FORM 10-K
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 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, 1996

                                       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)

        242 Crossways Park West
          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 X   No ___

Indicate by check mark if disclosure of delinquent  filers  pursuant to Item 405
of Regulation  S-K is not contained  herein,  and will not be contained,  to the
best of registrant's  knowledge,  in definitive proxy or information  statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |X|

Aggregate market value of voting stock held by  non-affiliates  of registrant as
of March 1, 1997: $35,550,000

Number of shares of Common Stock outstanding as of March 1, 1997:  7,750,000

                       DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant's  definitive proxy statement  pursuant to Regulation
14A, which  statement will be filed not later than 120 days after the end of the
fiscal year covered by this Report,  are  incorporated  by reference in Part III
hereof.


<PAGE>



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


                                TABLE OF CONTENTS

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


PART I
            1.  Business..................................................    3
            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 Financial Data...................................   17
            7.  Management's Discussion And Analysis Of
                Financial Condition And Results Of Operations.............   19
            8.  Financial Statements And Supplementary Data...............   24
            9.  Changes In And Disagreements With Accountants
                On Accounting And Financial Disclosure....................   24

PART III    ..............................................................   24

PART IV
            10. Exhibits, Financial Statements, And Reports On
                Form 8-K..................................................   25

Signatures................................................................   26

Exhibit Index.............................................................   27



<PAGE>



                                     PART I

ITEM 1. BUSINESS.

General

     Kapson Senior  Quarters  Corp.  (the  "Company")  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. A majority
of the Company's facilities are operated under the "Senior Quarters" trademark.

     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  residents  to live longer and to "age in
place." The Company's facilities are designed to provide premium  accommodations
and a comprehensive,  bundled package of standard  services for a single monthly
fee. These facilities offer, on a 24-hour basis,  personal,  supportive and home
health care services appropriate for their residents in a home-like setting, all
of 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, 1996, the average monthly fee for standard services
at the  Company's  facilities  was  approximately  $2,750 per unit.  The Company
believes that its facilities are generally  larger than typical  assisted living
facilities in terms of units and resident  capacity.  Its prototype  development
facility  consists of 125 units with capacity for up to 200  residents.  Over 50
years of combined  experience in the assisted living industry have led the three
senior  executives of the Company,  Glenn  Kaplan,  Wayne Kaplan and Evan Kaplan
(collectively,  the "Kaplans"),  to develop and implement this prototype,  which
enhances operating margins by capitalizing on economies of scale.

     At  December  31,  1996,  the Company  owned,  managed  and/or  operated 15
assisted  living  facilities with an aggregate of 1,623 units and a capacity for
2,392 residents,  located in New York, New Jersey, Connecticut and Pennsylvania.
Of these  facilities,  the Company  owned all or a portion of eleven  facilities
(seven entirely and four partially,  with partial  ownership  interests  ranging
from 10.0% to 50.1%) with an  aggregate  of 1,145 units and a capacity for 1,749
residents.  The Company also operates one facility  under a long-term  operating
lease.  Revenue from the twelve facilities in which the Company had an ownership
or leasehold interest constituted 93.7% of the Company's 1996 revenues, with the
balance provided by management fees from facilities owned by unaffiliated  third
parties.   The  average  age  of  residents  at  the  Company's   facilities  is
approximately  85, and the average length of stay is 24 months.  At December 31,
1996, the Company's  facilities that were stabilized  (i.e., in operation for at
least twelve months) had a weighted average  occupancy rate of 97.0%,  with many
of them maintaining waiting lists. Furthermore, such facilities have operated at
a 98.0% occupancy rate for the past five calendar


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years.  Management  attributes its success in maintaining  high monthly fees and
occupancy  levels  to a number of  factors,  such as the  premium  nature of its
facilities;  the comprehensive bundling of standard services as part of a single
package  and the quality of those  services;  referrals  from former  residents,
their  families  and  health  care  professionals;  and the long  tenure and low
turnover of its staff,  which produces strong  relationships  with the residents
and their families.

     Under   applicable  New  York  law  and  regulations,   a   publicly-traded
corporation is not permitted to be the licensed operator of a licensed facility,
although privately-owned  corporations are permitted to operate certain types of
licensed  facilities.  The Kaplans  individually  are the licensed  operators of
substantially  all of the Company's  facilities in New York, and the Kaplans may
in the future form one or more  corporations  to operate these  facilities.  The
Kaplans  have,  in turn,  engaged a  wholly-owned  subsidiary  of the Company to
provide certain management services at each such facility.

     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 (the  "Predecessor"),  a New York general  partnership  between the
Kaplans, acquired one of these assisted living facilities.  Since that time, The
Kapson Group has focused  strictly on its assisted living business and has built
an executive  management  team with  experience  and expertise in the financing,
acquisition,   development,   management   and  operation  of  assisted   living
facilities.

     The  Company  was formed in order to  consolidate  and expand the  assisted
living  facility  business of The Kapson Group. In connection with the Company's
initial  public   offering  (the  "Initial  Public   Offering"),   a  series  of
transactions designed to consolidate The Kapson Group's assisted living business
in the Company were  consummated.  The address of the Company's  headquarters is
242 Crossways Park West, Woodbury, New York 11797. Its telephone number is (516)
921-8900 and its  facsimile  number is (516)  921-8998.  Its website  address is
www.seniorquarters.com.  The Company is a Delaware  corporation  incorporated on
June 7, 1996.

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" at home and,  in certain  instances,  can  provide  most of the  services
available at


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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 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.
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.

     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 many
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.  Conversely,  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 to 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 has  implemented  its  Extended  Care
Program  at  certain  of its  facilities.  The  program  is  designed  to accept
residents with 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 additional  cost,  includes special services such
as:  personal  care aides  specifically  trained to help seniors with  declining
cognitive


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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 expand its
Extended Care Program to many of its current  facilities  and to offer it at all
new facilities.

     New York State  Assisted  Living  Program.  In June 1993,  the  Company was
awarded 400 of the 698 beds  (approximately  57%)  allocated  to the Long Island
Region under the State of New York's Assisted  Living  Program.  This program is
geared to  residents  who are  eligible  for  Medicaid  and who require a higher
acuity of care than is typically provided in assisted living facilities. As part
of this program,  the Company has committed to accept 380 Medicaid  residents at
two  facilities.  The  remaining  number of beds may be  filled  by  private-pay
residents.  The  Assisted  Living  Program is closed to new  applicants  and the
Company is not aware of any proposals  pending in the New York State Legislature
to enact  similar  programs  or to award  additional  beds  under  the  existing
program.

     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; 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,  1996,  the average  monthly  fee for  standard  services  at the  Company's
facilities was  approximately  $2,750 per unit. Among other things,  the Company
believes that this fee structure  distinguishes  the Company from other assisted
living providers and enhances the home-like environment of its facilities, makes
it easier for the Company to predict  operating  expenses at any given  facility
and, therefore, increases profitability at its facilities.

     Wellness Monitoring. The staff at the Company's facilities closely monitors
the physical and mental health of its residents in order to identify and respond
to changes and then,  together with the resident and the  resident's  family and
physician, as appropriate,  designs a solution to fit that resident's particular
needs.  This  monitoring  activity  takes  place at meals  and  other  scheduled
activities,  and  informally  as the staff  performs  its  services  around  the
facility.  In addition,  the staff works with home health care services agencies
to provide  services that the facilities  cannot  provide,  such as physical and
occupational therapy.

     Social and Recreational Activities.  The Company believes that an essential
part of enjoying an assisted living environment as well as maintaining a healthy
lifestyle is participation in social and recreational activities.  Residents are
encouraged to participate in facility activities,  and numerous activities rooms
(such as bingo  rooms,  card rooms and  cocktail  lounges)  are  included in the
design of each of its facilities.  At a typical  Company  facility there will be
between  eight and 14  scheduled  activities  per day,  seven  days a week.  The
activities vary facility by facility in accordance with the particular interests
of the facility's residents.


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     Resident  Participation.  Each facility has a Residents' Council and a Food
Service  Committee  comprised  of  several  residents  who are  elected by their
co-residents.  The  Residents'  Council  meets  with  the  administrator  of the
facility  on a  regular  basis  to  discuss  concerns  and  suggestions  of  the
residents.  The Food Service Committee meets with the administrator and the chef
on a frequent basis to discuss possible changes and variations to the menu. Both
of these  groups help to involve  residents  in the  community  while  providing
day-to-day quality control.

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 medical  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 small 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 is 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 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.


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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.

     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.  A 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

     Overview.  The Company's  growth  strategy for the next three to five years
will focus on the expansion of its existing  portfolio  through the  development
and acquisition of additional  assisted living facilities,  the expansion of its
ancillary  services,  such as  home  health  care  services,  in-house  pharmacy
services  and  its  Extended  Care  Program,   and   maintaining  its  focus  on
cost-efficient  facilities  management.  The Company also intends to continue to
capitalize  on  public  recognition  of  the  "Senior  Quarters"   trademark  to
distinguish itself from competitors.

     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.

     Since 1985,  the Company has developed ten assisted  living  facilities and
acquired  all or an interest in three  others,  formed home health care  service
agencies  in order to offer  such  services  in the  Company's  facilities,  and
developed its prototype facility for cost-effective management.


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Most of these  facilities have been located in New York State,  which has one of
the most  extensive  regulatory  frameworks  with  respect to the  provision  of
assisted living services. Accordingly, the Company believes that it not only has
the requisite experience but also the systems,  procedures and infrastructure to
support  its growth  strategy  and to adapt to  regulatory  change.  The Company
intends to continue to finance its development and acquisition of new facilities
through a variety of sources,  including  the  proceeds  of the  Initial  Public
Offering,  bank and other  financing,  long-term  operating  leases  with REITs,
future debt or equity offerings, joint ventures and other sources.

     The  Company  will seek to realize  future  growth  primarily  through  the
construction   of  new  facilities  and  through  the  acquisition  of  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  for  institutions  and
developers that do not have experience in operating an assisted living facility.

     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.

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


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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.  There can be no assurance,  however,  that
future projects will be completed on time and within budget.

     Development   Status.  The  Company  currently  has  four  assisted  living
facilities  under  construction  and an additional  five  facilities with zoning
approval.   The   Company  is   currently   involved   in   various   stages  of
pre-construction  development with respect to twelve assisted living facilities.
The  Company  is also in the  preliminary  stage of  discussions  to  develop or
acquire an additional 10 sites in six states.  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   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.  The Company currently has no binding
commitment or other  agreement,  arrangement or  understanding  to acquire or to
proceed  with  the  development  of any of  these  sites,  and  there  can be no
assurance  that the Company will  ultimately  be able to or elect to acquire and
develop any of these sites.

     On March 18,  1997,  the  Company  announced  that it plans to develop  six
assisted  living  facilities in North  Carolina and South  Carolina with a joint
venture partner.

Acquisition of Existing 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  for   well-financed,
experienced  operators.  Through its extensive experience in the assisted living
industry and its development and acquisition team, the Company continually seeks
to  acquire  facilities  in  its  targeted  markets.  In  evaluating   potential
acquisitions,  the Company  reviews and  considers:  (i) the location;  (ii) its
ability to cluster with existing  facilities;  (iii)  demographics  of the area;
(iv) the current and projected  revenues and cash flow of the facility,  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.


                                       10

<PAGE>



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 do arise.

Expansion of Company-Provided Ancillary Services.

     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.
The Company intends to provide such services  through the Kaplans' agency in all
of its New York  facilities.  The Company  expects to apply in the next year for
registration  as a pharmacy in New York in order to offer and  provide  in-house
pharmacy  services in its New York  facilities  and, where  permissible,  at its
other  facilities.  In addition,  the Company intends to offer its Extended Care
Program  for  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,  rather than having to  transfer to more  expensive  skilled
nursing  facilities,  but also that its provision of such services will increase
as its growth strategy is implemented.

     The Company also seeks to enhance and increase the amount and  diversity of
assisted living services it provides through: (i) the continued education of the
senior community,  particularly the residents and their families, concerning the
cost  effectiveness  of  receiving  additional  services in an  assisted  living
facility;  (ii) the continued  development  and  refinement  of assisted  living
programs designed to meet the needs of its residents as they "age in place"; and
(iii) the consistent delivery of quality services for residents.

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


                                       11

<PAGE>



for residents primarily on the basis of quality of service,  price,  reputation,
physical  appearance and location of the living  environment,  services offered,
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.  Most  states in which  the  Company  currently  does
business  require that assisted living  facilities and home health care services
agencies be licensed.  New York requires state  registration in order to own and
operate a  pharmacy;  other  states  in which the  Company  intends  to  provide
pharmacy services also regulate such services.

     Reimbursement. Government payments for assisted living facilities have been
limited and most assisted living  residents or their families  generally pay the
cost of their  care from their own  financial  resources.  In certain  instances
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 types of insurance become available. However, the Company's
two ALP  facilities  are intended to serve  primarily  Medicaid  residents.  The
residential  fee for  Medicaid  residents,  whether  eligible for SSI or not, is
based on the SSI  residential  rate  applicable  to ALP  facilities.  Home  care
services   provided  to   residents   of  the  ALP  facility  who  are  Medicaid
beneficiaries  are reimbursed by Medicaid on a per day basis,  which is equal to
50% of the  amount  that  would be paid  for the  anticipated  services  at each
resident's  level of care (based on social and nursing  assessments)  to nursing
facilities in the same  geographical  area for a Medicaid  resident's  home care
services.  Because the ALP facility  only  receives a fixed amount from Medicaid
for a range of home care services  within the resident's  level of care, the ALP
facility  would be at  financial  risk should its  Medicaid  eligible  residents
require a level of  services  within the range for the  specified  level of care
that exceeds the amount  reimbursed by Medicaid,  and there is no assurance that
the proposed federal and state legislation  involving Medicaid, in whatever form
such  legislation may take,  will not reduce  government  support.  The combined
payments  for  Medicaid-eligible  residents  are  approximately  the same as the
overall   monthly  fee  for  a  private   paying   resident  in  a  semi-private
accommodation.

     Other.  The  significant  aspects  of both  the  licensing  and  regulatory
environments in states where the Company currently operates and under applicable
federal law include the following:


                                       12

<PAGE>



     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 two 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,  and, with regard to ALP  facilities,  by the Department of
Health,  as well.  The Company's New York licensed  facilities  consist of Adult
Homes,  Enriched Housing  Programs and ALP facilities.  Adult Homes and Enriched
Housing Programs are a class of residential facilities for adults needing levels
of care that are more  moderate  than the higher  levels of care  required for a
resident  in order to  qualify  for an ALP  facility.  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  a  licensed  facility.  Natural  persons,  individually  or  in
partnership,  and privately-held  corporations may operate Adult Homes, Enriched
Housing Programs and ALP facilities.  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)  shall  maintain  ultimate  responsibility  and
liability for the licensed entity and the power to discharge  persons working at
the  licensed  facility.  Licensed  operators of ALP  facilities  may enter into
management  contracts that provide additionally that the licensed operator shall
retain control and responsibility for the day-to-day  operations by the licensed
operators,  retain the authority and power to hire and discharge persons working
at the  licensed  entity,  maintain  and  control  the books and  records of the
licensed  entity,  retain  ultimate  authority  to dispose of assets used in the
operation  of the  licensed  entity,  to incur  any  liability  on behalf of the
licensed entity and to adopt or enforce policies  regarding the operation of the
licensed  entity.  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,  which is owned and operated
by the Kaplans, has applied 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. A significant  portion of the home
care  services  provided in the  Company's  ALP  facilities  are  already  being
provided  by the Kapson  Licensed  Home Care  Services  Agency.  If and when its
license is extended to other  counties by the  Department of Health,  the Kapson
Licensed Home Care Services  Agency intends to maintain  on-site office space at
the Company's facilities.

     The  Company  expects  to  apply  within  the next  year to New York  State
authorities for registration as a pharmacy in order to provide in-house pharmacy
services  in all of its  facilities.  A New  York  pharmacy  may be  owned  by a
corporation  provided that the corporation  obtains a registration  and that the
actual practice of pharmacy is conducted by licensed pharmacists.

     New Jersey, Connecticut and Pennsylvania.  The State of New Jersey has four
levels of supportive  senior housing,  all of which are licensed,  regulated and
subject to inspection. In the


                                       13

<PAGE>



State of Connecticut,  assisted living  facilities are licensed and inspected by
the State Department of Health and Addiction Services 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  also  receive  a state  license  and are  subject  to
regulation and  inspection.  Publicly  traded  corporations  may own and operate
assisted living facilities in New Jersey, Connecticut and Pennsylvania.

     Federal and State Fraud and Abuse Laws and Regulations.  The federal "Stark
Law"  provides that where certain  health care  professionals  have a "financial
relationship"  with  a  provider  of  Medicaid-reimbursable  "designated  health
services"  (including,  among  other  things,  home  health  care  and  pharmacy
services), the health care professional may be prohibited from making a referral
to  the  health  care  provider,  and  such  health  care  professionals  may be
prohibited from billing for the designated health service.  Although the Company
believes  that  ownership  in it is not  subject to the Stark Law, a  "financial
relationship" may be interpreted by the government to include ownership of stock
of the  Company  directly  in the case of  pharmacy  services it may provide and
indirectly as a provider of management services to the home health care services
agency.  Accordingly,  referrals by certain  health care  professionals  who are
stockholders  of the Company to the Kapson Licensed Home Care Services Agency or
the  Company's  pharmacy  for  residents  whose  services  are  reimbursable  by
Medicaid,  and billing Medicaid by the ALP for such services,  may be prohibited
under the Stark Law. Certain exceptions available under the Stark Law to certain
health care  professionals  who are  investors  would not be  applicable  as the
Company does not currently meet the qualifying test of stockholder  equity of at
least $75.0  million.  Submission  of a claim for services for which  payment is
prohibited under the Stark Law could result in substantial civil penalties.  New
York State  imposes  similar  prohibitions  against  health  care  professionals
referring any patients to a company that provides pharmacy services in which the
health care professional has an ownership or financial  interest,  such as stock
ownership. Laws imposing various restrictions applicable to such referrals exist
in many other  states.  The  Company  reviews  and will  continue  to review all
aspects of its  operations  to assure  compliance  with federal and state health
care fraud and abuse laws,  and will monitor  developments  under such laws.  In
addition, in submitting claims to the Medicaid or Medicare programs,  such as in
its ALP and possible  future pharmacy and home care  activities,  the Company is
(and will be) subject to federal and state laws imposing  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,  1996,  the  Company  and  its  facilities   employed
approximately   1,000   persons,   including  32  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, including,
without limitation,  statements  appearing under Item 1, "Business," and Item 7,
"Management's Discussion


                                       14

<PAGE>



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 and Section 21E of the Securities Exchange Act of 1934). 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 Annual Report.

ITEM 2. PROPERTIES.

     The  Company  currently  owns/leases/manages  and/or  operates  15 assisted
living  facilities  containing  1,623 units with a capacity for 2,392 residents.
The following  chart sets forth  information  regarding  the Company's  existing
facilities.


<TABLE>
<CAPTION>
                                                                                                                            Year of
                                                                          Number of                                        Commence-
                                                                           Units/         Owned,            Year             ment
                                                                          Resident       Leased or       Constructed       of Kapson
Facility                                                      City        Capacity        Managed       or Converted      Operations
--------                                                      ----        --------        -------       ------------      ----------
<S>                                                      <C>             <C>              <C>             <C>                <C>
CONNECTICUT
         Senior Quarters at Stamford (1)...............     Stamford        94/188         100%             1988             1988
NEW JERSEY
         Senior Quarters at Cranford (1)(5)............     Cranford       173/254        Leased            1993             1993
         Change Bridge Inn (1).........................    Montville       103/112        23.75%            1988             1995
         Senior Quarters at Jamesburg (1)..............     Jamesburg      125/156          10%             1996             1996
NEW YORK
         Senior Quarters at Centereach I (2)...........    Centereach      101/200         100%             1979             1979
         Senior Quarters at Huntington Station (2).....    Huntington       99/198         100%             1987             1987
         Senior Quarters at Centereach II (1)..........    Centereach       99/198         100%             1989             1989
         The Regency at Glen Cove (3)..................     Glen Cove       95/105        Managed           1993             1993
         Senior Quarters at Chestnut Ridge (2).........  Chestnut Ridge     98/148         50.1%            1995             1995
         Castle Gardens (4)............................       Vestal        84/84         Managed         1990/1993          1996
         Senior Quarters at East Northport (2).........  East Northport    139/200         100%             1996             1996
         Senior Quarters at Lynbrook (2)...............      Lynbrook      126/200        Managed           1996             1996
         Town Gate East (2)............................     Penfield       100/120         100%             1972             1996
         Town Gate Manor (2)...........................     Rochester       67/79          100%             1970             1996
PENNSYLVANIA
         Senior Quarters at Glen Riddle (1)............    Glen Riddle     120/150          11%             1996             1996
                                                                         -----------
TOTAL..................................................                  1,623/2,392
</TABLE>

-----------

(1)  This  facility  is directly  managed by a  wholly-owned  subsidiary  of the
     Company.

(2)  In order to  comply  with  applicable  New York law and  regulations,  this
     facility is operated by the Kaplans  individually  pursuant to an operating
     agreement.  The  Kaplans  have  engaged a  wholly-owned  subsidiary  of the
     Company to provide  certain  management  services  pursuant to a management
     agreement.

(3)  This  facility  is  operated  by  its  owner,  a  New  York  not-for-profit
     corporation that is unaffiliated with the Company.  The owner has engaged a
     wholly-owned  subsidiary  of the  Company  to provide  management  services
     pursuant to a management agreement.

(4)  The portion of this  facility  that is operated  as an  independent  living
     facility (84 beds) is managed by a  wholly-owned  subsidiary of the Company
     pursuant to a  management  agreement.  The  portion  that is operated as an
     Enriched  Housing  Program  facility  (27 beds) is  operated  by a New York
     not-for-profit corporation.

(5)  This Facility is leased through a long-term operating lease with HealthCare
     REIT.


                                       15

<PAGE>


     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  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  and  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, 1996, the Company's facilities
that were  stabilized  (i.e.,  in operation  for at least  twelve  months) had a
weighted average occupancy rate of 97.0%, with many of them maintaining  waiting
lists.

     The Company leases 5,715 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 1996.


                                       16

<PAGE>



                                     PART II


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

     The Common Stock of the Company has traded on the National  Association  of
Securities Dealers Automated  Quotation System ("NASDAQ") National Market System
since  September  26, 1996 under the symbol KPSQ. On March 1, 1997 there were 43
holders of record of the Company's Common Stock.

     The following  table sets forth the high and low closing bid prices for the
Company's Common Stock as reported by NASDAQ:


Calendar Period                                       High                Low
---------------                                       ----                ---
1996:
Fourth Quarter......................................  10 1/4              6 3/8

     The Company has never  declared  or paid any cash  dividends  on its 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.

Recent Sales of Unregistered Securities

On October 22, 1996,  the Company  issued 50,000  unregistered  shares of Common
Stock to Hameem Associates,  L.P., ("Hameem"),  as partial consideration for the
purchase  by the Company of Hameem's  50%  limited  partnership  interest in the
entity that owns Senior Quarters at East Northport.

ITEM 6. SELECTED FINANCIAL DATA.

     The financial data for the years ended December 31, 1996, 1995 and 1994 and
balance  sheet data as of December  31, 1996 and 1995 have been derived from the
audited  financial  statements of the Company and the  Predecessor and should be
read in conjunction  with those financial  statements and notes thereto included
elsewhere in this Annual Report. In addition, the selected financial data should
be read in conjunction with "Business" and "Management's Discussion and Analysis
of Financial Condition and Results of Operations."


                                       17

<PAGE>



                             SELECTED FINANCIAL DATA


<TABLE>
<CAPTION>
                                                                                   Year ended December 31,
                                                           -------------------------------------------------------------------------
                                                              1992           1993          1994            1995           1996
                                                              ----           ----          ----            ----           ----

                                                                                The Predecessor (1)                  The Company (1)
                                                           ------------------------------------------------------    ---------------
                                                                     (in thousands, except per share data)
<S>                                                        <C>            <C>            <C>            <C>            <C>
Statement of Operations Data
Revenues:
    Assisted living revenues ............................    $11,553        $12,628        $13,349        $14,275        $22,534
    Management fee ......................................         24            248            348            443          1,080
    Other - affiliates ..................................        242            112             57             45             --
                                                           ---------      ---------      ---------      ---------      ---------
        Total revenues ..................................     11,819         12,988         13,754         14,763         23,614
                                                           ---------      ---------      ---------      ---------      ---------
Operating Expenses:
    Assisted living operating expenses ..................      7,289          7,591          7,837          8,314         14,804
    General and administrative ..........................      1,038            727          1,142          1,658          3,814
    Depreciation ........................................      1,264          1,188          1,180          1,234          2,091
                                                           ---------      ---------      ---------      ---------      ---------
        Total operating expenses ........................      9,591          9,506         10,159         11,206         20,709
                                                           ---------      ---------      ---------      ---------      ---------
Operating income ........................................      2,228          3,482          3,595          3,557          2,905
Interest income .........................................         22             12              8             44            463
Interest expense ........................................     (3,495)        (3,553)        (3,495)        (3,936)        (6,515)
Equity in income from joint ventures ....................         --             --             --             --             77
Other income (expense), net .............................        280            (10)            (1)           (34)          (205)
                                                           ---------      ---------      ---------      ---------      ---------
Income (loss) before minority interest and
    extraordinary item ..................................       (965)           (69)           107           (369)        (3,275)
Minority interest in net loss of combined
    partnerships ........................................         --             --             --             16            924
                                                           ---------      ---------      ---------      ---------      ---------
Income (loss) before provision for income taxes
    and extraordinary item ..............................       (965)           (69)           107           (353)        (2,351)
Provision for income taxes ..............................         --             --             --             --         (2,039)
Extraordinary item ......................................         --             --          4,399             --             --
                                                           ---------      ---------      ---------      ---------      ---------
        Net Income (loss) ...............................      $(965)          $(69)        $4,506          $(353)       $(4,390)
                                                           =========      =========      =========      =========      =========


Unaudited pro forma data:
    Income (loss) before taxes and extraordinary
        item ............................................      $(965)          $(69)          $107          $(353)       $(2,351)
    Pro forma benefit (provision) for income
        taxes ...........................................        386             28            (43)           141            941
                                                           ---------      ---------      ---------      ---------      ---------
    Income (loss) before extraordinary item .............       (579)           (41)            64           (212)        (1,410)
    Extraordinary item - forgiveness of debt, net
        of tax ..........................................         --             --          2,639             --             --
                                                           ---------      ---------      ---------      ---------      ---------
    Pro forma net income (loss) .........................      $(579)          $(41)        $2,703          $(212)       $(1,410)
                                                           =========      =========      =========      =========      =========

Pro forma income (loss) per share:
    Income (loss) before extraordinary item .............      ($.12)         ($.01)          $.01          ($.04)         ($.26)
    Extraordinary item ..................................         --             --            .56             --             --
                                                           ---------      ---------      ---------      ---------      ---------
    Income (loss) .......................................      ($.12)         ($.01)          $.57          ($.04)         ($.26)
                                                           =========      =========      =========      =========      =========

    Pro forma weighted average number of
         common shares outstanding ......................      4,758          4,758          4,758          4,758          5,510
                                                           =========      =========      =========      =========      =========
</TABLE>


                                       18

<PAGE>


<TABLE>
<CAPTION>
                                                                                   Year ended December 31,
                                                           -------------------------------------------------------------------------
                                                              1992           1993          1994            1995           1996
                                                              ----           ----          ----            ----           ----

                                                                                The Predecessor (1)                    The Company
                                                           ------------------------------------------------------    ---------------
<S>                                                        <C>            <C>            <C>            <C>            <C>
    Selected Operating Data:
    Assisted living units owned, managed and/or
        operated (end of period).........................  393              661            661            862          1,623
    Assisted living resident capacity (end of period)....  784            1,143          1,143          1,403          2,392
    Weighted average occupancy of fully-stabilized
        assisted living facilities.......................  99%              98%            98%            98%            97%
</TABLE>


<TABLE>
<CAPTION>
                                                                                   Year ended December 31,
                                                           -------------------------------------------------------------------------
                                                              1992           1993          1994            1995           1996
                                                              ----           ----          ----            ----           ----

                                                                                The Predecessor (1)                    The Company
                                                           ------------------------------------------------------    ---------------
                                                                                  (in thousands)
<S>                                                        <C>            <C>            <C>            <C>            <C>
Balance Sheet Data:
Working capital (deficit) ...............................  $(11,233)      $(22,603)      $(17,712)      $(3,596)       $12,455
Total assets ............................................    31,825         31,381         34,294        54,407         95,988
Long-term debt, excluding current portion ...............    30,547         18,500         20,461        53,808         72,409
Shareholders' and Partners' equity (deficit) ............   (11,704)       (12,325)        (8,740)       (9,811)        12,291
</TABLE>


-----------

(1)  The Predecessor  represents a combination of the businesses which owned all
     or part of eleven 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 assisting  living business of
     the  Predecessor.  The financial  data for the year ended December 31, 1996
     represent nine months of the Predecessor and three months of the Company.

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

Results of Operations

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;  (ii) the acquisition of Town Gate
East and Town Gate Manor 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.  Excluding  Senior  Quarters  at Chestnut  Ridge,  Senior
Quarters at East Northport,  Town Gate East, Town Gate Manor and Senior Quarters
at Cranford,  assisted  living  revenues were  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


                                       19

<PAGE>



twelve months ended  December 31, 1995, an increase of 143.9%.  The increase was
primarily  attributable to revenues from  Management  Contracts at Change Bridge
Inn, Senior Quarters at Jamesburg,  Castle Gardens,  Senior Quarters at Lynbrook
and Senior  Quarters  at Glen Riddle for which the  Company  assumed  management
responsibility for 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 $3.8 million for the twelve months ended December
31,  1996,  compared to $1.7 million for the twelve  months  ended  December 31,
1995. As a percentage of total revenues,  general and administrative expense was
16.1%  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  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 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 the  acquisition  of Town Gate East and Town
Gate Manor on April 1, 1996;  partially offset by a decrease in interest expense
from  refinancing  an  existing  mortgage  at a lower  interest  rate for Senior
Quarters at Centereach.

     Net 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


                                       20

<PAGE>



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,  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 Predecessor concurrent with the Initial Public
Offering.

Year Ended December 31, 1995 Compared to Year Ended December 31, 1994.

     Revenues.  Assisted living revenues increased to $14.3 million for the year
ended  December 31, 1995,  compared to $13.3 million for the year ended December
31,  1994,  an  increase of 6.9%.  The  increase is  attributable  primarily  to
increased  rental rates and to the opening of Senior  Quarters at Chestnut Ridge
on September  1, 1995,  which  contributed  revenue of  approximately  $283,000.
Excluding Senior Quarters at Chestnut Ridge,  assisted living revenues increased
4.8%.  Management fee revenue  increased to $443,000 for the year ended December
31, 1995, compared to $348,000 for the year ended December 31, 1994, an increase
of  27.3%.  The  increase  was  primarily  attributable  to Senior  Quarters  at
Cranford,  a facility  managed by the Company  which opened in late 1993 and for
which revenue  increased  significantly in 1995 due to a full year of stabilized
occupancy.

     Operating  Expenses.  Assisted living operating  expenses increased to $8.3
million for the year ended  December 31, 1995,  compared to $7.8 million for the
year ended  December 31, 1994,  an increase of 6.1%. As a percentage of assisted
living revenues, assisted living operating expenses were 58.2% and 58.7% for the
years  ended  December  31,  1995 and 1994,  respectively.  Excluding:  (i) pre-
opening  expenses and negative  margins  during the "rent-up"  period for Senior
Quarters at Chestnut  Ridge;  and (ii) a one-time  tax refund  related to a real
estate tax  grievance,  assisted  living  operating  expenses  would be 57.1% of
assisted  living  revenues for the year ended  December  31,  1995.  General and
administrative  expense was $1.7  million for the year ended  December 31, 1995,
compared to $1.1 million for the year ended  December  31, 1994,  an increase of
45.3%. As a percentage of total revenues, general and administrative expense was
11.2% and 8.3% for the years ended December 31, 1995 and 1994, respectively. The
increase  is  primarily  the result of: (i)  approximately  $160,000  related to
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; and (ii) approximately  $228,000
of general  and  administrative  expenses  related to the  Company's  expansion,
including  Senior  Quarters  at  Chestnut  Ridge,  Change  Bridge Inn and Castle
Gardens.

     Interest  Expense.  Interest  expense  was $3.9  million for the year ended
December  31,  1995,  compared to $3.5  million for the year ended  December 31,
1994,  an  increase of 12.6%.  The  increase is  primarily  attributable  to the
opening of Senior  Quarters at Chestnut  Ridge at which point  interest  expense
with respect to this facility was no longer capitalized.


                                       21

<PAGE>



     Income (Loss) Before Extraordinary Item. Income (loss) before extraordinary
item was ($353,000)  for the year ended December 31, 1995,  compared to $107,000
for the year ended  December 31,  1994.  The decrease in net income is primarily
the  result of the  opening  of Senior  Quarters  at  Chestnut  Ridge and higher
payroll costs in connection with the Company's  expansion plans. The Company was
not required to pay and did not pay federal or state income taxes.

     Extraordinary  Item.  For the year ended  December  31,  1994,  the Company
recorded  an  extraordinary  gain of $4.4  million.  This gain  resulted  from a
settlement with various lenders to satisfy  certain  outstanding  mortgage notes
payable and accrued interest payable at a $4.4 million discount. The Predecessor
simultaneously refinanced this debt with other lenders at then prevailing market
rates.

Liquidity and Capital Resources

     On October 1, 1996, the Company  completed an Initial Public Stock Offering
of 3,550,000  shares of Common Stock at $10.00 per share. The proceeds from this
sale of Common Stock,  net of  underwriting  fees and expenses of  approximately
$5.9  million,  totaled  approximately  $29.6  million.  Concurrently  with  the
completion of the offering,  the  Predecessor  contributed  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  and a
distribution of approximately  $6.0 million to cover capital gains taxes arising
out of the transaction.

     Net cash provided by (used in) operating  activities was ($0.9) million for
the twelve  months ended  December  31,  1996,  compared to $3.1 million for the
twelve months ended  December 31, 1995.  The decrease is primarily  attributable
to:  (i) a net loss for the twelve  months  ended  December  31,  1996,  of $4.4
million compared to a net loss for the twelve months ended December 31, 1995, of
$353,000;  (ii) a minority  interest in the net loss of  combined  partnerships;
(iii) a decrease in accrued interest; and (iv) an increase in other assets.

     Net cash (used in) investing  activities was ($28.1) million for the twelve
months  ended  December  31,  1996,  compared to ($17.6)  million for the twelve
months ended December 31, 1995.  Substantially all of the cash used in investing
activities  for the twelve  months ended  December 31, 1996 and 1995 was for the
development  and/or acquisition of new facilities (which was partially offset by
the sale of a minority  interest in Senior  Quarters at Chestnut  Ridge for $1.2
million)  during the twelve  months ended  December  31, 1996.  Net cash used in
investing activities was funded primarily through long-term debt.

     Net cash provided by financing  activities was $41.7 million for the twelve
months ended December 31, 1996,  compared to $16.0 million for the twelve months
ended  December 31, 1995.  Net cash provided by financing  activities  primarily
consists of the proceeds of long-term  debt offset by  principal  repayments  of
long-term debt,  distributions  to partners and shareholders of the Predecessor,
and  proceeds  from the Initial  Public  Offering net of  underwriting  fees and
offering costs.


                                       22

<PAGE>



     Historically,  and prior to the completion of its initial public  offering,
the Company has operated with significant  working capital deficits primarily as
a consequence  of current  liabilities  owed to an  uncombined  affiliate of the
Predecessor as well as certain financing activities. The working capital for the
Company was $12.5  million at December 31, 1996 and a deficit of $3.6 million at
December 31, 1995.  Excluding  current  liabilities  owed to an affiliate of the
Company (which did not become an obligation of the Company), the working capital
position at December 31, 1995 would have been a deficit of $296,000.

     In January  1995,  the Company  obtained a $40.0  million  acquisition  and
development  credit  facility  with Health Care REIT,  Inc.  ("HCR"),  providing
temporary construction and permanent financing. In September 1996, this facility
was increased to $140.0  million and  subsequently  reduced to $100.0 million by
mutual agreement of the parties, and includes temporary construction,  permanent
financing and operating leases.  The amounts drawn on the original $40.0 million
HCR credit  facility  were  applied  against  the new $100.0  million  facility.
Approximately  $23.0  million of the HCR  facility  has been drawn for  specific
projects and is secured by four facilities  (Senior  Quarters at Chestnut Ridge,
Town Gate Manor,  Town Gate East and the project at Briarcliff Manor, NY). As of
December  31, 1996,  an  additional  $26.1  million has been  committed  for two
facilities  (Senior Quarters at Cranford and the construction of Senior Quarters
at Albany) under operating leases.  Under the facility,  temporary  construction
financing  bears  interest at 3.5% above the base rate announced by the National
City Bank of Cleveland and permanent  financing  bears interest at the rate of a
ten-year U.S. Treasury Note plus either 4.0% per annum for mortgage indebtedness
or 3.75% per annum for permanent  operating leases. The permanent financing rate
increases by 25 basis points per annum. The HCR 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,
1996,  the  Company  was not in  compliance  with  certain  of these  covenants,
primarily as a result of the one-time non-cash charge of $2.4 million for income
taxes  taken in the  fourth  quarter  of 1996.  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.

     Indebtedness on two other properties (Senior Quarters at Huntington Station
and Senior Quarters at Stamford) having a combined  outstanding balance of $15.3
million matures in February 1999, at which time all unpaid  principal  balances,
if any, become due and payable.  The lending arrangements also contain an equity
participation  feature  payable at maturity in an amount which is the greater of
(a)  $480,000  or (b) 25% of  appraised  market  value over $17.5  million.  The
Company  expects to refinance such debt with the existing lender or with another
financing source.

     The Company  intends to finance its growth  strategy  for the next three to
five years through a variety of sources, including the proceeds of the Offering,
bank and other financing,  long-term operating leases with REITs, 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


                                       23

<PAGE>



long-term debt,  including  publicly issued debt. Because the Company intends to
use such  financing  for its  properties,  the amount of its  indebtedness  will
increase as the Company pursues its growth strategy. As a result of existing and
future  indebtedness,  a substantial  portion of the Company's cash flow will be
devoted to debt service. Further, increases in interest rates could increase the
Company's  debt  service  obligations,  and,  alone  or in  combination  with  a
contraction in the overall  availability of credit, could make it more difficult
for the Company to obtain future financing on commercially acceptable terms.

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.

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.

     Not applicable.


                                    PART III

     The information  required by Part III (Items 10 through 13) is incorporated
by reference to the captions "Principal  Stockholders," "Election of Directors,"
"Management"  and  "Certain  Transactions"  in the  Company's  definitive  Proxy
Statement to be filed  pursuant to Regulation  14A within 120 days after the end
of the Company's fiscal year covered by this Report.


                                       24

<PAGE>



                                     PART IV


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

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

     (b)  None.

     (c)  Exhibits

          See Exhibit Index immediately following signature pages.


                                       25

<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 hereunto duly authorized.

                                          KAPSON SENIOR QUARTERS CORP.


                                          By: /s/ Glenn Kaplan
                                              ----------------------------------
                                              Glenn Kaplan
                                              Chairman of the Board of Directors
                                              and Chief Executive Officer

Date:  March 27, 1997

     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.


<TABLE>
<S>                                                 <C>                                                           <C>
 /s/ Glenn Kaplan                                   Chairman of the Board of Directors                            March 27, 1997
-------------------------                           and Chief Executive Officer
    Glenn Kaplan                                    (principal executive officer)


 /s/ Wayne Kaplan                                   Vice Chairman, Senior Executive                               March 27, 1997
------------------------                            Vice President, Secretary and Director
    Wayne L. Kaplan

 /s/ Evan A. Kaplan                                 President, Chief Operating                                    March 27, 1997
-------------------------                           Officer and Director
  Evan A. Kaplan

 /s/ Raymond DioGuardi                              Chief Financial Officer                                       March 27, 1997
-------------------------                           (principal financial officer and
  Raymond DioGuardi                                 principal accounting officer)


 /s/ Bernard J. Korman                              Director                                                      March 27, 1997
------------------------
  Bernard J. Korman

 /s/ Gerald Schuster                                Director                                                      March 27, 1997
------------------------
  Gerald Schuster

 /s/ Joseph G. Beck                                 Director                                                      March 27, 1997
--------------------------
  Joseph G. Beck

 /s/ Risa Lavizzo-Mourey                            Director                                                      March 27, 1997
------------------------
  Risa Lavizzo-Mourey, M.D.
</TABLE>


                                       26

<PAGE>



                                  EXHIBIT INDEX
                                  -------------


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)).

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 Registrant,  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  Registrant,  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  Registrant  (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.


                                       27

<PAGE>



            (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)).

10.12*      Amendment  dated October 16, 1996, to Health Care REIT,  Inc. Credit
            Facility Commitment Letter.

10.13*      Waiver of covenants by Health Care REIT, Inc. dated March 6,1997.

21.1        Subsidiaries of the Company.  (incorporated  by reference to Exhibit
            21.1 to the  Company's  Registration  Statement  on Form  S-1  dated
            September 26, 1996 (Registration No. 333- 5945)).

27.1*       Financial Data Schedule.

*           Filed herewith.


                                       28



<PAGE>


                          KAPSON SENIOR QUARTERS CORP.
                          INDEX TO FINANCIAL STATEMENTS



<TABLE>
<CAPTION>
                                                                                               Page

<S>                                                                                             <C>
Report of Independent Accountants                                                               F-2

Consolidated  Balance  Sheet  of the  Company  as of  December  31,  1996 and                   F-3
     Combined Balance Sheet of the Predecessor as of December 31, 1995

Consolidated Statement of Operations of the Company for the year ended                          F-4
     December 31,1996, and the Combined Statements of Operations of
     the Predecessor for each of the two years in the period ended
     December 31, 1995 and 1994

Consolidated Statement of Shareholders' Equity of the Company for the                           F-5
     year ended December 31, 1996, and the Combined Statements of
     Shareholders' and Partners' Deficit of the Predecessor for each of the two
     years in the period ended December 31, 1995 and 1994

Consolidated Statement of Cash Flows of the Company for the year ended                          F-6
     December 31, 1996 and the Combined Statements of Cash Flows of the
     Predecessor for each of the two years in the period ended December 31, 1995
     and 1994

Notes to Consolidated and Combined Financial Statements                                         F-7 - F-19
</TABLE>




                                      F-1
<PAGE>



Report of Independent Accountants

To the Shareholders of
Kapson Senior Quarters Corp.

We have audited the  accompanying  consolidated  balance  sheet of Kapson Senior
Quarters Corp. (the "Company" as defined in Note 1) as of December 31, 1996, and
the related consolidated statements of operations, shareholders' equity and cash
flows for the year then ended.  We have also audited the combined  balance sheet
of The Kapson Group (the  "Predecessor" as defined in Note 1) as of December 31,
1995 and the  related  combined  statements  of  operations,  shareholders'  and
partners'  deficit and cash flows for each of the two years in the period  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, 1996 and the  consolidated  results of
its  operations and its cash flows for the year 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  financial position of The Kapson Group as of December 31, 1995 and
the combined  results of its  operations  and its cash flows for each of the two
years in the period ended  December  31,  1995,  in  conformity  with  generally
accepted accounting principles.

                                             Coopers & Lybrand L.L.P.



New York, New York
March 6, 1997



                                      F-2
<PAGE>

           CONSOLIDATED BALANCE SHEET OF KAPSON SENIOR QUARTERS CORP.
                             AS OF DECEMBER 31, 1996
               AND THE COMBINED BALANCE SHEET OF THE KAPSON GROUP
                             AS OF DECEMBER 31, 1995

                                     ASSETS


<TABLE>
<CAPTION>
                                                                                                     1996                  1995
                                                                                                 ------------          ------------
<S>                                                                                              <C>                   <C>
Current assets
   Cash and cash equivalents                                                                     $ 16,053,307          $  3,392,318
   Accounts receivable                                                                                 80,329                77,837
   Prepaid expenses and other current assets                                                          574,733               270,317
   Deferred income taxes                                                                              503,000                  --
                                                                                                 ------------          ------------

       Total current assets                                                                        17,211,369             3,740,472

Property and equipment, net                                                                        58,377,735            29,445,121
Facility development costs                                                                          1,190,727            16,374,566
Restricted cash                                                                                     3,134,695             2,592,185
Deferred financing costs, net                                                                       2,595,407             2,082,285
Intangibles, net                                                                                    4,821,842                  --
Investment in joint ventures                                                                          551,829                  --
Other assets                                                                                        8,104,648               172,163
                                                                                                 ------------          ------------

       Total assets                                                                              $ 95,988,252          $ 54,406,792
                                                                                                 ============          ============


          LIABILITIES AND SHAREHOLDERS' AND PARTNERS' EQUITY (DEFICIT)

Current liabilities
   Current portion of long-term debt                                                             $    943,658          $    245,867
   Accounts payable and accrued expenses                                                            3,294,040             3,219,472
   Accrued interest                                                                                      --                 363,198
   Due to affiliates                                                                                     --               3,300,450
   Deferred revenue                                                                                   519,168               207,564
                                                                                                 ------------          ------------

       Total current liabilities                                                                    4,756,866             7,336,551

Long-term debt                                                                                     72,408,516            53,807,880
Loan payable                                                                                          555,000                  --
Resident security deposits                                                                          1,725,192             1,278,147
Deferred income taxes                                                                               2,542,000                  --
Deferred interest payable                                                                             147,500               105,200
Construction retainage payable                                                                        613,057               227,200
                                                                                                 ------------          ------------

       Total liabilities                                                                           82,748,131            62,754,978
                                                                                                 ------------          ------------

Minority interest                                                                                     948,925             1,463,271
                                                                                                 ------------          ------------

Shareholders' and partners' equity (deficit)
   Common stock; $.01 par value, 30,000,000 shares authorized,
      7,750,000 issued and outstanding                                                                 77,500                  --
Additional paid-in capital                                                                         16,603,348                  --
Accumulated deficit                                                                                (4,389,652)                 --
Shareholders' and partners' deficit                                                                      --              (9,811,457)
                                                                                                 ------------          ------------

       Total shareholders' and partners' equity (deficit)                                          12,291,196            (9,811,457)
                                                                                                 ------------          ------------

       Total liabilities and shareholders' and partners' equity (deficit)                        $ 95,988,252          $ 54,406,792
                                                                                                 ============          ============
</TABLE>

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




                                      F-3
<PAGE>


      CONSOLIDATED STATEMENT OF OPERATIONS OF KAPSON SENIOR QUARTERS CORP.
                      FOR THE YEAR ENDED DECEMBER 31, 1996
          AND THE COMBINED STATEMENTS OF OPERATIONS OF THE KAPSON GROUP
    FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED DECEMBER 31, 1995 AND 1994


<TABLE>
<CAPTION>
                                                                                         1996             1995             1994
                                                                                     ------------     ------------     ------------
<S>                                                                                   <C>              <C>              <C>
Revenues:
   Assisted living revenues                                                           $22,533,855      $14,275,484      $13,349,033
   Management fees                                                                      1,080,223          442,825          347,839
   Other - affiliates                                                                        --             45,065           57,530
                                                                                     ------------     ------------     ------------

       Total revenues                                                                  23,614,078       14,763,374       13,754,402
                                                                                     ------------     ------------     ------------

Operating expenses:
   Assisted living operating expenses                                                  14,804,083        8,314,372        7,836,765
   General and administrative                                                           3,814,093        1,658,658        1,141,735
   Depreciation                                                                         2,090,996        1,233,843        1,180,418
                                                                                     ------------     ------------     ------------

       Total operating expenses                                                        20,709,172       11,206,873       10,158,918
                                                                                     ------------     ------------     ------------

Operating income                                                                        2,904,906        3,556,501        3,595,484

Equity in income from joint ventures                                                       76,829             --               --
Interest income                                                                           462,812           44,234            8,693
Interest expense                                                                       (6,514,389)      (3,935,796)      (3,496,063)
Other income (expense), net                                                              (205,074)         (34,065)          (1,070)
                                                                                     ------------     ------------     ------------

(Loss) income before minority interest                                                 (3,274,916)        (369,126)         107,044
Minority interest in net loss of partnerships                                             924,264           15,845             --
                                                                                     ------------     ------------     ------------

(Loss) income before provision for income taxes and extraordinary item                 (2,350,652)        (353,281)         107,044
Provision for income taxes                                                             (2,039,000)            --               --
                                                                                     ------------     ------------     ------------

(Loss) income before extraordinary item                                                (4,389,652)        (353,281)         107,044
Extraordinary item - forgiveness of debt                                                     --               --          4,398,672
                                                                                     ------------     ------------     ------------

     Net (loss) income                                                                ($4,389,652)       ($353,281)      $4,505,716
                                                                                     ============     ============     ============

Unaudited pro forma data:
   (Loss) income before provision for income taxes and extraordinary item             ($2,350,652)       ($353,281)        $107,044
   Benefit (provision) for income taxes                                                   940,261          141,312          (42,818)
                                                                                     ------------     ------------     ------------

   (Loss) income before extraordinary item                                             (1,410,391)        (211,969)          64,226
   Extraordinary item - forgiveness of debt, net of tax                                      --               --          2,639,204
                                                                                     ------------     ------------     ------------

   Pro forma net (loss) income                                                        ($1,410,391)       ($211,969)      $2,703,430
                                                                                     ============     ============     ============

   Pro forma (loss) income per share:
   (Loss) income before extraordinary item                                                 ($0.26)          ($0.04)           $0.01
   Extraordinary item, net of tax                                                            --               --               0.56
                                                                                     ------------     ------------     ------------

   (Loss) income per share                                                                 ($0.26)          ($0.04)           $0.57
                                                                                     ============     ============     ============

   Pro forma weighted average number
      of common shares outstanding                                                      5,510,000        4,758,000        4,758,000
                                                                                     ============     ============     ============
</TABLE>

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



                                      F-4
<PAGE>


 CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY OF KAPSON SENIOR QUARTERS CORP.
                      FOR THE YEAR ENDED DECEMBER 31, 1996
                AND THE COMBINED STATEMENTS OF SHAREHOLDERS' AND
                     PARTNERS' DEFICIT OF THE KAPSON GROUP
    FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED DECEMBER 31, 1995 AND 1994

<TABLE>
<CAPTION>

                                                Common Stock            Additional                     Shareholders'
                                         ---------------------------     Paid In        Accumulated    and Partners'
                                            Shares         Amount        Capital          Deficit         Deficit          Total
                                         ------------   ------------   ------------    ------------    ------------    ------------

<S>                                        <C>              <C>        <C>              <C>            <C>             <C>
December 31, 1993                                --             --             --              --      ($12,324,957)   ($12,324,957)

Distributions                                    --             --             --              --          (920,399)       (920,399)
Net income                                       --             --             --              --         4,505,716       4,505,716
                                         ------------   ------------   ------------    ------------    ------------    ------------

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             4,150,000        $41,500     (7,500,126)           --         7,458,626            --
Issuance of common stock in
  initial public offering                   3,550,000         35,500     29,603,974            --              --        29,639,474
Issuance of common stock for
  purchase of minority interest                50,000            500        499,500            --              --           500,000
Net loss                                         --             --             --       ($4,389,652)           --        (4,389,652)
                                         ------------   ------------   ------------    ------------    ------------    ------------

December 31, 1996                           7,750,000        $77,500    $16,603,348     ($4,389,652)           --       $12,291,196
                                         ============   ============   ============    ============    ============    ============
</TABLE>



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



                                      F-5
<PAGE>


      CONSOLIDATED STATEMENT OF CASH FLOWS OF KAPSON SENIOR QUARTERS CORP.
                      FOR THE YEAR ENDED DECEMBER 31, 1996
          AND THE COMBINED STATEMENTS OF CASH FLOWS OF THE KAPSON GROUP
    FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED DECEMBER 31, 1995 AND 1994


<TABLE>
<CAPTION>
                                                                                           1996            1995            1994
                                                                                       ------------    ------------    ------------
<S>                                                                                     <C>               <C>            <C>
Cash flows from operating activities:

Net (loss) income                                                                       ($4,389,652)      ($353,281)     $4,505,716
Adjustments to reconcile net (loss) income to net cash (used in)
   provided by operating activities:
     Depreciation                                                                         2,090,996       1,233,843       1,180,418
     Amortization                                                                           437,378         226,456         216,867
     Deferred income taxes                                                                2,039,000            --              --
     Extraordinary item                                                                        --              --        (4,398,672)
     Minority interest in net loss of combined partnerships                                (924,264)        (15,845)           --
     Equity in income from invesment in joint ventures                                      (76,829)           --              --
     Changes in other assets and  liabilities,  excluding the effect of acquired
      facilites:
         Accounts receivable                                                                 (2,492)        (49,396)        (10,729)
         Prepaid expenses and other current assets                                         (208,915)        (50,422)        (29,297)
         Restricted cash - resident security deposits                                       (16,855)        (19,336)       (249,637)
         Other assets                                                                      (407,884)       (128,144)        (23,620)
         Accounts payable and accrued expenses                                               74,568       1,961,924         230,555
         Accrued interest                                                                  (363,198)        101,325         155,937
         Resident security deposits                                                         447,045          79,115         122,845
         Deferred interest payable                                                           42,300          57,700          47,500
         Deferred revenue                                                                   311,604          29,851         (50,364)
                                                                                       ------------    ------------    ------------

              Net cash (used in) provided by operating activities                          (947,198)      3,073,790       1,697,519
                                                                                       ------------    ------------    ------------


Cash flows from investing activities:
Acquisition of facilities, (net of cash assumed
   of $518,000)                                                                          (9,856,250)           --              --
Increase in restricted mortgage escrow funds                                               (525,655)     (1,069,015)     (1,221,928)
Investment in joint venture                                                                (475,000)           --              --
Purchases and development of property and equipment                                      (9,031,911)    (16,530,708)       (724,971)
Purchase of minority interests in partnership interests                                  (2,100,000)           --              --
Sale of minority interests in combined partnerships                                       1,200,000            --         1,479,116
Increase in other assets                                                                 (7,341,007)           --              --
                                                                                       ------------    ------------    ------------

              Net cash used in investing activities                                     (28,129,823)    (17,599,723)       (467,783)
                                                                                       ------------    ------------    ------------

Cash flow from financing activities:
Proceeds from initial public offering, net of offering costs                             29,639,474            --              --
Proceeds from issuance of long-term debt                                                 20,019,470      17,565,212       1,907,136
Principal payment of long-term debt                                                        (721,043)        (78,039)       (370,939)
Proceeds from loan                                                                          555,000            --              --
Deferred financing costs                                                                   (732,272)       (887,668)     (1,481,980)
Due (from) to affiliates                                                                 (3,375,450)        150,648         204,920
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)       (920,399)
                                                                                       ------------    ------------    ------------

              Net cash provided by (used in) financing activities                        41,738,010      16,031,617        (661,262)
                                                                                       ------------    ------------    ------------

              Net increase in cash and cash equivalents                                  12,660,989       1,505,684         568,474
Cash and cash equivalents, beginning of period                                            3,392,318       1,886,634       1,318,160
                                                                                       ------------    ------------    ------------

Cash and cash equivalents, end of period                                                $16,053,307      $3,392,318      $1,886,634
                                                                                       ============    ============    ============

Cash paid during the year for:
         Interest                                                                        $6,877,587      $3,400,592      $3,036,255
                                                                                       ============    ============    ============
         Income taxes                                                                       $24,860            --              --
                                                                                       ============    ============    ============

Supplemental disclosure:

Issuance of common stock for purchase of remaining minority  interest
     in a facility                                                                         $500,000            --              --
                                                                                       ============    ============    ============
</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.

During the fourth quarter of 1996, the Company began  operating  Senior Quarters
at Cranford and the  construction  of Senior  Quarters at Albany under long-term
operating leases.

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:

<TABLE>
<CAPTION>
              FACILITY                                      FORM                                     %
              --------                                      ----                                     -
<S>                                                    <C>                                          <C>
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
</TABLE>


                                      F-7
<PAGE>


<TABLE>
<S>                                                    <C>                                          <C>
Minority Interests
 Senior Quarters at Jamesburg                          Limited Liability Company                     11
 Senior Quarters at Glen Riddle                        Limited Partnership                           10
*Senior Quarters at Montville                          Limited Partnership                         23.7
</TABLE>

*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  on the
equity method. All significant intercompany  transactions and accounts have been
eliminated in consolidation.  The 1996 consolidated financial statements reflect
the  operations of the Company for the three months ended  December 31, 1996 and
the Predecessor for the nine months ended September 30, 1996.

The combined  financial  statements  as of December 31, 1995 and for each of the
two years in the period ended December 31, 1995 include the assets,  liabilities
and  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  reflected at historical
cost. Investments in minority owned partnership investments are accounted for on
the equity method. 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.

Disclosures  made herein with  respect to the years ended  December 31, 1995 and
1994 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,  for  minority-owned  assisted  living  facilities,  are recorded when the
respective services are rendered.

Property and Equipment

Property and equipment are stated at cost with depreciation  calculated over the
assets' estimated useful lives using the straight-line method 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.




                                      F-8
<PAGE>



Intangible Assets

Intangible  assets  consist  of the  excess of cost  over the fair  value of net
assets of acquired facilities  ($4,547,632,  net of accumulated  amortization of
$165,686) which is amortized on the  straight-line  method over 15 years,  and a
covenant not to compete ($274,210,  net of accumulated  amortization of $48,390)
which is amortized on a straight-line basis over 5 years.  Amortization  expense
was $214,076 for the year ended December 31, 1996.

Long-Lived Assets

If  there  is an event or a change  in  circumstances  adversely  impacting  the
recoverability  of  long-lived  assets,  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  $523,877 and $304,729 at
December 31, 1996 and 1995, 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.

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.

Stock Options

In October 1995, the Financial  Accounting  Standards Board issued Statements of
Financial Accounting Standard No. 123, "Accounting for Stock-Based Compensation"
("SFAS No. 123"),  which  prescribes a new method of accounting for  stock-based
compensation that determines  compensation  expense based on fair value measured
at the grant date.  SFAS No. 123 provides  companies that grant stock options or
other equity instruments to employees, the option of either



                                      F-9
<PAGE>



adopting the new rules or continuing  current  accounting with disclosure of the
pro  forma  amounts  as if the new  rules  had been  adopted.  SFAS  No.  123 is
effective for transactions entered into after December 15, 1995. The Company has
elected the alternative disclosure provisions of SFAS No. 123 (see Note 9).

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  income  (loss)  per  share for each of the two years in the
period 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  (provision)  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  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 March 1997,  the Financial  Accounting  Standards  Board issued  Statement of
Financial  Accounting Standards No. 128, "Earnings per Share" ("SFAS No. 128") ,
which  establishes  standards for computing and  presenting  earnings per share.
SFAS No. 128 will be  effective  for  financial  statements  issued for  periods
ending after December 15, 1997. Earlier application is not permitted. Management
believes  that this change will not have any impact on the  Company's  financial
statements for the year ended December 31, 1996.

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:


                                                              December 31,
                                                      --------------------------
                                                          1996           1995
                                                      -----------    -----------

               Land                                    $4,800,644     $1,959,514

               Buildings and improvements              57,334,170     29,728,334

               Furniture and equipment                  6,972,718      6,396,074
                                                      -----------    -----------

                                                       69,107,532     38,083,922

               Less, accumulated depreciation          10,729,797      8,638,801
                                                      -----------    -----------

               Property and equipment, net            $58,377,735    $29,445,121
                                                      ===========    ===========



                                      F-10
<PAGE>




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

Included in other assets is a deposit for approximately $7,341,000 for leasehold
improvements in a leased facility.

4. Investments in Joint Ventures:

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) and a 23.75%  interest in a limited  partnership
(Senior  Quarters  at  Montville).  The equity  interest  in Senior  Quarters at
Montville was purchased for $475,000 on April 1, 1996. The Company does not have
operational  control  of any of these  entities.  The joint  venture  agreements
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.
Summarized financial information for these joint ventures is as follows:

                                                          December 31,
                                                 ------------------------------
Balance Sheet                                        1996              1995
                                                 ------------      ------------
Assets:
           Property and equipment, net           $ 26,757,516      $  1,511,423
           Construction in progress                    86,938         6,340,604
           Restricted investments                   8,820,661        20,884,931
           Other assets                             4,182,373         1,344,308
                                                 ------------      ------------
                                                 $ 39,847,488      $ 30,081,266
                                                 ============      ============
Liabilities and partners' capital:
           Notes payable                         $ 32,063,029      $ 25,585,142
           Other liabilities                        3,294,744         1,267,067
           Partners'/members' capital               4,489,715         3,229,057
                                                 ------------      ------------
                                                 $ 39,847,488      $ 30,081,266
                                                 ============      ------------
Income Statement:
           Revenues                              $  4,279,141      $       --
           Operating expenses                      (3,970,018)          (20,363)
           Other expense, net                      (1,013,609)             --
                                                 ------------      ------------
                      Net loss                   $   (704,486)     $    (20,363)
                                                 ============      ============

5. Acquisitions and Dispositions:

Acquisitions

On April 1, 1996, the Predecessor purchased two assisted living facilities (Town
Gate Manor and Town Gate East) for approximately  $10,375,000 which was financed
entirely  by  mortgage  notes  under the  Credit  Facility  (Notes 6 and 7). The
acquisition  has been  accounted for under the purchase  method and the purchase
price was allocated to the assets  acquired and  liabilities  assumed based upon
their relative fair value as follows:

Cash                                                               $    518,000
Property and equipment                                                6,422,000
Goodwill                                                              2,903,000
Covenant not to compete                                                 323,000
Other assets                                                            290,000
Other liabilities                                                       (81,000)
                                                                   ------------
                                                                   $ 10,375,000
                                                                   ============


                                      F-11
<PAGE>



In October 1996, the Company purchased for $2,600,000 the remaining 50% interest
of Senior  Quarters at East  Northport.  The $2,600,000  purchase price was paid
through the issuance of 50,000 shares of common stock  ($500,000) and $2,100,000
in cash. The entire  purchase price in excess of the basis of minority  interest
was allocated to goodwill.

Disposition

During  1996,  the  Predecessor  sold a 49.9%  interest  in Senior  Quarters  at
Chestnut Ridge to an unrelated party for $1,200,000.  Since the Company retained
operational and 50.1% voting control of the facility,  its results of operations
are  consolidated  in the  accompanying  financial  statements  with  the  49.9%
investment reflected as a component of minority interest.

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,  1996 and  1995,  adjusted  to give  effect to these
transactions as if they occurred on January 1, 1995.

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,
1995,  nor does it purport to  represent  the results of  operations  for future
periods.

                                                    Unaudited pro forma data
                                                 For the year ended December 31,
                                                 -------------------------------
                                                       1996             1995
                                                      -----             ----
Total revenue                                       $ 24,569          $ 18,308
Net (loss) income                                     (1,842)              227
Net (loss) income  per share                            (.33)              .05



                                      F-12
<PAGE>


6. Long-Term Debt:

<TABLE>
<CAPTION>
                                                                                                         December 31,
                                                                                           ----------------------------------------
                                                                                                  1996                        1995
                                                                                                  -----                       ----
<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. (B)                                                              $ 15,757,790                $ 16,000,000

      Mortgage note payable to a financial institution bearing interest at 4%
      above the financial institution's base lending rate (9.51% at December
      31, 1996) and  matures on February 28, 1999. (A) (B) (C) (E)                            6,763,544                   6,931,282

      Mortgage note payable to a financial  institution  bearing  interest at 4%
      above the financial institution's base lending rate (9.51% at December
      31, 1996) matures on February 28, 1999. (A) (B) (C) (E)                                 8,547,322                   8,759,298

      Mortgage note payable to an institution with interest only payments
      through December 1996 at 4.25% above U.S. Treasury Notes (10.67%
      at December 31, 1996); beginning January 1997 monthly payments of
      principal and interest are due and matures December 2006. (B) (D) (I)
      (Note 7)                                                                                8,000,000                   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.  (F)                                               19,320,238                  14,363,167

      Mortgage note payable to a financial institution with interest only
      payments through March 1997 at 4.25% above U.S. Treasury Notes
      (10.67% at December 31, 1996).  Beginning April 1997 monthly
      payments of principal and interest are due and matures April 2006.  (B)
      (F) (G) (I) (Note 7)                                                                    6,484,375                          --

      Mortgage note payable to a financial institution with interest only
      payments through March 1997 at 4.25% above U.S. Treasury Notes
      (10.67% at December 31, 1996).  Beginning April 1997 monthly
      payments of principal and interest are due and matures April 2006.  (B)
      (F) (G) (I) (Note 7)                                                                    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%  (11.75% at  December  31,  1996)  during the  construction
      phase, during which only payments of interest are due (H)
      (I) (Note 7)                                                                            4,588,280                          --
                                                                                        ---------------             ---------------
                                                                                             73,352,174                  54,053,747

      Less, current portion                                                                     943,658                     245,867
                                                                                        ---------------             ---------------
      Long-term portion                                                                    $ 72,408,516                $ 53,807,880
                                                                                        ===============             ===============
</TABLE>



                                      F-13
<PAGE>



(A)  Effective  February 1996,  the Company makes monthly  payments equal to the
     outstanding  mortgage principal balance multiplied by 12.0%. The difference
     between this payment and the interest  expense is applied as a reduction of
     principal.

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

(C)  The  mortgage  notes  include  an equity  participation  provision  for the
     lender.  The  Company  is  obligated  to pay the  lender at either  (i) the
     maturity of the loan;  (ii)  refinancing  of the loan; or (iii) sale of the
     facility,  the greater of $480,000 or 25% of the appraised  market value of
     the facility in excess of  $17,500,000.  The $480,000 is deferred  interest
     payable and is reflected in the accompanying financial statements under the
     effective  interest method.  The difference  between the effective interest
     rate  and the pay rate is  reflected  as  deferred  interest  payable.  The
     effective  interest  rate on this note was 10.1% and 10.4% at December  31,
     1996 and 1995, respectively.

(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 6.75% 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.  As of December 31, 1995 the
     note included an equity  participation for the lender however,  during 1996
     the agreement was revised and the equity participation was eliminated.  The
     effect on the consolidated  financial  statements was immaterial.  Prior to
     the revision the Company was obligated to pay the lender at the  expiration
     of the initial term, prepayment or upon default, the greater of $800,000 or
     50% of the  difference  between the fair market  value of the  facility and
     $8,000,000.  The difference between the effective interest rate and the pay
     rate is reflected as deferred interest payable. The effective interest rate
     on this note was 11.6% at December 31, 1995.

(E)  These notes are partially or totally guaranteed by the respective  partners
     and shareholders of the Predecessor.

(F)  Various prepayment penalties exist.

(G)  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.

(H)  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.

(I)  Various restrictive covenants exist.



                                      F-14
<PAGE>



Principal payments on long-term debt as of December 31, 1996 are as follows:

              Years ended
              December 31,
              ------------
                  1997                                 $   943,658
                  1998                                     996,589
                  1999                                  15,239,242
                  2000                                     751,842
                  2001                                     815,341
                  Thereafter                            54,605,502

7.   Credit Facility:

The Company has  available a $100 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 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 $26,100,000 at
December 31, 1996.  Commitments for operating leases reduce the amount available
under the facility.

The Credit Facility is  collateralized  by the Company's real estate,  equipment
and accounts  receivable.  At December 31, 1996, the Company has available under
the Credit Facility $50,935,942.

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, 1996,  the Company was not in  compliance  with certain of these
covenants.  Waiver on default of certain  financial  covenants was received from
Health  Care REIT Inc.  and the  facility  was  subsequently  amended  to revise
certain financial covenants to reflect the Company's current and future business
environment.



                                      F-15
<PAGE>


8. 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, 1996 are as
follows:

Deferred tax assets:
   Net operating losses                              $  236,000
   Deferred revenue                                     208,000
   Deferred interest                                     59,000
                                                     ----------
Deferred tax assets                                     503,000

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

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

Benefit at statutory rate                               $ (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                                  (89,000)
Other                                                      (72,000)
                                                        ----------
                                                        $2,039,000
                                                        ==========

The Company's net operating loss carryforwards for income tax purposes expire in
2011.

9. Commitments and Contingencies:

Management Agreements

The Company has agreements  with  unaffiliated  parties to manage their assisted
living  facilities.  These agreements,  which range from three to ten years with
five year renewal  options,  expire at various dates from 1997 through 2006. 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.



                                      F-16
<PAGE>


Operating Leases

The Company is obligated under certain long term non-cancelable operating leases
for its corporate office and office equipment  expiring at various dates through
2007. In addition, during the year, the Company entered into long-term operating
leases with Health Care REIT for an existing  assisted  living  facility and the
financing of a facility  under  development  (see Note 7). Future  minimum lease
payments  required  under all  operating  leases as of December  31, 1996 are as
follows:

                  Years ended
                  December 31,
                  ------------
                      1997                           $ 1,899,564
                      1998                             2,981,060
                      1999                             3,039,090
                      2000                             3,112,108
                      2001                             3,174,401

Rent expense was approximately $385,000, $90,000 and $75,000 for the years ended
December 31, 1996, 1995 and 1994, 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 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.  In
September  1996,  the Company  granted  117,500  stock options under the Plan to
various key employees and  non-employee  directors at the then fair market value
of the Company's common stock, or $10.00 per share.  There were no other options
granted under the Plan,  nor were any options  exercised or expired.  During the
year, 12,500 options were canceled.

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

       Pro forma net loss  - as reported                             ($ 1,410)
       Pro forma net loss  - as adjusted                             ($ 1,444)
       Pro forma loss per share - as reported                           ($.26)
       Pro forma loss per share - as adjusted                           ($.26)

The fair  value of stock  options  used to  compute  pro  forma net  income  and
earnings  per share in  accordance  with SFAS No. 123 is the  estimated  present
value at grant using the Black-Scholes  option-pricing  model with the following
weighted average assumptions for 1996: dividend yield of 0%; expected volatility
of 41.09%;  a risk free interest rate of 5.59% and an expected holding period of
5 years.



                                      F-17
<PAGE>


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 $213,000,  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  $219,000 in 1996 and is included in other
income (expense), in the accompanying consolidated statement of operations.

10. Extraordinary Item:

During 1994, the  Predecessor  negotiated a settlement  with various  lenders to
satisfy  outstanding  mortgage notes payable and accrued  interest  payable at a
$4,398,672 discount.  The Predecessor  simultaneously  refinanced this debt with
other  lenders  at the  then  prevailing  market  rates.  This  amount  has been
reflected in the 1994 combined statement of operations as an extraordinary item.

11. Related Party Transactions:

Due to Affiliates

These  amounts  represent  advances  to/from  affiliated  entities  that are not
included or combined as a component of the  Predecessor.  These advances,  which
are due on demand and bear interest at rates  ranging from 6.53% to 6.92%,  were
made to assist in the funding of the affiliated  entities  start-up  operations.
The Kaplans assumed these obligations in connection with the Offering.

Other - Affiliates

The Predecessor had arrangements with affiliated entities to provide real estate
advisory  services.  The  fees  received  by the  Predecessor  were  based  on a
percentage of the affiliate's annual rental revenue. These arrangements were not
assumed by the Company.

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, 1996 and 1995.


                                      F-18
<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. Shareholders' Equity:

The  Company's  Certificate  of  Incorporation  authorizes  the Company to issue
10,000,000  shares of Preferred Stock,  $.01 par value and 30,000,000  shares of
Common Stock, $.01 par value.

As of December 31, 1996, there are no issued shares of Preferred Stock.

16. Subsequent Events

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


                                      F-19