HEALTHCOR HOLDINGS INC, 10-K, 1998-04-15

HEALTHCOR HOLDINGS INC
10-K, 1998-04-15
MISC HEALTH & ALLIED SERVICES, NEC

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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

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

FOR THE YEAR ENDED DECEMBER 31, 1997

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES ACT OF
1934 FOR THE TRANSITION PERIOD FROM ______ TO ________.

HEALTHCOR HOLDINGS, INC.
(Exact name of registrant as specified in its charter)

Delaware 8090 75-2294072
(State or other (Primary Standard (I.R.S. Employer
jurisdiction Industrial Identification No.)
of incorporation or Classification
organization) Code Number)

8150 NORTH CENTRAL EXPRESSWAY, SUITE M2000
DALLAS, TEXAS 75206
(214) 692-4663
(Address, including zip code, and telephone number, including area code,
of registrant's principal executive offices)

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 $0.01 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 THE
FILING REQUIREMENTS FOR THE PAST 90 DAYS.

YES [X] NO [ ]

INDICATE BY CHECK MARK IF THE DISCLOSURE OF DELINQUENT FILERS PURSUANT TO
ITEM 405 OF ITEM 405 OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE
CONTAINED, TO THE BEST OF THE 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. [ ]

THE AGGREGATE MARKET VALUE OF THE REGISTRANT'S VOTING STOCK HELD BY
NON-AFFILIATES OF THE REGISTRANT, COMPUTED BY REFERENCE TO THE PRICE AT WHICH
THE STOCK WAS SOLD, OR AVERAGE OF THE CLOSING BID AND ASKED PRICES, AS OF APRIL
7, 1998 WAS $10,343,340. ALL OUTSTANDING SHARES OF COMMON STOCK, EXCEPT FOR
SHARES HELD BY EXECUTIVE OFFICERS AND MEMBERS OF THE BOARD OF DIRECTORS AND
THEIR AFFILIATES, ARE DEEMED TO BE HELD BY NON-AFFILIATES.

DOCUMENTS INCORPORATED BY REFERENCE
-----------------------------------

PART III INCORPORATES BY REFERENCE PORTIONS OF THE REGISTRANT'S DEFINITIVE
PROXY STATEMENT FOR ITS 1998 ANNUAL MEETING OF STOCKHOLDERS.
<PAGE>
ALL STATEMENTS, OTHER THAN STATEMENTS OF HISTORICAL FACTS, INCLUDED IN THIS
REPORT, INCLUDING THE COMPANY'S ABILITY TO ACHIEVE SIGNIFICANT EXPECTED COST
SAVINGS OR SYNERGIES FROM THE CLOSING OR CONSOLIDATION OF OFFICES AND OTHER
RESTRUCTURING EFFORTS, AND THE PLANS, OBJECTIVES AND EXPECTATIONS OF MANAGEMENT,
ARE FORWARD LOOKING STATEMENTS. THESE FORWARD LOOKING STATEMENTS ARE BASED ON
THE COMPANY'S CURRENT EXPECTATIONS. ALTHOUGH THE COMPANY BELIEVES THAT THE
EXPECTATIONS REFLECTED IN SUCH FORWARD LOOKING STATEMENTS ARE REASONABLE, THERE
CAN BE NO ASSURANCE THAT SUCH EXPECTATIONS WILL PROVE TO BE CORRECT. BECAUSE
FORWARD LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES, THE COMPANY'S ACTUAL
RESULTS COULD DIFFER MATERIALLY. THE COMPANY DISCLAIMS ANY INTENT OR OBLIGATION
TO UPDATE ITS FORWARD-LOOKING STATEMENTS.

PART I

ITEM 1. BUSINESS
RECENT DEVELOPMENTS

RECENT FINANCIAL PERFORMANCE. HealthCor's net revenues for the three months
ended December 31, 1997, increased by 18.1% to $34.6 million compared to $29.3
million recorded in the same period of 1996. HealthCor reported a net loss for
the quarter ended December 31, 1997 of $(15.4) million compared to net income
for the fourth quarter of 1996 of $1.7 million. The Company also recorded a loss
per share for the quarter of $(1.53) on 10.1 million average shares outstanding
compared to earnings of $0.17 per share on 10.0 million average shares
outstanding in the fourth quarter of 1996.

HealthCor's net revenues during 1997 increased by 34.1% to $143.2 million
compared to $106.8 million recorded in 1996. The net loss for 1997 was $(15.6)
million compared to net income of $5.3 million in 1996. The net loss per share
for 1997 was $(1.56) on 10.1 million average shares outstanding compared to
basic earnings per share of $0.69 on 7.8 million shares outstanding in 1996.

The net loss for the three months ended December 31, 1997, was adversely
affected by the following factors: the Company recorded a pre-tax charge of $9.9
million related to its previously announced restructuring plan predominantly
associated with its Medicare nursing business, consisting of a goodwill
write-off of $8.3 million and a restructuring charge of $1.6 million. The
Company also recorded a pre-tax charge of $0.3 million related to the write-off
of previously capitalized fees in connection with the Company's early repayment
of its bank credit facility, a pre-tax (non-cash) charge of $0.4 million related
to the termination of the Company's Employee Stock Ownership Plan and an
increase in the provision for doubtful accounts of $5.7 million. In addition,
results for the three months ended December 31, 1997, were adversely affected by
the Company's Medicare nursing operations exceeding cost limitations by a
pre-tax amount of $5.6 million.

PENDING LITIGATION. On March 20, 1998, the Company and several of its current
and former officers were named as defendants in a lawsuit alleging certain
violations of federal securities laws by the Company. The plaintiffs in the
lawsuit seek to represent a class of persons who purchased shares of the
Company's Common Stock from March 31, 1997 through and including August 14,
1997. The Company intends to vigorously defend the lawsuit but is unable to
assess the likelihood of success in this litigation, which is in the early stage
of fact finding. An adverse result in the litigation could have a material
adverse effect on the Company's business and operations.

REGULATORY CHANGES; CLOSING OF NURSING OFFICES. During 1997, the home health
care industry experienced several significant regulatory and reimbursement
changes. In February 1997, the Health Care Financing Administration ("HCFA")
announced that it intended to implement mileage limitations restricting the
distance between a nursing agency's principal office and its branches. Texas,
where the Company has significant operations, announced that it intended to
implement even more restrictive mileage limitation rules for branch offices.
During 1998, as a result of a moratorium on new Medicare provider numbers
announced by President Clinton, HCFA imposed a delay in permitting branch office
transfers.

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Congress has also recently adopted a per-beneficiary limit on reimbursement
for nursing services based upon historical cost, and on March 31, 1998,
published regulations which set forth the national and regional medians on which
such limits will be based, but has not issued the provider specific
per-beneficiary limits. The Company believes that these per-beneficiary limits
will have an adverse effect on the Company's Medicare nursing operations.

Other regulatory changes have reduced the level of reimbursement available to
the Company. On January 2, 1998, HCFA published final Medicare nursing per-visit
cost limitation guidelines which reduce per-visit cost limitations for the
Company by approximately 18%-20% for 1998. Also, regulations effective February
1, 1998, eliminate venipuncture as a covered service for Medicare nursing
visits, which will materially reduce the Company's Medicare nursing revenues. In
addition, reimbursement rates for Medicare home oxygen services, which represent
approximately 6% of the Company's annualized revenues, will be reduced by 25.0%
beginning January 1, 1998, with an additional 5.0% reduction to be effective
January 1, 1999.

ACCOUNTS RECEIVABLE MANAGEMENT. The Company's results for 1997 were adversely
affected by additional provisions for doubtful accounts of $8.4 million. The
additional provisions for doubtful accounts resulted from the Company's
continuing evaluation of certain accounts receivable and the general industry
environment.

SENIOR NOTES; BANK CREDIT FACILITY. On December 1, 1997, the Company issued
$80 million aggregate principal amount of its 11% Senior Notes due 2004 (the
"Notes"). On January 13, 1998, the Company filed a Registration Statement on
Form S-4 with respect to the Notes and on February 10, 1998, commenced an Offer
to Exchange the Notes for registered Exchange Notes. The Exchange Offer is
expected to be complete by April 30, 1998. The Company is party to a Second
Amended and Restated Credit Agreement, dated as of December 1, 1997 (the "New
Credit Facility"), which provides for an aggregate of $20.0 million of
borrowings. No borrowings under the New Credit Facility were outstanding on
December 31, 1997. The Company is currently in default of several of the
financial covenants under the New Credit Facility and is unable to incur
indebtedness under the facility.

THE COMPANY

The Company has diversified its business mix from 98% home nursing in 1990 to
52% home nursing for the year ended December 31, 1997. This shift reflects the
addition and growth of higher margin respiratory therapy/home medical equipment
and infusion therapy. The Company expects that it will continue to shift its
business mix towards respiratory therapy/home medical equipment and infusion
therapy. Home nursing, however, will continue to represent an important part of
HealthCor's business mix because managed care organizations and other referral
sources often will make arrangements for other home health care services after
first referring home nursing cases to a provider.

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The Company believes its ability to offer a full range of integrated home
nursing, respiratory therapy/ home medical equipment and infusion therapy in
almost all of its markets creates an important competitive advantage in
obtaining patient referrals. Managed care organizations and other referral
sources generally favor home health care providers that offer integrated health
care services, because "one-stop shop" providers like the Company provide
superior coordination of care and reduce the administrative and service quality
complications of contracting with multiple providers. In the last year, the
Company has entered into relationships with several managed care organizations
with approximately 1.5 million total enrollees. As an integrated provider, the
Company rarely engages subcontractors, which the Company believes permits it to
exercise greater control over quality of service and to improve patient care.

The Company believes it is a leader in developing and implementing financial
and clinical management information systems for providing home health care. Upon
the complete implementation of its proprietary medical information system
network, Medisyn(TM), expected to occur in 1998, the Company believes that it
will be able to achieve additional cost savings, increase productivity and
capture outcomes data that will provide significant advantages in obtaining
managed care business and adapting to regulatory and reimbursement changes.

INDUSTRY OVERVIEW

Home health care is among the fastest growing segments of the health care
industry with estimated annual expenditures of $36.1 billion in 1995, up from an
estimated $12.9 billion in 1990, representing a compounded annual growth rate of
approximately 23%. The underlying growth factors in the home health care
industry include: (i) the cost-effective nature of home health care; (ii) an
increasing number of patients due to growth in the elderly population; (iii)
technological advances that expand the range of home health care procedures; and
(iv) patient preference for treatment in the home.

The home health care industry is highly fragmented with more than 18,500
providers delivering home health care services in the United States, most of
which use unsophisticated information technology systems. Many of these
companies are local providers that offer a limited scope of services in a
defined geographical area and lack the capital necessary to substantially expand
their operations. Managed care organizations and cost containment initiatives by
payors have driven the growth of home health care by emphasizing lower cost
alternatives to hospitals and skilled nursing facilities. These organizations
and payors seek coordinated, consistent quality home health care across broad
geographic areas in order to serve their patients more effectively.

BUSINESS STRATEGY

HealthCor's business objective is to enhance its position as one of the
leading providers of comprehensive home health care services in the southwestern
and central United States. Elements of the Company's strategy include:

PROVIDE ONE-STOP SHOP HOME HEALTH CARE SERVICES. HealthCor provides payors,
physicians and patients with fully integrated one-stop shop home health care
services in almost all of its markets. The integration of comprehensive home
health care services enhances the Company's appeal to managed care organizations
and other referral sources that increasingly prefer single-source providers of
home health care. The Company believes that full integration of services enables
it to provide highly coordinated patient care and to increase revenues and
profitability by providing multiple services to an individual patient referral.

FOCUS ON MANAGED CARE RELATIONSHIPS. The Company has intensified its managed
care marketing efforts in order to take advantage of the increased market
penetration of managed care organizations in the home health care market and the
federal government's increasing preference for Medicare beneficiaries to enroll
in managed care plans. HealthCor is the sole or principal provider for a number
of large managed care plans, and the Company believes that its broad product
offering, quality of service, regional focus and advanced information systems
contribute to the Company's competitive advantage.

ENHANCE PROFITABILITY AND PRODUCTIVITY THROUGH INFORMATION TECHNOLOGY. The
Company seeks to enhance its profitability and productivity through the
development and use of innovative management information technology

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that collects and integrates demographic, financial and clinical information.
The Company is developing and implementing a proprietary financial and clinical
management information system, Medisyn(TM). The Company believes that
Medisyn(TM) will improve profitability by efficiently servicing increased
volumes of managed care referrals, increase productivity gains, reduce costs and
provide outcomes data to payors in an environment increasingly influenced by
managed care organizations and reimbursement changes.

MANAGED CARE RELATIONSHIPS

The Company is the sole or principal provider for a number of managed care
plans and intends to compete vigorously for additional significant managed care
business in the future. These relationships are almost all fee for service and
are consistent with the Company's strategy to price managed care contracts
profitably in order to provide quality service. A description of certain 1997
contracts is as follows:

o In May 1997, the Company became the exclusive provider of respiratory
therapy/home medical equipment to a large, multi-state managed care
organization's approximately 220,000 members in greater Denver, Colorado in
need of such services and equipment.

o In July 1997, the Company became the exclusive provider for a 60,000 member
health plan in Texas.

o In August 1997, the Company began receiving referrals as one of two
preferred providers (and the only one which is fully integrated) for a
managed care plan which has approximately 800,000 members in Texas,
Arkansas and Oklahoma.

o In August 1997, the Company began receiving referrals as a preferred
provider for a PPO which manages the health care needs for approximately
350,000 members in the Company's service area.

o In August 1997, the Company became a preferred provider for a 150,000
member PPO in Oklahoma.

Servicing new managed care business can require significant capital expenditures
and can generate significant revenues. For example, in the case of the Colorado
contract referred to above, the Company had almost no existing infrastructure in
Colorado and made capital expenditures in excess of $4.0 million to achieve full
implementation. Within two and one-half months of the contract becoming
effective, the Company had successfully transitioned approximately 1,500
patients and continues to receive additional referrals.

SERVICES AND PRODUCTS

HOME NURSING. The Company provides a wide range of nursing services to
individuals with acute illness, long-term chronic health conditions, permanent
disabilities, terminal illness or post-procedural needs. Patients are typically
referred to the Company by primary care or specialty physicians and managed care
case managers. After reviewing the patient's medical records and treatment plan
(which are displayed on PtCT Units), a nurse, therapist or home health aide,
where appropriate, provides care to the patient in the home. The plan of care
may require a few visits over a short period of time or many visits over several
years. The Company provides the following home nursing services:

GENERAL NURSING care is the periodic assessment of the appropriateness of
home health care, the performance of clinical procedures, and instruction of
the patient and the family or other care giver regarding proper treatments.
Such care is provided by registered nurses or licensed practical nurses.
Patients receiving such care typically include stabilized postoperative
patients, patients who are acutely ill but who do not require
hospitalization, and patients who are chronically or terminally ill.

SPECIALTY NURSING care is the provision of specialized nursing services
such as geriatric, pediatric or neonatal nursing. Such care is provided by
nurses with the appropriate experience or certification in such specialty.
Specialty nursing care also involves the instruction of the patient and the
family or other care giver in the self-administration of certain procedures,
such as wound care and infection control, emergency procedures and the

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proper handling and usage of medication, medical supplies and equipment.

THERAPY SERVICES consist of rehabilitation therapies such as physical,
occupational and speech therapy to patients recovering from strokes, trauma
or certain surgeries, services for high risk pregnancies, postpartum care,
AIDS therapy, various medical social services, and case management services
to insurance companies and self-insured employers.

HOME HEALTH AIDE CARE is the provision of personal care services and
assistance with activities of daily living such as personal hygiene and meal
preparation. The Company's home health aides must pass certain competency
tests and are supervised by a registered nurse.

PRIMARY HOME HEALTH CARE is provided by the Company through state
administered programs that pay for unskilled homemaker services to the
elderly or the disabled, as ordered by a physician. A registered nurse makes
the initial assessment and assigns a homemaker to provide housekeeping,
shopping and limited personal care.

RESPIRATORY THERAPY/HOME MEDICAL EQUIPMENT. The Company provides a wide
variety of home respiratory, monitoring and medical equipment. Respiratory
therapists provide care to the patient according to the physician-directed plan
of care and educate the patient and the family or other care giver regarding
treatment requirements, use of equipment and self-care. The Company rents, sells
and services respiratory equipment for patient use in the home and supplies
patients with aerosol medications for use in respiratory therapy treatments. The
Company's principal respiratory services include:

OXYGEN SYSTEMS THAT ASSIST PATIENTS WITH BREATHING. The Company provides
three types of oxygen systems: (i) oxygen concentrators, which are stationary
units that filter ordinary air in order to provide a continuous flow of
oxygen and are generally the most cost effective supply of oxygen for
patients who require a continuous flow of supplemental oxygen; (ii) liquid
oxygen systems, which are containers used for patients who require a
continuous high flow of supplemental oxygen; and (iii) high pressure oxygen
cylinders, which provide an ambulatory patient with the ability to obtain
supplemental oxygen outside of the home.

NEBULIZERS that deliver aerosol medications that are inhaled directly by
the patients. Nebulizers are used to treat patients with asthma, chronic
obstructive pulmonary disease, cystic fibrosis and neurologically related
respiratory problems, and patients with AIDS.

HOME VENTILATORS that mechanically sustain a patient's respiratory function
in cases of severe respiratory failure.

CONTINUOUS POSITIVE AIRWAY PRESSURE therapy that forces air through
respiratory passageways during sleep. This treatment is provided to adults
with sleep apnea, a condition in which a patient's normal breathing patterns
are disturbed during sleep. Monitoring services are usually provided with
this therapy.

The Company also leases and sells convalescent equipment, in connection with
the provision of its other services to patients in the home. Such equipment
includes hospital beds, wheelchairs, walkers, and patient lifts as well as
medical and surgical supplies such as stethoscopes, orthopedic supplies, urinary
catheters, syringes, and needles. The Company is able to increase revenues by
providing home medical equipment and supplies to its patients who are also
receiving nursing, respiratory therapy or infusion therapy.

The Company also provides monitoring services to assist physicians with
diagnoses. The Company's principal monitoring services currently comprise a
small portion of the Company's business but have experienced significant growth
in recent years. Monitoring services include:

CARDIAC MONITORING for the detection of arrhythmias, a condition that is
responsible for an estimated 500,000 deaths each year in the United States.
The Company provides cardiac loop event recorders which are monitored
electronically and are efficient and cost-effective arrhythmia detection
devices.

UTERINE MONITORING which detects, records and sends uterine activity
information to a prenatal monitoring

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center. Such monitoring is designed to alert health care professionals of
pre-term labor in high-risk pregnancies.

APNEA MONITORS provided to certain high risk newborn infants warn parents
of apnea episodes as a preventative measure against sudden infant death
syndrome.

HOME INFUSION THERAPY. The Company offers comprehensive home infusion
therapies. Home infusion therapy involves the administration of nutrients,
antibiotics and other medications intravenously (into the vein), subcutaneously
(under the skin), intramuscularly (into the muscle), intrathecally or epidurally
(via spinal routes), or through feeding tubes into the digestive tract. Infusion
therapy often begins during hospitalization of a patient and continues in the
home. New patients are instructed in the administration of infusion therapy and
related services by a registered nurse who provides the patient's first home
treatment and continuing supervision of care. The Company's principal infusion
therapies follow:

ANTIBIOTIC THERAPY is the infusion of antibiotic medications into a
patient's bloodstream to treat a variety of infections and diseases.

ENTERAL NUTRITION is the infusion of essential nutrients through a feeding
tube, and is necessary for patients who are unable to orally ingest adequate
nutrients.

TOTAL PARENTERAL NUTRITION is the infusion of a nutrient solution to
restore and/or maintain electrolyte balance and nutritional function.

PAIN MANAGEMENT is provided to patients experiencing acute pain as a result
of traumatic injury, surgical procedures or other medical disorders. The
Company provides a comprehensive approach to pain management that includes a
thorough knowledge of available agents, routes of administration and
appropriate dosage levels as directed.

CHEMOTHERAPY is provided in the home or in other locations and allows
patients with cancer an alternative to frequent and expensive hospital stays.

PENTAMIDINE is an agent used specifically in the treatment of patients with
AIDS who have experienced one or more episodes of pneumocystis carinii
pneumonia.

FINANCIAL AND CLINICAL MANAGEMENT INFORMATION SYSTEMS

The Company is implementing a proprietary financial and clinical management
information system, Medisyn(TM), which is comprised of several financial and
clinical components integrated through a central interface engine. Medisyn(TM)
is designed to integrate all aspects of the Company's operations by providing
centralized information management for each patient by linking clinical services
to its financial systems. The Company believes that Medisyn(TM) will enable it
to service increased volumes of managed care referrals, reduce costs and result
in more efficient collection of receivables. The Company also believes
Medisyn(TM) will provide competitive advantages by generating data that will
enhance the Company's ability to price and manage the Company's services and
products in a managed care environment and by measuring more accurately the
quality and cost of care that is delivered in the home. The Company believes
that it is the only home health care provider implementing this technology, and
has filed a patent application with respect to Medisyn(TM) with the United
States Patent Office.

Medisyn(TM) consists of the following four principal components, which
interface with the others through a central interface engine: (i) a proprietary,
customer information management system ("CIMS"); (ii) hand-held clinical system
point of care computers ("PtCT Units"); (iii) an integrated financial services
system (the "Lawson System"); and (iv) a contract management and billing system
(the "Innovative Managed Care System" or "IMACS"). Medisyn(TM) processes
referrals through CIMS, which captures patient information, creates a patient
profile and interfaces with the appropriate billing system(s) to create a
billing record. CIMS also assures that the requested services are authorized by
the payor. If the referral includes nursing services, the visit and clinical
information will be recorded at the patient's home in a PtCT Unit and
transmitted via modem to a central data base

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to be included in the patient profile. After services have been provided, the
IMACS system applies the contract terms of the payor and generates a customized
invoice, and through an interface provides this information to the Company's
financial systems, including cash posting and the general ledger. A description
of each principal component follows.

CIMS. CIMS coordinates all services for patients by assigning each patient a
single identification number and developing for each patient a readily
accessible comprehensive patient profile comprised of demographic, clinical,
case management and billing information. By integrating customer information
management for all of the Company's services, the Company is able to more
effectively service increased volumes of referrals from managed care payors.
CIMS enables the Company to record demographic data, obtain payor verification,
payor authorizations and diagnosis, all of which the Company believes will
enable it to more efficiently service managed care and other payor
relationships.

CIMS was implemented in February 1997 and currently services approximately
75% of the Company's managed care business through a central call center
covering the greater Dallas/Fort Worth, Houston, East Texas and Oklahoma
markets, each of which is characterized by a high degree of managed care market
penetration. Rollout to substantially all of the Company's remaining markets is
expected to be completed in 1998.

PtCT UNITS. The Company's nurses and home health aides are equipped with PtCT
Units, which are hand-held clinical system point of care computers. The PtCT
Units allow each of the Company's nurses to have an electronic patient chart in
hand and to transmit directly to the Company's system via modem clinical,
payroll and billing information. Once the clinical data has been recorded, the
system enables the Company to develop clinical assessments of patients via
computer generated documentation. Same-day reporting capabilities reduce
paperwork and transcription errors, which has increased certain nurse
productivity. The system also expedites the processing of payroll data,
accelerates the transfer of information to attending physicians, and improves
the consistency and completeness of the assessments generated.

INTEGRATED FINANCIAL SERVICES SYSTEM. The Company has substantially
implemented the Lawson System, which is an integrated suite of financial
services software, including a general ledger, cost accounting, accounts
payable, materials management/purchasing, payroll and human resource elements.
The conversion of the Company's financial system to the Lawson System in early
1997 delayed the Company's recognition of certain estimated purchases of
respiratory therapy/home medical equipment and infusion therapy equipment and
supplies until the second quarter of 1997. The general ledger, accounts payable
and payroll systems are fully operational and have improved the Company's
ability to analyze each element of its business to improve productivity and
operating efficiencies.

IMACS. IMACS, the Company's contract management and billing system, will
enable the Company to capture the essential elements of payor relationships
(including relationships with managed care organizations, other private payors,
Medicaid and Medicare), to assess pricing, eligibility, utilization and other
information necessary to assure accurate billing and to enhance contract
profitability. In addition, IMACS will allow the Company to more effectively
manage payor contract terms and to provide payors with a consolidated bill for
multiple services. Full implementation of IMACS is expected to be complete in
late 1998.

MARKETING

The Company's marketing efforts are based on a sales force of more than 25
persons, which is divided into two specialized groups: (i) national account
managers and (ii) field-based provider relations specialists. The national
account managers are responsible for developing additional managed care business
and for managing existing relationships. The field-based provider relations
specialists cover a specific geographic region and focus on referral sources
which include physicians, hospital discharge planners, social workers, and
community service organizations. In addition, at the local market level the
Company's employees, including office management, support the sales forces by
maintaining relationships with referral sources in order to provide them with
knowledge of the services provided by the Company.

The Company believes that its ability to provide a full range of services to
clients in all of its markets is a

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significant advantage in developing relationships with managed care
organizations. In addition, the Company works with managed care organizations to
meet their specialized demands for services, pricing, billing and other matters.

QUALITY ASSURANCE

The Company believes that the quality of services is critical to its ability
to obtain referrals and increase revenues and profitability. To assure the
delivery of high-quality patient care, and to assure the overall quality of
service, the Company has a quality improvement program designed to integrate and
assess the quality improvement activities and processes across all services. The
cornerstone to this quality improvement program is the HealthCor Survey Tool,
which is designed to routinely measure compliance with Medicare conditions of
participation, federal and state regulations, Joint Commission on Accreditation
of Health Organizations ("JCAHO") standards, and HealthCor's standards of care
and practice. The survey process includes review of clinical and billing
documentation, interviews of clinical personnel and observations of home visits
performed by Company staff. Other quality assurance initiatives include
measuring customer satisfaction, reporting adverse medical incidents, monitoring
risk management, and ensuring a safe and appropriate working environment.

The Company is accredited by JCAHO in a majority of its offices and believes
that this accreditation is generally preferred by managed care and other
third-party payors. The Company believes that it is JCAHO certified in all
markets where such certification is important to third-party payors.

HUMAN RESOURCE MANAGEMENT

The Company continuously recruits, screens, trains and offers benefits and
other programs in an effort to attract and retain its personnel. The Company
also recruits through Quest Personnel Resources, its personnel placement
division, reducing certain recruiting fees and expenses. Recruiting is conducted
primarily through advertising, personnel agencies, direct contact with community
groups and the use of bonuses.

The Company operates regional learning centers to provide orientation and
training to new employees and continuing education for existing employees. The
Company routinely develops and distributes quality improvement in-service
materials, manuals, and forms to its nurses and has implemented an internal
system of employee recognition and rewards. In addition, skilled nurses are
initially assigned to a nurse preceptor until the Company believes that these
new nurses have acquired a sufficient degree of home health care knowledge and
experience. The Company also has implemented an infusion therapy verification
program for skilled nurses. The Company is recognized as a provider of
continuing education units by the Texas Nursing Association, which is accredited
by the American Nursing Credentialing Center.

The retention of qualified employees is a high priority for the Company. As
of December 31, 1997, the Company employed over 2,000 individuals. Management
believes that the Company's employee relations are good. None of the Company's
employees are represented by a labor union or other collective bargaining
organization.

INSURANCE

The Company maintains professional liability insurance covering the negligent
acts and omissions of its home health care personnel while rendering services.
This policy provides coverage of $5.0 million in the aggregate or $5.0 million
per occurrence for each policy year. The Company believes that the insurance
which it maintains, in relation to the size of its business, is customary in the
home health care industry; however, there can be no assurance that any such
insurance will be adequate to cover the Company's liabilities. The Company
maintains product liability insurance on all of the medical equipment, supplies
and pharmaceuticals that it sells, leases or provides to its home health care
patients. This insurance provides coverage of $2.0 million in the aggregate or
$1.0 million per occurrence for each policy year. The Company also maintains
umbrella coverage in excess of its general liability insurance which provides
$4.0 million in the aggregate or $4.0 million per occurrence for each policy
year.

COMPETITION

The home health care industry is highly fragmented with more than 18,500
providers, with significant

9
<PAGE>
competition from multiple providers in most markets. The Company faces intense
competition for managed care contracts, patients, employees and acquisitions. In
recent years, independent home health care providers, including the Company,
have encountered significant competition from hospital-based home health care
organizations which have entered the home health care business. The Company has
experienced a significant decline in referrals from physicians with financial
and operating relationships with the parent hospitals of such organizations. In
addition, many of the Company's current and potential competitors are larger and
have significantly greater financial and marketing resources than those of the
Company.

REGULATION

The Company's business is subject to extensive and increasing regulation by
federal, state and local government. Federal agencies which regulate aspects of
the Company's business include the DHHS, HCFA, the Office of the Inspector
General, the Food and Drug Administration, the Department of Labor, the Drug
Enforcement Agency, and the Occupational Safety and Health Administration. In
most states, home health care providers are regulated by the state department of
health and board of pharmacy.

The Company is subject to federal laws regulating the repackaging and
dispensing of drugs and regulating interstate motor-carrier transportation and
state laws regulating pharmacies, nursing services and certain types of home
health agency activities. Under state laws, the Company's offices must be
licensed prior to commencing business and must renew their licenses
periodically. In addition, certain of the Company's employees are subject to
state laws and regulations governing the professional practice of respiratory
therapy, pharmacy and nursing. Failure to comply with regulatory laws could
expose the Company to criminal and civil penalties, and jeopardize the licensure
of one or more of its home health care agencies, or their participation in the
Medicare, Medicaid and other reimbursement programs.

As a provider of services under the Medicare and Medicaid programs, the
Company is subject to the various "anti-fraud and abuse" laws, including the
federal health care programs anti-kickback statute. This law prohibits any
offer, payment, solicitation or receipt of any form of remuneration to induce
the referral of business reimbursable under a federal health care program or in
return for the purchase, lease, order, arranging for, or recommendation of items
or services covered by any such program. Federal health care programs are any
health care plans or programs that are funded by the United States (other than
certain federal employee health insurance benefits) and certain state health
care programs that receive federal funds under various programs, such as
Medicaid. A related law forbids the offer or transfer of any item or service for
less than fair market value, or certain waivers of copayment obligations, to a
beneficiary of Medicare or a state health care program that is likely to
influence the beneficiary's selection of health care providers. Violations of
the anti-fraud and abuse laws can result in the imposition of substantial civil
and criminal penalties and, potentially, exclusion from furnishing services
under any federal health care programs. In addition, the states in which the
Company operates generally have laws that prohibit certain direct or indirect
payments or fee-splitting arrangements between health care providers where they
are designed to obtain the referral of patients to a particular provider.

Congress adopted legislation in 1989, known as the "Stark" Law, that
generally prohibits a physician ordering clinical laboratory services for a
Medicare beneficiary where the entity providing that service has a financial
relationship (including direct or indirect ownership or compensation
relationships) with the physician (or a member of his immediate family), and
prohibits such entity from billing for or receiving reimbursement for such
services, unless a specified exemption is available. Additional legislation
became effective as of January 1, 1993 known as "Stark II," that extends the
Stark Law prohibitions to services under state Medicaid programs, and beyond
clinical laboratory services to all "designated health services," including home
health services, durable medical equipment and supplies, outpatient prescription
drugs, and parenteral and enteral nutrients, equipment, and supplies. Violations
of the Stark Law may also trigger civil monetary penalties and program
exclusion. Pursuant to Stark II, physicians who are compensated by the Company
are prohibited from making referrals to the Company, and the Company will be
prohibited from seeking reimbursement for services rendered to such patients
unless an exception applies. Several of the states in which the Company conducts
business have also enacted statutes similar in scope and purpose to the federal
fraud and abuse laws and the Stark Laws.

Various federal and state laws impose criminal and civil penalties for making
false claims for Medicare,

10
<PAGE>
Medicaid or other health care reimbursements. The Company believes that it bills
for its services under such programs accurately. However, the rules governing
coverage of, and reimbursements for, the Company's services are complex. There
can be no assurance that these rules will be interpreted in a manner consistent
with the Company's billing practices.

In May 1995, the federal government instituted Operation Restore Trust, a
health care fraud and abuse initiative focusing on nursing homes, home health
care agencies and durable medical equipment companies located in the five states
with the largest Medicare populations. Texas, the Company's corporate base, was
one of the original targeted states. The purpose of this initiative is to
identify fraudulent and abusive practices such as billing for services not
provided, providing unnecessary services and making prohibited referral payments
to health care professionals. Operation Restore Trust has been responsible for
significant fines, penalties and settlements. Operation Restore Trust was
recently expanded to cover twelve additional states for the next two years. The
program was also expanded to include reviews of psychiatric hospitals, certain
independent laboratories and partial hospitalization benefits. Further, there
are plans eventually to apply the program's investigation techniques in all
fifty states and throughout the Medicare and Medicaid programs. One of the
results of the program has been increased auditing and inspection of the records
of health care providers and stricter interpretations of Medicare regulations
governing reimbursement and other issues. Specifically, the government plans to
double the number of comprehensive home health agency audits it performs each
year (from 900 to 1800) and also to increase the number of claims reviewed by
25.0% (from 200,000 to 250,000). In general, the application of these anti-fraud
and abuse laws is evolving.

Congress has also recently adopted a per-beneficiary limit on reimbursement
for nursing services based upon historical cost, and on March 31, 1998,
published regulations which set forth the national and regional medians on which
such limits will be based, but has not published regulations determining the
provider specific per-beneficiary limits. The Company believes that the
per-beneficiary limits will have an adverse effect on the Company's Medicare
nursing operations.

Recent other amendments affecting Medicare also require: (i) the imposition
of more stringent limits on reimbursable home health care costs; (ii) the
establishment of a prospective payment system for home health care services to
be implemented in late 1999; (iii) the separation of home health care services
into two distinct benefits under Medicare Part A and Medicare Part B; (iv)
requiring billing by location of service rather than by location of the home
health care agency's headquarters; and (v) the establishment of guidelines for
the frequency and duration of reimbursable home health visits. Such provisions
may adversely affect reimbursement for Medicare home health services over the
next several years. Partially in response to these changes and the reimbursement
changes described in the preceding paragraph, the Company has implemented a plan
to close or consolidate 32 of its Medicare nursing offices during the first
quarter of 1998. Based upon the initiatives described above and possible further
cost containment or other initiatives in the future, the Company expects the
reimbursements received from the Medicare program to be at continued risk of
substantial reductions in the future.

Recent DHHS rule making proposals affecting the home health care industry
include: (i) a rule which would revise Medicare's Conditions of Participation
that home health agencies must meet in order to participate in the

11
<PAGE>
Medicare program, and require that all home health care agencies conduct
background investigation of their employees; (ii) a rule that would require home
health care agencies to use standard measurements of the quality and outcomes of
patient care; and (iii) regulations that require home health agencies to obtain
surety bonds in order to continue to participate in the Medicare nursing
program. DHHS is expected to publish final rules in these areas. The Company
believes that it has the capacity to comply with changes in such rules.

INVESTMENT CONSIDERATIONS

RECENT FINANCIAL LOSSES

The Company reported a net loss for the quarter ended December 31, 1997 of
$(15.4) million compared to net income for the quarter ended December 31, 1996
of $1.7 million. The Company also recorded a loss per share for the quarter
ended December 31, 1997 of $(1.53) compared to earnings of $0.17 per share for
the quarter ended December 31, 1996. The Company recorded a loss for 1997 of
$(15.6) million compared to net income of $5.3 million in 1996. Earnings per
share decreased to a loss of $(1.56) in 1997 compared with earnings of $0.69 per
share in 1996. The Company's net loss in the quarter ended December 31, 1997 was
attributable to a pre-tax charge of $9.9 million relating to a restructuring
plan primarily associated with the Company's Medicare business, a pre-tax charge
of $0.3 million relating to charges in connection with the Company's early
repayment of its bank credit facility, a pre-tax charge of $0.4 million related
to the termination of the Company's ESOP, and an increase in the provision for
doubtful accounts of $5.7 million. In addition, results for the quarter ended
December 31, 1997 were adversely affected by the Company's Medicare nursing
operations exceeding cost limitations by a pre-tax amount of $5.6 million

PENDING LITIGATION

On March 20, 1998, the Company and several of its current and former officers
were named as defendants in a lawsuit alleging certain violations of federal
securities laws by the Company. The plaintiffs in the lawsuit seek to represent
a class of persons who purchased shares of the Company's common stock from March
31, 1997 through and including August 14, 1997. The Company intends to
vigorously defend the lawsuit but is currently unable to assess the likelihood
of success in this litigation, which is in the early stages of fact finding. An
adverse result in the litigation could have a material adverse effect on the
Company's business and operations.

POSSIBLE DELISTING FROM THE NASDAQ NATIONAL MARKET

The Company has received notice from The NASDAQ Stock Market that its common
stock no longer meets the standard for continued listing on The Nasdaq National
Market. The Company has appealed this notice, and a final decision on the matter
is expected in April 1998. In the event the common stock is delisted from The
NASDAQ National Market, the Company intends to seek listing on either The NASDAQ
Small Cap Market or the American Stock Exchange. There is no assurance that the
Company will be successful in any such application. Any delisting of the common
stock or failure to secure listing on an alternative market will adversely
affect the liquidity of the common stock.

SUBSTANTIAL LEVERAGE

The Company has substantial indebtedness and increased debt service
obligations compared to prior years. At December 31, 1997, the Company had
approximately $ 90.4 million of consolidated indebtedness (including capital
leases) as compared to the Company's stockholders' equity of $39.3 million. In
addition, as of December 31, 1997, the Company had a debt-to-equity ratio of 2.3
to 1. The Company expects that it will be necessary for its operating results to
improve significantly in order to permit it to meet the debt service obligations
under the Notes and there can be no assurance that the Company will be able to
make any interest payment thereunder. The ability of the Company to improve its
operating results will depend upon a variety of factors, including economic,
financial, competitive, regulatory and other factors beyond its control. There
can be no assurance that the Company will generate sufficient earnings or cash
flow from operations in the future to service the Notes and to meet its working
capital, capital expenditure and other requirements. There can be no assurance
that the implementation of

12
<PAGE>
the Company's restructuring plan will not generate significantly greater
negative cash flow than in 1997. If the Company is unable to service the Notes
using earnings or cash flow from operations, it will have to examine alternate
means of repayment that could include restructuring or refinancing its
indebtedness or seeking additional sources of debt or equity financing. There
can be no assurance that the Company would be able to effect such a
restructuring or refinancing or obtain such additional financing if permitted to
do so. The Company's ability to make payments with respect to the Notes and to
satisfy its other debt obligations will depend on its future operating
performance, which will be affected by governmental regulations, prevailing
economic conditions, financial factors, and other factors, certain of which are
beyond the Company's control. See "Capitalization" and "Description of the New
Credit Facility."

The degree to which the Company is leveraged could have important
consequences, including: (i) the Company's ability to obtain additional
financing in the future for operating expenses, acquisitions or general
corporate purposes may be impaired; (ii) a substantial portion of the Company's
cash flows from operations may be dedicated to the payment of principal and
interest on its indebtedness, thereby reducing the funds available for
operations; (iii) certain of the Company's indebtedness, including the New
Credit Facility, contain financial and other restrictive covenants, including
those restricting the incurrence of additional indebtedness, the creation of
liens, the payment of dividends, sales of assets and minimum net worth
requirements; and (iv) the Company's leverage will substantially increase the
Company's vulnerability to changes in the industry, including, among other
things, government regulations and changing economic conditions. The Company is
currently in default of several of the financial covenants under the New Credit
Facility and is unable to incur indebtedness under the facility.

DEPENDENCE ON REIMBURSEMENT BY THIRD-PARTY PAYORS; ACCOUNTS RECEIVABLE

In 1997, the percentages of the Company's net revenues from Medicare,
Medicaid and other third-party payors were approximately 51.9%, 3.9% and 44.2%,
respectively, and in 1996, the percentages of the Company's net revenues derived
from Medicare, Medicaid and other third-party payors were approximately 68.5%,
4.4% and 27.1%, respectively. The net revenues and profitability of the Company
are affected by the continuing efforts of all payors to contain or reduce the
costs of health care by, among other things, reducing reimbursement rates,
narrowing the scope of covered services, increasing case management review of
services and negotiating reduced contract pricing. In addition, the home health
care industry is characterized by long collection cycles for accounts receivable
due to the complex and time consuming requirements for obtaining reimbursement
from private and governmental third-party payors. Furthermore, reimbursement
from government payors is subject to audit and retroactive adjustment. Any
changes in reimbursement levels under Medicare, Medicaid or third-party payor
programs and any changes in applicable government regulations could have a
material adverse effect on the Company's business, financial condition, cash
flows or results of operations. Changes in the mix of the Company's patients
among Medicare, Medicaid and third-party payor categories could have a material
adverse effect on the Company's business, financial condition, cash flows or
results of operations. In addition, patients, including Medicare and Medicaid
beneficiaries, increasingly are participating in managed care plans. Managed
care organizations, in turn, are increasingly becoming involved in monitoring
and determining the appropriate health care settings for their enrollees based
primarily on cost and quality of care. The Company recorded additional
provisions for doubtful accounts of $8.4 million for 1997, because the Company's
continuing evaluation of accounts receivable resulted in the conclusion that
additional provisions were appropriate and in view of the general industry
environment. Managed care organizations in particular are increasingly
challenging the billings of home health care providers and limiting
reimbursements to home health care companies. This is an important trend in the
home health care industry, and there can be no assurance that this trend will
not continue or in the future will not have a material adverse effect on the
Company. Furthermore, there can be no assurance that the Company will be able to
maintain its current payor or revenue mix. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and "Business --
Regulation."

MEDICARE REIMBURSEMENT REFORMS; CLOSING OF NURSING OFFICES

The Company is subject to changes in federal, state and local regulations
which can have a significant effect on operating methods, costs and
reimbursement amounts provided by governmental and other third-party payors. The
federal government is continuing to review and assess alternative health care
delivery systems and payment methodologies. The federal government has recently
implemented, and is considering future additional, reductions

13
<PAGE>
in planned Medicare spending, a number of which directly affect the home health
care industry. During 1997, the home health care industry experienced several
significant regulatory and reimbursement changes. In February 1997, the Health
Care Financing Administration ("HCFA") announced that it intended to implement
mileage limitations restricting the distance between a nursing agency's
principal office and its branches. Texas, where the Company has significant
operations, announced that it intended to implement even more restrictive
mileage limitation rules for branch offices. During 1998, as a result of a
moratorium on new Medicare provider numbers announced by President Clinton, HCFA
imposed a delay in permitting branch office transfers.

Congress has also recently adopted a per-beneficiary limit on
reimbursement for nursing services based upon historical cost, and on March 31,
1998, published regulations which set forth the national and regional medians on
which such limits will be based, but has not published regulations determining
the provider specific per-beneficiary limits. The Company expects that the
per-beneficiary limits will have an adverse effect on the Company's Medicare
nursing operations.

Other regulatory changes have reduced the level of reimbursement available
to the Company. On January 2, 1998, HCFA published final Medicare nursing
per-visit cost limitation guidelines which reduce per-visit cost limitations for
the Company by approximately 18%-20% for 1998. Also, regulations effective
February 1, 1998, eliminate venipuncture as a covered service for Medicare
nursing visits, which will materially reduce the Company's Medicare nursing
revenues. In addition, reimbursement rates for Medicare home oxygen services,
which represent approximately 6% of the Company's annualized revenues, will be
reduced by 25.0% beginning January 1, 1998, with an additional 5.0% reduction to
be effective January 1, 1999.

In addition, the 1997 Federal Budget contains other provisions that would
reduce Medicare reimbursements to acute care hospitals for some Medicare
patients who are discharged from the hospital after a very short inpatient stay
to a home health care agency's care. This provision could have the effect of
reducing the utilization of home health services by giving hospitals the
incentive to retain some Medicare patients longer. Other recent amendments
reduce Medicare reimbursements for oxygen and oxygen equipment, freeze certain
payment levels for durable medical equipment and parenteral/enteral nutrition,
supplies and equipment, impose more stringent home health care limits, and
require surety bonds for Medicare or Medicaid participating home health agencies
and suppliers of durable medical equipment. In addition, costly new
administrative requirements have been implemented, such as the reporting of cost
by beneficiary location and the requirement for surety bonds for home health
agencies and suppliers of durable medical equipment, the costs of which are not
reimbursable. Further, the Department of Health and Human Services ("DHHS") is
required to develop and implement a Medicare prospective payment system for home
health services beginning October 1, 1999, to replace the current Medicare
reimbursement methodology based on the lower of allowable reimbursable costs or
actual charges, and a 15% cut in reimbursements is scheduled to take effect on
October 1, 1999.

During 1997 the Company was subject to Medicare cost limitations for home
nursing that were lower than the Company's operating expenses for that period,
resulting in the Company's Medicare nursing expenses exceeding reimbursable
limits by $8.4 million. Due in part to these regulatory changes the Company
implemented a plan to close or consolidate 32 of its Medicare nursing offices
during the first quarter of 1998. The result of these actions will reduce 1998
Medicare nursing revenue from the 1997 level by at least $25 million or 40%.
These developments will depress earnings for 1998, and resulted in a goodwill
write-off and a restructuring charge in the aggregate amount of $9.9 million for
1997. The Company believes that it will need to achieve substantial additional
cost savings to operate within Medicare nursing cost limitations and there can
be no assurance that the Company will not experience additional revenue
adjustments for 1998 and future periods. Based upon these and past initiatives
to reduce Medicare costs and possible further cost containment or other
initiatives in the future, the Company expects the reimbursements received from
the Medicare program to be at continued risk of substantial reduction in the
future. These changes in Medicare reimbursements for home health care will
reduce reimbursements available to the Company in 1998 and could have a material
adverse effect on the Company's business, financial condition, cash flows or
results of operations. The Company is also subject to audit of the
reimbursements it receives under the Medicare program. Any significant audit
adjustment could have a material adverse effect on the Company's business,
financial condition, cash flows or results of operations. See " -- Effect of
Government Regulations," "Management's Discussion and Analysis of Financial
Condition and Results of

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Operations" and "Business -- Regulation."

DEPENDENCE ON REFERRAL SOURCES

The growth and profitability of the Company depend in part on its ability to
establish and maintain close working relationships with referral sources,
including managed care organizations, payors, hospitals, physicians and other
health care professionals. The Company has experienced a significant decline in
the number of Medicare nursing referrals from such sources. There can be no
assurance that the Company will be able to successfully maintain significant
existing referral sources and develop new referral sources, or that certain of
its referral sources, such as managed care organizations and hospitals, will not
become providers of home health care services. Historically, independent home
health care companies have encountered significant competition from
hospital-based home health care organizations whose parent hospitals have
financial and operating relationships with referring physicians. There can be no
assurance that these physicians will refer cases to independent home health care
companies or, if these physicians do refer cases to independent home health care
companies, that the Company will be able to obtain referrals from these sources.
The loss of existing referral sources or the failure to develop important new
referral sources (such as managed care organizations) could have a material
adverse effect on the Company's business, financial condition, cash flows or
results of operations. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Overview."

EFFECT OF GOVERNMENT REGULATIONS

The Company's business is subject to extensive and increasing regulation by
federal, state and local governments, including the DHHS, HCFA, the Office of
the Inspector General, the Food and Drug Administration, the Department of
Labor, the Drug Enforcement Agency and the Occupational Safety and Health
Administration, as well as state departments of health and other local
regulatory agencies. The government recently has devoted substantial attention
to this industry and may continue to do so in the future, which could have a
material adverse effect on the Company. Federal laws governing the Company's
activities include regulations concerning the repackaging and dispensing of
drugs, Medicare certification of home health agencies, Medicare coverage and
reimbursement and various health care anti-fraud and abuse policies. The
facilities operated by the Company must comply with all applicable laws,
regulations and licensing standards. In addition, many of the Company's
employees must maintain certain licenses in order to provide some of the
services offered by the Company. In January 1998, one of the Company's home
health agencies was threatened by DHHS with a finding that it was not in
compliance with Medicare home health Conditions of Participation and that it
would be terminated from the Medicare program. Because the Company decided to
close this agency as part of its restructuring, the Company voluntarily withdrew
this home health agency from Medicare participation rather than appealing the
threatened adverse determination. There can be no assurance that federal, state
or local governments will not change existing standards or impose additional
standards or that the Company will meet, or continue to meet, existing or future
standards relating to all or a portion of the Company's activities.
Additionally, there can be no assurance that businesses acquired by the Company
would be in compliance with all applicable laws, regulations and licenses when
acquired. Changes in existing standards, the imposition of additional standards
or the inability of the Company to meet such standards could have a material
adverse effect on the Company's business, financial condition, cash flows or
results of operations. See " -- Medicare Reimbursement Reforms; Revenue
Adjustments; Closing of Nursing Offices" and "Business -- Regulation."

OPERATION RESTORE TRUST

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<PAGE>
fifty states and throughout the Medicare and Medicaid programs. One of the
results of the program has been increased auditing and inspection of the records
of health care providers and stricter interpretations of Medicare regulations
governing reimbursement and other issues. Specifically, the government plans to
double the number of comprehensive home health agency audits it performs each
year (from 900 to 1800) and also to increase the number of claims reviewed by
25.0% (from 200,000 to 250,000). The Company cannot predict the effect of
Operation Restore Trust on the Company or its results of operations. See
"Business -- Regulation."

MANAGEMENT INFORMATION SYSTEMS

Servicing a high volume of referrals from managed care organizations and
other payors requires the integration of complex and technical financial and
clinical information. Medisyn(TM), the Company's management information system,
is not yet fully implemented, and there can be no assurance that the Company
will successfully implement the remaining components of Medisyn(TM), or that the
Company will not experience unanticipated delays and expenses in such
implementation and integration. Successful implementation of Medisyn(TM) is an
important part of the Company's business strategy, and failure to successfully
implement the remaining components of Medisyn(TM), or to achieve expected cost
savings, improved productivity and more effective collection of receivables,
could have a material adverse effect on the Company's business, financial
condition, cash flows or results of operations. The Company's management
information systems existing prior to the implementation of Medisyn(TM) had
slowed the Company's response to regulatory and reimbursement changes, including
the Medicare nursing revenue adjustments and the additional provisions for
doubtful accounts; and the conversion of such systems contributed to a delay in
the recognition of certain direct expenses discussed elsewhere in this report.
See "-- Dependence on Reimbursement by Third-Party Payors; Accounts Receivable;"
"-- Medicare Reimbursement Reforms; Revenue Adjustments;" and "Business --
Financial and Clinical Management Information Systems." There can be no
assurance that the implementation of Medisyn(TM) will enable the Company to
successfully respond to such changes in the future. It is also impossible to
predict the effect of future regulatory changes on the ability of the Company's
management information systems to serve the Company's needs in an efficient and
profitable manner. Any malfunction or increase in expenses in connection with
the Company's management information systems could have a material adverse
effect on the Company's business, financial condition, cash flows or results of
operations. See "Business -- Financial and Clinical Management Information
Systems" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations."

RISK OF ACQUISITIONS AND EXPANSION INTO NEW MARKETS

The Company competes for acquisition opportunities with other providers, some
of which have greater financial resources than the Company. There can be no
assurance that the Company will be able to successfully acquire other companies,
that these companies, once acquired, will be integrated successfully into the
Company's operations or that any acquisition will not have a material adverse
effect upon the Company's operating and financial results, especially in the
fiscal quarters immediately following such transactions. Acquisitions involve
numerous short-term and long-term risks, including loss of referral sources,
diversion of management's attention, failure to retain key personnel, loss of
net revenues of the acquired company, incompatible information systems, the
possibility of the acquired company becoming subject to regulatory sanctions,
potential undisclosed liabilities and the continuing value of acquired
intangible assets. In addition, the Company may be required to comply with laws
and regulations of states that differ from those in which the Company currently
operates, and may face competitors with greater knowledge of such local markets.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources" and "Business -- Business
Strategy."

DEPENDENCE ON KEY PERSONNEL

The Company is highly dependent on the services of S. Wayne Bazzle, the
Company's Chairman of the Board and Chief Executive Officer, and Cheryl C.
Bazzle, the Company's President and Chief Operating Officer, as well as its
other senior management and its staff of health care professionals. There can be
no assurance that the Company will be able to retain such personnel. See
"Management -- Executive Officers and Directors."

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<PAGE>
COMPETITION

The home health care industry is highly fragmented, with significant
competition from multiple providers in most markets. The Company faces intense
competition for managed care contracts, patients, employees and acquisitions. In
recent years, independent home health care providers, including the Company,
have encountered significant competition from hospital-based home health care
organizations which have entered the home health care business. The Company has
experienced a decline in referrals from physicians with financial and operating
relationships with the parent hospitals of such organizations. There can be no
assurance that such decline will not continue or that the Company's strategy of
targeting such referrals will be successful. In addition, many of the Company's
current and potential competitors are larger and have significantly greater
financial and marketing resources than those of the Company. There can be no
assurance that such competition will not limit the Company's ability to maintain
or to increase its market share and will not adversely affect the Company's
business. See "--Dependence on Referral Sources" and "Business -- Competition."

LIABILITY AND ADEQUACY OF INSURANCE

In recent years, physicians, hospitals and other participants in the health
care industry have been subjected to an increasing number of lawsuits alleging
malpractice, product liability or negligence, many of which involve large claims
and significant defense costs. The Company may be subject to such suits. The
Company currently maintains liability insurance intended to cover such claims.
While the Company has been able to obtain liability insurance in the past, such
insurance varies in cost and may not be available in the future on acceptable
terms, if at all. A successful claim against the Company in excess of the
Company's insurance coverage could have a material adverse effect upon the
Company's financial condition and results of operations. See "Business --
Insurance."

CONTROL BY EXECUTIVE OFFICERS AND DIRECTORS

The Company's executive officers and directors and their affiliates
beneficially own 51.8% of the outstanding shares of the Company's common stock,
par value $0.01 per share (the "Common Stock"). As a result, these stockholders,
acting together, are able to control the Company and matters requiring approval
by the stockholders of the Company, including the election of directors. The
voting power of these stockholders under certain circumstances could have the
effect of delaying or preventing a change in control of the Company. See
"Management" and "Security Ownership."

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<PAGE>
ITEM 2. PROPERTIES

The Company currently leases all of its office space. The executive offices,
consisting of approximately 57,400 square feet, are subject to a lease expiring
November 2006. The rent payable thereunder is $65,754 monthly.

The following is a list of the Company's home health care offices.

TEXAS TEXAS (Cont'd) MISSOURI LOUISIANA

Abilene San Antonio Columbia Baton Rouge
Aransas Pass San Marcos Independence Bossier City
Beaumont Stephenville Kirksville Lafayette
Bryan Temple Mexico Metairie
Center Texarkana
Dallas Tyler ARIZONA KANSAS
El Paso Wichita Falls
Falfurrias Willis Casa Grande Kansas City
Grand Prairie Winnsboro Chandler Independence
Houston Mesa
Jasper OKLAHOMA Phoenix NEW MEXICO
Laredo
Longview Bartlesville ARKANSAS Hobbs
Lubbock Clinton Espanola
Lufkin Ft. Gibson Fayetteville
Mineral Wells Oklahoma City Fort Smith
Mission Ponca City Jonesboro COLORADO
Muleshoe Stillwater Little Rock
Rising Star Tulsa Texarkana Denver

ITEM 3. LEGAL PROCEEDINGS

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

None.

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PART II

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

The common stock of the Company is traded on the NASDAQ National Market
System ("NASDAQ") under the designation "HCOR." The following table sets forth
representative bid quotations of the common stock for each quarter since the
date of the Offering as provided by NASDAQ. The following bid quotations reflect
interdealer prices without retail mark-ups, mark-downs or commissions, and may
not necessarily represent actual transactions:

BID QUOTATIONS($)
-----------------
1996 HIGH LOW
---- ---- -----
Third Quarter (from August 8, 1996) 13.25 10.00
Fourth Quarter 12.25 7.38

1997
----
First Quarter 11.50 7.13
Second Quarter 10.13 6.25
Third Quarter 10.50 4.19
Fourth Quarter 7.63 3.13

The Company's common stock has been quoted on NASDAQ since August 8, 1996. On
April 7, 1998, the closing bid quotation for the common stock was $2.13 per
share, as reported by NASDAQ. The Company has been notified by NASDAQ that its
common stock may not qualify for listing thereon and a hearing has been
scheduled to determine the eligibility of the common stock for continued listing
on NASDAQ.

On January 31, 1998, there were 91 holders of record of the common stock.
Most of the Company's stockholders have their holdings in the street name of a
broker/dealer. The Company believes that the total number of stockholders ranges
between 1,400 and 1,700 individuals and entities.

The Company has not paid cash dividends on its common stock and does not
anticipate paying any such dividends in the foreseeable future. The Company is
prohibited under the New Credit Facility from declaring or paying any dividends.

19
<PAGE>
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The following tables set forth selected consolidated financial data which
have been derived from the consolidated financial statements of the Company. The
selected consolidated financial data at and for the years ended December 31,
1997, 1996, 1995, 1994 and 1993, have been derived from the audited consolidated
financial statements of the Company, audited by Arthur Andersen LLP, independent
public accountants. The following selected consolidated financial data is
qualified in its entirety and should be read in conjunction with the Company's
consolidated financial statements and related notes included elsewhere in this
report. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------------------------------
1997(1) 1996 1995 1994 1993
--------- -------- -------- ------- -------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net revenues ................................................ $ 143,205 $106,785 $ 81,557 $57,151 $60,097
Direct expenses ............................................. 67,380 48,314 41,392 30,337 33,302
--------- -------- -------- ------- -------
Gross profit ................................................ 75,825 58,471 40,165 26,814 26,795
Other costs and expenses:
General and administrative ................................ 62,038 41,418 30,663 21,280 21,493
Depreciation and amortization ............................. 4,984 2,579 1,240 789 895
Goodwill write-off and restructuring costs ................ 9,850 -- -- -- --
Provision for doubtful accounts ........................... 14,057 3,580 1,489 1,115 1,318
--------- -------- -------- ------- -------
Total costs and expenses ........................... 90,929 47,577 33,392 23,184 23,706
--------- -------- -------- ------- -------
Income (loss) from operations ............................... (15,104) 10,894 6,773 3,630 3,089
Interest, net ............................................... 5,318 2,144 987 244 427
--------- -------- -------- ------- -------
Income (loss) before income taxes ........................... (20,422) 8,750 5,786 3,386 2,662
Provision (credit) for income taxes ......................... (4,784) 3,418 2,202 1,359 1,129
--------- -------- -------- ------- -------
Net income (loss) ........................................... $ (15,638) $ 5,332 $ 3,584 $ 2,027 $ 1,533
========= ======== ======== ======= =======
Net income (loss) per common share .......................... $ (1.56) $ .69 $ .57 $ .32 $ .25
Net income (loss) per common share-assuming dilution ........ $ (1.56) $ .66 $ .55 $ .31 $ .24

Weighted average common shares outstanding .................. 10,054 7,770 6,297 6,297 6,204
Weighted average common shares outstanding and
dilutive common stock options .......................... 10,054 8,040 6,546 6,490 6,403

December 31,
-----------------------------------------------------------------
1997 1996 1995 1994 1993
--------- -------- -------- ------- -------
(in thousands)
BALANCE SHEET DATA:
Cash and cash equivalents ................................... $ 21,820 $ -- $ 1,628 $ 3,775 $ 506
Working capital (deficit) ................................... 45,025 5,774 (1,737) 1,296 1,292
Property and equipment, net ................................. 29,132 22,288 11,054 3,880 3,866
Total assets ................................................ 153,213 100,303 52,573 24,504 22,251
Total debt, including capital leases ........................ 90,353 24,432 19,584 4,374 1,678
Redeemable convertible preferred stock ...................... -- -- 5,340 5,340 5,342
Stockholders' equity ........................................ 39,262 54,555 12,062 7,074 5,046
</TABLE>
(1) See Note 5 of the Notes to Consolidated Financial Statements for the effects
of acquisitions completed during 1997 as if such acquisitions were effective at
the beginning of 1997 and 1996.

20
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS MAY DIFFER SIGNIFICANTLY FROM THE
RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS.

THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH THE
CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES CONTAINED ELSEWHERE HEREIN.

OVERVIEW

The Company is one of the largest fully integrated providers of comprehensive
home health care services based in the southwestern and central United States,
providing home nursing, respiratory therapy/home medical equipment and infusion
therapy. The Company has implemented a regional growth strategy, expanding from
12 offices in three states at its inception in 1984 to 96 offices in nine states
at December 31, 1997, although recent changes to Medicare reimbursement polices
and declining visit volume have prompted the Company to close or consolidate 32
Medicare nursing offices during the first quarter of 1998. For the year ended
December 31, 1997, the Company had net revenues of $143.2 million and a net loss
of $(15.6) million. The net loss was affected by significant pre-tax charges
during 1997, including goodwill write-off and restructuring costs of $9.9
million predominantly related to its Medicare nursing operations, a pre-tax
charge of $0.3 million related to early repayment of the Company's bank credit
facility, and a pre-tax charge of $0.4 million related to termination of the
Company's Employee Stock Ownership Plan,. In addition, 1997 results were
adversely affected by the Company's Medicare nursing operations exceeding
Medicare nursing cost limitations by $8.4 million. During 1997 the Company also
recorded an additional provisions for doubtful accounts of $8.4 million.

The Company has diversified its business mix from 98% home nursing in 1990 to
52% home nursing for the year ended December 31, 1997. This shift reflects the
addition and growth of higher margin respiratory therapy/home medical equipment
and infusion therapy. The Company expects that it will continue to shift its
business mix towards respiratory therapy/home medical equipment and infusion
therapy, accelerated in part as a result of significant regulatory and
reimbursement changes for Medicare nursing operations for 1998. Home nursing,
however, will continue to represent an important part of HealthCor's business
mix because managed care organizations and other referral sources often will
make arrangements for other home health services after first referring home
nursing cases to a provider.

Following is a breakdown of net revenue mix:

YEARS ENDED DECEMBER 31,
------------------------------
1997 1996 1995
------ ------ ------
Nursing .................................... 52.4% 56.9% 74.2%
Respiratory therapy/medical equipment ...... 29.8 27.1 19.8

Infusion therapy ........................... 13.6 14.9 6.0

Other ...................................... 4.2 1.1 --
------ ------ ------
Total .................................... 100.0% 100.0% 100.0%
====== ====== ======

As the Company has pursued its fully-integrated provider strategy, the
Company's revenue mix has shifted from predominately home nursing to higher
margin respiratory therapy/home medical equipment and infusion therapy. The
Company is paid for its services and products primarily by Medicare, Medicaid
and private payors, including managed care organizations, insurance companies
and other third-party payors. The following table represents the Company's payor
mix:

YEARS ENDED DECEMBER 31,
--------------------------
1997 1996 1995
------ ------ ------
Medicare Part A (cost-based) ................. 38.2% 50.1% 67.2%
Medicare Part B (charge-based) ............... 13.7 18.4 13.8
Medicaid ..................................... 3.9 4.4 1.3
Commercial payors and others ................. 44.2 27.1 17.7
------ ------ ------
Total ...................................... 100.0% 100.0% 100.0%
====== ====== ======

21
<PAGE>
Medicare reimburses the Company for both Part A and Part B services Medicare
Part A reimburses the Company on a "cost basis" based on the lower of the
Company's allowable cost as defined by Medicare regulations, not to exceed
annual cost limits, or the Company's actual charges. Allowable cost is the
actual cost directly related to providing home nursing, plus an overhead
allocation. A cost report evidencing the fiscal year allowable costs, visit
data, charges and other financial information is filed annually and subject to
audit. Medicare Part B is paid on a fixed fee-for-service basis similar to
third-party payors, such as managed care organizations.

RESULTS OF OPERATIONS

The following table sets forth certain items included in the Company's
consolidated statements of operations as a percentage of net revenues:

YEARS ENDED DECEMBER 31,
-----------------------------
1997 1996 1995
------ ------ ------
Net revenues ................................. 100.0% 100.0% 100.0%
Direct expenses .............................. 47.0 45.2 50.8
------ ------ ------
Gross profit ................................. 53.0 54.8 49.2
Other costs and expenses:
General and administration ................. 43.3 38.8 37.6
Depreciation and amortization .............. 3.5 2.4 1.5
Goodwill write-off and restructuring
costs .................................... 6.9 -- --
Provision for doubtful accounts ............ 9.8 3.4 1.8
------ ------ ------
Total operating expenses ................. 63.5 44.6 40.9
------ ------ ------
Income (loss) from operations ................ (10.5) 10.2 8.3
Interest, net ................................ 3.7 2.0 1.2
------ ------ ------
Income (loss) before income taxes ............ (14.2) 8.2 7.1

Provision (credit) for income taxes .......... (3.3) 3.2 2.7
------ ------ ------
Net income (loss) ............................ (10.9)% 5.0% 4.4%
====== ====== ======

YEARS ENDED DECEMBER 31, 1997 AND 1996

NET REVENUES. Net revenues increased to $143.2 million in 1997 from $106.8
million in 1996, an increase of $36.4 million, or 34.1%. This increase is
primarily the result of additional revenues from acquisitions and from internal
growth in respiratory therapy, infusion therapy and managed care nursing
revenues, partially offset by a decrease in Medicare nursing revenues from
certain offices resulting from regulatory changes and declining visit volumes.
The Company expects that Medicare nursing revenues for 1998 will be at least $25
million less than such revenues for 1997 because of the closing or consolidation
of 32 Medicare nursing offices in the first quarter of 1998. Operating results
for 1997 were adversely affected by the Company's Medicare nursing operations
exceeding cost limitations by a pre-tax amount of $8.4 million.

DIRECT EXPENSES. Direct expenses increased to $67.4 million for 1997 from
$48.3 million in 1996, an increase of $19.1 million, or 39.5%. This increase is
the result of the direct expenses associated with the operations of companies
acquired during 1996 and 1997 and internal growth. As a percentage of net
revenues, direct expenses increased to 47.0% for the year ended December 31,
1997, from 45.2% for the comparable period in 1996, primarily as a result of
higher costs incurred by the Company for pharmaceutical and nursing supplies and
higher costs incurred for respiratory sales and rental equipment. Direct
expenses include all costs directly related to the production of net revenues,
including salary and employee benefit costs, rental equipment depreciation,
medical supplies, and product purchase costs.

GENERAL AND ADMINISTRATIVE. General and administrative expenses increased to
$62.0 million for 1997 from $41.4 million in 1996, an increase of $20.6 million,
or 49.8%. This increase was primarily the result of additional field office
expenses associated with the operations of acquired companies and increased
central office costs. General and administrative expenses increased as a
percentage of net revenues to 43.3% in 1997 from 38.8% in 1996, primarily as a
result of increased development costs of Medisyn(TM) and other central office
expenses.

22
<PAGE>
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense
increased to $5.0 million for 1997 from $2.6 million in 1996, an increase of
$2.4 million, or 93.3%. This increase was primarily due to the amortization of
goodwill associated with acquisitions and depreciation of capital expenditures
relating to Medisyn(TM).

GOODWILL WRITE OFF AND RESTRUCTURING CHARGE. In response to recent Medicare
regulatory and reimbursement changes that impose significant reductions in
per-beneficiary visit reimbursement and in the annual per-beneficiary total
reimbursement amount, both of which are expected to have an unfavorable impact
on the Company's financial condition and results of operations, the Company has
implemented a restructuring plan predominantly related to its Medicare nursing
operations to close or consolidate 32 offices and reduce headcount to attempt to
mitigate the financial impact of these changes. As a result of these regulatory
changes and restructuring plan, for the three months ended December 31, 1997,
the Company reduced the carrying value of its recorded goodwill by approximately
$8.3 million and recorded approximately $1.6 million in restructuring costs,
consisting of direct severance costs of terminated employees of $.4 million and
future lease termination costs and other costs related to office closings of
approximately $1.2 million.

PROVISION FOR DOUBTFUL ACCOUNTS. The provision for doubtful accounts
increased to $14.1 million in 1997 from $3.6 million for 1996, an increase of
$10.5 million, or 292.6%. This increase is the result of increased revenues and
additional provisions for doubtful accounts of $8.4 million for 1997. These
additional provisions for doubtful accounts resulted from the Company's
continuing evaluation of certain accounts receivable in view of the current
industry environment.

INTEREST, NET. Interest, net increased to $5.3 million for 1997 from $2.1
million in 1996, or 148.0%. This increase resulted from interest costs
associated with indebtedness incurred in connection with acquisitions, increased
working capital borrowings to finance additional managed care business and
accounts receivable, interest on equipment leases to service additional home
medical equipment business and leases associated with the implementation and
development of Medisyn(TM), higher borrowing costs associated with the 11%
Senior Notes issued on December 1, 1997, and the write-off of financing fees of
$0.3 incurred in connection with the Company's early repayment of a bank credit
agreement.

PROVISION (CREDIT) FOR INCOME TAXES. The provision (credit) for income taxes
decreased to a credit of $4.8 million for 1997 from an expense of $3.4 million
in 1996, a decrease of $8.2 million. This decrease is a result of the 1997 loss
and resulting carryback to prior years, partially offset by $0.5 million in
state income taxes in 1997.

YEARS ENDED DECEMBER 31, 1996 AND 1995

NET REVENUES. Net revenues increased to $106.8 million in 1996 from $81.6
million in 1995, an increase of $25.2 million, or 30.9%. This increase is
primarily the result of additional revenues from acquisitions and from internal
growth in respiratory therapy, infusion therapy and managed care nursing
revenues, partially offset by a decrease in Medicare nursing revenues from
certain offices.

DIRECT EXPENSES. Direct expenses increased to $48.3 million for 1996 from
$41.4 million in 1995, an increase of $6.9 million, or 16.7%. This increase is
primarily the result of the direct expenses associated with the operations of
companies acquired during 1996 and 1995. As a percentage of net revenues, direct
expenses declined to 45.2% in 1996 from 50.8% in 1995 primarily as a result of a
shift in the Company's business mix to a higher percentage of respiratory
therapy/home medical equipment and infusion therapy, which have lower direct
expenses than home nursing.

GENERAL AND ADMINISTRATIVE. General and administrative expenses increased to
$41.4 million for 1996 from $30.7 million in 1995, an increase of $10.8 million,
or 35.1%. This increase was primarily the result of additional field office
expenses associated with the operations of acquired companies and increased
central office costs. General and administrative expenses increased as a
percentage of net revenues to 38.8% in 1996 from 37.6% in 1995, primarily as a
result of increased development costs of Medisyn(TM).

DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense
increased to $2.6 million for 1996 from

23
<PAGE>
$1.2 million in 1995, an increase of $1.4 million, or 108.0%. This increase was
primarily due to the amortization of goodwill associated with acquisitions and
depreciation of capital expenditures relating to Medisyn(TM).

PROVISION FOR DOUBTFUL ACCOUNTS. The provision for doubtful accounts
increased to $3.6 million in 1996 from $1.5 million for 1995, an increase of
$2.1 million, or 140.5%. This increase was primarily a result of revenue growth
and a shift in the Company's business mix to respiratory therapy/home medical
equipment and infusion therapy businesses, which historically carry a higher
provision for doubtful accounts.

INTEREST, NET. Interest, net increased to $2.1 million for 1996 from $1.0
million in 1995, or 117.2%. This increase resulted from interest costs
associated with indebtedness incurred in connection with acquisitions, increased
working capital borrowings to finance additional managed care business, interest
on equipment leases to service additional home medical equipment business and
leases associated with the implementation and development of Medisyn(TM), and
higher borrowing costs.

PROVISION FOR INCOME TAXES. The provision for income taxes increased to $3.4
million for 1996 from $2.2 million in 1995, an increase of $1.2 million, or
55.2%. This increase is a result of the growth of income before taxes and an
increase in the Company's effective income tax rate to 39.0% in 1996 from 38.0%
in 1995.

LIQUIDITY AND CAPITAL RESOURCES

The Company's primary capital requirements will be for debt service, for
additional working capital to fund growth of the Company's managed care business
and accounts receivable. The Company recorded a net loss of $(15.6) million
during 1997 and had negative cash flow from operations. The Company expects to
report additional net losses and negative cash flow amounts in 1998. This has
negatively impacted the availability of the Company's current bank financing
sources and is expected to decrease the Company's overall liquidity position
during 1998. Management believes that assuming the successful implementation of
a new potential secured working capital finance relationship, additional
equipment lease finance facility, controls to reduce losses from Medicare
nursing operations, intensified collection efforts and accelerated realization
of approximately $5-6 million of cash flow from tax positions, the Company will
have sufficient liquidity to meet its capital requirements through December 31,
1998.

At December 31, 1997, the Company had working capital of $45.0 million as
compared to working capital of $5.8 million as of December 31, 1996. This
increase is primarily a result of the issuance of the Company's 11% Senior Notes
and the repayment of its bank credit facility.

During the year ended December 31, 1997, the Company had capital expenditures
of $6.4 million. Capital expenditures were used to continue the development and
implementation of Medisyn(TM). The Company estimates that it will have aggregate
capital expenditures in 1998 of approximately $5.0 million.

Days of Sales Outstanding ("DSO") were 94 as of December 31, 1997, compared
to 82 at December 31, 1996. The increase in DSO from December 31, 1996 to
December 31, 1997, is attributable primarily to an overall increase in net
revenue from respiratory therapy/home medical equipment and infusion therapy,
which historically have higher DSO, delays by third parties in paying for
respiratory therapy/home medical equipment and infusion therapy, and a slowdown
in reimbursement from governmental payors.

Net cash provided by (used in) operating activities decreased from $0.6
million for the year ended December 31, 1996, to $(13.1) million for the year
ended December 31, 1997. This decrease is primarily attributable to the 1997 net
loss and an increase in accounts receivable and a reduction in accounts payable
and accrued expenses. Net cash used in operating activities may increase as a
result of the Company's decision to restructure its Medicare nursing operations
by closing or consolidating 32 Medicare nursing offices. During 1997 the Company
recorded higher depreciation and amortization expense of $3.5 million and
incurred a goodwill write-off of $8.3 million. An increase in income tax
receivable and a decrease in deferred revenue accounted for the remainder of the
decrease.

Net cash used in investing activities decreased to $(21.5) million for the
year ended December 31, 1997, from

24
<PAGE>
$(28.9) million for the comparable period in 1996, as the Company completed
fewer acquisitions. Payments under capital leases increased to $2.2 million for
the year ended December 31, 1997, compared to $1.6 million for the comparable
period in 1996, primarily as a result of increased expenditures on medical
equipment used to service managed care business and increased expenditures
relating to the implementation of Medisyn(TM).

As of March 6, 1998, the Company had cash balances of approximately $11.0
million. The Company had no outstanding amounts under its revolving credit line.
The Company is currently in default of several of the financial covenants under
its New Credit Facility and is unable to incur indebtedness under the facility.
As a result, the Company has classified certain capital lease obligations as
current liabilities under the cross-default provisions of the New Credit
Facility. The Company has letters of credit outstanding amounting to $0.8
million in connection with the Company's workers' compensation insurance program
under the New Credit Facility. In addition, the indenture under the Company's
Senior Notes prohibits the Company from incurring additional indebtedness (other
than limited permitted indebtedness) or issuing preferred equity interests (as
defined in the indenture) unless the consolidated fixed charge ratio is greater
than 2.0 to 1. At December 31, 1997, the Company's consolidated fixed charge
ratio is less than 2.0 to 1. The indenture, however, would permit the Company to
incur indebtedness under any replacement of the New Credit Facility in an amount
not to exceed $20.0 million.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

Consolidated financial statements and supplementary data are included herein.
See Item 14 of this report.

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

None.

25
<PAGE>
PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information with respect to Item 10 is incorporated by reference from the
Company's definitive Proxy Statement to be filed with the Commission not later
than 120 days after the end of the Company's fiscal year.

ITEM 11. EXECUTIVE COMPENSATION

Information with respect to Item 11 is incorporated by reference from the
Company's definitive Proxy Statement to be filed with the Commission not later
than 120 days after the end of the Company's fiscal year.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT

Information with respect to Item 12 is incorporated by reference from the
Company's definitive Proxy Statement to be filed with the Commission not later
than 120 days after the end of the Company's fiscal year.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information with respect to Item 13 is incorporated by reference from the
Company's definitive Proxy Statement to be filed with the Commission not later
than 120 days after the end of the Company's fiscal year.

26
<PAGE>
PART IV

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

(a)1. INDEX TO FINANCIAL STATEMENTS

The following Financial Statements are included herein:

PAGE
----
HEALTHCOR HOLDINGS, INC. AND SUBSIDIARIES

Report of Independent Public Accountants................... 28

Consolidated Balance Sheets as of December 31, 1997 and 1996 29

Consolidated Statements of Operations for the Years Ended
December 31, 1997, 1996, and 1995....................... 30

Consolidated Statements of Stockholders' Equity for the
Years Ended December 31, 1997, 1996, and 1995........... 31

Consolidated Statements of Cash Flows for the Years Ended
December 31, 1997, 1996, and 1995....................... 32

Notes to Consolidated Financial Statements................. 33

2. INDEX TO FINANCIAL SCHEDULES

The following Financial Statement Schedule is included herein:

Schedule II--Valuation and Qualifying Accounts............. 46

3. INDEX TO EXHIBITS

The Exhibits filed as part of this Report on Form 10-K are listed
in the Index to Exhibits immediately following the consolidated
financial statements.

(b) REPORTS ON FORM 8-K.

There was no Report on Form 8-K filed during the three month period ended
December 31, 1997.

27
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors,
HealthCor Holdings, Inc.:

We have audited the accompanying consolidated balance sheets of HealthCor
Holdings, Inc. (a Delaware corporation) and subsidiaries as of December 31, 1997
and 1996, and the related consolidated statements of operations, stockholders'
equity and cash flows for each of the three years in the period ended December
31, 1997. 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 financial position of HealthCor Holdings,
Inc. and subsidiaries as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.

Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the index to
consolidated financial statements and financial statement schedule is presented
for purposes of complying with the Securities and Exchange Commission's rules
and is not part of the basic financial statements. This schedule has been
subjected to the auditing procedures applied in the audits of the basic
financial statements and, in our opinion, fairly states in all material respects
the financial data required to be set forth therein in relation to the basic
financial statements taken as a whole.

ARTHUR ANDERSEN LLP

Dallas, Texas,
April 15, 1998

28
<PAGE>
HEALTHCOR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------
1997 1996
------------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents .................................... $ 21,820,308 $ --
Accounts receivable, net of allowance for doubtful accounts
of $11,441,000 and $5,101,000 in 1997 and 1996,
respectively ............................................... 38,635,806 26,843,981
Federal income tax receivable ................................ 5,828,888 833,538
Supplies inventory ........................................... 4,258,834 3,219,815
Prepaid expenses and other ................................... 1,358,026 2,040,698
Deferred income taxes ........................................ 973,233 1,837,173
------------- ------------
Total current assets .................................. 72,875,095 34,775,205

Property and equipment, net of accumulated depreciation of
$23,539,595 and $15,163,931 in 1997 and 1996, respectively ... 29,131,578 22,287,540
Excess of cost of acquired businesses over fair values of
net assets acquired, net of accumulated amortization of
$3,404,000 and $2,038,000 in 1997 and 1996, respectively ..... 48,085,306 40,838,391
Other assets ................................................... 3,121,044 2,401,862
------------- ------------
Total assets .......................................... $ 153,213,023 $100,302,998
============= ============

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Accrued payroll and related expenses ......................... $ 8,130,484 $ 7,020,813
Accounts payable and accrued expenses ........................ 11,099,771 6,755,011
Line of credit payable ....................................... -- 8,950,000
Current portion of long-term debt ............................ 1,576,502 3,582,096
Current portion of capital lease obligations ................. 6,738,548 2,369,300
State income taxes payable ................................... 305,000 324,309
------------- ------------
Total current liabilities ............................. 27,850,305 29,001,529

Deferred income taxes and other ................................ 4,063,260 7,216,476
Long-term debt ................................................. 644,236 7,114,778
11% Senior Notes ............................................... 80,000,000 --
Capital lease obligations ...................................... 1,393,691 2,415,667
------------- ------------
Total liabilities ..................................... 113,951,492 45,748,450

Commitments and contingencies

Stockholders' equity:
Common stock, $.01 par value, 40,000,000 shares
authorized; 10,089,346 and 10,015,967 shares issued and
outstanding in 1997 and 1996, respectively ................. 100,893 100,159
Additional paid-in capital ................................... 39,906,814 39,562,152
Retained earnings (deficit) .................................. (746,176) 14,892,237
------------- ------------
Total stockholders' equity ............................ 39,261,531 54,554,548
------------- ------------
Total liabilities and stockholders' equity ............ $ 153,213,023 $100,302,998
============= ============
</TABLE>
The accompanying notes are an integral part of
these consolidated balance sheets.

29
<PAGE>
HEALTHCOR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------------
1997 1996 1995
------------- ------------- ------------
<S> <C> <C> <C>
Net revenues ....................................... $ 143,204,750 $ 106,785,152 $ 81,557,284

Direct expenses .................................... 67,380,199 48,313,631 41,392,250
------------- ------------- ------------
Gross profit ....................................... 75,824,551 58,471,521 40,165,034

Other costs and expenses:

General and administrative ....................... 62,038,783 41,417,970 30,663,552
Depreciation and amortization .................... 4,983,681 2,578,751 1,239,728
Goodwill write-off and restructuring costs ....... 9,850,000 -- --
Provision for doubtful accounts .................. 14,057,018 3,580,394 1,488,885
------------- ------------- ------------
Total costs and expenses ................... 90,929,482 47,577,115 33,392,165
------------- ------------- ------------
Income (loss) from operations ...................... (15,104,931) 10,894,406 6,772,869

Other income (expense):

Interest income .................................. 141,625 44,454 162,283
Interest expense ................................. (5,459,343) (2,188,466) (1,149,260)
------------- ------------- ------------
Total other income and expense ............. (5,317,718) (2,144,012) (986,977)
------------- ------------- ------------
Income (loss) before income taxes .................. (20,422,649) 8,750,394 5,785,892

Provision (credit) for income taxes ................ (4,784,236) 3,418,386 2,202,367
------------- ------------- ------------
Net income (loss) .................................. $ (15,638,413) $ 5,332,008 $ 3,583,525
============= ============= ============
Net income (loss) per common share ................. $ (1.56) $ .69 $ .57
Net income (loss) per common share-assuming dilution $ (1.56) $ .66 $ .55

Weighted average common shares outstanding ......... 10,053,734 7,770,175 6,296,816
Weighted average common shares outstanding and
dilutive common stock options ............... 10,053,734 8,040,250 6,545,615
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.

30
<PAGE>
HEALTHCOR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL
------------------------- PAID-IN RETAINED
SHARES AMOUNT CAPITAL EARNINGS TOTAL
---------- -------- ----------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1994 ............... 2,935,720 $ 29,357 $ 1,068,234 $ 5,976,704 $ 7,074,295

Issuance of common stock to
ESOP ................................. 125,000 1,250 1,398,750 -- 1,400,000

Issuance of common stock ............... 2,083 21 4,145 -- 4,166

Net income ............................. -- -- -- 3,583,525 3,583,525
---------- -------- ----------- ------------ ------------
Balance, December 31, 1995 ............... 3,062,803 30,628 2,471,129 9,560,229 12,061,986

Exercise of common stock
warrants ............................. 150,000 1,500 298,500 -- 300,000

Conversion of Series A and B
preferred stock to common
stock ................................ 3,339,297 33,393 5,306,421 -- 5,339,814

Issuance of common stock in
initial public offering, net ......... 3,300,000 33,000 29,835,101 -- 29,868,101

Issuance of common stock to
ESOP ................................. 130,000 1,300 1,466,200 -- 1,467,500

Exercise of stock options .............. 33,867 338 78,229 -- 78,567

Tax benefit from early
dispositions of option stock ......... -- -- 106,572 -- 106,572

Net income ............................. -- -- -- 5,332,008 5,332,008
---------- -------- ----------- ------------ ------------
Balance, December 31, 1996 ............... 10,015,967 100,159 39,562,152 14,892,237 54,554,548

Exercise of stock options .............. 73,379 734 344,662 -- 345,396

Net loss ............................... -- -- -- (15,638,413) (15,638,413)
---------- -------- ----------- ------------ ------------
Balance, December 31, 1997 ............... 10,089,346 $100,893 $39,906,814 $ (746,176) $ 39,261,531
========== ======== =========== ============ ============
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.

31
<PAGE>
HEALTHCOR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) .................................................... $(15,638,413) $ 5,332,008 $ 3,583,525
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization ..................................... 8,248,711 4,773,892 2,299,357
Goodwill write-off ................................................ 8,300,000 -- --
Loss on disposition of fixed assets ............................... 28,677 69,855 61,784
Changes in operating assets and liabilities, net of acquired
businesses:
Accounts receivable, net ........................................ (13,166,754) (13,099,993) (4,790,507)
Supplies inventory .............................................. (726,362) (755,657) 109,842
Prepaid expenses and other assets ............................... 2,496,119 (1,295,126) (688,745)
Deferred income taxes ........................................... (5,000) 1,124,060 (821,616)
Accrued ESOP contribution ....................................... -- (60,079) (23,376)
Third-party payor settlement .................................... -- (322,566) 42,116
Accounts payable and accrued expenses ........................... 4,674,358 3,330,133 3,258,275
Income taxes payable/receivable ................................. (5,042,341) (1,821,149) 919,447
Deferred revenue ................................................ (2,291,274) 3,281,537 2,092,767
------------ ------------ ------------
Net cash provided by (used in) operating activities .......... (13,122,279) 556,915 6,042,869
------------ ------------ ------------
Cash flows from investing activities:
Payments for business acquisitions, net of cash
acquired .......................................................... (15,073,578) (21,032,649) (17,458,780)
Additions to property and equipment .................................. (6,436,244) (7,866,845) (7,179,800)
------------ ------------ ------------
Net cash used in investing activities ........................ (21,509,822) (28,899,494) (24,638,580)
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from issuance of debt, net .................................. 35,859,427 65,896,628 47,385,571
Proceeds from issuance of 11 % Senior Notes, net ..................... 77,100,000 -- --
Payments on debt and capital lease obligations ....................... (56,852,414) (69,535,229) (32,340,934)
Issuance of common stock, net ........................................ 345,396 30,353,240 1,404,166
------------ ------------ ------------
Net cash provided by financing
activities ....................................... 56,452,409 26,714,639 16,448,803
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents ................... 21,820,308 (1,627,940) (2,146,908)

Cash and cash equivalents, beginning of period ......................... -- 1,627,940 3,774,848
------------ ------------ ------------
Cash and cash equivalents, end of period ............................... $ 21,820,308 $ -- $ 1,627,940
============ ============ ============
Supplemental disclosure of cash flow information:
Debt issued in acquisitions .......................................... $ 1,450,000 $ 3,266,068 $ 1,567,321
Liabilities and debt assumed in acquisitions ......................... 772,209 635,753 566,340
Issuance of capital lease obligations ................................ 5,248,725 3,530,474 2,530,000
Issuance of common stock to employee stock option plan ............... -- 1,467,500 1,400,000
Interest paid ........................................................ 4,985,000 2,025,000 828,000
Income taxes paid .................................................... 2,006,000 4,055,000 1,826,000
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.

32
<PAGE>
HEALTHCOR HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 1997, 1996, AND 1995

1. GENERAL:

ORGANIZATION

HealthCor Holdings, Inc., a Delaware corporation, and subsidiaries (the
"Company") commenced operations in October 1989 and provide home healthcare
services to patients including nursing, respiratory therapy, infusion therapy,
and medical equipment. The Company has operations in Arizona, Colorado, Kansas,
Missouri, Oklahoma, Texas, New Mexico, Louisiana and
Arkansas.

2. BASIS OF REPORTING

The consolidated financial statements of the Company have been prepared under
generally accepted accounting principles assuming that the Company will continue
as a going concern. The Company recorded a net loss of approximately $15,600,000
during 1997 and had negative cash flow from operations. The Company expects to
report additional net losses and negative cash flow amounts in 1998. This has
negatively impacted the availability of the Company's current bank financing
sources (see Note 6) and is expected to decrease the Company's overall liquidity
position during 1998.

Management plans to take the following actions with respect to these matters:
(i) obtain a secured working capital finance relationship, (ii) obtain an
additional equipment lease finance facility, (iii) impose controls to reduce
losses from Medicare nursing operations, (iv) intensify collection efforts, and
(v) accelerate realization of approximately $5,800,000 of cash flow from tax
positions. Based on these actions, management believes that the Company will
have sufficient liquidity to meet its capital requirements through December 31,
1998 and therefore continue as a going concern.

The Company has engaged the services of an investment bank to assist it in
evaluating various approaches to strengthen and grow the Company. Management is
actively engaged in various negotiations designed to result in either a
recapitalization, merger or sale of the Company.

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

PRINCIPLES OF CONSOLIDATION AND PRESENTATION

The consolidated financial statements of the Company include the accounts of
HealthCor Holdings, Inc. and its wholly owned subsidiaries, HealthCor, Inc.
(HealthCor), HealthCor Oxygen & Medical Equipment, Inc. (HOME), HealthCor
Pharmacy, Inc., Physicians Home Health Network, Inc., HealthCor Rehabilitation
Services, Inc., HealthCor Personnel Services, Inc., HealthCor Foundation, and
CareNetwork, Inc. All significant intercompany transactions and accounts have
been eliminated in consolidation.

USE OF ESTIMATES

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

CASH AND CASH EQUIVALENTS

The Company considers all highly liquid investments with an original maturity
of three months or less to be cash

33
<PAGE>
equivalents.

SUPPLIES INVENTORY

Inventories are stated at the lower of cost (first-in, first-out method) or
market and consist primarily of medical and pharmaceutical supplies sold
directly to patients for use in their homes.

PROPERTY AND EQUIPMENT

Property and equipment are stated at cost or fair market value at the
acquisition date. See Note 5. The cost of equipment held under capital leases is
equal to the lower of the net present value of the minimum lease commitments or
the fair value of the leased property at the inception of the lease. See Note
10. Property and equipment is depreciated using the straight-line method over
the following useful lives:

YEARS
---------
Furniture and equipment................................... 5-10
Transportation equipment.................................. 5
Leasehold improvements (life of the lease)................ 3-10
Medical equipment......................................... 5
Computer equipment........................................ 3-5
Software development costs................................ 10

EXCESS OF COSTS OF ACQUIRED BUSINESSES OVER THE FAIR VALUES OF ASSETS ACQUIRED

The value of excess costs of acquired businesses over the fair values of
assets acquired (goodwill) is recorded at the dates of acquisition. Goodwill is
being amortized on a straight-line basis over a 40-year period in accordance
with the provisions of APB No. 17.

The Company reviews the carrying value of goodwill at least annually on a
market-by-market basis to determine if facts and circumstances exist which would
suggest that goodwill may be impaired or that the amortization period needs to
be modified. Among the factors the Company considers in making the evaluation
are changes in the Company's market position, reputation, profitability and
geographic penetration. If indicators are present which may indicate impairment
is probable, the Company will prepare a projection of the undiscounted cash
flows of the specific market and determine if goodwill is recoverable based on
these undiscounted cash flows. If impairment is indicated, then an adjustment
will be made to reduce the carrying amount of the goodwill to its fair value.
Similar reviews are made of other long-lived assets. No such adjustments were
required at December 31, 1996 or 1995. See Note 14 for a discussion of goodwill
impairment charge recorded during 1997.

OTHER ASSETS

Other assets include financing costs relating to the costs of issuing the 11%
Senior Notes. The deferred financing costs are being amortized on a
straight-line basis over the life of the notes.

INCOME TAXES

Deferred income taxes are provided for temporary differences between the
financial statement and income tax basis of assets and liabilities in
accordance with Statement of Financial Accounting Standards (SFAS) No. 109,
"Accounting for Income Taxes."

NET INCOME (LOSS) PER COMMON SHARE

In February 1997 the Financial Accounting Standards Board issued SFAS No.
128, "Earnings Per Share," which requires publicly held companies with
potentially dilutive securities to change their earnings per share computation
for years ending after December 15, 1997, and show a basic earnings per share
(based on the weighted average number of common shares outstanding) and a
diluted earnings per share (based on the weighted average number of common
shares outstanding plus the effect of all dilutive securities, such as stock
options and warrants). The new statement resulted in a slightly favorable impact
on net income per share for certain prior periods. The Company

34
<PAGE>
adopted SFAS No. 128 in the fourth quarter of 1997. See Note 17.

The Company has treated the redeemable convertible preferred stocks as common
shares outstanding for all periods presented since these shares were converted
to common shares in the initial public offering.

STOCK-BASED COMPENSATION

The Company has adopted SFAS No. 123, "Accounting for Stock-Based
Compensation," effective January 1, 1996. SFAS No. 123 allows companies adopting
the pronouncement to either change the actual accounting methods for stock-based
compensation in the financial statements or to disclose certain pro forma
results of operations as if the pronouncement had been adopted in the financial
statements. The Company accounts for its stock options granted under the
provisions of Accounting Principles Board Opinion No. 25 ("APB No. 25") and has
disclosed the pro forma information required by SFAS No. 123 in Note 15.

NET REVENUES AND ESTIMATED SETTLEMENTS WITH THIRD-PARTY PAYORS

Revenues are recognized on the date services and related products are
provided to patients and are recorded at estimated net realizable amounts from
patients, third-party payors, and others for services rendered. For the years
ended December 31, 1997, 1996, and 1995, approximately 38%, 50% and 67% of net
patient service revenues were derived under federal third-party reimbursement
programs which are based on cost reimbursement and case payment principles.
These revenues are subject to audit and retroactive adjustment by the respective
third-party fiscal intermediary. In the opinion of management, retroactive
adjustments, if any, will not be material to the financial position or results
of operations of the Company. Settlements based on third-party reimbursement
program audits are recorded in the year they become known. The Company
establishes allowances for reimbursements in anticipation of such settlements.

Certain capital expenditures relating to the implementation of a new
management information system have been appropriately expensed for third-party
reimbursement purposes resulting in deferred revenue of approximately $3,824,000
and $5,903,000 at December 31, 1997 and 1996, respectively.

DIRECT EXPENSES

Direct expenses include salaries, wages and related benefits, medical
supplies, equipment and related depreciation, and other direct costs of
delivering home medical services.

RECLASSIFICATIONS

Certain amounts for prior periods have been reclassified to conform to the
current year presentation.

4. CURRENT LIABILITIES:

Accrued payroll and related expenses consist of the following:

1997 1996
---------- ----------
Salaries ..................................... $4,332,983 $3,434,656
Workers' compensation ........................ 912,999 724,478
Life, medical and related insurance .......... 992,494 482,916
Other ........................................ 1,892,008 2,378,763
---------- ----------
$8,130,484 $7,020,813
========== ==========

Accounts payable and accrued expenses consist of the following:

1997 1996
----------- ----------
Accounts payable .......................... $ 4,913,745 $4,198,779
Accrued expenses .......................... 4,625,448 2,556,232

Accrued restructuring charges ............. 1,560,578 --
----------- ----------
$11,099,771 $6,755,011
=========== ==========

35
<PAGE>
5. ACQUISITIONS:

1997 ACQUISITIONS

Effective January 1, 1997, the Company acquired Sterling Health Services,
Inc., a provider of home nursing services in Kansas City, Missouri.

Effective April 1, 1997, the Company acquired, for $900,000 in cash and
$100,000 in debt, the net assets of VNS Health Services, Inc., which provides
Medicare, Medicaid and private duty nursing services in Santa Fe and Espanola,
New Mexico.

Effective April 19, 1997, the Company acquired, for $8,500,000 in cash and
$1,000,000 in debt, all of the outstanding capital stock of CareNetwork, Inc.,
which provides nursing services in Little Rock, Ft. Smith, Lowell and Hot
Springs, Arkansas.

Effective June 1, 1997, the Company acquired, for $3,100,000 in cash and
$250,000 in debt, the net assets of American Medical Home Care, Inc., which
sells and leases home medical equipment, respiratory therapy services and
rehabilitation equipment in Tucson, Arizona.

Effective December 31, 1997, the Company acquired, for $1,124,000 in cash,
the net assets of certain Texas operations of Lutheran Health System, which
provides comprehensive home health services throughout north central and east
Texas.

1996 ACQUISITIONS

On April 1, 1996, the Company acquired, for $800,000 in cash and $200,000 in
debt, the net assets of All Medical, Inc., a company located in Wichita Falls,
Texas, engaged in selling and leasing medical equipment and supplies to the home
health care industry.

Effective May 1, 1996, the Company acquired, for $11,750,000 in cash and
$566,000 in debt, the net assets of I Care of Arkansas, Inc. and all of the
outstanding capital stock of I Care, Inc. (d/b/a I Care Health Services) and I
Care Home IV Affiliates, Inc. (collectively "I Care"), which provide infusion
therapy services and respiratory therapy equipment throughout Arkansas.

Effective September 1, 1996, the Company acquired, for $5,000,000 in cash and
$600,000 in debt, the net assets of Southern Medical Mart, Inc., a respiratory
therapy/medical equipment company with four locations in Louisiana. Southern
Medical Mart is engaged primarily in the sale and rental of medical equipment.

The Company also completed the acquisition of six companies during the last
fiscal quarter of 1996 for $3,700,000 in cash and $1,900,000 in debt. Three of
the companies specialize in providing home nursing care services, two provide
respiratory therapy/medical equipment services and products, and one provides
personnel placement services. The companies are located in Oklahoma and Texas.

The 1997 and 1996 acquisitions have been accounted for using the purchase
method of accounting. Accordingly, the purchase price was allocated to the
assets acquired (including all identifiable intangible assets, if material) and
liabilities assumed based upon their estimated fair values at the dates of
acquisition in accordance with APB No. 16. The results of operations of the
acquired practices are included in the consolidated financial statements from
the respective dates of acquisition. None of the acquisition agreements contain
any significant earn-out provisions with the sellers.

36
<PAGE>
The following is a summary of the net assets acquired and liabilities assumed
in connection with the foregoing acquisitions in 1997 and 1996:

1997 1996
------------ -----------
ASSETS ACQUIRED:
Current assets ............................... $ 2,620,749 $ 4,528,624
Other assets ................................. 2,257,573 3,770,208
------------ -----------
Total assets ............................. 4,878,322 8,298,832

LIABILITIES ASSUMED:
Current liabilities .......................... 969,295 1,326,723
Other liabilities ............................ 4,282,209 706,978
------------ -----------
Total liabilities .......................... 5,251,504 2,033,701
------------ -----------
NET ASSETS ACQUIRED ............................ (373,182) 6,265,131

PURCHASE PRICE, INCLUDING ACQUISITION COSTS .... 16,523,578 24,678,741
------------ -----------
EXCESS COST OF BUSINESSES ACQUIRED ............. $ 16,896,760 $18,413,610
============ ===========

PRO FORMA INFORMATION

The following unaudited pro forma information reflects the effects on the
consolidated statements of income assuming that significant acquisitions were
consummated as of January 1, 1997 and 1996. This information does not purport to
be indicative of the results that would have actually been obtained if the
acquisitions had occurred on such dates. Therefore, pro forma information cannot
be considered indicative of future operations. The unaudited pro forma
information for the years ended December 31, 1997 and 1996 is as follows (in
thousands, except per share amounts):

YEARS ENDED DECEMBER 31,
--------------------------
1997 1996
--------- --------
(UNAUDITED)
Net revenues ................................. $ 161,521 $168,657
Net income (loss) ............................ (16,176) 5,979
Net income (loss) per common share ........... (1.61) .77

6. BANK CREDIT FACILITY:

At December 31, 1996, the Company was party to a bank credit facility, dated
as of October 31, 1996, that provided for aggregate borrowings of $75.0 million,
originally consisting of a $15.0 million revolving credit line and a $60.0
million term facility for acquisitions. The bank credit facility was amended to
increase the revolving credit line to $30.0 million and to reduce the term
facility to $45.0 million. The revolving credit line was scheduled to expire on
October 31, 1999, and the term facility was scheduled to expire on October 31,
1998, and was repayable in quarterly installments of principal and interest
through October 31, 2001. The revolving credit line provided for the quarterly
payment to the bank of a .25 % commitment fee (escalating to .375 % if the
funded debt to adjusted earnings ratio exceeds 1.75 to 1) on the unused portion
of the line. Interest on the loans outstanding under the bank credit facility
was payable quarterly at (a) the greater of the bank's prime rate or the federal
funds effective rate plus 1/2%, both rates adjustable in certain circumstances,
or (b) at the LIBOR rate plus a specified adjustable margin ranging from 1.25 %
to 2.75 %. As of November 30, 1997, the Company had outstanding $29.4 million
under the revolving credit facility and $21.4 million under the term facility.
At September 30, 1997, the Company was not in compliance with several of the
financial covenants contained in the bank credit facility. The lenders waived
the Company's existing defaults through December 1, 1997, the date at which the
outstanding loans under the then existing bank credit facility were repaid with
proceeds from the 11 % Senior Notes. See Note 7.

Simultaneously with the closing of the 11 % Senior Notes, the Company entered
into a new bank credit facility, consisting of a three-year revolving credit
facility providing up to $ 20 million of availability. The new bank credit
facility is available in multiple drawings from time to time subject to certain
conditions and limitations, and amounts borrowed and repaid may be reborrowed
until the third anniversary of the closing date. Advances under the new bank
credit facility may be used to finance the working capital and general corporate
requirements of the Company. Amounts outstanding under the new bank credit
facility will bear interest at a rate based on LIBOR plus a specified

37
<PAGE>
margin ranging from 1.25 % to 2.75 % or, at the option of the Company, at a rate
based on the prime rate plus a specified margin ranging from 0 % to 0.75 %. The
Company pays a commitment fee on the unused portion of the new bank credit
facility equal to 0.25 % to 0.375 % per annum of the daily average unused
commitment amount. The revolving credit line contains certain financial
covenants with respect to maintenance of a maximum ratio of funded debt to
adjusted earnings, a minimum fixed charge coverage ratio, consolidated
stockholders' equity of not less than $44,000,000 (as adjusted), and a funded
debt to total capitalization ratio of no greater than 70 % until June 29, 1998,
and 65 % thereafter. The Company is currently in default of several of the
financial covenants under the new bank credit facility and is unable to incur
indebtedness under the facility.

There are no outstanding loans under the new bank credit facility at December
31, 1997. However, the Company has committed $742,000 of the line to a letter of
credit issued in connection with the Company's workers' compensation insurance
coverage. In 1998, the letter of credit will be increased to $797,000. The
Company has classified certain other indebtedness cross-defaulted with the new
bank credit facility as a current liability at December 31, 1997. See Note 10.

7. 11% SENIOR NOTES:

During 1997 the Company engaged Bear Stearns, Inc. and Chase Securities Inc.
to offer senior notes to refinance indebtedness outstanding under the bank
credit facility. On December 1, 1997, the offering was completed, and the
Company sold $80 million principal amount of 11 % Senior Notes due December 1,
2004 (the "Senior Notes), to qualified institutional buyers in reliance on the
exemption from the registration requirements of the Securities Act of 1933
provided by Rule 144. The Company filed a Form S-4 registration statement with
the Securities and Exchange Commission to register the Senior Notes so the
original restricted notes may be exchanged, at the option of the holder, for
identical notes without resale or transfer restrictions. The Company has agreed
to pay the costs of registering the notes. At March 31, 1998, the registration
statement had not been declared effective.

The Senior Notes are general unsecured obligations of the Company ranking
senior in right of payment of all subordinated indebtedness and equal in right
of payment of all other obligations. The Senior Notes bear interest at the rate
of 11 % per annum, payable in arrears on June 1 and December 1 of each year,
commencing June 1, 1998. The Senior Notes are fully and unconditionally
guaranteed on a senior, unsecured and joint and several basis by all of the
Company's present and future subsidiaries. Proceeds of the Senior Notes were
$77,100,000 after offering expenses of $2,900,000 that are being amortized over
the duration of the Senior Notes on a straight-line basis.

The indenture under the Senior Notes prohibits the Company from incurring
additional indebtedness (other than certain limited permitted indebtedness) or
issuing preferred equity instruments unless the consolidated fixed charge ratio
is greater than 2.0 to 1. At December 31, 1997, the Company's consolidated fixed
charge ratio is less than 2.0 to 1. The Indenture, however, would permit the
Company to incur indebtedness under any replacement of the bank credit facility
in an amount not to exceed $20.0 million.

8. LONG-TERM DEBT:

Long-term obligations consist of the following:
<TABLE>
<CAPTION>
1997 1996
------------ ------------
<S> <C> <C>
Notes payable to individuals in connection with acquisitions; principal
and interest payable monthly at rates ranging from 5.5% to 8.5%,
matures through May 2000, unsecured ................................. $ 2,214,674 $ 3,146,457

Acquisition term loan facility with a bank; principal and interest
payable quarterly at rates ranging from (a) the greater of the bank's
prime rate or the federal funds effective rate plus 1/2% or (b) at
the LIBOR rate plus 1.25% to 2.75% .................................. -- 7,540,000

11% Senior Notes due 2004 ............................................. 80,000,000 --

Other ................................................................. 6,064 10,417
------------ ------------
82,220,738 10,696,874
Less: current portion ........................................ (1,576,502) (3,582,096)
------------ ------------
$ 80,644,236 $ 7,114,778
============ ============
</TABLE>

38
<PAGE>
Aggregate maturities of long-term obligations subsequent to December 31,
1997, are as follows:

1998 .......................................... $ 1,576,502
1999 .......................................... 520,560
2000 .......................................... 123,676
2001 .......................................... --
2002 and thereafter ........................... 80,000,000
------------
82,220,738
Less -- Current portion ....................... (1,576,502)
------------
Total ............................... $ 80,644,236
============
9. PROPERTY AND EQUIPMENT:

Property and equipment consist of the following:

1997 1996
----------- ------------
Furniture and equipment .............. 4,526,781 $ 4,031,607
Transportation equipment ............. 1,316,796 1,247,255
Leasehold improvements ............... 1,188,413 854,462
Medical equipment .................... 26,282,878 15,363,664
Computer equipment ................... 10,800,688 9,034,231
Software development costs ........... 8,555,617 6,920,252
----------- ------------
52,671,173 37,451,471
Less -- Accumulated depreciation ..... (23,539,595) (15,163,931)
----------- ------------
Property and equipment, net .......... $29,131,578 $ 22,287,540
=========== ============

10. LEASE COMMITMENTS:

The Company leases office space, furniture, and equipment under noncancelable
operating lease agreements which expire on various dates to 2009 and contain
renewal options for up to 5 years.

The Company leases various office equipment under capital lease arrangements.
The capitalized value of leases amounted to approximately $11,272,000 and
$7,600,000 at December 31, 1997 and 1996, respectively, and net book value
amounted to approximately $6,008,000 and $4,473,000 at December 31, 1997 and
1996, respectively. Future minimum lease payments at December 31, 1997, under
the capital leases and noncancelable operating leases with initial or remaining
terms of one year or more are as follows:

OPERATING CAPITAL
LEASES LEASES
------------ ---------
1998 ................................. $ 3,135,194 7,770,934
1999 ................................. 2,467,853 805,614
2000 ................................. 2,065,062 388,768
2001 ................................. 1,697,866 331,643

2002 and thereafter .................. 6,819,842 27,488
------------ ---------
Total minimum payments ............... $ 16,185,817 9,324,447
============
Amount representing interest ......... (1,192,208)
---------
Present value of minimum payments .... 8,132,239
Current portion ...................... (6,738,548)
---------
Total ................................ $1,393,691
=========

The maturity dates of certain capital leases accelerated due to defaults
under the Company's bank credit facility. These leases have been reflected as a
current liability at December 31, 1997.

Rent expense under all operating leases was approximately $3,736,000,
$3,050,000, and $2,270,000 for the years ended December 31, 1997, 1996, and
1995, respectively.

39
<PAGE>
11. INCOME TAXES:

The provision for income taxes includes the following components:

1997 1996 1995
----------- ----------- -----------
Current:
Federal ........... $(4,858,888) $ 2,571,912 $ 2,896,714
State ............. 514,500 326,233 329,962
----------- ----------- -----------
(4,344,388) 2,898,145 3,226,676
----------- ----------- -----------
Deferred:
Federal ........... (439,848) 468,175 (944,878)
State ............. -- 52,066 (79,431)
----------- ----------- -----------
(439,848) 520,241 (1,024,309)
----------- ----------- -----------
Total ..... $(4,784,236) $ 3,418,386 $ 2,202,367
=========== =========== ===========

The reconciliation of the provision for income taxes to the federal statutory
rate is as follows:

1997 1996 1995
----------- ---------- -----------
Income taxes at statutory rate $(6,943,701) $2,975,134 $ 1,967,204
Deferred income tax valuation
allowance .................. 2,068,595 -- --
Amortization ................. 153,000 148,931 108,954
State taxes, net of federal
tax effect ................. 322,400 249,691 165,350
Tax credits utilized ......... -- -- (92,500)

Other ........................ (384,530) 44,630 53,359
----------- ---------- -----------
$(4,784,236) $3,418,386 $ 2,202,367
=========== ========== ===========

Deferred tax assets and deferred tax liabilities consist of the following
items:

1997 1996
----------- -----------
Deferred tax assets:
Allowance for doubtful accounts ........ $ (467,443) $ 424,590
Self-insurance and workers'
compensation ......................... 720,312 567,034
Amounts due to third-party payors ...... 2,582,378 710,549
Accrued payroll and related expenses ... 223,751 186,222
State income taxes ..................... (17,170) (92,039)
Other .................................. -- 40,817
----------- -----------
Total before valuation
allowance .................... 3,041,828 1,837,173
Valuation allowance .................... (2,068,595) --
----------- -----------
Net deferred tax assets ........ 973,233 1,837,173

Deferred tax liabilities:
Depreciation and amortization .......... 661,028 (884,101)
Deferred software cost, net of
deferred revenue ..................... (1,746,639) (388,417)
Deferred compensation expense .......... (255,108) (425,118)
Accrued restructuring costs ............ 451,466 --
Other .................................. (62,328) (54,874)
----------- -----------
Total .......................... (951,581) (1,752,510)
----------- -----------
Other tax liability .................... (21,652) (89,663)
----------- -----------
Total net tax (liabilities) assets ....... $ -- $ (5,000)
=========== ===========

12. REDEEMABLE CONVERTIBLE PREFERRED STOCK:

In 1989, the Company sold 2,000,000 shares of its Series A preferred stock
($.01 par value) for $2,000,000, less issuance costs of $85,532, to an unrelated
entity. The shares were converted into 2,000,000 shares of the Company's common
stock coincident with the Company's initial public offering (IPO) on August 8,
1996.

In 1992, the Company issued 1,071,438 shares of its Series B preferred stock
($.01 par value) for $3,000,025 to the Series A preferred stock investor and an
unrelated investor and 178,575 shares of its Series B preferred stock for
$500,010 to the Company's Employee Stock Ownership Plan (ESOP). The Company paid
$72,636 in costs associated with these two issuances. The Series B preferred
shares were convertible into 1,562,517 shares of the Company's common stock. The
conversion rate was subject to adjustment of up to 1.25 for one (312,503
additional shares) common share based on the Company's post issuance earnings
level. On November 28, 1994, the 178,575 Series B preferred shares held by the
ESOP were converted to 223,220 common shares. The remaining Series B

40
<PAGE>
preferred shares were converted into 1,339,297 shares of common stock coincident
with the Company's IPO on August 8, 1996.

13. COMMON STOCK:

The Company completed an IPO of 3,000,000 shares of its common stock, $.01
par value, on August 8, 1996, and on September 11, 1996, the underwriters
exercised their overallotment option to purchase an additional 300,000 shares.
The Company used the net proceeds from the IPO of approximately $29,800,000 to
repay outstanding indebtedness under its bank credit facilities and for general
corporate purposes. In addition, on July 26, 1996, the Company declared a 5 for
2 stock split in the form of a stock dividend of its common stock. The
accompanying consolidated financial statements give retroactive effect to the
stock split.

14. GOODWILL WRITE-OFF AND RESTRUCTURING COSTS:

During 1997, the home health care industry experienced several significant
regulatory and reimbursement changes. In February 1997, the Health Care
Financing Administration ("HCFA") announced that it intended to implement
mileage limitations restricting the distance between a nursing agency's
principal office and its branches. Texas, where the Company has significant
operations, announced that it intended to implement even more restrictive
mileage limitation rules for branch offices. During 1998, following a moratorium
on new Medicare provider numbers announced by President Clinton, HCFA imposed a
delay in permitting branch office transfers. The 1997 Federal Budget contains
other reimbursement changes that will reduce the level of reimbursement
available to the Company. On January 2, 1998, HCFA published final Medicare
nursing per-visit cost limitation guidelines which reduce per-visit cost
limitations for the Company by approximately 18%-20% for 1998. Also, regulations
effective February 1, 1998, eliminate venipuncture as a covered service for
Medicare nursing visits, which will materially reduce the Company's Medicare
nursing revenues. In addition, reimbursement rates for Medicare home oxygen
services, which represent approximately 6% of the Company's annualized revenues,
will be reduced by 25.0% beginning January 1, 1998, with an additional 5.0%
reduction to be effective January 1, 1999. Based upon these and past initiatives
to reduce Medicare costs and possible further cost containment or other
initiatives in the future, the Company expects the reimbursements received from
the Medicare program to be at continued risk of substantial reduction in the
future. In view of the increased risks of the Medicare nursing program, the
Company has entered into active negotiations regarding a recapitalization,
merger or sale, which would enhance growth and efficiencies in the current
Medicare reimbursement environment.

Congress has also recently adopted a per-beneficiary limit on
reimbursement for nursing services based upon historical cost, and on March 31,
1998, published regulations which set forth the national and regional medians on
which such limits will be based, but has not published regulations determining
the provider specific per-beneficiary limits. The Company expects that the
per-beneficiary limits will have an adverse effect on the Company's Medicare
nursing operations.

During 1997 the Company was subject to Medicare cost limitations for home
nursing that were lower than the Company's operating expenses for that period,
resulting in a $8,400,000 revenue adjustment. To achieve cost savings in order
to attempt to operate within the Medicare nursing cost limitations for 1998, the
Company has implemented a plan to close or consolidate 32 Medicare nursing
offices during the first quarter of 1998. The Company believes that these
actions and the regulatory and reimbursement changes described above will reduce
1998 Medicare nursing revenue from the 1997 level by at least $25,000,000 or
40%. The Company believes that its Medicare nursing operations will operate in
excess of cost limitations in 1998.

The Company in late December 1997 began to assess the potential financial
effect of the above described regulatory changes on its Medicare nursing and
home oxygen service businesses. Coincident therewith the Company developed and
implemented a restructuring plan to mitigate the financial impact of the
changes. In addition, the changes prompted the Company to evaluate whether its
long-lived assets were impaired. As a result, the Company reduced the carrying
value of its recorded goodwill by approximately $8,300,000, recognized
additional Medicare cost limitations for 1997 aggregating $5,600,000 which
reduced revenues in the three months ended December 31, 1997, announced
significant headcount reductions, and closed 32 Medicare nursing field offices.
The offices were closed at March 31, 1998. As a result, the Company recorded
$1,575,000 in restructuring

41
<PAGE>
costs, consisting of direct severance costs of terminated employees of $375,000
and future lease termination costs and other costs related to office closings of
approximately $1,200,000.

15. EMPLOYEE BENEFIT PLANS:

The Company has two qualified incentive stock option plans and has reserved
387,500 shares of the Company's common stock, all of which were granted, for
issuance under the 1989 plan and 237,500 shares under the 1996 plan. Options for
187,000 shares have been granted under the 1996 stock option plan and 50,500 are
available for future grants. The Company accounts for its stock option plans in
accordance with the provisions of APB No. 25 and related interpretations, under
which no compensation cost is recognized for financial statement purposes.

Pro forma information regarding net income (loss) and net income (loss) per
share and net income (loss) per share assuming dilution is required by SFAS No.
123 and has been determined in accordance therewith. The fair value of each
option grant is estimated as of the date of grant using the Black-Scholes
option-pricing model with the following weighted-average assumptions used for
grants in 1997, 1996 and 1995, respectively: Risk-free interest rates of 6.0 %,
6.5 % and 6.5 %; expected dividend yield of zero; expected option lives until
exercise date of 6.5 years; and expected price volatility of 35%, 25 % and 25%,
respectively. Had compensation cost for stock options granted in 1997, 1996 and
1995 been determined based on the fair value at the grant dates for options
awarded consistent with the provisions of SFAS No. 123, the Company's net income
(loss) and net income (loss) per common share and net income (loss) per common
share assuming dilution for the years ended December 31, 1997, 1996 and 1995,
would have been reduced to the following pro forma amounts:

1997 1996 1995
------------ ---------- ----------
Net income (loss)..... As reported... $(15,638,413) $5,332,008 $3,583,525
Pro forma..... $(15,868,618) $5,206,173 $3,537,259
Net income (loss)
per common share..... As reported... $ (1.56) $ .69 $ .57
Pro forma.... $ (1.58) $ .67 $ .56

Net income (loss)
per common share-
assuming dilution.... As reported... $ (1.56) $ .66 $ .55
Pro forma.... $ (1.58) $ .65 $ .54

Since the provisions of SFAS No. 123 have not been applied to options granted
prior to January 1, 1995, the resulting pro forma compensation cost is not
representative of the pro forma compensation expected to be presented in future
years.

Options to purchase shares of the Company's common stock have been granted to
nonofficer and noninvestor directors and key employees. Options are granted at
fair market value at the dates of grant. Options granted become exercisable at
the rate of 1/3 per year, and expire 10 years after the date of grant.

Information on stock options and related information is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------------------------------- ------------------------- -------------------------
NUMBER OF WTD. AVG. NUMBER OF WTD. AVG. NUMBER OF WTD. AVG.
SHARES EX. PRICE SHARES EX. PRICE SHARES EX. PRICE
----------------- --------- ------------- --------- ------------ --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year.. 356,926 $5.63 359,627 $ 4.68 301,375 $ 3.79
Granted........................... 235,500 (1) 6.14 48,250 10.13 118,253 7.04
Exercised......................... (73,379) 5.07 (33,867) 2.32 (2,083) 2.00
Forfeited......................... (104,590) (1) 6.10 (17,084) 5.04 (57,918) 5.00
--------- ----- ------- --------- ------- -------
Outstanding at end of year........ 414,457 $4.49 356,926 $ 5.63 359,627 $ 4.68
======= ===== ======= ========= ======= =======
Exercisable at end of year........ 188,891 $3.86 198,884 $ 4.06 157,940 $ 2.70
======= ===== ======= ========= ======= =======
Price range....................... $.80 - $9.00 $.80.- $11.50 $.80 - $7.04
============ ============= ============
Weighted-average fair value of
options granted during the year.... $ 3.87 $ 4.26 $ 2.96
========== ========== ==========
</TABLE>
(1) Excludes 174,783 options repriced on September 16, 1997, at $5.00 per share
from $8.03 per share weighted

42
<PAGE>
average exercise price. Such options were treated as an option modification for
purposes of computing the weighted average fair value of options granted during
1997.

Exercise prices for options outstanding at December 31, 1997, ranged from
$.80 to $9.00 per share. The weighted average remaining contractual life for
those options is 7.7 years.

The following table summarizes information about stock options that are
exercisable at December 31, 1997:
<TABLE>
<CAPTION>
Weighted Average
Number of Options Remaining Weighted Average
OPTION GRANT DATE Exercisable Contractual Life Exercise Price
----------------- ---------------- ----------------
<S> <C> <C> <C>
August 1990 through January 1993.... 69,300 3.7 Years $ 1.57
January 1994 through December 1996.. 119,591 7.2 Years $ 5.18
-------
Total exercisable................... 188,891 5.9 Years $ 3.86
=======
</TABLE>
On April 1, 1990, the Company established an Employee Stock Ownership Plan
(ESOP), which will award shares of the Company's common stock on a
noncontributory basis to eligible employees of the Company. Contributions of
common stock and cash by the Company, when declared at the discretion of the
Board of Directors, are allocated to the accounts of participants based on the
ratio each participant's compensation for the year bears to all participants'
compensation for that year. The Company contributed 130,000 and 125,000 common
shares in 1996 and 1995. Participants are not vested in any amounts allocated to
them until they have completed at least 1,000 hours of service per year for one
year. After five such years, a participant is 100% vested in such amounts.
Generally, a participant also will be fully vested upon attaining age 65 or in
the event of total and permanent disability, death or termination of the ESOP.
ESOP shares which are committed to be released are treated as outstanding for
earnings per share computations. Compensation expense for the ESOP was
approximately $1,500,000 for the year ended December 31, 1995. During 1997 and
1996, the Board of Directors authorized no contribution to the ESOP. At December
31, 1996, the Company recorded approximately $1,100,000 related to accumulated
plan forfeitures as deferred compensation expense in the accompanying
consolidated balance sheets. In September 1997 the Board of Directors authorized
the termination of the ESOP. It is expected a final contribution of accumulated
forfeitures will be made to the plan during the first quarter of 1998, and,
accordingly, $447,000 has been charged to expense for the estimated value of the
Company's final contribution to the ESOP.

Effective April 1, 1991, the Company formed a deferred compensation plan
structured under Section 401(k) of the Internal Revenue Code. The plan covers
substantially all employees meeting certain minimum service requirements. Under
the plan, contributions are made by the employees and matched by the Company
subject to certain limitations. The Company's contribution to this plan was
approximately $329,000, $157,000, and $105,000 for the years ended December 31,
1997, 1996, and 1995, respectively.

16. COMMITMENTS AND CONTINGENCIES:

In addition, the Company, in the normal course of business, is party to
various other matters of litigation. Management is of the opinion that the
eventual outcome of these matters will not have a material adverse effect on the
Company's financial position or results of operations

The Company self-insures its employees and their dependents for injury and
hospitalization. The Company self-insures claims up to $75,000 per person, with
an insurance company covering claims in excess of this amount up to a maximum of
$1,000,000 per person. A liability is accrued for claims incurred but not yet
reported (IBNR) based

43
<PAGE>
on historical claims paid information as provided by the respective insurance
company. The IBNR liability at December 31, 1997 and 1996, was approximately
$1,005,000 and $468,000, respectively. The Company has paid claims of
approximately $1,126,000, $1,101,000, and $1,700,000 for the years ended
December 31, 1997, 1996, and 1995, respectively.

17. NET INCOME (LOSS) PER COMMON SHARE:

The following table sets forth the computation of basic and diluted net
income (loss) per common share:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------
1997 1996 1995
------------ ---------- ----------
<S> <C> <C> <C>
Numerator:
Net income (loss) .......................................... $(15,638,413) $5,332,008 $3,583,525
============ ========== ==========
Denominator:
Weighted average common shares issued ...................... 10,053,734 7,770,175 2,957,518
Assuming conversion of Series A preferred stock .......... -- -- 2,000,000
Assuming conversion of Series B preferred stock .......... -- -- 1,339,298
------------ ---------- ----------
Weighted average number of common shares
outstanding, including preferred shares ................ 10,053,734 7,770,175 6,296,816
Effect of dilutive stock options:
Assuming exercise of options, reduced by the number of
common shares which could have been purchased with the
proceeds from exercise of such options ............... -- 270,075 248,799
------------ ---------- ----------
Weighted average number of common shares
outstanding and dilutive stock options ................. 10,053,734 8,040,250 6,545,615
============ ========== ==========
Net income (loss) per common share ........................... $ (1.56) $ 0.69 $ 0.57
Net income (loss) per common share- assuming dilution ........ $ (1.56) $ 0.66 $ 0.55
</TABLE>
18. FAIR VALUE OF FINANCIAL INSTRUMENTS:

On January 1, 1995, the Company adopted SFAS No. 107, "Disclosure About Fair
Value of Financial Instruments." Cash and cash equivalents, accounts receivable,
and accounts payable and accrued liabilities are reflected in the consolidated
financial statements at fair value because of the short-term maturity of those
instruments. In addition, the fair value of the Company's long-term debt
(including the Senior Notes) and capital lease obligations were determined to
approximate its carrying value since the Senior Notes were issued on December 1,
1997.

44
<PAGE>
19. CONSOLIDATED QUARTERLY DATA (UNAUDITED):

The following is a summary of the consolidated quarterly results of
operations of the Company for the years ended December 31, 1997 and 1996:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
---------------------------------------------------
1997 MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
--------- ------- --------- ----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Net revenues................. $33,765 $34,314 $40,504 $34,622

Gross profit................. 19,961 16,588 23,052 16,224

Income (loss) from operations 3,675 (4,069) 3,592 (18,303)

Income (loss) before income
taxes...................... 3,014 (5,185) 2,154 (20,406)

Net income (loss)............ 1,808 (3,336) 1,293 (15,403)

Net income (loss) per common
share...................... .18 (.33) .13 (1.53)
Net income (loss) per common
share-assuming dilution.... .18 (.33) .13 (1.53)

Weighted average common
shares outstanding......... 10,023 10,041 10,064 10,086
Weighted average common
shares outstanding and
dilutive common stock
options.................... 10,178 10,041 10,159 10,086

THREE MONTHS ENDED
---------------------------------------------------
1996 MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
--------- --------- --------- ----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Net revenues................. $24,254 $25,968 $27,254 $29,309

Gross profit................. 12,734 14,273 15,374 16,090

Income from operations....... 2,134 2,520 2,880 3,360

Income before income taxes... 1,648 1,868 2,355 2,880

Net income................... 971 1,175 1,462 1,723

Net income per common share.. .15 .18 .18 .17
Net income per common
share-assuming dilution.... .15 .18 .17 .17

Weighted average common
shares outstanding......... 6,298 6,358 8,319 10,014
Weighted average common
shares outstanding
and dilutive common
stock options.............. 6,543 6,592 8,575 10,187
</TABLE>
During the three months ended December 31, 1997, the Company incurred a
number of charges that affected its results, including the following: an
adjustment of net revenues of $5,600,000 relating to Medicare nursing cost
limitations, a goodwill write-off of $8,275,000, a restructuring charge of
$1,575,000 relating to closed offices and headcount reductions, an increase in
the provision for doubtful accounts of $5,700,000, the write-off of previously
capitalized financing costs of $300,000 from a previous bank credit agreement,
and a charge of $447,000 related to the termination and liquidation of the
Company's Employee Stock Ownership Plan.

During the three months ended June 30, 1997, net revenues and net income were
adversely affected by a $2,800,000 revenue adjustment related to Medicare
nursing cost limitations and by an increase in the allowance for doubtful
accounts by $2,700,000.

*************************************

45
<PAGE>
HEALTHCOR HOLDINGS, INC. AND SUBSIDIARIES

VALUATION AND QUALIFYING ACCOUNTS

FOR THE YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
<TABLE>
<CAPTION>
ADDITIONS ADDITIONS
BALANCE AT CHARGED TO FROM BALANCE
BEGINNING COSTS AND ACQUIRED AT END
CLASSIFICATION OF PERIOD EXPENSES COMPANIES DEDUCTIONS OF PERIOD
-------------- ---------- ----------- ---------- ------------ -----------
<S> <C> <C> <C> <C> <C>
December 31, 1997:

Allowance for Doubtful Accounts ............... $5,101,000 $14,057,000 $4,122,000 $(11,839,000)(b) $11,441,000

Accrued Restructuring Costs ................... -- 1,575,000 -- -- 1,575,000

Accumulated Amortization of
Intangible Assets ......................... 2,038,000 9,641,000 -- (8,275,000) 3,404,000
---------- ----------- ---------- ------------ -----------
Total Reserves and Allowances ......... $7,139,000 $25,273,000 $4,122,000 $(20,114,000) $16,420,000
========== =========== ========== ============ ===========
December 31, 1996:

Allowance for Doubtful Accounts ............... $2,056,000 $ 3,580,000 $2,753,000 $ (3,288,000)(b) $ 5,101,000

Accumulated Amortization of
Intangible Assets ......................... 1,186,000 852,000 -- -- 2,038,000
---------- ----------- ---------- ------------ -----------
Total Reserves and Allowances ......... $3,242,000 $ 4,432,000 $2,753,000 $ (3,288,000) $ 7,139,000
========== =========== ========== ============ ===========
December 31, 1995:

Allowance for Doubtful Accounts ............... $1,285,000 $ 1,489,000 $ 624,000 $ (1,342,000)(b) $ 2,056,000

Accumulated Amortization of
Intangible Assets ......................... 717,000 469,000 -- -- 1,186,000
---------- ----------- ---------- ------------ -----------
Total Reserves and Allowances ......... $2,002,000 $ 1,958,000 $ 624,000 $ (1,342,000) $ 3,242,000
========== =========== ========== ============ ===========
</TABLE>
- -------------------

(a) This schedule should be read in conjunction with the Company's audited
consolidated financial statements and related notes thereto.

(b) Write-off of uncollectible receivables net of recoveries.

46
<PAGE>
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
April 15, 1998 on its behalf by the undersigned thereunto duly authorized.

HEALTHCOR HOLDINGS, INC.

By: /s/ S. WAYNE BAZZLE
S. Wayne Bazzle
Chairman of the Board and
Chief Executive Officer

Each person whose signature appears below hereby authorizes S. Wayne Bazzle
and Cheryl C. Bazzle, or either of them, as attorneys-in-fact to sign on his or
her behalf, individually and in the capacity stated below and to file all
amendments and supplements to the Annual Report on Form 10-K.

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 Company
and in the capacities and on the dates indicated.

SIGNATURE TITLE DATE
--------- ----- ----
/s/ S. WAYNE BAZZLE Chairman of the Board and April 15, 1998
S. Wayne Bazzle Chief Executive Officer

/s/ CHERYL C. BAZZLE President and Chief Operating April 15, 1998
Cheryl C. Bazzle Officer

/s/ JOEL H. WILLIAMS Vice President and Chief Financial April 15, 1998
Joel H. Williams Officer (Principal Financial and
Accounting Officer)

/s/ ROBERT B. CRATES Director April 15, 1998
Robert B. Crates

/s/ JANE B. FINLEY Director April 15, 1998
Jane B. Finley, Ph.D.

/s/ MICHAEL J. FOSTER Director April 15, 1998
Michael J. Foster

47
<PAGE>
EXHIBIT INDEX

(a) Exhibits

1.1 -- Purchase Agreement dated November 24, 1997, by and among the
Company, the guarantors named on the signature pages thereto, Bear,
Stearns & Co. Inc. and Chase Securities Inc (incorporated by reference
to the Company's Registration Statement on Form S-4 (File No.
333-44175), as filed with the Securities and Exchange Commission on
January 13, 1998).

3.1 -- Amended and Restated Certificate of Incorporation of the Company
(incorporated by reference to the Company's Registration Statement on
Form S-1 (File No. 333-5779), as filed with the Commission on June 12,
1996).

3.2 -- Amended and Restated Bylaws of the Company (incorporated by
reference to the Company's Registration Statement on Form S-1 (File No.
333-5779), as filed with the Commission on June 12, 1996).

4.1 -- Specimen Stock Certificate of the Company (incorporated by reference
to the Company's Registration Statement on Form S-1 (File No.
333-5779), as filed with the Commission on June 12, 1996).

4.2 -- Indenture dated as of December 1, 1997, by and among the Company,
the Guarantors Signatories Thereto and Norwest Bank Minnesota, National
Association, as Trustee (incorporated by reference to the Company's
Registration Statement on Form S-4 (File No. 333-44175), as filed with
the Securities and Exchange Commission on January 13, 1998).

4.3 -- First Supplemental Indenture dated as of December 2, 1997 to
Indenture dated as of December 1, 1997, by and among the Company, the
Guarantors Signatories Thereto and Norwest Bank Minnesota, National
Association, as Trustee (incorporated by reference to the Company's
Registration Statement on Form S-4 (File No. 333-44175), as filed with
the Securities and Exchange Commission on January 13, 1998).

4.4 -- Form of Global Note (included in Exhibit 4.2).

4.5 -- Registration Rights Agreement dated as of December 1, 1997, by and
among Bear Stearns & Co. Inc., Chase Securities Inc., the Company, and
certain subsidiaries of the Company, as Guarantors (incorporated by
reference to the Company's Registration Statement on Form S-4 (File No.
333-44175), as filed with the Securities and Exchange Commission on
January 13, 1998).

4.6 -- Second Amended and Restated Credit Agreement dated December 1, 1997,
by and among Texas Commerce Bank National Association, as Agent and an
Issuing Bank, the Several Financial Institutions from time to time a
party thereto and the Company (incorporated by reference to the
Company's Registration Statement on Form S-4 (File No. 333-44175), as
filed with the Securities and Exchange Commission on January 13, 1998).

10.1 -- Registration Rights Agreement, dated as of June 1, 1992 between the
Company and certain stockholders of the Company (incorporated by
reference to the Company's Registration Statement on Form S-1 (File No.
333-5779) as filed with the Commission on June 12, 1996).

10.2 -- The Company Employee Stock Ownership Plan and Trust, dated April 1,
1990, as amended (incorporated by reference to the Company's
Registration Statement on Form S-1 (File No. 333-5779) as filed with
the Commission on June 12, 1996).

10.3 -- Form of HealthCor Holdings, Inc. 1996 Long-Term Incentive Plan
(incorporated by reference to the Company's Registration Statement on
Form S-1 (File No. 333-5779) as filed with the Commission on June 12,
1996).

10.4 -- HealthCor Holdings, Inc. Employee Stock Ownership Plan and Trust,
dated April 1, 1990, as amended (incorporated by reference to the
Company's Registration Statement on Form S-1 (File No. 333-5779) as
filed with the Commission on June 12, 1996).

10.5 -- Warrant Agreement between the Company and an individual to purchase
Common Stock of the Company, dated as of November 1, 1994 (incorporated
by reference to the Company's Registration Statement on Form S-1 (File
No. 333-5779) as filed with the Commission on June 12, 1996).

10.6 -- Form of Indemnification Agreement entered into between the Company
and its

48
<PAGE>
executive officers and directors (incorporated by reference to the
Company's Registration Statement on Form S-1 (File No. 333-5779) as
filed with the Commission on June 12, 1996).

10.7 -- Stock Purchase Agreement, dated April 15, 1996, by and between I
Care Home I.V. Affiliates, Inc., I Care of Arkansas, Inc., I Care, Inc.
and the Company (incorporated by reference to the Company's
Registration Statement on Form S-1 (File No. 333-5779) as filed with
the Commission on June 12, 1996).

10.8 -- Asset Purchase Agreement, dated as of September 1, 1996, by and
between HealthCor Oxygen and Medical Equipment, Inc. and Southern
Medical Mart, Inc. (incorporated by reference to the Company's Current
Report on Form 8-K, as filed with the Commission on November 12, 1996).

10.9 -- Credit Agreement, dated as of October 31, 1996, by and between
HealthCor Holdings, Inc., HealthCor, Inc. and the certain financial
institutions named therein (incorporated by reference to the Company's
Annual Report on Form 10-K, as filed with the Commission on April 15,
1997).

10.10 -- Form of Change of Control Agreement (incorporated by reference to the
Company's Registration Statement on Form S-4 (File No. 333-44175) as
filed with the Commission on January 13, 1998.

11.1 -- Computation of net income (loss) per common share.

23.1 -- Consent of Arthur Andersen LLP, independent public accountants.

EXHIBIT 11

HEALTHCOR HOLDINGS, INC. AND SUBSIDIARIES
COMPUTATION OF NET INCOME (LOSS) PER COMMON SHARE
UNAUDITED

YEARS ENDED
BASIC AND DILUTED EARNINGS PER SHARE DECEMBER 31,
--------------------------
1997 1996
------------ ----------
Net income (loss) ............................... $(15,638,413) $5,332,008
============ ==========
Shares:
Weighted average common shares issued ...... 10,053,734 7,770,175
Assuming exercise of options, reduced by the
number of common shares which could have
been purchased with the proceeds from
exercise of such options ................ -- 270,075
------------ ----------
Weighted average number of common shares
outstanding, as adjusted ................ 10,053,734 8,040,250
============ ==========
Net income (loss) per common share:
Basic earnings (loss) per share ......... $ (1.56) $ 0.69
============ ==========
Diluted earnings (loss) per share ...... $ (1.56) $ 0.66
============ ==========

EXHIBIT 23.1

CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS

As independent public accountants, we hereby consent to the incorporation by
reference of our report included in this Form 10-K into the Company's previously
filed Registration Statement on Form S-8, No. 333-10967.

ARTHUR ANDERSEN LLP

Dallas, Texas
April 15, 1998

<ARTICLE> 5
<LEGEND>
THE FINANCIAL DATA SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED
FROM DECEMBER 31, 1997 10-K BALANCE SHEET & INCOME STATEMENT AND IS QUALIFIED
IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>

<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 21,820,308
<SECURITIES> 0
<RECEIVABLES> 38,635,806
<ALLOWANCES> 0
<INVENTORY> 4,258,834
<CURRENT-ASSETS> 72,875,095
<PP&E> 29,131,578
<DEPRECIATION> 0
<TOTAL-ASSETS> 153,213,023
<CURRENT-LIABILITIES> 27,850,305
<BONDS> 80,000,000
0
0
<COMMON> 100,893
<OTHER-SE> 39,160,638
<TOTAL-LIABILITY-AND-EQUITY> 153,213,023
<SALES> 143,204,750
<TOTAL-REVENUES> 143,204,750
<CGS> 67,380,199
<TOTAL-COSTS> 67,380,199
<OTHER-EXPENSES> 67,022,464
<LOSS-PROVISION> 23,907,018
<INTEREST-EXPENSE> 5,317,718
<INCOME-PRETAX> (20,422,649)
<INCOME-TAX> (4,784,236)
<INCOME-CONTINUING> (15,638,413)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (15,638,413)
<EPS-PRIMARY> (1.56)
<EPS-DILUTED> (1.56)

</TABLE>