development opportunities. In certain instances, the conversion of an existing
facility may have compelling economic advantages compared to the development of
a new facility, including: (i) lower total development costs; (ii) less time
required for preparation of the facility; and (iii) an expedited zoning permit
process. While the Company believes that the majority of the facilities it
develops in the future will be newly constructed, the Company also believes that
its extensive experience with conversions enlarges its universe of potential
development projects and will enable it to take advantage of economically
lucrative conversion opportunities that arise.

Competition

         The long-term care industry is highly competitive and the Company
expects that the assisted living industry will become more competitive in the
future. The Company competes with numerous local, regional and national
companies providing long-term care alternatives such as home care services
agencies, life care communities, skilled nursing facilities, community-based
service programs, retirement communities and convalescent centers. The Company
expects that as assisted living receives increased attention, competition will
grow, and that new market entrants will include companies focusing primarily on
assisted living. Assisted living providers compete for residents primarily on
the basis of quality of service, price, reputation, physical appearance and
location of the living environment, services offered,


                                       11
<PAGE>

family preferences and physician referrals. Moreover, the Company expects to
face competition for the development or acquisition of assisted living
facilities during the course of its implementation of its growth strategy.
Competition may be increased by changes in the regulatory environment,
especially in New York, where assisted living is highly regulated and a majority
of the Company's facilities is located. Some of the Company's present and
potential competitors are significantly larger and have, or may obtain, greater
financial resources than those of the Company.

Government Regulation

         The Company's facilities are and will continue to be subject to certain
federal, state and local regulations and licensing requirements. In addition,
the facilities are also subject to various local building codes and ordinances.
These requirements vary from state to state and are monitored to varying degrees
by state agencies. Specific categories and names of licensed facilities also
vary from state to state. The states in which the Company currently does
business require that most types of assisted living facilities and all home
health care services agencies be licensed.

         Reimbursement. Assisted living residents or their families generally
pay the cost of their care from their own financial resources. Occasionally,
private long-term care insurance may provide funds for assisted living services.
The purchase of private long-term care insurance appears to be increasing
dramatically as more varieties of insurance have become available. Government
payments for assisted living facilities have been limited.

         New York. The State of New York has a variety of levels of senior
housing ranging from those for residents requiring limited or no services to
those aimed at residents whose health needs are substantial. Certain of the
lower levels, such as independent living facilities, are subject to little or no
regulation as residential facilities. The Company owns and/or manages four
facilities that are in whole or in part independent living facilities. However,
residential facilities in which personal care and other services are provided
are licensed and regulated by New York State's Department of Social Services.
The Company's current New York licensed facilities consist of Adult Homes and
Enriched Housing Programs. The license application process for licensed
facilities, which includes an assessment of public need, is complex and may take
one year or more.

         Current New York law and regulations prohibit a publicly traded
corporation from operating an adult care licensed facility. Natural persons,
individually or in partnership, and privately-held corporations may operate
Adult Homes and Enriched Housing Programs. The licensed operator(s) of an Adult
Home or an Enriched Housing Program may enter into management contracts which
provide that the licensed operator(s) will maintain ultimate responsibility and
liability for the licensed entity and the power to discharge persons working at
the licensed facility. Any change in the operator of any type of licensed
facility requires prior notification and approval of the state. New York's
licensed facilities are also subject to periodic inspection and license renewal
every four years.

         The Kapson Licensed Home Care Services Agency ("KLHCSA"), which is
currently owned and operated by The Kapson Group, a partnership comprised of the
Kaplans, has applied or intends to apply to the New York State Department of
Health to extend its license to additional counties so as to provide such
services to all of the New York facilities serviced by the Company. If and when
its license is extended to other counties by the Department of Health, the
KLHCSA intends to maintain on-site office space at the Company's facilities. It
is intended that the ownership and responsibility for the operation of the home
care


                                       12
<PAGE>

agency shall be transferred to the Company upon receipt of regulatory approval
for the transfer. See "Certain Relationships and Related
Transactions--Arrangements Regarding the Operation of Certain of the Company's
Facilities."

         New Jersey, Connecticut, Pennsylvania, California, North Carolina,
South Carolina and Virginia. The State of New Jersey has four levels of
supportive senior housing, all of which are licensed, regulated and subject to
inspection, primarily by the State's Department of Health. In the State of
Connecticut, assisted living services are licensed and inspected by the State
Department of Public Health and are a combination of a "managed residential
community" and an "Assisted Living Services Agency." Assisted living facilities
in the State of Pennsylvania are designated "personal care homes," which must
receive a state license and are subject to regulation and inspection by the
State's Department of Public Welfare. In California, facilities designated as
"Residential Care Facilities for the Elderly" are licensed, regulated and
subject to inspection by the State Department of Social Services ("SDSS").
Management companies are required to be co-licensees with the owner/operator of
a facility.

         In the State of South Carolina, facilities are licensed by the State
Department of Health & Environmental Control, Division of Health Licensing. They
are called "community residential care facilities," and are permitted to provide
basic room, board and personal care assistance. In the State of North Carolina,
facilities are licensed by the State Department of Human Resources, Division of
Facility Services and are subject to inspection by the Department of Social
Services. They are called either "Adult Homes" or "Homes for the Aged" and they
also are permitted to provide basic room, board and personal care assistance.
Residents who require professional nursing care under continuous medical
supervision cannot be admitted to such facilities.

         In the State of Virginia, an "Adult Care Residence" that provides
assisted living services must be licensed by the Virginia Department of Social
Services ("VDSS"). Such facilities, which offer a level of service for adults
who may have certain physical or mental impairments and require at least a
moderate level of assistance with activities of daily living, are regulated and
subject to inspection by VDSS. The Company is in an early stage of development
in North Carolina, South Carolina and Virginia and has not yet applied for
facility licensure in any of those states.

         Publicly traded corporations may own and operate assisted living
facilities in all of these states.

         Federal and State Anti-Kickback, Self-Referral and Other Fraud and
Abuse Laws and Regulations. Various federal and state laws, including federal
and state anti-kickback laws and self-referral (or "Stark") laws prohibit or
severely limit (by subjecting to criminal or catastrophic civil penalties)
financial relationships between providers of health services (or other services
reimbursed by government programs) and individuals or entities who make
referrals to such providers. Federal false claim and civil monetary penalty
(generally fraud and abuse) laws also impose potentially catastrophic civil and
administrative sanctions on providers who recklessly file false or fraudulent
claims to any government program. The federal laws relate primarily to programs
funded in whole or in part by the federal government but the state laws
generally apply to all health care programs. Fraud in regard to any health care
program is a federal crime and is also a criminal offense under various state
laws. During the period March 1996 through June 1997, the Company owned and
provided management services to two New York State Assisted Living Program
("ALP") facilities. The ALP facilities, which were Adult Homes and licensed home
health care agencies pursuant to New York law, provided services to residents
requiring a high level of care, some of whom were Medicaid beneficiaries who
received home health services reimbursable by


                                       13
<PAGE>

Medicaid. The Company reviews and will continue to monitor developments under
federal and state anti-kickback, self-referral and other health care fraud and
abuse laws. In submitting claims to the Medicaid program for the ALP (and
possible future home care activities), the Company was (and may in the future
be) subject to all of such laws, including recent federal legislation creating
new federal crimes for health care fraud and abuse and committing increased
resources for government initiatives relating to long-term care under Medicaid.
These laws impose significant civil and criminal penalties for claims that the
Company knew or should have known were overstated or otherwise inappropriate.

Employees

         As of December 31, 1997, the Company and its facilities employed
approximately 1,750 persons, including 64 in the Company's corporate
headquarters. The Company believes its employee relations are good.

Forward-looking Statements

         Certain statements contained in this Annual Report on Form 10-K (the
"Form 10-K"), including, without limitation, statements appearing under Item 1,
"Business," and Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations," are forward-looking statements (within the
meaning of Section 27A of the Securities Act of 1933 (the "Securities Act") and
Section 21E of the Securities Exchange Act of 1934 (the "Exchange Act")). The
matters referred to in the forward-looking statements could be affected by the
risks and uncertainties involved in the Company's business. These risks and
uncertainties include, but are not limited to, the effect of economic and market
conditions, the availability of financing, general real estate and construction
risks, governmental regulation, competition and other business risks common to
assisted living operations, as well as certain other risks described above in
this Form 10-K. Such risks and uncertainties could affect the Company's actual
results and could cause the Company's actual results to differ materially from
those expressed in any forward-looking statements made by, or on behalf of, the
Company in this Form 10-K.


                                       14
<PAGE>

ITEM 2.         PROPERTIES.

         The Company currently owns, manages and/or operates 23 assisted living
facilities containing 2,521 units with a capacity for 3,452 residents. The
following chart sets forth information regarding the Company's existing
facilities.

<TABLE>
<CAPTION>
                                                           Number                          Year              Year of
                                                         of Units/        Owned,        Constructed       Commencement
                                                          Resident      Leased or           or              of Kapson
Facility                                      City        Capacity       Managed         Converted         Operations
--------                                      ----       ---------      --------        -----------       ------------
<S>                                       <C>          <C>             <C>               <C>                  <C>
CONNECTICUT
    Senior Quarters at Stamford.........  Stamford         94/188          100%            1988               1988
NEW JERSEY
    Senior Quarters at Cranford.........  Cranford        173/254         Leased           1993               1993
    Senior Quarters at Montville........  Montville       103/112         23.75%           1988               1995
    Senior Quarters at Jamesburg........  Jamesburg       125/156           10%            1996               1996
NEW YORK
    Senior Quarters at Centereach I.....  Centereach      101/200          100%            1979               1979
    Senior Quarters at Huntington
        Station ........................  Huntington       99/198          100%            1987               1987
    Senior Quarters at Centereach II ...  Centereach       99/198          100%            1989               1989
    Regency at Glen Cove................  Glen Cove        95/105        Managed           1993               1993
                                          Chestnut
    Senior Quarters at Chestnut Ridge...  Ridge            98/148         50.1%            1995               1995
    Castle Gardens......................  Vestal          111/111        Managed          1990/93             1996
                                          East
    Senior Quarters at East Northport...  Northport       139/200          100%            1996               1996
                                          Forest
    Senior Quarters at Forest Hills.....  Hills           160/160        Managed           1998               1998
    Senior Quarters at Lynbrook.........  Lynbrook        126/200          100%            1996               1996
    Senior Quarters at Penfield.........  Penfield        100/120          100%            1972               1996
    Senior Quarters at Greece Ridge.....  Rochester        67/79           100%            1970               1996
    Senior Quarters at Greenpoint.......  Syracuse        186/238        Managed           1991               1997
    Senior Quarters at Crossgate........  Albany           90/96           51%             1980               1997
    Senior Quarters at Albany Shaker....  Albany          120/125       51%/Leased         1997               1997
    Senior Quarters at Briarcliff Manor.  Briarcliff      106/130         50.1%            1997               1997
PENNSYLVANIA
                                          Chestnut
    Chestnut Hill Residence.............  Hill            107/107         Leased           1989               1997
                                          Glen
    Senior Quarters at Glen Riddle......  Riddle           120/150         11%             1996               1996
CALIFORNIA
    Hallmark at Bakersfield.............  Bakersfield      51/51         Managed           1990               1997
                                          Palm
    Hallmark at Palm Springs............  Springs          46/55         Managed           1990               1997
TOTAL...................................                2,521/3,452
</TABLE>

         The Company's facilities are generally located near or in a major
population center and close to shopping malls and social and cultural activity
centers. Management believes that, among other factors, residents generally
choose a facility that is located close to their homes or the homes of their
families. Room configurations consist of studios and variously sized one-bedroom
or two-bedroom apartments. Communal areas usually include a variety of activity
rooms, a medical examination room, beauty


                                       15
<PAGE>

salon/barber shop, library, chapel, media rooms, billiard room, a crafts room
and a 24-hour per day country kitchen.

         The Company believes that its facilities are generally larger than
typical assisted living facilities in terms of units and resident capacity.
Management believes that economies of scale enhance operating margins at large
facilities and that "rent-up" risk is minimized through management's extensive
experience in marketing, developing, acquiring, managing and/or operating large
facilities and the proximity of the Company's facilities to population centers
that can sustain such facilities. At December 31, 1997, the Company's facilities
that were stabilized (i.e., in operation for at least twelve months) had a
weighted average occupancy rate of 95%, with many of them maintaining waiting
lists, and all of the Company's facilities, including those in operation for
fewer than twelve months, had a weighted average occupancy rate of 89%. The
Company's fully stabilized facilities have operated at an average 97% occupancy
rate for the past five calendar years.

         The Company leases approximately 13,000 square feet of corporate office
space in Woodbury, New York.

ITEM 3. LEGAL PROCEEDINGS.

         The Company is involved in various lawsuits and other matters arising
in the normal course of business. In the opinion of management of the Company,
although the outcomes of these claims and suits are uncertain, in the aggregate
they should not have a material adverse effect on the Company's financial
position or results of operations.

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

         There were no matters submitted to a vote of security holders during
the fourth quarter of 1997.


                                       16
<PAGE>

                                     PART II

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

         The Common Stock has traded on the Nasdaq National Market since
September 26, 1996 (the date of the Initial Public Offering) under the symbol
KPSQ. The following table sets forth, for the periods indicated, the high and
low closing bid prices for the Common Stock as reported on the Nasdaq National
Market. The quotations reflect inter-dealer prices, without retail mark-up,
mark-down or commission, and may not represent actual transactions:

                                                              High         Low
                                                              ----         ---
1997:

Fourth Quarter..............................................  15.50       13.38
Third Quarter...............................................  15.38       10.50
Second Quarter..............................................  12.13        9.63
First Quarter...............................................  11.50        7.38

1996:

Fourth Quarter..............................................  10.00        6.38
Third Quarter (from September 26, 1996).....................  10.25       10.00

         As of March 1, 1998, there were approximately 39 holders of record of
the Common Stock.

         The Company has never declared or paid any cash dividends on the Common
Stock. The Company currently anticipates that it will retain all future earnings
for the expansion and operation of its business and does not anticipate paying
cash dividends in the foreseeable future.

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA.

         The selected historical financial and pro forma data as of and for the
years ended December 31, 1997 and 1996 and for the year ended December 31, 1995
has been derived from the audited consolidated financial statements of the
Company and the combined financial statements of the Predecessor (as defined in
Note 1 to the Financial Statements), respectively, included herein and should be
read in conjunction with those financial statements and notes thereto included
herein. The selected data as of December 31, 1995 and as of and for the years
ended December 31, 1994 and 1993 have been derived from the audited combined
financial statements of the Predecessor not included herein. In the opinion of
management, the unaudited consolidated and combined financial statements reflect
all adjustments which are of a normal recurring nature and necessary for a fair
presentation of the consolidated financial position and consolidated and
combined results of operations for the unaudited periods. The selected financial
data should be read in conjunction with the historical financial statements and
notes thereto included herein, as well as in conjunction with "Business" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."


                                       17
<PAGE>

<TABLE>
<CAPTION>
                                                                     Year Ended December 31,
                                           -----------------------------------------------------------------------
                                                       The Predecessor(1)                     The Company(1)
                                           -----------------------------------------    --------------------------
                                              1993           1994           1995            1996           1997
                                           -----------    -----------    -----------    -----------    -----------
<S>                                        <C>            <C>            <C>            <C>            <C>
Statement of Operations Data:
Revenues:
    Assisted living revenues ...........   $    12,628    $    13,349    $    14,275    $    22,534    $    34,882
    Management fee .....................           248            348            443          1,080          2,340
    Other-- affiliates .................           112             57             45             --             --
                                           -----------    -----------    -----------    -----------    -----------
      Total revenues ...................        12,988         13,754         14,763         23,614         37,222
                                           -----------    -----------    -----------    -----------    -----------

Operating Expenses:
    Assisted living operating
     expenses ..........................         7,591          7,837          8,314         14,804         23,604
    Facility rent ......................            --             --             --             --          2,054
    General and administrative .........           727          1,142          1,658          3,648          5,247
    Depreciation and amortization.......         1,188          1,180          1,234          2,257          3,096
    Transactional expenses .............            --             --             --             --            678
                                           -----------    -----------    -----------    -----------    -----------
      Total operating expenses .........         9,506         10,159         11,206         20,709         34,679
                                           -----------    -----------    -----------    -----------    -----------
Operating income .......................         3,482          3,595          3,557          2,905          2,543
Interest income ........................            12              8             44            463          1,686
Interest expense .......................        (3,553)        (3,495)        (3,936)        (6,515)        (6,480)
Equity in income (loss) from joint
  ventures .............................            --             --             --             77            (70)
Other income (expense), net ............           (10)            (1)           (34)          (205)          (919)
                                           -----------    -----------    -----------    -----------    -----------
Income (loss) before minority
   interest and extraordinary item .....           (69)           107           (369)        (3,275)        (3,241)
Minority interest in net loss of
  combined partnerships ................            --             --             16            924            369
                                           -----------    -----------    -----------    -----------    -----------
Income (loss) before (provision) benefit
  for income taxes and extraordinary
  item .................................           (69)           107           (353)        (2,351)        (2,872)
(Provision) benefit for
income taxes ...........................            --             --             --         (2,039)         1,199
                                           -----------    -----------    -----------    -----------    -----------
Income (loss) before extraordinary
  item(2) ..............................           (69)           107           (353)        (4,390)        (1,672)
                                           -----------    -----------    -----------    -----------    -----------
Extraordinary item .....................            --          4,399             --             --           (822)
                                           -----------    -----------    -----------    -----------    -----------
Net (loss) income ......................   $       (69)   $     4,506    $      (353)   $    (4,390)   $    (2,495)
                                           ===========    ===========    ===========    ===========
Preferred dividend .....................                                                                     2,287
                                                                                                       -----------
Net loss available to common
  shareholders .........................                                                               $    (4,781)
                                                                                                       ===========
Loss per common share (basic and diluted):
Loss before extraordinary item .........                                                               $     (0.51)
Extraordinary loss .....................                                                               $     (0.11)
                                                                                                       -----------
Net loss per share .....................                                                               $     (0.62)
                                                                                                       ===========
Weighted average number of
  common shares outstanding (basic and
  diluted) .............................                                                                 7,750,000
                                                                                                       ===========
</TABLE>


                                       18
<PAGE>

<TABLE>
<CAPTION>
                                                          Year Ended December 31,
                                       ------------------------------------------------------------
                                               The Predecessor(1)                 The Company(1)
                                       ----------------------------------     ---------------------
                                         1993         1994         1995         1996         1997
                                       --------     --------     --------     --------     --------
<S>                                    <C>          <C>          <C>          <C>          <C>
Unaudited Pro Forma Data:
Income (loss) before taxes
   and extraordinary item ..........   $    (69)    $    107     $   (353)    $ (2,351)    $     --
Pro forma benefit (provision)
  for income taxes(3) ..............         28          (43)         141          941           --
                                       --------     --------     --------     --------     --------
Pro forma income (loss) before
  extraordinary item ...............        (41)          64         (212)      (1,410)          --
Extraordinary item - forgiveness
  of debt, net of tax ..............         --        2,639           --           --           --
                                       --------     --------     --------     --------     --------
Pro forma net income (loss) ........   $    (41)    $  2,703     $   (212)    $ (1,410)          --
                                       ========     ========     ========     ========     ========
Pro forma income (loss) per share
  before extraordinary item ........   $   (.01)    $    .01     $   (.04)    $   (.26)          --
Pro forma extraordinary item
  per share ........................         --          .56           --           --           --
                                       --------     --------     --------     --------     --------
Pro forma income (loss)
  per share ........................   $   (.01)    $    .57     $   (.04)    $   (.26)          --
                                       ========     ========     ========     ========     ========
Pro forma weighted average
  number of common shares
  outstanding ......................      4,758        4,758        4,758        5,510           --

Selected Operating Data:
Assisted living  units owned,
  managed and/or operated ..........        661          661          862        1,650        2,521
Assisted living  resident
  capacity .........................      1,143        1,143        1,403        2,419        3,452
Weighted average occupancy of
  fully stabilized assisted living
  facilities(4) ....................         98%          98%          98%          97%          95%
Weighted average occupancy of
  all assisted living facilities ...         98%          98%          98%          84%          89%
Total number of facilities at end of
  period ...........................          4            6            7           13           22
</TABLE>

<TABLE>
<CAPTION>
                                                          Year Ended December 31,
                                       ------------------------------------------------------------
                                               The Predecessor(1)                 The Company(1)
                                       ----------------------------------     ---------------------
                                         1993         1994         1995         1996         1997
                                       --------     --------     --------     --------     --------
<S>                                    <C>          <C>          <C>          <C>          <C>
Balance Sheet Data:
Working capital (deficit) ..........   $(22,603)    $(17,712)    $ (3,596)    $ 12,455     $ 16,316
Total assets .......................     31,381       34,294       54,407       95,988      170,511
Long-term debt, excluding
  current portion ..................     18,500       20,461       53,808       72,409       84,221
Shareholders' and partners'
  equity (deficit) .................    (12,325)      (8,740)      (9,811)      12,291       64,497
</TABLE>

----------
(1)   The Predecessor (as defined in Note 1 to the Financial Statements)
      represents a combination of the businesses which owned all or part of 11
      assisted living facilities, facilities under development and an entity
      that provides facility management services. The Company was formed in
      order to consolidate and expand the assisted living business of the
      Predecessor and completed the Initial Public Offering on October 1, 1996.
      The financial data for the year ended December 31, 1996 represent nine
      months of the Predecessor and three months of the Company and are
      collectively referred to as the Company.
(2)   1996 includes a one-time, non-cash charge for income taxes of $2.4 million
      resulting from a change in tax status from non-taxable to taxable for
      facilities contributed to the Company by the Predecessor in connection
      with the Initial Public Offering.
(3)   The Predecessor comprised non-taxable entities. Accordingly, pro forma
      data includes provision/benefit for income taxes for all periods presented
      at the statutory rate. Historical earnings per share has not been
      presented. See Note 2 to the Financial Statements.
(4)   Assisted living facilities are considered fully stabilized twelve months
      after opening.


                                       19
<PAGE>

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

         The following discussion of the results of operations and financial
condition of the Company should be read in conjunction with the Company's
consolidated financial statements and notes thereto included elsewhere in this
Form 10-K.

Recent Developments

         On March 2, 1998, the Offeror commenced a tender offer, disclosed in
the Schedule 14D-1, to purchase all of the outstanding shares of the Common
Stock at the Common Stock Offer Price and all of the outstanding shares of the
Preferred Stock at the Preferred Stock Offer Price, in each case net to the
seller in cash and without interest, upon the terms and subject to the
conditions set forth in the Offer to Purchase and the related Letter of
Transmittal. The Offer is conditioned upon, among other things, there being
validly tendered and not withdrawn prior to the expiration date of the Offer
that number of shares of Common Stock representing at least a majority of the
outstanding shares of Common Stock on a fully diluted basis, and for the purpose
of the satisfaction of such condition, the tender of each share of Preferred
Stock will be deemed to be the tender of 1.92604 shares of Common Stock.

         The Offer is being made pursuant to the Merger Agreement, pursuant to
which, following the consummation of the Offer and the satisfaction or waiver of
certain conditions set forth in the Merger Agreement and in accordance with the
DGCL, the Offeror will be merged with and into the Company, the separate
corporate existence of the Offeror will cease and the Company will continue as
the Surviving Corporation. At the Effective Time, each outstanding Share (other
than Shares held in the treasury of the Company, Shares owned by any subsidiary
of the Company, Shares owned by the Offeror or Parent or Shares with respect to
which appraisal rights are properly exercised under the DGCL) will be converted
into and represent the right to receive, in the case of the Common Stock, the
Common Stock Offer Price, and in the case of the Preferred Stock, the Preferred
Stock Offer Price, in each case in cash without interest.

         In connection with the execution of the Merger Agreement, Parent
entered into the Stockholder Agreement with the Kaplans, who agreed, among other
things, to tender all shares of Common Stock beneficially owned by them in the
Offer and to grant Parent an irrevocable option, subject to the terms and
conditions of the Stockholder Agreement, to purchase these shares of Common
Stock at the Common Stock Offer Price.

         The Transaction represents the restructuring of an earlier agreement
among the parties relating to the acquisition of the Company.

Overview

         Prior to the Initial Public Offering, the Company's facilities were
owned, managed and/or operated by one or more S corporations, limited
partnerships or limited liability companies of the Company's predecessor, The
Kapson Group. The Kapson Group was a general partnership of which the Kaplans
were the sole equal partners. All references to the Company in connection with
historical financial data or otherwise include The Kapson Group.


                                       20
<PAGE>

         The historical financial statements of The Kapson Group represent the
combined historical results of operations and financial condition of: (i) four
facilities that were wholly owned by The Kapson Group (Senior Quarters at
Stamford, Senior Quarters at Huntington Station, Senior Quarters at Centereach I
and Senior Quarters at Centereach II); (ii) two wholly owned facilities of The
Kapson Group that were acquired on April 1, 1996 (Senior Quarters at Greece
Ridge and Senior Quarters at Penfield); (iii) one facility that was wholly owned
by The Kapson Group but in which a 49.9% interest was sold to an unrelated third
party in April 1996 (Senior Quarters at Chestnut Ridge); (iv) an entity through
which The Kapson Group controlled a 50% interest (and in October 1996 agreed to
acquire the remaining 50% interest) in a newly-developed facility in East
Northport, New York (Senior Quarters at East Northport) which began operations
on March 15, 1996; (v) an entity through which the Company owned a 23.75%
minority interest in Senior Quarters at Montville; (vi) two entities through
which The Kapson Group owned a minority interest in facilities that were under
construction (an 11% interest in Senior Quarters at Glen Riddle and a 10%
interest in Senior Quarters at Jamesburg); (vii) a management company which
received management fees from five related and four unrelated entities, and
(viii) an entity that provided administrative support to The Kapson Group and
other affiliated entities.

         The Company is an owner, operator, manager and developer of assisted
living facilities. The Company was formed in order to consolidate and expand the
assisted living business of The Kapson Group. The Company had no operations
prior to October 1, 1996.

New York State Assisted Living Program

         In June 1993, the Company was awarded approximately 57% of the beds
allocated to Long Island under the ALP. This program is designed for residents
who are eligible for Medicaid and who require a higher acuity of care than is
typically provided in assisted living facilities. In support of the program, the
Company dedicated a newly developed facility in East Northport, New York, which
opened in March 1996, and an existing fully occupied facility in Centereach, New
York (Senior Quarters at Centereach I).

         In April 1997, due to excessive delays and higher than expected costs
associated with the ALP, the Company was unable to implement the program at
these two facilities. Accordingly, the Company has taken action to reduce the
incremental operating costs associated with the program at both facilities and,
in June 1997, received regulatory approval to return their operations back to
Adult Homes. Both facilities were originally conceived and constructed as Adult
Homes and hold licenses to operate as Adult Homes in New York. The Company has
begun to accept private pay residents to fill rooms held vacant in anticipation
of the ALP at its East Northport facility and has substantially concluded the
transition at its Centereach facility back to an Adult Home facility.

         During the first and second quarters of 1997, losses incurred at the
East Northport facility and other incremental operating expenses associated with
the program resulted in higher than historical assisted living operating
expenses as a percentage of assisted living revenues and increased the Company's
net loss.

Results of Operations

Twelve Months Ended December 31, 1997 Compared to Twelve Months Ended December
31, 1996.

         Revenues. Assisted living revenues increased by $12.3 million, or
54.8%, to $34.9 million for the twelve months ended December 31, 1997, compared
to $22.5 million for the twelve months ended


                                       21
<PAGE>

December 31, 1996. The increase is attributable to: (i) the leasing of three
facilities in October 1996 (Senior Quarters at Cranford), in July 1997 (Senior
Quarters at Chestnut Hill) and in November 1997 (Senior Quarters at Albany
Shaker), which contributed combined revenues of $5.9 million; (ii) the
acquisition of two facilities in April 1997 (Senior Quarters at Wellspring) and
in September 1997 (Senior Quarters at Lynbrook), which contributed $2.4 million;
(iii) the "rent-up" of two new facilities in September 1995 (Senior Quarters at
Chestnut Ridge) and in March 1996 (Senior Quarters at East Northport), which
contributed additional combined revenues of $2.1 million; and (iv) additional
revenues of $438,000 generated from the home care program. Excluding the impact
of these new facilities and the home care program, assisted living revenues
would have been $18.9 million and $17.3 million for the twelve months ended
December 31, 1997 and 1996, respectively.

          At December 31, 1997, the Company had 15 contracts to manage assisted
living facilities, including 13 facilities that are currently operating and two
facilities under construction or development, compared to six management
contracts at December 31, 1996. There are seven management contracts with
unaffiliated third parties and the remaining contracts are with affiliates or
joint venture partners. The Company generally receives a monthly management fee
equal to 5% of facility revenues or a minimum of $12,500 per month, whichever is
greater. Management fee revenues increased by $1.3 million, or 117%, to $2.3
million for the twelve months ended December 31, 1997, compared to $1.1 million
for the twelve months ended December 31, 1996. The management fee revenues from
unaffiliated third parties for the twelve months ended December 31, 1997 were
$747,000, compared to $605,000 for the twelve months ended December 31, 1996.
There were nine new management contracts during the twelve months ended December
31, 1997, compared to two new management contracts in the same period of the
prior year.

         Operating Expenses. Assisted living operating expenses increased by
$8.8 million, or 59%, to $23.6 million for the twelve months ended December 31,
1997, compared to $14.8 million for the twelve months ended December 31, 1996.
As a percentage of assisted living revenues, assisted living operating expenses
were 67.7% and 65.7% for the twelve months ended December 31, 1997 and 1996,
respectively. The increase in assisted living operating expenses as a percentage
of assisted living revenues is primarily attributable to the opening of Senior
Quarters at East Northport and higher than expected costs associated with the
ALP for the first two quarters of 1997.

         Facility Rent Expense. Rent expense was $2.1 million for the twelve
months ended December 31, 1997 as a result of the leasing of three new
facilities (Senior Quarters at Cranford, Senior Quarters at Chestnut Hill and
Senior Quarters at Albany Shaker).

         General and Administrative Expense. General and administrative expense
increased by $1.6 million, or 43.8%, to $5.2 million for the twelve months ended
December 31, 1997, compared to $3.6 million for the twelve months ended December
31, 1996. As a percentage of total revenues, general and administrative expense
was 14.1% and 15.5% for the twelve months ended December 31, 1997 and 1996,
respectively. The increase is primarily the result of higher payroll and
employee benefit costs in connection with a strategic decision by the Company to
invest in its management and facility development capabilities in order to
support future growth through development, acquisition and management of
additional facilities.


                                       22
<PAGE>

         Transactional Expenses. Transactional expenses were $678,000 for the
twelve months ended December 31, 1997. These expenses were primarily
professional fees incurred in connection with the Merger Agreement.

         Interest Income. Interest income increased by $1.2 million to $1.7
million for the twelve months ended December 31, 1997 compared to $463,000 for
the twelve months ended December 31, 1996. The increase is attributable to
interest earned on the investment of the proceeds from the Initial Public
Offering and the proceeds from the Preferred Stock offering.

         Interest Expense. Interest expense remained constant at $6.5 million
for the twelve months ended December 31, 1997 compared to the twelve months
ended December 31, 1996. This is primarily attributable to the opening of three
new facilities during 1996, resulting in twelve months of interest expense in
1997, and the opening of two facilities during 1997, offset by the payoff of two
mortgages formerly held by General Electric Capital Corp. ("GECC").

         Extraordinary Loss. Extraordinary loss for the twelve months ended
December 31, 1997, was $1.4 million before income taxes ($822,000 net of income
tax benefit), resulting from the payment of one time equity participation fees
to GECC in connection with the prepayment of mortgage indebtedness formerly held
by GECC.

         Net Loss. Net loss was $2.5 million for the twelve months ended
December 31, 1997, compared to the pro forma net loss of $1.4 million for the
twelve months ended December 31, 1996. The increase in net loss is primarily the
result of the equity participation fee paid to GECC of $1.4 million, operating
losses at the East Northport ALP facility, incremental costs incurred during the
first two quarters of 1997 for the implementation of the ALP and, to a lesser
extent, higher payroll and benefit costs in connection with the Company's
expansion plans. Excluding the equity participation, Senior Quarters at East
Northport and the incremental costs associated with the ALP during the first two
quarters of 1997, net loss would have been $681,000 and $765,000, on a pro forma
basis, for the twelve months ended December 31, 1997 and 1996, respectively.

Twelve Months Ended December 31, 1996 Compared to Twelve Months Ended December
31, 1995

         Revenues. Assisted living revenues increased to $22.5 million for the
twelve months ended December 31, 1996, compared to $14.3 million for the twelve
months ended December 31, 1995, an increase of 57.9%. The increase is
attributable to: (i) the opening of Senior Quarters at Chestnut Ridge on
September 1, 1995 and Senior Quarters at East Northport on March 15, 1996, which
contributed combined revenue of $4.4 million in 1996; (ii) the acquisition of
Senior Quarters at Greece Ridge and Senior Quarters at Penfield on April 1,
1996, which contributed combined revenue of $2.9 million; and (iii) the leasing
of Senior Quarters at Cranford, which contributed $835,000 in 1996. Excluding
Senior Quarters at Chestnut Ridge, Senior Quarters at East Northport, Senior
Quarters at Greece Ridge, Senior Quarters at Penfield and Senior Quarters at
Cranford, assisted living revenues would have been approximately equivalent for
the twelve months ended December 31, 1996 and 1995. Management fee revenue
increased to $1.1 million for the twelve months ended December 31, 1996,
compared to $443,000 for the twelve months ended December 31, 1995, an increase
of 143.9%. The increase is primarily attributable to revenues from management
contracts at Senior Quarters at Montville, Senior Quarters at Jamesburg, Castle
Gardens, Senior Quarters at Lynbrook and Senior Quarters at Glen Riddle, for
which the Company


                                       23
<PAGE>

assumed management responsibility on August 8, 1995, February 1, 1996, January
1, 1996, June 1, 1996 and June 19, 1996, respectively.

         Operating Expenses. Assisted living operating expenses increased to
$14.8 million for the twelve months ended December 31, 1996, compared to $8.3
million for the twelve months ended December 31, 1995, an increase of 78.1%. As
a percentage of assisted living revenues, assisted living operating expenses
were 65.7% and 58.2% for the twelve months ended December 31, 1996 and 1995,
respectively. The increase in assisted living operating expenses as a percentage
of assisted living revenues is primarily attributable to the opening of Senior
Quarters at Chestnut Ridge and Senior Quarters at East Northport on September 1,
1995 and March 15, 1996, respectively. As is consistent with the Company's
experience during the initial "rent-up" of a new facility, assisted living
operating expenses as a percentage of assisted living revenues are higher than
they are for a facility which is operating at or near full occupancy. Excluding
Senior Quarters at Chestnut Ridge and Senior Quarters at East Northport,
assisted living operating expenses as a percentage of assisted living revenues
would have been 60.5% and 57.1% for the twelve months ended December 31, 1996
and 1995, respectively. This increase is attributable to: (i) inclement winter
weather during the first quarter of 1996, which adversely affected revenues and
increased operating expenses; and (ii) increased payroll and employee benefits
related to start-up costs for one of the Company's ALP facilities and the
introduction of the Company's Extended Care Program at another facility. General
and administrative expense was $3.6 million for the twelve months ended December
31, 1996, compared to $1.7 million for the twelve months ended December 31,
1995, an increase of 120%. As a percentage of total revenues, general and
administrative expense was 15.5% and 11.2% for the twelve months ended December
31, 1996 and 1995, respectively. The increase is primarily the result of: (i)
higher payroll and employee benefit costs in connection with a strategic
decision by the Company to invest in its management and facility development
capabilities in order to support future growth through the development,
acquisition and management of additional facilities; and (ii) costs related to
the opening of Senior Quarters at Chestnut Ridge, Senior Quarters at East
Northport, Senior Quarters at Lynbrook, Senior Quarters at Jamesburg and Senior
Quarters at Glen Riddle.

         Interest Expense. Interest expense was $6.5 million for the twelve
months ended December 31, 1996, compared to $3.9 million for the twelve months
ended December 31, 1995, an increase of 65.5%. The increase is attributable to:
(i) new borrowings incurred in connection with the opening of Senior Quarters at
Chestnut Ridge and Senior Quarters at East Northport on September 1, 1995 and
March 15, 1996, respectively; and (ii) the acquisition of Senior Quarters at
Greece Ridge and Senior Quarters at Penfield on April 1, 1996. The increase was
partially offset by a decrease in interest expense due to the refinancing of an
existing mortgage at a lower interest rate for Senior Quarters at Centereach.

         Net Income (Loss). Net loss, including a one-time, non-cash charge for
income taxes of $2.4 million, was ($4.4 million) for the twelve months ended
December 31, 1996, compared to ($353,000) for the twelve months ended December
31, 1995. The increase in net loss is primarily the result of the opening of
Senior Quarters at Chestnut Ridge and Senior Quarters at East Northport and, to
a lesser extent, higher payroll and benefit costs in connection with the
Company's expansion plans. Excluding the one-time, non-cash charge for income
taxes of $2.4 million, and the operations of Senior Quarters at Chestnut Ridge
and Senior Quarters at East Northport, net income (loss) would have been
($330,000) and $439,000 for the twelve months ended December 31, 1996 and 1995,
respectively. The one-time, non-cash charge for income taxes of $2.4 million
resulted from a change in tax status from non-taxable to taxable for facilities
contributed to the Company by The Kapson Group concurrent with the Initial
Public Offering.


                                       24
<PAGE>

Liquidity and Capital Resources

         Net cash used in operating activities was $1.0 million for the twelve
months ended December 31, 1997, compared to $1.7 million for the twelve months
ended December 31, 1996. The decrease is primarily attributable to an increase
in deferred financing fees and accounts receivable, offset in part by a decrease
in net loss for the twelve months ended December 31, 1997 over the prior year
and by increases in accounts payable and accrued expenses.

         Net cash used in investing activities was $64.3 million for the twelve
months ended December 31, 1997, compared to $28.1 million for the twelve months
ended December 31, 1996. Substantially all of the cash used in investing
activities for the twelve months ended December 31, 1997 was for the acquisition
and development of new facilities and purchases and development of property and
equipment. Net cash used in investing activities was funded primarily through
long-term debt and the net proceeds from the Company's Preferred Stock offering.

         Net cash provided by financing activities was $71.1 million for the
twelve months ended December 31, 1997, compared to $42.5 million for the twelve
months ended December 31, 1996. Net cash provided by financing activities
primarily consists of the net proceeds from the Company's Preferred Stock
offering and the proceeds of long-term debt, offset by principal repayments of
long-term debt.

         In July 1997, the Company sold 2,000,000 shares of Preferred Stock at a
price of $25.00 per share and realized net proceeds of approximately $47.4
million. In August 1997, the Company sold an additional 400,000 shares of
Preferred Stock and realized net proceeds of $9.6 million. The Company intends
to use such proceeds towards continued development and acquisitions of assisted
living facilities. In addition, the Company has used a portion of the proceeds
to repay $15.2 million of mortgage indebtedness, with a weighted average
interest rate of 10.25% maturing on February 28, 1999, and $1.6 million in
equity participation amounts on the repaid indebtedness. The Company has
recorded for the twelve months ended December 31, 1997 an extraordinary loss on
the early retirement of this debt of approximately $1.4 million before income
taxes ($822,000 net of income tax benefit).

         In June 1997, the Company entered into a $50.0 million Non-Revolving
Credit Facility with GMAC Commercial Mortgage Corporation (the "GMAC Facility")
to provide construction and acquisition financing collateralized by assisted
living or independent living facilities. Amounts borrowed will vary depending on
the value of the facility and will bear interest rates based on the 30-day LIBOR
rate plus 2.45% to 3%. The GMAC Facility has a two-year term with acquisition
and construction loans payable in full after three and five years, respectively.
The amount available under the facility, which at December 31, 1997 is $39.2
million, has been reduced by the gross lease payments guaranteed by the Company
at one facility.

         In November 1997, the Company amended and increased its existing
acquisition, leasing and development credit facility (the "HCR Facility") with
Health Care REIT, Inc. ("Health Care REIT") providing for temporary construction
and permanent financing. Under the amended HCR Facility, the line of credit
amount was increased from $100 million to $140 million and the initial interest
rate for financings was reduced to a corresponding term U.S. Treasury Note plus
3.25% per annum with annual increases of 15 basis points. In addition, the
interest rate for existing financings with Health Care REIT will be reduced by
50 basis points on a dollar for dollar basis for all new financing under the HCR
Facility. Under the HCR Facility, temporary construction financing bears
interest at 3.5% above the base rate announced by the National Bank of
Cleveland.


                                       25
<PAGE>

         Prior to the amendment, permanent financing interest was at the rate of
a comparable period U.S. Treasury Note plus either 4% per annum for mortgage
indebtedness or 3.75% per annum for permanent operating leases with rate
increases of 25 basis points per annum. There was no change in the interest rate
for temporary construction financing. The Company currently has drawn and
committed $59.9 million, with an additional $80.1 million remaining for future
financing under the HCR Facility.

         In February 1997, the Company was granted a line of credit with Fleet
Bank for the issuance of standby letters of credit in an aggregate amount of up
to $6,359,500. At December 31, 1997, approximately $2,189,250 was available
under the line of credit.

         The Company leases four facilities under operating leases for periods
ranging from 10 to 45 years with aggregate annual lease payments of
approximately $3.7 million.

         At December 31, 1997, the Company had 27 facilities under construction
or in various stages of development with an estimated number of units and beds
of approximately 3,208 and 3,785, respectively. Of these facilities, two will be
managed properties with an unaffiliated third party and three facilities will be
operated under long-term leases. The remaining facilities will be constructed
and owned by the Company with ownership percentages ranging from 50% to 100%.
The average all-in cost of a new facility is estimated to be $13.5 million, and
the aggregate all-in cost of these facilities is estimated to approximate $350
million. In addition, the Company also has an additional ten facilities in
preliminary stages of development with an all-in cost estimated to approximate
$140 million.

         The Company intends to finance its growth strategy through a variety of
sources, including the remaining proceeds from the Preferred Stock offering,
bank and other financing, long-term operating leases with Health Care REIT,
future debt or equity offerings, joint ventures and other sources. To a limited
extent, the Company may also use other forms of financing such as taxable or
tax-exempt long-term debt, including publicly issued debt. The Company is
currently negotiating with lending institutions for expanded or new credit
facilities to fund acquisition and development activities.

Impact of Inflation and Changing Prices

         Assisted living revenue and management fees from assisted living
facilities are the primary sources of revenue earned by the Company. These
properties are affected by rental rates, which are highly dependent upon market
conditions and the competitive environments where the facilities are located.
Employee compensation is the principal cost element of property operations.
Although there can be no assurance it will continue to do so, the Company has
been able historically to offset the effects of inflation on salaries and other
operating expenses by increasing rental rates.

         The Company believes that after giving effect to the Transaction and
the incurrence of indebtedness related thereto, based on current levels of
operations and anticipated growth, its cash from operations, together with other
available sources of liquidity, will be sufficient over the next several years
to fund anticipated capital expenditures and make required payments of principal
and interest on its debt. In addition, the Company continually evaluates
potential developments and acquisitions and expects to fund such acquisitions
from its available sources of liquidity, including borrowings under the GMAC
Facility and HCR Facility.


                                       26
<PAGE>

Impact of Recently Issued Accounting Pronouncements

         In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS No. 128").
SFAS No. 128 replaced the previously reported primary and fully diluted earnings
per share with basic and diluted earnings per share. Unlike primary earnings per
share, basic earnings per share excludes any dilutive effects of options,
warrants and convertible securities. Diluted earnings per share is very similar
to the previously reported fully diluted earnings per share. All per share
amounts for all periods presented have been restated to conform to the SFAS No.
128 requirements.

         In 1997, the Company adopted Financial Accounting Standards Board
Statement of Financial Accounting Standards No. 129, "Disclosure of Information
about Capital Structure" ("SFAS No. 129"), which requires that descriptive
information about securities be shown in the financial statements. The adoption
of this statement did not have any impact on the Company's disclosure in the
financial statements for the year ended December 31, 1997.

         In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 130, "Reporting Comprehensive Income"
("SFAS No. 130"), which requires that changes in comprehensive income be shown
in a financial statement that is displayed with the same prominence as other
financial statements. SFAS No. 130 becomes effective in fiscal year 1998.
Management believes that the adoption of this statement will not have any impact
on the Company's financial statements.

         In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 131, "Disclosures About Segments of an
Enterprise and Related Information" ("SFAS No. 131"), which changes the way
public companies report information about segments. SFAS No. 131, which is based
on the management approach to segment reporting, includes requirements to report
selected segment information quarterly and entity-wide disclosures about
products and services, major customers and the material countries in which the
entity holds and reports revenues. SFAS No. 131 becomes effective in fiscal year
1998. Management believes that the adoption of this statement will not have any
impact on the Company's financial statements.

Year 2000

         The Company utilizes a significant number of computer software programs
and operating systems across its entire organization, including applications
used in financial, business systems and various administrative functions. To the
extent that the Company's software applications contain source code that is
unable to appropriately interpret the upcoming calendar year "2000" and beyond,
some level of modification, or replacement of such applications, will be
necessary. The Company is in the process of identification of applications that
are not "Year 2000" compliant and expects to commence modification or
replacement of such applications, as necessary. Given information known at this
time about the Company's systems, coupled with the Company's ongoing, normal
course-of-business efforts to upgrade or replace critical systems, as necessary,
management does not expect Year 2000 compliance costs to have any material
adverse impact on the Company's liquidity or ongoing results of operations. No
assurance can be given, however, that all of the Company's systems will be Year
2000 compliant or that compliance costs or the impact of the Company's failure
to achieve substantial Year 2000 compliance will not have a material adverse
effect on the Company's future liquidity or results of operations.


                                       27
<PAGE>

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

         See Item 14 of Part IV of this Report.

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

         None.

                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

         The following table sets forth information regarding the executive
officers and directors of the Company as of March 1, 1998. Glenn Kaplan, Wayne
L. Kaplan and Evan A. Kaplan are brothers. There are no other family
relationships among any directors or officers of the Company. Each of the
directors of the Company has been a director since 1996. Officers are appointed
by and serve at the discretion of the Board of Directors. The Merger Agreement
provides that Glenn Kaplan and Evan A. Kaplan will continue as directors of the
Company subsequent to the consummation of the Offer. It is expected that,
pursuant to the Merger Agreement, Parent will request the Company to secure the
resignations of the other directors.

     Name            Age                         Position
     ----            ---                         --------
Glenn Kaplan         45  Chairman of the Board of Directors and Chief Executive
                         Officer

Wayne L. Kaplan      42  Vice Chairman of the Board of Directors, Senior
                         Executive Vice President, Secretary and General Counsel

Evan A. Kaplan       38  President, Chief Operating Officer and Director

Raymond DioGuardi    42  Chief Financial Officer

Joseph G. Beck       43  Director

Bernard J. Korman    66  Director

Risa Lavizzo-Mourey, 42  Director
M.D.

Gerald Schuster      67  Director

         Glenn Kaplan is the Chairman of the Board of Directors and Chief
Executive Officer of the Company. Prior to June 1996, he was a partner and
co-founder of The Kapson Group. Glenn received a B.S. degree in Accounting from
the University of Bridgeport.

         Wayne L. Kaplan is the Vice Chairman of the Board of Directors, Senior
Executive Vice President, Secretary and General Counsel of the Company. Prior to
June 1996, he was a partner and co-founder of The Kapson Group. Wayne is a
member of the New York State Bar and was appointed to the New York


                                       28
<PAGE>

State Life Care Community Council. Additionally, he serves on the board of
directors of the Assisted Living Federation of America, the Connecticut Assisted
Living Association, the Empire State Association of Adult Homes and the New
Jersey Assisted Living Association. Wayne received a B.S. degree in Business
from the University of Rhode Island and a J.D. degree from the George Washington
University School of Law.

         Evan A. Kaplan is the President, Chief Operating Officer and a director
of the Company. Prior to June 1996, he was a partner and co-founder of The
Kapson Group. Evan received a B.A. degree in Psychology from Syracuse
University.

         Raymond DioGuardi has been the Chief Financial Officer of the Company
since January 1997. From November 1994 to January 1997, Mr. DioGuardi was Senior
Vice President of Finance and Chief Financial Officer of Dataflex Corporation, a
public company that sells computer hardware and related services. From December
1989 to October 1994, Mr. DioGuardi was Vice President of Finance, Chief
Financial Officer and Secretary of Nathan's Famous, Inc. From 1977 to 1989, Mr.
DioGuardi was employed by the accounting firm of Price Waterhouse, where he
became a senior manager with responsibility for planning, coordinating and
executing financial audits and special projects for major corporate clients. Mr.
DioGuardi is a certified public accountant and received a B.A. degree in
Business from Rutgers University.

         Joseph G. Beck, director, is a founding principal and executive
committee member of Shattuck Hammond Partners Inc. ("Shattuck Hammond"), a
specialty health care investment banking firm based in New York. He directs
Shattuck Hammond's activities in the area of long-term care and related
companies. Prior to Shattuck Hammond, he was a Vice President (1987-1990) and
Principal (1990-1993) at Cain Brothers, Shattuck & Company, a predecessor to
Shattuck Hammond. From 1985 to 1987, he was a Vice President at Chemical Bank
where he eventually directed the investment banking work with hospitals and
other health care companies. Prior thereto, he was a senior credit analyst at
Moody's Investors Services, Inc., a financial services company. From 1978 to
1982, he held several positions in health care regulation and policy analysis
for various departments of the New York State Government and for the New York
State Senate. Mr. Beck is a member of the Board of Trustees of The Lighthouse, a
not-for-profit vision rehabilitation, research and training agency. He received
a B.A. degree from LeMoyne College and a Masters degree in Health Policy and
Management from the Harvard University School of Public Health.

         Bernard J. Korman, director, has been Chairman of the Board of
Directors of The Graduate Health System, a Philadelphia-based, not-for-profit
health system with hospitals in Pennsylvania and New Jersey, since November
1996. From November 1995 to October 1996, Mr. Korman was Chief Executive Officer
and a director of PCI Services, Inc., a publicly traded packaging company. Since
1986, Mr. Korman has been Chairman of the Board of Directors of NutraMax
Products, Inc., a publicly traded consumer health care products company. From
October 1980 to October 1995, Mr. Korman was President, Chief Executive Officer
and a director of MEDIQ Incorporated, a publicly traded health care services
company. Mr. Korman is currently a director of The New America High Income Fund,
Pep Boys - Manny, Moe & Jack, Today's Man, Inc., Omega Healthcare Investors,
Inc., InnoServ Technologies, Inc. and Kranzco Realty Trust. Mr. Korman received
a B.S. degree from the University of Pennsylvania and an L.L.B. degree from the
University of Pennsylvania School of Law.

         Dr. Risa Lavizzo-Mourey, director, has been Director of the Institute
of Aging, Chief of the Division of Geriatric Medicine and Associate Executive
Vice President for Health Policy at the University


                                       29
<PAGE>

of Pennsylvania, Ralston-Penn Center, since 1994. From 1992 to 1994, Dr.
Lavizzo-Mourey served with the Agency for Health Care Policy and Research, U.S.
Public Health Service of the Department of Health and Human Services. Dr.
Lavizzo-Mourey has been on the faculty of the University of Pennsylvania School
of Medicine since 1986, and is currently the Sylvan Eisman Associate Professor
of Medicine. Dr. Lavizzo-Mourey is a director of Beverly Enterprises, Inc.,
Medicus Systems Corp., Managed Care Solutions, Inc. and Nellco Puritan Bennett
Inc. Dr. Lavizzo-Mourey received an M.D. degree from the Harvard Medical School
and an M.B.A. degree in Health Care Administration from The Wharton School of
Business, University of Pennsylvania.

         Gerald Schuster, director, has been President and Chief Executive
Officer of Continental Wingate Company, Inc., a real estate, health care and
financial services company which is engaged in commercial mortgage lending and
servicing, development and syndication of multi-family housing, and has
developed and operated eight long-term care and rehabilitation facilities with
1,100 beds in New York and Massachusetts, since 1971. Mr. Schuster serves as
Chairman of the Advisory Committee for the Massachusetts Housing Finance Agency,
a state authority for the issuance of multi-family housing debt.
Mr. Schuster received a B.B.A. degree from Clark University.

Directors Upon Consummation of the Offer

         Pursuant to the Merger Agreement, promptly upon the purchase of shares
of Common Stock pursuant to the Offer, Parent will be entitled to designate such
number of directors, rounded up to the next whole number, on the Board of
Directors of the Company as will give Parent, subject to compliance with Section
14(f) of the Exchange Act, representation on the Board of Directors equal to the
product of (a) the total number of directors on the Board of Directors and (b)
the percentage that the number of shares of Common Stock purchased by Parent
bears to the number of shares of Common Stock outstanding, and the Company will,
upon request by Parent, promptly increase the size of the Board of Directors
and/or exercise its reasonable best efforts to secure the resignations of such
number of directors as is necessary to enable the persons (the "Parent
Designees") designated by Parent to be elected to the Board of Directors and
will cause the Parent Designees to be so elected.

         It is expected that the Parent Designees may assume office at any time
following the purchase by Parent of a majority of the outstanding Shares on a
fully diluted basis pursuant to the Offer, and that, upon assuming office, the
Parent Designees together with the continuing directors of the Company will
thereafter constitute the entire Board of Directors of the Company.

         Parent has informed the Company that the Parent Designees will be the
persons set forth below:

         Robert P. Freeman, 52, has been a General Member of Lazard Freres & Co.
LLC since January 1998 and a Principal of LFREI since January 1993. Mr. Freeman
received a J.D. degree from Harvard Law School and a B.A. degree from Stanford
University. He is currently a director of American Apartment Communities,
Atlantic American Properties Trust, Commonwealth Atlantic Properties, ARV
Assisted Living Inc. ("ARV") and The Rubenstein Company, L.P. ("TRC").

         Murry N. Gunty, 30, is a Principal of LFREI, which he joined in 1995.
From 1995 to 1996, Mr. Gunty was a Vice President of LFREI. From 1993 to 1995,
he was associated with J.E. Robert Company, a real estate investment company. He
is currently a director of Atlantic American Properties Trust, ARV


                                       30
<PAGE>

and TRC. Mr. Gunty received an M.B.A. degree from Harvard Business School and an
A.B. from Harvard College.

         Howard H. Stevenson, 56, has been the Sarofim-Rock Professor of
Business Administration at Harvard University, Graduate School of Business
Administration since 1994. He was Senior Associate Dean, Director of Financial
and Information Systems from 1991 to 1994. Dr. Stevenson was a founder of the
Baupost Group, Inc., a large money management organization, and serves as vice
chairman and chairman of its mutual fund. He is also chairman and a founder of
Quadra Capital Partners, a financial services firm. He is currently a director
of Bessemer Securities Corporation, Camp Dresser & McKee Inc., Landmark
Communications, Gulf States Steel and the Baupost Group, Inc. He received a B.S.
degree in mathematics from Stanford University and M.B.A. and D.B.A. degrees
from Harvard University.

         Parent has informed the Company that each of the persons listed above
has consented to act as a director of the Company. None of the Parent Designees
currently is a director of, or holds any position with, the Company. To the best
knowledge of the Company, none of the Parent Designees beneficially owns any
equity securities, or rights to acquire any equity securities, of the Company or
has been involved in any transactions with the Company or any of its directors
or executive officers that are required to be disclosed pursuant to the rules
and regulations of the Securities and Exchange Commission (the "Commission").

Committees of the Board of Directors

          Audit Committee. The Audit Committee, which consists of a majority of
independent directors who are not affiliated with the Kaplans ("Independent
Directors"), makes recommendations concerning the engagement of independent
public accountants, reviews with the independent public accountants the plans
and results of the audit engagement, approves professional services provided by
the independent public accountants, reviews the independence of the independent
public accountants, considers the range of audit and non-audit fees and reviews
the adequacy of the Company's internal accounting controls. Evan A. Kaplan,
Bernard J. Korman and Risa Lavizzo-Mourey are the members of the Audit
Committee. The Audit Committee held one meeting in 1997.

         Compensation Committee. The Compensation Committee, which consists of a
majority of Independent Directors, approves the salaries and other benefits of
the executive officers of the Company and administers any non-stock based bonus
or incentive compensation plans of the Company (excluding any cash awards
intended to qualify for the exception for performance-based compensation under
Section 162(m) of the Internal Revenue Code of 1986, as amended (the "Code")).
In addition, the Compensation Committee consults with the Company's management
regarding pension and other benefit plans and compensation policies and
practices of the Company. Glenn Kaplan, Joseph G. Beck and Gerald Schuster are
the members of the Compensation Committee. The Compensation Committee held one
meeting in 1997.

         Stock Option Committee. The Stock Option Committee, consisting solely
of directors who, to the extent legally required, qualify as "outside directors"
under Section 162(m) of the Code and as "non-employee directors" under Rule
16b-3(c) of the Exchange Act, administers any stock-based incentive plans of the
Company, including the Company's 1996 Stock Incentive Plan (the "Incentive
Plan"). In addition, the Stock Option Committee is responsible for granting any
cash awards intended to qualify for the exception for performance-based
compensation under Section 162(m) of the Code. Bernard J. Korman,


                                       31
<PAGE>

Risa Lavizzo-Mourey and Gerald Schuster are the members of the Stock Option
Committee. The Stock Option Committee did not hold any meetings in 1997.

         Nominating Committee. The Company does not have a nominating committee
of the Board of Directors.

Meetings of Directors

         The Board of Directors held four meetings and acted by unanimous
written consent several times in 1997. Each of the directors of the Company
attended more than 75% of the aggregate of (i) the total number of meetings of
the Board of Directors and (ii) the total number of meetings held by all
committees of the Board of Directors on which such director served.

Compliance with Section 16(a) of the Securities Exchange Act of 1934 Beneficial
Ownership Reporting Compliance

         Based solely on a review of the reports and representations furnished
to the Company during the last fiscal year, the Company believes that each of
the persons required to file reports under Section 16(a) of the Exchange Act was
in compliance with all applicable filing requirements with respect to the
Company's most recent fiscal year, except that each of Raymond DioGuardi and
Gerald Schuster failed to file on a timely basis one report required by Section
16(a) of the Exchange Act.

ITEM 11. EXECUTIVE COMPENSATION.

         The following table sets forth historical executive compensation
information of the Company's Chief Executive Officer and the other three highly
compensated executive officers whose total cash compensation exceeded $100,000
during the fiscal year ended December 31, 1997.


                                       32
<PAGE>

                           SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
                                                     Annual                                            Long Term
                                                  Compensation                                        Compensation
                                    -----------------------------------------        ---------------------------------------------
                                                                        Other
                                                                        Annual                       Securities
            Name and                                                 Compensation  Restricted Stock  Underlying       All Other
       Principal Position           Year     Salary ($)   Bonus ($)       ($)        Award(s) ($)    Options #    Compensation ($)
       ------------------           ----     ----------   ---------       ---        ------------    -----------  ----------------
<S>                                 <C>     <C>          <C>           <C>                <C>            <C>        <C>
Glenn Kaplan (1)                    1997      234,144         0          294,579           0              0               0
Chairman of the Board and Chief
Executive Officer                   1996     90,645(2)    26,500(3)     83,924(4)          0              0           31,825(5)

                                    1995       67,177         0         10,789(4)          0              0          39,500 (5)
Wayne L. Kaplan (1)                 1997      234,144         0          279,716           0              0               0
Vice Chairman of the Board,
Senior Executive Vice President,    1996     90,645(2)    26,500(3)     75,114(4)          0              0           31,825(5)
Secretary and General Counsel
                                    1995       67,177         0         2,113(4)           0              0          39,500 (5)
Evan A. Kaplan (1)                  1997      234,144         0          279,640           0              0               0
President and Chief Operating
Officer                             1996     90,645(2)    26,500(3)     75,114(4)          0              0           31,825(5)

Raymond DioGuardi (6)               1995       67,177         0         1,982(4)           0              0          39,500 (5)
Chief Financial Officer
                                    1997      124,384         0             0              0              0               0
</TABLE>

----------
(1)      Each of the Kaplans entered into an employment agreement with the
         Company effective October 1, 1996 and is compensated from that date
         forward in accordance with the terms of that employment agreement. On
         February 23, 1998, the Kaplans entered into new employment agreements
         with the Company that will become effective at the Effective Time. See
         "Certain Relationships and Related Transactions--The Employment
         Agreements."
(2)      Represents, in each case, $44,508 paid as salary by The Kapson Group
         from January 1, 1996 through September 30, 1996, plus $46,137 paid as
         salary from October 1, 1996 through December 31, 1996 pursuant to the
         Kaplans' employment agreements.
(3)      Pursuant to the Kaplans' employment agreements, the bonus amounts were
         awarded by the Compensation Committee and paid in 1997 for services
         rendered from October 1, 1996 through December 31, 1996.
(4)      For 1997, represents: (i) fees paid to each of the Kaplans under
         operating agreements ($272,300 in each case); (ii) personal use of the
         Company automobile; (iii) paid medical benefits; and (iv) with respect
         to Glenn Kaplan only, partial payment of club membership dues. For
         1996, represents: (i) fees paid by the Company under the operating
         agreements from October 1, 1996 through December 31, 1996 ( $73,114 in
         each case); (ii) personal use of The Kapson Group/Company-paid
         automobile; (iii) paid medical benefits; and (iv) with respect to Glenn
         Kaplan only, partial payment of club membership dues. For 1995,
         represents: (i) personal use of The Kapson Group-paid automobile; and
         (ii) with respect to Glenn Kaplan only, partial payment of club
         membership dues.
(5)      For 1996 and 1995, represents, in each case, the Company's payment of
         premiums on a life insurance policy.
(6)      Raymond DioGuardi commenced employment in January 1997.


                                       33
<PAGE>

Stock Options

         The following table contains information concerning the grant of
options under the Incentive Plan to the only named executive officer of the
Company who was granted stock options during the year ended December 31, 1997.
No stock appreciation rights ("SARS") were granted in 1997.

                        OPTION GRANTS IN LAST FISCAL YEAR

<TABLE>
<CAPTION>
                                                  Individual Grants
                              -----------------------------------------------------
                                               Percent of                                Potential Realizable
                                Number of         Total                                    Value at Assumed
                               Securities        Options                                    Annual Rates of
                               Underlying      Granted to     Exercise                    Stock Appreciation
                                 Options      Employees in      Price     Expiration        for Option Term
         Name                 Granted(#)(1)    Fiscal Year    ($/Share)     Date(2)       5%             10%
----------------------------  -------------    -----------    ---------     -------    ------------------------
<S>                               <C>             <C>           <C>         <C>  <C>    <C>            <C>
Raymond DioGuardi...........      21,000          100.0%        $10.00      1/27/07     $58,019        $132,068
</TABLE>

----------
(1)      All options were granted pursuant to the Incentive Plan. The grant to
         Mr. DioGuardi is exercisable in annual increments of 25% of the total
         grant, beginning on the first anniversary of the date of grant. All
         options were granted at the fair market value of Common Stock on the
         effective date of grant.
(2)      The option is subject to earlier termination if the officer's
         employment with the Company is terminated.

         The following table sets forth information for each of the named
executive officers with respect to the value of options exercised during the
year ended December 31, 1997 and the value of outstanding and unexercised
options held as of December 31, 1997. There were no SARs exercised during 1997
and none were outstanding as of December 31, 1997.

                 AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
                        AND FISCAL YEAR-END OPTION VALUES

<TABLE>
<CAPTION>
                                                                       Number of
                                                                 Securities Underlying             Value of Unexercised
                                     Shares                       Unexercised Options              In-the-Money Options
                                    Acquired      Value          at December 31, 1997             at December 31, 1997(1)
                                  on Exercise   Realized    -------------------------------   -------------------------------
                 Name                  ($)         ($)      Exercisable       Unexercisable   Exercisable       Unexercisable
------------------------------    -----------   --------    -----------       -------------   -----------       -------------
<S>                                    <C>           <C>         <C>             <C>              <C>              <C>
Raymond DioGuardi.............          --           --          0               21,000           $0               $102,375
</TABLE>

----------
(1)      Represents the difference between the closing market price of the
         Common Stock as reported by the Nasdaq National Market on December 31,
         1997 of $14.875 per share and the exercise price per share of
         in-the-money options multiplied by the number of shares underlying the
         in-the-money options.


                                       34
<PAGE>

Employment Agreements

         On September 25, 1996, the Company entered into substantially similar
employment agreements with each of Glenn Kaplan (as Chairman and Chief Executive
Officer), Wayne L. Kaplan (as Vice Chairman, Senior Executive Vice President,
Secretary and General Counsel) and Evan A. Kaplan (as President and Chief
Operating Officer) (each individually, an "Executive"). Each agreement provides
for an initial five-year term which is automatically renewable for successive
one-year terms (the "Employment Term") unless either party gives written notice
to the other at least six months prior to the expiration of the then Employment
Term. During the Employment Term, the Executive will be obligated to devote
substantially all his business time, energy, skill and efforts to the
performance of his duties under the agreement and shall faithfully serve the
Company, subject to his right to perform his obligations as operator of one or
more of the Company's facilities in his individual capacity.

         The agreement currently provides for an annual base salary of $237,000
(as adjusted annually in the discretion of the Compensation Committee and also
for cost of living increases) and a discretionary bonus. The Compensation
Committee shall determine the amount of the bonus to be awarded to the Kaplans,
taking into account the operating results of the Company as well as such
subjective factors as the Compensation Committee deems appropriate and in the
best interests of the Company and its stockholders, which bonus amount will be
shared equally by the Kaplans. In addition, under the agreement the Executive
will be entitled to long-term disability coverage, use of an automobile and club
membership and benefits generally provided to executive employees.

         The agreement also provides that, during the Employment Term and
thereafter, the Company will indemnify the Executive, to the fullest extent
permitted by law, in connection with any claim against the Executive as a result
of the Executive serving as an officer or director of the Company or in any
capacity at the request of the Company in or with regard to any other entity,
employee benefit plan or enterprise. Following the Executive's termination of
employment, the Company will continue to cover the Executive under the Company's
directors' and officers' insurance for the period during which the Executive may
be subject to potential liability for any claim, action or proceeding (whether
civil or criminal) as a result of his service as an officer or director of the
Company at the highest level then maintained for any then or former officer or
director.

         Any dispute or controversy arising under or in connection with the
agreement (other than injunctive relief) shall be settled exclusively by
arbitration. Each party shall bear its own legal fees except that, in the event
the Executive prevails on any material issue, the arbitrator shall award the
Executive his legal fees, except for those attributable to frivolous positions.

         The agreement may be terminated at any time by the Executive for Good
Reason (including a Change in Control of the Company) or by the Company with or
without Cause (as each capitalized term is defined in the agreement). Good
Reason also includes an event of default or termination, other than in
accordance with its terms, by the Company or its subsidiaries without cause, of
any operating agreement between the Company and the Kaplans, as operators of the
Company's facilities, or any management services agreement between the Company's
wholly-owned subsidiary and the Kaplans. If the employment of the Executive is
terminated for any reason, he may withdraw as a licensed operator of certain of
the Company's facilities. Likewise, if the Executive is terminated by the
Company as an operator of one of its facilities, he may resign his employment
with the Company.


                                       35
<PAGE>

         If the Executive terminates his employment with the Company for Good
Reason (including the Company giving notice of non-renewal) or is terminated
without Cause, he will receive severance pay (i) in an amount equal to two
years' base salary and bonus, plus (ii) continued medical benefits for two
years. The agreement provides that the Executive will have no obligation to
mitigate the Company's financial obligations in the event of his termination for
Good Reason or without Cause and there will be no offset against the Company's
financial obligations for other amounts earned by the Executive. If termination
is the result of the Executive's death or disability, the Company will pay to
the Executive (or his estate) an amount equal to six months' base salary at his
then current rate of pay (reduced in the case of disability by his long-term
disability policy payments). If the Executive's employment is terminated by him
for Good Reason or by the Company without Cause, he may also withdraw as an
operator of the Company's facilities; in such an event, he will be entitled to
receive twice his pro rata share of the operating fees (net of fees payable
under the applicable management services agreement) for the preceding twelve
months.

         For a description of the new employment agreements each of the Kaplans
and Raymond DioGuardi entered into with the Company on February 23, 1998 in
connection with the Transaction, see "Certain Relationships and Related
Transactions--The Employment Agreements."

Compensation of Directors

         The Company pays its directors who are not employees of the Company an
annual fee of $10,000 and a per meeting fee of $500 for each directors meeting
and each committee meeting attended. Under the Incentive Plan, each non-employee
director was granted a non-qualified option to purchase 10,000 shares of Common
Stock at $10.00 per share (the price per share to the public in the Initial
Public Offering) and each new non-employee director upon the date of his or her
election or appointment will be granted a non-qualified option to purchase
10,000 shares of Common Stock at the fair market value on the date of grant. All
options granted to non-employee directors will vest at the rate of 25% on each
of the first four anniversaries of the date of grant, assuming the non-employee
director is a director on those dates, and all such options generally will be
exercisable for a period of ten years from the date of grant. Upon a Change of
Control (as defined in the Incentive Plan), all unvested options (which have not
yet expired) will automatically become 100% vested. Directors who are employees
of the Company are not compensated for services as a director.

Compensation Committee Interlocks and Insider Participation

         Compensation policies and decisions, including those relating to
salary, bonuses and benefits of executive officers, were set or made by the
Board of Directors from the formation of the Company to the time of the Initial
Public Offering. The Kaplans participated as members of the Board of Directors
in deliberations concerning executive officer compensation. Upon consummation of
the Initial Public Offering, the Board of Directors created a Compensation
Committee consisting of a majority of independent directors, which recommends to
the Board the cash compensation to be paid to the Company's executive officers.
The members of the Compensation Committee are Glenn Kaplan, Joseph Beck and
Gerald Schuster. Glenn Kaplan is the Chief Executive Officer of the Company, is
party to certain agreements by which he in his individual capacity is the
licensed operator of certain of the Company's New York facilities, and was party
to certain transactions with the Company in connection with the formation of the
Company. Glenn Kaplan does not participate in discussions regarding compensation
to be paid to him or to Wayne Kaplan or Evan Kaplan.


                                       36
<PAGE>

Compensation Committee Report

         Compensation Policies. The principal goal of the Company's compensation
program as administered by the Compensation Committee is to help the Company
attract, motivate and retain the executive talent required to develop and
achieve the Company's strategic and operating goals with a view to maximizing
stockholder value.

         CEO's Compensation; Compensation of the Kaplans

         Salary. The Company entered into employment agreements with each of
Glenn Kaplan, Wayne L. Kaplan and Evan A. Kaplan prior to the formation of the
Compensation Committee. Pursuant to such agreements, the Company paid to each
Kaplan an annualized base salary of $234,144 from January 1, 1997 to December
31, 1997. These base salaries are competitive with those payable to executives
holding corresponding positions at corporations within the Company's industry
that are of comparable size. Individual experience and performance is considered
when setting salaries within the range for each position, although the current
employment agreements between the Company and each of the Kaplans provide that
each Kaplan shall receive equal compensation. Annual reviews are held and
adjustments are made based on attainment of individual goals and in a manner
consistent with the Company's overall operating and financial performance. On
February 23, 1998, the Board of Directors approved new employment agreements for
each of the Kaplans and for the chief financial officer that will become
effective at the Effective Time. See "Certain Relationships and Related
Transactions--The Employment Agreements."

         Bonus. The Kaplans did not receive any bonus for the period from
January 1, 1997 to December 31, 1997.

         Compensation of Other Executive Officers and Key Employees

         Base Salary. Base salaries paid in 1997 to the Company's executive
officers and key employees are competitive with those payable to executives
holding corresponding positions at corporations within the Company's industry
that are of comparable size. Individual experience and performance are
considered when setting salaries within the range for each position. Annual
reviews are held and adjustments are made based on attainment of individual
goals and in a manner consistent with the Company's overall operating and
financial performance.

         Annual Bonus. The annual bonus is intended to motivate individual and
team performance by creating potential to earn annual incentive awards that are
contingent upon the performance of the Company and that are comparable to those
payable to executives and key employees holding corresponding positions at
corporations within the Company's industry that are of comparable size. There
were no bonuses paid for 1997.

         Long-Term Incentives. The Company provides its executives and key
employees with long-term incentive compensation through grants of stock options
under the Company's stock option plans. The grant of stock options aligns the
executive's interests with those of the Company's stockholders by providing the
executive with an opportunity to purchase and maintain an equity interest in the
Company and to share in


                                       37
<PAGE>

the appreciation of the value of the Common Stock. The size of option grants is
comparable to grants by other corporations within the Company's industry that
are of comparable size.


                                       The Compensation Committee

                                       Glenn Kaplan
                                       Joseph G. Beck
                                       Gerald Schuster


                                       38
<PAGE>

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

         The following table shows as of March 5, 1998 the beneficial ownership
of Common Stock with respect to (i) each person who was known by the Company to
own beneficially more than 5% of the outstanding shares of Common Stock, (ii)
each director, (iii) each executive officer of the Company, and (iv) directors
and executive officers as a group.

                                                        Shares of
                                                         Common
                                                          Stock        Percent
                                                       Beneficially      of
Name and Address of Beneficial Owner (1)                  Owned         Class
----------------------------------------                  -----         -----
Glenn Kaplan                                          4,150,000 (2)      53.5
Wayne L. Kaplan                                       4,150,000 (2)      53.5
Evan A. Kaplan                                        4,150,000 (2)      53.5
Raymond DioGuardi                                      21,000 (3)          *
Joseph G. Beck                                         11,000 (3)          *
Bernard J. Korman                                      10,000 (3)          *
Risa Lavizzo-Mourey, M.D.                              10,000 (3)          *
Gerald Schuster                                        15,000 (3)          *

All directors and executive officers as a
 group (8 persons) (4)                                4,217,000          54.4

Prometheus Senior Quarters LLC
30 Rockefeller Center
New York, New York 10020 (5)                          4,150,000 (6)      53.5
Sirach Capital Management, Inc.
600 University Street
Seattle, Washington 98101 (7)                            730,300          9.4
Magten Asset Management Corp.
35 East 21st Street
New York, New York 10010 (8)                             689,200          8.9

----------

*        Less than one percent.

(1)      Unless otherwise indicated, the address of the listed persons is c/o
         Kapson Senior Quarters Corp., 125 Froehlich Farm Boulevard, Woodbury,
         New York 11797.
(2)      Includes shares owned of record by the Kaplans, each of whom shares
         voting and dispositive power over all of these shares, and Herbert and
         Jean Kaplan, who have a pecuniary interest in and have


                                       39
<PAGE>

         shared voting and dispositive power over 300,001 shares of Common
         Stock. Herbert and Jean Kaplan are the parents of the Kaplans.
(3)      Includes shares of Common Stock which the directors and executive
         officers have the right to acquire through the exercise of options, as
         follows: Raymond DioGuardi - 21,000 (5,250 of which are currently
         vested); Joseph G. Beck - 10,000; Bernard Korman - 10,000; Risa
         Lavizzo-Mourey - 10,000; and Gerald Schuster - 10,000 shares.
(4)      Includes shares of Common Stock as indicated in the preceding
         footnotes.
(5)      Parent is wholly owned by LFREI.
(6)      Parent has the right to cause the shares of Common Stock beneficially
         owned by the Kaplans to be voted in favor of the Merger Agreement and
         has an option to acquire all of such shares and, therefore, Parent may
         be deemed to be the beneficial owner of such shares.
(7)      Information regarding Sirach Capital Management, Inc. ("Sirach") was
         obtained from a Schedule 13G filed by it with the Commission on January
         30, 1997. Such Schedule 13G states that Sirach, a Washington
         corporation, is an investment advisor that has sole voting power and
         sole dispositive power over 730,300 shares of Common Stock.
(8)      Magten Asset Management Corp., a Delaware corporation, is an investment
         advisor that has shared voting power over 468,700 shares of Common
         Stock and shared dispositive power over 689,200 shares of Common Stock.

         The following table shows as of March 5, 1998 the beneficial ownership
of Preferred Stock with respect to (i) each person who was known by the Company
to own beneficially, upon conversion of its shares of Preferred Stock, more than
5% of the outstanding shares of Common Stock. To the knowledge of the Company,
none of the directors, Parent Designees or executive officers owns any shares of
Preferred Stock.

                                          Shares of
                                          Preferred
                                            Stock                       "As
                                        Beneficially  Percent of    Converted"
Name and Address of Beneficial Owner        Owned        Class    Percentage (1)
------------------------------------        -----        -----    --------------
J.P. Morgan & Co., Incorporated
60 Wall Street
New York, New York 10260                   420,000       17.5         13.0(2)

Dean Witter Intercapital
2 World Trade Center
New York, New York 10048                   345,000       14.4          7.9

Guardian Life Insurance Co. of America
201 Park Avenue South
New York, New York 10003                   320,000       13.3          7.4

Forest Investment Management LLC
53 Forest Avenue
Old Greenwich, Connecticut 06810(3)        240,000       10.0          5.6


                                       40
<PAGE>

                                          Shares of
                                          Preferred
                                            Stock                       "As
                                        Beneficially  Percent of    Converted"
Name and Address of Beneficial Owner        Owned        Class    Percentage (1)
------------------------------------        -----        -----    --------------
General Motors Investment Management
Corporation
767 Fifth Avenue
New York, New York 10153 (4)               220,000        9.2          5.2

----------
(1)      Percentage of Common Stock that each stockholder would own assuming
         only that stockholder has converted its shares of Preferred Stock into
         Common Stock.
(2)      Includes 304,000 shares of Common Stock beneficially owned by J.P.
         Morgan & Co., Incorporated ("J.P. Morgan").
(3)      Information regarding Forest Investment Management LLC ("Forest") was
         obtained primarily from a Schedule 13G filed by it with the Commission
         on February 17, 1998. Forest, as an investment advisor, Founders
         Financial Group L.P. ("Founders"), as the owner of a controlling
         interest in Forest, Michael A. Boyd, Inc. ("MAB, Inc."), as the general
         partner of Founders, and Michael A. Boyd, as the sole director and
         shareholder of MAB, Inc., upon conversion of the 240,000 shares of the
         Preferred Stock held by each of them, each would have sole voting power
         and sole dispositive power over 462,240 shares of Common Stock.
(4)      Information regarding General Motors Investment Management Corporation
         ("GMIMCo") was obtained from a Schedule 13G filed by it with the
         Commission on March 3, 1998. Such Schedule 13G states that General
         Motors Employees Domestic Group Pension Trust (the "Trust"), a trust
         formed under and for the benefit of one or more employee benefit plans
         (the "Plans") of General Motors Corporation, and GMIMCo, as investment
         advisor to the Plans, may acquire, and thus are deemed to be the
         beneficial owners of, these shares, which are currently beneficially
         owned by J.P. Morgan, as an investment manager with respect to the
         Plans, because of GMIMCo's authority to terminate J.P. Morgan. Such
         shares are also reported in the above table as being beneficially owned
         by J.P. Morgan.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Arrangements Regarding the Operation of Certain of the Company's Facilities

         Because of New York law and regulations, the Kaplans individually
currently are, and subsequent to any consummation of the Offer or the Merger
will continue to be, the operators of most of the Company's assisted living
facilities located in New York until such time as a successor entity controlled
by one of the Kaplans and an individual associated with LFREI is approved as a
replacement operator in accordance with applicable law. Subsequent to
consummation of the Merger, each operating agreement with a facility that is
wholly owned by the Company will have a term of five years and provide for a
management fee to the operators of $5,000 per month. The current operating
agreements with facilities not wholly owned by the Company generally have a term
of at least five years and provide for an operating fee equal to 5% of gross
revenues or the greater of 5% of gross revenues and a minimum fee (if there is a
minimum fee, it is usually set at $150,000 per annum which, in some instances,
will phase out over a period of time) and the Company may also be entitled to an
incentive fee. The Kaplans or the successor entity, as operators of each of
these facilities, will engage a wholly owned subsidiary of the Company to
provide certain management services


                                       41
<PAGE>

in connection with the day-to-day operations of each facility, in each case
pursuant to a separate management agreement. The term of the management
agreements will be five years. The fee payable to the Company's subsidiary under
each management agreement with a facility operated by the Kaplans or a successor
entity and wholly owned by the Company will be $4,000 per month. The fee payable
to the Company's subsidiary under management agreements related to facilities
that are not wholly owned by the Company will be the greater of (i) 5% of total
gross revenues less $1,000 or (ii) $11,500 per month, but the foregoing fee will
be contingent on the operators receiving payment of said amount from the owner
of the facility. To the extent one or more of the Kaplans retains operating
fees, such amounts will be offset against the Company's payment obligations
under their employment agreements with the Company. The Company has agreed to
indemnify the Kaplans from and against any losses, claims, damages and other
liabilities they may sustain as a result of their serving as operators of any
facility owned by the Company or its affiliates after the Merger or, under
certain circumstances, after the Offer.

         Pursuant to a letter agreement among the Company, the Kaplans, the
Offeror and Parent, dated February 23, 1998 (the "Home Health Agency Letter
Agreement"), the Kaplans have agreed, for no monetary consideration, to use
their reasonable best efforts to arrange and obtain regulatory approval for the
transfer of responsibility for the operation of the KLHCSA to the Company
promptly after the consummation of the Offer or the Merger. The Kaplans have
also agreed to cause KLHCSA to maintain its existing business arrangements with
the Company and its subsidiaries until the ownership of KLHCSA is transferred to
the Company, which the parties acknowledge may take a considerable period of
time due to the need for regulatory review of the transfer application by the
New York Department of Health.

         The operating agreements, the Interim Management Services Agreement and
the Master Management Services Agreement are in the process of being revised to
conform to comments recently received from the New York State Department of
Health. These revisions will reduce the role of the Company in the operation of
the New York facilities and increase the authority of the operator of the New
York facilities.

Indemnification and Insurance

         The Merger Agreement provides that Parent will cause the Surviving
Corporation to keep in effect provisions in its Certificate of Incorporation and
By-laws providing for exculpation of director and officer liability and
indemnification of each person who is now or has at any time prior to the date
of the Merger Agreement been entitled to the benefit of the indemnification
provisions set forth in the Company's Certificate of Incorporation and By-laws
(the "Indemnified Parties"), to the fullest extent now or hereafter permitted
under the DGCL, which provisions will not be amended except as required by
applicable law or except to make changes permitted by law that would enlarge the
Indemnified Parties' right of indemnification. Pursuant to the Merger Agreement,
the Surviving Corporation will pay all expenses, including attorneys' fees, that
may be incurred by any Indemnified Parties in enforcing the indemnity
obligations provided for in this paragraph. The Merger Agreement provides that
the rights of each Indemnified Party thereunder will be in addition to any other
rights such Indemnified Party may have under the Certificate of Incorporation or
By-laws of the Company, under the DGCL or otherwise. Further, the Merger
Agreement provides that for the period from the time the Offeror first purchases
Shares pursuant to the Offer through the Effective Time, Parent will not permit
the Company to amend the provisions in its Certificate of Incorporation or
By-laws providing for exculpation of directors' and officers' liability and
indemnification of the Indemnified Parties.


                                       42
<PAGE>

         Under the Merger Agreement, the Surviving Corporation will maintain in
effect for not less than three years after the Effective Time the current
policies of directors' and officers' liability insurance maintained by the
Company with respect to matters occurring on or prior to the Effective Time;
provided, however, that the Surviving Corporation may substitute therefor
policies of at least the same coverage (with carriers comparable to the
Company's existing carriers) containing terms and conditions which are no less
advantageous to the Indemnified Parties; provided, however, that the Surviving
Corporation will not be required to maintain or procure such coverage to pay an
annual premium in excess of 150% of the current annual premium paid by the
Company for its coverage (the "Cap"); and provided, further, that if equivalent
coverage cannot be obtained, or can be obtained only by paying an annual premium
in excess of the Cap, the Surviving Corporation will be required to obtain only
as much coverage as can be obtained by paying an annual premium equal to the
Cap.

The Stockholder Agreement

         Pursuant to the Stockholder Agreement, the Kaplans, who beneficially
own in the aggregate approximately 54% of the outstanding shares of Common
Stock, have agreed to tender and sell to Parent pursuant to the Offer all the
Common Stock held by them and not to withdraw any Common Stock tendered in the
Offer.

         Each of the Kaplans has further agreed to: (1) vote all of the shares
of Common Stock beneficially owned by him in favor of the Merger, the Merger
Agreement and the transactions contemplated by the Merger Agreement; (2) vote
the shares of Common Stock beneficially owned by him against any action or
agreement involving a sale of such shares, merger or sale of substantially all
of the assets of the Company that would result in a breach in any material
respect of any obligation of the Company under the Merger Agreement; and (3)
vote the shares of Common Stock beneficially owned by him against any action or
agreement that would reasonably be expected to impede, interfere with, delay or
attempt to discourage the Merger. If any of the Kaplans fails to comply with the
foregoing, as determined by Parent in its sole discretion, such failure will
result in the automatic, irrevocable appointment of Parent as the attorney and
proxy of such Kaplan, with full power of substitution, to vote, and otherwise
act with respect to, all shares of Common Stock that such Kaplan is entitled to
vote on any of the foregoing matters.

         The Kaplans also have granted to Parent an irrevocable option (the
"Stock Option") to purchase for $14.50 per share (i) all, but not less than all,
of the shares of Common Stock beneficially owned by the Kaplans and (ii) any
additional shares of Common Stock acquired by the Kaplans during the term of the
Stockholder Agreement. The Stockholder Agreement sets no limitation on the
number of shares of Common Stock the Kaplans can own. The Stock Option may be
exercised by Parent at any time prior to the termination of the Stockholder
Agreement and prior to the earliest to occur of (i) the first anniversary of the
date of the Stockholder Agreement, (ii) if the Merger Agreement is terminated,
or Parent provides written or oral notice to the Company that it elects not to
consummate the Offer or close the transactions contemplated by the Merger
Agreement, as a result of the failure of any of the conditions specified in
Exhibit A to the Merger Agreement, and at the time of such termination or notice
there does not exist any Alternative Proposal (as defined in the Merger
Agreement) at $14.50 or more per share of Common Stock for 75% or more of the
outstanding Common Stock of the Company, the termination of the Merger Agreement
and (iii) if the Merger Agreement is terminated, or Parent provides written or
oral notice to the Company that it elects not to consummate the Offer or close
the transactions contemplated by the Merger Agreement, as a result of the
failure of any of the conditions specified in Exhibit A to the Merger Agreement,
and at the time of such termination or notice there exists any Alternative
Proposal at $14.50


                                       43
<PAGE>

or more per share of Common Stock for 75% or more of the outstanding Common
Stock of the Company, the date six months after the date of the termination of
the Merger Agreement; provided, however, that if a tender offer is commenced by
any party or entity other than Parent and its affiliates with respect to the
Common Stock, then, notwithstanding any provision of the Stockholder Agreement,
the Kaplans may tender all or any of their shares of Common Stock into such
tender offer on or before the time 48 hours before the expiration of such offer.

         Each of the Kaplans has also made certain covenants with respect to the
disposition or encumbrance of the shares of Common Stock beneficially owned by
him, the acquisition of additional shares and the solicitation of transactions
relating to the shares of Common Stock beneficially owned by him. Each of the
Kaplans has further agreed that, in the event of any change in the
capitalization of the Company, he will adjust the number and kind of the shares
of Common Stock beneficially owned by him and the consideration payable in
respect of such shares so as to restore to Parent its rights and privileges
under the Stockholder Agreement.

The Employment Agreements

         In connection with the execution of the Merger Agreement, the Company
has entered into an amended and restated employment agreement with each of the
following employees: (1) Glenn Kaplan as Chief Executive Officer; (2) Evan A.
Kaplan as Chief Operating Officer; (3) Wayne L. Kaplan as Senior Executive Vice
President, Secretary or General Counsel; and (4) Raymond DioGuardi as Chief
Financial Officer. Base compensation under the employment agreements will be not
less than $250,000 per year for Glenn Kaplan, not less than $225,000 per year
for Evan A. Kaplan, not less than $200,000 per year for Wayne L. Kaplan and not
less than $175,000 per year for Mr. DioGuardi. In addition, each of the
employees will be entitled to receive a target bonus, based upon the Company's
achievement of certain operating and/or financial goals, equal to a specified
percentage of each employee's then current annual base salary (up to 75% in the
case of Glenn Kaplan and Wayne L. Kaplan, up to 100% in the case of Evan A.
Kaplan and up to 50% in the case of Mr. DioGuardi). With respect to each of
Glenn Kaplan, Evan A. Kaplan and Wayne L. Kaplan, any bonus payable in respect
of the fiscal year beginning January 1, 1998 shall be payable, with interest at
an annual rate equal to 4%, within five days following the end of fiscal year
1999; provided, however, that no bonus shall be payable for such fiscal year in
the event the employee's employment with the Company shall have been terminated
by the Company for "Cause" (as defined in such employee's employment agreement)
or voluntarily by the employee without "Good Reason" (as defined in such
employee's employment agreement) on or prior to December 31, 1999. The Board of
Directors may increase an employee's bonus for any fiscal year to an amount
greater than the percentages specified above; provided, however, that the
Company has attained no less than 95% of the applicable operating or financial
goals for such fiscal year. Each of the employees shall be eligible to
participate in all benefit plans and receive all fringe benefits available to
similarly situated employees which, in the aggregate, shall be no less favorable
than those provided to any other employee of the Company determined as of the
date of the employment agreements.

         The term of each agreement is for two years commencing at the Effective
Time, which term will be automatically renewed for successive one-year terms
unless either party gives written notice no less than six months prior to the
then applicable term that the term will not be so extended. The Company may
terminate the employees at any time and for any reason, but the employees may
resign only for Good Reason. If an employee's employment with the Company is
terminated: (i) by the Company other than for Cause, death or disability; or
(ii) voluntarily by the employee with Good Reason, the employment agreement


                                       44
<PAGE>

provides that the Company will continue to pay such employee an amount equal to
his then current annual base salary for the remainder of the then applicable
employment term, and the Company will continue such employee's then current
medical coverage for a period of two years following the termination of the
employee's employment.

         Pursuant to non-competition covenants contained in the employment
agreements, each of the employees has agreed that he will not, during the term
of his employment and for a period of three years after the date of his
termination (five years if he is terminated for Cause), directly or indirectly
own, manage, operate, join, control, be employed by or participate in the
ownership, management, operation or control of, or be connected in any manner,
including, but not limited to, holding the positions of stockholder, director,
officer, consultant, independent contractor, employee, partner or investor, with
any person or entity engaged in the business of providing assisted living,
independent living, skilled nursing facilities or continuing care retirement
centers (containing assisted living, independent living and skilled nursing
facilities in one campus) (each a "Competitive Business") within a 25-mile
radius of any such business operated or in the pipeline to be operated (to the
extent the employee has knowledge thereof after due inquiry) by the Company,
LFREI or any affiliate of LFREI (a "Competing Enterprise"); provided, however,
that if Mr. DioGuardi's employment with the Company shall be terminated by his
giving notice of his intention not to extend his employment past the second
anniversary of the effective date of his employment agreement (the "Initial
Term"), he shall not be precluded from accepting the position of chief financial
officer with any Competing Enterprise; and provided, further, that if Mr.
DioGuardi's employment is terminated by the Company giving notice of its
intention not to extend his employment beyond the Initial Term (a "Limited
DioGuardi Termination"), Mr. DioGuardi shall have no restriction on his
employment after the Initial Term.

         In addition, during the term of his employment and for a period of two
years thereafter, each of the employees has agreed not to interfere with the
Company's relationship with, or endeavor to entice away from the Company, any
person who at any time during the employee's term of employment was an employee
or customer of the Company or otherwise had a material business relationship
with the Company. With respect to each of Glenn Kaplan, Evan A. Kaplan and Wayne
L. Kaplan, the foregoing shall not apply with respect to Mr. DioGuardi if (i)
Mr. DioGuardi's employment shall have terminated pursuant to a Limited DioGuardi
Termination; and (ii) Mr. DioGuardi shall not be employed in any Competitive
Business.

The Escrow Agreement

         Pursuant to an Escrow Agreement, dated as of February 23, 1998, among
the Kaplans, the Company, the Offeror and Parent and a letter agreement among
the same parties dated as of the same date (collectively, the "Escrow
Agreement"), the Kaplans have agreed that $6,000,000 of the proceeds from the
shares tendered by them in the Offer or sold by the Kaplans to Parent pursuant
to the Stockholder Agreement will be placed in escrow. The escrowed funds will
be delivered to the Company if the Kaplans or any of the Kaplans licensed to
operate certain of the Company's facilities loses any such operating certificate
or if the Kaplans cause any such facility to be without a licensed operator as a
result of the breach by the Kaplans of their obligations under certain
agreements between the Kaplans and the Company (a "License Loss Breach") to the
extent that such License Loss Breach damages the Company. The escrowed funds
will be delivered to the Kaplans upon (i) the retention by the Kaplans of such
operating certificates for a given period of time, (ii) the issuance of such
operating certificates for all such facilities to a Replacement Operator (as
defined in the Escrow Agreement), or (iii) the satisfaction of certain other
conditions.


                                       45
<PAGE>

Certain Transactions Regarding Sales of Common Stock

         Restrictions on Transfer. Each Kaplan has agreed with the Company that
he will not, for as long as he will be the licensed operator of any of the
Company's facilities, transfer any shares of Common Stock if it would result in
his personally owning fewer than 500,000 shares of Common Stock initially, or
250,000 shares of Common Stock after the fifth anniversary of the consummation
of the Initial Public Offering, in each case subject to certain exceptions. In
addition, a stockholders agreement between the Kaplans and the Company provides
(i) each Kaplan with a right of first refusal with respect to a transfer of the
shares of Common Stock of the other Kaplans, except for a limited exception in
the case of death, and (ii) that the Kaplans will vote all their shares of
Common Stock as a unit. In connection with the Offer, the Board of Directors of
the Company has agreed to release the Kaplans from their obligation each to
maintain ownership of 500,000 shares of Common Stock, and the Kaplans have
waived their rights of first refusal with respect to each other's shares to be
sold pursuant to the Offer.

         Registration Rights. Each of the Kaplans, along with Herbert Kaplan,
who beneficially own in the aggregate 4,150,000 shares of Common Stock, is
entitled to certain rights with respect to the registration of such shares under
the Securities Act. These rights are subject to certain restrictions, conditions
and limitations, including the right of the underwriters of an offering to limit
the number of shares included in such registration.

                                     PART IV

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

         (a) See Index to Financial Statements immediately following Exhibit
         Index.

         (b) A Form 8-K with respect to Item 5 was filed October 2, 1997.

         (c) Exhibits

2.1      Agreement, dated as of August 27, 1997, between Kapson Lynbrook Corp.
         and Pensun Associates, as amended September 29, 1997 (incorporated by
         reference to Exhibit 1 to the Company's Current Report on Form 8-K
         dated March 30, 1998).

2.2      Amended and Restated Agreement and Plan of Merger, dated as of February
         23, 1998, among Prometheus Senior Quarters, LLC, Prometheus Acquisition
         Corp. and the Company (incorporated by reference to Exhibit 1 to the
         Company's Solicitation/Recommendation Statement on Schedule 14D-9 dated
         March 2, 1998).

3.1      Certificate of Incorporation of the Company (incorporated by reference
         to Exhibit 3.1 to the Company's Registration Statement on Form S-1
         dated September 26, 1996 (Registration No. 33-5945)).

3.2      By-laws of the Company (incorporated by reference to Exhibit 3.2 to the
         Company's Registration Statement on Form S-1 dated September 26, 1996
         (Registration No. 33-5945)).


                                       46
<PAGE>

4.1      Certificate of Designations of $2.00 Convertible Exchangeable Preferred
         Stock, par value $.01 per share, of the Company (incorporated by
         reference to Exhibit 4.1 to the Company's Current Report on Form 8-K
         dated July 3, 1997).

10.1     Form of Operating Agreement (incorporated by reference to Exhibit 10.1
         to the Company's Registration Statement on Form S-1 dated September 26,
         1996 (Registration No. 33-5945)).

10.2     Form of Management Services Agreement (incorporated by reference to
         Exhibit 10.2 to the Company's Registration Statement on Form S-1 dated
         September 26, 1996 (Registration No. 33-5945)).

10.3     Form of Kapson Senior Quarters Corp. 1996 Stock Incentive Plan
         (incorporated by reference to Exhibit 10.3 to the Company's
         Registration Statement on Form S-1 dated September 26, 1996
         (Registration No. 33-5945)).

10.4     Form of Registration Rights Agreement among the Company, Glenn Kaplan,
         Wayne L. Kaplan, Evan A. Kaplan and Herbert Kaplan (incorporated by
         reference to Exhibit 10.4 to the Company's Registration Statement on
         Form S-1 dated September 26, 1996 (Registration No. 33-5945)).

10.5     Form of Stockholder Agreement among the Company, Glenn Kaplan, Wayne L.
         Kaplan and Evan A. Kaplan (incorporated by reference to Exhibit 10.22
         to the Company's Registration Statement on Form S-1 dated September 26,
         1996 (Registration No. 33-5945)).

10.6     Form of Employment Agreement between each of Glenn Kaplan, Wayne L.
         Kaplan and Evan A. Kaplan and the Company (incorporated by reference to
         Exhibit 10.23 to the Company's Registration Statement on Form S-1 dated
         September 26, 1996 (Registration No. 33-5945)).

10.7     Form of Indemnification Agreement (incorporated by reference to Exhibit
         10.24 to the Company's Registration Statement on Form S-1 dated
         September 26, 1996 (Registration No. 33-5945)).

10.8     Mortgage, Security Agreement, Assignment of Leases and Rents and
         Fixture Filing made March 1996 by Kapson Rochester Manor, LLC in favor
         of Health Care REIT, Inc. (incorporated by reference to Exhibit 10.25
         to the Company's Registration Statement on Form S-1 dated September 26,
         1996 (Registration No. 33-5945)).

10.9     Mortgage Note in the sum of $3,890,625.00, dated March 1996, made by
         Kapson Rochester Manor, LLC to the order of Health Care REIT, Inc.
         (incorporated by reference to Exhibit 10.26 to the Company's
         Registration Statement on Form S-1 dated September 26, 1996
         (Registration No.
         33-5945)).

10.10    Loan Agreement, dated March 1996, between Kapson Rochester Manor, LLC
         and Health Care REIT, Inc. (incorporated by reference to Exhibit 10.27
         to the Company's Registration Statement on Form S-1 dated September 26,
         1996 (Registration No. 33-5945)).

10.11    Form of Health Care REIT, Inc. $140 million Credit Facility Commitment
         Letter (incorporated by reference to Exhibit 10.28 to the Company's
         Registration Statement on Form S-1 dated September 26, 1996
         (Registration No. 33-5945)).


                                       47
<PAGE>

10.12    Amendment, dated October 16, 1996, to Health Care REIT, Inc. Credit
         Facility Commitment Letter (incorporated by reference to Exhibit 10.12
         to the Company's Annual Report on Form 10-K dated March 31, 1997).

10.13    Waiver of covenants by Health Care REIT, Inc. dated March 6, 1997
         (incorporated by reference to Exhibit 10.13 to the Company's Annual
         Report on Form 10-K dated March 31, 1997).

10.14    Form of operating agreement among Glenn Kaplan, Wayne L. Kaplan, Evan
         A. Kaplan and Senior Quarters Management Corp. (incorporated by
         reference to Exhibit 3 to the Company's Solicitation/Recommendation
         Statement on Schedule 14D-9 dated March 2, 1998).

10.15    Master Management Services Agreement, dated as of September 30, 1997,
         among Glenn Kaplan, Wayne L. Kaplan, Evan A. Kaplan and Senior Quarters
         Management Corp. (incorporated by reference to Exhibit 4 to the
         Company's Solicitation/Recommendation Statement on Schedule 14D-9 dated
         March 2, 1998).

10.16    Interim Management Services Agreement, dated as of September 30, 1997,
         among Glenn Kaplan, Wayne L. Kaplan, Evan A. Kaplan and Senior Quarters
         Management Corp. (incorporated by reference to Exhibit 5 to the
         Company's Solicitation/Recommendation Statement on Schedule 14D-9 dated
         March 2, 1998).

10.17    Letter agreement relating to the indemnification of Glenn Kaplan, Wayne
         L. Kaplan and Evan A. Kaplan by Kapson Senior Quarters Corp.
         (incorporated by reference to Exhibit 6 to the Company's
         Solicitation/Recommendation Statement on Schedule 14D-9 dated March 2,
         1998).

10.18    Home Health Agency letter agreement, dated February 23, 1998, among
         Glenn Kaplan, Wayne L. Kaplan, Evan A. Kaplan, Kapson Senior Quarters
         Corp., Prometheus Senior Quarters, LLC and Prometheus Acquisition Corp.
         (incorporated by reference to Exhibit 7 to the Company's
         Solicitation/Recommendation Statement on Schedule 14D-9 dated March 2,
         1998).

10.19    Second Amended and Restated Stockholders Agreement, dated as of
         February 23, 1998, among Prometheus Senior Quarters, LLC, Glenn Kaplan,
         Wayne L. Kaplan and Evan A. Kaplan (incorporated by reference to
         Exhibit 8 to the Company's Solicitation/Recommendation Statement on
         Schedule 14D-9 dated March 2, 1998).

10.20    Amended and Restated Employment Agreement, dated as of February 23,
         1998, between Kapson Senior Quarters Corp. and Glenn Kaplan
         (incorporated by reference to Exhibit 9 to the Company's
         Solicitation/Recommendation Statement on Schedule 14D-9 dated March 2,
         1998).

10.21    Amended and Restated Employment Agreement, dated as of February 23,
         1998, between Kapson Senior Quarters Corp. and Wayne L. Kaplan
         (incorporated by reference to Exhibit 10 to the Company's
         Solicitation/Recommendation Statement on Schedule 14D-9 dated March 2,
         1998).

10.22    Amended and Restated Employment Agreement, dated as of February 23,
         1998, between Kapson Senior Quarters Corp. and Evan A. Kaplan
         (incorporated by reference to Exhibit 11 to the Company's
         Solicitation/Recommendation Statement on Schedule 14D-9 dated March 2,
         1998).


                                       48
<PAGE>

10.23    Amended and Restated Employment Agreement, dated as of February 23,
         1998, between Kapson Senior Quarters Corp. and Raymond DioGuardi
         (incorporated by reference to Exhibit 12 to the Company's
         Solicitation/Recommendation Statement on Schedule 14D-9 dated March 2,
         1998).

10.24    Amended and Restated Escrow Agreement, dated as of February 23, 1998,
         and related letter agreement among Glenn Kaplan, Wayne L. Kaplan, Evan
         A. Kaplan, Kapson Senior Quarters Corp. and Prometheus Acquisition
         Corp. (incorporated by reference to Exhibit 13 to the Company's
         Solicitation/Recommendation Statement on Schedule 14D-9 dated March 2,
         1998).

21.1*    Subsidiaries of the Company.

27.1*    Financial Data Schedule.

----------

*        Filed herewith.


                                       49
<PAGE>

                                   SIGNATURES

         Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.

                                      KAPSON SENIOR QUARTERS CORP.


                                      By: /s/ Glenn Kaplan
                                          ------------------------------------
                                          Glenn Kaplan
                                          Chairman and Chief Executive Officer

Date: March 31, 1998

         Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

/s/ Glenn Kaplan
------------------------  Chairman of the Board of Directors     March 31, 1998
Glenn Kaplan              and Chief Executive Officer
                          (principal executive officer)

/s/ Wayne L. Kaplan
------------------------  Senior Executive Vice President,       March 31, 1998
Wayne L. Kaplan           Vice Chairman, Secretary and Director

/s/ Evan A. Kaplan
------------------------  President, Chief Operating             March 31, 1998
Evan A. Kaplan            Officer and Director

/s/ Raymond DioGuardi
------------------------  Chief Financial Officer                March 31, 1998
Raymond DioGuardi         (principal financial officer and
                          principal accounting officer)

/s/ Bernard J. Korman
------------------------  Director                               March 31, 1998
Bernard J. Korman

/s/ Gerald Schuster
------------------------  Director                               March 31, 1998
Gerald Schuster

/s/ Joseph G. Beck
------------------------  Director                               March 31, 1998
Joseph G. Beck


------------------------  Director                               March __, 1998
Risa Lavizzo-Mourey, M.D.


                                       50
<PAGE>

                                  EXHIBIT INDEX

2.1       Agreement, dated as of August 27, 1997, between Kapson Lynbrook Corp.
          and Pensun Associates, as amended September 29, 1997 (incorporated by
          reference to Exhibit 1 to the Company's Current Report on Form 8-K
          dated March 30, 1998).

2.2       Amended and Restated Agreement and Plan of Merger, dated as of
          February 23, 1998, among Prometheus Senior Quarters, LLC, Prometheus
          Acquisition Corp. and the Company (incorporated by reference to
          Exhibit 1 to the Company's Solicitation/Recommendation Statement on
          Schedule 14D-9 dated March 2, 1998).

3.1       Certificate of Incorporation of the Company (incorporated by reference
          to Exhibit 3.1 to the Company's Registration Statement on Form S-1
          dated September 26, 1996 (Registration No. 33-5945)).

3.2       By-laws of the Company (incorporated by reference to Exhibit 3.2 to
          the Company's Registration Statement on Form S-1 dated September 26,
          1996 (Registration No. 33-5945)).

4.1       Certificate of Designations of $2.00 Convertible Exchangeable
          Preferred Stock, par value $.01 per share, of the Company
          (incorporated by reference to Exhibit 4.1 to the Company's Current
          Report on Form 8-K dated July 3, 1997).

10.1      Form of Operating Agreement (incorporated by reference to Exhibit 10.1
          to the Company's Registration Statement on Form S-1 dated September
          26, 1996 (Registration No. 33-5945)).

10.2      Form of Management Services Agreement (incorporated by reference to
          Exhibit 10.2 to the Company's Registration Statement on Form S-1 dated
          September 26, 1996 (Registration No. 33-5945)).

10.3      Form of Kapson Senior Quarters Corp. 1996 Stock Incentive Plan
          (incorporated by reference to Exhibit 10.3 to the Company's
          Registration Statement on Form S-1 dated September 26, 1996
          (Registration No. 33-5945)).

10.4      Form of Registration Rights Agreement among the Company, Glenn Kaplan,
          Wayne L. Kaplan, Evan A. Kaplan and Herbert Kaplan (incorporated by
          reference to Exhibit 10.4 to the Company's Registration Statement on
          Form S-1 dated September 26, 1996 (Registration No. 33-5945)).

10.5      Form of Stockholder Agreement among the Company, Glenn Kaplan, Wayne
          L. Kaplan and Evan A. Kaplan (incorporated by reference to Exhibit
          10.22 to the Company's Registration Statement on Form S-1 dated
          September 26, 1996 (Registration No. 33-5945)).

10.6      Form of Employment Agreement between each of Glenn Kaplan, Wayne L.
          Kaplan and Evan A. Kaplan and the Company (incorporated by reference
          to Exhibit 10.23 to the Company's Registration Statement on Form S-1
          dated September 26, 1996 (Registration No. 33-5945)).

10.7      Form of Indemnification Agreement (incorporated by reference to
          Exhibit 10.24 to the Company's Registration Statement on Form S-1
          dated September 26, 1996 (Registration No. 33-5945)).

10.8      Mortgage, Security Agreement, Assignment of Leases and Rents and
          Fixture Filing made March 1996 by Kapson Rochester Manor, LLC in favor
          of Health Care REIT, Inc. (incorporated by


                                       51
<PAGE>

          reference to Exhibit 10.25 to the Company's Registration Statement on
          Form S-1 dated September 26, 1996 (Registration No. 33-5945)).

10.9      Mortgage Note in the sum of $3,890,625.00, dated March 1996, made by
          Kapson Rochester Manor, LLC to the order of Health Care REIT, Inc.
          (incorporated by reference to Exhibit 10.26 to the Company's
          Registration Statement on Form S-1 dated September 26, 1996
          (Registration No. 33-5945)).

10.10     Loan Agreement, dated March 1996, between Kapson Rochester Manor, LLC
          and Health Care REIT, Inc. (incorporated by reference to Exhibit 10.27
          to the Company's Registration Statement on Form S-1 dated September
          26, 1996 (Registration No. 33-5945)).

10.11     Form of Health Care REIT, Inc. $140 million Credit Facility Commitment
          Letter (incorporated by reference to Exhibit 10.28 to the Company's
          Registration Statement on Form S-1 dated September 26, 1996
          (Registration No. 33-5945)).

10.12     Amendment, dated October 16, 1996, to Health Care REIT, Inc. Credit
          Facility Commitment Letter (incorporated by reference to Exhibit 10.12
          to the Company's Annual Report on Form 10-K dated March 31, 1997).

10.13     Waiver of covenants by Health Care REIT, Inc. dated March 6, 1997
          (incorporated by reference to Exhibit 10.13 to the Company's Annual
          Report on Form 10-K dated March 31, 1997).

10.14     Form of operating agreement among Glenn Kaplan, Wayne L. Kaplan, Evan
          A. Kaplan and Senior Quarters Management Corp. (incorporated by
          reference to Exhibit 3 to the Company's Solicitation/Recommendation
          Statement on Schedule 14D-9 dated March 2, 1998).

10.15     Master Management Services Agreement, dated as of September 30, 1997,
          among Glenn Kaplan, Wayne L. Kaplan, Evan A. Kaplan and Senior
          Quarters Management Corp. (incorporated by reference to Exhibit 4 to
          the Company's Solicitation/Recommendation Statement on Schedule 14D-9
          dated March 2, 1998).

10.16     Interim Management Services Agreement, dated as of September 30, 1997,
          among Glenn Kaplan, Wayne L. Kaplan, Evan A. Kaplan and Senior
          Quarters Management Corp. (incorporated by reference to Exhibit 5 to
          the Company's Solicitation/Recommendation Statement on Schedule 14D-9
          dated March 2, 1998).

10.17     Letter agreement relating to the indemnification of Glenn Kaplan,
          Wayne L. Kaplan and Evan A. Kaplan by Kapson Senior Quarters Corp.
          (incorporated by reference to Exhibit 6 to the Company's
          Solicitation/Recommendation Statement on Schedule 14D-9 dated March 2,
          1998).

10.18     Home Health Agency letter agreement, dated February 23, 1998, among
          Glenn Kaplan, Wayne L. Kaplan, Evan A. Kaplan, Kapson Senior Quarters
          Corp., Prometheus Senior Quarters, LLC and Prometheus Acquisition
          Corp. (incorporated by reference to Exhibit 7 to the Company's
          Solicitation/Recommendation Statement on Schedule 14D-9 dated March 2,
          1998).

10.19     Second Amended and Restated Stockholders Agreement, dated as of
          February 23, 1998, among Prometheus Senior Quarters, LLC, Glenn
          Kaplan, Wayne L. Kaplan and Evan A. Kaplan (incorporated by reference
          to Exhibit 8 to the Company's Solicitation/Recommendation Statement on
          Schedule 14D-9 dated March 2, 1998).


                                       52
<PAGE>

10.20     Amended and Restated Employment Agreement, dated as of February 23,
          1998, between Kapson Senior Quarters Corp. and Glenn Kaplan
          (incorporated by reference to Exhibit 9 to the Company's
          Solicitation/Recommendation Statement on Schedule 14D-9 dated March 2,
          1998).

10.21     Amended and Restated Employment Agreement, dated as of February 23,
          1998, between Kapson Senior Quarters Corp. and Wayne L. Kaplan
          (incorporated by reference to Exhibit 10 to the Company's
          Solicitation/Recommendation Statement on Schedule 14D-9 dated March 2,
          1998).

10.22     Amended and Restated Employment Agreement, dated as of February 23,
          1998, between Kapson Senior Quarters Corp. and Evan A. Kaplan
          (incorporated by reference to Exhibit 11 to the Company's
          Solicitation/Recommendation Statement on Schedule 14D-9 dated March 2,
          1998).

10.23     Amended and Restated Employment Agreement, dated as of February 23,
          1998, between Kapson Senior Quarters Corp. and Raymond DioGuardi
          (incorporated by reference to Exhibit 12 to the Company's
          Solicitation/Recommendation Statement on Schedule 14D-9 dated March 2,
          1998).

10.24     Amended and Restated Escrow Agreement, dated as of February 23, 1998,
          and related letter agreement among Glenn Kaplan, Wayne L. Kaplan, Evan
          A. Kaplan, Kapson Senior Quarters Corp. and Prometheus Acquisition
          Corp. (incorporated by reference to Exhibit 13 to the Company's
          Solicitation/Recommendation Statement on Schedule 14D-9 dated March 2,
          1998).

21.1*     Subsidiaries of the Company.

27.1*     Financial Data Schedule.

----------

*         Filed herewith.


                                       53
<PAGE>

                          Index to Financial Statements


                                       F-1

<PAGE>

                          KAPSON SENIOR QUARTERS CORP.
                          INDEX TO FINANCIAL STATEMENTS

                                                                        Page

Report of Independent Accountants                                       F-2

Consolidated Balance Sheet of the Company as of December 31, 1997       F-3
      and 1996

Consolidated Statement of Operations of the Company for the years       F-4
      ended December 31, 1997 and 1996, and the Combined
      Statement of Operations of the Predecessor for the year
      ended December 31, 1995

Consolidated Statement of Shareholders' Equity of the Company for       F-5
      the years ended December 31, 1997 and 1996, and the
      Combined Statement of Shareholders' and Partners' Deficit
      of the Predecessor for the year ended December 31, 1995.

Consolidated Statement of Cash Flows of the Company for the years       F-6
      ended December 31, 1997 and 1996 and the Combined Statement
      of Cash Flows of the Predecessor for the year ended
      December 31, 1995

Notes to Consolidated and Combined Financial Statements              F-7 - F-24



                                       F-1
<PAGE>

Report of Independent Accountants

To the Shareholders of
Kapson Senior Quarters Corp.

We have audited the accompanying consolidated balance sheets of Kapson Senior
Quarters Corp. (the "Company" as defined in Note 1) as of December 31, 1997 and
1996, and the related consolidated statements of operations, shareholders'
equity and cash flows for each of the years then ended. We have also audited the
combined statements of operations, shareholders' and partners' deficit and cash
flows of The Kapson Group (the "Predecessor" as defined in Note 1) for the year
ended December 31, 1995. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Kapson
Senior Quarters Corp. as of December 31, 1997 and 1996 and the consolidated
results of its operations and its cash flows for each of the years then ended,
in conformity with generally accepted accounting principles. Further, in our
opinion, the combined financial statements referred to above present fairly, in
all material respects, the combined results of operations and cash flows of The
Kapson Group for the year ended December 31, 1995, in conformity with generally
accepted accounting principles.



                                                        Coopers & Lybrand L.L.P.


New York, New York
March 6, 1998


                                       F-2
<PAGE>

                          KAPSON SENIOR QUARTERS CORP.
                           CONSOLIDATED BALANCE SHEETS
                           DECEMBER 31, 1997 AND 1996

                                     ASSETS

<TABLE>
<CAPTION>
                                                                         1997             1996
                                                                    -------------    -------------
<S>                                                                 <C>              <C>
Current assets
   Cash and cash equivalents                                        $  21,848,929    $  16,053,307
   Accounts receivable                                                    688,024           80,329
   Prepaid expenses and other current assets                            1,162,820          574,733
   Deferred income taxes                                                  420,052          503,000
                                                                    -------------    -------------

       Total current assets                                            24,119,825       17,211,369

Property and equipment, net                                           103,809,324       58,377,735
Facility development costs                                             17,771,391        1,190,727
Restricted cash                                                         2,726,375        3,134,695
Deferred financing costs, net                                           3,674,129        2,595,407
Intangibles, net                                                        7,344,575        4,821,842
Investment in joint ventures                                            1,773,196          551,829
Other assets                                                            9,292,578        8,104,648
                                                                    -------------    -------------

       Total assets                                                 $ 170,511,393    $  95,988,252
                                                                    =============    =============

                      LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities
   Current portion of long-term debt                                $     729,731    $     943,658
   Accounts payable and accrued expenses                                6,163,529        3,294,040
   Deferred revenue                                                       910,071          519,168
                                                                    -------------    -------------

       Total current liabilities                                        7,803,331        4,756,866

Long-term debt                                                         84,220,586       72,408,516
Loan payable                                                              548,063          555,000
Resident security deposits                                              2,519,942        1,725,192
Deferred income taxes                                                     711,510        2,542,000
Deferred interest payable                                                      --          147,500
Construction retainage payable                                          1,219,879          613,057
                                                                    -------------    -------------

       Total liabilities                                               97,023,311       82,748,131
                                                                    -------------    -------------

Minority interest                                                       8,990,835          948,925
                                                                    -------------    -------------

Committments and Contingencies (Note 10)

Shareholders' equity
   Preferred stock; $.01 par value; 10,000,000 shares authorized,
      2,400,000 issued and outstanding                                     24,000               --
   Common stock; $.01 par value, 30,000,000 shares authorized,
      7,750,000 issued and outstanding                                     77,500           77,500
Additional paid-in capital                                             73,566,573       16,603,348
Accumulated deficit                                                    (9,170,826)      (4,389,652)
                                                                    -------------    -------------

       Total shareholders' equity                                      64,497,247       12,291,196
                                                                    -------------    -------------

       Total liabilities and shareholders' equity                   $ 170,511,393    $  95,988,252
                                                                    =============    =============
</TABLE>

 The accompanying notes are an integral part of these consolidated and combined
                             financial statements.


                                       F-3
<PAGE>

      CONSOLIDATED STATEMENTS OF OPERATIONS OF KAPSON SENIOR QUARTERS CORP.
                 FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996
          AND THE COMBINED STATEMENT OF OPERATIONS OF THE KAPSON GROUP
                      FOR THE YEAR ENDED DECEMBER 31, 1995

<TABLE>
<CAPTION>
                                                                            1997            1996            1995
                                                                    ------------    ------------    ------------
<S>                                                                  <C>             <C>             <C>
Revenues:
   Assisted living revenues                                          $34,881,837     $22,533,855     $14,275,484
   Management fees                                                     2,339,719       1,080,223         442,825
   Other - affiliates                                                         --              --          45,065
                                                                    ------------    ------------    ------------

       Total revenues                                                 37,221,556      23,614,078      14,763,374
                                                                    ------------    ------------    ------------

Operating expenses:
   Assisted living operating expenses                                 23,603,861      14,804,083       8,314,372
   Facility rent                                                       2,053,816              --              --
   General and administrative                                          5,246,731       3,648,407       1,658,658
   Depreciation and amortization                                       3,096,314       2,256,682       1,233,843
   Transactional expenses                                                678,280              --              --
                                                                    ------------    ------------    ------------

       Total operating expenses                                       34,679,002      20,709,172      11,206,873
                                                                    ------------    ------------    ------------

Operating income                                                       2,542,554       2,904,906       3,556,501

Equity in (loss) income from joint ventures                              (69,833)         76,829              --
Interest income                                                        1,686,186         462,812          44,234
Interest expense                                                      (6,480,345)     (6,514,389)     (3,935,796)
Other income (expense), net                                             (919,141)       (205,074)        (34,065)
                                                                    ------------    ------------    ------------

Loss before minority interest                                         (3,240,579)     (3,274,916)       (369,126)
Minority interest in net loss of partnerships                            368,886         924,264          15,845
                                                                    ------------    ------------    ------------

Loss before provision for income taxes and extraordinary item         (2,871,693)     (2,350,652)       (353,281)
Benefit (provision) for income taxes, deferred                         1,199,398      (2,039,000)             --
                                                                    ------------    ------------    ------------

Loss before extraordinary item                                        (1,672,295)     (4,389,652)       (353,281)
Extraordinary item, net                                                 (822,212)             --              --
                                                                    ------------    ------------    ------------

     Net loss                                                        ($2,494,507)    ($4,389,652)      ($353,281)

Preferred dividends                                                    2,286,667              --              --
                                                                    ------------    ------------    ------------
Net loss available to common shareholders                            ($4,781,174)    ($4,389,652)      ($353,281)
                                                                    ============    ============    ============

Loss per common share (basic and diluted):
Loss before extraordinary item                                            ($0.51)
Extraordinary loss                                                         (0.11)
                                                                    ------------
Net loss per share                                                        ($0.62)
                                                                    ============

Weighted average number of shares outstanding (basic and diluted)      7,750,000
                                                                    ============

Unaudited pro forma data:
   Loss before provision for income taxes and extraordinary item                     ($2,350,652)      ($353,281)
   Benefit for income taxes                                                              940,261         141,312
                                                                                    ------------    ------------
   Pro forma net loss                                                                ($1,410,391)      ($211,969)
                                                                                    ============    ============

   Pro forma loss per share (basic and diluted):
   Loss per share                                                                         ($0.26)         ($0.04)
                                                                                    ============    ============
   Pro forma weighted average numbe
      of common shares outstanding (basic and diluted)                                 5,510,000       4,758,000
                                                                                    ============    ============
</TABLE>

The accompanying notes are an integral part of these consolidated and combined
financial statements.


                                       F-4
<PAGE>

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY OF KAPSON SENIOR QUARTERS CORP.
                 FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996
                  AND THE COMBINED STATEMENT OF SHAREHOLDERS'
                   AND PARTNERS' DEFICIT OF THE KAPSON GROUP
                      FOR THE YEAR ENDED DECEMBER 31, 1995


<TABLE>
<CAPTION>
                                                               Preferred Stock         Common Stock
                                                             -------------------   -------------------
                                                               Shares    Amount      Shares    Amount
                                                             ---------   -------   ---------   -------
<S>                                                          <C>         <C>       <C>         <C>
December 31, 1994                                                                         --        --

Distributions                                                       --        --          --        --
Net loss                                                            --        --          --        --
                                                             ---------   -------   ---------   -------

December 31, 1995

Distributions to owners of Predecessor                              --        --          --        --
Contributions by owners of Predecessor                              --        --          --        --
Issuance of common stock for net assets of the Predecessor          --        --   4,150,000   $41,500
Issuance of common stock in initial public offering                 --        --   3,550,000    35,500
Issuance of common stock for purchase of minority interest          --        --      50,000       500
Net loss                                                            --        --          --        --
                                                             ---------   -------   ---------   -------

December 31, 1996                                                   --        --   7,750,000    77,500

Issuance of preferred stock, net                             2,400,000   $24,000          --        --
Dividends on preferred stock                                                  --          --        --
Net loss                                                            --        --          --        --
                                                             ---------   -------   ---------   -------

December 31, 1997                                            2,400,000   $24,000   7,750,000   $77,500
                                                             =========   =======   =========   =======

<CAPTION>
                                                              Additional                  Shareholders'
                                                               Paid In      Accumulated   and Partners'
                                                               Capital        Deficit        Deficit          Total
                                                             -----------    -----------    -----------    -----------
<S>                                                          <C>            <C>            <C>            <C>
December 31, 1994                                                     --             --    ($8,739,640)   ($8,739,640)

Distributions                                                         --             --       (718,536)      (718,536)
Net loss                                                              --             --       (353,281)      (353,281)
                                                             -----------    -----------    -----------    -----------

December 31, 1995                                                     --             --     (9,811,457)    (9,811,457)

Distributions to owners of Predecessor                       ($6,000,000)            --       (918,236)    (6,918,236)
Contributions by owners of Predecessor                                --             --      3,271,067      3,271,067
Issuance of common stock for net assets of the Predecessor    (7,500,126)            --      7,458,626             --
Issuance of common stock in initial public offering           29,603,974             --             --     29,639,474
Issuance of common stock for purchase of minority interest       499,500             --             --        500,000
Net loss                                                              --    ($4,389,652)            --     (4,389,652)
                                                             -----------    -----------    -----------    -----------

December 31, 1996                                             16,603,348     (4,389,652)            --     12,291,196

Issuance of preferred stock, net                              56,963,225             --             --     56,987,225
Dividends on preferred stock                                          --     (2,286,667)            --     (2,286,667)
Net loss                                                              --     (2,494,507)            --     (2,494,507)
                                                             -----------    -----------    -----------    -----------

December 31, 1997                                            $73,566,573    ($9,170,826)            --    $64,497,247
                                                             ===========    ===========    ===========    ===========
</TABLE>

The accompanying notes are an integral part of these consolidated and combined
financial statements.


                                      F-5
<PAGE>

      CONSOLIDATED STATEMENTS OF CASH FLOWS OF KAPSON SENIOR QUARTERS CORP.
                 FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996
          AND THE COMBINED STATEMENTS OF CASH FLOWS OF THE KAPSON GROUP
                      FOR THE YEAR ENDED DECEMBER 31, 1995

<TABLE>
<CAPTION>
                                                                                     1997            1996            1995
                                                                                 ------------    ------------    ------------
<S>                                                                              <C>             <C>             <C>
Cash flows from operating activities:
Net loss                                                                          ($2,494,507)    ($4,389,652)      ($353,281)
Adjustments to reconcile net loss to net cash (used in)
   provided by operating activities:
     Depreciation                                                                   2,608,920       2,090,996       1,233,843
     Amortization                                                                     638,331         437,378         226,456
     Deferred income taxes                                                         (1,747,542)      2,039,000              --
     Minority interest in net loss of combined partnerships                          (368,886)       (924,264)        (15,845)
     Equity in (loss) income from investment in joint ventures                         69,833         (76,829)             --
     Changes in other assets and liabilities, excluding the effect of acquired
     facilities:
                    Accounts receivable                                              (607,695)         (2,492)        (49,396)
                    Prepaid expenses and other current assets                        (559,841)       (208,915)        (50,422)
                    Restricted cash - resident security deposits                     (538,198)        (16,855)        (19,336)
                      Other assets                                                   (620,051)       (407,884)       (128,144)
                    Accounts payable and accrued expenses                           2,863,680          74,568       1,961,924
                    Accrued interest                                                       --        (363,198)        101,325
                    Resident security deposits                                        794,750         447,045          79,115
                    Deferred interest payable                                        (147,500)         42,300          57,700
                    Deferred revenue                                                  390,903         311,604          29,851
                    Deferred financing costs                                       (1,285,387)       (732,272)       (887,668)
                                                                                 ------------    ------------    ------------

                       Net cash (used in) provided by operating activities         (1,003,190)     (1,679,470)      2,186,122
                                                                                 ------------    ------------    ------------

Cash flows from investing activities:
Acquisition of facilities, (net of cash assumed of $0 in 1997
   and $518,000 in 1996)                                                          (29,680,000)     (9,856,250)             --
(Decrease) increase in restricted mortgage escrow funds                               946,518        (525,655)     (1,069,015)
Investment in joint venture                                                        (1,291,200)       (475,000)             --
Purchases and development of property and equipment                               (29,983,571)     (9,031,911)    (16,530,708)
Purchase of minority interests in partnership interests                                    --      (2,100,000)             --
Sale of minority interest in partnerships                                           1,200,000       1,200,000              --
Loans to joint venture partners                                                    (1,079,372)             --              --
Increase in other assets                                                                   --      (7,341,007)             --
Increase in development costs                                                      (4,424,493)             --              --
                                                                                 ------------    ------------    ------------

                       Net cash used in investing activities                      (64,312,118)    (28,129,823)    (17,599,723)
                                                                                 ------------    ------------    ------------

Cash flow from financing activities:
Proceeds from initial public offering, net of offering costs                               --      29,639,474              --
Proceeds from preferred stock offering, net of offering costs                      56,987,225              --              --
Proceeds from issuance of long-term debt                                           27,475,716      20,019,470      17,565,212
Principal payment of long-term debt                                               (15,877,573)       (721,043)        (78,039)
Proceeds from loan                                                                         --         555,000              --
Dividends                                                                          (2,286,667)             --              --
Due (from) to affiliates                                                                   --      (3,375,450)        150,648
Contributions to capital by shareholders and partners of the Predecessor                   --       3,271,067              --
Distributions to shareholders and partners of the Predecessor                              --      (6,918,236)       (718,536)
Increase in contributed capital by minority partners                                4,812,229              --              --
                                                                                 ------------    ------------    ------------

                       Net cash provided by financing activities                   71,110,930      42,470,282      16,919,285
                                                                                 ------------    ------------    ------------

                       Net increase in cash and cash equivalents                    5,795,622      12,660,989       1,505,684
Cash and cash equivalents, beginning of year                                       16,053,307       3,392,318       1,886,634
                                                                                 ------------    ------------    ------------

Cash and cash equivalents, end of year                                            $21,848,929     $16,053,307      $3,392,318
                                                                                 ============    ============    ============

Cash paid during the year for:
                       Interest, net of amounts capitalized                        $6,771,049      $6,877,587      $3,400,592
                                                                                 ============    ============    ============
                       Income taxes                                                   $79,356         $24,860              --
                                                                                 ============    ============    ============

Supplemental disclosure:
Issuance of common stock for purchase of remaining minority  interest
     in a facility                                                                         --        $500,000              --
                                                                                 ============    ============    ============
Issuance of notes receivable to finance minority partners capital
     investment                                                                    $2,398,567              --              --
                                                                                 ============    ============    ============
</TABLE>

 The accompanying notes are an integral part of these consolidated and combined
                             financial statements.


                                       F-6
<PAGE>

                          KAPSON SENIOR QUARTERS CORP.
             NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS

1. Operations:

The Company

Kapson Senior Quarters Corp. (the "Company") is an owner, operator, lessee,
manager and developer of assisted living facilities for senior citizens which
was incorporated under the General Corporation Law of Delaware on June 7, 1996
by three individual equal owners (the "Kaplans"). The Company was formed in
order to consolidate and expand the assisted living facility business of the
Kapson Group (the "Predecessor") of which the Kaplans were owners. The Company
had no operations prior to October 1, 1996.

On October 1, 1996, the Company sold 3,550,000 shares of common stock to the
public at a price of $10 per share in an initial public offering (the
"Offering"). The Company realized net proceeds from the Offering of
approximately $29.6 million, after deducting offering costs of approximately
$5.9 million. Concurrently with the completion of the Offering, the Predecessor
contributed at its historical cost, its interests in its wholly owned, majority
and minority owned facilities and management agreements with respect to
facilities which were owned by unrelated parties to the Company in exchange for
4,150,000 shares of common stock of the Company. In addition, simultaneously
with the Offering, the Company declared and distributed approximately $6.0
million in cash to the owners of the Predecessor to satisfy tax liabilities
incurred by the owners pertaining to the transfer of the Predecessor interests
in the facilities to the Company. This distribution was funded through the
Offering proceeds.

In July 1997, the Company sold 2,000,000 shares of its $2.00 Convertible
Exchangeable Preferred Stock at a price of $25.00 per share in a Rule 144A
Offering under the U.S. Securities Act of 1933, as amended (the "Preferred
Offering"). The Company realized net proceeds from the Preferred Offering of
approximately $47.4 million. Each share of Preferred Stock has a liquidation
preference of $25, plus accrued and unpaid dividends. Dividends will be
cumulative from the date of original issuance, and will be payable quarterly, in
arrears commencing September 30, 1997, at an annual rate of $2.00 per share in
cash. In August 1997, the Company sold an additional 400,000 shares of Preferred
Stock, representing the over allotment, and realized net proceeds of
approximately $9.6 million.

The Preferred Stock is convertible at any time prior to redemption, at the
option of the holder, into shares of the Company's Common Stock at a conversion
rate equal to the liquidation preference divided by $12.98. The Preferred Stock
is not redeemable prior to July 1, 2000. The Preferred Stock is exchangeable, in
whole or in part, at the option of the Company on any dividend payment date
beginning September 30, 1997 for the Company's 8% Convertible Subordinated Notes
(the "Notes") at the rate of $1,000 principle amount of Notes for each 40 shares
of Preferred Stock. As of December 31, 1997 none of the Company's Preferred
Stock had been exchanged.


                                       F-7
<PAGE>

The Predecessor

The Predecessor represents a combination of the businesses of Sub Chapter S
Corporations, Partnerships or Limited Liability Companies which owned six
assisted living facilities, additional facilities under development (including
joint venture interests), an entity that provides facility management services
to unrelated entities and an entity that provided administrative support to the
Predecessor entities and the Company.

The assisted living facilities owned and operated by the Predecessor were as
follows:


              FACILITY                           FORM                        %
              --------                           ----                        -

Wholly and Majority Owned
  Senior Quarters at Stamford               Sub Chapter S                   100
  Senior Quarters at Huntington Station     Sub Chapter S                   100
  Senior Quarters at Centereach I           General Partnership             100
  Senior Quarters at Centereach II          Sub Chapter S                   100
*Town Gate East                             Limited Liability Company       100
*Town Gate Manor                            Limited Liability Company       100
  Senior Quarters at Chestnut Ridge         Limited Liability Company       50
  Senior Quarters at East Northport         Limited Partnership             50

Minority Interests
  Senior Quarters at Jamesburg              Limited Liability Company       11
  Senior Quarters at Glen Riddle            Limited Partnership             10
*Senior Quarters at Montville               Limited Partnership            23.75


*Ownership percentages were acquired or sold in April 1996 (Notes 4 and 5)

Basis of Presentation

The accompanying consolidated financial statements include the accounts of the
Company's wholly owned subsidiaries and majority owned partnership investments.
The Company accounts for its minority owned partnership investments under the
equity method. All significant intercompany transactions and accounts have been
eliminated in consolidation. The 1996 consolidated statements of operations,
shareholders' equity and cash flows and related disclosures reflect the twelve
months of operations of the assisted living business consisting of the nine
months ended September 30, 1996 under the legal structure of the Predecessor and
the three months ended December 31, 1996 under the legal structure of the
Company and are collectively defined and referred to herein as those of the
Company.

The combined financial statements for the year ended December 31, 1995 include
the operations associated with the wholly and majority owned entities of the
Predecessor listed above. Since the entities have common ownership and
management interest, the assets and liabilities are recorded at historical cost.
Investments in minority owned partnership investments are accounted for under
the equity method since the Company is one of the general partners and exercises
significant influence over the entities. All significant intercompany
transactions and accounts have been eliminated in combination.

Minority interests represent the net equity attributable to non-affiliated
investors of the Company or the Predecessor.


                                       F-8
<PAGE>

Disclosures made herein with respect to the years ended December 31, 1995 and
during the nine months ended September 30, 1996 are to be read as disclosures of
the Predecessor. All other disclosures unless specifically identified are
disclosures of the Company.

2. Summary of Significant Accounting Policies:

Estimates

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

Revenues

Assisted living revenues are recorded when services are rendered and consist of
resident fees for basic housing, support services and fees associated with
additional services such as personalized health and support services. Management
fees are recorded when the respective services are rendered.

Property and Equipment

Property and equipment are stated at original cost less accumulated
depreciation. Fixed asset depreciation is calculated over the assets' estimated
useful lives using the straight-line method and leasehold improvements are
amortized over the life of the improvement or the lease term whichever is
shorter, as follows:

            Buildings and improvements          35 years
            Furniture and equipment             7-10 years

Interest incurred during construction periods is capitalized as part of the
building costs. Maintenance and repairs are expensed as incurred; renewals and
improvements are capitalized. Upon retirement or disposal, the asset cost and
related accumulated depreciation and amortization are eliminated from the
respective accounts and the resulting gain or loss, if any, is included in the
results of operations.

Intangible Assets

Intangible assets consist of the excess of cost over the fair value of net
assets of acquired facilities which is amortized on the straight-line method
over a period of 15 to 40 years, and a covenant not to compete which is
amortized on a straight-line basis over 5 years. Accumulated amortization at
December 31, 1997 and 1996 was $643,345 and $214,076, respectively. Amortization
expense was $429,269 and $214,076 for the years ended December 31, 1997 and
1996, respectively.


                                       F-9
<PAGE>

Long-Lived Assets

If there is an event or a change in circumstances adversely impacting the
recoverability of long-lived assets, including goodwill, the Company's policy is
to assess any impairment in value by making a comparison of the current and
projected operating cash flows of the asset over its remaining useful life, on
an undiscounted basis, to the carrying amount of the asset. Such carrying
amounts would be adjusted, if necessary, to reflect an impairment in the value
of the assets.

Facility Development Costs

Facility development costs include direct costs related to development and
construction of facilities. When a project is completed, related costs are
transferred to property and equipment. If a project is abandoned, all costs
previously capitalized are expensed.

Deferred Financing Costs

Deferred financing costs are amortized over the term of the related debt using
the interest method. Accumulated amortization was $351,613 and $523,877 at
December 31, 1997 and 1996, respectively.

Income Taxes

Effective October 1, 1996, the Company recognizes deferred tax liabilities and
assets for the expected future tax consequences of events that have been
included in the financial statements or tax returns. Deferred tax liabilities
and assets are determined based on the differences between the financial
statement and tax bases of assets and liabilities using enacted tax rates in
effect for the year in which the differences are expected to reverse. The
Company recorded a deferred tax liability of $2,400,000 for the year ended
December 31, 1996 resulting from the change in tax status from a non-taxable to
a taxable entity in connection with the Company's Offering.

The businesses comprising the Predecessor elected to be taxed as either S
Corporations, Partnerships or Limited Liability Companies pursuant to the
provisions of the Internal Revenue Code and, as such, were not subject to
federal or state income taxes because their taxable income or loss accrues to
individual shareholders, partners or members, respectively.

Restricted Cash

Included in restricted cash are resident security deposits and escrowed funds
that cannot be used in operating activities.


                                      F-10
<PAGE>

Cash Equivalents

The Company considers all investments with maturities, from the date of
purchase, of three months or less to be cash equivalents.

Pre-opening Costs

Costs incurred in connection with preparing facility units for initial rental
are expensed as incurred.

Investments in Joint Ventures

The Company accounts for its interest in minority owned non-controlled joint
ventures under the equity method.

Pro Forma Presentation (unaudited)

The pro forma net loss per share for the year ended December 31, 1995 was
determined based upon the number of shares of common stock assumed to be issued
by the Company in the Offering to fund the approximately $6,000,000 distribution
based on the Offering price of $10 per share (608,000) plus, the issuance of the
4,150,000 shares of common stock to the Kaplans in the exchange. The $6,000,000
distribution was made to satisfy the tax liabilities of the Kaplans expected to
be incurred pertaining to the transfer of the Predecessor interests in the
facilities to the Company. The weighted average shares used to determine pro
forma net loss for the year ended December 31, 1996 is based upon the shares
issued to the Kaplans in the exchange (4,150,000), the shares issued in the
Offering (3,550,000) and the shares issued to acquire the remaining minority
interest in Senior Quarters at East Northport (50,000).

The pro forma benefit for income taxes for the Company and the Predecessor is
based on the historical financial data of the Company and the Predecessor as if
the Company and the entities comprising the Predecessor had operated as taxable
corporations for all periods presented and is recorded at the statutory rate in
effect during the period (40%).

Earnings per share are not presented for 1996 and 1995 on an historical basis
since the Predecessor operated as a group of non-taxable entities. In addition,
no shares of common stock were issued until the Offering, therefore, disclosure
of historical earnings per share would not be meaningful.

Impact of Recently Issued Accounting Pronouncements

In 1997, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 128, "Earnings per Share" ("SFAS No. 128"). SFAS No.
128 replaced the previously reported primary and fully diluted earnings per
share with basic and diluted earnings per share. Unlike primary earnings per
share, basic earnings per share excludes any dilutive effects of options,
warrants, and convertible securities. Diluted earnings per share is very similar
to the previously


                                     F-11
<PAGE>

reported fully diluted earnings per share. All earnings per share amounts for
all periods have been restated to conform to the SFAS No. 128 requirements. The
effect of the exercise of stock options under the treasury stock method and the
conversion of preferred stock into common stock are not reflected in diluted
earnings per share since they are anti-dilutive.

In 1997, the Company adopted Financial Accounting Standards Board Statement of
Financial Accounting Standards No. 129, "Disclosure of Information about Capital
Structure" which requires that descriptive information about securities be shown
in the financial statements. The adoption of this statement did not have any
impact on the Company's disclosures in the financial statements for the year
ended December 31, 1997.

In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS
No. 130"), which requires that changes in comprehensive income be shown in a
financial statement with the same prominence as other financial statement
disclosures. SFAS No. 130 becomes effective in fiscal year 1998. Management
believes that the adoption of this statement will not have any impact on the
Company's financial statements.

In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures About Segments of an
Enterprise and Related Information" ("SFAS No. 131") , which changes the way
public companies report information about segments. SFAS No. 131, which is based
on the management approach to segment reporting, includes requirements to report
selected segment information quarterly and entity-wide disclosures about
products and services, major customers and the material countries in which the
entity holds and reports revenues. SFAS No. 131 becomes effective in fiscal year
1998. Management believes that the adoption of this statement will not have any
impact on the Company's financial statements.

Reclassification

Certain items have been reclassified to conform with the current year
presentation.

3. Property and Equipment:

Property and equipment are stated at cost and consist of the following:


                                       1997             1996
                                       ----             ----
Land                               $15,776,244       $4,800,644
Buildings and improvements          90,179,652       57,334,170
Furniture and equipment              9,342,146        6,972,718
Leasehold improvements               1,849,999               --
                                 -------------    -------------
                                   117,148,041       69,107,532
Less, accumulated depreciation     (13,338,717)     (10,729,797)
                                 -------------    -------------
Property and equipment, net       $103,809,324      $58,377,735
                                 =============    =============


                                      F-12
<PAGE>

Depreciation expense was $2,608,920, $2,090,996, $1,233,843 for the years ended
December 31, 1997, 1996, and 1995, respectively.

Capitalized interest costs during development approximated $1,362,000, $459,000
and $1,105,000 for the years ended December 31, 1997, 1996, and 1995,
respectively.

4. Equity Investments:

The Company has an 11% general partnership interest in a limited partnership
(Senior Quarters at Glen Riddle), a 10% interest in a limited liability company
(Senior Quarters at Jamesburg), a 23.75% interest in a limited partnership
(Senior Quarters at Montville) and a 50% interest in a limited liability company
(Muhlenberg Development LLC). The equity interest in Senior Quarters at
Montville was purchased for $475,000 on April 1, 1996. The equity interest in
Muhlenberg was purchased for $1,291,200 in October 1997. The Company does not
have operational control of any of these entities. The joint venture agreements,
with the exception of Muhlenberg, provide the Company's joint venture partners
with preference distributions on their initial capital contributions and
provisions for a return of capital before any distribution can be made to the
Company. Senior Quarters at Glen Riddle and Senior Quarters at Jamesburg
commenced operations during 1996. Muhlenberg Development LLC is currently under
development. Summarized financial information for these joint ventures is as
follows:


                                                   December 31,
                                           ----------------------------
Balance Sheet                                  1997            1996
                                               ----            ----
Assets:
             Property and equipment, net   $ 29,061,144    $ 26,757,516
             Construction in progress         1,756,814          86,938
             Restricted investments           6,145,662       8,820,661
             Other assets                     4,727,772       4,182,373
                                           ------------    ------------
                                           $ 41,691,392    $ 39,847,488
                                           ============    ============
Liabilities and partners' capital:
             Notes payable                   32,108,930    $ 32,063,029
             Other liabilities                2,788,612       3,294,744
             Partners'/members' capital       6,793,850       4,489,715
                                           ------------    ------------
                                           $ 41,691,392    $ 39,847,488
                                           ============    ============
Income Statement
             Revenues                         8,690,557    $  4,279,141
             Operating expenses              (6,671,718)     (3,970,018)
             Other expense, net              (2,269,606)     (1,013,609)
                                           ------------    ------------

             Net loss                      $   (250,767)   $   (704,486)
                                           ============    ============


                                      F-13
<PAGE>

5. Acquisitions and Dispositions:

In March 1997, the Company sold a 49.9% interest in its wholly-owned subsidiary
Kapson Briarcliff Manor, LLC for $1.2 million.

In April 1997, the Company formed a joint venture in which it has a 51% equity
interest and purchased a 90 unit facility in Albany, New York for $3.8 million
in cash.

In September 1997, the Company completed the acquisition of a 126 unit facility
located in Lynbrook, New York for $25.8 million which was funded by a mortgage
note of $10.5 million and $15.3 million in cash.

During 1996, the Company purchased an interest in three assisted living
facilities for $12,975,000, of which $500,000 was financed through the issuance
of common stock. In addition, the Predecessor sold an interest in one facility
for $1,200,000.

Unaudited Pro Forma Financial Information

The unaudited pro forma financial information set forth below is based upon the
Company's and the Predecessor's historical statements of operations for the
years ended December 31, 1997, and 1996, adjusted to give effect to these
transactions as if they occurred on January 1, 1996.

The unaudited pro forma financial information is presented for informational
purposes only and may not be indicative of what actual results of operations
would have been had the acquisitions and disposition occurred on January 1,
1996, nor does it purport to represent the results of operations for future
periods.

                                       Unaudited pro forma data
                                    For the year ended December 31,
                                    -------------------------------
                                           1997        1996
                                           ----        ----

Total revenue                            $ 41,795    $ 25,877
Loss before extraordinary item               (626)     (2,984)
Extraordinary item, net of tax benefit       (822)         --
Net loss                                   (1,448)     (2,984)
Basic and diluted net loss per common                       )
 share                                   $   (.48)   $   (.54)

6. Joint Venture Agreements

Joint venture arrangements where the Company has an equity ownership greater
than 50% have been consolidated because minority shareholders do not have
participatory rights but protective rights.

In March 1997, the Company announced the formation of a joint venture through
which it intends to develop six assisted living facilities in North and South
Carolina. In October 1997, the


                                     F-14
<PAGE>

Company and its joint venture partner obtained $7.0 million in financing with a
bank and commenced construction on a 100 unit facility located in Lake Wylie,
South Carolina. The Company has a 50.1% equity interest in this project.

In June and August 1997, the Company formed two joint ventures with a partner in
which it has a 51% equity interest for purposes of constructing and operating a
142 unit facility in Kew Gardens, New York and a 205 unit facility in Riverdale,
New York. During the third quarter of 1997, the Company and its joint venture
partner obtained approximately $46 million in financing and commenced
construction on these facilities.

In September 1997, the Company entered into a joint venture agreement in which
it owns a 50.1% equity interest in a parcel of land for purposes of constructing
and operating a 100 unit assisted living facility in Stratford, Connecticut.
During the fourth quarter of 1997, the Company and its joint venture partner
obtained $12.7 million in financing and commenced construction on this facility.

In September 1997, the Company entered into a joint venture agreement in which
it owns a 51% interest in a forty-five year operating lease to renovate an
existing building for purposes of operating a 216 unit assisted living facility
in New York City, New York. Current annual lease payments are approximately
$720,000. During the first quarter of 1998 the Company and its joint venture
partner obtained up to $23 million in financing and commenced construction on
this facility. The Company does not have a purchase option.


                                      F-15
<PAGE>

7.  Long-Term Debt:

<TABLE>
<CAPTION>
                                                                                          December 31,
                                                                                   -------------------------
                                                                                      1997           1996
                                                                                      ----           ----
<S>                                                                                <C>           <C>
Mortgage note payable to a financial institution bearing interest at 7.605% per
annum due in monthly principal and interest installments of $119,333 through
December 1, 2005 when unpaid balance of $12,954,978 is due. (A)                    $15,515,960   $15,757,790

Mortgage note payable to a financial institution bearing interest at 4% above
the financial institution's base lending rate This mortgage was paid off in
September 1997. (A) (Note 11)                                                               --     6,763,544

Mortgage note payable to a financial institution bearing interest at 4% above
the financial institution's base lending rate. This mortgage was paid off in
September 1997. (A) (Note 11)                                                               --     8,547,322

Mortgage note payable to a financial institution with interest only payments
through December 1996. Beginning January 1997, monthly payments of principal and
interest at 4.55% above US Treasury Notes (10.55% at December 31, 1997) are due
and matures December 2006. (A) (B) (E) (Note 8)                                      7,935,925     8,000,000

Construction note payable to a financial institution, maturing June 1, 2036,
bearing interest at 9.325% per annum and monthly payments of principal and
interest of $164,072                                                                19,483,700    19,320,238

Mortgage note payable to a financial institution with interest only payments
through March 1997. Beginning April 1997, monthly payments of principal and
interest at 4.3% above US Treasury Notes (10.78% at December 31, 1997) are due
and matures April 2006. (A) (C) (E) (Note 8)                                         6,446,157     6,484,375

Mortgage note payable to a financial institution with interest only payments
through March 1997. Beginning April 1997, monthly payments of principal and
interest at 4.3% above US Treasury Notes (10.78% at December 31, 1997) are due
and matures April 2006. (A) (C) (E) (Note 8)                                         3,867,694     3,890,625

Mortgage note payable to a financial institution, maturing July 15, 2017 and
providing up to $12,810,000 in funding, bearing interest at the prime rate plus
3.5% (10.82% at December 31, 1997), during the construction phase, during which
only payments of interest are due. (D) (E) (Note 8)                                 12,810,000     4,588,280

Construction note payable to a financial institution with interest only payments
through January 25, 1999 bearing interest at LIBOR plus 2.4%                           501,468            --

Construction note payable to a financial institution with interest only payments
through June 6, 1999 bearing interest at LIBOR plus 2.3%                             3,776,710            --

Construction note payable to a financial institution with interest only payments
through August 21, 1999 bearing interest at LIBOR plus 2.3%                          4,227,993            --

Mortgage note payable to a financial institution with interest at LIBOR plus
1.75% maturing on September 29, 2002. (A)                                           10,384,710            --

                                                                                   -----------   -----------
                                                                                    84,950,317    73,352,174
Less, current portion                                                                  729,731       943,658
                                                                                   -----------   -----------
Long-term portion                                                                  $84,220,586   $72,408,516
                                                                                   ===========   ===========
</TABLE>


                                      F-16
<PAGE>

      (A)   The mortgage notes are collateralized by the facilities' property
            and equipment.

      (B)   Monthly principal and interest payments are based upon a 25-year
            amortization period. At maturity, the Company has an option to renew
            the note for ten years at a rate of 6.75% above U.S. Treasury Notes
            increased annually by 30 basis points. Monthly principal and
            interest payments will be based upon a 16-year amortization period.

      (C)   Monthly principal and interest payments are based upon a 25-year
            amortization period. At maturity, the Company has an option to renew
            the note for ten years at a rate of 6.25% above U.S. Treasury Notes
            increased annually by 30 basis points. Monthly principal and
            interest payments will be based upon a 16-year amortization period.

      (D)   Monthly principal and interest payments are based upon a 25-year
            amortization period. At maturity, the Company has an option to renew
            the note for ten years at a rate of 6.25% above U.S. Treasury Notes
            increased annually by 30 basis points.

      (E)   Various restrictive covenants exist.

Principal payments on long-term debt as of December 31, 1997 are as follows:

                        Years ended
                        December 31,
                        ------------
                        1998                       $  729,731
                        1999                          948,892
                        2000                        1,063,636
                        2001                        1,136,870
                        200                         1,217,972
                        Thereafter                 79,853,216

8. Credit Facilities:

The Company has available a $140 million recourse line of credit (the "Credit
Facility") from Health Care REIT Inc. The Credit Facility provides both
construction and permanent financing as well as operating leases.

Construction financings, which can also be used for acquisitions, generally
expire on the earlier of fifteen months after the closing or date of licensure.
Interest on construction financing is 3.5% above the base rate announced by
National City Bank of Cleveland. Monthly payments of interest only are required.
At the expiration date the construction financing is automatically converted to
a permanent financing.

Permanent financings ("Mortgage Notes") are for initial terms of 10 years, with
a 10-year renewal at the Company's option. Interest, which is fixed on the date
of the permanent financing, is charged at 4.0% above comparable U.S. Treasury
Notes during the initial financing term and


                                      F-17
<PAGE>

will be increased annually by 25 basis points during each subsequent year of the
initial and renewal terms. Monthly payments of interest only are due during the
first year, after which monthly payments of principal and interest are due based
on a 25-year amortization period.

The Credit Facility also provides for financings structured as operating leases.
Operating leases are for initial terms of 10 years, with three (3) five year
renewals. Interest is charged at 3.75% above comparable U.S. Treasury Notes
during the initial term and will be increased by 25 basis points during the
second and each subsequent year of the initial and renewal terms. The amount of
financings committed for these long-term operating leases was $28,674,457 at
December 31, 1997. Commitments for operating leases reduce the amount available
under the facility.

Effective November 10, 1997, interest on new borrowings will be 3.25% above
comparable U.S. Treasury Notes and will be increased by 15 basis points each
year. The interest rate for all borrowings, including operating leases,
outstanding at December 31, 1997 will be reduced on a financing-by-financing
basis by 50 basis points as new borrowings are closed which equal or exceed the
amount of borrowings currently outstanding. The agreement provides for the
Company to pay a fee of 25 basis points on the unused portion of the facility.

The Credit Facility is collateralized by the Company's real estate, equipment
and accounts receivable. At December 31, 1997, the Company has available under
the Credit Facility approximately $80,140,543.

The Credit Facility requires, as a condition to future drawings, certain
financial covenants on the date of each closing, to include requirements of
minimum net worth and cash balances, payment coverage, current and debt to
equity ratios and non-financial covenants to include changes in ownership,
additional debt on a facility and modification of material contracts, all as
further defined in the facility.

At December 31, 1997, the Company was not in compliance with certain of these
covenants. Waiver on default of certain financial covenants was received from
HCR and the facility was subsequently amended to revise certain financial
covenants to reflect the Company's current and future business environment.

In September 1997, the Company entered into a $50 million Non-Revolving Credit
Facility with GMAC Mortgage Corporation to provide construction and acquisition
financing collateralized by assisted living or independent living facilities.
Amounts borrowed will vary depending on the value of the facility and will bear
interest rates based on the 30-day LIBOR Rate plus 2.45% to 3%. The credit
facility has a two year term with acquisition and construction loans payable in
full after three and five years, respectively. The amount available under the
facility, which at December 31, 1997 is $39.2 million, has been reduced by the
gross lease payments guaranteed by the Company at one facility.


                                      F-18
<PAGE>

In February 1997, the Company was granted a line of credit with Fleet Bank for
the issuance of standby letters of credit in the aggregate amount of up to
$6,359,500. As of December 31, 1997, approximately $2,189,250 was available
under the line of credit.

9. Income Taxes:

Prior to October 1, 1996, the Predecessor was not subject to federal and state
income taxes and the Company had no operations until the Offering. The deferred
tax provision was $2,039,000 for the three months ended December 31, 1996.

The Company recorded a one time, non cash charge to earnings of $2,400,000 to
reflect the impact of deferred tax liabilities incurred relating to the change
in tax status of the Company to a taxable corporation. The deferred tax
liabilities arose due to the difference in the tax basis of the Company's
property and equipment and the basis recorded for financial reporting purposes.
The change in tax status was required as part of the Offering.

The deferred tax effects of temporary differences as of December 31, 1997 and
1996 are as follows:

                                                      1997           1996
                                                  -----------    -----------
Deferred tax assets:
   Net operating losses                           $ 2,050,000    $   236,000
   Deferred revenue                                   363,672        208,000
   Deferred interest                                       --         59,000
   Accrued liabilities                                 56,023             --
                                                  -----------    -----------
Deferred tax assets                                 2,469,695        503,000

Deferred tax liabilities:
   Depreciation of property and equipment           2,761,153      2,542,000
                                                  -----------    -----------
Net deferred tax liabilities                      $   291,458    $ 2,039,000
                                                  ===========    ===========

The difference between the actual income tax provision (benefit) and the income
tax provision (benefit) computed by applying the statutory federal income tax
rate to income (loss) before provision (benefit) for income taxes is
attributable to the following:

                                                      1997           1996
                                                  -----------    -----------
Benefit at statutory rate                         $  (976,375)   $  (799,000)
Benefit attributable to Predecessor                        --        599,000
Provision recorded attributable to change in
  tax status, including state income tax impact            --      2,400,000
State NOL, net of federal                            (109,759)       (89,000)
Adjustment to                                         (56,718)            --
  deferred tax assets
Other                                                 (56,546)       (72,000)
                                                  -----------    -----------
                                                  $1,199, 398    $ 2,039,000
                                                  ===========    ===========


                                      F-19
<PAGE>

The Company's net operating loss carryforwards for income tax purposes which
approximates $5,125,000, expire in 2011 and 2012.

10. Commitments and Contingencies:

Management Agreements

The Company has agreements with unaffiliated parties to manage their assisted
living facilities. These agreements, which range primarily from three to ten
years with five year renewal options, expire at various dates from 1997 through
2007. The fees received under these agreements are generally 5% of gross rental
revenue of the facility and incentive fees related to facility operating
results.

Legal Proceedings

The Company is named as a defendant in various lawsuits which arise in the
normal course of business. Although the ultimate outcome of these proceedings
cannot be determined, management believes that any outcome will not have a
material adverse effect on the Company's financial position or results of
operations.

Operating Leases

The Company is obligated under certain long term non-cancelable operating leases
for four assisted living facilities, its corporate office and office equipment
expiring at various dates through 2042. Future minimum lease payments required
under all operating leases as of December 31, 1997 are as follows:

                        Years ended
                        December 31,
                        ------------
                             1998                 $6,560,670
                             1999                  7,134,517
                             2000                  6,983,452
                             2001                  6,421,441
                             2002                  6,527,681

Total rent expense was approximately $ 2,600,000, $385,000 and $90,000 for the
years ended December 31, 1997, 1996 and 1995, respectively.

Stock Options

The Company adopted the 1996 Stock Incentive Plan (the "Plan") under which
options may be awarded to key employees. Pursuant to the Plan, a maximum of
600,000 shares of common stock may be issued. The Plan provides for the grant of
any or all of the following types of


                                      F-20
<PAGE>

awards to eligible employees: (i) stock options, including incentive stock
options and non-qualified stock options; (ii) stock appreciation rights, in
tandem with stock options or freestanding; (iii) restricted stock; and (iv)
performance shares. In addition, the Plan provides for the non-discretionary
award of stock options to non-employee directors of the Company as a portion of
their annual retainer fee. Awards may be granted singly, in combination, or in
tandem, as determined by the Stock Option Committee. The maximum number of
shares of common stock subject to stock options, performance shares, restricted
stock or stock appreciation rights that may be granted to any individual under
the Plan is 50,000 for each fiscal year of the Company during the term of the
Plan. The exercise price may not be less than the fair market value of the
common stock at the time of grant. The options expire ten years from date of
grant and vest ratably over four years.

A summary of the Company's stock options is as follows:

<TABLE>
<CAPTION>
                                                                1997                      1996
                                                                ----                      ----
                                                                      Exercise                 Exercise
                                                         Shares         Price        Shares      Price
                                                         -------    ------------     -------    -------
<S>                                                      <C>        <C>              <C>        <C>
Options outstanding, beginning of year                   105,000             $10          --         --
Granted                                                   39,350    $9.625 to 10     117,500        $10
Canceled or lapsed                                            --              --     (12,500)        --
                                                         -------    ------------     -------    -------
Options outstanding, end of year                         144,350    $9.625 to 10     105,000        $10
                                                         =======    ============     =======    =======
Options exercisable, end of year                          26,250                          --
                                                         =======
Options available for grant, end of year                 455,650                     495,000
                                                         =======                     =======
Weighted-average fair value of options                     $3.88                       $4.61
   granted during the year
</TABLE>

The Company has adopted the disclosure-only provision of SFAS 123, "Accounting
for Stock-Based Compensation." Accordingly, no compensation cost has been
recognized for the stock incentive plan. Had the Company recorded compensation
cost of the Plan based upon the fair value at grant date, the Company's net loss
and loss per share for the years ended December 31, 1997 and 1996 would have
been the following as adjusted amounts indicated below (in thousands, except per
share amounts):

<TABLE>
<CAPTION>
                                                           1997 Actual    1996 Proforma
                                                           -----------    -------------
<S>                                                        <C>            <C>
Net loss  - as reported                                      $(2,494)       $( 1,410)
Net loss  - as adjusted                                      $(2,630)       $( 1,444)
Basic and diluted loss per common share - as reported        $  (.62)          $(.26)
Basic and diluted loss per common share - as adjusted        $  (.63)          $(.26)
</TABLE>

The fair value of stock options used to compute net loss and loss per share in
accordance with SFAS No. 123 is the estimated present value at grant using the
Black-Scholes option-pricing model with the


                                      F-21
<PAGE>

following weighted average assumptions for options granted during 1997 and 1996
respectively: dividend yield of 0%; expected volatility of 30.97% and 41.09%; a
risk free interest rate of 6.44% and 5.59% and an expected holding period of 5
years. The remaining contractual life of options outstanding at December 31,
1997 is 8.9 years.

Employment Agreements

The Company has entered into employment agreements with the Kaplans, each of
whom will receive annual cash compensation and a bonus pursuant to substantially
identical five year employment contracts. These agreements are renewable from
year to year after the initial five year period. Each contract provides for a
salary of $237,000, increased annually by a percentage equal to the Consumer
Price Index. Each contract also provides for a discretionary bonus to be set by
the Company's Compensation Committee, based on the earnings of the Company and
other criteria determined by the Compensation Committee. If the executive
covered by the contract is terminated by the Company without cause, the
executive shall be paid the salary provided for in the contract for the
remainder of the term of the contract but in no event less than one year's
salary. In addition, the contract provides for a payment equal to two year's
base salary upon the occurrence of certain events relating to a change of
control of the Company and subsequent termination. Each executive officer has
agreed to devote substantially all of his time to the Company and not to compete
with the Company while employed thereby and for a period of one year from the
date of termination unless such executive officer is terminated without cause.

Operating Agreements

The Kaplans, due to New York State law, are required to individually be the
licensed operators of all of the Company's assisted living facilities located in
New York. The Company has entered into operating agreements with the Kaplans,
relating to the facilities, for a term of 25 years at a net fee of 3.5% of the
respective facilities' first $23.0 million in revenues and .2% thereafter. Total
payments to the Kaplans approximated $1,302,000 in 1997 and $219,000 in 1996 and
are included in other income (expense), in the accompanying consolidated
statement of operations.

11. Extraordinary Item:

In September 1997, the Company prepaid approximately $15 million in debt and
$1.6 million in equity participation fees relating to mortgage loans on two
facilities. The Company recorded an extraordinary loss on the early retirement
of this debt of approximately $1.4 million before the benefit for income taxes
($822,000 net of income tax benefit.)

12. Employee Benefit Plan:

During 1995, the Company established a 401(k) plan for all employees that meet
minimum employment criteria. The plan provides that the Company may, at its
option, contribute to the plan up to 6% of employees' salary. Employees are
always 100% vested in their own contributions and vested in Company
contributions over seven years. No contributions have been made for the years
ended December 31, 1997, 1996 and 1995.


                                      F-22
<PAGE>

13. Concentration of Risk:

Business and Credit Concentration

Concentration of credit risk with respect to resident receivables is limited due
to the large number of residents comprising the resident roster and the policy
of the Company to obtain security deposits and personal guarantees from third
parties in many instances.

Financial Risk

The Company maintains its cash primarily at two financial institutions which
management believes are of high credit quality.

Geographic Concentration

The Company's facilities are located primarily in the Northeast region of the
United States. This concentration imposes on the Company certain risks, which
include local economic conditions, that are not within management's control.

14. Fair Value of Financial Instruments:

Cash and cash equivalents, and variable rate and fixed rate mortgage notes
payable are reflected in the accompanying balance sheet at amounts considered by
management to reasonably approximate fair value. Management estimates the fair
value of its long-term fixed rate notes payable using discounted cash flow
analysis based upon the Company's current borrowing rate for debt with similar
maturities.

15. Subsequent Event:

On March 2, 1998, Prometheus Acquisition Corp., (the "Offeror") a wholly owned
subsidiary of Prometheus Senior Quarters, LLC, ("Parent") and an affiliate of
Lazard Freres Real Estate Investors, L.L.C., ("LFREI"), commenced a tender offer
to purchase all of the outstanding shares of common stock of the Company at a
price of $14.50 per share, net to the seller in cash, without interest, and all
of the outstanding shares of $2.00 Convertible Exchangeable Preferred Stock,
(together with the Common Stock, the "Shares"), of the Company at a price of
$27.93 per share, net to the seller in cash without interest, upon the terms and
subject to the conditions set forth in the Offer to Purchase, dated March 2,
1998. The Offer is conditioned upon, among other things, there being validly
tendered and not withdrawn prior to the expiration date of the Offer that number
of shares of Common Stock representing at least a majority of the outstanding
shares of Common Stock on a fully diluted basis, and for the purpose of the
satisfaction of such condition, the tender of each share of Preferred Stock will
be deemed to be the tender of 1.92604 shares of Common Stock.

The Offer is being made pursuant to an Amended and Restated Agreement and Plan
of Merger, dated as of February 23, 1998 (the "Merger Agreement"), among the
Company, Parent and the Offeror, pursuant to which, following the consummation
of the Offer and the satisfaction or waiver of certain conditions set forth in
the Merger Agreement and in accordance with the General Corporation Law of the
State of Delaware (the "DGCL), the Offeror will be merged with


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and into the Company (the "Merger" and, together with the Offer, the
"Transaction"), the separate corporate existence of the Offeror will cease and
the Company will continue as the surviving corporation following the Merger (the
"Surviving Corporation"). At the effective time of the Merger (the "Effective
Time"), each outstanding Share (other than Shares held in the treasury of the
Company, Shares owned by any subsidiary of the Company, Shares owned by the
Offeror or Parent or Shares with respect to which appraisal rights are properly
exercised under the DGCL) will be converted into and represent the right to
receive, in the case of the Common Stock, the Common Stock Offer Price, and in
the case of the Preferred Stock, the Preferred Stock Offer Price, in each case
in cash without interest.

The accompanying consolidated statement of operations for the year ended Dec.
31, 1997 includes $678,280 of transactional expenses relating to the tender
offer.


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