NEW GRANCARE INC
424B3, 1997-01-13
SKILLED NURSING CARE FACILITIES
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                                                            FILED PURSUANT TO
                                                             RULE 424(b)(3)
                               NEW GRANCARE, INC.           FILE NO: 333-19091
 
                                  COMMON STOCK
                           PAR VALUE $0.001 PER SHARE
 
  This Prospectus covers up to 24,000,000 shares of the common stock, par value
$.001 per share ("New GranCare Common Stock), of New GranCare, Inc., a Delaware
corporation ("New GranCare"). This Prospectus is being furnished to the
shareholders of GranCare, Inc., a California corporation (the "Company"), the
sole stockholder of New GranCare, in connection with the proposed distribution
(the "Distribution") to the Company's shareholders of all the outstanding
shares of New GranCare Common Stock, pursuant to the terms of an Amended and
Restated Agreement and Plan of Distribution, dated as of September 3, 1996, by
and between the Company and New GranCare (the "Distribution Agreement"). The
Company is proposing to make the Distribution in connection with and as part of
a proposed reorganization that also involves the merger of the Company (the
"Merger") with and into Vitalink Pharmacy Services, Inc., a Delaware
corporation ("Vitalink"), immediately following the Distribution, pursuant to
an Agreement and Plan of Merger by and between Vitalink and the Company dated
September 3, 1996, as amended through the date hereof (the "Merger Agreement"),
a copy of which is attached as Annex B to the Proxy Statement/Prospectus (the
"Proxy Statement/Prospectus") of the Company and Vitalink relating to the
solicitation of proxies in order to obtain shareholder approval of the
Distribution and Merger which accompanies this Prospectus. Immediately
following the Merger, New GranCare will change its name to "GranCare, Inc." The
Merger is conditioned upon the successful completion of the Distribution. The
completion of both the Merger and the Distribution is subject to the approval
of the shareholders of the Company.
 
  One share of New GranCare Common Stock will be distributed for each share of
common stock of the Company (the "Distribution Ratio"), without par value
("Company Common Stock"), issued and outstanding on the date established by the
Board of Directors of GranCare for determining shareholders of record entitled
to receive New GranCare Common Stock in the Distribution (the "Distribution
Record Date").
 
  At the time of the Distribution, New GranCare will own all of the Company's
businesses and assets other than the Company's institutional pharmacy business
(the "Institutional Pharmacy Business"), currently operated through the
Company's TeamCare, Inc. subsidiary ("TeamCare"). The businesses to be owned
and operated by New GranCare include the Company's skilled nursing facilities,
home health and assisted living operations and contract management businesses
(the "Skilled Nursing Business").
 
  No consideration will be paid by the Company's shareholders for the shares of
New GranCare Common Stock to be received by them in the Distribution. There is
currently no public trading market for the shares of New GranCare Common Stock.
New GranCare intends to list the New GranCare Common Stock on the New York
Stock Exchange, Inc. ("NYSE").
 
  The consummation of the Distribution is a condition to, among other things,
the Company's and Vitalink's respective obligations to consummate the Merger.
 
  SHAREHOLDERS OF THE COMPANY AS OF THE DISTRIBUTION RECORD DATE SHOULD
CAREFULLY CONSIDER THE INFORMATION SET FORTH UNDER THE CAPTION "RISK FACTORS"
ON PAGE 12 HEREOF.
 
 THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
 EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
 AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
 ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS
 A CRIMINAL OFFENSE.
 
                                  -----------
                 
              The date of this Prospectus is January 8, 1997.     

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                      [THIS PAGE INTENTIONALLY LEFT BLANK]
 
                                       2
<PAGE>
 
                         NEW GRANCARE, INC. PROSPECTUS
 
                               TABLE OF CONTENTS
 
<TABLE>
<CAPTION>
                                                                           PAGE
                                                                           ----
<S>                                                                        <C>
PROSPECTUS SUMMARY........................................................   5
RISK FACTORS..............................................................  12
BUSINESS..................................................................  17
  General.................................................................  17
  Long-Term Care Industry.................................................  17
  Business Strategy.......................................................  18
  Marketing and Development of Payor Sources..............................  22
  Competition.............................................................  22
  Regulation..............................................................  23
  Employee Training and Development.......................................  27
  Employees...............................................................  28
  Insurance...............................................................  28
  Legal Proceedings.......................................................  28
THE DISTRIBUTION..........................................................  30
  Reasons for the Distribution............................................  30
  Contribution of Skilled Nursing Business to New GranCare................  30
  Consummation of the Distribution; Treatment of Company Stock Options....  31
  Manner of Effecting the Distribution....................................  32
  Listing of New GranCare Common Stock; Restrictions on Resale............  33
  Interests of Certain Persons in the Distribution and Merger.............  33
  Treatment of Certain Indebtedness.......................................  35
  Expenses................................................................  38
  Conditions..............................................................  39
  Terms of the Distribution Agreement.....................................  39
  Terms of Employee Benefits Agreement....................................  41
  Terms of the Non-competition Agreement..................................  42
  Terms of Shareholders Agreement.........................................  42
  Terms of the Interim Services Agreement.................................  43
  Terms of the Pharmaceutical Supply Agreements...........................  43
  Terms of the Voting Agreement...........................................  44
  Terms of the Tax Allocation Agreement...................................  44
CERTAIN FEDERAL INCOME TAX CONSEQUENCES...................................  46
  Consequences of the Distribution........................................  46
  Consequences of the Merger to the Company, Vitalink and the Company
   Shareholders...........................................................  46
  Possible Future Legislation.............................................  47
  Back-up Witholding Requirements.........................................  47
</TABLE>
 
 
                                       3
<PAGE>
 
                         NEW GRANCARE, INC. PROSPECTUS
 
                         TABLE OF CONTENTS (CONTINUED)
 
<TABLE>
<CAPTION>
                                                                          PAGE
                                                                          ----
<S>                                                                       <C>
CAPITALIZATION...........................................................  48
DIVIDEND POLICY..........................................................  49
UNAUDITED PRO FORMA GRANCARE, INC. FINANCIAL STATEMENTS..................  49
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA..........................  55
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
 OF OPERATIONS...........................................................  57
  General................................................................  57
  Results of Operations..................................................  58
  Liquidity and Capital Resources........................................  62
  Impact of Inflation....................................................  66
PROPERTIES...............................................................  67
  Long-Term Health Care Facilities.......................................  67
  Contract Management....................................................  72
  Home Health............................................................  72
MANAGEMENT...............................................................  73
  Executive Officers and Directors.......................................  73
  Committees of the Board of Directors...................................  78
  Compensation of Directors..............................................  79
  Compensation of Executive Officers.....................................  80
  Stock Options..........................................................  86
  Long-Term Incentive Plans--Awards Since December 31, 1995..............  88
  Company Annual Incentive Plan..........................................  88
  Certain Relationships and Related Party Transactions...................  88
COMMON STOCK OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.......  91
DESCRIPTION OF NEW GRANCARE CAPITAL STOCK................................  94
  New GranCare Common Stock..............................................  94
  Preferred Stock........................................................  94
  The Charters and Bylaws of the Company and New GranCare................  94
  Significant Differences Between the Corporation Laws of California and
   Delaware..............................................................  95
  Application of the General Corporation Law of California to Delaware
   Corporations.......................................................... 101
SHARES ELIGIBLE FOR FUTURE SALES......................................... 102
AVAILABLE INFORMATION.................................................... 102
LEGAL MATTERS............................................................ 103
EXPERTS.................................................................. 103
INDEX TO FINANCIAL STATEMENTS............................................ F-1
</TABLE>
 
                                       4
<PAGE>
 
                               PROSPECTUS SUMMARY
 
  This Prospectus is furnished to shareholders of the Company together with the
Proxy Statement/Prospectus. The following summary is qualified in its entirety
by the more detailed information and financial statements, including the notes
thereto, appearing elsewhere in this Prospectus and the Proxy
Statement/Prospectus. Except where otherwise indicated, the description of New
GranCare and its businesses contained herein assumes the completion of the
Distribution and the Merger.
 
                                  NEW GRANCARE
 
  New GranCare is currently a wholly-owned subsidiary of the Company
incorporated under the laws of the State of Delaware. In order to effect the
Distribution, all of the assets and businesses of the Company, other than those
used primarily in the conduct of its Institutional Pharmacy Business, will be
contributed to New GranCare prior to the Distribution. The mailing address of
the Company's principal executive offices is One Ravinia Drive, Suite 1500,
Atlanta, Georgia 30346, and the telephone number at such address is (770) 393-
0199. Following the Distribution, New GranCare's principal executive offices
and phone number will be the same as indicated above. In addition, immediately
following the Distribution and the Merger, New GranCare will change its name to
"GranCare, Inc.".
 
                                THE TRANSACTIONS
 
  The Company has entered into the Merger Agreement whereby, upon the terms and
subject to the conditions set forth therein, the Company will be merged with
and into Vitalink, with Vitalink as the surviving corporation. As a condition
to and in order to facilitate the Merger, the Company has agreed to effect the
Distribution, pursuant to which all of the outstanding shares of New GranCare
Common Stock will be distributed to the Company's shareholders on the basis of
one share of New GranCare Common Stock for each share of Company Common Stock
held by a shareholder as of the Distribution Record Date. The Distribution is
intended to be tax-free to the Company's shareholders for federal income tax
purposes. See "Certain Federal Income Tax Consequences."
 
  Pursuant to the Merger Agreement, at the effective time of the Merger (the
"Effective Time") each issued and outstanding share of Company Common Stock
(other than shares of Company Common Stock that are owned by the Company as
treasury stock and any shares of Company Common Stock that are owned by
Vitalink or any wholly-owned subsidiary of Vitalink, which will be cancelled)
shall be converted into the right to receive 0.478 (the "Exchange Ratio") of a
share of common stock, par value $0.01 per share, of Vitalink (the "Vitalink
Common Stock") as described under "Description of the Transactions--Merger
Terms" in the Proxy Statement/Prospectus. In addition, as a consequence of the
Merger, Vitalink's consolidated indebtedness will increase by approximately
$108.0 million (prior to an offsetting compensatory payment by the Company) due
to the assumption or funding of the discharge of the obligations of the Company
in respect of the $100.0 million principal amount of 9 3/8% Senior Subordinated
Notes due 2005 (the "9 3/8% Notes") issued by the Company. In order to obtain a
third party consent of Health and Retirement Properties Trust ("HRPT"), a
creditor and landlord the Company, required in connection with the Distribution
and Merger, Vitalink will pay a consent fee of $10.0 million, which will be
promptly reimbursed by New GranCare following the consummation of the
Distribution and Merger. Vitalink will also enter into a limited guaranty of
certain obligations of New GranCare to HRPT. To support Vitalink's limited
guaranty of New GranCare's obligations, New GranCare will provide an
irrevocable letter of credit in the amount of $15.0 million payable to Vitalink
in the event Vitalink makes any payments under the limited guaranty. See "The
Distribution--Treatment of Certain Indebtedness."
 
  As a consequence of the Distribution and in accordance with the terms of the
Agreement Respecting Employee Benefit Matters by and between the Company and
New GranCare (the "Employee Benefits
 
                                       5
<PAGE>
 
Agreement"), each holder of an option to purchase shares of Company Common
Stock (the "Company Options") will receive an option (the "New GranCare
Options") to purchase a number of shares of New GranCare Common Stock as is
equal to the number of shares of Company Common Stock subject to
Company Options held by such holder as of the Distribution Record Date. The
exercise price of all Company Options will be allocated between the New
GranCare Options issued in respect of such Company Options and the existing
Company Options pursuant to a formula. As a result of the application of such
formula, subsequent to the Distribution approximately 61.568% of the exercise
price of each Company Option will be allocated to, and shall become, the
exercise price of each existing Company Option (the "Adjusted Company Options")
and 38.432% of the exercise price of each Company Option will be allocated to
each New GranCare option. The terms and conditions of the New GranCare Options
will be the same as the terms of the Company Options prior to the Distribution.
As a result of the Merger, Vitalink will assume all of the Adjusted Company
Options. Each Adjusted Company Option will be exercisable upon the same terms
and conditions as under the applicable Company plan and the applicable option
agreement issued thereunder, except that (i) each such option shall be
exercisable for that number of shares of Vitalink Common Stock as is equal to
the number of shares of Company Common Stock that would have been acquired upon
exercise of such option as of the Effective Time of the Merger multiplied by
the Exchange Ratio. As a result of the Merger, the exercise price of each
Adjusted Company Option will be further adjusted by dividing such exercise
price by the Exchange Ratio. See "The Distribution--Consummation of the
Distribution; Treatment of Company Stock Options."
 
  The terms of the Company Options provide that upon the occurrence of certain
events (a "Change of Control"), all unvested Company Options shall vest and
become fully and immediately exercisable. The Merger constitutes a Change of
Control for purposes of the Company Options. Furthermore, the consummation of
the Merger will not constitute a termination of employment and holders of
Adjusted Company Options will continue to be able to exercise such options
following the completion of the Merger even if such holder is not an employee
of Vitalink. As a result of the foregoing, approximately 2,355,250 shares of
New GranCare Common Stock will be issuable upon the exercise of New GranCare
Options and 1,125,809 shares of Vitalink Common Stock will be issuable upon the
exercise of Adjusted Company Options following the completion of the
Distribution and the Merger.
 
  Pursuant to the Distribution Agreement, prior to the Distribution the Company
will transfer or cause to be transferred to New GranCare all of the Company's
assets and liabilities relating to the Skilled Nursing Business other than (i)
the capital stock of the Pharmacy Subsidiaries (as defined in the Distribution
Agreement), (ii) the assets and liabilities used or arising primarily in
connection with the conduct of the Institutional Pharmacy Business and (iii)
the payment obligations in respect of the Company's 9 3/8% Notes. In addition,
pursuant to the Distribution Agreement, the Company and its subsidiaries other
than the Pharmacy Subsidiaries, on the one hand, and the Pharmacy Subsidiaries,
on the other hand, will net out all intercompany accounts and the expected net
balance due from the Pharmacy Subsidiaries to the Company and the Company's
subsidiaries will be contributed by the Company or the appropriate subsidiary
of the Company to which such amount (or portion thereof) is owing, to the
appropriate Pharmacy Subsidiary as additional capital.
 
  In accordance with the terms of the Distribution Agreement and the Tax
Allocation and Indemnification Agreement (the "Tax Allocation Agreement") by
and among the Company, New GranCare and certain subsidiaries of the Company,
the Company and New GranCare have agreed to indemnify one another after the
Distribution Date (as defined in the Distribution Agreement) with respect to
certain losses, damages, claims and liabilities arising from their respective
businesses or as a consequence of the occurrence of certain events following
the Distribution Date that result in the proposed transactions not being
accorded tax-free treatment. See "The Distribution--Terms of the Tax Allocation
Agreement."
 
  The foregoing is a brief summary of certain terms of the Distribution and the
Merger. A more complete description of the Merger and the Merger Agreement may
be found in the Proxy Statement/Prospectus under "The Merger Agreement." The
Distribution and the Distribution Agreement are more fully described herein
under "The Distribution." The Merger Agreement and the Distribution Agreement
are attached as Annexes B and C to the Proxy Statement/Prospectus,
respectively. Copies of the Tax Allocation Agreement and the Employee Benefits
Agreement have been filed as exhibits to the Registration Statement of which
this Prospectus is a part.
 
                                       6
<PAGE>
 
 
                                THE DISTRIBUTION
 
<TABLE>
<S>                                 <C>
Distributing Corporation..........  The Company.
Distributed Corporation...........  New GranCare, which, by the Distribution
                                    Date, will hold all of the assets of, and
                                    will have assumed all of the liabilities
                                    associated with, the Skilled Nursing
                                    Business.
Distribution Ratio................  One share of New GranCare Common Stock for
                                    each share of Company Common Stock owned as
                                    of the Distribution Record Date. See "The
                                    Distribution--Manner of Effecting the
                                    Distribution;" and "--Terms of the
                                    Distribution Agreement."
Federal Income Tax Consequences...  It is the opinion of Powell, Goldstein,
                                    Frazer & Murphy LLP (the "Tax Opinion"),
                                    that the Distribution will qualify as a
                                    tax-free reorganization pursuant to Section
                                    355 of the Internal Revenue Code of 1986,
                                    as amended (the "Code"), the Merger will
                                    qualify as a tax-free reorganization within
                                    the meaning of Section 368(a) of the Code
                                    and that no gain or loss will be recognized
                                    by shareholders of the Company in
                                    connection with their receipt of New
                                    GranCare Common Stock and Vitalink Common
                                    Stock in the Distribution and the Merger,
                                    respectively, except with respect to cash
                                    received in lieu of fractional shares of
                                    Vitalink Common Stock. See "Certain Federal
                                    Income Tax Consequences."
Trading Market and Symbol.........  There is currently no public market for New
                                    GranCare Common Stock. New GranCare intends
                                    to apply for the listing of New GranCare
                                    Common Stock on the NYSE under the Trading
                                    Symbol "GC".
Indemnification Obligations After
 the Distribution and Merger......  The Company and New GranCare (and Vitalink
                                    as the successor to the Company following
                                    the Merger) have agreed to indemnify each
                                    other after the Distribution with respect
                                    to certain losses, damages, claims and
                                    liabilities arising primarily from their
                                    respective businesses, including certain
                                    tax liabilities. See "Risk Factors--
                                    Relationship with Vitalink" and "The
                                    Distribution--Terms of the Distribution
                                    Agreement" and "--Terms of the Tax
                                    Allocation Agreement."
Relationship With Vitalink After
 the Distribution and the Merger..  As of the Effective Time of the Merger, New
                                    GranCare, Vitalink and Manor Care, Inc., a
                                    Delaware corporation ("Manor Care") and the
                                    beneficial owner of approximately 82.3% of
                                    the issued and outstanding shares of
                                    Vitalink Common Stock prior to the
</TABLE>
 
                                       7
<PAGE>
 
<TABLE>
<S>                                 <C>
                                    Effective Time of the Merger, will enter
                                    into a Non-competition Agreement (the "Non-
                                    competition Agreement") pursuant to which
                                    New GranCare and Manor Care will agree not
                                    to engage in the institutional pharmacy
                                    business for a period of three years and
                                    Vitalink will agree not to engage in the
                                    skilled nursing business for a similar
                                    period of time. See "The Distribution--
                                    Terms of the Non-competition Agreement."
                                    Following the Merger, Manor Care will own
                                    approximately 45% of the issued and
                                    outstanding Vitalink Common Stock. In
                                    addition, as a consequence of the Merger,
                                    Vitalink will succeed to the various
                                    pharmaceutical supply agreements between
                                    TeamCare and substantially all of New
                                    GranCare's skilled nursing and other
                                    facilities. New GranCare has agreed that
                                    for so long as Vitalink's limited guaranty
                                    of certain obligations of New GranCare to
                                    HRPT is in effect, New GranCare will not
                                    terminate any such agreements. As a result,
                                    New GranCare anticipates that these
                                    pharmaceutical supply agreements may extend
                                    through December 31, 2010, depending on
                                    certain circumstances. See "The
                                    Distribution--Terms of the Pharmaceutical
                                    Supply Agreements" and "--Treatment of
                                    Certain Indebtedness--HRPT Obligations."

Distribution Record Date..........  It is expected that the Distribution Record
                                    Date will be immediately prior to the
                                    Effective Time of the Merger.

Distribution Agent, Transfer Agent  
 and Registrar....................  American Stock Transfer & Trust Company.

Risk Factors......................  Shareholders should carefully evaluate
                                    certain considerations in evaluating the
                                    securities offered hereby, including New
                                    GranCare's debt and lease obligations, the
                                    uncertainty associated with health care
                                    reform and government regulations, the risk
                                    associated with reimbursement by third
                                    party payers, New GranCare dependence on
                                    acquisitions for growth, competition in the
                                    skilled nursing business and the absence of
                                    a prior trading market in New GranCare
                                    Common Stock. See "Risk Factors."
</TABLE>
 
                                       8
<PAGE>
 
 
                        NEW GRANCARE STOCK OPTION PLANS
 
  New GranCare will have various employee benefit plans pursuant to which
shares or options to purchase shares of New GranCare Common Stock will be
issued or issuable to or for the benefit of employees, former employees and
directors. It is expected that a total of 2,355,250 shares will be reserved and
issued under the Replacement Stock Option Plan (the "Replacement Plan")
pursuant to which current holders of Company Options will be granted New
GranCare Options in connection with the Distribution. See "The Distribution --
Consummation of the Distribution; Treatment of Company Stock Options." In
addition, New GranCare has adopted, and the Company as its sole shareholder has
approved, the 1996 Stock Incentive Plan (the "New GranCare Plan") pursuant to
which New GranCare will be able to make stock incentive awards to its officers,
directors and key employees on a going forward basis. See "Management--
Compensation of Executive Officers--1996 Stock Incentive Plan." New GranCare
has reserved 1,500,000 shares of New GranCare Common Stock for issuance under
the New GranCare Plan. The New GranCare Plan will be submitted for the approval
of the stockholders of New GranCare in connection with the Proxy/Statement
Prospectus. Approximately 500,000 shares are expected to be used for options
granted to officers and key employees shortly after the date of the
Distribution. New GranCare has also reserved up to 200,000 shares to cover
stock options to be granted to non-employee directors under a separate plan
(the "Directors Plan"), of which approximately 90,000 shares are expected to be
used for options granted to non-employee directors shortly after the date of
the Distribution. See "Management--Compensation of Directors--Directors Plan."
 
                                       9
<PAGE>
 
                      SUMMARY CONSOLIDATED FINANCIAL DATA
         (DOLLARS IN THOUSANDS, EXCEPT RATIOS AND STATISTICAL AMOUNTS)
 
  The following summary historical consolidated financial data of the Company
has been derived from the historical financial statements and should be read in
conjunction with such financial statements and notes thereto, which are
included elsewhere herein. The Company data for the nine months ended September
30, 1995 and 1996 have been derived from the unaudited consolidated financial
statements which are also included elsewhere herein. The pro forma adjusted
data gives retroactive effect to the Merger and reflects the recapitalization/
reorganization of the Company, the contribution to TeamCare's capital of the
Company's receivable from TeamCare, and the redemption or assumption of certain
indebtedness. The pro forma adjusted financial operating information gives
effect to the Merger as if the transaction had occurred on January 1, 1995. The
pro forma adjusted balance sheet data gives retroactive effect to the Merger as
if it had occurred on September 30, 1996. The pro forma adjusted data should be
read in conjunction with the pro forma balance sheet, pro forma statements of
income, and notes thereto included elsewhere herein.
 
<TABLE>
<CAPTION>
                                                                      NINE MONTHS ENDED
                                   YEAR ENDED DECEMBER 31,              SEPTEMBER 30,
                         -------------------------------------------- -----------------
                         1991(4)  1992(5)  1993(5)  1994(5)  1995(5)  1995(5)  1996(5)
                         -------- -------- -------- -------- -------- -------- --------
<S>                      <C>      <C>      <C>      <C>      <C>      <C>      <C>
STATEMENT OF OPERATIONS
 DATA:
 Net revenues........... $290,958 $434,638 $611,689 $717,471 $816,462 $604,569 $745,653
 Depreciation and
  amortization..........    5,064    6,922   12,349   16,440   21,611   14,785   19,400
 Interest expense and
  financing charges.....    7,256    7,908   19,601   21,481   27,054   19,557   26,228
 Income from continuing
  operations:
  Before income taxes
   and extraordinary
   charge...............   12,297   25,507   26,178   37,814   35,329   23,571   38,971
  Before extraordinary
   charge(1)............    8,347   16,806   16,089   24,290   20,564   13,274   24,162
 Net income............. $ 11,275 $ 16,806 $ 14,804 $ 24,290 $ 20,564 $ 13,274 $ 24,162
                         ======== ======== ======== ======== ======== ======== ========
 Pro forma net
  income(1)............. $  9,994 $ 15,350 $ 14,019 $    N/A $    N/A $    N/A $    N/A
                         ======== ======== ======== ======== ======== ======== ========
</TABLE>
 
<TABLE>
<CAPTION>
                         PRO FORMA, AS ADJUSTED      PRO FORMA, AS ADJUSTED
                         YEAR ENDED DECEMBER 31, NINE MONTHS ENDED SEPTEMBER 30,
                               1995 (2)(3)                 1996 (2)(3)
                         ----------------------- -------------------------------
<S>                      <C>                     <C>
STATEMENT OF OPERATIONS
 DATA:
 Net revenues...........        $639,780                    $577,165
 Depreciation and
  amortization..........          16,906                      14,420
 Interest...............          19,275                      20,104
 Income from continuing
  operations before
  income taxes..........          25,203                      23,980
 Net income.............          14,525                      15,167
 Earnings per share.....            0.61                        0.63
</TABLE>
 
<TABLE>
<CAPTION>
                                                          PRO FORMA, AS ADJUSTED
                                                          SEPTEMBER 30, 1996 (2)
                                                          ----------------------
<S>                                                       <C>
BALANCE SHEET DATA:
 Cash and cash equivalents...............................        $ 34,882
 Working capital.........................................         135,446
 Total assets............................................         584,988
 Long-term debt, including current portion...............         298,148
 Shareholders' equity....................................         137,945
</TABLE>
 
                                            (Footnotes appear on following page)
 
                                       10
<PAGE>
 
(Footnotes from the previous page)
- --------
(1) Prior to June 30, 1993, the Evergreen predecessor entity consisted of two
    partnerships and, accordingly, Evergreen was not subject to federal or
    state income taxes. For informational purposes, the pro forma net income
    for the years 1991 through 1993 includes a pro forma provision for income
    taxes as if Evergreen had been a taxable corporation for these periods.
    Such pro forma calculations were based on the income tax laws and rates in
    effect during those periods, and FASB Statement No. 109.
(2) Adjusted to reflect the redemption or assumption of the Company's
    Convertible Debentures (defined hereafter) and 9 3/8% Notes as if such
    amounts were redeemed or assumed as of January 1, 1995 for income statement
    data and as of September 30, 1996 for balance sheet data.
(3) Does not reflect Merger related costs estimated at $30.0 million which are
    expected to be recognized by the Company in the results of operations for
    the fourth quarter of 1996.
(4) The ARA Living Centers--Pacific, Inc. ("ARA") acquisition occurred on
    September 27, 1991 and, therefore, (i) the operating results of the ARA
    facilities are included in the historical operating results of the Company
    for the fourth quarter of 1991 and (ii) the assets and liabilities of the
    ARA facilities, as adjusted for related financing transactions, are
    included in the balance sheet of the Company as of December 31, 1991.
(5) All acquisitions which occurred in 1992, 1993, 1994, 1995 and 1996 except
    for the CompuPharm, Inc. ("CompuPharm") acquisition and the merger with
    Evergreen (defined below), are reflected from the date of each acquisition
    in the historical operating results of the Company and the assets and
    liabilities relating to these acquisitions are included in the balance
    sheets of the Company since that time. All years presented includes
    CompuPharm and Evergreen which were combined with the Company in pooling-
    of-interests transactions.
 
                                       11
<PAGE>
 
                                 RISK FACTORS
 
  In addition to the other information contained in this Prospectus, the
following factors should be considered carefully in evaluating New GranCare
before making any decisions with respect to the New GranCare Common Stock to
be received in the Distribution.
 
SIGNIFICANT DEBT AND LEASE OBLIGATIONS
 
  New GranCare will have substantial indebtedness in relation to its
stockholder's equity. It is expected that immediately following the
Distribution and the Merger, New GranCare will have total consolidated long-
term indebtedness of approximately $300.3 million (net of current maturities),
accounting for 69.3% of its total capitalization. New GranCare will also have
significant lease obligations with respect to the facilities operated pursuant
to long-term non capitalized or operating leases. During the 12 months
following the Distribution and the Merger, New GranCare's rent and property
expenses are expected to be approximately $43.0 million and $9.8 million,
respectively. New GranCare's leverage, rent and property expenses could have
important consequences to holders of the New GranCare Common Stock, including
the following: (i) New GranCare's ability to obtain financing in the future
for working capital, capital expenditures, acquisitions or general corporate
purposes may be impaired; (ii) a substantial portion of New GranCare's cash
flow from operations may be dedicated to the payment of principal and interest
on its indebtedness and rent and property expenses, thereby reducing the funds
available to New GranCare for its operations; (iii) certain of New GranCare's
borrowings are expected to bear variable rates of interest, which may expose
New GranCare to increases in interest rates; and (iv) certain of New
GranCare's indebtedness is expected to contain financial and other restrictive
covenants, including those restricting the incurrence of additional
indebtedness, the creation of liens, the payment of dividends and sales of
assets and imposing minimum net worth requirements. Although the Company's
cash flows from its operations have been sufficient to meet its debt service
obligations and rent and property expenses in the past, and although the Pro
Forma Financial Information indicates that New GranCare's cash flows from
operations should be sufficient to meet such obligations going forward, there
can be no assurance that New GranCare's operating results will be sufficient
to make payments with respect to New GranCare's indebtedness and other
expenses in the future. See "Unaudited Pro Forma GranCare, Inc. Financial
Statements" and "The Distribution--Treatment of Certain Indebtedness."
 
UNCERTAINTY ASSOCIATED WITH HEALTH CARE REFORM.
 
  In addition to extensive government health care regulation, there are
numerous initiatives on the federal and state levels for comprehensive reforms
affecting the payment for and availability of health care services. It is not
clear at this time what proposals, if any, will be adopted or, if adopted,
what effect such proposals may have on New GranCare's future business. Aspects
of certain of these health care proposals such as cutbacks in Medicare and
Medicaid programs, containment of health care costs on an interim basis by
means that could include a short-term freeze on rates paid to health care
providers, and permitting greater flexibility to the states in the
administration of Medicaid could adversely affect New GranCare. See "--
Reimbursement by Third-Party Payors." There can be no assurance that currently
proposed or future health care legislation or other changes in the
administration or interpretation of governmental health care programs will not
have an adverse effect on New GranCare. Concern about the potential effects of
the proposed reform measures has contributed to the volatility of prices of
securities of companies in health care and related industries, including the
Company, and may similarly affect the price of the New GranCare Common Stock
in the future. See "Business--Regulation."
 
RISK INVOLVED WITH REIMBURSEMENT BY THIRD PARTY PAYORS.
 
  For the year ended December 31, 1995, the Company derived approximately
44.7% and 30.2%, of its net patient revenues from Medicare and Medicaid,
respectively, and New GranCare expects to derive a significant portion of its
revenue from such federal and state reimbursement programs. There can be no
assurance that New GranCare will achieve or improve this payor revenue mix.
Both governmental and private payor sources have instituted cost containment
measures designed to limit payments made to long-term care providers, and
there can be no assurance that future measures will not adversely affect both
the timing and amount of reimbursement to
 
                                      12
<PAGE>
 
New GranCare. Furthermore, government reimbursement programs are subject to
statutory and regulatory changes, retroactive rate adjustments, administrative
rulings and government funding restrictions, all of which could materially
decrease the rates paid to New GranCare for its future services or the
services for which New GranCare is able to seek reimbursement. There have
been, and New GranCare expects that under the current and future presidential
administrations there will continue to be, a number of proposals to limit
Medicare and Medicaid reimbursement for long-term health care services. New
GranCare cannot predict at this time whether any of these proposals will be
adopted or, if adopted and implemented, what effect such proposals would have
on New GranCare. There can be no assurance that payments under state or
federal governmental programs will remain at levels comparable to present
levels or will be sufficient to cover the costs allocable to patients eligible
for reimbursement pursuant to such programs, particularly with respect to
individual, state-administered Medicaid programs, which generally provide
lower reimbursement rates than does the Medicare program. In addition, there
can be no assurance that the facilities to be operated by New GranCare and the
services and supplies to be provided by New GranCare will meet or continue to
meet the requirements for participation in such programs.
 
  Federal law requires state Medicaid programs to reimburse nursing facilities
for the costs that are incurred by efficiently and economically operated
providers in order to meet quality and safety standards. Nursing facilities
may seek to enforce this requirement in the state or federal courts.
Nevertheless, there can be no assurance that budget constraints or other
factors will not cause states to reduce Medicaid reimbursement to nursing
facilities or that litigation to prevent such reductions will be successful.
As a result, there can be no assurance that states in which New GranCare will
operate will continue to meet their Medicaid obligations on a timely basis.
Any failure by such states to meet their Medicaid obligations on a timely
basis could have a material adverse effect on New GranCare.
 
  In addition, several states are considering various health care reforms,
including reforms through Medicaid managed care demonstration projects.
Several states in which the Company operates and in which New GranCare will
operate have applied for, or received, approval from the U.S. Department of
Health and Human Services for waivers from certain Medicaid requirements which
are generally required for managed care projects. Although these demonstration
projects generally exempt institutional care, including long-term care
facilities, no assurance can be given that these waiver projects ultimately
will not change the reimbursement system for long-term care from fee-for-
service to managed care negotiated or capitated rates. It is not possible to
predict which reforms of the health care system will be adopted and the
effect, if any, the reforms will have on New GranCare's business.
 
RISKS RELATED TO GROWTH STRATEGY.
 
  New GranCare's growth strategy is to acquire long-term health care
facilities and related businesses in its existing markets and in other
targeted geographic areas in which regulatory and reimbursement policies are
favorable and where opportunities exist to improve operational efficiencies.
Due to possible rapid growth through acquisitions, New GranCare may be subject
to the uncertainties and risks associated with any expanding business such as
the continuing need of capital to fund acquisitions, the need to successfully
integrate the operations of acquired businesses in order to realize economies
of scale, the need to obtain synergies from the disparate operations and the
need to hire and incentivize competent, growth-oriented management. New
GranCare's expected growth may place significant demands on New GranCare's
financial resources and management. Most facilities to be operated by New
GranCare were acquired in groups, some of which have not met their expected
strategic or performance objectives.
 
GOVERNMENT REGULATION.
 
  The federal government and all states in which New GranCare will operate
regulate various aspects of the Skilled Nursing Business to be operated by New
GranCare. In particular, the operation of long-term care facilities and the
provision of specialty medical services are subject to federal, state and
local laws relating to the adequacy of medical care, equipment, personnel,
operating policies, fire prevention, rate-setting and compliance with building
codes and environmental and other laws. The facilities to be operated by New
GranCare are subject to periodic inspection by governmental and other
regulatory authorities to assure continued compliance with various standards
and to provide for their continued licensing under state law and certification
under the
 
                                      13
<PAGE>
 
Medicare and Medicaid programs. In the past, from time to time such facilities
have received statements of deficiencies from regulatory agencies. Should New
GranCare receive such statements of deficiency in the future, New GranCare
expects to implement plans of correction with respect to any such statement to
address any alleged deficiencies. While New GranCare will endeavor to comply
with federal, state and local regulatory requirements for the maintenance and
operation of its facilities, there can be no assurance that all facilities
will always be operated in full compliance. The failure to obtain or renew any
required regulatory approvals or licenses could adversely affect New
GranCare's operations.
 
  New GranCare will also be subject to federal and state laws that govern
financial and other arrangements between health care providers. These laws
often prohibit certain direct and indirect payments or fee-splitting
arrangements between health care providers that are designed to induce or
encourage the referral of patients to, or the recommendation of, a particular
provider for medical products and services. Such laws include the anti-
kickback provisions of the federal Medicare and Medicaid Patients and Program
Protection Act of 1987. These provisions prohibit, among other things, the
offer, payment, solicitation or receipt of any form of remuneration in return
for the referral of Medicare and Medicaid patients. In addition, many states
prohibit business corporations from providing, or holding themselves out as a
provider of, medical care. These laws vary from state to state and have seldom
been interpreted by the courts or regulatory agencies. Additionally, federal
enactments that expand the list of health care services subject to existing
federal referral prohibitions became effective on January 1, 1995. See
"Business--Regulation."
 
GEOGRAPHIC PAYOR CONCENTRATION.
 
  A significant portion of New GranCare's total operating revenues are
expected to be derived from operations in California, Michigan and Wisconsin
and, in particular, from the California, Michigan and Wisconsin Medicaid
programs. Additionally, a significant portion of New GranCare's total revenues
will be attributable to New GranCare's operations in Indiana and Illinois. The
table below presents historical total operating revenues derived from the
Company's business in California, Illinois, Indiana, Michigan and Wisconsin as
a percentage of net patient revenues for the nine-month period ended September
30, 1996.
 
<TABLE>
<CAPTION>
                                                              PRIVATE PAY
                                            MEDICAID MEDICARE  AND OTHER  TOTAL
                                            -------- -------- ----------- -----
      <S>                                   <C>      <C>      <C>         <C>
      California...........................   6.9%     12.1%      5.6%    24.6%
      Illinois.............................   2.8%      1.5%      1.7%     6.0%
      Indiana..............................   4.6%      3.3%      1.8%     9.7%
      Michigan.............................   3.8%      6.9%      2.3%    13.0%
      Wisconsin............................   5.9%      4.1%      2.5%    12.5%
</TABLE>
 
  Although New GranCare expects that geographic concentration will provide
operational advantages and efficiencies, the business prospects of New
GranCare will be significantly affected by general economic factors affecting
the California, Illinois, Indiana, Michigan and Wisconsin health care
industries and by the laws and regulatory environment in these states,
including Medicaid reimbursement rates. Medicaid reimbursement programs are
administered at the state level but subject to requirements imposed by the
federal government. Medicare is a federal program and reimbursement by private
pay and other payors is subject to market and/or negotiated rates.
 
COMPETITION.
 
  The long-term care industry is highly competitive. New GranCare will compete
with other providers on the basis of the breadth and quality of its services,
the quality of its facilities and, to a limited extent, price. New GranCare
will also compete with other providers in the acquisition and development of
additional facilities. New GranCare's long-term care competitors will include
national, regional and local operators of long-term care facilities, acute
care hospitals and rehabilitation hospitals, extended care centers, retirement
centers and community home health agencies, and similar institutions, many of
which have significantly greater financial and other resources than New
GranCare. In addition, New GranCare will compete with a number of tax-exempt
nonprofit organizations which can finance acquisitions and capital
expenditures on a tax-exempt basis or receive
 
                                      14
<PAGE>
 
charitable contributions unavailable to New GranCare. There can be no
assurance that New GranCare will not encounter increased competition which
could adversely affect its business, results of operations or financial
condition.
 
ABSENCE OF PRIOR TRADING MARKET.
 
  There is no existing trading market for the New GranCare Common Stock to be
received by the Company's shareholders in the Distribution and there can be no
assurance as to the establishment of an active trading market. New GranCare
expects to list its common stock on the NYSE. New GranCare's management
expects that approximately 23,401,992 shares of New GranCare Common Stock will
be outstanding after the Distribution. New GranCare Common Stock may
experience volatility following the Distribution until trading values become
established. As a result, it could be difficult to make purchases or sales of
New GranCare Common Stock in the market at any particular time. There can be
no assurance either as to the price at which New GranCare Common Stock will
trade following the consummation of the Distribution and the Merger or whether
such price will be significantly below the book value per share of New
GranCare Common Stock.
 
CERTAIN INDEMNIFICATION OBLIGATIONS.
 
  Pursuant to the Distribution Agreement and Tax Allocation Agreement, New
GranCare has agreed to indemnify Vitalink with respect to certain losses,
damages, claims and liabilities which may arise from the consummation of the
transactions described herein, the conduct of the Skilled Nursing Business
prior to the Distribution Date and certain tax liabilities. Pursuant to the
Tax Allocation Agreement, New GranCare has agreed, upon the occurrence of
certain circumstances (all of which are under New GranCare's control), to
indemnify Vitalink from any losses in the event the proposed transactions are
not accorded tax-free treatment. See "The Distribution--Terms of the Tax
Allocation Agreement."
 
CERTAIN LEASE TERMS.
 
  Eighteen of the facilities which New GranCare expects to operate in Indiana
and West Virginia are currently leased from an outside group of affiliated
entities. These leases are scheduled to expire in 1999, but negotiations are
currently under way with the lessors to extend the lease term for all 18
facilities. Unless concluded prior to the Distribution, New GranCare intends
to continue these negotiations. The leases for 14 of these facilities grant
the lessors the right, upon termination thereof, to purchase certain operating
assets which will be owned by New GranCare, at a price equal to the book value
of such assets. New GranCare does not anticipate that the lessors will
exercise this purchase right because Medicaid reimbursement available to those
facilities would be markedly reduced in the event of any such purchase.
Although New GranCare believes that the current leases will be extended or new
leases for such properties will be negotiated, in either case, upon acceptable
terms, there can be no assurance that either the Company or New GranCare will
be able to do so or that the lessors will not exercise their purchase rights.
 
RELATIONSHIP WITH VITALINK.
 
  Following the Distribution and Merger, New GranCare will be prohibited from
competing with Vitalink in the institutional pharmacy business for a period of
three years. See "The Distribution--Terms of the Non-competition Agreement."
In the past, a significant portion of the Company's net income has been
derived from the Institutional Pharmacy Business. In 1995, the Company derived
approximately 51% of its net income from the Institutional Pharmacy Business.
The Non-competition Agreement will therefore restrict New GranCare's ability
to pursue a line of business that has historically contributed a significant
portion of the Company's net income.
 
  Upon completion of the Merger, Vitalink will succeed to all of the Company's
existing pharmaceutical supply agreements with substantially all of the
Company's facilities, which facilities will be operated by New GranCare after
the Merger. These agreements are for five year terms. However, New GranCare
has agreed that for so long as Vitalink's limited guaranty of certain
obligations of New GranCare to HRPT is in effect, New
 
                                      15
<PAGE>
 
GranCare will not terminate any of such pharmaceutical supply agreements.
Accordingly, it is anticipated that such pharmaceutical supply agreements may
extend through December 31, 2010, the date when all present New GranCare
obligations to HRPT will be satisfied, subject to certain conditions. Gene E.
Burleson, Chairman of New GranCare, will become Chief Executive Officer of
Vitalink upon consummation of the Merger. Mr. Burleson and three other
directors of New GranCare will become directors of Vitalink upon the
consummation of the Merger. See "The Distribution--Terms of the Pharmaceutical
Supply Agreements" and "Management--Certain Relationships and Related Party
Transactions."
 
                                      16
<PAGE>
 
                                   BUSINESS
 
GENERAL
 
  The Company is, and New GranCare expects to be, a leading provider of
comprehensive post-acute health care services, primarily skilled nursing care,
subacute and medically complex care, long-term acute hospital care,
inpatient/outpatient therapy, hospital contract management, assisted living,
hospice, home health care and adult day care. At present, New GranCare expects
to provide these services through 140 long-term care facilities (136 skilled
nursing facilities and four assisted living facilities), and twelve agencies
currently operated by the Company's home health division (home health, hospice
and private duty, each in the States of California, Indiana, Michigan and
Wisconsin). The Company continues to evaluate certain long-term care
facilities which are underperforming or do not fit within the Company's or New
GranCare's long-term strategic plans. All or a portion of these facilities may
be divested in the future. In addition, New GranCare will, through the
contract management business to be assumed by it, manage approximately 145
medical programs in acute care hospitals. In selected markets, the Company has
sought and New GranCare will continue to seek to operate these businesses as
an interrelated network of services to provide a continuum of cost-effective,
post-acute care. New GranCare's vision is to become the preeminent health care
provider in select markets by offering a full continuum of care to address the
needs of patients from the time of their discharge from acute care hospitals
until their recovery.
 
  New GranCare's anticipated focus on the post-acute level of health care,
like the approach historically taken by the Company, will respond to general
demographic trends and health care cost containment initiatives of third-party
payors. As the number of people over the age of 65 continues to grow
significantly faster than the overall population, and advances in medicine and
technology continue to increase life expectancies, New GranCare anticipates
that the need for long-term care facilities and related services will continue
to increase. Additionally, the growing emphasis on cost containment measures
in the health care industry has caused third-party payors to seek lower cost
alternatives to hospital-based care. The subacute care and other post-acute
services to be provided by New GranCare respond to cost containment
initiatives of third-party payors by providing a lower cost alternative for
patients who continue to require a high level of medical and nursing care, but
whose medical condition permits discharge from the traditional acute care
hospital setting. Based on the Company's experience, New GranCare believes the
long-term care facilities that it plans to operate will have lower capital and
operating costs than acute care hospitals. New GranCare believes that it will
be able to offer complex subacute medical services to these patients generally
at a lower cost than acute care hospitals.
 
  New GranCare's strategy will be to: (i) develop "cluster markets," comprised
of a significant concentration of skilled nursing and subacute beds and/or the
provision of diverse subacute services in selected markets, (ii) provide a
continuum of post-acute care comprised of medical and rehabilitative
treatments in a variety of alternative sites, (iii) establish collaborative
relationships with acute care hospitals and physicians in order to increase
referrals and provide a basis for the provision of higher margin services,
(iv) continue to shift to a higher acuity and higher quality mix patient
population, (v) grow through new construction of assisted living and skilled
nursing facilities in select clusters, and (vi) continue to grow through
selective acquisitions and (vii) expand specialty medical services, including
rehabilitation, respiratory, psychiatric, home health, hospice and adult day
care. Of particular importance to New GranCare's future growth will be (i) New
GranCare's ability to improve margins at existing facilities through portfolio
management, accelerated reserve enhancement through aggressive expansion of
the range of specialty medical services and programs offered by New GranCare
and the rollout of new systems and best operating practices, (ii) selective
acquisitions in targeted cluster markets and (iii) the de novo construction of
assisted living and skilled nursing facilities and acute care programs in
targeted cluster markets.
 
LONG-TERM CARE INDUSTRY
 
  The demand for long-term health care is increasing because acute care
hospitals are driven by third-party payor cost containment initiatives to
discharge patients at earlier stages of recovery and because an increasing
number of patients have ailments that require extended recovery periods. This
is due not only to general demographic trends in the United States but also to
advances in medical technology. New technologies are
 
                                      17
<PAGE>
 
increasing the life expectancy of a growing number of patients who require a
high degree of care traditionally not available outside of acute care
hospitals. As life expectancies increase, the likelihood of contracting
diseases or ailments involving a protracted period of medical care and
recovery increases. As a result, individuals over the age of 65, particularly
those over 85, are the primary recipients of long-term post-acute care.
Although demand is increasing, industry data indicate that the total supply of
licensed skilled nursing beds available in the United States, currently
approximately 1.7 million, is growing substantially slower than the overall
population. Also, the addition of new beds in long-term care facilities is
presently restricted by regulation in many states, most of which require
entities that desire to enter the local long-term care market to apply for and
obtain Certificates of Need ("CON") or other approvals. The application and
approval process for a CON generally involves approval by a state regulatory
agency of the construction, acquisition or closure of a long-term care
facility, the addition or reduction of beds at a facility, or the addition of
services provided by a facility. The significant construction costs and start-
up expenses in some markets may further limit the number of new beds. Market
share data reflect that the industry is fragmented, with the 30 largest
operators accounting for approximately 25% of the total beds available.
 
  According to the U.S. Bureau of the Census, approximately 1.4% of the people
65-74 years of age received care in long-term care facilities in 1990; this
percentage increased to 6% for people 75-84 years of age and to 25% for those
85 years of age and over. In addition, according to the U.S. Bureau of the
Census, the number of individuals over age 75 was approximately 11 million
(4.62% of the total population in the U.S.), in 1993. Additional increases are
expected in this segment of the population by the year 2000. Although there is
limited growth projected for the population of individuals over 65 years of
age between 1990 and 2000, a significant increase in the proportion of people
over age 85 is anticipated. The segment of the population over 85 years of
age, which comprises the largest percentage of residents at long-term care
facilities (53%), is the fastest-growing segment of the population, projected
to increase by more than 26%, from approximately 3.4 million, or 1.3% of the
total population in the U.S., in 1993, to more than 4.3 million, or 1.6% of
the total population, in the year 2000. By 2050, it is anticipated that the
nursing home population of those 85 years of age and older will be triple its
1990 level.
 
  These demographic changes, coupled with increasing cost containment
initiatives by governmental and managed care payors have changed medical
practices, resulting in an increasing proportion of complex medical care being
delivered outside the acute care hospital setting. The health care industry
has responded by developing a range of post-acute care services, including
skilled nursing care and home health therapy to provide care following a
patient's hospital-based acute care treatment. The complex medical care and
intensive nursing care provided to patients with higher acuity disorders are
categorized as subacute care. This level of care is appropriately delivered in
a skilled nursing environment where New GranCare believes clinical outcomes
compare favorably to those achieved in acute care settings and where the cost
structure is significantly lower. New GranCare believes that subacute care
provided in a skilled nursing facility is often less expensive than hospital-
based care. Skilled nursing facilities are significantly less capital
intensive and do not require the specialized equipment used in acute care
hospitals. Labor costs are also lower than hospitals', which typically have a
higher physician to nursing staff ratio and significantly more administrative
personnel, including nursing staff not fully dedicated to providing care. As a
result of the ability of subacute care providers to achieve successful
outcomes at a significantly lower cost than acute care hospitals are generally
able to provide, hospital discharge planners, physicians and managed care and
insurance company case managers are referring an increasing number of patients
to long-term care facilities.
 
BUSINESS STRATEGY
 
  New GranCare's principal objective will be to continue developing a
continuum of post-acute health care services in order to address market
demands created by ongoing changes in the health care delivery system, changes
in patient demographics, and pressures to contain the cost of delivering care.
In order to take advantage of the growth of the post-acute health care market,
New GranCare's strategy is to:
 
  .  Develop Cluster Markets. The Company has sought and New GranCare will
     continue to seek to establish a significant presence in regional markets
     by establishing clusters of skilled nursing facilities
 
                                      18
<PAGE>
 
     and related specialty medical businesses that together form a continuum
     of care. Each cluster will be developed where relationships with key
     acute care hospitals and physicians provide a strong referral base and
     where other favorable market characteristics exist. New GranCare will
     evaluate the needs within each cluster and address these demands by
     developing specialized programs in facilities most capable of serving a
     particular market need. New GranCare believes, and the Company's
     experience indicates, that local expertise coupled with a critical mass
     of facilities will allow New GranCare to negotiate more effectively with
     large contract payors (including managed care organizations), achieve
     operating efficiencies, and gain access to critical referral sources.
     Once a cluster market is developed with one or more services, additional
     services can be introduced to further expand the continuum of care. New
     GranCare intends to expand the eight cluster markets developed by the
     Company located in Arizona, Colorado, Northern and Southern California,
     Illinois, Wisconsin, Michigan, and South Carolina. New GranCare will
     also operate concentrations of facilities in Indiana, Iowa and
     Mississippi that will form the base for the expansion of services in
     these areas.
 
  .  Provide a Continuum of Care. New GranCare's services will focus on the
     needs of patients with medically complex conditions who do not require
     acute care hospitalization. To serve these patients' needs fully, New
     GranCare will aim to offer a full continuum of care whereby New GranCare
     will provide medical and rehabilitative treatments in a variety of
     alternative sites. These settings include skilled nursing and assisted
     living facilities, subacute care and other specialty care units operated
     in conjunction with acute care hospitals and home health. As patients
     progress through stages of recovery, they may be served by different
     elements of the continuum. Medical services provided include physical,
     occupational, speech, respiratory and psychological therapies;
     pharmaceutical treatments; and laboratory and radiology services. The
     primary benefit of offering a full continuum of care is to provide
     patients and payor sources with the most appropriate level of care in
     the most cost-effective setting.
 
  .  Establish Collaborative Relationships. The Company has placed and New
     GranCare will continue to place strategic emphasis on establishing
     referral relationships with acute care hospitals and physicians. Based
     on the Company's experience, New GranCare expects that a substantial
     portion of its patients will be admitted upon discharge from acute care
     hospitals. As part of its effort to strengthen the relationships
     established with acute care hospitals by the Company, New GranCare
     expects to continue a variety of collaborative programs originally
     established by the Company. The most extensive of these programs are
     contract management relationships whereby New GranCare will operate a
     subacute medical unit in under-utilized space within an acute care
     hospital. In this manner, New GranCare expects to work with, rather than
     compete with, key referral sources. As such, New GranCare expects that
     this contract business will strengthen its relationship with a given
     hospital, while allowing the hospital or its physicians to place a
     patient in a lower cost environment and expanding New GranCare's revenue
     base. The acquisition of Cornerstone Health Management Company
     ("Cornerstone"), significantly increased the Company's presence in this
     area and is expected to benefit New GranCare through the acquisition of
     over 100 contracts to manage subacute, geriatric, psychiatric and
     primary care programs for acute care hospitals in 17 states. Cornerstone
     is a company that specializes in implementing and managing subacute and
     other specialized medical programs.
 
  .  Improve Payor Mix. By expanding its subacute and home health care
     services, New GranCare intends to shift its payor mix away from state-
     reimbursed Medicaid programs toward a higher quality mix consisting of
     Medicare, managed care and private-pay business. Generally, the
     profitability of caring for private-pay and Medicare patients is higher
     than that of Medicaid. Historically, the Company has been successful in
     increasing the quality of its payor mix (Medicare, private, and other
     pay) as a percent of total revenues from 48% in 1994 to 55% in 1995. New
     GranCare believes that opportunities still exist to continue to improve
     the quality of the Company's current payor mix.
 
  .  Grow through New Construction. In 1995 the Company expanded its capital
     improvements program to include the development of newly constructed
     facilities. With over $82.6 million in capital improvements since 1991,
     the Company gained significant experience in facility development. In
 
                                      19
<PAGE>
 
     September 1996 the Company opened SouthPointe HealthCare Center, its
     first newly constructed facility in Milwaukee, Wisconsin. Several other
     projects are under various stages of review. The Company and New
     GranCare believe that an aggressive program to build new skilled nursing
     and assisted living facilities as well as new programs such as long term
     acute care wings in its existing facilities in selective cluster markets
     will have a significant positive impact on New GranCare's operations.
     New skilled nursing and assisted living facilities generally experience
     a higher occupancy rate than older facilities and receive a greater
     percentage of revenue from private pay sources. Additionally, the
     Company and New GranCare believe that having a significant number of new
     skilled nursing and assisted living facilities has the intangible
     benefit of bettering the overall reputation of a company.
 
  .  Grow through Acquisitions. New GranCare intends to pursue a strategy of
     growth through selected acquisitions in order to accelerate the
     achievement of its objectives. During 1995, the Company completed two
     significant transactions--the acquisition of Cornerstone and the merger
     with Evergreen Healthcare, Inc. ("Evergreen"). New GranCare intends to
     continue pursuing acquisitions in order to further develop its continuum
     of care in existing markets and expand into new markets where
     demographics, economic conditions, and regulatory and reimbursement
     policies are considered favorable.
 
  .  Expand Specialty Medical Services. New GranCare intends to continue to
     increase the specialty medical services currently provided by the
     Company so as to further expand the continuum of care. The existing
     specialty medical services currently provided by the Company include
     providing home health care, laboratory, radiology, subacute care,
     pharmacy and other specialized services. The Company is, and New
     GranCare will continue, expanding subacute services by developing
     innovative programs with managed care providers, acute care hospitals
     and physician groups, which may include sharing the costs and benefits
     of providing subacute services. New GranCare believes that providing a
     higher level of care through the expansion of its specialty medical
     services should improve New GranCare's payor mix, expand its customer
     base and generate increased operating margins for its skilled nursing
     divisions. While the Merger will have the effect of lowering New
     GranCare's percentage of revenue derived from specialty medical services
     from the level achieved by the Company in the past, New GranCare
     believes that significant opportunities will exist to expand the
     percentage of its revenue derived from specialty medical services other
     than pharmacy. See "The Distribution--Terms of Non-competition
     Agreement."
 
 Skilled Nursing Services and Subacute Care
 
  As of January 1, 1997, the Company operates 140 long-term care facilities,
including 136 skilled nursing and four assisted living facilities, with 17,597
licensed beds in 15 states, all of which are currently operated by the
Company. The Company continues to evaluate certain long-term care facilities
which are underperforming or do not fit within the Company's or New GranCare's
long-term strategic plans. All or a portion of these facilities may be
divested in the future. All of the long-term care facilities to be operated by
New GranCare are certified as "skilled nursing facilities" by appropriate
regulatory agencies, other than the four assisted living facilities, which are
located in states that do not require such certification. The facilities to be
operated by New GranCare focus on the care of medically dependent patients
with multiple medical or behavioral problems requiring continuing special care
and treatment. Skilled nursing care is rendered in such facilities 24 hours a
day by registered, licensed practical or vocational nurses and nurses' aides
administering prescribed medical services. Patients in the facilities to be
operated by New GranCare also receive assistance in matters such as bathing,
dressing, medication and diet. All patients in such facilities receive routine
care which includes basic nursing care, room and board, housekeeping and
laundry services and dispensing of medication. These basic services are a
platform for the delivery of more intensive medical rehabilitative and
subacute care. New GranCare expects to provide physical, occupational, speech,
respiratory and psychological therapy services in each of its long-term care
facilities, a majority of which will be outsourced. The Company currently
provides the aforementioned services on a similar basis. The four assisted
living facilities to be operated by New GranCare provide furnished
 
                                      20
<PAGE>
 
rooms and suites designed for individuals who are either able to live
independently within a sheltered community or who require minimal nursing
attention. The ADL services (assistance with activities of daily life)
currently provided by the Company in the assisted living facilities include
protective oversight, food, shelter, bathing, dressing, eating,
transportation, toiletry and related services that enhance the quality of a
resident's life. New GranCare intends to continue providing these services.
 
  The Company has implemented and New GranCare will continue certain specialty
medical programs in all of its skilled nursing facilities certified to provide
care to Medicare patients (including more extensive subacute programs) in
order to provide additional services and accelerate growth and profitability.
New GranCare also expects to operate 34 specialized units with 710 beds
located in certain long-term care facilities, currently being operated by the
Company, which provide higher acuity, subacute and other care to medically
complex patients. These units presently include transitional rehabilitation
programs and specialized units for cancer, HIV and wound care patients, as
well as Alzheimer's care, subacute rehabilitation and hospice care. These
specialized units will compete with acute care and rehabilitation hospitals
which New GranCare believes typically charge rates that are often twice the
rates historically charged by the Company for comparable services. New
GranCare intends to expand its capabilities in this area through collaborative
efforts with acute care specialists. After giving effect to the Distribution
and Merger, it is anticipated that New GranCare's skilled nursing facilities,
on a pro forma basis, accounted for 86.7% of its net revenues for the 6 months
ended June 30, 1996.
 
 Contract Management
 
  Through the acquisition of Cornerstone by the Company in April 1995, New
GranCare will benefit from a contract management business that specializes in
the implementation and management of geriatric specialty programs for acute
care hospitals. The Company's contract management business which will be
assumed by New GranCare includes approximately 145 programs in acute care
hospitals located in 20 states (with an additional approximately 10 contracts
pending) as of January 1, 1997. Programs managed on behalf of acute care
hospitals include subacute skilled nursing, geriatric mental health, specialty
acute hospitals and geriatric primary care networks and other ancillary
programs. Cornerstone is generally responsible for managing the clinical and
operational aspects, including quality control, of the programs it
administers. Cornerstone receives a monthly management fee, typically based on
the number of beds it manages under a contract. Program design and
implementation is handled by a team of clinical, financial and reimbursement
experts employed by Cornerstone. Following implementation, Cornerstone
provides a program administrator who is supported by a centralized staff of
experts, who are employed by Cornerstone, with care being provided primarily
by employees of the hospital. The number of experts provided by Cornerstone
depends on the type of program being administered, with routine subacute
skilled nursing generally requiring only a Cornerstone program administrator
who oversees the hospitals' employees, and geriatric mental health generally
requiring a Cornerstone program administrator as well as up to seven
Cornerstone experts who administer care.
 
 Other Services
 
  The home health care operation to be assumed by New GranCare was established
by the Company in 1992 to provide skilled nursing services, rehabilitation
therapy and home health aides. This operation is comprised of home health care
agencies located in California, Indiana, Michigan and Wisconsin encompassing
twelve agencies (home health, hospice and private duty in each of the
aforementioned states). Services include intermittent visits, hourly care,
infusion therapy and a specialty program for terminally ill patients. New
GranCare believes that following the Distribution and Merger, it will be well
positioned to expand these existing home health services as well as adult day
care operations in current and additional markets. The Company acquired one
home health care agency and one hospice in Michigan and one home health agency
in Indiana during 1996 and New GranCare intends to evaluate opportunities in
other states where it will have operations.
 
  The Company is developing and New GranCare intends to continue developing a
variety of laboratory services at several facilities, including pathology and
gastrointestinal analysis. New GranCare will operate a wholly-owned subsidiary
that will provide such services in South Carolina. It will also have an equity
ownership
 
                                      21
<PAGE>
 
interest in an X-ray provider which serves certain of the facilities to be
operated by it in Michigan. Further, New GranCare will provide a variety of
therapy services to patients at its facilities and to outpatients at certain
of its facilities. These services (which are currently being provided by the
Company) include physical, occupational, speech, respiratory and psychological
therapies.
 
MARKETING AND DEVELOPMENT OF PAYOR SOURCES
 
  New GranCare's marketing strategy is to establish and maintain cooperative
relationships and networks with physicians, acute care hospitals and other
health care providers, with an emphasis on specialists who treat ailments
involving long-term care and rehabilitation. These referral networks will form
a strong basis for increasing occupancy levels at skilled nursing facilities
to be operated by New GranCare for improving the payor mix of such facilities.
New GranCare intends to continue the incentive program created by the Company
which motivates facility administrators to spend time in the community
developing relationships in order to increase awareness of facilities and
services to be offered by New GranCare. New GranCare will employ promotional
literature focusing on its philosophy of care, service capabilities, quality
of employees and family assistance programs to support local marketing
efforts.
 
  Most of the facilities to be operated by New GranCare are currently operated
as part of a marketing cluster by the Company. The marketing program of each
cluster will be tailored to the health care needs, referral sources and
demographic and economic characteristics of the local market in which the
cluster is located. Each facility administrator will be expected to contribute
to the development of a detailed strategic plan and specific operating goals
for each cluster. Local managers of Cornerstone and home health operations to
be operated by New GranCare also will be expected to participate in the
strategic planning and marketing process to coordinate New GranCare's efforts
across the continuum of post-acute care. Moreover, each of the regional
service centers will be expected to coordinate the activities of the clusters
within the region, as well as manage key relationships with managed care
providers and promote New GranCare's expertise in rehabilitation and subacute
services. New GranCare's therapy providers will also be expected to promote
the capabilities of its facilities within their local market area, in addition
to promoting their individual therapy services.
 
  New GranCare also plans to take advantage of other opportunities for
increased profitability, including joint ventures with health care providers
such as health maintenance organizations ("HMOs"). The Company is establishing
relationships with managed care providers which it believes will increase its
subacute care business, which are anticipated to benefit New GranCare. The
cluster market approach is expected to give New GranCare the enhanced ability
to serve large providers of managed care within its targeted markets.
Typically, patients referred by managed care providers (including HMOs and
preferred provider organizations) generate significantly higher revenues per
patient day. New GranCare's ability to provide subacute and specialty medical
services at a lower cost than acute care hospitals will be a competitive
advantage in becoming the provider of choice for these managed care providers.
Following the Distribution and Merger, New GranCare expects to derive an
increasing proportion of its business from managed care and similar sources.
 
COMPETITION
 
  New GranCare will be one of the largest publicly traded nursing home
companies in the country in terms of the number of beds owned, managed or
leased. The long-term care facilities to be operated by New GranCare compete
in fifteen states on a local and regional basis with other long-term health
care providers. Some competing operators have greater financial resources than
New GranCare will have following the Distribution and Merger and some are non-
profit or charitable organizations. The management of New GranCare, based on
its experience with the Company, expects that significant competitive factors
will include the quality and spectrum of care and services provided, the
reputation of the medical personnel employed, the physical appearance of the
facilities and, in the case of private-pay patients, the level of charges for
services. The management of New GranCare also believes that New GranCare's
facilities will compete on a local and regional basis, rather than on a
national basis. As a result, New GranCare will seek to meet competition in
each locality or region, as the case may be, by improving the quality and type
of services provided in and the appearance of
 
                                      22
<PAGE>
 
its facilities, by establishing a reputation within the local medical
communities for providing quality care, and by responding appropriately to
regional variations in demographics and preferences. Each facility to be
operated by New GranCare will have a Medical Director who will assess patient
needs, coordinate care plans, and, as a member of the local medical community
will be familiar with local health care concerns. Historically, regulations
such as building code requirements and CON requirements have often deterred
the construction of long-term care facilities. Recently, one state in which
the Company operates, Indiana, has eased its CON requirements to allow
construction based on a standard other than "need," which may result in
increased competition in the long-term care market. There is no price
competition with respect to Medicare and Medicaid patients since revenues for
services administered to such patients are based on strictly controlled fixed
rates and cost reimbursement principles.
 
  Cornerstone is one of the nation's premier contract providers of specialty
healthcare services for the elderly. This division, which will be operated by
New GranCare, will manage approximately 145 programs (with approximately 10
additional contracts pending) with acute care hospitals in 20 states.
Cornerstone develops, manages and operates specialty geriatric programs which
include subacute skilled care, mental health, senior health centers, rural
health clinics and ancillary services. In addition, Cornerstone operates four
long-term acute care hospitals through lease or management arrangements.
Cornerstone is generally recognized as the only "full service" geriatric
provider within the industry. Although the Company and New GranCare are not
aware of any companies that compete with Cornerstone on a national basis or
which offer the same array of services provided by Cornerstone, other contract
management companies may compete with Cornerstone in some markets along
discrete product lines.
 
  Home health currently has a market presence and operations in four states.
The competition among home health organizations is intense and is based on
quality and breadth of service and price. Competitors vary from large national
chains to regional and local agencies as well as hospital-based organizations.
New program development in infusion therapy with Vitalink and adult day care
will offer integrated services not currently being provided by New GranCare's
competitors in these states.
 
REGULATION
 
  Licensing. All of the long-term care facilities and home health agencies to
be operated by New GranCare are required to be licensed on an annual basis by
state health care agencies and are subject to extensive federal, state, and
local regulatory and inspection requirements. License and certification
standards vary from jurisdiction to jurisdiction and undergo periodic
revision. These requirements relate to, among other things, the quality of the
professional care provided, the qualification of administrative personnel and
professional or licensed staff, the adequacy of the facility and its
equipment, and continuing compliance with laws and regulations relating to the
operation of the facilities. The failure to obtain, renew or maintain any of
the required regulatory approvals or licenses could adversely affect expansion
of New GranCare's business and could prevent the location involved from
offering services to patients. The Company believes it is currently in
substantial compliance with licensing requirements; however, there can be no
assurance that New GranCare will be able to maintain such licenses for its
facilities or that New GranCare will not be required to expend significant
funds in order to meet such requirements.
 
  Medicare and Medicaid. New GranCare expects to derive a significant portion
of its revenues from federal and state reimbursement programs. Substantially
all of the skilled nursing facilities and home health agencies to be operated
by New GranCare are certified to receive benefits under Medicare and under
joint federal and state funded programs administered by the various states to
provide health care assistance to low income individuals, generally known as
"Medicaid." These programs are highly regulated and subject to periodic
change.
 
  Medicare utilizes a cost-based reimbursement system for nursing facilities
and home health agencies which, subject to limits fixed for the particular
geographic area, reimburse nursing facilities and home health agencies for
reasonable direct and indirect allowable costs incurred in providing "routine
services" (as defined by the program) as well as capital costs and ancillary
costs. The Company is filing Routine Cost Limit Exception
 
                                      23
<PAGE>
 
appeals for the facilities which exceed the limits and fit the criteria as
exception candidates. New GranCare may benefit from exceptions to the routine
cost limits. Allowed costs include nursing, administrative and general,
dietary, housekeeping, laundry, social services, activities, central supply,
maintenance and plant operations as well as ancillary and capital costs.
 
  For federal fiscal years 1994 and 1995, the Omnibus Budget Reconciliation
Act of 1993 ("OBRA '93") froze the routine cost limits for nursing facilities
and the per visit limits on reasonable costs imposed on home health agencies.
In addition, OBRA '93 imposed new restrictions on the amount of relief which
can be realized through the Routine Cost Limit Exception appeal process. For
fiscal 1996, the 1993 imposed freeze on routine cost limits was lifted. In
addition, the inflation indexes were adjusted which lowered the routine cost
limits for 1996 and prior years.
 
  Medicaid programs currently exist in all of the states in which the Company
has and New GranCare will have health care facilities. While these programs
differ in certain respects from state to state, they are all subject to
requirements imposed by the federal government, which provides approximately
50% of the funds available under these programs. California provides
reimbursement for skilled nursing services at a flat daily rate, as determined
by the responsible state agency. In all other states in which New GranCare
expects to operate, payments are based upon specific cost reimbursement
formulas established by that state, which formulas are generally based on
historical costs with adjustments for inflation.
 
  For the years ended December 31, 1994 and 1995 and the nine months ended
September 30, 1996 the Company derived approximately 24.7%, 30.2% and 38.6%,
respectively, of its net patient revenues from Medicare and approximately
51.6%, 44.7% and 38.6% of its net patient revenues from Medicaid, and New
GranCare expects to derive a significant portion of its revenue from such
federal and state reimbursement programs. Both governmental and private-payor
sources have instituted cost containment measures designed to limit payments
made to long-term health care providers, and there can be no assurance that
future measures will not adversely affect reimbursements to New GranCare.
Furthermore, government reimbursement programs are subject to statutory and
regulatory changes, retroactive rate adjustments, administrative rulings and
government funding restrictions, all of which could materially decrease the
service covered or the rates paid to New GranCare for its services. There has
been, and New GranCare expects that under the current and future presidential
administrations there will continue to be, a number of proposals to limit
Medicare and Medicaid reimbursement for long-term care services and other
services to be provided by New GranCare. Proposals to reduce the growth in
Medicare and Medicaid expenditures are under active consideration in the
current session of Congress. New GranCare cannot predict at this time whether
any of these proposals will be adopted or, if adopted and implemented, what
effect such proposals would have on New GranCare. There can be no assurance
that payments under state or federal governmental programs will remain at
levels comparable to present levels or will be sufficient to cover the costs
allocable to patients eligible for reimbursement pursuant to such programs,
particularly with respect to the Medicaid programs, which generally provide
lower reimbursement rates than the Medicare program. In addition, there can be
no assurance that facilities to be operated by, and the services and supplies
to be provided by, New GranCare will meet or continue to meet the requirements
for participation in such programs.
 
  Although federal regulations do not recognize state budget deficiencies as a
legitimate ground to curtail funding of their Medicaid cost reimbursement
programs, states have nevertheless curtailed such funding in the past. No
assurance can be given that states will not do so in the future or that the
future funding of Medicaid programs will remain at levels comparable to
present levels. Federal law currently recognizes that Medicaid and Medicare
reimbursement rates for nursing facilities must be reasonable and adequate to
meet the costs that must be incurred by efficiently operated facilities in
order to provide care and services in conformity with applicable laws,
regulations and quality and safety standards. However, legislative proposals
in Congress which have been endorsed by the National Governors' Association
would eliminate that protection. Medicare and Medicaid programs are subject to
statutory and regulatory changes, administrative rulings and interpretations,
determinations by reimbursement intermediaries, and governmental funding
restrictions, all of which may materially increase or decrease the rate of
program payments to long-term care facilities expected to be operated
 
                                      24
<PAGE>
 
by New GranCare. In addition, there can be no assurance that facilities owned,
leased or managed by New GranCare, now or in the future, will initially meet
or continue to meet the requirements for participation in such programs.
 
  New GranCare believes that the facilities to be operated by it are in
substantial compliance with the various Medicare and Medicaid regulatory
requirements currently applicable to them, including the requirements of the
Omnibus Budget Reconciliation Act of 1987 ("OBRA"). In the ordinary course of
its business, however, the Company has received and New GranCare may receive
notices of deficiencies for failure to comply with various regulatory
requirements. New GranCare will review such notices and take appropriate
corrective action. Historically, in most cases, the Company and the reviewing
agency have been able to agree upon the steps to be taken to bring a facility
into compliance with regulatory requirements. In some cases or upon repeat
violations, the reviewing agency may take a number of actions against a
facility. Effective October 1, 1990, OBRA increased the enforcement powers of
state and federal certification agencies. Additional sanctions have been
authorized to correct noncompliance with regulatory requirements, including
fines, temporary suspension of admission of new patients to the facility,
decertification from participation in the Medicare or Medicaid programs and,
in extreme circumstances, revocation of a facility's license. In certain
circumstances, conviction of abusive or fraudulent behavior with respect to
one facility may subject other facilities under common control or ownership to
disqualification from participation in Medicare and Medicaid programs. In the
past, notices of deficiencies and citations have not had a material adverse
effect on the Company.
 
  The Department of Health and Human Services ("DHS") has released new survey
and certification regulations under OBRA, which went into effect July 1, 1995.
These new regulations make significant changes in the process of surveying
skilled nursing facilities under Medicare and Medicaid and for certifying
these facilities to meet federal requirements for participation in the
Medicare and Medicaid programs and impose a graduated system of penalties to
match the severity of violations of laws passed by Congress and DHS which
implement health, safety and quality standards for residents of long-term care
facilities. These new regulations also set forth a number of alternative
remedies, in addition to those set forth above, which may be imposed by
surveying agencies on facilities that do not comply with the federal
requirements (instead of, or in addition to, termination of such facilities'
participation in Medicare and Medicaid) and specify remedies for state survey
agencies that do not meet surveying requirements. These regulations have not
had a material adverse effect on the Company's operations and New GranCare
does not believe that they will have a material adverse effect on New
GranCare's operations.
 
  Certificate of Need. Of the states in which New GranCare expects to operate
skilled nursing facilities, Tennessee, Mississippi, West Virginia, Iowa, Ohio,
Michigan, Wisconsin, South Carolina, and Georgia have a CON statute. In states
that have such statutes, approval by the appropriate state health regulatory
agencies must be obtained and a CON or similar authorization issued prior to
certain changes in the management of a long-term care facility, the addition
of new beds or services or the making of certain capital expenditures. To the
extent CON approvals are required for expansion of New GranCare's operations,
such expansion may be delayed or otherwise affected. Furthermore, certain
states, including Mississippi, Ohio, West Virginia, and Wisconsin, have now or
in the past imposed moratoriums on the development of new nursing facility
beds. Some states require separate approval to obtain Medicare and Medicaid
reimbursement for facility costs. Some states also require approval of capital
expenditures under Section 1122 of the Social Security Act and provide
Medicare and Medicaid reimbursements of capital costs (depreciation, interest
and lease expense) for approved capital expenditures only.
 
  Referral Restrictions. New GranCare will also be subject to federal and
state laws which govern financial and other arrangements between health care
providers. These laws often prohibit certain direct and indirect payments or
fee splitting arrangements between health care providers that are designed to
induce or encourage the referral of patients to, or the recommendation of, a
particular provider for medical products and services. Such laws include the
anti-kickback provisions of the federal Medicare and Medicaid Patients and
Program Protection Act of 1987. These provisions prohibit, among other things,
payment, solicitation or receipt of any form of remuneration in return for the
referral of Medicare and Medicaid patients. In addition, some states restrict
 
                                      25
<PAGE>
 
certain business relationships between physicians and pharmacies, and many
states prohibit business corporations from providing, or holding themselves
out as a provider of, Medicaid care. Possible sanctions for violation of any
of these restrictions or prohibitions include loss of licensure or eligibility
to participate in reimbursement programs as well as civil and criminal
penalties. These laws vary from state to state and have seldom been
interpreted by the courts or regulatory agencies. Additionally, OBRA '93
contains provisions that expand the list of health care services subject to
existing federal referral prohibitions. This expanded referral ban became
effective on January 1, 1995.
 
  OBRA '93 also contains referral restrictions related to physician ownership
interests, and restricts referrals by a physician to an entity with which he
has a "compensation arrangement," which is broadly defined to include any
arrangement involving "remuneration." However, there are a number of
exceptions for certain type of compensation arrangements, including exceptions
for personal service arrangements, space and equipment leases, employment
relationships, certain prepaid health plans, isolated transactions and certain
other payment arrangements that are consistent with the fair market value, so
long as these arrangements meet certain specific criteria. With respect to
physician ownership interests, an exception exists for ownership of investment
securities that may be purchased on terms generally available to the public
and that are listed on a national exchange (including the NYSE) or any
regional exchange, provided that the corporation issuing such investment
securities has at the end of its most recent fiscal year, or on average for
its previous three fiscal years, shareholders' equity exceeding $75.0 million.
New GranCare anticipates that the New GranCare Common Stock will be traded on
the NYSE and that its shareholders' equity will exceed the minimum
shareholders' equity. Although it is possible that certain arrangements
between New GranCare and physicians will be affected by these referral
restrictions, New GranCare does not believe that the restrictions will have a
material adverse effect on revenues.
 
  The Medicare program reimburses skilled nursing facility services, pharmacy
services and home health services based on reasonable costs of care, subject
to certain limitations. In determining allowable costs, the Medicare program
will not recognize as allowable the charge made for services provided to the
skilled nursing facility or home health agency by an entity that is related
through substantial ownership or substantial control, unless it qualifies for
an exception. Instead, Medicare will recognize as allowable only the
supplier's cost of (rather than its charge for) supplying the service.
 
  Contract Management Regulation. Contract managers of geriatric mental health
centers, subacute care units, specialty acute hospitals and senior health
centers are not typically subject to direct regulation, although New GranCare
may be held responsible for violation of certain federal and state laws, such
as the referral restrictions described above. Further, the facilities to be
managed by New GranCare are subject to regulation. Management contracts with
these facilities may hold New GranCare accountable in certain instances to a
facility which is cited for non-compliance with regulatory requirements.
Further, there can be no assurance that the facilities to be managed by New
GranCare will not be subject to statutory or regulatory changes which might
adversely impact these facilities and, indirectly, New GranCare's contract
management business.
 
  Home Health Regulation. Home health agencies must be certified by HCFA to
receive reimbursement for services and supplies from Medicare and Medicaid. As
a condition of participation in the Medicare and Medicaid home health care
program, HCFA requires compliance with certain standards with respect to
personnel, services and supervision; the preparation of annual budgets, cost
reports, and quarterly cost and visit analyses; and the establishment of a
professional advisory group that includes at least one practicing physician,
one registered nurse and other representatives from related disciplines or
consumer groups. Home health agencies are surveyed for compliance with these
requirements at least once every 15 months. Failure to comply may result in
termination of the agency's Medicare and Medicaid provider agreements. In
1989, Congress directed the Department of Health and Human Services ("DHS") to
develop and implement a range of intermediate, or alternative, sanctions for
home health agencies. DHS published proposed rules to implement this authority
in 1991; however, these rules have not been finalized and thus have not taken
effect. The proposed sanctions would include civil monetary penalties,
temporary management, suspension of payment for new admissions, and other
sanctions.
 
                                      26
<PAGE>
 
  Health Care Reform. While neither the present administration's health care
reform proposals nor alternative health care reform proposals introduced by
certain members of Congress were adopted in 1995, the Health Insurance
Portability and Accountability Act of 1996 (the "Accountability Act") was
passed by Congress and signed into law by President Clinton on August 21, 1996
and will generally take effect July 1, 1997. While the Accountability Act
contains provisions regarding health insurance or health plans, such as
portability and limitations on pre-existing condition exclusions, guaranteed
availability and renewability, it also contains several anti-fraud measures
that significantly change health care fraud and abuse provisions. Some of
those provisions include (i) creation of an anti-fraud and abuse trust fund
and coordination of fraud and abuse efforts by federal, state and local
authorities, (ii) extension of the criminal anti-kickback statute to all
federal health programs, (iii) expansion of and increase in the amount of
civil monetary penalties and establishment of a knowledge standard for
individuals or entities potentially subject to civil monetary penalties, and
(iv) revisions to current sanctions for fraud and abuse, including mandatory
and permissive exclusion from participation in the Medicare or Medicaid
programs. Additionally, the Accountability Act provides mechanisms for further
guidance to health care providers on health care fraud and abuse issues in the
form of additional safe harbors or modifications to existing safe harbors,
fraud alerts and the issuance of advisory opinions by DHS. New GranCare does
not believe that the Accountability Act will have a material adverse effect on
New GranCare's operations.
 
  Health care reform remains an issue for health care providers. Many states
are currently evaluating various proposals to restructure the health care
delivery system within their jurisdictions. It is uncertain at this time what
legislation on health care reform will ultimately be implemented or whether
other changes in the administration or interpretation of governmental health
care programs will occur. New GranCare anticipates that federal and state
legislatures will continue to review and assess various health care reform
proposals and alternative health care systems and payment methodologies. New
GranCare is unable to predict the ultimate impact of any federal or state
restructuring of the health care system, but such changes could have a
material adverse impact on the operations, financial condition and prospects
of New GranCare.
 
EMPLOYEE TRAINING AND DEVELOPMENT
 
  As a policy matter, New GranCare believes that nursing and professional
staff retention and development will be a critical factor in the success of
New GranCare. Accordingly, New GranCare's compensation program will provide
ongoing performance evaluations and salary reviews. Additionally, New GranCare
will provide financial incentives to its employees to encourage facility staff
motivation and productivity and to reduce turnover rates. New GranCare
believes that wage rates for professional nursing staff currently being used
by the Company are commensurate with market rates. New GranCare also intends
to provide employee benefit programs that New GranCare believes, as a package,
will exceed industry standards. In the past, the Company has not experienced
any significant difficulty in attracting or retaining qualified personnel, and
New GranCare does not anticipate any difficulty in this regard in the future.
 
  In addition, New GranCare intends to continue the ongoing informal training
and education programs currently provided by the Company for its nursing
staff, both professional and non-professional, as well as its non-nursing
staff, both professional and non-professional. With respect to education and
training programs conducted by entities other than New GranCare, New GranCare
expects to provide tuition reimbursement to all levels of staff to encourage
continual learning in all aspects of facility operations.
 
  Examples of training, development and education programs offered by the
Company, and which will be offered by New GranCare to its management employees
include the following: (i) communication skills, (ii) supervisory skills,
(iii) conflict-resolution skills, (iv) diversity training, (v) performance
management skills, and (vi) hiring skills.
 
  The Company has been offering certification programs to its nursing
assistants for a considerable period of time. This three-week program,
conducted on site at the Company's facilities consists of two weeks of
classroom work and one week of clinical preparation. Upon completion,
graduates are generally hired into one of the Company's facilities located
near the facility where the certification course was offered. The program also
will be continued by New GranCare.
 
                                      27
<PAGE>
 
EMPLOYEES
   
  As of January 1, 1997, the Company had approximately 16,000 full-time and
part-time employees, with 300 full-time employees at its corporate and
regional offices. Following the Distribution and Merger, New GranCare will
have approximately 13,800 full-time and part-time employees, with 250 full-
time employees at its corporate and regional offices. New GranCare estimates
that approximately 20% of these employees will be physicians, nurses and
professional staff. In addition, New GranCare will have collective bargaining
agreements with unions representing employees at 21 facilities. Currently, the
Company is negotiating two collective bargaining contracts involving
facilities in two states. New GranCare cannot predict the effect continued
union representation or organizational activities will have on New GranCare's
future activities. However, the Company has never experienced any material
work stoppages and New GranCare believes that its relations with its employees
and the SEIU will continue to be good.     
 
INSURANCE
 
  The Company maintains, and New GranCare will continue to maintain, on behalf
of itself and its subsidiaries, annual Blanket Property Damange/Business
Interruption insurance in the amount of $750.0 million and annual
General/Professional Liability insurance in the amount of $100.0 million, both
of which policies are on an occurrence form. New GranCare will also require
that physicians practicing at its long-term care facilities carry medical
malpractice insurance to cover their individual practice. New GranCare expects
to maintain a captive insurance company for the purposes of paying worker's
compensation claims as well as reinsurance contracts to minimize its insurance
exposure.
 
LEGAL PROCEEDINGS
 
  From time to time, the Company has been a party to various legal proceedings
in the ordinary course of its business. In the opinion of New GranCare, except
as described below, there are currently no proceedings which, individually or
in the aggregate, after taking into account the insurance coverage maintained
by the Company (and to be maintained by New GranCare) would have a material
adverse effect on New GranCare's financial position or results of operations.
 
  On September 9, 1996, a shareholder of the Company filed a civil complaint
in the Superior Court of the State of California, County of Los Angeles:
Howard Gunty Profit Sharing v. Gene E. Burleson, Charles M. Blalack,
Antoinette Hubenette, Joel S. Kanter, Ronald G. Kenny, Robert L. Parker,
William G. Petty, Jr., Edward V. Regan, Gary U. Rolle and GranCare, Inc., Case
No. DC156996. This complaint alleges, generally, that the defendants have
breached their fiduciary duties owed to the Company's shareholders by failing
to take all reasonable steps necessary to ensure that the Company's
shareholders receive maximum value for their shares of Company Common Stock in
connection with the proposed Distribution and Merger. The complaint further
alleges that the directors of the Company acted in concert as part of a scheme
to deprive the plaintiffs unfairly of their investment in the Company and to
unjustly enrich themselves. The plaintiffs are seeking (i) an injunction
prohibiting the consummation of the proposed Distribution and Merger or
(ii) alternatively, if the proposed Distribution and Merger are consummated,
to have such transactions rescinded and set aside and an order requiring the
defendants to account to the plaintiff for all profits realized as a result of
the proposed Distribution and Merger. In addition, the plaintiffs are seeking
unspecified compensatory damages, costs and to have the complaint certified as
a class action. The Company intends to vigorously defend this lawsuit.
 
  On December 19, 1996, a Conditional Agreement and Stipulation of Settlement
(the "Settlement Agreement") was reached in the above referenced litigation.
Completion of the settlement is subject to notice to the proposed class and a
hearing, as outlined below, and final consideration by the court, among other
conditions and considerations.
 
  Class counsel and counsel for the defendants intend to seek Final Approval
(as defined in the Settlement Agreement) of the proposed settlement and
dismissal of the claims that have been or could have been asserted in the
litigation by plaintiff and the Settlement Class (as defined below).
 
                                      28
<PAGE>
 
  Plaintiff's counsel investigated the facts and circumstances underlying the
issues raised in the Complaint and researched the law applicable thereto. The
investigation by plaintiff's counsel has included a review and analysis of the
Company's public disclosures, an analysis of its financial statements, a
review of other non-public information and a review of the draft Proxy
Statement/Prospectus submitted to the Securities and Exchange Commission in
anticipation of the Distribution and Merger. Plaintiff's counsel submitted
suggestions regarding the disclosure pertaining to the proposed Distribution
and Merger which have been considered in the context of the overall disclosure
contained in the Proxy Statement/Prospectus. As a result of comments received
from plaintiff's counsel and the Securities and Exchange Commission, a number
of disclosure enhancements have been made regarding the proposed Distribution
and Merger and related transactions. The Company and the plaintiff believe
that these disclosure enhancements will aid the shareholders in their
understanding and consideration of the proposed Distribution and Merger and
related transactions.
 
  The Defendants have vigorously denied all liability and allegations of
wrongdoing, and the settlement is not to be construed for any purpose as an
inference or admission of liability or wrongdoing by them. The plaintiffs and
defendants have concluded that it is desirable to settle the action to avoid
the further expense, burden and uncertainty of this litigation, and to put to
rest all controversies which were or could have been asserted in connection
with any of the matters set forth in the Complaint.
 
  In connection with the settlement the class shall be defined as set forth
below (the "Settlement Class"):
 
    All persons and entities who owned at any time one or more shares of
  Company Common Stock, from and including September 2, 1996 through and
  including December 19, 1996, excluding the following: the defendants,
  members of the families of the defendants; any entity in which any
  defendant owns or holds a controlling interest; and the legal
  representatives, heirs, successors or assigns of any such excluded parties.
 
  The settlement also provides, in summary, that the plaintiff or his counsel
may submit an application, subject to court review and approval, seeking an
award of attorney's fees and expenses in an aggregate amount of no more than
$350,000. Defendants will not oppose such application to the extent the
application does not seek more than $350,000, and the Company will pay the
amount the court awards up to $350,000, which is the maximum possible payment
exposure of the Company under the Settlement Agreement.
 
  The effect of the proposed settlement will be to extinguish the claims
contained in the action, along with granting of a general release from other
claims, whether asserted or not, as allowed by law.
 
  Current shareholders of record will receive notice of a hearing to determine
whether the proposed settlement of this action is fair, reasonable and
adequate and should be approved by the court. As of this time, the hearing
date has not been set.
 
  Under the proposed settlement agreement, class members will be given the
opportunity to be excluded from the Settlement Class, subject to certain
conditions. If the proposed Settlement Agreement is approved in final form by
the court, it will be binding on all class members who have not previously
been excluded from the Settlement Class.
 
                                      29
<PAGE>
 
                               THE DISTRIBUTION
 
  This section of the Prospectus describes certain aspects of the proposed
Distribution. For information describing certain aspects of the Merger, see
"Description of the Transactions" and "The Merger Agreement" in the Proxy
Statement/Prospectus. The descriptions of the various agreements contained
herein, including, without limitation, the Distribution Agreement, Employee
Benefits Agreement, Non-competition Agreement, Shareholders Agreement and the
Tax Allocation Agreement, do not purport to be complete and are qualified in
their entirety by reference to forms of such agreements which are attached
either as annexes to the Proxy Statement/Prospectus or filed as an exhibit to
the Registration Statement of which this Prospectus is a part, which annexes
and exhibits, as the case may be, are incorporated herein by reference. All
Company shareholders are urged to read such agreements in their entirety.
 
REASONS FOR THE DISTRIBUTION
 
  Because the assets and liabilities relating to the Institutional Pharmacy
Business conducted by the Company are the only assets that Vitalink is willing
to acquire in the Merger, the Company determined to effect the Distribution.
Both the Distribution and the Merger are intended to be tax-free to the
Company's shareholders for federal income tax purposes, except to the extent
that cash payments are received for fractional shares.
 
  For information concerning the background and reasons for the Distribution
and the Merger, see "Description of the Transactions--GranCare's Reasons for
the Merger; Recommendation of the Board of Directors of GranCare" and "--
Vitalink's Reasons for the Merger" in the Proxy Statement/Prospectus. As
indicated therein, the Company believes that the Distribution and the Merger
are fair to and in the best interests of the Company's shareholders for a
number of reasons including that Company shareholders will be able to
participate as equity owners in a significantly larger institutional pharmacy
business, which the Company believes will generate financial and operational
synergies and other financial benefits. At the same time, shareholders will
continue to participate as equity owners in the Skilled Nursing Business to be
conducted by New GranCare.
 
CONTRIBUTION OF SKILLED NURSING BUSINESS TO NEW GRANCARE
 
  Prior to the Distribution Record Date, the Company will engage in an
internal reorganization pursuant to which all the assets and liabilities
relating to the Skilled Nursing Business will be reorganized in various tax-
free transactions such that upon completion of such reorganization, the
Skilled Nursing Business will be conducted by New GranCare, a direct
subsidiary of the Company, and various direct and indirect subsidiaries of New
GranCare. At the same time, the assets and liabilities relating primarily to
the Institutional Pharmacy Business will be reorganized so that upon
completion of the internal reorganization the Institutional Pharmacy Business
will be conducted by TeamCare, a direct subsidiary of the Company, and various
direct and indirect subsidiaries of TeamCare. In connection with the
consummation of the transactions contemplated by the Distribution Agreement
and the Merger Agreement, the Company, New GranCare and Vitalink will enter
into additional agreements and arrangements designed to further effect the
separation of the Company's Skilled Nursing Business from its Institutional
Pharmacy Business and to establish the parameters of certain intercompany
relationships subsequent to the completion of the Merger. Among these
agreements are (i) the Employee Benefits Agreement, (ii) the Tax Allocation
Agreement, (iii) the Non-competition Agreement, (iv) the Shareholders
Agreement (the "Shareholders Agreement") between Vitalink and Manor Care, (v)
the Interim Services Agreement (the "Interim Services Agreement") between New
GranCare and Vitalink, and (vi) the Voting Agreement (the "Voting Agreement")
between Manor Care and the Company.
 
  As provided in the Distribution Agreement, prior to the consummation of the
Distribution, the Company will take certain actions as the sole stockholder of
New GranCare or will ratify actions taken by officers and directors of New
GranCare in connection with establishing New GranCare as an independent
company. These actions include (i) merging GCI Properties, Inc., a California
corporation ("GCI") and wholly-owned subsidiary of the Company, with and into
New GranCare, with New GranCare being the surviving entity (all of the assets
 
                                      30
<PAGE>
 
pertaining to the Company's Skilled Nursing Business will then be contributed
to New GranCare following such merger), (ii) adopting the Certificate of
Incorporation and Bylaws of New GranCare in the form submitted herewith as
Exhibits 3.1 and 3.2, respectively, to be in effect at the Time of
Distribution (as defined in the Distribution Agreement), (iii) electing as
directors of New GranCare the individuals named in this Prospectus and causing
the appointment of officers of New GranCare to serve in such capacities
following the Distribution and (iv) adopting various incentive compensation
plans for the benefit of directors, officers and employees of New GranCare to
be in effect following the Distribution. For information concerning a
comparison of California and Delaware law and the Charter and Bylaws of New
GranCare, see "Description of New GranCare Capital Stock--The Charter and
Bylaws of the Company and New GranCare" and "Significant Differences Between
the Corporation Laws of California and Delaware." For information concerning
the individuals who may serve as directors and executive officers of New
GranCare following the Distribution and certain compensatory arrangements for
their benefit, including stock incentive plans, see "Management--Executive
Officers and Directors--Compensation of Directors" and "--Compensation of
Executive Officers."
 
  Pursuant to the Distribution Agreement, New GranCare will acquire the right
to use the name "GranCare" in connection with continuing the conduct of the
Skilled Nursing Business. It is anticipated that immediately following the
Merger, New GranCare will change its name to "GranCare, Inc."
 
CONSUMMATION OF THE DISTRIBUTION; TREATMENT OF COMPANY STOCK OPTIONS
 
  The Distribution will be effected immediately prior to the Merger. Although
the Distribution will not be effected unless the Merger is approved by the
Company's shareholders and is about to occur, the Distribution is separate
from the Merger and the New GranCare Common Stock to be received by holders of
Company Common Stock in the Distribution does not constitute part of the
Merger Consideration. While the Company does not believe that shareholder
approval of the Distribution is required under California law, such approval
is being sought pursuant to the requirements of the Merger Agreement and to
ensure that the objectives of the Company's shareholders are consistent with
the objectives sought to be accomplished by the Company's Board of Directors
pursuant to the Distribution and the Merger. The Board of Directors of the
Company has not yet established the Distribution Record Date. It is
anticipated that the Distribution Date will be the date on which the
Distribution occurs and will be immediately prior to the Effective Time of the
Merger.
 
  On the Distribution Date, the Company's Board of Directors will cause the
Company to pay a dividend to the Company's shareholders as of the Distribution
Record Date, which dividend will be payable in shares of New GranCare Common
Stock. Each shareholder of the Company as of the Distribution Record Date will
receive one share of New GranCare Common Stock for each share of Company
Common Stock held as of the Distribution Record Date. Immediately following
the completion of the Distribution, New GranCare will be a publicly-owned
corporation and it is contemplated that the shares of New GranCare Common
Stock will be listed on the NYSE. See "--Listing of New GranCare Common Stock;
Restrictions on Resale."
 
  Following the completion of the Distribution, the Company will merge with
and into Vitalink with Vitalink being the surviving corporation in the Merger.
Each shareholder of the Company will receive 0.478 of a share of Vitalink
Common Stock in exchange for each share of Company Common Stock held by a
shareholder of the Company as of the Effective Time of the Merger. As a result
of the Merger, the Institutional Pharmacy Business will be conducted through
various direct and indirect subsidiaries of Vitalink.
 
  As a consequence of the Distribution, each holder of Company Options will
receive options to purchase such number of shares of New GranCare Common Stock
as is equal to the number of shares of Company Common Stock subject to Company
Options held by such holder as of the Distribution Record Date. The exercise
price of a New GranCare Option will be equal to a percentage of the exercise
price of the existing Company Option, while the current exercise price of
existing Company Options will be correspondingly adjusted downward by the
amount allocated as the exercise price of the New GranCare Option. The
allocation of the exercise price between the existing Company Options and the
New GranCare Options will be determined pursuant to a formula which is
intended to apportion such exercise price in a manner that reflects the value
received by the Company's shareholders in respect of the Institutional
Pharmacy Business (in the case of the
 
                                      31
<PAGE>
 
portion of the exercise price allocated to the existing Company Options) and
the remaining portion of the exercise price is intended to reflect the implied
value of the Company's Skilled Nursing Business (in the case of the portion of
the exercise price allocated to the New GranCare Options). The option exercise
price allocation formula is as follows: (i) multiply the Average Vitalink
Stock Price (as defined below) by the Exchange Ratio and (ii) divide the
product so obtained by the Average Company Stock Price (defined below) to
obtain the "Company Option Allocation Percentage". The percentage of the
exercise price of each existing Company Option that will be allocated to the
New GranCare Option issued with respect to such Company Option (the "New
GranCare Option Allocation Percentage") is equal to 1.00 minus the Company
Option Allocation Percentage. For purposes of the foregoing exercise price
allocation calculation, the "Average Vitalink Stock Price" and the "Average
Company Stock Price" were determined to be $23.03 and $17.88, respectively,
constituting the average closing price per share for Vitalink Common Stock and
Company Common Stock for the 120 consecutive trading day period ending on
August 29, 1996. As a result of the foregoing process, the Company Option
Allocation Percentage will be approximately 61.568% of the exercise price of
each existing Company Option and the New GranCare Option Allocation Percentage
will be approximately 38.432% of the exercise price of each existing Company
Option. As a result of the Merger, the exercise price of the Adjusted Company
Options (as defined below) will be adjusted to give effect to the 0.478
Exchange Ratio.
 
  As a result of the foregoing, the exercise price of each existing Company
Option will be adjusted by multiplying the exercise price by the Company
Option Allocation Percentage (the "Adjusted Company Option"). As a consequence
of the Merger, each holder of an Adjusted Company Option as of the Effective
Time of the Merger will receive an option to purchase such number of shares of
Vitalink Common Stock as is equal to the number of shares of Company Common
Stock issuable upon exercise of the Adjusted Company Option multiplied by the
0.478 Exchange Ratio. The exercise price of each Adjusted Company Option will
be further adjusted by dividing such exercise price by the 0.478 Exchange
Ratio.
 
  The terms and conditions of the New GranCare Options and the Adjusted
Company Options will be substantially the same as the terms of the Company
Options prior to the Distribution. Options to purchase 2,355,250 shares of
GranCare Common Stock were outstanding as of November 30, 1996 of which
options to purchase 930,227 shares of GranCare Common Stock were unvested and
not exercisable. However, all of such unvested Company Options contain change
of control provisions that provide that such options will become fully vested
and exercisable upon the occurrence of a change of control transaction such as
the Merger. The option agreements also provide that such Company Options do
not expire upon a termination of employment following a change of control.
Thus, even if the holder of a Company Option does not become an employee of
the Institutional Pharmacy Business following the Merger, such employee will
continue to have the right to exercise Adjusted Company Options following the
Merger until the expiration date of such option. Conversely, an employee of
the Institutional Pharmacy Business who does not become an employee of the
Skilled Nursing Business following the Merger will continue to have the right
to exercise New GranCare Stock Options following the Merger until the
expiration date of such options. The existing Company Options, which were
granted at fair market value at the time of grant, have exercise prices
ranging from $1.61 to $21.00 per share.
 
MANNER OF EFFECTING THE DISTRIBUTION
 
  It is expected that upon the formal declaration by the Company's Board of
Directors of the Distribution that the Distribution will be made on the
Distribution Date to shareholders of record of the Company Common Stock as of
the Distribution Record Date. The Merger is expected to take place promptly
following the satisfaction of certain conditions set forth in the Merger
Agreement and is expected to occur on or about February 10, 1997. In order to
receive shares of Vitalink Common Stock pursuant to the Merger, holders of
Company Common Stock must surrender the certificates representing such stock
held by them. Following the Merger, all outstanding shares of Company Common
Stock will represent the right to receive shares of Vitalink Common Stock, in
accordance with the terms of the Merger Agreement. The Distribution will not
take place unless all of the conditions to effecting the Merger (other than
the completion of the Distribution) have been fulfilled, and there can be no
assurance as to the timing or consummation of the Distribution. The Company's
transfer agent, American Stock Transfer & Trust Company, will act as the
Distribution Agent for the Distribution and will deliver certificates for New
GranCare Common Stock as soon as practicable to holders of record of Company
Common Stock as of
 
                                      32
<PAGE>
 
the close of business on the Distribution Record Date on the basis of one
share of New GranCare Common Stock for each share of Company Common Stock held
on the Distribution Record Date. All shares of New GranCare Common Stock will
be fully paid and non-assessable and the holders thereof will not be entitled
to preemptive rights. See "Description of Capital Stock." Following the
completion of the Distribution New GranCare will operate as an independent
public company.
 
  YOU WILL NOT BE REQUIRED TO PAY ANY CASH OR OTHER CONSIDERATION FOR THE
SHARES OF NEW GRANCARE COMMON STOCK RECEIVED IN THE DISTRIBUTION NOR WILL YOU
NEED TO SURRENDER YOUR COMPANY COMMON STOCK CERTIFICATE IN ORDER TO RECEIVE
SHARES OF NEW GRANCARE COMMON STOCK IN THE DISTRIBUTION. THE DISTRIBUTION
AGENT WILL SEND YOU YOUR NEW GRANCARE STOCK CERTIFICATES FOLLOWING THE
CONSUMMATION OF THE DISTRIBUTION.
 
LISTING OF NEW GRANCARE COMMON STOCK; RESTRICTIONS ON RESALE
 
  New GranCare will apply for listing the New GranCare Common Stock on the
NYSE. The New GranCare Common Stock received pursuant to the Distribution will
be freely transferable under the Securities Act of 1933, as amended (the
"Securities Act"), except for shares of New GranCare Common Stock received by
any persons who may be deemed to be an "affiliate" of New GranCare within the
meaning of Rule 144 under the Securities Act. Persons who may be deemed to be
affiliates of New GranCare after the Distribution generally include
individuals or entities that control, are controlled by, or are under common
control with New GranCare, and may include the directors and executive
officers of New GranCare as well as any principal stockholders of New
GranCare. Persons who are affiliates of New GranCare will be permitted to sell
their New GranCare Common Stock received pursuant to the Distribution only
pursuant to an effective registration statement under the Securities Act or
pursuant to an exemption from the registration requirements of such act. This
Registration Statement will not cover resales of New GranCare Common Stock by
affiliates of New GranCare. See "Shares Eligible for Future Sales."
 
INTERESTS OF CERTAIN PERSONS IN THE DISTRIBUTION AND MERGER
 
  Certain members of the Company's management and the Company's Board of
Directors may be deemed to have interests in the Distribution and Merger in
addition to their interests as Company shareholders generally, which may cause
potential conflicts of interest. The Company's Board of Directors was aware of
these factors and considered them, among other factors, in approving the
Distribution Agreement and the transactions contemplated thereby. Among these
factors are (i) the acceleration of the vesting of currently unvested Company
Options as a result of the consummation of the Merger as described under "--
Consummation of the Distribution; Treatment of Company Stock Options," (ii)
the treatment of Company Options in the Distribution and the Merger as
described under "--Consummation of the Distribution; Treatment of Company
Stock Options," (iii) the indemnification provisions of the Distribution
Agreement as described under "--Terms of the Distribution Agreement" (iv) the
payment by Vitalink of a portion of the premiums for directors' and officers'
liability insurance for current Company directors and officers as described
under "--Terms of the Distribution Agreement" and (v) cash payments as a
result of the early termination of certain incentive compensation plans of the
Company and employment agreements. See also, "Description of the
Transactions--Interests of Certain Persons in the Transactions" in the Proxy
Statement/Prospectus. It is expected that substantially all of the directors
and executive officers of the Company will be directors and executive officers
of New GranCare following the Distribution except for Gene E. Burleson, who
will be Chief Executive Officer and a director of Vitalink as well as Chairman
of the Board and a director of New GranCare, and Arlen B. Reynolds, who will
be Executive Vice President of Vitalink. See "Management--Certain
Relationships and Related Party Transactions" herein and "Description of the
Transactions--Directors and Officers of Vitalink Following the Merger" in the
Proxy Statement/ Prospectus.
 
  As of November 30, 1996, the 29 executive officers and directors of the
Company (as a group) beneficially owned an aggregate of 2,118,460 shares of
Company Common Stock (excluding shares subject to outstanding stock options).
All such shares will be treated in the Merger and the Distribution in the same
manner as shares of Company Common Stock held by other shareholders of the
Company.
 
                                      33
<PAGE>
 
  As of November 30, 1996, the executive officers of the Company (as a group)
also held options to purchase an aggregate of 1,622,871 shares of Company
Common Stock pursuant to the Company's stock option plans, of which 759,900
are not currently exercisable. In addition, as of November 30, 1996, the non-
employee directors of the Company (as a group) held options to purchase an
aggregate of 251,740 shares of Company Common Stock. Upon the consummation of
the Merger, all of the options held by such executive officers and non-
employee directors will immediately become exercisable in full. The treatment
of such options is described under "--Consummation of the Distribution;
Treatment of Company Stock Options."
 
  The Company's executive officers participate in certain cash incentive plans
initiated by the Company that provide for annual cash bonuses (the "Annual
Incentive Plan") and long term cash bonuses (the "Shareholder Value Program")
based upon the performance of the Company. Both the Annual Incentive Plan and
Shareholder Value Program provide that the benefits under such plans vest upon
a change in control. In addition, each of the Company's executive officer's
employment agreements provides for the payment of benefits upon the occurrence
of a change in control. The Merger constitutes a change in control under the
Company's incentive plans as well as its employment agreements. The maximum
amount of payments that the Company may be required to make pursuant to such
incentive plans and employment agreements is approximately $11.5 million
(assuming every executive officer elects to exercise the change in control
provisions of his or her employment agreement). The Company's Board of
Directors has determined that upon consummation of the Distribution and the
Merger the Shareholder Value Program will be paid out at the "Superior" level.
In addition, shares of restricted Company Common Stock held by non-officers of
the Company which are unvested will vest as a consequence of the change of
control event that will occur upon completion of the Merger. Such restricted
stock has a value of approximately $2.5 million.
 
  The Company has determined that no benefits will be payable under the Annual
Incentive Plan because costs associated with the Distribution and Merger will
not allow the participants to attain the required performance goals. Under the
Shareholder Value Program, however, as a result of the Merger, Messrs.
Burleson, Athans, Benton, Schneider and Finney (the individuals named in the
Summary Compensation Table on page 79) will receive cash payments of $852,000,
$420,000, $420,000, $330,000 and $234,000, respectively, upon the vesting of
benefits under this program. Other executive officers will receive in the
aggregate $2.25 million under this program for an aggregate payout under the
Shareholder Value Program of $4.5 million which is included in the $11.5
million referenced above.
 
  Messrs. Burleson and Athans have agreed to waive their change in control
payments under their employment agreements in exchange for entering into new
employment agreements with Vitalink and New GranCare, respectively. Mr. Finney
has resigned from the Company effective January 1, 1997. Under the terms of
Mr. Finney's resignation, he will receive a payment of $240,000 (one year's
base salary) regardless of whether the Merger occurs. Assuming Messrs. Benton
and Schneider were to elect not to be employed by New GranCare, they would
receive $1,050,000 (three times base salary) and $825,000 (three times base
salary), respectively, under the change in control provisions of their
employment agreements.
 
  To the extent an executive officer of the Company is not employed by New
GranCare or Vitalink following the consummation of the Distribution and
Merger, such individual will be entitled to the change of control payments
specified in such individual's employment agreement, which will be triggered
by the Merger (six month's base salary for Vice Presidents, one year's base
salary for Senior Vice Presidents and three year's base salary for Executive
Vice Presidents). Any executive officer who is a party to an employment
agreement will be required to waive his or her rights under such agreement as
a condition to obtaining a replacement employment agreement with New GranCare
following the Distribution. See "Management--Compensation of Executive
Officers--Employment Agreements."
 
  Immediately following the consummation of the Merger, the Company's Chief
Executive Officer, Gene E. Burleson, will become Vitalink's Chief Executive
Officer and a member of Vitalink's Board of Directors. Mr. Burleson has an
employment agreement with the Company that became effective January 1, 1994,
which will be assumed by Vitalink. The employment agreement will be extended
for a five year term commencing at
 
                                      34
<PAGE>
 
the Effective Time and provide for annual adjustments in base salary as
determined by a management compensation committee. Mr. Burleson's base salary
has been established at $430,000 for 1996. The agreement also provides for
severance compensation upon termination of employment by Vitalink for any
reason other than for "Cause," as defined in the agreement, consisting of a
minimum of three years' base salary and, in the event of a change-in-control,
as defined in the agreement, payment of a minimum of five year's base salary
and accelerated vesting of all options held by Mr. Burleson. In addition, Mr.
Burleson will be named Chairman of the Board of New GranCare and, in
connection therewith, it is anticipated that New GranCare will enter into a
consulting agreement with Mr. Burleson in the amount of $100,000 per year.
 
TREATMENT OF CERTAIN INDEBTEDNESS
 
  9 3/8% Notes--As of November 30, 1996, there was $100 million aggregate
principal amount of 9 3/8% Notes outstanding. The 9 3/8% Notes bear interest
at the rate of 9 3/8% per annum, mature on September 15, 2005 and are not
redeemable prior to September 15, 2000. The 9 3/8% Notes are senior
subordinated obligations of the Company ranking subordinate in right of
payment to all senior indebtedness of the Company (including indebtedness
outstanding under the Existing Credit Facility (defined below)) and senior in
right of payment to all subordinated indebtedness (including the Convertible
Debentures). The Indenture dated as of September 15, 1995, between the Company
and Marine Midland Bank pertaining to the Notes (the "Note Indenture")
contains certain restrictive covenants including: (i) a limitation on
additional indebtedness; (ii) a limitation on other senior subordinated debt;
(iii) a limitation on liens; (iv) a limitation on the issuance of preferred
stock by the Company's subsidiaries; (v) a limitation on transactions with
affiliates; (vi) a limitation on restricted payments, (vii) a restriction on
the application of proceeds from certain asset sales; (viii) a limitation on
restrictions on subsidiary dividends; (ix) a restriction on mergers,
consolidations and the transfer of all or substantially all of the assets of
the Company to another person; (x) a limitation on investments and loans and
(xi) a limitation on lines of business. As certain of these covenants may be
breached by the Distribution, and in order to ensure greater operating
flexibility for Vitalink following the Merger, it is a condition to the Merger
that the tender offer be consummated and the Consent (defined below) be
obtained.
 
  Tender offer materials describing the Company's tender offer for all of the
outstanding 9 3/8% Notes at a price of $1,090 per $1,000 principal amount of
the 9 3/8% Notes have been mailed previously to holders thereof. The materials
include a description of the consent (the "Consent"), which holders of the 9
3/8% Notes are required to sign as a condition to tendering their 9 3/8%
Notes, which provides for an amendment (the "Proposed Amendment") to the Note
Indenture which would delete the covenants described in the preceding
paragraph (other than those described in clauses (iii) and (vii)). The
Proposed Amendment requires the consent of holders of a majority in aggregate
principal amount of the 9 3/8% Notes then outstanding the Company believes
that the holders of a majority in aggregate principal amount of 9 3/8% Notes
will tender their 9 3/8% Notes and execute the Consent. The Proposed Amendment
will become effective immediately prior to the consummation of the
Distribution and Merger. It is a condition to the obligations of the Company
and Vitalink under the Merger Agreement that the Tender Offer be consummated
at a price not exceeding 109% of principal amount and that the requisite
Consent be obtained. There can be no assurance that the Tender Offer will be
consummated and the requisite Consent will be obtained.
 
  Vitalink will refinance the indebtedness represented by the 9 3/8% Notes
tendered in the tender offer through borrowings under a credit facility
available to Vitalink. In connection with the assumption by Vitalink of any
untendered 9 3/8% Notes, New GranCare has agreed to pay Vitalink a fee with
respect to such 9 3/8% Notes representing the present value (discounted back
to the effective time of the Merger from the date the 9 3/8% Notes first
become redeemable) of the estimated interest rate differential between the 9
3/8% Notes and the borrowing cost that would be incurred by Vitalink in
connection with the issuance of similar securities. In addition, any premium
paid in connection with the tender offer of the 9 3/8% Notes (and all related
expenses) will be a Shared Transaction Expense.
 
  Convertible Debentures. The Distribution Agreement and the Merger Agreement
also require that the Company take commercially reasonable efforts to call for
redemption prior to the Distribution Date all of the
 
                                      35
<PAGE>
 
Company's outstanding 6 1/2% Convertible Subordinated Debentures due 2003 (the
"Convertible Debentures"). Under the Merger Agreement, the failure of the
Company to comply with requirement set forth in the previous sentence may give
rise to a right of Vitalink to terminate the Merger Agreement. At present, the
Company does not foresee any difficulty in completing the redemption of the
Convertible Debentures. The Convertible Debentures are issued pursuant to the
terms of an Indenture dated January 29, 1993 between the Company and First
Union National Bank (the "Debenture Indenture") and are presently redeemable
at a redemption price of 104.55% of the principal amount of the Convertible
Debentures plus accrued and unpaid interest to the date of redemption. There
are currently $60.0 million in aggregate principal amounts of Convertible
Debentures outstanding resulting in an aggregate redemption premium of
approximately $2.73 million which will also be a Shared Transaction Expense
(such premium shall be reduced by $390,000 in the event the redemption occurs
after January 15, 1997). See "--Expenses."
 
  Existing Credit Facility. The Company currently has in place a revolving
credit facility which permits borrowings of up to $150.0 million (the
"Existing Credit Facility"). The Existing Credit Facility was established
pursuant to a Credit Agreement dated as of March 31, 1995 (as heretofore
amended, the "Existing Credit Agreement"), by and among the Company, as
borrower, First Union National Bank of North Carolina, as Agent (in such
capacity, the "Existing Agent") and letter of credit bank, and the financial
institutions signatory thereto as lenders. As of September 30, 1996,
approximately $88.9 million was outstanding under the Existing Credit
Facility. The Existing Credit Facility includes a $45.0 million subfacility
for working capital loans. Incorporated as part of the working capital line is
a $10.0 million subline for standby letters of credit and a $5.0 million
swingline from the Existing Agent.
 
  The Existing Credit Agreement provides that all outstanding principal under
the Existing Credit Facility on June 30, 1998 (the "Term Conversion Date")
will be converted to term loans which mature four years after the Term
Conversion Date. Such term loans are to be amortized in sixteen equal
quarterly installments prior to maturity.
 
  The obligations of the Company under the Existing Credit Facility are
guaranteed by the Company's direct and indirect subsidiaries other than GCI
Indemnity, Inc. (the "Existing Subsidiary Guaranty Obligations") and are
secured by a pledge of all of the capital stock of the Company's direct
subsidiaries and a security interest in all or substantially all of the
otherwise unencumbered assets of the Company. The Existing Subsidiary Guaranty
Obligations are secured by a pledge of all of the capital stock of the
Company's indirect subsidiaries (other than GCI Indemnity, Inc.) and a
security interest in all or substantially all of the otherwise unencumbered
assets of such indirect subsidiaries.
 
  Loans outstanding from time to time under the Existing Credit Facility bear
interest at either the Base Rate or at the Eurodollar Rate (defined below) (at
the Company's option), in each case plus the applicable margin. The Base Rate
is defined as the higher of (i) the prime rate announced from time to time by
First Union National Bank of North Carolina or (ii) the effective Federal
Funds Rate, plus 0.50% per annum (the "Base Rate"). The Existing Credit
Agreement defines the Eurodollar Rate as the average London Interbank Offered
Rate ("Libor") of one, two, three or six-month Eurodollar deposits (the
"Eurodollar Rate"). Interest is payable in arrears.
 
  The Existing Credit Facility contains representations and warranties,
affirmative covenants, reporting covenants, negative covenants and events of
default customary for similar financing transactions. Covenants include (but
are not limited to) certain restrictions on acquisitions, capital
expenditures, debt incurrence, contingent obligations, liens, investments,
consolidations, mergers and asset sales, payment of dividends, the purchase or
redemption of capital stock, and the purchase, payment or other retirement of
subordinated debt. In addition, the Company is required to comply with certain
financial covenants governing, among other things, the ratio of debt to equity
and earnings to interest expense that must be maintained by the Company.
 
  New Credit Facility. In order to effect the Distribution, the Company will
be required to replace its Existing Credit Facility and currently has a
commitment letter from First Union National Bank of North Carolina, as
Administrative Agent ("First Union"), and The Chase Manhattan Bank, as
Syndication Agent ("Chase"), and First Union Capital Markets Corp. and Chase
Securities Inc., as Arrangers, whereby each of such banks has agreed to
provide to the Company for the benefit of New GranCare a replacement credit
facility (the "New
 
                                      36
<PAGE>
 
Credit Facility") in the aggregate amount of $300.0 million (with First Union
and Chase each committing $150.0 million). The New Credit Facility will
consist of two components: a $200.0 million five-year revolving credit
facility (which includes a $40.0 million sub-limit for the issuance of standby
letters of credit) and a $100.0 million five-year term loan. Borrowings for
working capital and general corporate purposes may not exceed $75.0 million.
The first $25.0 million of exposure for letters of credit issued under the
letter of credit sub-facility will correspondingly reduce availability under
the working capital sub-facility. It is anticipated that the initial use of
the New Credit Facility will be to redeem the Convertible Debentures, to repay
outstanding balances under the Existing Credit Facility and to pay for
expenses related to the Transactions.
 
  The obligations of New GranCare under the New Credit Facility will be
guaranteed by New GranCare's present and future direct and indirect
subsidiaries other than GCI Indemnity, Inc. (the "New Subsidiary Guaranty
Obligations") and will be secured by a pledge of all of the capital stock of
New GranCare's present and future direct subsidiaries, a security interest in
all or substantially all of the otherwise unencumbered assets of New GranCare
and a pledge of all intercompany notes held by New GranCare. The New
Subsidiary Guaranty Obligations are to be secured by a pledge of all of the
capital stock of the indirect subsidiaries of New GranCare (other than GCI
Indemnity, Inc.), a security interest in all or substantially all of the
otherwise unencumbered assets of such indirect subsidiaries and a pledge of
all intercompany notes held by such subsidiaries.
 
  The revolving credit portion of the New Credit Facility will mature in five
years. The term loan portion of the New Credit Facility will be amortized in
ten quarterly installments of $7.0 million each commencing two years after the
New Credit Facility closes, thereafter increasing to $10.0 million per
quarter. All remaining principal and accrued and unpaid interest shall be due
and payable in full on the last day of the calendar month during which the
fifth anniversary of the closing date of the New Credit Facility occurs.
 
  Interest on outstanding borrowings shall accrue, at the option of New
GranCare, at the Base Rate or at the Eurodollar Rate plus, in each case, an
applicable margin. The Base Rate is defined as the higher of (i) First Union's
prime rate or (ii) the effective Federal Funds Rate, plus 0.50% per annum. The
Eurodollar Rate is defined as the published rate or the arithmetic mean of
rates at which Eurodollar deposits are offered for periods of one, two, three
or six-months. Interest is payable in arrears. The applicable margin varies in
accordance with a pricing matrix based upon New GranCare's ratio of
Consolidated Senior Debt to EBITDA and varies depending on the type of
interest rate selected by New GranCare. For Base Rate loans, the applicable
margin ranges from 0.000% (for a Consolidated Senior Debt to EBITDA ratio of
less than 2.5) to 0.500% (for a Consolidated Senior Debt to EBITDA ratio of
greater than 4.0). The applicable margin for Eurodollar loans ranges from
0.75% to 1.75% for the same Consolidated Senior Debt to EBITDA ratios set
forth above. In order to qualify for the lowest applicable margin for Base
Rate Loans or Eurodollar loans, New GranCare's Total Debt to EBITDA must also
be less than 3.0. Initially, the applicable margins will be 0.25% for Base
Rate loans and 1.50% for Eurodollar loans until New GranCare delivers its
financial statements for the quarter ended December 31, 1996. Thereafter, the
applicable margins will be adjusted in accordance with the pricing matrix
referred to above, except that the applicable margin for Eurodollar loans
cannot be adjusted to less than 1.25% until New GranCare delivers its
financial statements for the quarter ended March 31, 1997.
 
  All of the net proceeds of (i) asset sales (subject to certain customary
exceptions) (ii) issuances of subordinated debt and (iii) certain equity
issuances must be applied to permanently reduce outstanding borrowings and
commitments under the New Credit Facility. However, if at least $100.0 million
of subordinated debt is issued, New GranCare will be permitted (though it will
not be obligated) to apply up to $35.0 million of the proceeds of such
issuance to the repurchase of New GranCare capital stock. The remaining
balance of such proceeds are to be applied pro rata to reduce the outstanding
balance on the term loan portion of the New Credit Facility, and thereafter to
the outstanding balance on the revolving loan portion of the New Credit
Facility. To the extent amounts prepaid on the revolving loan portion of the
New Credit Facility are not re-employed to fund permitted acquisitions within
six months, the revolving loan commitment will be permanently reduced.
 
  The New Credit Facility will contain representations and warranties,
affirmative covenants, reporting covenants, negative covenants and events of
default customary for similar financing transactions. Covenants will
 
                                      37
<PAGE>
 
include (but not be limited to) certain restrictions on acquisitions, capital
expenditures, debt incurrence, contingent obligations, liens, investments,
consolidations, mergers and asset sales, payment of dividends, the purchase or
redemption of capital stock, and the purchase, payment or other retirement of
subordinated debt. In addition, New GranCare will be required to comply with
certain financial covenants governing, among other things, the ratio of debt
to equity, earnings to interest expense and rent expense, and debt to earnings
which must be maintained by New GranCare, as well as maximum limits on rental
expense.
 
  The funding of the New Credit Facility is subject, among other things, to
the satisfactory completion of due diligence, obtaining all necessary consents
and the execution of satisfactory loan documentation.
 
  HRPT Obligations. HRPT is the holder of a mortgage loan to AMS Properties,
Inc., a wholly-owned Subsidiary of the Company, dated October 1, 1994, in the
original principal amount of $11.5 million (the "HRPT Loan"). The HRPT Loan is
secured, in part by mortgage and security agreements dated as of March 31,
1995 (collectively, the "Mortgages") in favor of HRPT and encumbering two
nursing facilities in Wisconsin owned by AMS Properties, Inc. The HRPT Loan
was incurred in connection with the acquisition and lease by AMS Properties,
Inc. of several nursing facilities in Wisconsin, California, Colorado and
Illinois pursuant to an Acquisition Agreement, Agreement to Lease and Mortgage
Loan Agreement dated as of December 28, 1990 (as amended, the "HRPT
Acquisition Agreement"). The remaining balance under the HRPT Loan is due
December 31, 2010 and may be prepaid upon the payment of certain prepayment
penalties, which penalties essentially provide that HRPT will receive the
future value of the amounts owed. HRPT has also leased 7 nursing facilities
located in Arizona, California and South Dakota to GCI Health Care Centers,
Inc. ("GCIHCC") under a master lease agreement dated as of June 30, 1992 (the
"GCIHCC Lease"). Pursuant to Section 9.15A of the Acquisition Agreement, HRPT
the consent of HRPT is required in order to permit the Distribution, Merger
and related transactions (the "HRPT Consent"). As a condition to granting the
HRPT Consent and in consideration of HRPT releasing the Company and its
subsidiaries (other than New GranCare and its subsidiaries), which will become
subsidiaries of Vitalink following the Merger from all obligations to HRPT,
Vitalink will (a) pay a consent fee to HRPT in the amount of $10.0 million
(the "Consent Fee"), which will be reimbursed by New GranCare promptly
following the consummation of the Distribution and Merger and (b) enter into a
limited guaranty (not to exceed $15.0 million in the aggregate) which will
guaranty payment by New GranCare, AMS Properties and GCIHCC under the
Mortgages, the GCIHCC Lease, and the HRPT Loan (collectively, the "HRPT
Obligations") for so long as such obligations remain outstanding or until the
New GranCare Letter of Credit (as defined below) is drawn upon by Vitalink.
New GranCare, AMS Properties, Inc. and GCIHCC will retain primary liability
for the HRPT Obligations and will retain sole liability under the HRPT
Acquisition Agreement. To support Vitalink's limited guaranty of the foregoing
obligations, New GranCare will provide an irrevocable letter of credit in the
amount of $15.0 million payable to Vitalink in the event Vitalink makes any
payments under the limited guaranty (the "New GranCare Letter of Credit"). New
GranCare has also agreed that for so long as Vitalink's limited guaranty is in
effect, New GranCare will not terminate any of the Supply Agreements. As a
result, it is anticipated that the pharmaceutical supply agreements may extend
through December 31, 2010, the date when all present HRPT Obligations will be
satisfied, unless the New GranCare Letter of Credit is drawn upon earlier by
Vitalink or certain other conditions are satisfied. See "The Distribution--
Terms of the Pharmaceutical Supply Agreements."
 
EXPENSES
 
  New GranCare (on behalf of itself and the Company) and Vitalink will each be
responsible for one-half of the total documented fees, expenses and other
items of cost (other than legal fees) which are incurred by New GranCare, the
Company and Vitalink in connection with the consummation of the various
transactions contemplated by the Distribution Agreement, the Merger Agreement
and the various other agreements contemplated thereby (the "Shared Transaction
Expenses"). The Shared Transaction Expenses include various commitment and
related fees incurred in connection with the New Credit Facility, the
redemption premium that will be incurred in connection with the redemption of
the Convertible Debentures and any premium that may be paid in connection with
a tender offer of, or consent solicitation pertaining to, the 9 3/8% Notes,
various consent fees incurred by New GranCare and the Company, financial
advisory and investment banking fees, accounting fees, the cost of maintaining
the Company's directors' and officers' liability insurance coverage for a
three year
 
                                      38
<PAGE>
 
period following the Effective Time of the Merger and miscellaneous fees and
expenses such as printing fees and filing fees that will be payable to various
federal and state regulatory authorities. The Company estimates that the fees
and expenses constituting Shared Transaction Expenses will approximate $22.0
million. In addition to the Shared Transaction Expenses, the Company estimates
that the Transactions will result in an additional $19.0 million of expenses
which will be incurred by the Company.
 
CONDITIONS
 
  The Merger Agreement requires, as a condition to the consummation of the
Merger, shareholder approval of the Distribution. The completion of the
Distribution is also a condition to the consummation of the Merger and the
Company does not presently intend to consummate the Distribution unless and
until all of the conditions to the consummation of the Merger (other than the
completion of the Distribution) have been satisfied. The consummation of the
Merger is subject to a number of conditions set forth in the Merger Agreement.
See "The Merger Agreement--Conditions" in the Proxy Statement/Prospectus.
 
TERMS OF THE DISTRIBUTION AGREEMENT
 
  Simultaneously with the execution of the Merger Agreement between Vitalink
and the Company, New GranCare and the Company executed the Distribution
Agreement. Following the Merger of the Company into Vitalink, Vitalink will
succeed to the Company's obligations arising pursuant to the Distribution
Agreement by operation of law. The Distribution Agreement provides a general
framework for allocating the Company's assets and liabilities pursuant to the
Internal Restructuring Plan (attached as Exhibit A to the Distribution
Agreement) to segregate the Skilled Nursing Business from the Institutional
Pharmacy Business prior to the Distribution Date in preparation for the
Distribution and Merger. The Distribution Agreement also sets forth the
general terms on which the Company will conduct its business prior to the
Distribution Date as well as the terms regarding certain relationships between
Vitalink and New GranCare following the Distribution.
 
  The Distribution Agreement provides that the Distribution will be effected
by distributing to each holder of Company Common Stock as of the close of
business on the Distribution Date certificates representing one share of New
GranCare Common Stock for each share of Company Common Stock held by such
holder as of such time. See "--Manner of Effecting the Distribution."
 
  The Distribution Agreement provides that prior to the Distribution Date all
intercompany accounts existing between the Company and any of its subsidiaries
(other than the Pharmacy Subsidiaries), on the one hand, and the Pharmacy
Subsidiaries, on the other hand, will be netted out, in each case in such
manner and amount as may be agreed to in writing by duly authorized
representatives of the Company, Vitalink and New GranCare. It is expected that
a resulting net balance will be due from the Pharmacy Subsidiaries to the
Company and certain of the Company's other subsidiaries. The amount of such
net balance due shall be contributed by the Company or the appropriate
subsidiaries of the Company to which such amount is owing, to the appropriate
Pharmacy Subsidiaries as additional capital.
 
  The Distribution Agreement also provides for the payment by Vitalink of the
costs of purchasing the 9 3/8% Notes tendered in the tender offer undertaken
by the Company with respect to such notes and for the assumption by Vitalink
(as part of the Merger) of the Company's outstanding indebtedness associated
with the Institutional Pharmacy Business and the 9 3/8% Notes not tendered in
the tender offer. See "-- Treatment of Certain Indebtedness." In connection
therewith, the Company will make an offsetting payment to Vitalink. The
offsetting payment will be determined pursuant to a formula under which the
Company will make a payment to Vitalink in an amount based on the excess of
(i) the amount of indebtedness assumed or incurred by Vitalink by operation of
law in the Merger (currently estimated to be $118.0 million including the
Consent Fee) over (ii) the sum of $88.4 million plus the acquisition price of
any institutional pharmacy business acquired by the Company subsequent to June
1, 1996 (currently estimated to be $7.9 million) plus certain cash and cash
equivalents held by TeamCare. This payment will be further adjusted to ensure
that each party shares equally the Shared Transaction Expenses. This formula
is designed to ensure that Vitalink emerges from the Distribution and Merger
with a predetermined amount of net debt (assumed or incurred indebtedness
offset by cash, cash equivalents and new assets).
 
                                      39
<PAGE>
 
  The Distribution Agreement provides that from and after the Distribution
Date, Vitalink will indemnify, defend and hold harmless New GranCare and its
subsidiaries as well as the directors and officers of New GranCare and the
various New GranCare subsidiaries (collectively, the "New GranCare
Indemnitees") from and against all losses arising out of or relating to (i)
the Institutional Pharmacy Liabilities (as defined in the Distribution
Agreement), (ii) any breach, whether before or after the Distribution Date, by
the Company or the Pharmacy Subsidiaries of any provision of the Distribution
Agreement or any Ancillary Agreement (as defined in the Distribution
Agreement) and (iii) the Proxy Statement/Prospectus to the extent that any
such loss relates to or arises out of information contained in the Proxy
Statement/Prospectus that specifically relates to Vitalink.
 
  Following the Distribution Date, New GranCare has agreed pursuant to the
Distribution Agreement to indemnify, defend and hold harmless, the Company,
each Pharmacy Subsidiary, and the directors and officers of the Company and
the Pharmacy Subsidiaries from and against losses arising out of or resulting
from (i) the Skilled Nursing Liabilities (as defined in the Distribution
Agreement), (ii) the breach, whether before or after the Distribution Date, by
New GranCare or any New GranCare subsidiary, of any provision of the
Distribution Agreement or any Ancillary Agreement, (iii) any claims arising
out of this Prospectus or the Registration Statement of which this Prospectus
is a part, and (iv) the Proxy Statement/Prospectus to the extent that such
loss relates to or arises out of information contained in the Proxy
Statement/Prospectus that specifically relates to New GranCare or the Company.
See "The Merger Agreement--Indemnification; Insurance" in the Proxy
Statement/Prospectus for information regarding Vitalink's indemnification
obligations arising pursuant to the Merger Agreement.
 
  For a period of three years following the Effective Time of the Merger,
Vitalink will maintain in effect the Company's policies of directors' and
officers' liability insurance with respect to claims arising from facts or
events occurring prior to the Effective Time of the Merger. The cost of
maintaining such coverage in effect is a Shared Transaction Expense. See "--
Expenses." Notwithstanding the foregoing, if during such three year "tail"
period, premiums for such coverage increase by more than 150% of the annual
premiums paid as of the date of the Merger Agreement, Vitalink is only
required to obtain the maximum amount of directors' and officers' liability
insurance coverage as can then be purchased for an annual premium equal to
150% of the annual premium being paid by the Company as of the date of the
Merger Agreement.
 
  The Company will maintain in effect through the Distribution Date all
insurance that was in force as of the date of execution of the Distribution
Agreement. Following the Distribution Date, Vitalink shall be responsible for
providing such insurance coverage as it may deem appropriate with respect to
the assets and business of the Institutional Pharmacy Business. Similarly, New
GranCare shall be responsible for maintaining such insurance coverage as it
deems appropriate with respect to the assets and business of the Skilled
Nursing Business. Following the Distribution Date, New GranCare shall retain
the responsibility for administering any and all insurance claims asserted
prior to the Distribution Date with respect to the Institutional Pharmacy
Business or the Skilled Nursing Business. In such capacity, New GranCare shall
also be responsible for any premiums, deductibles and retentions in respect of
such insurance policies and the cost of any such claims shall be the sole
responsibility and obligation of New GranCare. Any resulting actuarial gains
or losses relating to pre-Distribution Date claims shall inure solely to New
GranCare.
 
  Following the Distribution Date, Vitalink shall file with New GranCare all
claims asserted subsequent to the Distribution Date that relate to occurrences
prior to the Distribution Date arising out of or in connection with the
Institutional Pharmacy Business and New GranCare shall be responsible for
notifying the appropriate insurance carrier and providing Vitalink with copies
of all correspondence relating to such notification. Thereafter, Vitalink
shall be responsible for administering all such claims wherein New GranCare is
not named as a co-defendant. To the extent that both New GranCare and Vitalink
are co-defendants in any such claim, each party will be entitled to direct its
own defense at its own cost. New GranCare shall be responsible for
administering all insurance proceeds received pursuant to insurance coverage
in effect prior to the Distribution Date and shall pay such proceeds, as
appropriate, to Vitalink with respect to Institutional Pharmacy Liabilities
and retain such proceeds that relate to Skilled Nursing Liabilities except
with respect to proceeds received in respect of claims asserted prior to the
Distribution Date, which shall be retained by New GranCare.
 
                                      40
<PAGE>
 
  Prior to the consummation of the Merger, the Distribution Agreement may only
be amended with the consent of the Company, New GranCare and Vitalink.
 
TERMS OF EMPLOYEE BENEFITS AGREEMENT
 
  On the Distribution Date, the Company and New GranCare will execute and
deliver the Employee Benefits Agreement pursuant to which the responsibility
for the rights and claims of employees of the Skilled Nursing Business and the
Institutional Pharmacy Business will be allocated. The Employee Benefits
Agreement provides that New GranCare will assume all of the Company's tax
qualified plans which include a 401(k) plan as well as the AMS Pension Plan
(the termination of which was approved by the Board of Directors of the
Company at the September 17, 1996 meeting of the Board of Directors).
Following the Merger, the employees of the Institutional Pharmacy Business
will be able to participate in a separate 401(k) plan sponsored by Vitalink
into which New GranCare will transfer the assets relating to the accounts of
such employees. New GranCare will also assume the Company's self-funded health
and dental plans including all "run-out liability" attributable to the
Company's participants who are employees of the Institutional Pharmacy
Business. The Company will retain certain insured welfare plans relating
specifically to employees of the Institutional Pharmacy Business.
 
  The Company will retain all existing non-qualified benefit plans and New
GranCare will adopt new non-qualified plans and assume the liability for all
employees of the Skilled Nursing Business who release the Company from
liability under existing plans. The Company will cause the existing rabbi
trust funding benefit entitlements under such plans to transfer to a new rabbi
trust established by New GranCare a proportionate part of the assets in the
existing trust to fund benefit entitlements of New GranCare employees. Rabbi
trusts are irrevocable with respect to assets contributed to the trust, except
in the case of bankruptcy, in which case assets contributed to the trust are
subject to and become a part of the bankruptcy estate of the settlor. New
GranCare will also adopt new flexible spending accounts as well as a
replacement executive life insurance plan.
 
  The Company will amend its existing incentive equity plans to provide that
the Distribution will not cause a termination of employment with respect to
outstanding stock grants. New GranCare will adopt certain new incentive equity
plans and will grant to each holder of a Company Option as of the Distribution
Date an option to purchase an equivalent number of shares of New GranCare
Common Stock. The exercise price of each Company Option will be allocated
between the New GranCare Options and the Adjusted Company Options pursuant to
the formula described above. As a consequence of the Merger, all outstanding
Adjusted Company Options and the relevant exercise prices thereof will be
converted at the Exchange Ratio such that following the Merger such options
will be exercisable for shares of Vitalink Common Stock. See "--Consummation
of the Distribution; Treatment of Company Stock Options."
 
  The annual performance goals under the Company's annual incentive bonus plan
will be adjusted to reflect the Distribution and the annual incentive bonus
plan will be amended to provide that the Distribution will not cause a
termination of employment for purposes of such plan. Similarly, the Company's
Shareholder Value Program (as defined hereafter) will be amended to provide
that the Distribution will not be deemed to cause a termination of employment.
However, the consummation of the Merger will constitute a change of control
which will cause an acceleration of the payouts under such plans. See
"Management--Long Term Incentive Plans; Awards in Last Fiscal Year."
 
  The Employee Benefits Agreement provides that New GranCare will offer
employment agreements to each employee of the Company who is a party to an
employment agreement as of the Distribution Date other than those specified
employees who will become employees of Vitalink following the Merger. Any New
GranCare employee executing a new employment agreement will simultaneously
release the Company from any liability under such employee's prior agreement.
Any employee that does not execute an appropriate release and asserts a claim
for payment under his or her existing employment agreement will be paid such
amounts as are required to be paid under such agreement and such agreement
will not be replaced or superseded. It is anticipated that any employee of the
Skilled Nursing Business who asserts a claim for payment under his or her
existing employment agreement will not be offered employment with New GranCare
following the completion of the Distribution and the Merger. See "Management--
Compensation of Executive Officers--Employment Agreements."
 
                                      41
<PAGE>
 
  New GranCare employees will be given full credit for service with the
Company and its affiliates for purposes of determining benefit entitlements
under benefit plans sponsored by New GranCare. Any benefit plans not
specifically addressed in the Employee Benefits Agreement will be assumed by
New GranCare.
 
TERMS OF THE NON-COMPETITION AGREEMENT
 
  In connection with the Distribution and the Merger, Manor Care, Vitalink and
New GranCare will enter into a Non-competition Agreement whereby Manor Care
and New GranCare will agree not to engage in the institutional pharmacy
business within the United States during the three year term of such agreement
except temporarily in connection with future acquisitions of skilled nursing
businesses that have an established pharmacy operation imbedded in the
acquired skilled nursing business. Similarly, Vitalink will agree not to
engage in the skilled nursing business during the three year term of such
agreement.
 
  In the event that Manor Care or New GranCare shall, during the term of the
Non-competition Agreement, acquire a skilled nursing business that has as a
component, a pharmacy operation, the acquiror must offer to sell such pharmacy
operation to Vitalink at a purchase price not to exceed 120% of the product of
(i) EBITDA for such pharmacy component of the acquisition and (ii) a fraction,
the numerator of which is the aggregate purchase price for the proposed
acquisition and the denominator of which is the EBITDA for the proposed
acquisition taken as a whole. If the parties do not agree on a purchase price
for such pharmacy operations, then the acquiror (Manor Care or New GranCare,
as appropriate) may complete the proposed acquisition but must use its
commercially reasonable efforts to divest the pharmacy operations so acquired
within one year. Any sale of such pharmacy operations to a third party must be
at a purchase price that is equal to or greater than the formula purchase
price referenced above. If the proposed sale to a third party is at a price
less than the price derived pursuant to the formula purchase price discussed
above then Vitalink shall have a right of first refusal at such lesser price.
 
  In the event Vitalink acquires a skilled nursing business in conjunction
with the acquisition of a pharmacy business, Vitalink must use its
commercially reasonable efforts to divest itself of such skilled nursing
business within one year.
 
TERMS OF SHAREHOLDERS AGREEMENT
 
  As of the Effective Time of the Merger, Vitalink and Manor Care will execute
the Shareholders Agreement which provides for continuity in the composition of
the Vitalink Board of Directors during the three year term of such agreement.
Manor Care is currently the beneficial owner of approximately 82.3% of the
issued and outstanding Vitalink Common Stock. Following completion of the
Merger, Manor Care will be the beneficial owner of approximately 45% of the
issued and outstanding Vitalink Common Stock.
 
  During the term of the Shareholders Agreement, Manor Care will vote all
shares of Vitalink Common Stock beneficially owned by Manor Care in favor of
four nominees designated by the Company prior to the Merger (the "Company
Nominees"). The Company has nominated Gene E. Burleson, Joel S. Kanter, Gary
U. Rolle and Robert L. Parker as the Company's Nominees. Following the
Effective Time of the Merger, Manor Care will vote its Vitalink Common Stock
in favor of any successor to any Company Nominee designated by a majority of
the then remaining Company Nominees. Any vacancy on the Vitalink Board of
Directors created by the departure of a Company Nominee will be filled by the
nominee selected by a majority of the then remaining Company Nominees.
 
  Pursuant to the Shareholders Agreement, Manor Care has also agreed that it
will not vote its shares of Vitalink Common Stock in favor of the removal of a
Company Nominee unless requested to do so by a majority of the Company
Nominees. Furthermore, during the term of such agreement, Manor Care will vote
its shares of Vitalink Common Stock in favor of the removal of any director if
such removal is for cause and is recommended by a majority of Vitalink's
directors.
 
                                      42
<PAGE>
 
  The Shareholders Agreement also requires Manor Care to limit sales of its
Vitalink Common Stock to (i) sales complying with the volume limitations set
forth in Rule 144 under the Securities Act, (ii) sales pursuant to a
registered secondary offering, (iii) private sales in an amount not in excess
of 10% of the total number of shares of issued and outstanding Vitalink Common
Stock and (iv) private sales in an amount in excess of 10% of the total number
of shares of issued and outstanding Vitalink Common Stock if the purchaser
thereof becomes a party to the Shareholders Agreement.
 
TERMS OF THE INTERIM SERVICES AGREEMENT
 
  Prior to the Distribution Date, New GranCare and the Company will execute
the Interim Services Agreement which establishes a framework for New GranCare
to provide to Vitalink, as the successor to the Company following the
Effective Time of the Merger, certain services as may be requested by Vitalink
to ensure an orderly transition. The contemplated services are generally
expected to be those that were historically provided by the Company on a
centralized basis to the Institutional Pharmacy Business such as cash
management, compensation and benefits, management information systems and
legal. The term of the agreement is for one year unless earlier terminated by
mutual agreement. New GranCare shall be reimbursed for all direct and indirect
costs and expenses incurred in connection with providing any services as well
as the allocated portion of the base salaries of the New GranCare employees
actually providing services.
 
TERMS OF THE PHARMACEUTICAL SUPPLY AGREEMENTS
 
  Substantially all of the New GranCare facilities existing prior to the
Effective Time of the Merger have entered into Pharmaceutical Supply
Agreements (the "Supply Agreements") with TeamCare. The terms of such
agreements are for five years and are automatically extended for an additional
year on each anniversary of the commencement date thereof unless written
notice to the contrary is given not more than 120 days and not less than 90
days prior to any such anniversary. The supplies and services to be provided
pursuant to such agreements include all pharmaceutical and related goods
required by each New GranCare facility and the residents thereof.
Pharmaceutical supplies include prescription and non-prescription medications.
Related goods include all nutritional supplements, intravenous solutions and
supplies, parenteral and enteral supplies and equipment, orthotic and
prosthetic devices, ostomy supplies, urological supplies, wound care supplies
and equipment, and personal care items. All goods and services are to be
provided in accordance with all applicable requirements of federal, state and
local laws and regulations.
 
  Depending upon the payor source, either TeamCare will bill the payor source
directly or the skilled nursing facility will bill the payor source and then
pay TeamCare. In the event that TeamCare does not service at least 90% of the
residents of a skilled nursing facility during a given month, the skilled
nursing facility will pay to TeamCare an additional $10 per month for each
resident not serviced by TeamCare; provided, however, that if TeamCare has
elected not to furnish pharmaceutical goods or related goods for any resident,
such resident will be disregarded for purposes of this calculation.
 
  New GranCare cannot transfer ownership or control of a skilled nursing
facility during the term of the Supply Agreement relating to such facility
unless and until the proposed transferee (i) agrees to accept and comply with
the Supply Agreement or (ii) an agreement is reached between TeamCare and New
GranCare for the payment of damages by New GranCare to TeamCare to compensate
TeamCare for losses over the remaining term of the subject Supply Agreement.
 
  In the event of a material breach by TeamCare of its obligations under the
terms of the Supply Agreement, New GranCare must give TeamCare written notice
detailing such breach and TeamCare will have 30 days in which to cure any such
alleged breach. If TeamCare fails to cure the alleged breach within such time,
New GranCare may obtain services from another pharmacy provider; provided,
however, that TeamCare may, in its discretion, contest the allegation of
breach via arbitration as specified within the Supply Agreement. In the event
that it is determined that TeamCare has not committed a material breach of its
duties under the Supply Agreement, New GranCare shall
 
                                      43
<PAGE>
 
be liable to TeamCare for the net revenue lost by TeamCare as a result of New
GranCare and/or New GranCare's residents having obtained goods and/or services
from another pharmacy provider.
 
   Upon any subsequent acquisition by New GranCare of a skilled nursing
business, New GranCare shall have no obligation to contract with Vitalink or
TeamCare to provide pharmaceutical supplies and services at such facility and
New GranCare will not be required to terminate any then existing agreements
providing for the provision of pharmaceutical supplies and services to such
facility by an alternative supplier. See "--Non-competition Agreement" for a
description of New GranCare's obligations upon acquiring a skilled nursing
business that includes a pharmacy operation. Notwithstanding the foregoing, it
is New GranCare's intent to consolidate its requirements for pharmaceutical
supplies and services with Vitalink or TeamCare for so long as Vitalink and
TeamCare are viewed as superior providers based on prevailing industry
standards including, without limitation, pricing, service and quality. In
addition, New GranCare has agreed that for so long as Vitalink's limited
guaranty of certain obligations of the HRPT Obligations is in effect, New
GranCare will not terminate any of the Supply Agreements. It is anticipated
that the Supply Agreements may extend through December 31, 2010, the date when
all present HRPT Obligations will be satisfied, unless the New GranCare Letter
of Credit is drawn upon earlier by Vitalink or certain other conditions are
satisfied. See "The Distribution--Treatment of Certain Indebtedness--HRPT
Obligations."
 
TERMS OF THE VOTING AGREEMENT
 
  The Company and Manor Care have entered into a Voting Agreement dated as of
September 3, 1996. The Voting Agreement requires Manor Care to vote its
approximate 82.3% of the issued and outstanding Vitalink Common Stock in favor
of the Merger.
 
TERMS OF THE TAX ALLOCATION AGREEMENT
 
  In connection with the Distribution, the Company, New GranCare and their
respective subsidiaries will enter into the Tax Allocation Agreement, which
sets forth each party's rights and obligations with respect to the allocation
and payment of tax liabilities and entitlements to refunds, if any, for any
federal, state, local or foreign taxes for periods before and after the
Effective Time of the Merger. The Tax Allocation Agreement also provides for
related matters such as the allocation of responsibility and the provision for
cooperation in connection with the preparation and filing of any tax returns
and the conduct of proceedings related to taxes and certain other matters.
 
  In general, the Tax Allocation Agreement provides for the allocation and
payment (or reimbursement) with respect to the following: (a) any and all
taxes resulting from the failure of the Distribution to qualify as a tax-free
reorganization and distribution within the meaning of Sections 368(a)(1)(D)
and 355 of the Code, as well as any claims resulting therefrom,
("Restructuring Taxes"); (b) the loss resulting from the disallowance of a tax
deduction for payments made to certain employees which are classified as
"excess parachute payments" under the provisions of Section 280G of the Code
("Lost Parachute Payment Tax Benefits"); (c) the tax benefit resulting from
the exercise of an Adjusted Company Option or a New GranCare Option, or the
disqualifying disposition of the stock received upon such exercise by an
employee ("Stock Option Tax Benefits"); and (d) all other taxes ("Other
Taxes"). The Tax Allocation Agreement also assigns to the parties to the
agreement responsibility for preparing tax returns (generally, with limited
exception, New GranCare will be responsible for preparing all consolidated or
combined tax returns which include the Company and/or any of its subsidiaries
for any period which ends on or before the Distribution Date), and defines the
parties' rights and responsibilities with respect to the carryback of losses
after the Distribution Date to taxable periods ending on or before the
Distribution Date (generally, New GranCare may carryback only those losses
which it is required to carryback by law and may carry back certain capital
losses to periods during which it was a member of a group of corporations that
filed a consolidated or combined return that included the Company or any of
its subsidiaries after the Distribution Date). The Tax Allocation Agreement
also provides that to the extent one of the parties to the Tax Allocation
Agreement is responsible (as set forth below) for any liability covered under
such agreement, that party shall indemnify and hold the other parties to the
Tax Allocation Agreement harmless from such liability.
 
  Under the Tax Allocation Agreement, Vitalink, as the successor to the
Company following the Merger is responsible for (i) any and all liability
which might arise for Restructuring Taxes if Vitalink or any of the Company's
subsidiaries after the Distribution Date (the "Post Distribution Vitalink
Group") undertakes or fails
 
                                      44
<PAGE>
 
to undertake one or more specified acts (a "Vitalink Tainting Act"), provided
that New GranCare or any of its subsidiaries after the Distribution (the "New
GranCare Group") has not previously undertaken or failed to undertake one or
more specified acts (a "New GranCare Tainting Act"), (ii) any and all
liability which might arise for Restructuring Taxes if the Post Distribution
Vitalink Group undertakes or fails to undertake an act (other than a Vitalink
Tainting Act) which gives rise to such liability for Restructuring Taxes,
provided that the New GranCare Group has neither committed a New GranCare
Tainting Act nor taken an act or failed to take an act (other than a New
GranCare Tainting Act) which gives rise to such liability for Restructuring
Taxes, (iii) one- half ( 1/2) of any and all liability for Restructuring Taxes
that arise due to a retroactive change in the law, provided that there is a
complete absence of Vitalink Tainting Acts and New GranCare Tainting Acts, and
a complete absence of any other acts or failures to act (other than Vitalink
Tainting Acts and New GranCare Tainting Acts) by both the Post Distribution
Vitalink Group and the New GranCare Group which give rise to such liability
for Restructuring Taxes, (iv) one-half ( 1/2) of any and all liability for
Restructuring Taxes, but not in excess of $10.0 million, if the liability for
Restructuring Taxes is the result of either multiple acts or failures to act
(other than Vitalink Tainting Acts and New GranCare Tainting Acts) by both the
Post Distribution Vitalink Group and the New GranCare Group which give rise to
such liability for Restructuring Taxes or there is a complete absence of any
acts or failures to act (including Vitalink Tainting Acts and New GranCare
Tainting Acts) and the liability for Restructuring Taxes is not the result of
a retroactive change in the law, (v) paying to New GranCare the Lost Parachute
Tax Benefits to the extent that such Lost Parachute Tax Benefits relate to
payments made to Gene E. Burleson or Arlen Reynolds if such payments would
have been deductible, but for the provisions of Code Section 280G, on or
before the closing, (vi) paying to New GranCare the Stock Option Tax Benefits
to the extent that such Stock Option Tax Benefits arise as a result of the
exercise of a stock option with respect to New GranCare Stock by an employee
of the Post Distribution Vitalink Group, or the disqualifying disposition by
such employee of such stock, and (vii) any and all liability for Other Taxes
of the Post Distribution Vitalink Group to the extent those Other Taxes are
allocable to any period or portion thereof beginning after the Distribution
Date.
 
  Under the Tax Allocation Agreement, New GranCare is responsible for (i) any
and all liability which might arise for Restructuring Taxes if any member of
the New GranCare Group commits a New GranCare Tainting Act, provided that the
Post Distribution Vitalink Group has not previously committed a Vitalink
Tainting Act, (ii) any and all liability which might arise for Restructuring
Taxes if the New GranCare Group undertakes or fails to undertake an act (other
than a New GranCare Tainting Act) which gives rise to such liability for
Restructuring Taxes, provided that the Post Distribution Vitalink Group has
neither committed a Vitalink Tainting Act nor taken an act or failed to take
an act (other than a Vitalink Tainting Act) which gives rise to such liability
for Restructuring Taxes, (iii) one-half ( 1/2) of any and all liability for
Restructuring Taxes that arise due to a retroactive change in the law,
provided that there is a complete absence of Vitalink Tainting Acts and New
GranCare Tainting Acts, and a complete absence of any other acts or failures
to act (other than Vitalink Tainting Acts and New GranCare Tainting Acts) by
both the Post Distribution Vitalink Group and the New GranCare Group which
give rise to such liability for Restructuring Taxes, (iv) one-half ( 1/2) of
the first $20.0 million of any and all liability for Restructuring Taxes, plus
all liability for such Restructuring Taxes that are in excess of $20.0
million, if the liability for Restructuring Taxes is the result of either
multiple acts or failures to act (other than Vitalink Tainting Acts and New
GranCare Tainting Acts) by both the Vitalink Post Distribution Group and the
New GranCare Group which give rise to such liability for Restructuring Taxes
or there is a complete absence of any acts or failures to act (including
Vitalink Tainting Acts and New GranCare Tainting Acts) and the liability for
Restructuring Taxes is not the result of a retroactive change in the law,
(v) paying to Vitalink the Lost Parachute Tax Benefits to the extent that such
Lost Parachute Tax Benefits relate to payments made to employees of the post
Spin-Off post Distribution Vitalink or its subsidiaries, other than Gene E.
Burleson or Arlen Reynolds, if such payments would have been deductible, but
for the provisions of Code Section 280G, after the closing, (vi) paying to
Vitalink the Stock Option Tax Benefits to the extent that such Stock Option
Tax Benefits arise as a result of the exercise of a stock option with respect
to the Vitalink Common Stock by an employee of the New GranCare Group, or the
disqualifying disposition by such employee of such stock, (vii) any and all
liability for Other Taxes of the Company or any of its subsidiaries (prior to
the Distribution) to the extent those Other Taxes are allocable to any period
or portion thereof ending on or before
 
                                      45
<PAGE>
 
the Distribution Date, and (viii) any and all liability for Other Taxes of the
New GranCare Group to the extent those Other Taxes are allocable to any period
or portion thereof beginning after the Distribution Date.
 
                    CERTAIN FEDERAL INCOME TAX CONSEQUENCES
 
  The following is a summary of certain material federal income tax
consequences of the Distribution and the Merger to the holders of Company
Common Stock. The federal income tax discussion set forth below is for general
information only and may not apply to particular categories of holders of
Company Common Stock who are subject to special treatment under the Code,
including, without limitation, foreign holders and holders whose Company
securities were acquired pursuant to the exercise of any employee stock option
or otherwise as compensation. EACH HOLDER OF COMPANY COMMON STOCK IS URGED TO
CONSULT HIS TAX ADVISOR AS TO THE SPECIFIC TAX CONSEQUENCES TO HIM OF THE
DISTRIBUTION, AND THE MERGER, INCLUDING THE APPLICATION AND EFFECT OF STATE,
LOCAL AND FOREIGN INCOME AND OTHER TAX LAWS.
 
CONSEQUENCES OF THE DISTRIBUTION
 
  GranCare has received an opinion from Powell, Goldstein, Frazer & Murphy LLP
("Counsel"), to the effect that, based upon certain assumptions, and upon the
representations of the management of GranCare and New GranCare, as to certain
facts, for federal income tax purposes:
 
    1. The Distribution of New GranCare Common Stock will be tax-free for
  federal income tax purposes to the Company under Section 355(c)(1) of the
  Code and to Company shareholders under Section 355(a) of the Code.
 
    2. The Restructuring will be tax-free for federal income tax purposes
  under Sections 361(a)(1) and 368(a)(1)(D) of the Code.
 
 
  Current Treasury Regulations require that each Company shareholder who
receives New GranCare Common Stock pursuant to the Distribution attach to his
or her federal income tax return for the year in which the Distribution occurs
a detailed statement setting forth such information as may be appropriate in
order to demonstrate the applicability of Section 355 of the Code to the
Distribution. The Company or its successor, Vitalink, will convey the
appropriate information to each Company shareholder of record as of the
Distribution Record Date.
 
CONSEQUENCES OF THE MERGER TO THE COMPANY, VITALINK AND THE COMPANY
SHAREHOLDERS
 
  Immediately after the Distribution, the Company will merge with and into
Vitalink pursuant to the Merger Agreement, and the Company will, prior to the
Distribution and the Merger, receive an opinion from Counsel to the effect
that, based upon certain assumptions, and upon the representations of the
management of GranCare and Vitalink, as to certain facts, for federal income
tax purposes:
 
    1. The Merger will qualify as a tax-free reorganization within the
  meaning of Section 368(a) of the Code.
 
    2. Vitalink and the Company will each be a "party to a reorganization"
  within the meaning of Section 368(b) of the Code with respect to the
  Merger.
 
  Counsel's opinion is based upon certain representations and assumptions and
represents Counsels' best legal judgment, and is not binding upon the Internal
Revenue Service (the "IRS") or the courts. If any representation or assumption
relied upon in rendering Counsel's opinion with respect to the Distribution is
materially inaccurate, or if the IRS were to challenge successfully the
federal income tax treatment of the Distribution set forth in Counsel's
opinion, then, in general, although not entirely free from doubt, for federal
income tax
 
                                      46
<PAGE>
 
purposes it is likely that (i) each Company shareholder would be required to
recognize income or gain on the receipt of the shares of New GranCare Common
Stock in the Distribution in an amount up to the fair market value of the
shares of New GranCare Common Stock received in the Distribution and (ii) the
Company would be required to recognize gain on the Distribution. If the IRS
were to challenge successfully the federal income tax treatment of the Merger
set forth in Counsel's opinion, although not entirely free from doubt, it is
likely that, for federal income tax purposes, (i) each Company shareholder
would be required to recognize gain or loss equal to the difference between
the fair market value of the Vitalink shares that are received in exchange for
the Company shares in the Merger and the basis in his or her Company Common
Stock, and (ii) the Company would recognize gain or loss as if it had sold its
assets, subject to its liabilities, to Vitalink in a taxable transaction.
 
POSSIBLE FUTURE LEGISLATION
 
  The Clinton Administration's Budget Proposal issued March 19, 1996 contains
several revenue proposals, including a proposal (the "Anti-Morris Trust
Proposal") which would require a distributing corporation in a transaction
otherwise qualifying as a tax-free distribution under Section 355 of the Code
to recognize gain on the distribution of the stock of the controlled
corporation unless the direct and indirect shareholders of the distributing
corporation own more than 50 percent of the distributing corporation and
controlled corporation at all times during the four year period commencing two
years prior to the distribution. The Anti-Morris Trust Proposal would apply to
any distributions occurring after March 19, 1996, unless such distribution was
(i) pursuant to a binding contract on such date, (ii) described in a ruling
request submitted to the IRS on or before such date, or (iii) described in a
public announcement or SEC filing on or before such date.
 
  On March 29, 1996, Senator William V. Roth, Chairman of the Senate Finance
Committee and Congressman Bill Archer, Chairman of the House Ways & Means
Committee, issued a joint statement (the "Roth-Archer Statement") to the
effect that should certain of the revenue proposals included in the
Administration's Budget Proposal, including the Anti-Morris Trust Proposal, be
enacted, the effective date of such proposals will be no earlier than the date
of "appropriate Congressional action." As of the date of this Prospectus, no
legislation has been introduced relating to the Anti-Morris Trust Proposal.
There can be no assurances that Congress will not adopt Anti-Morris Trust
legislation which would apply to the Distribution.
 
BACK-UP WITHHOLDING REQUIREMENTS
 
  United States information reporting requirements and backup withholding at
the rate of 31% may apply with respect to dividends paid on, and proceeds from
the taxable sale, exchange or other disposition of Company Common Stock,
unless the shareholder (i) is a corporation or comes within certain other
exempt categories, and, when required, demonstrates these facts, or (ii)
provides a correct taxpayer identification number, certifies as to no loss of
exemption from backup withholding and otherwise complies with applicable
requirements of the backup withholding rules. A shareholder who does not
supply the Company with his, her or its correct taxpayer identification number
may be subject to penalties imposed by the Internal Revenue Service ("IRS").
Any amount withheld under these rules will be refunded or credited against the
shareholder's federal income tax liability. Shareholders should consult their
tax advisers as to their qualification for exemption from backup withholding
and the procedure for obtaining such an exemption. If information reporting
requirements apply to a shareholder, the amount of dividends paid with respect
to such shares will be reported annually to the IRS and to such shareholder.
 
  These backup withholding tax and information reporting rules currently are
under review by the United States Treasury Department and proposed Treasury
Regulations issued on April 15, 1996 would modify certain of such rules
generally with respect to payments made after December 31, 1997. Accordingly,
the application of such rules could be changed.
 
                                      47
<PAGE>
 
                                CAPITALIZATION
 
  Following the Distribution and the Merger, New GranCare will change its name
to GranCare, Inc. and will be treated as the continuation of the Company for
financial reporting purposes. See "Unaudited Pro Forma GranCare, Inc.
Financial Statements" and the consolidated financial statements of the Company
and notes thereto included elsewhere herein. The following table sets forth
the Company's historical and pro forma capitalization as of September 30, 1996
and as adjusted to give effect to the Distribution and Merger:
 
<TABLE>
<CAPTION>
                                                           SEPTEMBER 30, 1996
                                                         ----------------------
                                                         HISTORICAL AS ADJUSTED
                                                         ---------- -----------
                                                             (UNAUDITED, IN
                                                               THOUSANDS)
<S>                                                      <C>        <C>
Short-term debt:
  Current portion of long-term debt.....................  $  4,219   $  2,550
                                                          --------   --------
Long-term debt, less current portion:
  Credit Agreement(1)...................................  $ 88,850    159,543
  Mortgages.............................................   124,015    124,015
  6 1/2% Convertible Subordinated Debentures due
   2003(2)..............................................    60,000        --
  9 3/8% Senior Subordinated Notes due 2005(3)..........   100,000        --
  Other.................................................    12,040     12,040
                                                          --------   --------
    Total long-term debt................................  $384,905   $295,598
                                                          --------   --------
Shareholder's equity:
  Preferred Stock; 2,000,000 shares authorized as Series
   A, B, C or D; no shares outstanding..................       --         --
  Common Stock; 50,000,000 shares authorized;
   23,401,992 shares issued and outstanding(4)..........   125,401        --
  Common Stock; $0.001 par value; 50,000,000 shares
   authorized; 23,401,992 shares issued and
   outstanding(4).......................................       --          23
  Paid in capital(4)....................................       --     120,348
  Treasury stock, (200,000 shares)(5)...................    (5,030)       --
  Equity component of minimum pension liability.........      (465)      (465)
  Unrealized gain on investment, net income taxes
   ($3,963).............................................     5,747      5,747
  Retained earnings.....................................    76,021     12,292
                                                          --------   --------
  Total shareholders' equity............................  $201,674   $137,945
                                                          ========   ========
  Total capitalization..................................  $590,798   $433,543
                                                          ========   ========
Long-term debt as a percentage of total capitaliza-
 tion(6)................................................      65.2%      69.3%
</TABLE>
 
- --------
(1) The current $150 million credit facility with First Union National Bank of
    North Carolina, as agent will be repaid and replaced with a $300 million
    credit facility with First Union National Bank of North Carolina and the
    Chase Manhattan Bank which will fund required new borrowings.
(2) Will be redeemed at a redemption price of 104.55% of the principal amount
    plus accrued and unpaid interest to the date of redemption.
(3) The Company has undertaken a tender offer for the 9 3/8% Senior
    Subordinated Notes at a purchase price of 109% of the principal amount
    plus accrued and unpaid interest to the date of purchase. As a result of
    the Merger, Vitalink will succeed to the obligations of the Company with
    respect to any 9 3/8% Senior Subordinated Notes not purchased in the
    tender offer.
(4) One for one conversion of GranCare Common Stock for New GranCare Common
    Stock.
(5) Cancellation and retirement of GranCare Common Stock held in treasury
    immediately prior to the conversion for New GranCare Common Stock.
(6) See "Risk Factors--Significant Debt and Lease Obligations."
 
 
                                      48
<PAGE>
 
                                DIVIDEND POLICY
 
  New GranCare does not expect to pay any dividends for the foreseeable
future. Rather, New GranCare expects that it will reinvest any earnings into
funding future acquisitions and growth. Any future payments of dividends and
the amount thereof will be dependent upon New GranCare's results of
operations, financial condition, cash requirements, future prospects and other
factors deemed relevant by the Board of Directors of New GranCare from time to
time.
 
            UNAUDITED PRO-FORMA GRANCARE, INC. FINANCIAL STATEMENTS
 
  GranCare, Inc. ("GranCare") has entered into an Agreement and Plan of Merger
between Vitalink Pharmacy Services, Inc. ("Vitalink") and GranCare dated as of
September 3, 1996, as amended. The form of the proposed transactions are: (1)
GranCare's skilled nursing facilities, along with this contract management and
home health businesses are to be reorganized into New GranCare, Inc. ("New
GranCare") all of the shares of common stock of New GranCare distributed to
the GranCare shareholders in a tax-free spin-off; (2) GranCare (then
consisting solely of the institutional pharmacy and related business known as
TeamCare) would merge into and be acquired by Vitalink through a tax-free
exchange of shares of common stock of Vitalink for shares of common stock of
GranCare; and (3) New GranCare would become a public company upon the
effectiveness of its initial registration statement. Notwithstanding the legal
structure of the proposed transactions, for accounting/financial reporting
purposes such transactions will be treated as the spin-off of TeamCare in the
form of a dividend of the Vitalink Common Stock to be received and
reorganization/recapitalization of GranCare into New GranCare as New GranCare
will continue the majority of the GranCare businesses. New GranCare will
change its name to and be treated as the continuation of GranCare. No gain
will be recognized as a result of the Distribution for the difference between
the market value of the Vitalink Common Stock received and the carrying value
of the net assets of TeamCare. New GranCare will continue to reflect the
historical cost basis of assets and liabilities of the Company. The closing
under the Merger Agreement is subject to a number of conditions, including
approval of GranCare's shareholders. The accompanying unaudited pro-forma
balance sheet at September 30, 1996 gives effect to the transactions as if
they occurred at that date. The accompanying unaudited income statements for
the year ended December 31, 1995 and for the nine months ended September 30,
1996 give effect to the transactions as if they occurred on January 1, 1995.
The unaudited pro forma financial statements are not necessarily indicative of
the operating results that would have been achieved had the spin-off and
reorganization/ recapitalization been consummated as of those dates, nor are
they necessarily indicative of future operating results. The unaudited pro-
forma financial statements should be read in conjunction with the consolidated
financial statements of GranCare and the related notes thereto.
 
                                      49
<PAGE>
 
                                 GRANCARE, INC.
                 PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
                               SEPTEMBER 30, 1996
                             (DOLLARS IN THOUSANDS)
                                  (UNAUDITED)
 
<TABLE>
<CAPTION>
                                          PRO FORMA ADJUSTMENTS
                          ---------------------------------------------------------
                           GRANCARE    TEAMCARE    OTHER PRO FORMA   GRANCARE
                          HISTORICAL HISTORICAL(1)   ADJUSTMENTS     PRO FORMA
                          ---------- ------------- ---------------   ---------
<S>                       <C>        <C>           <C>               <C>        <C>
         ASSETS
Current assets:
  Cash and cash
   equivalents..........   $ 25,750    $    (868)     $ 88,628 (3)   $ 34,882
                                                        84,772 (6a)
                                                      (160,000)(6b)
                                                        (3,400)(6b)
  Accounts receivable,
   less allowance for
   doubtful accounts....    218,529      (47,099)          --         171,430
  Inventories...........     17,833      (15,573)          --           2,260
  Prepaid expenses and
   other current
   assets...............     41,034       (2,749)          --          38,285
  Deferred income
   taxes................     11,599       (3,338)        3,800 (7)     13,543
                                                         1,482 (8)
                           --------    ---------      --------       --------
Total current assets....    314,745      (69,627)       15,282        260,400
Property and equipment..    276,441      (28,150)          --         248,291
  Less accumulated
   depreciation.........    (67,111)      14,706           --         (52,405)
                           --------    ---------      --------       --------
                            209,330      (13,444)          --         195,886
Other assets:
  Investments, at fair
   value................     36,359          --            --          36,359
  Goodwill..............    129,863      (75,621)          --          54,242
  Other intangibles.....      8,573       (1,930)          --           6,643
  Other.................     39,068       (3,711)       39,015 (2)     31,458
                                                       (88,628)(3)
                                                        84,725 (4)
                                                       (35,112)(5)
                                                        (3,899)(8)
                           --------    ---------      --------       --------
Total assets............   $737,938    $(164,333)     $ 11,383       $584,988
                           ========    =========      ========       ========
    LIABILITIES AND
  SHAREHOLDERS' EQUITY
Current liabilities:
  Accounts payable and
   accrued expenses.....   $ 84,291    $ (19,921)     $    --        $ 64,370
  Merger costs payable..        --           --         30,000 (7)     30,000
  Accrued wages and
   related liabilities..     20,461       (4,362)          --          16,099
  Interest payable......      5,137         (261)          --           4,876
  Income taxes payable..      7,059          --            --           7,059
  Notes payable and
   current maturities of
   long-term debt.......      4,219       (1,669)          --           2,550
                           --------    ---------      --------       --------
Total current
 liabilities............    121,167      (26,213)       30,000        124,954
Long-term debt..........    384,905      (10,679)       84,772 (6a)   295,598
                                                      (160,000)(6b)
                                                        (3,400)(6b)
Due to/from parent......        --       (39,015)       39,015 (2)        --
Deferred income taxes...     15,628       (3,171)                      12,457
Other...................     14,564         (530)                      14,034
Commitments and
 contingencies
Shareholders' equity:
  Common stock; no par
   value................    125,401      (46,379)       46,379 (4)        --
                                                      (125,401)(9)
  Common stock; $0.001
   par value............        --           --             23 (9)         23
  Paid in capital.......        --           --        120,348 (9)    120,348
  Treasury stock........     (5,030)         --          5,030 (9)        --
  Equity component of
   minimum pension
   liability............       (465)         --            --            (465)
  Unrealized gain on
   investments, net of
   income taxes.........      5,747          --            --           5,747
  Retained earnings.....     76,021      (38,346)       38,346 (4)     12,292
                                                       (35,112)(5)
                                                       (26,200)(7)
                                                        (2,417)(8)
                           --------    ---------      --------       --------
                            201,674      (84,725)       20,996        137,945
                           --------    ---------      --------       --------
Total liabilities and
 shareholders' equity...   $737,938    $(164,333)     $ 11,383       $584,988
                           ========    =========      ========       ========
</TABLE>
 
                                       50
<PAGE>
 
Pro Forma Adjustments:
 
Adjustments affecting assets, liabilities and shareholders' equity to reflect
dividend of TeamCare assets and liabilities pursuant to Merger:
  (1) Reflects elimination of historical stand-alone amounts of TeamCare,
  Inc.
  (2) Contribution of Teamcare due to Company amount to TeamCare capital
  (3) Retirement of debt and reduction in investment in TeamCare in relation
  to cash payment (reflecting incremental debt assumed/refinanced) received
  from Vitalink upon consummation of Merger:
 
<TABLE>
     <S>                                                               <C>
     Cash received from Vitalink upon consummation of merger:
       Agreed value of initial debt to be assumed by Vitalink........   $88,383
       Additional debt assumed for TeamCare acquisitions subsequent
        to
        June 1, 1996.................................................     7,925
       Shared transaction expense settlement amount..................       400
       TeamCare cash and cash equivalents at September 30, 1996......       868
       Retirement of Winyah debt prior to merger.....................     3,400
       Less: Existing debt on TeamCare balance sheet at September 30,
        1996.........................................................   (12,348)
                                                                       --------
         Retirement of debt upon consummation of merger/decrease in
          investment in TeamCare.....................................   $88,628
                                                                       ========
</TABLE>
 
  (4) Adjustment to investment in TeamCare to reflect net equity balance
  (5) Elimination of net investment in TeamCare reflects: TeamCare historical
  equity--$84,725; plus contribution to capital of due to GranCare balance--
  $39,015; less cash payment (incremental debt assumed/refinanced by
  Vitalink) received upon consummation of Merger--$88,628.
 
  Other Merger related adjustments:
<TABLE>
   <S>                                                                 <C>
   (6) Retirement of debt instruments and incremental borrowing under
    line of credit:
    (a) Incremental new borrowings under line of credit:
</TABLE>
<TABLE>
     <S>                                                                <C>
       Estimated Merger costs.........................................  $30,000
       Less: Amounts to be funded from current cash balances..........  (20,000)
                                                                        -------
         New borrowings under line of credit to fund Merger costs.....   10,000
       New borrowings to fund retirement of debt:
         $60 million Convertible Debentures...........................   60,000
         $100 million Senior Subordinated Notes.......................  100,000
                                                                        -------
                                                                        160,000
         Less: retirement of debt from Vitalink upon consummation of
          Merger/decrease in investment in TeamCare...................  (88,628)
                                                                        -------
         New borrowings under line of credit to fund subordinated debt
          retirement..................................................   71,372
       New borrowings under line of credit to fund retirement of
        Winyah debt...................................................    3,400
                                                                        -------
           Total new borrowings under line of credit..................   84,772
                                                                        -------
      (a) Retirement of debt:
</TABLE>
<TABLE>
     <S>                                                                <C>
       Retirement of subordinated debt:
         $60 million Convertible Debentures............................  60,000
         $100 million Senior Subordinated Notes........................ 100,000
                                                                        -------
                                                                        160,000
                                                                        -------
       Retirement of Winyah debt....................................... $ 3,400
                                                                        -------
</TABLE>
 
 
                                      51
<PAGE>
 
  (7) Accrual of estimated Merger costs, net of income tax effect (assumes
  $10,000 of total cost is deductible for tax purposes, 38% assumed tax
  rate), components of estimated Merger charge consists of the following
  (amounts to be recognized in operations of New GranCare upon consummation
  of Merger):
<TABLE>
   <S>                                                                <C>
     Shared Transaction costs:
      Redemption premium--$100 million Senior Subordinated Notes .... $ 9,000
      Redemption premium--$60 million Convertible Subordinated
       Debentures(a).................................................   2,730
      Investment banker fees.........................................   4,000
      Other professional fees and merger related costs...............   6,270
                                                                      -------
     Total shared Merger costs.......................................  22,000
     Less costs to be paid by Vitalink............................... (11,000)
                                                                      -------
     GranCare portion of shared Transaction costs....................  11,000
     Other Transaction related costs:
      Consent fee paid to landlord...................................  10,000
      Amounts payable under GranCare Shareholder Value Plan..........   4,500
      Amounts payable under Restricted Stock Plan....................   2,500
      Other employee severance and other related costs(b)............   2,000
                                                                      -------
                                                                       30,000
      Less: Income taxes.............................................  (3,800)
                                                                      -------
     Total estimated Merger costs, net of income taxes(a)............ $26,200
                                                                      =======
</TABLE>
    --------
    (a) The amount of the redemption premium shall be reduced by $.39
    million in the event the redemption occurs after January 15, 1997.
    (b) additional amounts of up to $5.0 million could be paid if
    additional officers elect to exercise the change of control provision.
 
  (8) Elimination of deferred financing fees related to the Convertible
  Debentures and 9 3/8% Senior Subordinated Notes, net of income tax effect
  at assumed 38% tax rate
  (9) One to one conversion of Company Common Stock for New GranCare Common
  Stock and cancellation and retirement of Company Common Stock held in
  treasury immediately prior to the conversion for New GranCare Common Stock
 
                                      52
<PAGE>
 
                                GRANCARE, INC.
 
             PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF INCOME
 
                         YEAR ENDED DECEMBER 31, 1995
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
                         (UNAUDITED, EXCEPT AS NOTED)
 
<TABLE>
<CAPTION>
                                        PRO FORMA ADJUSTMENTS
                                    ------------------------------
                          GRANCARE     TEAMCARE    OTHER PRO FORMA GRANCARE
                         HISTORICAL HISTORICAL (1)   ADJUSTMENTS   PRO FORMA
                         ---------- -------------- --------------- ---------
                         (AUDITED)
<S>                      <C>        <C>            <C>             <C>
Net revenues............  $816,462    $(194,898)       $18,216 (2) $639,780
Expenses:
  Operating expenses
   (excluding items
   shown below).........   669,512     (168,173)        18,216 (3)  519,555
  Rent and property
   expenses.............    51,206       (4,115)           --        47,091
  Depreciation and
   amortization.........    21,611       (4,705)           --        16,906
  Interest expense and
   financing charges....    27,054         (497)        (7,282)(4)   19,275
  Nonrecurring costs--
   merger and other
   costs................    11,750          --             --        11,750
                          --------    ---------        -------     --------
    Total expenses......   781,133     (177,490)        10,934      614,577
                          --------    ---------        -------     --------
Income before income
 taxes..................    35,329      (17,408)         7,282       25,203
Income taxes............    14,765       (7,000)         2,913 (5)   10,678
                          --------    ---------        -------     --------
Net income..............  $ 20,564    $ (10,408)       $ 4,369     $ 14,525
                          ========    =========        =======     ========
Net income per common
 and common equivalent
 share:
  Primary...............  $   0.86                                 $   0.61 (6)
                          ========                                 ========
  Fully diluted.........  $   0.86                                      N/A (6)
                          ========                                 ========
Weighted average number
 of common and common
 equivalent
 shares outstanding:
  Primary...............    23,794                                   23,794 (6)
                          ========                                 ========
  Fully diluted.........    23,919                                      N/A (6)
                          ========                                 ========
Pro Forma Adjustments:
(1)Reflects elimination of historical stand-alone amounts of
 TeamCare, Inc.
(2)Revenues--pro forma adjustments for revenues are as follows:
  Add back intercompany revenues of TeamCare which are eliminated
   in GranCare historical amounts................................. $ 18,216
                                                                   ========
(3)Operating expenses--pro forma adjustments for operating
 expenses are as follows:
  Add back intercompany cost of sales of TeamCare which are
   eliminated in GranCare historical amounts...................... $ 18,216
                                                                   ========
(4)Interest expense--pro forma adjustments for interest expense
 are as follows:
  Elimination of interest expense on $60 million 6.5% Convertible
   Subordinated Debentures........................................ $ (3,900)
  Elimination of interest expense on $100 million 9 3/8% Senior
   Subordinated Notes.............................................   (9,375)
  Elimination of amortization of deferred financing fees related
   to the Convertible Debentures and 9 3/8% Senior Subordinated
   Notes..........................................................     (155)
  Interest expense on incremental new borrowings under line of
   credit (estimated at $86.0 million, reflects net impact of
   redemption of $100 and $60 million subordinated debt
   instruments less cash received/incremental debt assumed upon
   consummation of Merger) at 7.25%--average interest rate under
   existing credit facility.......................................    6,148
                                                                   --------
                                                                   $ (7,282)
                                                                   ========
</TABLE>
(5) Income taxes are adjusted to reflect tax provision for elimination of
    pharmacy amounts and other pro forma adjustments.
(6) Income per share amounts are based on the combined weighted average shares
    adjusted for retirement of the Company's 6.5% Convertible Debentures. Pro
    forma fully diluted earnings per share are not presented as the difference
    in primary and fully diluted amounts is less than 3% after the assumed
    retirement of the $60 million Convertible Debentures.
 
                                      53
<PAGE>
 
                                GRANCARE, INC.
 
             PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF INCOME
 
                     NINE MONTHS ENDED SEPTEMBER 30, 1996
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
                                  (UNAUDITED)
<TABLE>
<CAPTION>
                                         PRO FORMA ADJUSTMENTS
                                       --------------------------
                                                         OTHER
                             GRANCARE     TEAMCARE     PRO FORMA    GRANCARE
                            HISTORICAL HISTORICAL (1) ADJUSTMENTS   PRO FORMA
                            ---------- -------------- -----------   ---------
<S>                         <C>        <C>            <C>           <C>
Net revenues...............  $745,653    $(194,624)     $26,136 (2) $577,165
Expenses:
  Operating expenses
   (excluding items shown
   below)..................   599,958     (164,615)      26,136 (3)  461,479
  Rent and property
   expenses................    42,696       (3,914)         --        38,782
  Depreciation and
   amortization............    19,400       (4,980)         --        14,420
  Interest expense and
   financing charges.......    26,228         (449)      (5,675)(4)   20,104
  One-time charges.........    18,400          --           --        18,400
                             --------    ---------      -------     --------
    Total expenses.........   706,682     (173,958)      20,461      553,185
                             --------    ---------      -------     --------
Income before income
 taxes.....................    38,971      (20,666)       5,675       23,980
Income taxes...............    14,809       (8,266)       2,270 (5)    8,813
                             --------    ---------      -------     --------
Net income.................  $ 24,162    $ (12,400)     $ 3,405     $ 15,167
                             ========    =========      =======     ========
Net income per common and
 common equivalent share:
  Primary..................  $   1.01                               $   0.63(6)
                             ========                               ========
  Fully diluted............  $   0.98                                    N/A(6)
                             ========                               ========
Weighted average number of
 common and common
 equivalent shares
 outstanding:
  Primary..................    24,021                                 24,021(6)
                             ========                               ========
  Fully diluted............    26,653                                    N/A(6)
                             ========                               ========
Pro Forma Adjustments:
(1) Reflects elimination of historical stand-alone amounts of
    TeamCare
(2) Revenues--pro forma adjustments for revenues are as follows:
  Add back intercompany revenues of TeamCare which are eliminated
   in GranCare historical amounts................................   $ 26,136
                                                                    ========
(3) Operating expenses--pro forma adjustments for operating
    expenses are as follows:
  Add back intercompany cost of sales of TeamCare which are
   eliminated in GranCare historical amounts.....................   $ 26,136
                                                                    ========
(4)Interest expense--pro forma adjustments for interest expense
 are as follows:
  Elimination of interest expense on $60 million 6.5% Convertible
   Subordinated Debentures.......................................   $ (2,925)
  Elimination of interest expense on $100 million 9 3/8% Senior
   Subordinated Notes............................................     (7,031)
  Elimination of amortization of deferred financing fees related
   to the Convertible Debentures and 9 3/8% Senior Subordinated
   Notes.........................................................       (330)
  Interest expense on incremental new borrowings under line of
   credit (estimated at $86.0 million, reflects net impact of
   redemption of $100 and $60 million subordinated debt
   instruments less cash received/incremental debt assumed upon
   consummation of Merger) at 7.25%--average interest rate under
   existing credit facility......................................      4,611
                                                                    --------
                                                                    $ (5,675)
                                                                    ========
</TABLE>
(5) Income taxes are adjusted to reflect tax provision for elimination of
    pharmacy amounts and other pro forma adjustments.
 
(6) Income per share amounts are based on the combined weighted average shares
    adjusted for retirement of the Company's 6.5% Convertible Debentures. Pro
    forma fully diluted earnings per share are not presented as the difference
    in primary and fully diluted amounts is less than 3% after the assumed
    retirement of the $60 million Convertible Debentures.
 
                                      54
<PAGE>
 
                SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
             (IN THOUSANDS, EXCEPT PER SHARE AND STATISTICAL DATA)
 
  The following selected historical consolidated financial data of GranCare
have been derived from the historical financial statements and should be read
in conjunction with the financial statements and notes included herein.
GranCare data for the nine months ended September 30, 1995 and 1996 have been
derived from the unaudited consolidated financial statements which are also
included herein.
<TABLE>
<CAPTION>
                                                                       NINE MONTHS ENDED
                                   YEAR ENDED DECEMBER 31,               SEPTEMBER 30,
                         --------------------------------------------- -----------------
                         1991 (7)  1992 (8) 1993 (8) 1994 (8) 1995 (8) 1995 (8) 1996 (8)
                         --------  -------- -------- -------- -------- -------- --------
<S>                      <C>       <C>      <C>      <C>      <C>      <C>      <C>
STATEMENT OF OPERATIONS
 DATA(9):
 Net revenues........... $290,958  $434,638 $611,689 $717,471 $816,462 $604,569 $745,653
 Expenses:
 Operating expenses
  (excluding items shown
  below)................  239,057   357,189  506,542  589,245  669,512  496,918  599,957
 Rent and property......   27,284    35,998   42,446   44,291   51,206   37,988   42,697
 Depreciation and
  amortization..........    5,064     6,922   12,349   16,440   21,611   14,785   19,400
 Interest expense and
  financing charges.....    7,256     7,908   19,601   21,481   27,054   19,557   26,228
 Nonrecurring costs--
  other (1992 & 1996);
  merger and other (1993
  & 1995)(1)............      --      1,114    4,573      --    11,750   11,750   18,400
 Restructuring
  costs(2)..............      --        --       --     8,200      --       --       --
                         --------  -------- -------- -------- -------- -------- --------
 Total expenses.........  278,661   409,131  585,511  679,657  781,133  580,998  706,682
                         --------  -------- -------- -------- -------- -------- --------
 Income before income
  taxes and
  extraordinary charge..   12,297    25,507   26,178   37,814   35,329   23,571   38,971
 Income taxes...........    3,950     8,701   10,089   13,524   14,765   10,297   14,809
                         --------  -------- -------- -------- -------- -------- --------
 Income before
  extraordinary charge..    8,347    16,806   16,089   24,290   20,564   13,274   24,162
 Extraordinary charge--
  gain on settlement of
  debt (1991); loss on
  extinguishment of debt
  (1993)(3).............   (2,928)      --     1,285      --       --       --       --
                         --------  -------- -------- -------- -------- -------- --------
 Net income............. $ 11,275  $ 16,806 $ 14,804 $ 24,290 $ 20,564 $ 13,274 $ 24,162
                         ========  ======== ======== ======== ======== ======== ========
Pro forma income tax
 data(4):
 Income before income
  taxes and
  extraordinary charge.. $ 12,297  $ 25,507 $ 26,178      n/a      n/a      n/a      n/a
 Income taxes...........    4,060    10,157   10,874      n/a      n/a      n/a      n/a
                         --------  -------- --------
 Income before
  extraordinary
  charge(5).............    8,237    15,350   15,304      n/a      n/a      n/a      n/a
 Extraordinary
  charge(5).............   (1,757)      --     1,285      n/a      n/a      n/a      n/a
                         --------  -------- --------
Pro forma net income.... $  9,994  $ 15,350 $ 14,019      n/a      n/a      n/a      n/a
                         ========  ======== ========
Net income per common
 and common equivalent
 share(4):
 Primary:
  Income before
   extraordinary item...    $0.59     $0.97    $0.84    $1.07    $0.86    $0.55    $1.01
  Extraordinary item....     0.24        --    (.07)       --       --       --       --
                         --------  -------- -------- -------- -------- -------- --------
  Net income............    $0.83     $0.97    $0.77    $1.07    $0.86    $0.55    $1.01
                         ========  ======== ======== ======== ======== ======== ========
 Fully diluted:
  Income before
   extraordinary item...    $0.53     $0.90    $0.80    $1.07    $0.86    $0.55    $0.98
  Extraordinary item....     0.22        --    (.07)       --       --       --       --
                         --------  -------- -------- -------- -------- -------- --------
  Net income............    $0.75     $0.90    $0.73    $1.07    $0.86    $0.55    $0.98
                         ========  ======== ======== ======== ======== ======== ========
</TABLE>
 
                                      55
<PAGE>
 
<TABLE>
<CAPTION>
                                                                 NINE MONTHS ENDED
                             YEAR ENDED DECEMBER 31,               SEPTEMBER 30,
                         --------------------------------------  ------------------
                         1991     1992    1993    1994    1995     1995      1996
                         ----    ------  ------  ------  ------  --------  --------
<S>                      <C>     <C>     <C>     <C>     <C>     <C>       <C>
STATISTICAL DATA(9):
 Average licensed beds..  -- (6) 11,358  15,103  16,112  16,148    16,263    16,097
 Average occupancy......  -- (6)     86%     87%     88%     87%       87%       85%
</TABLE>
 
<TABLE>
<CAPTION>
                                         DECEMBER 31,
                         --------------------------------------------
                         1991 (7) 1992 (8) 1993 (8) 1994 (8) 1995 (8)  SEPTEMBER 30, 1996 (8)
                         -------- -------- -------- -------- -------- ------------------------
<S>                      <C>      <C>      <C>      <C>      <C>      <C>      <C> <C> <C> <C>
BALANCE SHEET DATA(9):
 Working capital........ $ 22,821 $31,483  $59,688  $89,626  $123,030 $193,578
 Total assets...........  115,437 242,656  390,881  520,193   645,161  737,938
 Long-term debt,
  including current
  portion...............   52,948  96,770  202,650  243,231   339,605  389,124
 Shareholders' equity...   12,760  54,230   86,971  161,417   172,599  201,674
 Partners equity........      320   4,988      --       --        --       --
</TABLE>
(Footnotes from the preceding page)
 
- --------
(1) The $1.1 million non-recurring charge in 1992 consisted of expenses
    related to a retirement agreement reached with an employee of CompuPharm
    and terminated negotiations regarding the possible sale of CompuPharm.
    Such expenses were incurred prior to the merger of GranCare and CompuPharm
    in December 1993 (the "CompuPharm Merger"), after which CompuPharm became
    a wholly owned subsidiary of GranCare. The $4.6 million merger costs in
    1993 relate to the CompuPharm Merger. The $11.75 million charge in 1995
    relates to the Evergreen Merger and other one time costs. The $18.4
    million charge in 1996 relates to one-time charges for the planned
    disposition of assets and leasehold improvements or closure of certain
    long-term care facilities and write off of notes receivable related
    thereto; amounts required to present TeamCare's separate financial
    statements on a stand-alone basis in connection with the Vitalink merger
    and other one-time costs.
(2) The $8.2 million restructuring charge in 1994 is related to the Company's
    formal plan of restructuring announced in August 1994. See Note 12 of
    Notes to the Consolidated Financial Statements for information on the 1994
    restructuring.
(3) The $2.9 million extraordinary gain in 1991 resulted from an Evergreen
    settlement of debt. The Company's extraordinary debt extinguishment charge
    of $1.3 million in 1993 resulted from debt repayments associated with the
    CompuPharm Merger.
(4) Prior to June 30, 1993, the Evergreen predecessor entity consisted of two
    partnerships and, accordingly, Evergreen was not subject to federal or
    state income taxes. For informational purposes, the selected historical
    consolidated financial data for the years 1991 through 1993 include a pro
    forma presentation that includes a provision for income taxes as if
    Evergreen had been a taxable corporation for these periods. Such pro forma
    calculations were based on the income tax laws and rates in effect during
    those periods, and FASB Statement No. 109. Earnings per share for 1991,
    1992 and 1993 are based on pro forma net income.
(5) See note (3) above relating to the extraordinary items. The pro forma
    reduction to the 1991 gain is due to an income tax provison adjustment
    resulting from the fact that Evergreen was not a taxable entity during
    1991.
(6) These numbers are not available from Evergreen for fiscal 1991 and,
    accordingly, the Company is unable to report such numbers on a
    consolidated basis.
(7) The ARA Living Centers-Pacific, Inc. ("ARA") acquisition occurred on
    September 27, 1991 and, therefore, (i) the operating results of the ARA
    facilities are included in the historical operating results of the Company
    for the fourth quarter of 1991 and (ii) the assets and liabilities of the
    ARA facilities, as adjusted for related financing transactions, are
    included in the balance sheet of the Company as of December 31, 1991.
(8) All acquisitions which occurred in 1992, 1993, 1994, 1995 and 1996, except
    for the CompuPharm, Inc. ("CompuPharm") acquisition and Evergreen merger,
    are reflected from the date of each acquisition in the historical
    operating results of the Company and the assets and liabilities relating
    to these acquisitions are included in the balance sheets of the Company
    since that time. See note (9) below and Note 3 to the consolidated
    financial statements for a discussion of the CompuPharm and Evergreen
    mergers.
(9) All years have been restated for the December 28, 1993 merger with
    CompuPharm and for the July 20, 1995 merger with Evergreen. See Notes 1
    and 3 to the consolidated financial statements for a description of these
    combinations.
 
                                      56
<PAGE>
 
          MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
                           AND RESULTS OF OPERATIONS
 
  The following discussion is based upon and should be read in conjunction
with the Selected Historical Consolidated Financial Data, Pro Forma Financial
Information and the historical consolidated financial statements of GranCare
and the notes thereto, included or incorporated elsewhere herein.
 
GENERAL
 
  The Company was incorporated in September 1987. Since its inception, the
Company has grown rapidly through acquisitions of long-term care facilities
and specialty medical businesses such as institutional pharmacy operations. In
April 1995, the Company acquired Cornerstone, a contract management firm that
specializes in the implementation and management of subacute and other
specialized medical programs in acute care hospitals. In addition, on July 20,
1995, the Company acquired Evergreen Healthcare, Inc. ("Evergreen") by merger
in a transaction accounted for as a pooling-of-interests for financial
reporting purposes. During  1996 the Company acquired RN Health Care Services,
Inc., a home health agency in Michigan and Jennings Visiting Nurse
Association, Inc., a home health agency in Indiana. Also in 1996, the Company
acquired Emery Pharmacy, Inc., a provider of institutional pharmacy services
in upstate New York and RX Corporation, a provider of institutional pharmacy
services in southern California.
 
  At the time of the merger with Evergreen the Company operated 78 long-term
care facilities and Evergreen operated 64 long-term care facilities. As a
result of the Cornerstone acquisition, the Company acquired 92 contracts with
acute care hospitals to manage subacute skilled nursing units, geriatric
mental health programs and geriatric primary care networks.
 
  The Company's revenues and profitability are affected by ongoing efforts of
third-party payors to contain health care costs by limiting reimbursement
rates, increasing case management review and negotiating reduced contract
pricing. Government payors, such as state-administered Medicaid programs and,
to a lesser extent, the federal Medicare program, generally provide more
restricted coverage and lower reimbursement rates than private pay sources.
For the year ended December 31, 1995, the percentage of the Company's revenues
derived from Medicaid and Medicare programs were 44.7% and 30.2%,
respectively, of the Company's net revenues. For the nine-months ended
September 30, 1996, the percentage of the Company's net patient revenues
derived from Medicaid and Medicare programs were 38.6% and 38.6%,
respectively, of the Company's total revenues.
 
  Excluding the Institutional Pharmacy Business, for the year ended December
31, 1995, the percentage of the Company's revenues derived from the Medicaid
and Medicare programs were 44.8% and 31.5%, respectively, of the Company's net
revenues. Excluding the Institutional Pharmacy Business for the nine months
ended September 30, 1996, the percentage of the Company's revenues derived
from the Medicaid and Medicare programs were 37.4% and 40.7%, respectively, of
the Company's total revenues.
 
  The Company derives its revenues by providing (i) skilled nursing, (ii)
pharmacy, therapy, subacute and other specialty medical services and (iii)
contract management of specialty medical programs for acute care hospitals. In
general, the Company generates higher revenues and profitability from the
provision of specialty medical services than from routine skilled nursing
care, and the Company believes that this trend will continue. The Company
seeks to enhance its operating margins by increasing the proportion of its
revenues derived from specialty medical services.
 
  While the initial results of the Merger will be a decrease in the percentage
of revenue from specialty medical services received by New GranCare from the
percentage of specialty medical services revenue received by the Company
because of the loss of the revenue from the Institutional Pharmacy Business,
the Company believes that opportunities exist for New GranCare to increase the
percentage of its revenue derived from specialty medical services from sources
other than the Institutional Pharmacy Business such as specialty medical
service revenue from therapy and subacute care.
 
                                      57
<PAGE>
 
RESULTS OF OPERATIONS
 
  The following tables set forth, as a percentage of patient revenues, certain
revenue data for the periods indicated:
 
              REVENUE COMPOSITION/PERCENTAGE OF PATIENT REVENUES
 
<TABLE>
<CAPTION>
                                                            NINE MONTHS ENDED
                                 YEAR ENDED DECEMBER 31,      SEPTEMBER 30,
                                --------------------------  -----------------
                                 1995     1994(1)   1993      1996      1995
                                -------  --------- -------  --------  --------
<S>                             <C>      <C>       <C>      <C>       <C>
Skilled nursing and subacute
 care:
 Routine services..............    53.8%     57.6%    60.2%     44.7%     54.8%
 Therapy, subacute and other
  ancillary services(2)........    19.8      18.3     19.9      25.9      19.4
                                -------   -------  -------  --------  --------
                                   73.6%     75.9%    80.1%     70.6      74.2
                                -------   -------  -------  --------  --------
Pharmacy(2)....................    23.5      23.8     19.6      25.9      23.3
Contract management............     2.9       0.3      0.3       3.5       2.5
                                -------   -------  -------  --------  --------
                                  100.0%    100.0%   100.0%    100.0%    100.0%
                                =======   =======  =======  ========  ========
</TABLE>
 
    REVENUES PER PATIENT DAY DERIVED FROM SKILLED NURSING AND SUBACUTE CARE
 
<TABLE>
<CAPTION>
                                                            NINE MONTHS ENDED
                                    YEAR ENDED DECEMBER 31,    SEPTEMBER 30,
                                    ----------------------- -------------------
                                     1995   1994(1)  1993     1996      1995
                                    ------- ------- ------- --------- ---------
<S>                                 <C>     <C>     <C>     <C>       <C>
Routine skilled nursing............ $ 87.07 $ 79.52 $ 78.07 $   89.35 $   87.02
Specialty medical services(3)......   35.65   27.69   27.59     58.89     34.05
                                    ------- ------- ------- --------- ---------
                                    $122.72 $107.21 $105.66   $148.24   $121.07
                                    ======= ======= ======= ========= =========
</TABLE>
- --------
(1) Excludes results of operations from August 1 through December 31, 1994 for
    facilities divested or to be divested as part of the restructuring plan.
(2) Before elimination of intercompany sales.
(3) Excludes pharmacy and other specialty medical revenue from beds not
    operated by the Company.
 
 Nine Months Ended September 30, 1996 Compared to Nine Months Ended September
30, 1995
 
  The Company's net revenues for the nine-month period ended September 30,
1996 were $745.7 million, compared to $604.6 million for the same period in
1995, a net increase of $141.1 million, or 23.3%. Included in net revenues and
classified as investment and other revenue for the nine month period ended
September 30, 1996 is the approximate $18 million gain on the sale of the
Company's investment in an unconsolidated affiliate which occurred in the
third quarter of 1996. Of the foregoing change, $75.5 million resulted from
acquisitions and $69.0 million was attributable to same-store growth. Those
increases were partially offset by loss of net revenue of $21.4 million from
facilities divested. Specialty medical revenues increased $123.6 million over
the same period in 1995. This was primarily the result of the growth in the
number of Medicare residents which utilize higher margin ancillary services
(physical, respiratory, occupational and speech therapy).
 
  Excluding the Institutional Pharmacy Business, the Company's net revenues
for the nine-month period ended September 30, 1996 were $577.2 million,
compared to $474.2 million for the same period in 1995, a net increase of
$103.0 million, or 21.7%. Of the foregoing change, $18 million resulted from
the gain on sale of the Company's investment in an unconsolidated affiliate.
$44.3 million resulted from same store growth and $62.1 million resulted from
acquisitions. Those increases were partially offset by loss of net revenue of
$21.4 million from facilities divested. Specialty medical revenues increased
$71.7 million over the same period in 1995. This was primarily the result of
the growth in the number of Medicare residents which utilize higher margin
ancillary services (physical, respiratory, occupational and speech therapy).
 
  Operating expenses for the nine-month period ended September 30, 1996, were
$642.7 million compared to $534.9 million for the same period in 1995, a net
increase of $107.8 million, or 20.2%. Of the foregoing increase,
 
                                      58
<PAGE>
 
$66.0 million resulted from acquisitions and $62.1 million was attributable to
same-store growth increases in expenses. These increases were partially offset
by a reduction of expenses of $20.3 million from facilities divested.
Specialty medical revenues generate additional costs from the higher staffing
levels required to care for the higher acuity Medicare residents. The
additional ancillary services (physical, respiratory, occupational and speech
therapy) utilized generate additional costs in line with the growth realized
in the specialty medical revenues.
 
  Excluding the Institutional Pharmacy Business, operating expenses for the
nine-month period ended September 30, 1996, were $500.3 million, compared to
$420.8 million for the same period in 1995, a net increase of $79.5 million,
or 18.9%. Of the foregoing increase, $47.2 was attributable to same store
increases in expenses and $52.6 million resulted from acquisitions. These
increases were partially offset by a reduction of expenses of $20.3 million
from facilities divested.
 
  Depreciation and amortization expenses for the nine-month period ended
September 30, 1996 were $19.4 million compared to $14.8 million for the same
period in 1995, an increase of $4.6 million, or 31.1%. This increase was
primarily the result of depreciation and amortization expenses attributable to
businesses acquired and additions to property and equipment.
 
  Excluding the Institutional Pharmacy Business, depreciation and amortization
expenses for the nine-month period ended September 30, 1996 were $14.4 million
compared to $11.4 million for the same period in 1995, an increase of $3.0
million, or 26.3%.
 
  Interest expense and financing charges for the nine-month period ended
September 30, 1996, were $26.2 million compared to $19.6 million for the same
period in 1995, an increase of $6.6 million, or 33.7%. These increases were
primarily due to interest on additional indebtedness incurred in connection
with acquisitions, the issuance of $100 million of 9 3/8% Notes (the "9 3/8%
Notes") and to a lesser extent, borrowings to fund working capital.
 
  Excluding the Institutional Pharmacy Business, interest expense and
financing charges for the nine-month period ended September 30, 1996, were
$25.8 million compared to $19.2 million for the same period in 1995, an
increase of $6.6 million, or 34.4%.
 
  During the third quarter of 1996, the Company recorded exit and other one-
time costs of $18.4 million as a charge to operations. Approximately $10.6
million of this charge relates to management's decision to close five
facilities which are operated under long term operating leases, as these
facilities did not fit the Company's operating strategies. The $10.6 million
reflects the remaining net book value of leasehold improvements at the dates
of closure and the remaining rent due to the landlord for periods after the
dates of closure. The revenues and net operating losses of these facilities
are not significant. Approximately $3 million of the charge relates to the
write-off of notes receivable for loans made by the Company to a sublease
lessee to fund working capital. Accounts receivable from the facility under
lease serve as collateral for the working capital loans. During the third
quarter of 1996, the loans to the lessee began to significantly exceed the
collateral, indicating that the loan would not be recoverable. Accordingly,
the Company decided to terminate the sublease arrangement and to write off the
loans which it concluded would not be recoverable. In addition, in the third
quarter of 1996, the Company recorded $4.8 million of other charges which
included $2.9 million of additional bad debt expense related to TeamCare. The
charge for bad debt expense was necessary to provide for the increased risk of
collection resulting from the deterioration in the financial condition of
certain customers in the third quarter of 1996. These charges do not have a
negative effect on short-term cash flow. In the third quarter of 1995, the
Company incurred certain costs related to the completion of the pooling-of-
interests with Evergreen on July 20, 1995 and other one-time costs.
 
  Income taxes for the nine month period ended September 30, 1996, were $14.8
million compared to $10.3 million for the same period in 1995, an increase of
$4.5 million.
 
  Excluding the Institutional Pharmacy Business, income taxes for the nine-
month period ended September 30, 1996, were $6.5 million compared to $5.3
million for the same period in 1995, an increase of $1.2 million.
 
                                      59
<PAGE>
 
  As a result of the foregoing, net income for the nine-month period ended
September 30, 1996, was $24.2 million compared to $13.3 million for the same
period in 1995, an increase of $10.9 million.
 
  Excluding the Institutional Pharmacy Business, net income for the nine-month
period ended September 30, 1996, was $11.8 million compared to $5.8 million
for the same period in 1995, an increase of $6.0 million.
 
  During the first quarter of 1996, the Company adopted as required FASB
Statement No. 121 ("Statement No. 121"), Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of. In accordance
with Statement No. 121, the Company records impairment losses on long-lived
assets used in operations when events and circumstances indicate the assets
might be impaired and the undiscounted cash flows estimated to be generated by
those assets may be less than the carrying amounts of those assets. The
Company adopted Statement No. 121 and it had no effect on the financial
statements.
 
  Year Ended December 31, 1995 Compared to Year Ended December 31, 1994
 
  The Company's net revenues for 1995 were $816.5 million compared to $717.5
million for 1994, an increase of $99.0 million, or 13.8%. $112.0 million of
the increase is attributable to acquisitions completed. Same-store growth
increased $27.8 million from increases in specialty medical services provided
and an increase in average daily rates due to an improved payor mix, but was
adversely affected by a decrease in the level of reimbursement rates
implemented in the State of Indiana in August 1994. Specialty medical revenues
increased $88.6 million over the same period in 1994. This was the result of
growth in the number of Medicare residents which utilize higher margin
ancillary services (physical, respiratory, occupational and speech therapy).
The overall increase was partially offset by a $40.8 million decrease in
revenues resulting from the divestiture of certain business units and the loss
of the pharmacy division's contract with the State of New Jersey. Included in
net revenues for 1995 and 1994 were $1.8 million and $0.8 million,
respectively, relating to routine cost limit exceptions. While the Company has
applied for these exceptions, and has only recognized a portion of the
estimated recovery, there can be no assurance that the actual revenues from
routine cost limit exceptions will equal those amounts recognized by the
Company in 1994 and 1995.
 
  Excluding the Institutional Pharmacy Business, the Company's net revenues
for 1995 were $639.8 million compared to $559.0 million for 1994, an increase
of $80.8 million, or 14.5%. Of the foregoing change $33.4 million resulted
from same store growth and $67.1 million resulted from acquisitions. The
overall increase was partially offset by a $19.7 million decrease in revenues
resulting from the divestiture of certain business units. Specialty medical
revenues increased $64.9 million over the same period in 1994. This was the
result of growth in the number of Medicare residents which utilize higher
margin ancillary services (physical, respiratory, occupational and speech
therapy).
 
  Operating expenses (excluding rent and property expenses) for 1995 were
$669.5 million compared to $589.2 million for 1994, an increase of $80.3
million, or 13.6%. $92.6 million of the increase was attributable to
acquisitions, as well as costs associated with an increase of specialty
medical services provided, and the duplicate Evergreen overhead incurred prior
to the merger of the Company with Evergreen. On a same-store basis, operating
expenses increased $29.2 million. The increases were partially offset by
reduction of expenses of $41.5 million from facilities divested. Specialty
medical revenues generate additional costs from the higher staffing levels
required to care for the higher acuity Medicare residents. The additional
ancillary services (physical, respiratory, occupational and speech therapy)
utilized generate additional costs in line with the growth realized in the
specialty medical revenues. This increase was partially offset by a reduction
in costs from more appropriate staffing given patient acuity levels at skilled
nursing facilities and an increased use of third-party vendors for therapy
services.
 
  Excluding the Institutional Pharmacy Business, operating expenses (excluding
rent and property expenses) for 1995 were $519.5 million compared to $457.0
million for 1994, an increase of $62.5 million, or 13.7%. Of the foregoing
increase, $31.0 million was attributable to same-store increases in expenses
and $51.0 million was attributable to acquisitions completed. These increases
were partially offset by a reduction of expenses of $19.5 million from the
divestiture of certain business units.
 
  Rent and property expenses for 1995 were $51.2 million compared to $44.3
million for 1994, an increase of $6.9 million, or 15.6%. This increase was
primarily attributable to additional facilities operated and scheduled
increases in rental expense, partially offset by the divestiture of certain
business units.
 
                                      60
<PAGE>
 
  Excluding the Institutional Pharmacy Business, rent and property expenses
for 1995 were $47.1 million compared to $41.5 million for 1994, an increase of
$5.6 million, or 13.5%.
 
  Depreciation and amortization expenses for 1995 were $21.6 million compared
to $16.4 million for 1994, an increase of $5.2 million, or 31.7%. This
increase was primarily the result of depreciation and amortization expenses
attributable to businesses acquired and additions to property and equipment,
partially offset by depreciation and amortization expenses related to divested
business units.
 
  Excluding the Institutional Pharmacy Business, depreciation and amortization
expenses for 1995 were $16.9 million compared to $12.9 million for 1994, an
increase of $4.0 million, or 31.0%.
 
  Interest expense and financing charges for 1995 were $27.1 million compared
to $21.5 million in 1994, an increase of $5.6 million, or 26.0%. This increase
was primarily due to interest on additional indebtedness incurred in
connection with acquisitions, the issuance of $100 million of Senior
Subordinated Notes and, to a lesser extent, borrowings to fund working
capital.
 
  Excluding the Institutional Pharmacy Business, interest expenses and
financing charges for 1995 were $26.6 million compared to $20.8 million for
1994, an increase of $5.8 million, or 27.9%.
 
  In 1995, the Company recorded a merger and other one-time costs charge of
$11.8 million. Those costs include professional fees (legal, accounting and
investment bankers) of $5.1 million, personnel costs (severance and
relocation) of $3.2 million, a directors and officers policy of $0.5 million,
other deferred acquisition costs of $1.1 million, a divestiture charge of $1.5
million for certain Evergreen facilities which do not fit the Company's
strategy and another charge of $0.4 million relating to TeamCare converting
Evergreen's pharmacy to their system. In 1994, the Company recorded a
restructuring charge of $8.2 million in connection with a restructuring plan
adopted by the Board of Directors in August 1994. See "Liquidity and Capital
Resources."
 
  Income taxes for 1995 were $14.8 million compared to $13.5 million for 1994.
 
  Excluding the Institutional Pharmacy Business, income taxes for 1995 were
$7.8 million compared to $5.8 million for 1994.
 
  As a result of the foregoing, net income for 1995 was $20.6 million compared
to $24.3 million for 1994, a decrease of $3.7 million, or 15.2%.
 
  Excluding the Institutional Pharmacy Business, net income for 1995 was
$10.2 million compared to $12.8 million for 1994, a decrease of $2.6 million,
or 20.3%.
 
  Year Ended December 31, 1994 Compared to Year Ended December 31, 1993
 
  The Company's net revenues for 1994 were $717.5 million compared to $611.7
million for 1993, an increase of $105.8 million, or 17.3%. This increase is
primarily attributable to acquisitions completed and, to a lesser extent,
same-store growth. On a same-store basis, net revenues increased 6.7%. Same-
store revenue growth resulted from increases in specialty medical services
provided and an increase in average daily rates due to an improved payor mix,
but was adversely affected by a decrease in the level of reimbursement rates
implemented in the State of Indiana in August 1994. Specialty medical revenues
increased to 42.4% compared to 39.8% for the same period in 1993. This was the
result of growth in the number of Medicare residents which utilize higher
margin ancillary services (physical, respiratory, occupational and speech
therapy). The overall increase was partially offset by a decrease in revenues
resulting from the divestiture of certain business units. Included in net
revenues for 1994 and 1993 were $0.8 million and $1.9 million, respectively,
relating to routine cost limit exceptions.
 
                                      61
<PAGE>
 
  Operating expenses (excluding rent and property expenses) for 1994 were
$589.2 million compared to $506.5 million for 1993, an increase of $82.7
million, or 16.3%. This increase was primarily attributable to acquisitions,
as well as costs associated with an increase of specialty medical services
provided, and a $1.0 million charge in connection with the relocation of the
Company's corporate offices. Specialty medical revenues generate additional
costs from the higher staffing levels required to care for the higher acuity
Medicare residents. The additional ancillary services (physical, respiratory,
occupational and speech therapy) utilized generate additional costs in line
with the growth realized in the specialty medical revenues. This increase was
partially offset by a reduction in costs from the dispositions of certain
business units, more appropriate staffing given patient acuity levels at
skilled nursing facilities and an increased use of third-party vendors for
therapy services.
 
  Rent and property expenses for 1994 were $44.3 million compared to $42.4
million for 1993, an increase of $1.9 million, or 4.5%. This increase was
primarily attributable to additional facilities operated and scheduled
increases in rental expense, partially offset by the divestiture of certain
business units.
 
  Depreciation and amortization expenses for 1994 were $16.4 million compared
to $12.3 million for 1993, an increase of $4.1 million, or 33.3%. This
increase was primarily the result of depreciation and amortization expenses
attributable to businesses acquired and additions to property and equipment,
partially offset by depreciation and amortization expenses related to divested
business units.
 
  Interest expense and financing charges for 1994 were $21.5 million compared
to $19.6 million in 1993, an increase of $1.9 million, or 9.7%. This increase
was primarily due to interest on additional indebtedness incurred in
connection with acquisitions and, to a lesser extent, borrowings to fund
working capital. Higher rates on floating rate debt also increased interest
expense.
 
  In 1994 the Company recorded a restructuring charge of $8.2 million in
connection with a restructuring plan adopted by the Board of Directors in
August 1994. See "Liquidity and Capital Resources."
 
  Income taxes for 1994 were $13.5 million compared to $10.1 million for 1993.
 
  As a result of the foregoing, net income for 1994 was $24.3 million compared
to $14.8 million for 1993, an increase of $9.5 million, or 64.2%.
 
LIQUIDITY AND CAPITAL RESOURCES
 
  The Company's primary source of liquidity at September 30, 1996 was $25.8
million in cash and cash equivalents compared to $17.7 million at December 31,
1995, an increase of $8.1 million. On August 5, 1996, the Company sold its
entire interest in Alternative Living Services, Inc. ("ALS"), resulting in net
proceeds to the Company of approximately $24.6 million and an approximate
$18.0 million gain on the sale. The increase in cash and cash equivalents was
due primarily to proceeds realized from the sale of ALS. Payments received by
the Company from the Medicaid and Medicare programs are the Company's largest
source of cash from operations.
 
  Accounts receivable at September 30, 1996 were $218.5 million compared to
$173.1 million at December 31, 1995, an increase of $45.4 million or 26.2%.
The Company's accounts receivable include receivables from third-party
reimbursement programs, primarily Medicaid and Medicare settlements. The
Company receives payment for skilled nursing services based on rates set by
individual state Medicaid programs. Although payment cycles for these programs
vary, payments generally are made within 30 to 60 days of services provided,
except in Illinois, where the Medicaid program delays payments for 120 days.
The federal Medicare program, a cost-reimbursement system, pays interim rates,
based on estimated costs of services, on a 30 to 45-day basis. Final cost
settlements, based on the difference between audited costs and interim rates,
are paid following final cost report audits by Medicare fiscal intermediaries.
Because of the cost report and audit process, final settlement may not occur
until up to 24 months after services are provided. The Company accounts for
such
 
                                      62
<PAGE>
 
open cost reports by taking appropriate reserves to offset potential audit
adjustments. Management has no knowledge of any material pending claims or
unsettled matters pertaining to such cost reports. Specialty medical services
generally increase the amount of payments received on a delayed basis.
 
  Excluding the Institutional Pharmacy Business, accounts receivable at
September 30, 1996 were $171.4 million compared to $135.3 million at December
31, 1995, an increase of $36.1 million.
 
  While federal regulations do not provide states with grounds to curtail
payments under their Medicaid reimbursement programs due to state budget
deficiencies or delays in enactment of new budgets, states have nevertheless
curtailed payments in such circumstances in the past. In particular, some
states have delayed the payment of significant amounts owed to health care
providers such as the Company for health care services provided under their
respective Medicaid programs.
 
  In addition to principal and interest payments on its long-term
indebtedness, the Company has significant rent obligations relating to its
leased facilities, as well as property expenses (principally property taxes
and insurance) relating to all of its facilities. The Company's estimated
principal payments, cash interest payments, rent and property expense
obligations for 1996 are approximately $100.0 million.
 
  Excluding the Institutional Pharmacy Business, the Company's estimated
principal payments, cash interest payments, rent and property expense
obligations for 1996 are approximately $87.0 million.
 
  The Company's operations require capital expenditures for renovations of
existing facilities in order to continue to meet regulatory requirements, to
upgrade facilities for the treatment of subacute patients and to accommodate
the addition of specialty medical services, and to improve the physical
appearance of its facilities for marketing purposes. Total capital
expenditures for the year ended December 31, 1995 were $23.5 million,
excluding $2.5 million of capital expenditures reimbursed by Health and
Retirement Properties Trust ("HRPT"). Total capital expenditures for the nine-
month period ended September 30, 1996, were $24.0 million. The Company
estimates that capital expenditures for the year ending December 31, 1996,
will be approximately $32.0 million.
 
  Excluding the Institutional Pharmacy Business, total capital expenditures
for the year ended December 31, 1995 and the nine-month period ended September
30, 1996, were $21.2 million and $20.1 million, respectively.
 
  The Company maintains a $150.0 million credit facility (the "Existing Credit
Facility") with a syndicate of banks for whom First Union National Bank of
North Carolina ("First Union") acts as lead bank, which may be used for
working capital, other general corporate purposes and acquisitions. As of
September 30, 1996, approximately $88.9 million was outstanding under the
Existing Credit Facility. The Company will be able to borrow under the
Existing Credit Facility through June 1998, at which time it will convert to a
term loan, unless it is refinanced or extended. Upon conversion, the amount
then outstanding will be payable in equal quarterly installments through June
2002. See "The Distribution--Treatment of Certain Indebtedness--Existing
Credit Facility." Shortly before the Distribution, the Company will contribute
the stock of its skilled nursing facility subsidiaries to New GranCare.
Immediately prior to the Distribution, New GranCare plans to enter into the
New Credit Facility with a syndicate of banks, certain proceeds from which
will be paid by New GranCare on behalf of its subsidiaries to the Company in
satisfaction of intercompany debt owed by New GranCare and its skilled nursing
facility subsidiaries to the Company and the TeamCare subsidiaries. Amounts so
paid by New GranCare to the Company will be applied to satisfy various third-
party debt of the Company (including the Existing Credit Facility and the
Convertible Debentures). See "The Distribution--Treatment of Certain
Indebtedness--New Credit Facility."
 
  In September 1995, the Company completed an offering of $100.0 million
aggregate principal amount of its 9 3/8% Notes. The net proceeds from this
offering were used to repay outstanding amounts under the Existing Credit
Facility. The Distribution Agreement provides that Vitalink will assume such
Notes by operation of law. See "The Distribution--Treatment of Certain
Indebtedness--9 3/8% Notes."
 
                                      63
<PAGE>
 
  The Company believes that its cash from operations, existing working capital
and available borrowings under its line of credit will be sufficient to fund
the fixed obligations, capital expenditures and other obligations referred to
above, as well as to repay certain indebtedness when due. At this time the
Company believes that any additional required financing could be obtained at
market rates on terms that are acceptable to the Company, although no
assurance can be given regarding the terms or availability of additional
financing in the future.
 
  In conjunction with a 1990 acquisition, the Company borrowed $15.0 million
under a promissory note agreement with HRPT. The note is secured by mortgages
on two facilities and 1,000,000 shares of HRPT common stock owned by the
Company. The HRPT note had a balance of $8.7 million, with an interest rate of
13.75% at December 31, 1994. During 1995, the Company renegotiated the note
with HRPT, whereby the principal balance of the promissory note was increased
to $11.5 million, resulting in additional proceeds to the Company. Minimum
interest on the note is 11.5% per year payable monthly in arrears. Additional
interest is payable commencing on January 1, 1996, in an amount equal to 75%
of the percentage increase in the Consumer Price Index, with certain defined
limitations. Principal payments will begin two years after the date of the
note on a 30-year direct reduction basis, with the remaining balance due
December 31, 2010.
 
  The Company has operating leases for 24 facilities, including land,
buildings, and equipment from HRPT under two Master Lease Documents.
Subsequent to December 31, 1994, the existing Master Lease Documents were
amended. Under the amended lease arrangements, minimum rent for the aggregate
facilities is the annual sum of $11,550,000, payable in equal monthly
installments. In addition, beginning January 1, 1996, the amended lease
agreement provides for additional rent to be paid monthly, in advance, based
on 75% of the increase in the Consumer Price Index multiplied by the minimum
rent due, provided, however, that the maximum rent (minimum rent plus
additional rent) each January shall be limited to a 2% increase over the total
monthly rent paid in the prior December. The operating leases for 17
facilities expire on December 28, 2010, and there are two 10 year renewal
options. The leases for seven facilities expire in June 2006 and there are two
10 1/2-year renewal options. The Company has subleased seven of the 24
facilities to unrelated parties. Following the Distribution and Merger, New
GranCare will succeed to the obligations of the Company to HRPT.
 
  The Company is a beneficial owner of 1,000,000 shares of stock of HRPT,
which are held in trust and pledged as collateral for the obligations of two
of the Company's subsidiaries under mortgage notes and lease obligations with
HRPT. The pledge agreement strictly limits the Company's ability to sell the
shares until its obligations to HRPT are satisfied, which will not be until
the year 2010. As a result, these shares cannot be sold to meet other
financial obligations. In addition, such mortgage notes and lease obligations
contain provisions that restrict, upon the occurrence of an event of default
thereunder, the ability of such subsidiaries to make dividends, loans or
advances to the Company. In accordance with FASB Statement No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," the HRPT
stock is carried at fair market value, with unrealized gains and losses
reported as a separate component of equity. The Existing Credit Facility and
indenture pursuant to which the 9 3/8 Notes were issued also contain
restrictions on the ability of the Company to pay dividends to its
shareholders upon the failure to satisfy certain financial covenants.
 
  The Company maintains a captive insurance subsidiary to provide reinsurance
for its obligations under workers' compensation and general and professional
liability plans. These obligations are funded with long-term, fixed income
investments, which are not available to satisfy other obligations of the
Company. It is expected that following the Distribution and Merger that New
GranCare will succeed to the aforementioned fixed income investments and
operate such captive insurance subsidiary.
 
  As of December 31, 1995, the Company had recorded the following charges
against the $8.2 million restructuring reserve recognized in the third quarter
of 1994: (i) the write-off of certain unamortized financing fees; (ii)
operating gains and losses from the facilities to be divested for the period
of August 1, 1994 through December 31, 1995; (iii) gains and losses from the
sale of facilities and; (iv) severance and other personnel-related costs. The
net restructuring reserve balance at December 31, 1995 is $500,000. The
Company believes that the provisions for the restructuring continue to be
adequate and will not require material adjustment in future periods.
 
                                      64
<PAGE>
 
  The following transactions affecting the liquidity and capital resources of
both the Company and New GranCare have been entered into or contemplated in
connection with the proposed Distribution and Merger.
 
  New Credit Facility. In order to affect the Distribution, the Company will
be required to replace its Existing Credit Facility and currently has a
commitment letter from First Union and Chase, whereby each of such banks has
agreed to provide the Company, for the benefit of New GranCare, a replacement
credit facility in the aggregate amount of $300.0 million (with First Union
and Chase each committing to $150.0 million). The New Credit Facility will
consist of two components: a $200.0 million 5-year revolving credit facility
(which includes a $40.0 million sub-limit for the issuance of standby letters
of credit) and a $100.0 million 5-year term loan. Borrowings for working
capital and general corporate purposes may not exceed $75.0 million. The first
$25.0 million of exposure for letters of credit issued under the letter of
credit sub-facility will correspondingly reduce availability under the working
capital sub-facility. Following the consummation of the Distribution and
Merger, the Company anticipates that New GranCare will have approximately
$24.0 million outstanding under the working-capital sub-facility. The
revolving credit portion of the New Credit facility will mature in five years.
The term loan portion of the New Credit Facility will be amortized in ten
quarterly installments of $7.0 million each commencing two years after the New
Credit Facility closes, thereafter increasing to $10.0 million per quarter.
All remaining principal and accrued, unpaid interest shall be due and payable
in full on the fifth anniversary of the closing date of the New Credit
Facility. Interest on outstanding borrowing shall accrue, at the option of New
GranCare, at the Base Rate or at the Eurodollar Rate plus, in each case, an
applicable margin. See "The Distribution--Treatment of Certain Indebtedness--
New Credit Facility."
 
  9 3/8% Notes. The Company has commenced a consent solicitation to obtain the
approval of holders of the required principal amount of the Company's
outstanding 9 3/8% Notes to the transactions contemplated by the Distribution
Agreement and the Merger Agreement and to such modifications of certain
covenants contained in the Note Indenture as Vitalink, as the successor
obligor to the Company, may reasonably request. In connection with the
assumption by Vitalink of the Company's 9 3/8% Notes and related obligations
arising pursuant to the Note Indenture, the Company has agreed to pay Vitalink
a fee based on a formula described in "The Distribution--Terms of the
Distribution Agreement" (which fee is a Shared Transaction Expense). The
Company has also undertaken a tender offer for at least 50% of the outstanding
principal balance of the 9 3/8% Notes. A condition of the Company's obligation
to complete the tender offer is that every tendering noteholder must consent
to the requested covenant modifications referenced above. Any premium paid and
expenses incurred in connection with any such tender offer will be a Shared
Transaction Expense. See "The Distribution--Treatment of Certain
Indebtedness--9 3/8% Notes."
 
  Convertible Debentures. The Distribution Agreement and the Merger Agreement
also require that the Company take commercially reasonable efforts to call for
redemption prior to the Distribution Record Date all of the Company's 6 1/2%
outstanding convertible debentures (the "Convertible Debentures"). The
Convertible Debentures are currently redeemable at a redemption price of
104.55% of the principal amount of the Convertible Debentures plus accrued and
unpaid interest to the date of redemption. There are currently $60.0 million
in aggregate principal amount of Convertible Debentures outstanding resulting
in an aggregate redemption premium of approximately $2.73 million which shall
be a Shared Transaction Expense (such premium shall be reduced by $390,000 in
the event the redemption occurs after January 15, 1997).
 
  New GranCare Capital Resources. Following the Distribution and Merger, New
GranCare believes that its cash from operations, existing working capital and
available borrowings under the New Credit Facility will be sufficient to fund
the fixed obligations, capital expenditures and other obligations referred to
above, as well as to repay any required indebtedness when due, and further
expand New GranCare's business. Also in connection with the Distribution and
Merger, Vitalink has agreed to assume (as part of the Merger) certain items of
the Company's consolidated indebtedness aggregating approximately $108.0
million (which includes the Company's obligations in respect of the 9 3/8%
Notes). However, in the event that New GranCare continues to grow through
acquisitions, New GranCare may need to raise additional capital, either
through borrowings, sale-leaseback financings or the sale of debt or equity
securities, to finance the acquisition price and any additional working
 
                                      65
<PAGE>
 
capital and capital expenditure requirements related to such acquisitions. At
this time, the Company believes that any additional required financing may be
obtained at market rates on terms that are acceptable to New GranCare,
although no assurance can be given regarding the terms that are available of
additional financing in the future.
 
IMPACT OF INFLATION
 
  The health care industry is labor-intensive. Wages and other labor costs are
especially sensitive to inflation. In addition, the Company operates and New
GranCare intends to operate a majority of its facilities pursuant to operating
leases which contain provisions for increased rent, based upon inflation.
Increases in wages and other labor costs and rent expense as a result of
inflation, without a corresponding increase in Medicare and Medicaid
reimbursement rates, could adversely impact the Company or New GranCare.
 
  Both the Medicare and Medicaid programs operate under routine cost limits or
targeted ceilings. These limits are usually adjusted on an annual basis
utilizing numerous inflation indexes. Each State can operate under a different
index resulting in the adjustments to the targeted ceilings being different in
each State. The Company cannot predict the level of the expected increase each
year and each of these programs is subject to changes in regulation,
retroactive rate adjustments and government funding which could adversely
affect the amounts paid to New GranCare. See "Risk Factors--Risk Involved with
Reimbursement by Third Party Payors."
 
                                      66
<PAGE>
 
                                  PROPERTIES
 
  As of July 31, 1996, the Company operated 137 long-term care facilities (133
skilled nursing facilities and four assisted living facilities), which will be
operated by New GranCare. New GranCare believes the aforementioned physical
properties will be in good operating condition and suitable for the purposes
for which they are intended to be used when it assumes the operation of such
properties. New GranCare will operate 37 long-term care facilities, including
one assisted living facility and rehabilitation center, all of which will be
included in the collateral which secures certain financial obligations to
creditors and lessors to be assumed by New GranCare. Ninety-two other
facilities (including three assisted living facilities) will be operated by
New GranCare under long-term leases. New GranCare expects to pledge all of its
leasehold interests to certain creditors. See "The Distribution--Treatment of
Certain Indebtedness--New Credit Facility." Seven of the Company's long-term
care facilities will be managed by New GranCare.
 
LONG-TERM HEALTH CARE FACILITIES
 
  The following chart shows the geographic distribution of the facilities to
be operated by New GranCare:
 
<TABLE>
<CAPTION>
                                                                    PERCENTAGE
  STATE                                       FACILITIES(1)  BEDS  OF TOTAL BEDS
  -----                                       ------------- ------ -------------
<S>                                           <C>           <C>    <C>
Arizona(1)...................................        7         982       5.7%
California(1)................................       28       3,181      18.5
Colorado.....................................        4         661       3.8
Georgia......................................        1         100       0.6
Illinois.....................................       20       2,089      12.1
Indiana......................................       19       3,057      17.8
Iowa.........................................        7         547       3.2
Louisiana....................................        3         240       1.4
Michigan.....................................       13       1,863      10.8
Mississippi..................................       10       1,104       6.4
Ohio.........................................        1         100       0.6
South Carolina...............................        8         832       4.8
Tennessee....................................        2         226       1.3
West Virginia................................        1         164       1.1
Wisconsin....................................       13       2,052      11.9
                                                   ---      ------     -----
  Total......................................      137      17,198     100.0%
                                                   ===      ======     =====
<CAPTION>
CLASSIFICATION
- --------------
<S>                                           <C>           <C>    <C>
Owned........................................       38       4,794      27.9%
Leased.......................................       91      11,067      64.3
Managed......................................        8       1,337       7.8
                                                   ---      ------     -----
  Total......................................      137      17,198     100.0%
                                                   ===      ======     =====
</TABLE>
- --------
(1) Includes two assisted living facilities in the State of Arizona comprising
    170 licensed beds and two assisted living facilities in the State of
    California comprising 218 licensed beds.
 
                                      67
<PAGE>
 
  The following facilities are organized by state, and in California by region:
 
<TABLE>
<CAPTION>
                                                       LICENSED   OCCUPANCY
               FACILITY                    LOCATION      BEDS   PERCENTAGE(1)
               --------                  ------------- -------- -------------
<S>                                      <C>           <C>      <C>
ARIZONA
Colter Village Health Care and
 Rehabilitation Center(2)                Glendale         186       91.6%
Colter Village Retirement Center(4)(2)   Glendale         105       72.5
GranCare Medical Center of Paradise
 Valley                                  Phoenix          200       93.1
East Valley Medical & Rehabilitation
 Center                                  Mesa             174       57.2
La Mesa Rehabilitation and Care Center   Yuma             125       89.9
Sunquest Village of Yuma(4)              Yuma              65       62.3
Village Green Care Center                Phoenix          127       92.8
                                                        -----       ----
 TOTAL ARIZONA                                            982       81.7%
NORTHERN CALIFORNIA
Almaden HealthCare Center                San Jose          77       91.2%
Driftwood HealthCare Center--Santa Cruz  Santa Cruz        92       88.5
Driftwood HealthCare Center--Hayward     Hayward           88       93.5
Excell Health Care Center(2)             Oakland           99       91.6
Florin Health Care Center                Sacramento       122       94.0
Fremont HealthCare Center                Fremont          122       90.4
Fruitvale HealthCare Center              Oakland          140       98.0
Hayward Hills Health Care Center         Hayward           74       92.4
La Salette Rehabilitation and
 Convalescent Hospital                   Stockton         120       89.5
Parkview Health Care Center              Hayward          121       84.7
Skyline HealthCare Center -- San Jose    San Jose         253       96.5
Vale HealthCare Center                   San Pablo        202       91.1
                                                        -----       ----
 TOTAL NORTHERN CALIFORNIA                              1,510       92.3%
SOUTHERN CALIFORNIA
Autumn Hills Convalescent Hospital       Glendale          99       97.2%
Driftwood Health Care Center             Torrance          99       96.5
El Rancho Vista Health Care Center       Pico Rivera       86       93.3
Flagship Health Care Center              Newport Beach    167       95.2
Inglewood Health Care Center             Inglewood         99       95.0
Lancaster Health Care Center             Lancaster         99       91.4
Laurelwood HealthCare Center             N. Hollywood      99       88.6
Monterey Palms Health Care Center(3)     Palm Desert       99       88.0
Newport Villa(4)                         Newport Beach    109       83.8
Newport Villa West(4)                    Newport Beach    109       82.6
Santa Monica Health Care Center          Santa Monica      59       91.2
Skyline Health Care Center               Los Angeles       99       94.1
Tarzana Extended Care & Rehabilitation
 Center                                  Tarzana          173       92.9
Thousand Oaks Health Care Center         Thousand Oaks    125       95.5
Van Nuys Health Care Center              Van Nuys          58       95.1
Verdugo Vista Health Care Center         La Crescenta      92       95.7
                                                        -----       ----
 TOTAL SOUTHERN CALIFORNIA                              1,671       92.4
 TOTAL CALIFORNIA OPERATIONS                            3,181       92.3%
</TABLE>
 
                                       68
<PAGE>
 
<TABLE>
<CAPTION>
                                                     LICENSED   OCCUPANCY
               FACILITY                   LOCATION     BEDS    PERCENTAGE(1)
               --------                 ------------ -------- --------------
<S>                                     <C>          <C>      <C>
COLORADO
Camelia HealthCare Center               Aurora          150        87.7%
Cedars HealthCare Center                Lakewood        175        95.0
Cherrelyn Manor HealthCare Center       Littleton       236        88.8
Red Rocks HealthCare Center(2)          Denver          100        87.7
                                                      -----        ----
 TOTAL COLORADO                                         661        90.0%
GEORGIA
Lafayette Health Care(2)                Lafayette       100        91.6%
                                                      -----        ----
 TOTAL GEORGIA                                          100        91.6%
ILLINOIS
Birchwood HealthCare Center(2)          Casey            75        91.7%
LaSalle HealthCare Center               LaSalle         101        93.8
Litchfield HealthCare Center            Litchfield      123        78.4
Charleston Manor(2)                     Charleston       62        78.3
Crestview HealthCare Center(2)          Clinton         103        89.7
Dixon Health Care Center(2)             Dixon           110        88.1
Fairview HealthCare Center(2)           Belvidere        80        94.4
Flora HealthCare Center                 Flora            99        94.0
Good Samaritan HealthCare Center        East Peoria     120        75.4
Havana Healthcare Center(2)             Havana           98        83.8
Montebello HealthCare Center(2)         Hamilton        139        81.9
Nature Trail HealthCare Center(2)       Mount Vernon     74        98.8
Odin HealthCare Center(2)               Odin             99        93.4
Parkway Healthcare Center(2)            Wheaton          69        88.9
Rochelle Healthcare Center(2)           Rochelle         50        95.7
Rochelle Healthcare Center--East(2)     Rochelle         74        88.6
Rockford Healthcare Center(2)           Rockford         81        92.3
Community HealthCare Center             Naperville      153        76.5
Springfield Healthcare Center           Springfield     170        93.6
Wynscape HealthCare Center(5)           Wheaton         209        92.4
                                                      -----        ----
 TOTAL ILLINOIS                                       2,089        89.1%
INDIANA
Anderson HealthCare Center(5)           Anderson        175        55.8%
Anthony Wayne HealthCare Center         Fort Wayne      126        65.8
Beech Grove Healthcare Center           Beech Grove     189        65.3
Central Healthcare Center               Indianapolis    147        75.5
Chelsea Healthcare Center(5)            Elkhart         157        45.9
Country Trace Healthcare Center         Indianapolis     49        73.5
Eagle Valley Healthcare Center          Indianapolis    120        85.3
Forest Park Healthcare Center           Kokomo          188        92.5
Lafayette Healthcare Center(5)          Lafayette       202        40.0
Monticello Healthcare Center            Monticello      206        77.6
New Castle Healthcare Center(5)         New Castle      171        77.9
Noblesville Healthcare and Alzheimer's
 Special Care Center                    Noblesville     195        71.5
Pine Tree HealthCare Center             Indianapolis    179        71.6
Universal HealthCare Center(5)          Franklin        123        61.3
Southside HealthCare Center             Indianapolis    155        49.2
Wabash Healthcare Center(5)             Wabash          101        63.0
</TABLE>
 
                                       69
<PAGE>
 
<TABLE>
<CAPTION>
                                                        LICENSED   OCCUPANCY
              FACILITY                     LOCATION       BEDS    PERCENTAGE(1)
              --------                 ---------------- -------- --------------
<S>                                    <C>              <C>      <C>
INDIANA (CONTINUED)
Washington HealthCare Center(5)        Evansville          199        58.4%
Willowbrook HealthCare Center          Clarkville          195        88.3
Willow Ridge HealthCare Center         Fort Wayne          180        57.2
                                                         -----        ----
 TOTAL INDIANA                                           3,057        67.5%
IOWA
Altoona HealthCare Center              Altoona             114        86.1%
Carroll HealthCare Center              Carroll              51        91.9
Granger HealthCare Center              Granger              71        85.2
Heritage HealthCare Center--Des
 Moines(2)                             Des Moines           99        86.4
Jefferson HealthCare Center            Jefferson            93        94.0
Norwalk HealthCare Center              Norwalk              51        86.2
Polk City HealthCare Center            Polk City            68        89.4
                                                         -----        ----
 TOTAL IOWA                                                547        92.8%
LOUISIANA
Alexandria HealthCare Center           Alexandria           75        67.0%
Heritage HealthCare Center--Crowley    Crowley              57        93.4
Heritage HealthCare Center--Hammond    Hammond             108        85.1
                                                         -----        ----
 TOTAL LOUISIANA                                           240        82.0%
MICHIGAN
Bedford Villa HealthCare Center(2)     Southfield           61        83.3%
Cambridge East HealthCare Center(2)    Madison Heights     160        93.8
Cambridge North HealthCare Center(2)   Clawson             120        95.8
Cambridge South HealthCare Center(2)   Beverly Hills       102        95.7
Clinton-Aire HealthCare Center(2)      Clinton Township    150        95.0
Crestmont HealthCare Center(2)         Fenton              132        93.7
Frenchtown HealthCare Center(2)        Monroe              229        76.9
Heritage Manor HealthCare Center(2)    Flint               180        92.3
Hope HealthCare Center(2)              Westland            142        94.3
Madonna HealthCare Center(2)           Detroit             138        88.5
Middlebelt HealthCare Center(2)        Livonia             162        95.1
Nightingale HealthCare Center(2)       Warren              185        95.6
St. Anthony HealthCare Center(2)       Warren              102        90.5
                                                         -----        ----
 TOTAL MICHIGAN                                          1,863        91.8%
MISSISSIPPI
Heritage HealthCare Center--Cleveland  Cleveland            75        94.3%
Heritage HealthCare Center--Clinton    Clinton             135        96.2
Heritage HealthCare Center--Columbia   Columbia            119        95.6
Heritage HealthCare Center--Corinth    Corinth              95        94.9
Heritage HealthCare Center--Greenwood  Greenwood           110        94.9
Heritage HealthCare Center--Grenada    Grenada             137        95.3
Heritage HealthCare Center--Holly
 Springs                               Holly Springs       120        93.9
Heritage HealthCare Center--Indianola  Indianola            75        98.0
Trace Haven HealthCare Center          Natchez              58        93.4
Heritage HealthCare Center--Yazoo
 City                                  Yazoo City          180        95.3
                                                         -----        ----
 TOTAL MISSISSIPPI                                       1,104        95.2%
</TABLE>
 
                                       70
<PAGE>
 
<TABLE>
<CAPTION>
                                                       LICENSED   OCCUPANCY
              FACILITY                    LOCATION       BEDS    PERCENTAGE(1)
              --------                ---------------- -------- --------------
<S>                                   <C>              <C>      <C>
OHIO
Rosegate HealthCare Center            West Worthington     100       84.7%
                                                        ------      -----
 TOTAL OHIO                                                100       84.7%
TENNESSEE
Heritage HealthCare Center--
 Collierville                         Collierville         114      101.2%
Heritage HealthCare Center--Memphis   Memphis              112       89.0
                                                        ------      -----
 TOTAL TENNESSEE                                           226       95.1%
SOUTH CAROLINA
Faith HealthCare Center               Florence             124       93.0%
Hallmark HealthCare Center            Summerville           88       98.3
Jolley Acres HealthCare Center        Orangeberg            60       92.6
Lake City Scranton HealthCare Center  Scranton              88       98.9
Oakbrook Health and Rehabilitation
 Center                               Summerville           88       97.3
Prince George HealthCare Center       Georgetown           148       83.6
St. George HealthCare Center          St. George            88       97.1
Springdale HealthCare Center          Camden               148       95.6
                                                        ------      -----
 TOTAL SOUTH CAROLINA                                      832       93.5%
WEST VIRGINIA
Parkview HealthCare Center            Parkersburg          164       90.8%
                                                        ------      -----
 TOTAL WEST VIRGINIA                                       164       90.8%
WISCONSIN
Ashland Health and Rehabilitation
 Center(2)                            Ashland              121       87.0%
Audubon Health Care Center(2)         Bayside              282       96.6
Christopher East HealthCare Center    Milwaukee            215       91.5
Greentree Health and Rehabilitation
 Center                               Clintonville          78       76.3
Hillside Health Care Center(2)        Milwaukee             39       94.0
Northwest Health Care Center(2)       Milwaukee            102       88.0
Park Manor Health Care Center         Milwaukee            118       87.1
Pine Manor Health Care Center         Clintonville         109       82.2
River Hills West Health Care
 Center(2)                            Pewaukee             237       92.9
Sunny Hill Health Care Center         Madison               73       89.8
The Shores Transitional Care and
 Rehabilitation Center(2)             Glendale             347       84.5
The Virginia Health Care Center       Waukesha             105       96.4
Woodland HealthCare Center            Brookfield           226       96.4
                                                        ------      -----
 TOTAL WISCONSIN                                         2,052       90.2%
                                                        ------      -----
  TOTAL GRANCARE OPERATIONS                             17,198       86.6%
                                                        ======      =====
</TABLE>
- --------
(1) Average occupancy rate for the seven months ended July 1996, for all
    facilities. See notes below.
(2) Facilities owned by the Company.
(3) Facility is managed by outside facility management company.
(4) Facilities operated as retirement living centers.
(5) Facilities managed by the Company.
 
                                       71
<PAGE>
 
CONTRACT MANAGEMENT
 
  Subject to the exceptions set forth below, the Company's contract management
business, which will be owned and operated by New GranCare after the
Distribution, enters into contracts with acute care hospitals for the
management of geriatric specialty programs, generally located inside such
hospitals. Such management contracts do not generally involve the lease or
purchase of any property. Cornerstone does, however, lease two properties in
connection with its operations. The two leased facilities are The Specialty
Hospital of Austin (Texas) and The Specialty Hospital of Houston (Texas),
which as of the end of fiscal 1995 had 104 beds and 45 beds, respectively, and
an average occupancy rate of 35.4% and 55%, respectively. Cornerstone's
corporate headquarters is located in Dallas, Texas.
 
HOME HEALTH
 
  The Company owns and operates home health, private duty and hospice agencies
located in California, Michigan, Wisconsin and Indiana, which will be owned
and operated by New GranCare following the Distribution. The agencies are
operated by subsidiaries of the Company and lease the space for their
operations; all such leases are immaterial in amount.
 
 
                                      72
<PAGE>
 
                                  MANAGEMENT
 
EXECUTIVE OFFICERS AND DIRECTORS.
   
  The executive officers and directors of the Company, as well as their ages
as of January 1, 1997, are listed below, followed by brief accounts of their
business experience and certain other information. Although the contemplated
restructuring of the Company may result in the elimination of certain
management positions filled by persons listed below, it is expected that most,
if not all, of the officers listed below (other than Mr. Reynolds who will
become an executive officer of Vitalink following the Distribution and Merger)
will be asked to continue their employment with New GranCare in substantially
the same capacity as such individuals have served the Company. It is also
expected that the present directors of the Company will continue as directors
of New GranCare. Certain of the executive officers listed below have
employment agreements with the Company that provide for certain payments in
the event of a "change of control" of the Company (as such term is defined in
the relevant employment agreements). Executives entitled to payments in
connection with a change of control under their current Company employment
contracts will be asked to waive any change of control payments to which they
are entitled in consideration of grants of New GranCare Options and as a
condition to entering into a new employment contract with New GranCare. It is
contemplated that the employment agreements to be entered into between such
executives and New GranCare will provide for certain payments in the event of
a "change of control" (as such term will be defined in the relevant New
GranCare employment agreements) of New GranCare. The current directors of New
GranCare are Messrs. Athans, Benton and Schneider. Immediately following the
Distribution, Messrs. Benton and Schneider will resign from the Board of
Directors of New GranCare and will be replaced by the current directors of the
Company. Mr. Athans will continue to serve on the Board of Directors of New
GranCare. New GranCare will reevaluate the size and composition of its Board
of Directors at the next annual meeting of stockholders. Mr. Athans also will
become President and Chief Executive Officer of New GranCare following the
Distribution. Other than Mr. Athans, no assurance can be given that any of the
officers or directors listed below will accept any offered positions with New
GranCare or that the management team of New GranCare will remain substantially
the same as the Company's management team. Gene E. Burleson, currently the
Chairman, President and Chief Executive Officer of the Company, will become
Chief Executive Officer and a director of Vitalink following the Distribution
and the Merger, and will continue to act as Chairman of the Board and a
director of New GranCare. Arlen B. Reynolds, currently a Senior Vice President
of the Company and President of TeamCare, will become Executive Vice President
of Vitalink following the Distribution and the Merger.     
 
<TABLE>   
<CAPTION>
 NAME               AGE                                POSITION
 ----               ---                                --------
 <C>                <C> <S>
 Gene E. Burleson.. 56  Chairman, President and Chief Executive Officer
 Charles M.
  Blalack.......... 69  Director
 Antoinette
  Hubenette, M.D... 48  Director
 Joel S. Kanter.... 40  Director
 Ronald G. Kenny... 41  Director
 Robert L. Parker.. 62  Director
 William G. Petty,
  Jr............... 51  Director
 Edward V. Regan... 66  Director
 Gary U. Rolle..... 55  Director
 M. Scott Athans... 50  Executive Vice President and Chief Operating Officer (present
                        director of New GranCare)
 Evrett W. Benton.. 48  Executive Vice President, General Counsel and Secretary (present
                        director of New GranCare)
 Jerry A.           
  Schneider........ 49  Executive Vice President and Chief Financial Officer (present 
                        director of New GranCare)                                    
 Kay L. Brown...... 43  Senior Vice President and Director of Corporate Communications and
                        Investor Relations
 Dennis J. Hansen.. 49  Senior Vice President, Chief Information Officer
 Dennis G.          
  Johnston......... 49  Senior Vice President, President of Cornerstone Health Management 
                        Company                                                          
</TABLE>    
 
                                      73
<PAGE>
 
<TABLE>   
<CAPTION>
 NAME                      AGE                     POSITION
 ----                      ---                     --------
 <C>                       <C> <S>
 Aruna Poddatoori......... 42  Senior Vice President, Western Operations
 Arlen B. Reynolds........ 55  Senior Vice President and President of TeamCare
 Mark H. Rubenstein....... 51  Senior Vice President, Director of Human
                               Resources
 Richard J. Spinello...... 50  Senior Vice President, Director of Risk
                               Management
 R. Jeffrey Taylor........ 47  Senior Vice President, GCI Rehab
 Dennis Wheeler........... 45  Senior Vice President, Eastern Operations
 Frank E. Scott, D.O. .... 51  Senior Vice President, Corporate Medical
                               Director
 Keith J. Yoder........... 44  Senior Vice President, Controller and Treasurer
 Thomas J. Benes.......... 43  Vice President, Director of Materials
                               Management
 David R. Borchers........ 45  Vice President, Director of Facility Management
 James G. Burkhart........ 32  Vice President, Operational Finance
 M. Henry Day, Jr......... 43  Vice President, Assistant General Counsel and
                               Assistant Secretary
 Victoria A. Eberle....... 32  Vice President, Director of Tax
 Clark D. Hettinga........ 31  Vice President, Assistant Controller
 Helayne R. O'Keiff....... 42  Vice President, President of GranCare Home
                               Health Services
 Sandra L. Long........... 45  Vice President, Sales and Marketing
 Jeffrey L. Peterson...... 42  Vice President, Business Development
 Michael H. Rosen......... 47  Vice President, Director of Business Compliance
                               and Controls
 Robert E. Schmidt........ 38  Vice President, Operational Finance
</TABLE>    
 
  Gene E. Burleson has served as Chairman of the Board of the Company since
January 1994. Additionally, Mr. Burleson has served as President and Chief
Executive Officer of the Company since December 1990. Mr. Burleson will cease
acting as President and Chief Executive Officer upon completion of the
Distribution and the Merger. Mr. Burleson has served as President and a
Director of the Company since October 1989. From 1974 to September 1989, Mr.
Burleson was employed by American Medical International, Inc. ("AMI"), a
provider of health care services, where from early 1988 to March 1989 he
served as President while continuing his role as Chief Operating Officer, a
position he assumed in 1986. Prior to serving as President of AMI,
Mr. Burleson was President and Chief Executive Officer of American Medical
International--European Operations for nine years. Mr. Burleson currently
serves on the boards of directors of three other public companies: Alternative
Living Services, Inc. ("ALS"), a developer and manager of assisted living
facilities; Deckers Outdoor Corp., a footwear manufacturer; and Walnut
Financial Services, a provider of financial services.
 
  Charles M. Blalack became a director of the Company in March 1989. From
March 1993 to the present, Mr. Blalack has been Chairman and Chief Executive
Officer of Blalack & Company, a member of the National Association of
Securities Dealers, Inc. ("NASD"). From September 1969 to March 1993, Mr.
Blalack was Chairman of the Board and Chief Executive Officer of Blalack-Loop,
Incorporated, a member of the NASD and a registered investment advisor. Mr.
Blalack was a director of Beverly Enterprises, Inc. ("Beverly Enterprises"),
the largest operator of long-term care facilities in the United States, from
1964 to 1975, and he currently serves on the board of directors of Advanced
Micro Devices, Inc., a publicly held company.
 
  Antoinette Hubenette, M.D. became a director of the Company in April 1992.
Dr. Hubenette is a medical doctor who specializes in internal medicine and
geriatric care. Since 1982, Dr. Hubenette has been a partner with the Medical
Group of Beverly Hills, and recently became the President of the group. In
1968, Dr. Hubenette received her bachelor's degree from the University of
California, Berkeley, and in 1976 completed her M.D. at George Washington
University. Currently, Dr. Hubenette serves on the board of directors of
Cedars-Sinai Medical Care Foundation and is a member of several professional
organizations, including the American Medical Association.
 
  Joel S. Kanter became a director of the Company in December 1990. From 1986
to the present, Mr. Kanter has been the President of Windy City, Inc., a
private investment company, and from 1988 to February 27, 1995 he served as a
consultant to Walnut Capital Corporation ("WCC"), a closely held investment
management and advisory firm. From February 27, 1995 to the present, Mr.
Kanter has served as the President of WCC and
 
                                      74
<PAGE>
 
Walnut Financial Services. Prior to 1986, Mr. Kanter was Managing Director of
the Investors' Washington Service, an investment advisory company specializing
in providing advice to institutional clients about the impact of federal
legislative and regulatory decisions on debt and equity markets. Mr. Kanter
serves on the board of directors of five other publicly held companies, I-Flow
Corporation (a home infusion pump manufacturer), TransGlobal Services, Inc.
(an engineering personnel temporary firm), Walnut Financial Services, Inc. (a
provider of small business financial and consulting services), Healthcare
Acquisition Corp. (a corporation involved in acquiring healthcare related
companies) and Osteoimplant Technology, Inc. (a manufacturer of shoulder and
hip implant devices), and several privately held companies.
 
  Ronald G. Kenny became a director of the Company in July 1995 in connection
with the Company's merger with Evergreen. Mr. Kenny served as a director of
Evergreen from June 1993 up to the time of the Evergreen merger and currently
serves as Vice President--Finance of Huizenga Capital Management, a privately
held investment management company, since 1990. Mr. Kenny was a director of
National Heritage, Inc. ("NHI") from October 1992 to June 1993. Mr. Kenny
serves on the board of directors of Alternative Living Services, Inc. ("ALS"),
a public corporation that owns and manages assisted living facilities.
 
  Robert L. Parker became a director of the Company in July 1995 in connection
with the Company's merger with Evergreen. Mr. Parker served as Chairman of the
Board of Directors of Omega Healthcare Investors, Inc., a real estate
investment trust ("Omega") from March 1992 to July 1995 and was a Managing
Director of Omega Capital, Ltd., a private health care investment fund ("Omega
Capital"), from 1986 to 1992. From 1972 through 1983, Mr. Parker was a senior
officer of Beverly Enterprises. At the time of his retirement in 1983, Mr.
Parker was Executive Vice President of Beverly Enterprises. Mr. Parker is a
registered architect, licensed in California and Oklahoma. Mr. Parker
continues to serve as a director of Omega and also serves as a director of
First National Bank of Bethany, Oklahoma, a private commercial bank.
 
  William G. Petty, Jr. became a director of the Company in July 1995 in
connection with the Company's merger with Evergreen. Since July 1, 1996, Mr.
Petty has been a principal of Beecken, Petty & Company LLC, which is the
general partner of Healthcare Equity Partners, a venture capital partnership.
Mr. Petty served as Chairman of the Board of Directors, President and Chief
Executive Officer of Evergreen from June 30, 1993 to July 1995. He served as
Chairman of the Board, Chief Executive Officer and President of NHI from
October 1992 to June 1993. From 1988 to 1992, he served as President and Chief
Executive Officer of Evergreen Healthcare Ltd., L.P. ("EHL"), an affiliate of
Evergreen, and has been a Managing Director of Omega Capital, Ltd., a private
health care investment fund since 1986. Mr. Petty has been the Chairman of the
Board of ALS since 1993. Mr. Petty also served as the Chief Executive Officer
of ALS from 1993 until February 1996.
 
  Edward V. Regan became a director of the Company in January 1994. From 1979
to 1993, Mr. Regan served as New York State Comptroller. From 1992 to the
present, Mr. Regan has been associated with the Jerome Levy Economics
Institute, a non-partisan research center generating public policy
alternatives through the study of economics. Mr. Regan is a member of the U.S.
Competitiveness Policy Council. From 1988 to 1992, Mr. Regan was an adjunct
professor at New York University's Stern Graduate School of Business. Mr.
Regan currently serves on the board of directors of the Oppenheimer Funds,
Inc. and River Bank America, a publicly held company and Offitbank, a
professional money management firm and a publicly held company.
 
  Gary U. Rolle became a director of the Company in February 1994. From 1983
to the present, Mr. Rolle has been the Executive Vice President and Chief
Investment Officer of Transamerica Investment Services, a subsidiary of
Transamerica Corp., a financial services company. Mr. Rolle is currently the
Chairman and President of Transamerica Income Shares, director of Transamerica
Investors, Transamerica Occidental Life Insurance Company, Transamerica Life
Insurance & Annuity, Transamerica Assurance Company, Transamerica Realty
Services and Arbor Life Insurance Company and Chairman of Separate Account
Funds B & C. Mr. Rolle is also a member of the Board of Trustees of Harvey
Mudd College.
 
  M. Scott Athans joined the Company in November 1993 as Executive Vice
President and Chief Operating Officer. Prior to joining the Company, Mr.
Athans was the Chief Operating Officer of Healthfield Inc., a home
 
                                      75
<PAGE>
 
health care business with operations in Georgia, Tennessee, Alabama,
Massachusetts and Florida. From March 1990 to July 1991, Mr. Athans served as
the Chief Executive Officer of the Georgia Baptist Medical Center. Prior to
that, Mr. Athans spent six years as Senior Vice President and Regional
Director of AMI.
 
  Evrett W. Benton joined the Company in January 1992 and shortly thereafter
became Executive Vice President, General Counsel and Secretary. Prior to
joining the Company, he was with a national law firm, Andrews & Kurth L.L.P.,
where he began his legal career in Houston in 1975. In 1989, he moved to the
firm's Los Angeles office where he served as managing partner. His practice
specialized in business law, with an emphasis on finance, mergers and
acquisitions and general corporate law.
 
  Jerry A. Schneider joined the Company in January 1995 as Executive Vice
President and Chief Financial Officer. Mr. Schneider served as President of
J&K Alan Company, Ltd., London, England, an investment management company,
from 1991 to 1994. From 1985 to 1991, Mr. Schneider was the Chief Financial
Officer and Legal Counsel to Eugene V. Klein, dba Del Rayo Racing Stables, a
major thoroughbred racing and breeding operation. Prior to 1985, he spent
seven years as the Vice President of Taxes and International Chief Financial
Officer of AMI.
 
  Kay L. Brown, a Senior Vice President since February 1993, is Director of
Corporate Communications and Investor Relations of the Company. From June 1992
through February 1993, Ms. Brown was Vice President, Home Health of the
Company. Prior to joining the Company in 1992, from December 1988 to June 1992
Ms. Brown served as President and Chief Executive Officer of Visiting Nurse
Associations of America ("VNAA"), the organization representing visiting nurse
associations throughout the United States. From February 1987 to December
1988, Ms. Brown was VNAA's Vice President and Chief Operating Officer.
 
  Dennis J. Hansen joined the Company in February 1993 as the Director of
Reimbursement and in August 1993 became the Director of Reimbursement and
Management Information Services. Currently, Mr. Hansen serves as Senior Vice
President and Chief Information Officer. In January 1994, Mr. Hansen was
promoted to Vice President and in January 1995 he became a Senior Vice
President of the Company. Prior to joining the Company, Mr. Hansen spent ten
years as the Corporate Vice President, Director of Reimbursement Services of
AMI.
 
  Dennis G. Johnston joined the Company as President of Cornerstone in April
1995 and became Senior Vice President of the Company in July 1995.
Mr. Johnston was the co-founder of Cornerstone in 1990, and served as its
President and Chief Executive Officer from 1990 to 1995. From 1984 to 1989,
Mr. Johnston held various positions with the management subsidiary of Republic
Health Corporation, including that of Senior Development Officer.
   
  Aruna Poddatoori became Senior Vice President, Western Operations, of the
Company in January 1997 after having served as Vice President, Western
Division Operations of the Company since October 1995. Ms. Poddatoori joined
the Company in 1991 when the Company acquired certain facilities from ARA
Living Centers where she served as Executive Director of Driftwood Health Care
Center in Torrence, California.     
 
  Arlen B. Reynolds joined the Company in September 1995 as Senior Vice
President and President of TeamCare. In connection with the Merger, Mr.
Reynolds will resign as an officer of the Company and become an Executive Vice
President of Vitalink. From 1993 to September 1995, Mr. Reynolds was the
administrator and Chief Operating Officer of Brookwood Medical Center in
Alabama. From 1988 to 1993, he served in several capacities with AMI,
including Chief Executive Officer and President of an acute care hospital.
   
  Mark H. Rubenstein became a Senior Vice President of the Company in January
1997. Prior to that, Mr. Rubenstein was employed by AMS for eleven years and
joined the Company as Vice President, Director of Human Resources in
connection with the acquisition of AMS in December 1990.     
          
  Frank E. Scott, D.O. became a Senior Vice President of the Company in
January 1997. Prior to this, he served as the Company's Executive Vice
President of Clinical Affairs and National Medical Director since 1995.     
 
                                      76
<PAGE>
 
   
Since completing his fellowship in rheumatology and clinical immunology at
Walter Reed Army Medical Center in 1983, Dr. Scott has served as a clinical
professor at various medical universities and currently is on the teaching
staff as an Associate Professor at the College of Osteopathic Medicine of the
Pacific in Ponomo, California and at Kirksville College of Osteopathic
Medicine, Kirksville, Missouri. Since 1985, Dr. Scott has maintained a private
practice and served as President of the Southwest Arthritis Center in Phoenix,
Mesa and Chandler, Arizona.     
 
  Richard J. Spinello became a Senior Vice President in January 1996. Prior to
this, he served as Vice President and Director of Risk Management since
January 1993 and in various other capacities with the Company from the time he
joined the Company in 1991. Prior to joining the Company, Mr. Spinello was
Director of both Professional Liability Claims and Loss Control at AMI.
   
  R. Jeffrey Taylor joined the Company in February 1996 as President of GCI
Renal Care, Inc., became President of the Company's ancillary services
division in November 1996 and was appointed Senior Vice President of the
Company in January 1997. Prior to joining the Company, Mr. Taylor was Chief
Executive Officer of American Outpatient Services Corporation, a dialysis
company, since July 1995. From January 1992 to June 1994 he was President of
Weisman, Taylor, Simpson & Sabatino, a health care merchant banking firm based
in California. From 1982 through 1992 Mr. Taylor served in several executive
capacities with AMI including General Counsel and Executive Vice President,
Chief Administrative Officer.     
   
  Dennis Wheeler joined the Company in 1992 when the Company acquired
International Health Care Management, Inc., where he was Director of
Operations. Following the acquisition, he was appointed as the Company's
director of operations for Georgia and South Carolina when the Company
expanded into those markets. Mr. Wheeler was elected Senior Vice President,
Eastern Operations, of the Company in January 1997.     
 
  Keith J. Yoder joined the Company in July 1995 as Senior Vice President,
Controller and Treasurer. He previously served as Vice President, Chief
Financial Officer of Evergreen since January 1992, Secretary of Evergreen
since June 1993 and as Treasurer of Evergreen since December 1993. He served
as Vice President of NHI from December 1992 to June 1993 and as the Chief
Financial Officer and Secretary of NHI from January 1993 to June 1993. Prior
to joining Evergreen, Mr. Yoder served as Area Controller for ARA from 1989 to
1992.
 
  Thomas J. Benes joined the Company in March 1995 as Director of Materials
Management. In January 1996, Mr. Benes was promoted to Vice President. Prior
to joining the Company, Mr. Benes served in several capacities with Main Line
Health, Inc. from 1987 to 1994.
 
  David R. Borchers joined the Company in November 1993, as Director of
Facility Management, and became Vice President in January 1995. Prior to
joining the Company, Mr. Borchers served as Vice President of Facilities
Development and Engineering for Dole Food Company since 1988.
   
  James G. Burkhart joined the Company in May 1996 as Chief Financial Officer
of TeamCare and became Vice President in January 1997. Prior to joining the
Company, Mr. Burkhart served as Senior Vice President of Finance of Community
Care of America from 1995 to 1996. Prior to this, Mr. Burkhart served as
Executive Vice President and Chief Financial Officer of Nationwide Care from
1993 to 1995. Prior to 1993, Mr. Burkhart worked for the accounting firm of
Ernst & Young LLP for seven years.     
 
  M. Henry Day, Jr. became a Vice President of the Company in January 1996.
Prior to this, he served as Assistant General Counsel and Assistant Secretary
of the Company since September 1994. Before joining the Company, Mr. Day was
General Counsel of Life Care Centers of America, Inc., a privately-owned
Cleveland, Tennessee based long-term healthcare provider.
 
  Victoria A. Eberle joined the Company in January 1992 as Corporate Tax
Manager and became Vice President in January 1994. Prior to joining the
Company, Ms. Eberle worked for the accounting firm of Deloitte & Touche LLP
for five years.
 
                                      77
<PAGE>
 
  Clark D. Hettinga was elected Vice President in January 1996. Previously, Mr.
Hettinga served as Director of Accounting, Assistant Controller, Director of
Financial Reporting and Corporate Reporting and SEC Compliance Supervisor for
the Company from 1992 to present. From 1989 to 1992, Mr. Hettinga was an
auditor with Ernst & Young LLP in Milwaukee, Wisconsin.
 
  Sandra L. Long became Vice President, Sales and Marketing of the Company in
October 1995 after serving as Director of Operations--Midwest Region since
1993. Previously, Ms. Long served as the Executive Director of The Shores
Transitional Care and Rehabilitation Institute during 1992 and 1993.
 
  Helayne R. O'Keiff joined the Company in April 1995 as the President of
GranCare Home Health Services. In January 1996, Ms. O'Keiff became a Vice
President of the Company. From 1992 to 1995 Ms. O'Keiff served as the Chief
Operating Officer of Home Technology Healthcare, Inc., a Nashville, Tennessee
based home care services provider. From 1987 to 1992, Ms. O'Keiff was Director
of Home Health Services at Barnes Hospital in St. Louis, Missouri.
   
  Jeffery L. Petersen became a Vice President of the Company in January 1997.
Previously, Mr. Petersen served as Director of Acquisitions and Facility
Development since 1995. In 1994, Mr. Petersen served as a consultant to the
Acquisition Department of the Company. Prior to joining the Company, Mr.
Petersen served as the General Partner of RPR Partnership 1, a real estate
partnership, and was a medical practice management consultant for 15 years.
    
  Michael H. Rosen joined the Company in October 1991 as Controller. In January
1994 he was promoted to Vice President of the Company. In 1995, Mr. Rosen
became Director of Business Compliance and Controls.
          
  Robert E. Schmidt became a Vice President of the Company in January 1997.
Prior to this, he served as Vice President, Operational Finance of the
Company's facilities division since August 1995. Prior to this, he served as
Vice President--Corporate Controller for Transitional Health Services during
1995. Before joining Transitional Health Services, Mr. Schmidt served in
various capacities at MedRehab, Inc., the country's largest privately held
medical rehabilitation company, from 1990-1994.     
 
COMMITTEES OF THE BOARD OF DIRECTORS
 
  The Company presently has a total of five standing committees of its Board of
Directors including an Audit Committee, a Finance Committee, a Management
Compensation Committee, a Nominating Committee and a Quality Committee. It is
anticipated that New GranCare will establish similar committees of its Board of
Directors. A brief description of the responsibilities of each of the standing
committees of the Company's Board of Directors and the members of each such
committee is set forth below.
 
  Messrs. Kanter (Chairman), Regan and Kenny are the members of the Company's
Audit Committee. The Audit Committee is responsible for coordinating matters
with independent auditors, reviewing internal accounting controls and
recommending the engagement of independent accountants to the Board of
Directors.
 
  The Finance Committee consists of Messrs. Petty (Chairman), Burleson, Kanter
and Rolle. The Finance Committee is responsible for evaluating financing
alternatives and advising management on financial strategies and major
financial transactions.
 
  Messrs. Rolle (Chairman), Blalack, Parker and Dr. Hubenette are the members
of the Management Compensation Committee. The Management Compensation Committee
is charged with administering the Company's incentive programs and reviewing
and making recommendations to the Board of Directors with respect to the
compensation of all officers of the Company and all issuances of equity
securities of the Company to the Company's directors, officers, employees and
consultants.
 
  The Nominating Committee consists of Messrs. Burleson (Chairman), Blalack and
Petty. The Nominating Committee is responsible for selecting and nominating
individuals to fill vacancies on the Board of Directors,
 
                                       78
<PAGE>
 
and appointing officers. The Nominating Committee will consider nominees
recommended by shareholders pursuant to the notice and other provisions set
forth in the Company's Bylaws.
 
  The Quality Committee is comprised of Dr. Hubenette (Chairperson) and
Messrs. Burleson and Blalack. The Quality Committee is responsible for
evaluating the quality of patient care and services provided at the Company's
facilities.
 
COMPENSATION OF DIRECTORS
 
  The initial New GranCare Board of Directors (which consists of Messrs.
Athans, Benton and Schneider prior to the Distribution) has adopted, and the
Company, the sole stockholder of New GranCare prior to the Distribution, has
approved a compensation program for its outside directors (the "New GranCare
Directors Plan") that is identical to the program that is currently used by
the Company (the "GranCare Directors Plan"). As part of this program, New
GranCare has adopted, and the Company has approved, the Outside Directors
Stock Incentive Plan, pursuant to which New GranCare is authorized to issue up
to 200,000 shares of New GranCare Common Stock subject to options granted in
connection with the New GranCare Directors Plan. Of the shares authorized to
be issued under the New GranCare Directors Plan, options for 90,000 shares of
New GranCare Common Stock will be issued immediately after the Distribution to
replace options granted under the GranCare Directors Plan maintained by the
Company prior to the Distribution. As a result of the Distribution and the
Merger, outstanding options to purchase Company Common Stock awarded under the
program currently used by the Company will be treated in the same manner as
all other Company Options. See "The Distribution--Consummation of the
Distribution; Treatment of Company Stock Options."
 
 Stock Awards
 
  The New GranCare Directors Plan provides for the automatic annual grant of
shares of New GranCare Common Stock to each non-employee director. The number
of shares of New GranCare Common Stock issued to each non-employee director
will equal the result obtained by dividing 12,000 by the fair market value of
the shares of New GranCare Common Stock on the first trading day in April
1997, (the "Effective Date"). On the third anniversary of the Effective Date
of the Directors Plan and each third anniversary thereafter, the denominator
of the formula will be revised so that it equals the fair market value of the
New GranCare Common Stock on the first trading date in April of such year. The
terms of the stock awards discussed above are identical to the terms contained
in the GranCare Directors Plan.
 
 Option Awards
 
  Under the New GranCare Directors Plan, each non-employee director will also
receive options to purchase 10,000 shares of New GranCare Common Stock upon
his or her initial appointment as a director and will receive options to
purchase an additional 6,000 shares of New GranCare Common Stock at each of
the next two annual meetings of shareholders. After a non-employee director
has received options to purchase 22,000 shares of New GranCare Common Stock,
he or she will then receive options to purchase an additional 2,000 shares of
New GranCare Common Stock at each succeeding annual meeting of shareholders.
The exercise price of all of such options will be the fair market value of the
New GranCare Common Stock on the date of grant and such options will vest in
equal annual increments over a three year period.
 
  In the event of the death or disability of a non-employee director while
serving as a member of the New GranCare Board of Directors, or upon the
occurrence of a "change in control" (as defined in the New GranCare Directors
Plan) of New GranCare, all outstanding options granted under the New GranCare
Directors Plan vest and become immediately exercisable. Each option expires
ten years from the date of grant, but expires earlier to the extent not vested
upon the cessation of a non-employee director's service on the New GranCare
Board of Directors for reasons other than death or disability. In the event
that a change in control of New GranCare occurs as a result of certain "tender
offers" (as defined in the New GranCare Directors Plan), all outstanding
options will be surrendered in exchange for a cash payment by New GranCare.
The terms of the stock awards discussed above are identical to the terms
contained in the GranCare Directors Plan.
 
                                      79
<PAGE>
 
 Tax Consequences
 
  A New GranCare director will not be taxed on the receipt of an option. A
director will be taxed, however upon the exercise of an option in an amount
equal to the difference between the exercise price of the option and the fair
market value of the New GranCare Common Stock subject to the exercised option
on date of exercise, and New GranCare will then be entitled to a corresponding
deduction.
 
 Cash Awards
 
  The non-employee directors will also receive annual cash compensation of
$12,000 consisting of four payments of $3,000 each for each of the four
regularly scheduled Board Meetings attended. Each non-employee director will
also receive $1,000 per day for committee meetings attended on a date when a
regular board meeting or retreat is not also scheduled.
 
COMPENSATION OF EXECUTIVE OFFICERS
   
  The following table sets forth certain summary information concerning
compensation paid or accrued by the Company on behalf of the Chief Executive
Officer and the four most highly compensated executive officers of the Company
other than the Chief Executive Officer for the fiscal years ended December 31,
1994, 1995 and 1996. Mr. Gene E. Burleson, currently the Chairman of the
Board, Chief Executive Officer and President of the Company, will become Chief
Executive Officer of Vitalink following the Merger and will not be an
executive officer of New GranCare. New GranCare presently intends to continue
the compensation policies and practices of the Company following the
Distribution although there can be no assurance that changes to or
modification of such practices and policies will not be implemented if deemed
appropriate by the New GranCare Board of Directors and management.     
 
                      COMPANY SUMMARY COMPENSATION TABLE
 
<TABLE>   
<CAPTION>
                                                                        LONG-TERM
                                   ANNUAL COMPENSATION                 COMPENSATION
                              --------------------------------------   ------------
                                                           OTHER        SECURITIES
                                                           ANNUAL       UNDERLYING     ALL OTHER
   NAME AND PRINCIPAL          SALARY       BONUS       COMPENSATION   OPTIONS/SARS   COMPENSATION
        POSITION         YEAR  ($)(1)        ($)            ($)            (#)           ($)(2)
   ------------------    ---- --------     --------     ------------   ------------   ------------
<S>                      <C>  <C>          <C>          <C>            <C>            <C>            <C>
Gene E. Burleson         1996 $430,000        --          $  --           56,760(3)     $ 25,234(4)
 Chairman of the Board,                       --
  Chief                  1995  385,000                          --          --            65,263
 Executive Officer and                        --
  President              1994  350,000                     180,542(5)       --            66,933
M. Scott Athans          1996 $350,000        --          $  --           28,000(3)     $ 16,769(6)
 Executive Vice                               --
  President and          1995  330,000                          --          --            55,756
 Chief Operating Officer 1994  300,000        --             --             --            13,312
Evrett W. Benton         1996 $350,000        --          $  --           28,000(3)     $ 13,556(7)
 Executive Vice                               --
  President,             1995  330,000                          --(8)       --            33,163
 General Counsel and                          --
  Secretary              1994  300,000                       --             --            32,657
Jerry A. Schneider       1996 $275,000        --          $  --           22,000(3)     $ 13,073(9)
 Executive Vice                               --
  President and          1995  239,583(10)                  34,375(11)   125,000(12)      13,417
 Chief Financial Officer 1994    --           --             --             --             --
Donald D. Finney(13)     1996 $240,000        --          $  --           15,600(3)     $293,989(14)
 Senior Vice President
  and President          1995  217,405(15)       --          --           25,000(16)       1,227
 of Long Term Care
  Division               1994  189,035(17)  119,843(17)      --           42,004(17)       1,169(17)
</TABLE>    
- --------
 (1) The Company has a deferred compensation program (the "Deferred
     Compensation Program") that is applicable to compensation paid or payable
     to eligible employees of the Company. Under such program the Company may
     elect to match a portion of any compensation amounts deferred. Deferred
     salary amounts are reported in this table under the Salary column and
     matching amounts paid or accrued are reported in this table under the All
     Other Compensation column.
 
                                      80
<PAGE>
 
   
 (2) The amounts shown in this column include the Company's contributions in
     respect of the Company's profit sharing plan (the "Profit Sharing Plan");
     all non-union employees who have completed two years of employment with
     the Company can participate in the Profit Sharing Plan. The Company makes
     an annual contribution to the Profit Sharing Plan in an amount equal to
     2% of each participating employee's salary for the previous year, plus an
     additional 2% of any portion of the employee's salary that exceeds one-
     half of the social security wage base, subject to certain limitations.
     Amounts shown also include the Company's payment in respect of the
     Company's 401(k) Plan; all non-union employees who have completed one
     year of employment with the Company can participate in the 401(k) Plan.
     Eligible employees may contribute from 1% to 15% percent of their salary
     to the 401(k) Plan, subject to certain limitations. The Company
     contributes a matching amount each year to the 401(k) Plan equal to 25%
     of the first 4% of each participant's contribution for that year. This
     column also includes benefits to the Company's officers relating to
     premiums paid by the Company with respect to the Executive Split Dollar
     Life Insurance Plan and long-term disability insurance, for which only
     the Company's officers are eligible and Group Life Term Insurance, which
     is provided to all of the Company's employees ("Group Term Life
     Insurance"). The Executive Split Dollar Life Insurance Plan became
     effective in fiscal year 1993 and provides that premiums are returned to
     the Company upon termination of each policy.     
   
 (3) Represents stock options granted on January 23, 1996 at an exercise price
     of $14.75.     
   
 (4) Represents the Company's contribution of $1,215 to the 401(k) Plan and
     $5,388 to the Profit Sharing Plan, $47 for Group Term Life Insurance and
     $11,892 for long-term disability insurance. Also includes $6,692 under
     the Executive Split Dollar Life Insurance Plan. The amount of benefit
     received under the Executive Split Dollar Life Insurance Plan was
     determined by subtracting the total premiums paid under the Plan during
     1996 ($11,100) from the increase in the cash surrender value of the Plan
     from December 31, 1995 to December  31, 1996 ($17,792).     
   
 (5) Represents $162,542 in relocation expense and $18,000 in car allowance.
         
          
 (6) Represents the Company's contribution of $1,286 to the 401(k) Plan,
     $1,823 pursuant to the Company's Deferred Compensation Program, $47 for
     Group Term Life Insurance and $12,886 for long-term disability insurance.
     Also includes $727 under the Executive Split Dollar Life Insurance Plan.
     The amount of benefit received under the Executive Split Dollar Life
     Insurance was determined by subtracting the total premiums paid under the
     Plan during 1996 ($17,400) from the increase in the cash surrender value
     of the Plan from December 31, 1995 to December 31, 1996 ($18,127).     
   
 (7) Represents the Company's contribution of $1,286 to the 401(k) Plan and
     $5,388 to the Profit Sharing Plan, $47 for Group Term Life Insurance and
     $6,845 for long-term disability insurance. Does not include any amounts
     under the Executive Split Dollar Life Insurance Plan as the premiums paid
     under the Plan during 1996 ($17,800) exceeded the increase in the cash
     surrender value of the Plan from December 31, 1995 to December 31, 1996
     ($17,311).     
          
 (8) Mr. Benton received certain benefits in 1995 that are properly not
     reflected in this table. For a description of these benefits, see
     "Certain Relationships and Related Party Transactions."     
   
 (9) Represents the Company's contribution of $1,100.00 to the 401(k) Plan,
     $47 for Group Term Life Insurance, $8,888 for long-term disability
     insurance and the Company's contribution of $3,038 to the Company's
     Deferred Compensation Program. Does not include any amounts under the
     Executive Split Dollar Life Insurance Plan as the premiums paid under the
     Plan during 1996 ($54,400) exceeded the increase in the cash surrender
     value of the Plan from December 31, 1995 to December 31, 1996 ($37,474).
         
                                      81
<PAGE>
 
(10) Mr. Schneider joined the Company in January 1995 and his salary for 1995
     reflects a partial year of service.
 
(11) Represents $20,000 paid to Mr. Schneider in respect of relocation
     expenses and $14,375 in respect of Mr. Schneider's car allowance.
 
(12) Represents stock options granted on January 27, 1995 at an exercise price
     of $15.75 per share.
   
(13) Resigned effective January 1, 1997.     
   
(14) Represents the Company's payment of premiums of $47 for Group Term Life
     Insurance, $2,442 for long-term disability insurance and the Company's
     contribution of $1,500 to the 401(k) Plan. Also includes $290,000 paid to
     Mr. Finney in connection with the termination of his employment agreement
     with Evergreen HealthCare, Inc. ("Evergreen") in July 1995. Mr. Finney
     received this termination payment in 1996 upon his execution of an
     employment agreement with the Company. Does not include any amounts under
     the Executive Split Dollar Life Insurance Plan as the premiums paid under
     the Plan during 1996 ($23,717) exceeded the increase in the cash
     surrender value of the Plan from December 31, 1995 to December 31, 1996
     ($14,390).     
   
(15) Mr. Finney became an employee of the Company on July 21, 1995 in
     connection with the merger with Evergreen, which was treated as a pooling
     of interests for financial reporting purposes. Represents $98,436
     received from the Company after the merger with Evergreen and $118,969
     received from Evergreen prior to such merger. The amounts shown for the
     years 1993 and 1994 were paid entirely by Evergreen.     
          
(16) Represents stock options granted on July 21, 1995 at an exercise price of
     $17.25.     
   
(17) Represents amounts and options paid by Evergreen, the acquisition of
     which was treated as a pooling of interests for financial reporting
     purposes.     
 
 Employment Agreements
 
  Following the Distribution and the Merger, New GranCare intends to enter
into employment agreements with most of the executive officers who have
employment agreements with the Company as of the Distribution Date. As a
condition to any executive officer executing an employment agreement with New
GranCare or Vitalink, each executive officer must agree to waive his or her
rights to certain change of control payments granted under any existing
employment agreement with the Company which may be triggered by the
Distribution and the Merger. Although the specific terms of employment
agreements to be entered into between New GranCare and its executive officers
have not yet been determined, it is anticipated that such employment
agreements will be substantially similar to the existing agreements with the
Company and will provide for certain payments to executive officers in the
event of a "change of control" (as such term is defined in the relevant New
GranCare employment agreements) of New GranCare.
   
  Mr. Burleson has a five-year employment agreement with the Company which
became effective January 1, 1994 and provides for annual adjustments in base
salary as determined by the Management Compensation Committee (the
"Committee"). The employment agreement provides for annual automatic
extensions of the term year for an additional year unless the Board or Mr.
Burleson elects not to have the term so extended. The Committee previously
established Mr. Burleson's base salary at $430,000 for 1996. The agreement
also provides for severance compensation upon termination of employment by the
Company for any reason other than for "Cause," as defined in agreement,
consisting of a minimum of three year's base salary and, in the event of a
change-in-control, as defined in the agreement, payment of a minimum of five
years base salary and accelerated vesting of all options held by Mr. Burleson.
Following the Merger, Mr. Burleson will become an employee of Vitalink. It is
anticipated that Vitalink will assume Mr. Burleson's existing employment
contract on substantially the same terms as those described above. In
addition, Mr. Burleson will be named Chairman of the Board of New GranCare
and, in connection therewith, it is anticipated that New GranCare will enter
into a consulting agreement with Mr. Burleson in the amount of $100,000 per
year.     
 
                                      82
<PAGE>
 
  Mr. Athans has a three-year employment agreement with the Company which
became effective January 1, 1994 and provides for annual adjustments in base
salary as determined by the Committee. The employment agreement provides for
annual automatic extensions of the term for an additional year unless the
Board or Mr. Athans elects not to have the term so extended. The Committee
previously established Mr. Athans' base salary at $350,000 for 1996. The
agreement also provides for severance compensation upon termination of
employment by the Company for any reason other than for "Cause," as defined in
the agreement, consisting of a minimum of two year's base salary and, in the
event of a change-in-control, as defined in the agreement, payment of a
minimum of three years base salary and accelerated vesting of all options held
by Mr. Athans.
 
  Mr. Benton has a three-year employment agreement with the Company which
became effective January 1, 1994 and provides for annual adjustments in base
salary as determined by the Committee. The employment agreement also provides
for annual automatic extensions of the term for an additional year unless the
Board or Mr. Benton elects not to have the term so extended. The Committee
previously established Mr. Benton's base salary at $350,000 for 1996. The
agreement also provides for severance compensation upon termination of
employment by the Company for any reason other than for "Cause," as defined in
the agreement, consisting of a minimum of two year's base salary and, in the
event of a change-in-control, as defined in the agreement, payment of a
minimum of three years base salary and accelerated vesting of all options held
by Mr. Benton.
 
  Mr. Schneider has a three year employment agreement with the Company, which
became effective January 16, 1995 and provides for annual adjustments in base
salary as determined by the Committee. The employment agreement also provides
for annual automatic extensions of the term for an additional year unless the
Board or Mr. Schneider elects not to have the term so extended. The Committee
previously established Mr. Schneider's base salary at $275,000 for 1996. The
agreement also provides for severance compensation upon termination of
employment by the Company for any reason other than for "Cause," as defined in
the agreement, consisting of a minimum of two year's base salary and, in the
event of a change-in-control, as defined in the agreement, payment of a
minimum of three years base salary and accelerated vesting of all options held
by Mr. Schneider.
 
  Mr. Finney has a two-year employment agreement with the Company which became
effective July 20, 1995 and provides for annual adjustments in base salary as
determined by the Committee. The employment agreement also provides for annual
automatic extensions of the term for an additional year unless the Board or
Mr. Finney elects not to have the term so extended. The agreement provided for
a minimum base salary of $240,000 for 1995 which is also Mr. Finney's base
salary for 1996. The agreement also provides for severance compensation upon
termination of employment by the Company for any reason other than for
"Cause," as defined in the agreement, consisting of a minimum of one year's
base salary and, in the event of a change-in-control, as defined in the
agreement, payment of a minimum of one years base salary and accelerated
vesting of all options held by Mr. Finney. Mr. Finney has resigned from his
position with the Company effective January 1, 1997. In connection therewith,
the Company has agreed to pay Mr. Finney $240,000 (one year's salary),
regardless of whether the Merger occurs.
 
 New GranCare Replacement Stock Option Plan
 
  The New GranCare Board has adopted, and the Company, as the sole stockholder
of New GranCare prior to the Distribution, has approved, the 1996 Replacement
Plan (the "Replacement Plan"). The Replacement Plan was adopted solely for the
purpose of granting options to executives of the Company in connection with
the Distribution. All options granted pursuant to the Replacement Plan will be
fully vested and exercisable on substantially the same terms, other than
price, as the related Company Options outstanding as of the Distribution
Record Date. Under the terms of the Replacement Plan, New GranCare Options
will be exercisable for a limited period following the termination of an
executive's employment with New GranCare.
 
 1996 Stock Incentive Plan
 
  The initial New GranCare Board of Directors has adopted, and the Company, as
the sole stockholder of New GranCare prior to the Distribution, has approved,
the 1996 Stock Incentive Plan (the "New GranCare
 
                                      83
<PAGE>
 
Plan"). The purpose of the New GranCare Plan is to allow New GranCare to
attract and retain qualified officers, key employees and consultants and to
provide these individuals with additional incentive to devote themselves to
the future success of New GranCare. Additionally, New GranCare believes that
awards under the New GranCare Plan will more closely align the interests of
its personnel with those of its stockholders.
 
  The New GranCare Plan replaces the incentive plans that were available for
the grant of incentive awards to officers, key employees and consultants of
the Company, pursuant to which awards were granted in the form of qualified
and non-qualified stock options, stock appreciation rights ("SARs") and shares
of restricted stock, all of which types of awards will continue to be
available under the New GranCare Plan. In addition, the New GranCare Plan
provides for several types of equity-based incentive compensation awards not
currently available under the Company's existing incentive plans, namely
performance units, performance shares, phantom stock, unrestricted bonus stock
and dividend equivalent rights.
 
  The New GranCare Plan thus increases New GranCare's flexibility in
structuring equity-based incentive compensation by broadening the types of
incentive awards that may be made. The Board of Directors of New GranCare
believes that a flexible plan is needed to fashion equity-based incentives
consistent with New GranCare's philosophy of linking executive compensation to
total shareholder returns and the long-term financial performance of New
GranCare.
 
  The New GranCare Plan will be administered by the Management Compensation
Committee of the Board of Directors of New GranCare (the "Committee"), and it
is intended that each member of the Committee will be "disinterested" within
the meaning of Rule 16b-3 under the Securities Exchange Act of 1934. As a
practical matter, directors who are employees of New GranCare are not eligible
to serve as members of the Committee. The Committee will determine the persons
to whom, and the times at which, awards will be granted, the type of awards to
be granted and all other related terms and conditions of the awards, subject
to the limitations described below and as set forth in the New GranCare Plan.
The terms and conditions of each award will be set forth in a written
agreement with a participant or a written program established by the
Committee. All officers and key employees of New GranCare and its affiliates
are eligible to participate in the New GranCare Plan. It is currently
estimated that approximately 33 individuals are eligible to participate.
 
  A total of 1,500,000 shares of New GranCare Common Stock are reserved for
issuance pursuant to the New GranCare Plan, of which no more than 500,000
shares may be used for restricted stock and stock bonus grants. The number of
shares of New GranCare Common Stock reserved under the New GranCare Plan is
subject to adjustment in the event of stock dividends, stock splits,
recapitalizations and similar events.
 
  The per share exercise price of any options may not be less than the fair
market value of a share of New GranCare Common Stock at the time of grant.
Once an option is granted, the exercise price may not be reduced by amendment
and an option may not be exchanged for a new option with a lower exercise
price. No incentive stock option may be granted on or after the tenth
anniversary of the date the New GranCare Plan was approved by the Board of
Directors of New GranCare.
 
  The Committee shall determine whether stock appreciation rights, performance
unit awards, dividend equivalent rights, performance share awards and phantom
stock awards shall be settled in cash or in shares of New GranCare Common
Stock valued at fair market value on the date of payment. The Committee also
shall be authorized to accelerate the vesting, exercisability and settlement
of awards and to permit the exercise price of an option to be paid in cash or
by the delivery or withholding of shares.
 
  The Board of Directors of New GranCare may amend or terminate the New
GranCare Plan without the approval of the shareholders, but may condition any
amendment on shareholder approval if the Board believes it is necessary or
advisable to comply with any applicable tax or regulatory requirement. No
termination or amendment of the New GranCare Plan without the consent of the
holder of an award shall adversely affect the rights of that participant.
 
                                      84
<PAGE>
 
  The Committee may provide with respect to any award that, in the event of a
Change in Control (as defined in the New GranCare Plan) of New GranCare, the
award shall be cashed out in an amount based on the fair market value of the
New GranCare Common Stock without regard to the exercisability of the award or
any other conditions or restrictions.
 
  Federal Income Tax Consequences. A participant will not recognize income
upon the grant of an option or at any time prior to the exercise of an option.
At the time the participant exercises a non-qualified option, he or she will
recognize compensation taxable as ordinary income in an amount equal to the
excess of the fair market value of the New GranCare Common Stock on the date
the option is exercised over the price paid for the New GranCare Common Stock,
and New GranCare will then be entitled to a corresponding deduction.
 
  A participant who exercises an incentive stock option will not be taxed at
the time he or she exercises his or her option or a portion thereof. Instead,
he or she will be taxed at the time he or she sells the New GranCare Common
Stock purchased pursuant to the option. The participant will be taxed on the
excess of the amount for which he or she sells the stock over the price he or
she had paid for the stock. If the participant does not sell the stock prior
to two years from the date of grant of the option and one year from the date
the stock is transferred to him or her, the gain will be capital gain and New
GranCare will not get a corresponding deduction. If the participant sells the
stock prior to that time, the difference between the amount the participant
paid for the stock and the lesser of the fair market value on the date of
exercise or the amount for which the stock is sold, will be taxed as ordinary
income and New GranCare will be entitled to a corresponding deduction. If the
participant sells the stock for less than the amount he or she paid for the
stock prior to the one or two year periods indicated, no amount will be taxed
as ordinary income and the loss will be taxed as a capital loss. Exercise of
an incentive option may subject a participant to, or increase a participant's
liability for, the federal alternative minimum income tax.
 
  A participant generally will not recognize income upon the grant of any
stock appreciation right, dividend equivalent right, performance unit award,
performance share award or phantom share. At the time a participant receives
payment under any such award, he or she generally will recognize compensation
taxable as ordinary income in an amount equal to the cash or the fair market
value of the New GranCare Common Stock received, and New GranCare will then be
entitled to a corresponding deduction.
 
  A participant will not be taxed upon the grant of a stock award if such
award is not transferable by the participant or is subject to a "substantial
risk of forfeiture," as defined in the Internal Revenue Code. However, when
the shares of New GranCare Common Stock that are subject to the stock award
are transferable by the participant and are no longer subject to a substantial
risk of forfeiture, the participant will recognize compensation taxable as
ordinary income in an amount equal to the fair market value of the stock
subject to the stock award, less any amount paid for such stock, and New
GranCare will then be entitled to a corresponding deduction.
 
  The Plan is not qualified under Section 401(a) of the Internal Revenue Code
of 1986.
 
 Annual Incentive Plan
 
  The Board of Directors of New GranCare has adopted, and the Company as its
sole stockholder prior to the Distribution has approved, the Annual Incentive
Plan (the "Annual Incentive Plan"). The Annual Incentive Plan is a bonus plan
intended to link the amount of annual cash bonuses paid to New GranCare's
officers and key employees to corporate performance based on the relative
responsibility of the individual for whom the bonus is to be awarded. Awards
are based on predetermined performance goals established by the Committee
within the first ninety days of each fiscal year of New GranCare. The Annual
Incentive Plan replaces the annual incentive plan that is in effect for
officers and key employees of the Company prior to the Distribution and Merger
and the terms of the Annual Incentive Plan are similar in all material
respects to the terms of Company's annual incentive plan.
 
                                      85
<PAGE>
 
  The primary performance goal for most participants in the Annual Incentive
Plan will be based on New GranCare's earnings per share. Corporate earnings
per share targets are the sole performance standard by which bonuses will be
measured for the Chief Executive Officer, President and Executive Vice
Presidents. The annual bonus for Divisional Presidents will be based 50% on
the corporate earnings per share targets and 50% on the targeted improvement
for the applicable division in earnings before interest, taxes, depreciation,
amortization and rents ("EBITDAR").
 
  Bonus awards will be payable based upon the attainment of one of three
different levels of performance: threshold, target and superior. No bonus
award will be payable with respect to a performance goal unless the threshold
level of performance is achieved. At the threshold, target and superior
performance levels, 50%, 100% and 150% of the targeted bonus amount allocated
to that performance goal is payable, respectively. The maximum yearly bonus
payable to any individual under the Annual Incentive Plan will be $600,000 per
year.
 
  Payment of annual incentive awards will be made in cash unless the employee
elects, within the first ninety days of the fiscal year, to have payment of
the award made in shares of New GranCare Common Stock. In the event that an
employee makes such an election, he or she will receive New GranCare Common
Stock under the Plan having a fair market value equal to 125% of the value of
the cash award. These shares will be subject to
 
STOCK OPTIONS
 
  The following tables provide information on options to purchase Company
Common Stock granted to the executive officers named in the Summary
Compensation Table above since December 31, 1995 and summarize the value of
Company Options held by the executive officers named in the Summary
Compensation Table as of September 30, 1996. As a result of the Distribution
and the Merger, all outstanding Company Options will be adjusted as described
under "The Distribution--Consummation of the Distribution; Treatment of
GranCare Stock Options."
 
            AGGREGATED OPTION/SAR EXERCISES SINCE DECEMBER 31, 1995
                   
                AND VALUE OF OPTIONS AT DECEMBER 31, 1996     
 
<TABLE>   
<CAPTION>
                                                      NUMBER OF UNEXERCISED     VALUE OF UNEXERCISED
                                                      SECURITIES UNDERLYING         IN-THE-MONEY
                                                         OPTIONS/SARS AT           OPTIONS/SARS AT
                           SHARES                      FISCAL YEAR-END(2)     FISCAL YEAR-END($)(2)(3)
                         ACQUIRED ON     VALUE      ------------------------- -------------------------
          NAME           EXERCISE(#) REALIZED($)(1) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
          ----           ----------- -------------- ----------- ------------- ----------- -------------
<S>                      <C>         <C>            <C>         <C>           <C>         <C>
Gene E. Burleson........       0         $  0         158,000      136,760    $  859,000    $547,375
Evrett W. Benton........       0            0         190,000       88,000     1,216,250     365,000
M. Scott Athans.........    2,000        1,000        163,000       88,000       753,875     365,000
Jerry A. Schneider......       0            0          59,895       87,105       127,277     207,098
Donald D. Finney(4).....       0            0          59,715       31,746       358,562      58,841
</TABLE>    
- --------
 (1) Calculated on the basis of the fair market value of the underlying
     securities at the exercise date minus the exercise price.
 
 (2) All outstanding options become exercisable as a result of the
     Distribution and Merger. See "The Distribution--Consummation of the
     Distribution; Treatment of Company Stock Options."
   
 (3) Calculated on the basis of the closing price of the underlying securities
     on December 31, 1996 ($17.875 per share) minus the exercise price.     
 
 (4) Resigned effective January 1, 1997.
       
                                      86
<PAGE>
 
                   OPTION/SAR GRANTS SINCE DECEMBER 31, 1993
<TABLE>
<CAPTION>
                                       INDIVIDUAL GRANTS
                         ----------------------------------------------
                                                                        POTENTIAL REALIZABLE
                                                                          VALUE AT ASSUMED
                          NUMBER OF                                       ANNUAL RATES OF
                          SECURITIES                                        STOCK PRICE
                          UNDERLYING    % OF TOTAL  EXERCISE              APPRECIATION FOR
                         OPTIONS/SARS  OPTIONS/SARS OR BASE                 OPTION TERM
                           GRANTED      GRANTED IN   PRICE   EXPIRATION --------------------
          NAME              (#)(1)     FISCAL YEAR   ($/SH)     DATE     5% ($)    10% ($)
          ----           ------------  ------------ -------- ---------- --------- ----------
<S>                      <C>           <C>          <C>      <C>        <C>       <C>
Gene E. Burleson
 1996...................    56,760(1)      14.1%     $14.75   1/23/06    $526,732 $1,334,427
 1995...................         0            0         --      --            --         --
 1994...................         0            0         --      --            --         --
Evrett W. Benton
 1996...................    28,000(1)       7.0       14.75   1/23/06     259,840    658,280
 1995...................         0            0         --      --            --         --
 1994...................         0            0         --      --            --         --
M. Scott Athans
 1996...................    28,000(1)       7.0       14.75   1/23/06     259,840    658,280
 1995...................         0            0         --      --            --         --
 1994...................         0            0         --      --            --         --
Jerry A. Schneider
 1996...................    22,000(1)       5.5       14.75   1/23/06     204,160    517,220
 1995...................   125,000(2)        34       15.75   1/27/05   1,238,136  3,137,680
 1994...................       --           --          --        --          --         --
Donald D. Finney(3)
 1996...................    15,600(1)       3.9       14.75   1/23/06     144,768    366,756
 1995...................    25,000(4)       6.8       17.25   7/21/05     271,210    687,301
 1994...................       --           --          --      --            --         --
</TABLE>
- --------
 (1) Represents options granted January 23, 1996.
 
 (2) Represents options granted to Mr. Schneider on January 27, 1995 upon his
     initial employment with the Company.
 
 (3) Resigned effective January 1, 1997.
 (4) Represents options granted to Mr. Finney on July 21, 1995 upon his
     initial employment with the Company.
 
                                      87
<PAGE>
 
LONG-TERM INCENTIVE PLANS--AWARDS SINCE DECEMBER 31, 1995
 
  The Senior Executive Shareholder Value Program for the Company's senior
level executive officers and the Shareholder Value Program for all other
executive officers and employees (collectively the "Shareholder Value
Program") were adopted by the Board of Directors in January 1996 and approved
by the shareholders at the 1996 annual meeting. The Shareholder Value Program
provides for the payment of cash incentives based upon the performance of the
Company over a three year performance period vis-a-vis a peer group and the
S&P 500. After the performance period, the value of each unit is determined by
comparing the Company's stock price to the stock prices of the companies
comprising the peer group and S&P 500. At the threshold level (50%), each unit
is worth $500. At the superior level (95%), each unit is worth $3,000. The
Shareholder Value Program vests upon a "Change of Control," which the Merger
constitutes.
 
  The Board of Directors of the Company has determined that upon consummation
of the Merger, each of the above-named executives will receive payment under
the Senior Executive Shareholder Value Program at the superior level,
resulting in payments of $852,000, 420,000, 420,000, 330,000 and 234,000 to
Messrs. Burleson, Athans, Benton, Schneider and Finney, respectively, and all
other plan participants would receive, in the aggregate, approximately $2.2
million.
 
COMPANY ANNUAL INCENTIVE PLAN
 
  The Company maintains an Annual Incentive Plan that provides for the payment
of annual cash bonuses to its officers and key employees upon the attainment
by the Company of certain pre-determined performance criteria. The criteria
utilized by the Company for the annual incentive plan is earnings per share.
The Company does not anticipate making any payments under the Annual Incentive
Plan as the Company believes that costs associated with the Distribution and
Merger that will be recognized in the fourth quarter will have a negative
effect on earnings per share, which is the standard by which awards under the
annual incentive plan are determined.
 
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
   
  Upon completion of the Merger, Vitalink will succeed to all of the Company's
existing pharmaceutical supply agreements with the various facilities that
will be operated by New GranCare. These agreements are generally for a term of
five years and are automatically extended on an annual basis for an additional
one year unless timely notice of intent to terminate is given. Gene E.
Burleson, Chairman of New GranCare, will become Chief Executive Officer of
Vitalink upon consummation of the Merger. Mr. Burleson and three other
directors of New GranCare (Messrs. Parker, Kanter & Rolle) will become
directors of Vitalink upon the consummation of the Merger. See "The
Distribution--Terms of the Pharmaceutical Supply Agreements" herein, and
"Descriptions of the Transactions--Interests of Certain Persons" and
"Relationship between Vitalink and GranCare" in the Proxy
Statement/Prospectus. Following the Distribution and Merger, New GranCare will
not compete with Vitalink in the institutional pharmacy business for a period
of three years. See "The Distribution--Terms of the Non-competition
Agreement." In addition, Mr. Burleson will be named Chairman of the Board of
New GranCare and, in connection therewith, it is anticipated that New GranCare
will enter into a consulting agreement with Mr. Burleson in the amount of
$100,000 per year.     
 
  In connection with the consolidation of the Company's headquarters in
Atlanta, Georgia, the Company assisted certain of its senior level executive
officers with their relocations to Atlanta. The assistance was in the form of
loans to and, in certain instances, the purchase of residences from, the
affected senior level executive officers. New GranCare will be the obligee
under these loans following the Distribution and the Merger.
 
  In connection with Mr. Benton's (the Company's Executive Vice President,
General Counsel and Secretary) relocation to Atlanta from the Company's former
corporate headquarters in Culver City, California, the Company purchased Mr.
Benton's California residence for $747,500 in lieu of paying Mr. Benton's
relocation expenses. Mr. Benton purchased this residence for $885,000 in
August 1989. The Company subsequently sold Mr. Benton's residence for
$584,777. Additionally, the Company loaned Mr. Benton $100,000. The loan is
evidenced by a promissory note that bears interest at the prime rate and is
due January 15, 1997. The loan is
 
                                      88
<PAGE>
 
secured by the proceeds from the Executive Split Dollar Life Insurance policy
that the Company maintains on Mr. Benton's behalf.
 
  In connection with Kay Brown's (the Company's Senior Vice President and
Director of Corporate Communications and Investor Relations) relocation to
Atlanta from the Company's former corporate headquarters in Culver City,
California, the Company purchased Ms. Brown's residence for $515,440 and
subsequently sold Ms. Brown's residence for $440,440. In connection with this
loss, Ms. Brown executed a $75,000 promissory note that bears interest at the
prime rate and is due January 15, 1997. The loan is secured by the proceeds
from the Executive Split Dollar Life Insurance policy that the Company
maintains on Ms. Brown's behalf.
 
  Robert L. Parker was formerly Chairman of the Board of Directors of Omega
Healthcare Investors, Inc. ("Omega"), a creditor of the Company. In connection
with his appointment to the Board of Directors of the Company, Mr. Parker
resigned as Chairman of the Board of Directors of Omega but continues to serve
as a director of Omega. Omega is the mortgagee on the Company's facilities
located in the State of Michigan. The Company's indebtedness to Omega as of
December 31, 1995 was approximately $58.8 million. During the years ended
December 31, 1995, 1994, 1993 and for the last three months of 1992, the
Company made or accrued interest payments to Omega totaling approximately $8.2
million, $8.0 million, $7.0 million and $1.9 million, respectively. New
GranCare will be the obligee under this loan following the Distribution and
Merger and it is expected that Mr. Parker will be a member of New GranCare's
Board of Directors and the Vitalink Board of Directors.
 
  Mr. Gene E. Burleson, the Company's Chairman of the Board, President and
Chief Executive Officer and, following the Distribution and the Merger,
Chairman of the Board and a director, of New GranCare, and Messrs. Ronald G.
Kenny and William G. Petty, Jr., both directors of the Company and, following
the Distribution and the Merger, directors of New GranCare, are also directors
of Alternative Living Services, Inc. ("ALS"). The Company previously owned a
19% equity interest in ALS, which the Company sold in August 1996 in
connection with the initial public offering of ALS's common stock. In
addition, Mr. Petty is Chairman of the Board and was formerly Chief Executive
Officer of ALS. ALS owns and manages assisted living facilities. The Company
has entered into discussions with ALS pursuant to which ALS will conduct
feasibility studies for the Company on the development of assisted living
facilities at various sites. If these feasibility studies render positive
results, it is contemplated that ALS will develop and manage such facilities
on behalf of the Company. The Company has not yet determined whether to
construct any such facilities. At the time of the ALS public offering, Mr.
Kenny owned .5% of a limited liability corporation that owned a 63% equity
interest in ALS and Mr. Kenny's employer, Huizenga Capital Management, owned
5.0% of such corporation.
 
  In December 1993 the Company sold two of its long-term care facilities and
related accounts receivable to Charles H. Hargis, who was engaged by the
Company during 1993 to act as a consultant on various acquisitions and
divestitures. The Company financed $1,050,000 of the $1,250,000 purchase price
of the facilities, and the Company financed the entire $1,100,000 purchase
price of the accounts receivable. On October 1, 1996, the Company (i)
repurchased one of the long-term care facilities it sold to Charles H. Hargis
in December 1993 for $3,110,000 in cash, and (ii) purchased from an entity
owned or controlled by Mr. Hargis the management agreement for a long-term
care facility leased by the Company for $100,000 in cash. As part of the
aforesaid transaction, Mr. Hargis and entities owned or controlled by him
entered into a three year non-competition agreement with the Company, and the
Company entered into a three year consulting agreement with an entity owned or
controlled by Mr. Hargis providing for payments of $108,000 per year.
Subsequent to October 1, 1996, Mr. Hargis satisfied all obligations to the
Company.
 
  On March 31, 1994, the Company subleased a facility to Joseph M. Higdon, a
former Vice President of the Company for $1,400,000, of which $210,000 was
paid in cash at closing and $1,190,000 of which was financed by the Company
over seven years at 6% per annum over the first two years and 7% per annum
over the remaining five years. In addition, Mr. Higdon purchased $450,000 of
the subject facility's accounts receivable, which purchase was financed by the
Company over three years at 7% per annum.
 
                                      89
<PAGE>
 
  On April 29, 1994, the Company subleased two facilities to Mr. Higdon for
$1,600,000, of which $240,000 was paid in cash at closing and $1,360,000 of
which was financed by the Company over seven years at 6% per annum over the
first two years and 7% per annum over the remaining five years. In addition,
Mr. Higdon purchased $450,000 of the subject facilities' accounts receivable,
which purchase was financed by the Company over three years at 7% per annum.
 
                                      90
<PAGE>
 
      COMMON STOCK OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
   
  New GranCare will be a wholly-owned subsidiary of the Company until the
consummation of the Distribution. Because all of the shares of New GranCare
Common Stock now held by the Company will be distributed to shareholders of
the Company in connection with the Distribution, the number of shares of New
GranCare Common Stock shown below to be owned beneficially by each director
and by all directors and officers as a group will depend upon the number of
shares held by such persons at the time of the Distribution. This table
assumes that each of the executive officers set forth below will (i) be
offered a position with New GranCare and (ii) accept such position if offered.
In order to present estimated beneficial ownership of the persons and entities
set forth below immediately following the Distribution, the following table
shows: (i) the number of shares of Company Common Stock beneficially owned by
such person or entities as of January 1, 1997 (including, if applicable,
shares underlying Company Options exercisable within 60 days of such date) and
(ii) the number of shares of New GranCare Common Stock that such persons or
entities would own immediately following the Distribution (including, if
applicable, shares underlying New GranCare Options exercisable within 60 days
of such date), assuming none of such persons or entities disposes of any
shares of Company Common Stock prior to the Distribution and Merger.     
 
<TABLE>   
<CAPTION>
                                                              POST DISTRIBUTION
                                                           BENEFICIAL OWNERSHIP OF
                          BENEFICIAL OWNERSHIP OF                NEW GRANCARE
                            COMPANY COMMON STOCK                 COMMON STOCK
                          -------------------------------  -------------------------------
                           NUMBER OF                        NUMBER OF
                            SHARES            PERCENTAGE     SHARES            PERCENTAGE
    BENEFICIAL OWNER       OWNED(1)            OWNED(1)     OWNED(1)            OWNED(1)
    ----------------      --------------     ------------  --------------     ------------
<S>                       <C>                <C>           <C>                <C>
Wellington Management   
 Company................       1,615,776(2)           6.9%      1,615,776              6.9%
 75 State Street
 Boston, Massachusetts
 02109
Gene E. Burleson........         794,220(3)           3.3%        872,060(17)          3.6%
 Chairman of the Board,
 President and Chief
 Executive Officer
Charles M. Blalack......          59,347(4)             *          61,014(18)            *
 Director
Antoinette Hubenette,   
 M.D. ..................          23,133(5)             *          24,800(19)            *
 Director
Joel S. Kanter..........         313,343(6)             *         315,010(20)          1.3%
 Director
Ronald G. Kenny.........          50,937(7)             *          55,937(21)            *
 Director
Robert L. Parker........         225,613(8)           1.0%        230,613(22)            *
 Director
William G. Petty, Jr. ..         728,011(9)           3.1%        733,011(23)          3.1%
 Director
Edward V. Regan.........          17,800(10)            *          22,800(24)            *
 Director
Gary U. Rolle...........         167,800(11)            *         172,800(25)            *
 Director
M. Scott Athans.........         189,333(12)            *         253,000(26)          1.1%
 Executive Vice
 President and Chief
 Operating Officer
Evrett W. Benton........         243,463(13)            *         292,130(27)          1.2%
 Executive Vice
 President, General
 Counsel and Secretary
Donald D. Finney........         182,133(14)            *         207,638(28)            *
 Senior Vice President
 and President of
 Long Term Care Division
Jerry A. Schneider......          79,936(15)            *         154,500(29)            *
 Executive Vice Presi-
 dent and Chief Finan-
 cial Officer
All directors and
 executive officers as a
 group (36 persons).....       3,486,540(16)         13.9%      4,044,179(30)         15.8%
</TABLE>    
 
                                      91
<PAGE>
 
- --------
  *Less than 1%.
 (1) In determining the number of issued and outstanding shares of the Company
     as of January 1, 1997, the Company Common Stock obtainable upon
     conversion of the outstanding common stock of Evergreen and National
     Heritage, Inc., a predecessor of Evergreen, have been assumed to be
     shares of issued and outstanding Company Common Stock. In addition, the
     number of shares of New GranCare Common Stock outstanding following the
     Distribution include all Company Options, which vest upon a Change in
     Control. Except as otherwise indicated, each of the persons included in
     the table above has sole voting and investment power over the shares
     owned except as to the rights of his or her spouse under applicable
     community property laws.
 (2) Wellington Management Company ("WMC") is an investment adviser registered
     with the Securities and Exchange Commission under the Investment Advisers
     Act of 1940, as amended. As of January 1, 1997, WMC, in its capacity as
     investment adviser, may be deemed to have beneficial ownership of
     1,615,776 shares that are owned by numerous investment advisory clients,
     none of which is known to have such interest with respect to more than
     five percent of the class. As of January 1, 1997, WMC had voting power
     and investment power as follows:
<TABLE>
       <S>                       <C>
       Sole Voting Power:                0 shares
       Shared Voting Power:        658,276 shares
       Sole Investment Power:            0 shares
       Shared Investment Power:  1,615,776 shares
</TABLE>
 (3) Includes 216,920 shares which may be acquired within 60 days after
     January 1, 1997, pursuant to the exercise of stock options.
 (4) Includes 22,333 shares which may be acquired within 60 days after January
     1, 1997, pursuant to the exercise of stock options.
 (5) Includes 22,333 shares which may be acquired within 60 days after January
     1, 1997, pursuant to the exercise of stock options.
 (6) Includes 22,333 shares which may be acquired within 60 days after January
     1, 1997, pursuant to the exercise of stock options. Also includes 47,400
     shares owned by Windy City, Inc, 200,000 shares owned by Walnut Capital
     Corporation and 40,110 shares owned by the Kanter Family Foundation. Mr.
     Kanter serves as President and Director of such companies. In addition,
     the number includes 400 shares held by the Ricki Kanter IRA, 1,050 shares
     owned by 21 Club Trust I, 150 shares owned by 21 Club Trust II and 100
     shares owned by 21 Club Trust III. The beneficiaries of such trusts are
     Mr. Kanter's minor children. Mr. Kanter has shared voting and investment
     powers in the shares held by such corporations, such foundation and such
     trusts. Mr. Kanter disclaims beneficial ownership of such shares.
 (7) Includes 11,000 shares which may be acquired within 60 days after January
     1, 1997, pursuant to the exercise of stock options. Also includes 4,560
     shares held by trusts for the benefit of Mr. Kenny's children. Mr. Kenny
     has no voting or investment power over such shares and disclaims
     beneficial ownership of such shares. In addition, 387 shares are held by
     the Ronald Kenny IRA over which Mr. Kenny has sole voting and investment
     power.
 (8) Includes 11,000 shares which may be acquired within 60 days after January
     1, 1997, pursuant to the exercise of stock options. Also includes 13,438
     shares of Common Stock held by the Parker Charitable Trust of 1991. Mr.
     Parker has shared voting and investment power with respect to such shares
     and disclaims beneficial ownership of such shares.
 (9) Includes 98,740 shares which may be acquired within 60 days after January
     1, 1997, pursuant to the exercise of stock options. Also includes 415,147
     shares held by a trust of which Mr. Petty is a beneficiary. Also includes
     150,894 shares owned by Mr. Petty's wife, over which Mr. Petty has shared
     voting and investment power. Mr. Petty disclaims beneficial ownership of
     shares. Also includes 62,430 shares held by trusts for the benefit of Mr.
     Petty's children over which Mr. Petty has shared voting and investment
     power. Mr. Petty disclaims beneficial ownership of such shares.
(10) Includes 17,000 shares which may be acquired within 60 days after January
     1, 1997, pursuant to the exercise of stock options.
 
                                      92
<PAGE>
 
(11) Includes 17,000 shares which may be acquired within 60 days after January
     1, 1997, pursuant to the exercise of stock options. Also includes 150,000
     shares of Common Stock owned by Transamerica Investment Services
     ("Transamerica"). Mr. Rolle is the Chief Investment Officer of
     Transamerica and in such capacity, he has voting and management authority
     over such shares.
(12) Includes 187,333 shares which may be acquired within 60 days after
     January 1, 1997, pursuant to the exercise of stock options.
(13) Includes 229,333 shares which may be acquired within 60 days after
     January 1, 1997, pursuant to the exercise of stock options.
(14) Includes 65,956 shares which may be acquired within 60 days after January
     1, 1997, pursuant to the exercise of stock options.
(15) Includes 72,436 shares which may be acquired within 60 days after January
     1, 1997, pursuant to the exercise of stock options.
(16) Includes 1,354,472 shares which may be acquired within 60 days after
     January 1, 1997, pursuant to the exercise of stock options.
(17) Indicates the shares reflected in Note 3, plus an additional
     77,840 shares obtainable pursuant to the exercise of options that will
     vest upon the consummation of the Merger.
(18) Indicates the shares reflected in Note 4, plus an additional 1,667 shares
     obtainable pursuant to the exercise of options that will vest upon the
     consummation of the Merger.
(19) Indicates the shares reflected in Note 5, plus an additional 1,667 shares
     obtainable pursuant to the exercise of options that will vest upon the
     consummation of the Merger.
(20) Indicates the shares reflected in Note 6, plus an additional 1,667 shares
     obtainable pursuant to the exercise of options that will vest upon the
     consummation of the Merger.
(21) Indicates the shares reflected in Note 7, plus an additional 5,000 shares
     obtainable pursuant to the exercise of options that will vest upon the
     consummation of the Merger.
(22) Indicates the shares reflected in Note 8, plus an additional 5,000 shares
     obtainable pursuant to the exercise of options that will vest upon the
     consummation of the Merger.
(23) Indicates the shares reflected in Note 9, plus an additional 5,000 shares
     obtainable pursuant to the exercise of options that will vest upon the
     consummation of the Merger.
(24) Indicates the shares reflected in Note 10, plus an additional
     5,000 shares obtainable pursuant to the exercise of options that will
     vest upon the consummation of the Merger.
(25) Indicates the shares reflected in Note 11, plus an additional
     5,000 shares obtainable pursuant to the exercise of options that will
     vest upon the consummation of the Merger.
(26) Indicates the shares reflected in Note 12, plus an additional
     63,667 shares obtainable pursuant to the exercise of options that will
     vest upon the consummation of the Merger.
(27) Indicates the shares reflected in Note 13, plus an additional
     48,667 shares obtainable pursuant to the exercise of options that will
     vest upon the consummation of the Merger.
(28) Indicates the shares reflected in Note 14, plus an additional
     25,505 shares obtainable pursuant to the exercise of options that will
     vest upon the consummation of the Merger.
(29) Indicates the shares reflected in Note 15, plus an additional
     74,564 shares obtainable pursuant to the exercise of options that will
     vest upon the consummation of the Merger.
(30) Indicates the shares reflected in Note 16, plus an additional 557,639
     shares obtainable pursuant to the exercise of options that will vest upon
     the consummation of the Merger.
 
  There are no arrangements known to the Company the operation of which may,
at a subsequent date, result in a change in control of New GranCare.
 
                                      93
<PAGE>
 
                   DESCRIPTION OF NEW GRANCARE CAPITAL STOCK
 
  The authorized capital stock of New GranCare will consist of 50,000,000
shares of New GranCare Common Stock, par value $0.001 per share, and 2,000,000
shares of Preferred Stock, par value $0.001 per share ("Preferred Stock").
Immediately following the Distribution there are expected to be approximately
23,401,992 shares of New GranCare Common Stock outstanding and held of record
by approximately 1,042 persons, and approximately 2,355,250 shares of New
GranCare Common Stock issuable upon the exercise of New GranCare Options based
upon the capitalization and record holders of the Company as of November 30,
1996. No shares of Preferred Stock have been issued by New GranCare.
 
NEW GRANCARE COMMON STOCK
 
  Holders of New GranCare Common Stock will be entitled to one vote for each
share held of record on all matters on which stockholders may vote, including
the election of directors. The holders of New GranCare Common Stock will be
entitled to participate in cash dividends, when, as and if declared by the New
GranCare Board of Directors out of funds legally available therefor, subject
to any dividend preference which may be attributable to any series of
Preferred Stock which may be outstanding. Such holders will not have any
statutory preemptive or other rights to subscribe for additional shares.
Subject to the rights of holders of Preferred Stock of New GranCare, if any,
all holders of New GranCare Common Stock will be entitled to share ratably in
any assets available for distribution to stockholders upon the liquidation,
dissolution or winding up of New GranCare. There are no conversion, redemption
or sinking fund provisions applicable to New GranCare Common Stock.
 
PREFERRED STOCK
 
  The New GranCare Certificate of Incorporation will permit the New GranCare
Board of Directors, without further action by the shareholders, to issue up to
2,000,000 shares of Preferred Stock in one or more series and fix and
determine the relative rights, voting powers, preferences and limitations of
each series so authorized. The issuance of any shares of Preferred Stock could
adversely affect the voting power of the holders of New GranCare Common Stock
or could have the effect of discouraging or making more difficult any attempt
by a person or group to obtain control of New GranCare. As of the date of this
Prospectus, it is not expected that New GranCare will issue any shares of
Preferred Stock in the near future.
 
THE CHARTERS AND BYLAWS OF THE COMPANY AND NEW GRANCARE
 
  The provisions of the New GranCare Certificate of Incorporation and Bylaws
are similar to those of the Company's Articles of Incorporation and Bylaws in
most respects. New GranCare is a Delaware corporation, and Delaware law
permits the implementation of certain provisions in a corporation's
certificate of incorporation or bylaws which would alter some of the rights of
shareholders and the powers of management that are different from those of a
California company. Although the Board of Directors of New GranCare has no
current plan to implement these changes, certain changes could be implemented
in the future by amendment of the Certificate of Incorporation of New GranCare
(following stockholder approval) and certain changes could be implemented by
amendment of the Bylaws of New GranCare without stockholder approval. For a
discussion of such changes, see "Significant Differences Between the
Corporation Laws of California and Delaware." This discussion of the
Certificate of Incorporation and Bylaws of New GranCare is qualified in its
entirety by reference to Exhibits 3.1 and 3.2 hereto, respectively.
 
  Authorized Stock. The Articles of Incorporation of the Company authorize
fifty million shares of Common Stock without par value and two million shares
of undesignated Preferred Stock. The Certificate of Incorporation of New
GranCare authorizes New GranCare to issue fifty million shares of Common
Stock, $0.001 par value, as well as two million shares of undesignated
Preferred Stock, $0.001 par value.
 
                                      94
<PAGE>
 
  Number of Directors. The Bylaws of the Company authorize the directors to
fix the number of directors within a range from seven to 15, with the number
of directors currently set at nine. Delaware law permits a corporation to set
forth the means of determining the number of directors in the bylaws. In
contrast to the Bylaws of the Company, the Bylaws of New GranCare permit the
board of directors to fix the number of directors by resolution without
further stockholder approval. See "Significant Differences Between the
Corporation Laws of California and Delaware--Size of the Board of Directors."
Initially, the Board of Directors of New GranCare will consist of ten members.
 
  Monetary Liability of Directors. The Articles of Incorporation of the
Company and the Certificate of Incorporation of New GranCare both provide for
the elimination of personal monetary liability of directors to the fullest
extent permissible under the laws of each corporation's respective state of
incorporation. The provision eliminating monetary liability of directors set
forth in the Certificate of Incorporation of New GranCare is potentially more
expansive in that it incorporates future amendments to Delaware law with
respect to the elimination of such liability.
 
SIGNIFICANT DIFFERENCES BETWEEN THE CORPORATION LAWS OF CALIFORNIA AND
DELAWARE
 
  The General Corporation Laws of California and Delaware differ in many
respects. While not all of such differences are summarized in this Prospectus,
a number of the principal differences which could materially affect the rights
of shareholders are discussed below.
 
  Size of the Board of Directors. Under California law, although changes in
the number of directors must in general be approved by a majority of the
outstanding shares, the Board of Directors may fix the exact number of
directors within a stated range set forth in the articles of incorporation or
bylaws, if that stated range has been approved by the shareholders. Delaware
law permits a board of directors alone to change the authorized number, or the
range, of directors by amendment to the bylaws, unless the directors are not
authorized to amend the bylaws or the number of directors is fixed in the
certificate of incorporation (in which case a change in the number of
directors may be made only by amendment to the certificate of incorporation
approved by the stockholders) or pursuant to the provisions of the certificate
of incorporation. The Certificate of Incorporation of New GranCare provides
that the number of directors shall be as specified in the Bylaws and
authorizes the Board of Directors to make, alter, amend or repeal the Bylaws.
The Board of Directors of New GranCare may therefore change the authorized
number of directors.
 
  Cumulative Voting. Under California law, if any shareholder gives notice of
his or her intention to cumulate votes for the election of directors, any
other shareholder of the corporation is also entitled to cumulate his or her
votes at such election. Under Delaware law, cumulative voting in the election
of directors is not mandatory and may exist only if provided for in the
corporation's certificate of incorporation. The Certificate of Incorporation
of New GranCare does not provide for cumulative voting, and therefore
stockholders of New GranCare will have no cumulative voting rights. The
elimination of cumulative voting would limit the ability of minority
stockholders to obtain representation on the Board of Directors.
 
  Classified Board of Directors. A classified board is one on which a certain
number of the directors, but not all, are elected on a rotating basis each
year. Under California law, directors must be elected annually, unless the
corporation is a listed corporation and such corporation's articles or bylaws
provide for a classified board. Neither the Company's articles nor bylaws
currently provide for a classified board. Delaware law permits, but does not
require, a classified board of directors, with staggered terms under which
one-third of the directors are elected for terms of three years. This method
of electing directors makes changes in the composition of the board of
directors, and thus a change in control of a corporation, a more difficult
process. The New GranCare Certificate of Incorporation and Bylaws do not
provide for a classified board of directors. The establishment of a classified
board following the Distribution would require the approval of the
stockholders of New GranCare.
 
  Power to Call Special Shareholders' Meetings. Under California law, a
special meeting of shareholders may be called by the board of directors, the
chairman of the board, the president, the holders of shares entitled to cast
not less than ten percent of the votes at such meeting and such additional
persons as are authorized by the articles of incorporation or the bylaws.
Under Delaware law, a special meeting of stockholders may be called by
 
                                      95
<PAGE>
 
the board of directors or by any other person authorized to do so in the
certificate of incorporation or the bylaws. The Certificate of Incorporation
of New GranCare provides that special meetings of stockholders may be called
only by the board of directors or the chairman of the board pursuant to a
resolution adopted by a majority of the total number of directors.
 
  Action by Written Consent. Both the Delaware and California law permit
stockholders, unless specifically prohibited by the certificate or articles of
incorporation, to take action without a meeting by the written consent of the
holders of at least the number of shares necessary to authorize or take such
action at a meeting at which all shares entitled to vote therein were present
and voted. Action by written consent may, in some circumstances, permit the
taking of stockholder action opposed by the Board of Directors more rapidly
than would be possible if a meeting of stockholders were required. Although
the Bylaws of the Company currently provide for shareholder action by written
consent, the Certificate of Incorporation of New GranCare includes a
prohibition on stockholder action by written consent without a meeting.
 
  Stockholder Approval of Certain Business Combinations. In the last several
years, a number of states have adopted special laws designed to make certain
kinds of "unfriendly" corporate takeovers, or other transactions involving a
corporation and one or more of its significant shareholders, more difficult.
Under Section 203 of the Delaware General Corporation Law ("Section 203"),
certain "business combinations" with "interested stockholders" of Delaware
corporations are subject to a three-year moratorium unless specified
conditions are met.
 
  Section 203 prohibits a Delaware corporation from engaging in a "business
combination" with an "interested stockholder" for three years following the
time that such person becomes an interested stockholder. With certain
exceptions, an interested stockholder is a person or group who or which owns
15% or more of the corporation's outstanding voting stock (including any
rights to acquire stock pursuant to an option, warrant, agreement, arrangement
or understanding, or upon the exercise of conversion or exchange rights, and
stock with respect to which the person has voting rights only), or is an
affiliated associate of the corporation and was the owner of 15% or more of
such voting stock at any time within the previous three years.
 
  For purposes of Section 203, the term "business combination" is defined
broadly to include mergers with or caused by the interested stockholder; sales
or other dispositions to the interested stockholder (except proportionately
with the corporation's other stockholders) of assets of the corporation or a
subsidiary equal to ten percent or more of the aggregate market value of the
corporation's consolidated assets or its outstanding stock; the issuance or
transfer by the corporation or a subsidiary of stock of the corporation or
such subsidiary to the interested stockholder (except for transfers in a
conversion or exchange or a pro rata distribution or certain other
transactions, none of which increase the interested stockholder's
proportionate ownership of any class or series of the corporation's or such
subsidiary's stock); or any receipt by the interested stockholder (except
proportionately as a stockholder), directly or indirectly, of any loans,
advances, guarantees, pledges or other financial benefits provided by or
through the corporation or a subsidiary.
 
  The three-year moratorium imposed on business combinations by Section 203
does not apply if (i) prior to the time when such stockholder becomes an
interested stockholder the board of directors approves either the business
combination or the transaction which resulted in the person becoming an
interested stockholder; (ii) the interested stockholder owns 85% of the
corporation's voting stock upon consummation of the transaction which made him
or her an interested stockholder (excluding from the 85% calculation shares
owned by directors who are also officers of the target corporation and shares
held by employee stock plans which do not permit employees to decide
confidentially whether to accept a tender or exchange offer); or (iii) on or
after the time when such person becomes an interested stockholder, the board
approves the business combination and it is also approved at a stockholder
meeting by sixty-six and two-thirds percent (66 2/3%) of the voting stock not
owned by the interested stockholder.
 
  Section 203 applies only to Delaware corporations which have a class of
voting stock that is listed on a national securities exchange, are quoted on
an interdealer quotation system such as NASDAQ or are held of record by more
than 2,000 stockholders. However, a Delaware corporation may elect not to be
governed by
 
                                      96
<PAGE>
 
Section 203 by a provision in its original certificate of incorporation or an
amendment thereto or to the bylaws, which amendment must be approved by a
majority of the shares entitled to vote and, in the case of a bylaw amendment,
may not be further amended by the board of directors. New GranCare does not
intend to elect not to be governed by Section 203, therefore, Section 203 will
apply to New GranCare.
 
  The Company believes that Section 203 will have the effect of encouraging
any potential acquiror to first negotiate with New GranCare's Board of
Directors in connection with contemplated "business combinations." Section 203
should also discourage certain potential acquirors unwilling to comply with
its provisions.
 
  California law requires that in certain transactions involving tender offers
or acquisition proposals made to a target corporation's shareholders by a
person who either (a) controls the target corporation, (b) is an officer or
director of the target or is controlled by an officer or director, or (c) is
an entity in which a director or executive officer of the target has a
material financial interest, a written opinion of an independent expert be
provided as to the fairness of the consideration to the shareholders of the
target corporation. The statute also provides that if a competing proposal is
made at least ten (10) days before shareholders are to vote or shares are to
be purchased under the pending offer by the affiliated party, the latter offer
must be communicated to shareholders and they must be given a reasonable
opportunity to revoke their vote or withdraw their shares, as the case may be.
 
  Removal of Directors. Under California law, any director or the entire board
of directors may be removed, with or without cause, with the approval of a
majority of the outstanding shares entitled to vote; however, no individual
director may be removed (unless the entire board is removed) if the number of
votes cast against such removal would be sufficient to elect the director
under cumulative voting. Under Delaware law, a director of a corporation that
does not have a classified board of directors or cumulative voting may be
removed with or without cause. The Certificate of Incorporation of New
GranCare does not provide for a classified Board of Directors. Consequently
the entire Board of Directors may be removed, with or without cause, with the
approval of a majority of the outstanding shares of capital stock entitled to
vote.
 
  Filling Vacancies on the Board of Directors. Under California law, any
vacancy on the board of directors, other than one created by removal of a
director, may be filled by the board. If the number of directors is less than
a quorum, a vacancy may be filled by the unanimous written consent of the
remaining directors in office, or the affirmative vote of a majority of the
remaining directors at a meeting. A vacancy created by removal of a director
may be filled by the board only if so authorized by a corporation's articles
of incorporation or by a bylaw approved by the corporation's shareholders. The
Company's Bylaws do not permit directors to fill vacancies created by removal
of a director. Under Delaware law, vacancies and newly created directorships
may be filled by a majority of the directors then in office (even though less
than a quorum) unless otherwise provided in the certificate of incorporation
or bylaws. The Bylaws of New GranCare provide that any vacancy on New
GranCare's Board of Directors may be filled only by majority vote of the
directors then in office (even though less than a quorum) even if the vacancy
is created by the removal of a director by the stockholders.
 
  Loans to Officers and Employees. Pursuant to California law and the Bylaws
of the Company, the Board of Directors of the Company is currently authorized
to approve loans or guaranties to or on behalf of officers (whether or not
such officers are directors) if the Board of Directors determines that such
loans or guaranties may reasonably be expected to benefit the corporation.
Under Delaware law, a corporation, its officers or other employees may make
loans to, guarantee the obligations of or otherwise assist its officers or
other employees of those or its subsidiaries (including directors who are also
officers or employees) when such action, in the judgment of the directors, may
reasonably be expected to benefit the corporation.
 
  Indemnification and Limitation of Liability. California and Delaware have
similar laws respecting indemnification by a corporation of its officers,
directors, employees and other agents. The laws of both states also permit a
corporation to adopt a provision in its articles of incorporation or
certificate of incorporation eliminating the liability of a director to the
corporation or its shareholders for monetary damages for breach of the
director's fiduciary duty in certain circumstances. There are nonetheless
certain differences between the laws of the two states respecting
indemnification and limitation of liability.
 
                                      97
<PAGE>
 
  The Articles of Incorporation of the Company eliminate the liability of
directors for monetary damages to the fullest extent permissible under
California law.
 
  California law does not permit the elimination of monetary liability where
such liability is based on: (i) intentional misconduct or knowing and culpable
violation of law; (ii) acts or omissions that a director believes contrary to
the best interests of the corporation or its shareholders, or that involve the
absence of good faith on the part of the director; (iii) receipt of an
improper personal benefit; (iv) acts or omissions that show reckless disregard
for the director's duty to the corporation or its shareholders, where the
director in the ordinary course of performing a director's duties should be
aware of a risk of serious injury to the corporation or its shareholders; (v)
acts or omissions that constitute an unexcused pattern of inattention that
amounts to an abdication of the director's duty to the corporation and its
shareholders; (vi) interested transactions between the corporation and a
director in which a director has a material financial interest; or (vii)
liability for improper distributions, loans or guarantees.
 
  The Certificate of Incorporation of New GranCare also eliminates the
liability of directors to the fullest extent permissible under Delaware law,
as such law exists currently or as it may be amended in the future. Under
Delaware law, such a provision may not eliminate or limit director monetary
liability for (i) breaches of the director's duty of loyalty to the
corporation or its stockholders; (ii) acts or omissions not in good faith or
involving intentional misconduct or knowing violations of law; (iii) the
payment of unlawful dividends or unlawful stock repurchases or redemptions; or
(iv) transactions in which the director received an improper personal benefit.
Such a limitation of liability provision also may not limit a director's
liability for violation of, or otherwise relieve New GranCare or its directors
from the necessity of complying with, federal or state securities laws or
affect the availability of non-monetary remedies such as injunctive relief or
rescission.
 
  California law permits indemnification of expenses incurred in derivative or
third-party actions, except that with respect to derivative actions (i) no
indemnification may be made without court approval when a person is adjudged
liable to the corporation in the performance of that person's duty to the
corporation and its shareholders, unless a court determines that person is
entitled to indemnity for expenses, and then such indemnification may be made
only to the extent that the court so determines, and (ii) no indemnification
may be made without court approval in respect of amounts paid or expenses
incurred in settling or otherwise disposing of a threatened or pending action
or in respect of amounts incurred in defending a pending action which is
settled or otherwise disposed of without court approval.
 
  Indemnification is permitted by California law only for acts taken in good
faith and believed to be in the best interests of the corporation and its
shareholders, as determined by a majority vote of a disinterested quorum of
the directors, independent legal counsel (if a quorum of independent directors
is not obtainable), a majority vote of a quorum of the shareholders (excluding
shares owned by the indemnified party), or the court handling the action.
California law requires indemnification when the individual has successfully
defended the action on the merits (as opposed to Delaware law which requires
indemnification relating to any successful defense, whether on the merits or
otherwise).
 
  Delaware law generally permits indemnification of expenses (including
attorneys' fees) incurred in the defense or settlement of a derivative or
third-party action, provided there is a determination by a majority vote of
the disinterested directors (even though less than a quorum), by independent
legal counsel or by stockholders that the person seeking indemnification acted
in good faith and in a manner reasonably believed to be in or (in contrast to
California law) not opposed to the best interests of the corporation. Without
court approval, however, no indemnification may be made in respect of any
derivative action in which such person is adjudged liable for negligence or
misconduct in the performance of his or her duty to the corporation. Delaware
law also requires indemnification of expenses when the individual being
indemnified has successfully defended the action on the merits or otherwise.
 
  California corporations may include in their articles of incorporation a
provision which extends the scope of indemnification through agreements,
bylaws or other corporate action beyond that specifically authorized by
statute. The Articles of Incorporation of the Company include such a
provision.
 
                                      98
<PAGE>
 
  A provision of Delaware law states that the indemnification provided by
statute shall not be deemed exclusive of any other rights under any bylaw,
agreement, vote of stockholders or disinterested directors or otherwise. As a
result, Delaware law permits indemnification agreements between a Company and
its officers and directors. At this time, New GranCare does not have any such
indemnification agreements in place, but may enter into them in the future.
The Certificate of incorporation of New GranCare provides for mandatory
indemnification of directors and officers to the fullest extent permitted by
law.
 
  The indemnification and limitations of liability provisions of California
law, and not Delaware law, will apply to actions of the directors and officers
of the Company taken prior to the Distribution and Merger.
 
  Inspection of Shareholder's List. Both California and Delaware law allow any
shareholder to inspect a corporation's shareholders' list for a purpose
reasonably related to such person's interest as a shareholder. California law
provides, in addition, an absolute right to inspect and copy the corporation's
shareholders' list to persons holding an aggregate of 5% or more of a
corporation's voting shares, or shareholders holding an aggregate of 1% or
more of such shares who have filed a Schedule 14B with the Securities and
Exchange Commission relating to the election of directors. Delaware law does
not provide for any such absolute right of inspection, and no such right is
granted under the Certificate of Incorporation or Bylaws of New GranCare.
 
  Dividends and Repurchases of Shares. California law dispenses with the
concepts of par value of shares as well as statutory definitions of capital,
surplus and the like. The concepts of par value, capital and surplus are
retained under Delaware law.
 
  Under California law, a corporation may not make any distribution (including
dividends, whether in cash or other property, and repurchases of its shares)
unless either the corporation's retained earnings immediately prior to the
proposed distribution equal or exceed the amount of the proposed distribution
or, immediately after giving effect to such distribution, the corporation's
assets (exclusive of goodwill, capitalized research and development expenses
and deferred charges) would be at least equal to 1-1/4 times its liabilities
(not including deferred taxes, deferred income and other deferred credits),
and the corporation's current assets would be at least equal to its current
liabilities (or 1-1/4 times its current liabilities if the average pre-tax and
pre-interest expense earnings for the preceding two fiscal years were less
than the average expense for such years). Under California law, there are
exceptions to the foregoing rules for repurchases of shares in connection with
certain rescission actions or pursuant to certain employee stock plans.
 
  Delaware law permits a corporation to declare and pay dividends out of
"surplus" or, if there is no surplus, out of net profits for the fiscal year
in which the dividend is declared and/or for the preceding fiscal year as long
as the amount of "capital" of the corporation following the declaration and
payment of the dividend is not less than the aggregate amount of the capital
represented by the issued and outstanding stock of all classes having a
preference upon the distribution of assets. In addition, Delaware law
generally provides that a corporation may redeem or repurchase its shares only
if such redemption or repurchase would not impair the capital of the
corporation.
 
  To date, the Company has not paid cash dividends on its capital stock. Its
is the current policy of the Board of Directors to retain earnings for use in
the Company's business, and therefore, neither the Company nor New GranCare
anticipate paying cash dividends on their common stock in the foreseeable
future.
 
  Shareholder Voting. Both California and Delaware law generally require that
the holders of a majority in voting power of the outstanding shares of stock
of both constituent corporations entitled to vote approve mergers. Delaware
law does not require a stockholder vote of the surviving corporation in a
merger (unless the corporation provides otherwise in its certificate of
incorporation) if (i) the merger agreement does not amend the existing
certificate of incorporation, (ii) each share of the surviving corporation
outstanding before the merger is an identical outstanding or treasury share
after the merger, and (iii) the number of shares to be issued by the surviving
corporation in the merger does not exceed 20% of the shares outstanding
immediately prior to the merger. California law contains a similar exception
to its voting requirements for reorganizations where
 
                                      99
<PAGE>
 
shareholders or the corporation itself, or both, immediately prior to the
reorganization will own immediately after the reorganization equity securities
constituting more than five-sixths of the voting power of the surviving or
acquiring corporation or its parent entity.
 
  Both California and Delaware law also require that a sale of all or
substantially all of the assets of a corporation be approved by a majority of
the outstanding voting shares of the corporation transferring such assets.
 
  With certain exceptions, California law also requires that mergers,
reorganizations, certain sales of assets and similar transactions be approved
by a majority vote of each class of shares outstanding. By contrast, Delaware
law generally does not require class voting (unless otherwise required by a
corporation's certificate of incorporation), except in certain transactions
involving an amendment to the certificate of incorporation which adversely
affects a specific class or series of shares.
 
  California law also requires that holders of nonredeemable common stock
receive nonredeemable common stock in a merger of the corporation with the
holder of more than 50% but less than 90% of such common stock or its
affiliate unless all of the holders of such common stock consent to the
transaction. This provision of California law may have the effect of making a
"cash-out" merger by a majority shareholder more difficult to accomplish.
Delaware law has no comparable provision.
 
  California law also provides that except in certain circumstances, when a
tender offer or a proposal for a reorganization or for a sale of assets is
made by an interested party (generally, a controlling or managing party of the
target corporation), an affirmative opinion in writing as to the fairness of
the consideration to be paid to the shareholders must be delivered to
shareholders. This fairness opinion requirement does not apply to a
corporation which does not have shares held of record by at least 100 persons,
or to a transaction which has been qualified under California state securities
laws. Furthermore, if a tender of shares or vote is sought pursuant to an
interested party's proposal and a later proposal is made by another party at
least ten days prior to the date of acceptance of the interested party
proposal, the shareholders must be informed of the later offer and be afforded
a reasonable opportunity to withdraw any vote, consent or proxy, or to
withdraw any tendered shares. Again, Delaware law has no comparable provision.
 
  Interested Director Transactions. Under both California and Delaware law,
certain contracts or transactions in which one or more of a corporation's
directors has an interest are not void or voidable solely because of such
interest provided that certain conditions, such as obtaining the required
approval and fulfilling the requirements of good faith and full disclosure,
are met. With certain exceptions, the conditions are similar under California
and Delaware law. Under California and Delaware law, either (a) the
shareholders or the board of directors must approve any such contract or
transaction after full disclosure of the material facts (and in the case of
board approval the contract or transaction must also be "just and reasonable"
in California), or (b) the contract or transaction must have been "just and
reasonable" (in California) or "fair" (in Delaware), as applicable, to the
corporation at the time it was approved. In the latter case, California law
explicitly places the burden of proof on the interested director. Under
California law, if shareholder approval is sought, the interested director is
not entitled too vote his shares at a shareholder meeting with respect to any
action regarding such contract or transaction. If board approval is sought,
the contract or transaction must be approved by a majority vote of a quorum of
the directors, without counting the vote of any interested directors (except
that interested directors may be counted for purposes of establishing a
quorum). Under Delaware law, if board approval is sought, the contract or
transaction must be approved by a majority of the disinterested directors
(even though less than a majority of a quorum). Therefore, certain
transactions that the Board of Directors of the Company might not be able to
approve because of the number of interested directors, or the exclusion of
interested director shares, could be approved by a majority of the
disinterested directors of New GranCare, although less than a quorum, or by a
majority of all voting shares, which might not include the holder of a
majority of the disinterested shares. Neither the Company nor New GranCare is
aware of any plans to propose any transaction involving directors of the
Company which could not be so approved under California law but could be so
approved under Delaware law.
 
                                      100
<PAGE>
 
  Shareholder Derivative Suits. California law provides that, under certain
circumstances, a shareholder bringing a derivative action on behalf of a
corporation need not have been a shareholder at the time of the transaction in
question, provided that certain tests are met. Under Delaware law, a
stockholder may only bring a derivative action on behalf of the corporation if
the stockholder was a stockholder of the corporation at the time of the
transaction in question or his or her stock thereafter devolved upon him or
her by operation of law. California law also provides that the corporation or
the defendant in a derivative suit may make a motion to the court for an order
requiring the plaintiff shareholder to furnish a security bond. Delaware does
not have a similar bonding requirement.
 
  Appraisal Rights. Under both California and Delaware law, a shareholder of a
corporation participating in certain corporate transactions may, under varying
circumstances, be entitled to appraisal rights pursuant to which such
shareholder may receive cash in the amount of the fair value of his or her
shares in lieu of the consideration he or she would otherwise receive in the
transaction. Under Delaware law unless the certificate of incorporation
otherwise provides, such appraisal rights are not available (i) with respect
to the sale, lease or exchange of all or substantially all of the assets of a
corporation, (ii) with respect to a merger or consolidation by a corporation
the shares of which are either listed on a national securities exchange (or
authorized for quotation on the Nasdaq National Market System) or are held of
record by more than 2,000 holders if such stockholders receive only shares of
the surviving corporation or shares of any other corporation which are either
listed on a national securities exchange (or authorized for quotation on the
Nasdaq National Market System) or held of record by more than 2,000 holders,
plus cash in lieu of fractional shares, or any combination thereof, or (iii)
to stockholders of a corporation surviving a merger if no vote of the
stockholders of the surviving corporation is required to approve the merger
because the merger agreement does not amend the existing certificate of
incorporation, each share of the surviving corporation outstanding prior to
the merger is an identical outstanding or treasury share after the merger, and
the number of shares to be issued in the merger does not exceed 20% of the
shares of the surviving corporation outstanding immediately prior to the
merger and if certain other conditions are met.
 
  The limitations on the availability of appraisal rights under California law
are different from those under Delaware law. Shareholders of a California
corporation whose shares are listed on a national securities exchange or on a
list of over-the-counter margin stocks issued by the Board of Governors of the
Federal Reserve System generally do not have such appraisal rights unless the
holders of at least 5% of the class of outstanding shares perfect the right
pursuant to the provisions of the CGCL or unless the corporation or any law
restricts the transfer of such shares. Appraisal rights are unavailable,
however, if the shareholders of a corporation or the corporation itself, or
both, immediately prior to the reorganization will own immediately after the
reorganization equity securities constituting more than five-sixths of the
voting power of the surviving or acquiring corporation or its parent entity.
In general, California law affords appraisal rights in sale of assets
reorganizations.
 
  While shareholders of the Company have appraisal rights under California
law, the Certificate of Incorporation of New GranCare does not provide for
such rights and, accordingly, appraisal rights will not be available to
shareholders of New GranCare.
 
  Dissolution. Under California law, shareholders holding 50% or more of the
total voting power may authorize a corporation's dissolution, with or without
the approval of the corporation's board of directors, and this right may not
be modified by the articles of incorporation. Under Delaware law, unless the
board of directors approves the proposal to dissolve, the dissolution must be
approved by stockholders holding 100% of the total voting power of the
corporation. Only if the dissolution is initiated by the board of directors
may it be approved by a simple majority of the corporation's stockholders. In
the event of such a board-initiated dissolution, a majority of shares
outstanding and entitled to vote would be required to approve a dissolution of
New GranCare which had previously been approved by its Board of Directors.
 
APPLICATION OF THE GENERAL CORPORATION LAW OF CALIFORNIA TO DELAWARE
CORPORATIONS
 
  Under Section 2115 of the California General Corporation Laws ("CGCL") ,
certain foreign corporations (i.e. corporations not organized under California
law) are placed in a special category if they have characteristics
 
                                      101
<PAGE>
 
of ownership and operation which indicate that they have significant contacts
with California. So long as a Delaware or other foreign corporation is in this
special category, and it does not qualify for one of the statutory exemptions,
it is subject to a number of key provisions of the CGCL applicable to
corporations incorporated in California. Among the more important provisions
are those relating to the election and removal of directors, cumulative
voting, standards of liability and indemnification of directors,
distributions, dividends and repurchases of shares, shareholder meetings,
approval of certain corporate transactions, dissenters' and appraisal rights
and inspection of corporate records. See "Significant Differences Between the
Corporation Laws of California and Delaware" above.
 
  Exemptions from Section 2115 of the CGCL are provided for corporations whose
shares are listed on a major national securities exchange or are traded in the
NASDAQ National Market System and which have 800 or more shareholders of
record. Following the Distribution, the New GranCare Common Stock will
continue to be traded on the NYSE, and held beneficially by more than 800
stockholders as of the Distribution Date, and, accordingly, New GranCare will
be exempt from Section 2115 of the CGCL.
 
                       SHARES ELIGIBLE FOR FUTURE SALES
 
  Upon completion of the Distribution, New GranCare will have an estimated
23,401,992 shares of New GranCare Common Stock outstanding, all of which will
be freely tradable without restriction or further registration under the
Securities Act, except to the extent such shares are held by "affiliates" of
New GranCare, which will be subject to the limitations of Rule 144 promulgated
under the Securities Act. In general, under Rule 144 as currently in effect,
beginning 90 days after the date of this Prospectus, persons who may be deemed
affiliates of New GranCare, as that term is defined in the Securities Act
would be entitled to sell within any three-month period a number of shares
that does not exceed the greater of 1% of the then outstanding shares of New
GranCare Common Stock (approximately 234,020 shares immediately after the
Distribution) or the average weekly trading volume during the four calendar
weeks preceding a sale by such person. Sales under Rule 144 are also subject
to certain provisions relating to the manner and notice of sale and
availability of current public information about New GranCare. Following the
Distribution, 2,355,250 shares of New GranCare Common Stock will be issuable
upon the exercise of options held by directors and employees of New GranCare
and former employees of the Company.
 
                             AVAILABLE INFORMATION
 
  New GranCare has filed with the Securities and Exchange Commission (the
"Commission") a Registration Statement on Form S-1 (the "Registration
Statement") under the Securities Act of 1933, as amended (the "Securities
Act"), with respect to the shares of New GranCare Common Stock described in
this Prospectus. This Prospectus, which is a part of the Registration
Statement, does not contain all of the information set forth in the
Registration Statement or the exhibits and schedules thereto, certain portions
having been omitted pursuant to the rules and regulations of the Commission.
Statements made in this Prospectus as to the contents of any contract or other
document are not necessarily complete with respect to each such contract or
other document filed with the Commission as an exhibit to the Registration
Statement. Reference is made to such exhibits for a more complete description
of the matter involved, and each such statement shall be deemed qualified in
its entirety by such reference.
 
  The Registration Statement and the exhibits and schedules thereto filed with
the Commission may be inspected and copied (at prescribed rates) at the Public
Reference Section of the Commission at Room 1024, Judiciary Plaza, 450 Fifth
Street, N.W., Washington, D.C. 20549, and at the Commission's regional offices
located at 7 World Trade Center, 13th Floor, New York, New York, 10048, and
the Citicorp Center, 500 West Madison, Suite 1400, Chicago, Illinois 60661-
2511.
 
                                      102
<PAGE>
 
  New GranCare intends to list the New GranCare Common Stock on the NYSE.
Future reports of New GranCare filed pursuant to either the Securities Act or
the Securities Exchange Act of 1934, as amended (the "Exchange Act") may be
inspected at such exchange and may also be reviewed through the Commission's
Electronic Data Gathering Analysis and Retrieval System, which is publicly
available through the Commission's Web site (http://www.sec.gov).
 
  New GranCare intends to furnish its shareholders with annual reports
containing audited financial statements and quarterly reports containing
unaudited financial information for each of the first three quarters of each
fiscal year.
 
                                 LEGAL MATTERS
 
  The validity of the shares of New GranCare Common Stock offered hereby and
the status of the Distribution and Merger as tax-free transactions will be
passed upon for New GranCare by Powell, Goldstein, Frazer & Murphy LLP,
Atlanta, Georgia.
 
                                    EXPERTS
 
  The consolidated financial statements and schedule of GranCare, Inc. at
December 31, 1995 and 1994, and for each of the three years in the period
ended December 31, 1995, appearing in this Prospectus and Registration
Statement have been audited by Ernst & Young LLP, independent auditors, as set
forth in their report thereon appearing elsewhere herein, which, as to the
years 1994 and 1993, is based in part on the report of KPMG Peat Marwick LLP,
independent auditors. The financial statements and schedule referred to above
are included in reliance upon such reports given upon the authority of such
firms as experts in accounting and auditing.
 
  The balance sheet of New GranCare, Inc. at September 30, 1996, appearing in
this Prospectus and Registration Statement has been audited by Ernst & Young
LLP, independent auditors, as set forth in their report thereon appearing
elsewhere herein, and is included in reliance upon such report given upon the
authority of such firm as experts in accounting and auditing.
 
 
                                      103
<PAGE>
 
                         INDEX TO FINANCIAL STATEMENTS
 
<TABLE>
<CAPTION>
                                                                           PAGE
                                                                           ----
<S>                                                                        <C>
GRANCARE, INC.
Reports of Independent Auditors..........................................  F-2
Consolidated Balance Sheets as of December 31, 1995 and 1994.............  F-4
Consolidated Statements of Income for the years ended December 31, 1995,
 1994 and 1993...........................................................  F-5
Consolidated Statements of Shareholders' and Partners' Equity for the
 years ended December 31, 1995, 1994 and 1993............................  F-6
Consolidated Statements of Cash Flows for the years ended December 31,
 1995, 1994 and 1993.....................................................  F-7
Notes to Consolidated Financial Statements...............................  F-9
Schedule II--Valuation and Qualifying Accounts...........................  F-27
Unaudited Condensed Consolidated Balance Sheet as of September 30, 1996..  F-28
Unaudited Condensed Consolidated Statements of Income for the nine-month
 periods ended September 30, 1996 and 1995...............................  F-30
Unaudited Condensed Consolidated Statements of Cash Flows for the nine-
 month periods ended September 30, 1996 and 1995 ........................  F-31
Notes to Unaudited Condensed Consolidated Financial Statements...........  F-33
NEW GRANCARE, INC.
Report of Independent Auditors...........................................  F-35
Balance Sheet as of September 30, 1996...................................  F-36
Note to Balance Sheet....................................................  F-37
</TABLE>
 
                                      F-1
<PAGE>
 
                        REPORT OF INDEPENDENT AUDITORS
 
The Board of Directors and Shareholders
GranCare, Inc.
 
  We have audited the consolidated balance sheets of GranCare, Inc. (the
Company) as of December 31, 1995 and 1994, and the related consolidated
statements of income, shareholders' and partners' equity, and cash flows for
each of the three years in the period ended December 31, 1995. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits. We did not audit the financial statements of Evergreen Healthcare,
Inc., (Evergreen) which became a wholly-owned subsidiary in 1995, as of
December 31, 1994 and for the years ended December 31, 1994 and 1993. The
Evergreen amounts represent 21% of the consolidated total assets at December
31, 1994, and 38% and 26% of consolidated net income for the years ended
December 31, 1994 and 1993, respectively. The financial statements were
audited by other auditors, whose reports have been furnished to us, and our
opinion, with respect to the consolidated financial statements as of and for
the years ended December 31, 1994 and 1993, insofar as it relates to data
included for Evergreen, is based solely on the reports of the other auditors.
 
  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 and the reports of other
auditors provide a reasonable basis for our opinion.
 
  In our opinion, based on our audits and the reports of other auditors, the
financial statements referred to above present fairly, in all material
respects, the consolidated financial position of GranCare, Inc. at
December 31, 1995 and 1994, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended December 31,
1995 in conformity with generally accepted accounting principles.
 
  As discussed in Note 7 to the consolidated financial statements, effective
January 1, 1993, the Company changed its method of accounting for income
taxes. Also, as discussed in Note 2 to the consolidated financial statements,
effective December 31, 1993, the Company changed its method of accounting for
its marketable equity security investments.
 
                                          Ernst & Young LLP
 
Atlanta, Georgia
February 27, 1996
 
                                      F-2
<PAGE>
 
                         INDEPENDENT AUDITORS' REPORT
 
The Board of Directors Evergreen Healthcare, Inc.:
 
  We have audited the consolidated balance sheet of Evergreen Healthcare, Inc.
and subsidiaries as of December 31, 1994 and the related consolidated
statements of operations, stockholders' equity and cash flows for the year
ended December 31, 1994 and the six-month period ended December 31, 1993 and
the related combined statements of operations, partners' equity and cash flows
of Evergreen Healthcare LTD, L.P., Predecessor to Evergreen Healthcare, Inc.,
for the six month period ended June 30, 1993 (not presented separately
herein). These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated 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 and combined financial statements referred
to above present fairly, in all material respects, the financial position of
Evergreen Healthcare, Inc. and subsidiaries as of December 31, 1994 and the
results of operations and cash flows of Evergreen Healthcare, Inc. and
subsidiaries for the year ended December 31, 1994, and the six-month period
ended December 31, 1993 and the related combined statements of operations,
partners' equity and cash flows of Evergreen Healthcare LTD., L.P.,
predecessor to Evergreen Healthcare, Inc., for the six month period ended June
30, 1993, in conformity with generally accepted accounting principles.
 
                                          KPMG Peat Marwick LLP
 
Indianapolis, Indiana
August 17, 1995
 
                                      F-3
<PAGE>
 
                          CONSOLIDATED BALANCE SHEETS
 
<TABLE>
<CAPTION>
                                                            DECEMBER 31,
                                                        ----------------------
                                                           1995        1994
                                                        ----------  ----------
                                                        DOLLARS IN THOUSANDS
<S>                                                     <C>         <C>
ASSETS
Current assets:
  Cash and cash equivalents............................ $   17,738  $   28,611
  Accounts receivable, less allowance for doubtful
   accounts (1995--$10,856 and 1994--$9,892)...........    173,068     128,121
  Inventories..........................................     13,527      11,125
  Prepaid expenses and other current assets............     16,498      14,344
  Deferred income taxes (Note 7).......................     10,933       7,395
                                                        ----------  ----------
Total current assets...................................    231,764     189,596
Property and equipment:
  Land and improvements................................     10,238      10,937
  Buildings and improvements...........................    192,875     185,293
  Equipment............................................     66,929      53,662
                                                        ----------  ----------
                                                           270,042     249,892
  Less accumulated depreciation........................    (55,689)    (42,042)
                                                        ----------  ----------
                                                           214,353     207,850
Other assets:
  Investments, at fair value (Notes 4 and 11)..........     30,305      20,353
  Goodwill (accumulated amortization: 1995--$5,535;
   1994--$1,959).......................................    120,946      58,418
  Other intangibles (accumulated amortization: 1995--
   $8,051; 1994--$5,940)...............................      9,793      11,501
  Other (Note 2).......................................     38,000      32,475
                                                        ----------  ----------
Total assets........................................... $  645,161  $  520,193
                                                        ==========  ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
  Accounts payable and accrued expenses................ $   72,935  $   59,411
  Accrued wages and related liabilities................     24,069      22,643
  Interest payable.....................................      6,793       3,683
  Income taxes payable (Note 7)........................        --        2,667
  Notes payable and current maturities of long-term
   debt (Notes 3, 4 and 11)............................      4,937      11,566
                                                        ----------  ----------
Total current liabilities..............................    108,734      99,970
Long-term debt (Notes 3, 4 and 11).....................    334,668     231,665
Deferred income taxes (Note 7).........................     16,735      15,496
Other..................................................     12,425      11,645
Commitments and contingencies (Notes 5 and 6)
Shareholders' equity (Notes 2 and 8):
  Common stock; no par value; 50,000,000 shares
   authorized (shares issued: 1995--23,948,728 and
   1994--23,173,429)...................................    134,699     132,141
  Treasury stock, at cost (1995--915,000 shares and
   1994--200,000 shares)...............................    (18,700)     (5,030)
  Equity component of minimum pension liability........       (465)       (364)
  Unrealized gain on investments (net of income taxes:
   1995--$3,453; 1994--$2,250).........................      5,206       3,375
  Retained earnings....................................     51,859      31,295
                                                        ----------  ----------
                                                           172,599     161,417
                                                        ----------  ----------
Total liabilities and shareholders' equity............. $  645,161  $  520,193
                                                        ==========  ==========
</TABLE>
 
                            See accompanying notes.
 
                                      F-4
<PAGE>
 
                       CONSOLIDATED STATEMENTS OF INCOME
 
<TABLE>
<CAPTION>
                                                  YEAR ENDED DECEMBER 31,
                                              --------------------------------
                                                 1995       1994       1993
                                              ---------- ---------- ----------
                                              DOLLARS AND SHARES IN THOUSANDS,
                                                   EXCEPT PER SHARE DATA
<S>                                           <C>        <C>        <C>
REVENUES
Net patient revenues......................... $  811,402 $  701,783 $  609,250
Investment and other income..................      5,060     15,688      2,439
                                              ---------- ---------- ----------
Total revenues...............................    816,462    717,471    611,689
EXPENSES
Operating expenses:
  Salary and related.........................    360,530    322,471    289,276
  Rent and property..........................     51,206     44,291     42,446
  Other operating............................    308,982    266,774    217,266
                                              ---------- ---------- ----------
                                                 720,718    633,536    548,988
Depreciation and amortization................     21,611     16,440     12,349
Interest expense and financing charges.......     27,054     21,481     19,601
Nonrecurring costs--merger and other costs...     11,750        --       4,573
Restructuring costs (Note 12)................        --       8,200        --
                                              ---------- ---------- ----------
Total expenses...............................    781,133    679,657    585,511
                                              ---------- ---------- ----------
Income before income taxes and extraordinary
 charge......................................     35,329     37,814     26,178
Income taxes.................................     14,765     13,524     10,089
                                              ---------- ---------- ----------
Income before extraordinary charge...........     20,564     24,290     16,089
Extraordinary charge--loss on early
 extinguishment of debt, net of income tax
 benefit of $856.............................        --         --       1,285
                                              ---------- ---------- ----------
Net income................................... $   20,564 $   24,290 $   14,804
                                              ========== ========== ==========
NET INCOME PER COMMON AND COMMON EQUIVALENT
 SHARE
Primary:
  Income before extraordinary charge......... $     0.86 $     1.07 $     0.88
  Extraordinary charge.......................        --         --        (.07)
                                              ---------- ---------- ----------
  Net income................................. $     0.86 $     1.07 $     0.81
Fully diluted:
  Income before extraordinary charge......... $     0.86 $     1.07 $     0.84
  Extraordinary charge.......................        --         --        (.07)
                                              ---------- ---------- ----------
  Net income................................. $     0.86 $     1.07 $     0.77
                                              ========== ========== ==========
Weighted average number of common and common
 equivalent shares outstanding:
  Primary....................................     23,794     22,631     18,205
                                              ========== ========== ==========
  Fully diluted..............................     23,919     24,966     19,241
                                              ========== ========== ==========
</TABLE>
 
                            See accompanying notes.
 
                                      F-5
<PAGE>
 
         CONSOLIDATED STATEMENTS OF SHAREHOLDERS' AND PARTNERS' EQUITY
 
<TABLE>
<CAPTION>
                                     COMPUPHARM                  EQUITY
                                     CONVERTIBLE                COMPONENT      UNREALIZED
                           COMMON     PREFERRED  TREASURY      OF MINIMUM        GAIN ON   RETAINED  PARTNERS'
                            STOCK       STOCK      STOCK    PENSION LIABILITY  INVESTMENTS  EARNINGS   EQUITY    TOTAL
                          --------  ------------ --------  ------------------ ------------ --------- ---------- --------
                                                              DOLLARS IN THOUSANDS
<S>                       <C>       <C>          <C>       <C>                <C>          <C>       <C>        <C>
Balances at January 1,
 1993...................  $ 65,039     $  24     $ (6,221)       $(294)          $  --      $(4,318)  $ 5,550   $ 59,780
 Issuance of 170,284
  shares of common stock
  on exercise of
  warrants and options
  (Note 8)..............       884       --           --           --               --          --        --         884
 Issuance of 6,000
  shares of common
  stock.................        80       --           --           --               --          --        --          80
 Dividends on CompuPharm
  convertible preferred
  stock.................       --        --           --           --               --         (182)      --        (182)
 GranCare and CompuPharm
  pooling transactions
  (Note 3):
 Retirement of
  CompuPharm treasury
  stock.................    (1,191)      --         1,191          --               --          --        --         --
 Conversion of
  CompuPharm convertible
  preferred stock.......        24       (24)         --           --               --          --        --         --
 Conversion of
  CompuPharm convertible
  debt..................       350       --           --           --               --          --        --         350
 Exercise of CompuPharm
  warrants..............     1,660       --           --           --               --          --        --       1,660
 Exercise of CompuPharm
  non-compensatory
  options...............       150       --           --           --               --          --        --         150
 Reverse acquisition
  transaction (Note 3):
 Issuance of common
  stock for partnership
  interest..............     6,656       --           --           --               --          --     (6,656)       --
 Issuance of common
  stock for assets of
  affiliated
  partnership...........     2,105       --           --           --               --          --        --       2,105
 Issuance of common
  stock for acquisition
  of minority interest
  of NHI................     5,693       --           --           --               --          --        --       5,693
 Final distribution to
  former general and
  limited partners......      (490)      --           --           --               --          --        --        (490)
 Distributions to
  partners..............       --        --           --           --               --          --       (864)      (864)
 Unrealized gain on
  investments, net of
  income taxes of
  $2,800................       --        --           --           --             4,200         --        --       4,200
 Net income.............       --        --           --           --               --       12,834     1,970     14,804
 Four months of
  CompuPharm 1993 net
  income included in
  both 1992 and 1993
  (Note 3)..............       --        --           --           --               --       (1,329)      --      (1,329)
 Minimum pension
  liability adjustment..       --        --           --           130              --          --        --         130
                          --------     -----     --------        -----           ------     -------   -------   --------
Balances at December 31,
 1993...................    80,960       --        (5,030)        (164)           4,200       7,005       --      86,971
 Issuance of 221,655
  shares of common stock
  on exercise of
  warrants and options
  (Note 8)..............     1,603       --           --           --               --          --        --       1,603
 Issuance of 1,000,000
  shares of common stock
  in connection with LTC
  acquisition (Note 3)..    20,000       --           --           --               --          --        --      20,000
 Issuance of 5,048
  shares of common stock
  on conversion of debt
  issued in connection
  with Winyah
  acquisition (Note 3)..       100       --           --           --               --          --        --         100
 Issuance of 2,421,875
  shares of common stock
  in public offering....    28,478       --           --           --               --          --        --      28,478
 Issuance of 77,500
  shares of common stock
  in connection with HS
  Healthcare acquisition
  (Note 3)..............     1,000       --           --           --               --          --        --       1,000
 Unrealized loss on
  investments, net of
  income taxes of $550..       --        --           --           --              (825)        --        --        (825)
 Net income.............       --        --           --           --               --       24,290       --      24,290
 Minimum pension
  liability adjustment..       --        --           --          (200)             --          --        --        (200)
                          --------     -----     --------        -----           ------     -------   -------   --------
Balances at December 31,
 1994...................   132,141       --        (5,030)        (364)           3,375      31,295       --     161,417
 Issuance of 769,799
  shares of common stock
  on exercise warrants
  and options (Note 8)..     2,476       --           --           --               --          --        --       2,476
 Issuance of 5,500
  shares of common
  stock.................        82       --           --           --               --          --        --          82
 Repurchase of 715,000
  shares of common
  stock.................       --        --       (13,670)         --               --          --        --     (13,670)
 Unrealized gain on
  investments, net of
  income taxes of
  $1,203................       --        --           --           --             1,831         --        --       1,831
 Net income.............       --        --           --           --               --       20,564       --      20,564
 Minimum pension
  liability adjustment..       --        --           --          (101)             --          --        --        (101)
                          --------     -----     --------        -----           ------     -------   -------   --------
Balances at December 31,
 1995...................  $134,699     $ --      $(18,700)       $(465)          $5,206     $51,859   $   --    $172,599
                          ========     =====     ========        =====           ======     =======   =======   ========
</TABLE>
 
                            See accompanying notes.
 
                                      F-6
<PAGE>
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
 
<TABLE>
<CAPTION>
                                                    YEAR ENDED DECEMBER 31,
                                                  -----------------------------
                                                    1995       1994      1993
                                                  ---------  --------  --------
                                                     DOLLARS IN THOUSANDS
<S>                                               <C>        <C>       <C>
OPERATING ACTIVITIES
Net income......................................  $  20,564  $ 24,290  $ 14,804
Adjustments to reconcile net income to net cash
 provided by operating activities:
  Provision for doubtful accounts...............      6,281     7,918     3,592
  Depreciation and amortization.................     21,611    16,440    12,349
  Gain on sale of assets........................       (829)  (12,518)   (1,672)
  Deferred income taxes.........................      1,171      (333)      922
  Amortization of deferred financing costs......        531       522       373
  Restructuring costs...........................        --      8,200       --
  Changes in operating assets and liabilities
   net of effects of acquisitions (Note 3):
    Accounts receivable.........................    (49,018)  (33,491)  (29,548)
    Prepaid expenses and other current assets...     (3,215)    1,992    (4,270)
    Accounts payable, accrued wages and other
     accrued expenses...........................     15,388     2,145     6,461
    Interest payable............................      3,110       769     2,704
    Income taxes payable........................     (3,199)     (883)   (5,870)
    Other.......................................     (3,400)   (1,320)      714
                                                  ---------  --------  --------
Net cash provided by operating activities.......      8,995    13,731       559
INVESTING ACTIVITIES
Acquisition of businesses (net of cash acquired
 of $2,469 in 1994 and
 $10 in 1993)...................................    (68,467)  (49,414)  (19,273)
Purchases of property and equipment.............    (23,495)  (14,938)  (20,918)
Proceeds from disposition of assets.............      4,155    13,726       374
Purchases of investments........................     (6,944)   (6,978)       (4)
Repayments (advances) of notes receivable.......        943    (1,610)    3,009
Other...........................................     (1,972)   (2,212)   (1,251)
                                                  ---------  --------  --------
Net cash used in investing activities...........    (95,780)  (61,426)  (38,063)
FINANCING ACTIVITIES
Issuance of stock...............................         82    29,063     1,140
Payment of stock issuance costs.................        --       (585)      --
Proceeds from exercise of warrants and options..      2,776     1,603       584
Purchase of treasury stock......................    (13,670)      --        --
Long-term debt payments.........................   (177,870)  (23,207)  (14,580)
Proceeds from long-term debt borrowings.........    270,018    44,787    66,900
Advances (repayments) of short-term notes
 payable........................................        --       (600)    2,598
Payment of debt issuance costs..................     (5,424)   (1,136)   (3,763)
Payment of dividends on preferred stock.........        --        --       (261)
Distributions to former general and limited
 partners.......................................        --        --     (1,354)
                                                  ---------  --------  --------
Net cash provided by financing activities.......     75,912    49,925    51,264
                                                  ---------  --------  --------
Net increase (decrease) in cash and cash
 equivalents....................................    (10,873)    2,230    13,760
Less CompuPharm increase in cash for period
 January 1, 1993 through
 April 30, 1993 (Note 3)........................        --        --     (1,687)
Cash and cash equivalents at beginning of year..     28,611    26,381    14,308
                                                  ---------  --------  --------
Cash and cash equivalents at end of year........  $  17,738  $ 28,611  $ 26,381
                                                  =========  ========  ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
  Interest paid.................................  $  22,566  $ 20,712  $ 15,300
                                                  =========  ========  ========
  Income taxes paid.............................  $  17,964  $ 14,406  $ 12,035
                                                  =========  ========  ========
</TABLE>
 
                            See accompanying notes.
 
                                      F-7
<PAGE>
 
                       SUPPLEMENTAL CASH FLOW INFORMATION
 
ACQUISITIONS
 
  The 1995, 1994 and 1993 acquisitions (see Note 3) had the following effects
on cash:
 
<TABLE>
<CAPTION>
                                                  YEAR ENDED DECEMBER 31,
                                                 ----------------------------
                                                   1995      1994      1993
                                                 --------  --------  --------
                                                    DOLLARS IN THOUSANDS
<S>                                              <C>       <C>       <C>
Fair values of assets acquired (net of cash
 received)...................................... $(75,317) $(90,713) $(48,392)
Fair values of liabilities assumed..............    6,850    20,299    29,119
                                                 --------  --------  --------
                                                  (68,467)  (70,414)  (19,273)
Issuance of stock...............................      --     21,000       --
                                                 --------  --------  --------
Net effect on cash.............................. $(68,467) $(49,414) $(19,273)
                                                 ========  ========  ========
</TABLE>
 
NONCASH TRANSACTIONS
 
  In connection with the acquisition of Professional Health Care Management,
Inc. (PHCM) in October 1992, GranCare issued 45,000 shares of GranCare Series D
Exchangeable Preferred Stock (the Series D Preferred Stock), which had an
aggregate liquidation preference of $9,000,000. In January 1993, the Series D
Preferred Stock was converted into two promissory notes and, in April 1993,
GranCare prepaid the notes using proceeds from its 6.5% Subordinated Debenture
offering.
 
  As part of the 1993 NHI reverse acquisition (see Note 3), approximately
7,200,000 common shares (GranCare equivalent), which is net of treasury shares
retired, were issued.
 
  Plant and equipment acquired under financing notes and capital lease
arrangements aggregated approximately $1,021,000, $3,222,000, and $4,904,000 in
1995, 1994, and 1993 respectively.
 
 
 
                            See accompanying notes.
 
                                      F-8
<PAGE>
 
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE 1. BASIS OF PRESENTATION
 
  GranCare, Inc. (GranCare or the Company) merged with Evergreen Healthcare,
Inc. (Evergreen) on July 20, 1995 (the Merger). On that date, GranCare issued
approximately 9,673,000 shares of its common stock in exchange for the
approximately 12,500,000 shares of Evergreen common stock then outstanding
based on an exchange ratio of its shares of GranCare common stock for each
share of Evergreen common stock.
 
  The consolidated financial statements give retroactive effect to the Merger,
which has been accounted for using the pooling-of-interests method and, as a
result, the financial position, results of operations and cash flows are
presented as if the combining companies had been consolidated for all periods
presented. The consolidated statements of shareholders' and partners' equity
also reflect retroactive combination of the accounts of GranCare and Evergreen
for all periods presented, with adjustments to outstanding shares based on the
exchange ratio.
 
  Prior to the June 30, 1993 National Heritage, Inc. (NHI) reverse acquisition
transaction described in Note 3, the historical Evergreen entity included in
these consolidated financial statements consisted of: (a) Evergreen Healthcare
Ltd., L.P. (ELP), a limited partnership and; (b) Omega/Indiana Pharmacy, L.P.
(OLP), also a limited partnership. Prior to the June 30, 1993 transaction, ELP
had a September 30 fiscal year-end and OLP had a calendar year-end.
 
  Evergreen amounts for the 1994 and 1993 consolidated financial statements
have been conformed to the Company's December 31 year-end.
 
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
  Business and Consolidation The Company operates approximately 136 leased and
owned long-term health care facilities that provide skilled nursing and
residential care services in 15 states. In addition, the Company also owns and
operates or serves 30 institutional pharmacies, a specialty hospital geriatric
services company, which manages approximately 100 geriatric care units in
acute hospitals in 18 states, and home health operations in three states.
 
  The facilities and pharmacy divisions represented approximately 72% and 23%,
respectively, of the total net revenues of the Company. Substantially all of
the facilities and pharmacies receive benefits under the Medicare and Medicaid
programs. These programs are highly regulated and subject to periodic change.
 
  The consolidated financial statements include the accounts of GranCare and
all of its subsidiaries. All significant intercompany accounts and
transactions have been eliminated. Investments in affiliates in which the
Company has less than a 50% interest are accounted for by the equity method.
 
  Use of Estimates The preparation of the financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
 
  Cash Equivalents The Company considers all highly liquid instruments
purchased with original maturity dates of three months or less to be cash
equivalents.
 
  Inventories Inventories are stated at the lower of cost, using the first-in,
first-out method, or market value. Inventories consist primarily of purchased
pharmaceuticals and various medical equipment of the pharmacies and supplies
used in the care of residents in long-term care facilities.
 
  Property and Equipment Property and equipment are recorded at cost.
Depreciation is computed by the straight-line method over the estimated useful
lives of the assets as stated below. Leases and leasehold
 
                                      F-9
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
improvements that have been capitalized are amortized over the lives of the
leases. Amortization of these assets is included in depreciation expense.
 
<TABLE>
      <S>                                                             <C>
      Buildings and improvements..................................... 8-35 years
      Equipment......................................................  5-7 years
</TABLE>
 
  Investments In May 1993, the FASB issued Statement of Financial Accounting
Standards No. 115 (Statement No. 115), "Accounting for Certain Investments in
Debt and Equity Securities." As permitted under Statement No. 115, GranCare
elected the early adoption of provisions of the new standard as of December
31, 1993, and recognized the unrealized gain ($4,200,000, net of income taxes)
as a direct component of equity (see Note 11). Evergreen adopted the new
standard on July 1, 1994.
 
  Goodwill and Other Intangibles In connection with the Company's
acquisitions, costs in excess of the amounts assigned to identifiable assets
acquired, less liabilities assumed, are recorded as goodwill. Goodwill is
amortized on a straight-line basis principally over a period of 35 years.
Goodwill recorded in the Cornerstone acquisition (unamortized balance of
$48,721,000 at December 31, 1995) is being amortized over 25 years. The
carrying value of goodwill is reviewed if the facts and circumstances suggest
that it may be impaired. If this review indicates that goodwill will not be
recoverable, as determined based on undiscounted cash flows of the acquired
entity over the remaining amortization period, the Company's carrying value of
the goodwill is reduced by the estimated shortfall of cash flows.
 
  Other intangibles, which primarily were obtained in connection with the
Company's acquisitions, mainly represent covenants not to compete and lease
contract rights that are amortized over the terms of the noncompetition
agreements and leases, respectively.
 
  Other Assets The Company defers financing costs incurred to obtain long-term
debt and amortizes such costs using the straight-line method over the term of
the related obligation. An investment in an unconsolidated affiliate at
December 31, 1995 consists of a 28% owned interest in Alternative Living
Services, Inc. (ALS), which is recorded using the equity method. In 1994, the
Company's 53% interest in ALS was consolidated with the Company. The remaining
other assets are individually not significant in their impact to the Company.
 
  Stock Based Compensation The Company grants stock options for a fixed number
of shares to employees with an exercise price equal to the fair value of the
shares at the date of grant. The Company accounts for stock option grants in
accordance with APB Opinion No. 25, "Accounting for Stock Issued to
Employees," and intends to continue to do so.
 
  Net Patient Revenues Patient revenues are reported in the period in which
services are provided. Net patient revenues reflect contractual discounts and
the results of other arrangements for providing services at less than
established rates. Contractual adjustments include differences between
established billing rates and amounts estimated by management as reimbursable
under various cost reimbursement formulas or service contracts.
 
  The administrative procedures related to the Medicare and Medicaid cost
reimbursement programs, in effect, generally preclude final determination of
amounts due the Company until cost reimbursement reports, filed by the
Company, are audited or otherwise reviewed and settled with the applicable
administrative agencies. Normal estimation differences between final
settlements and amounts accrued in previous years are reported in current net
patient revenues. Actual results could differ from these estimates. Included
in accounts receivable are settlement amounts due from Medicare and Medicaid
programs totalling $45,764,000 and $20,204,000 at December 31, 1995 and 1994,
respectively. In the opinion of management, adequate provision has been made
for adjustments, if any, that might result from subsequent review. The
Medicare and Medicaid cost reimbursement programs approximated 75%, 76% and
77% of net patient revenues for the years ended December 31, 1995, 1994 and
1993, respectively.
 
                                     F-10
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  Earnings Per Share Earnings per share are computed based on the weighted
average common and (if dilutive) common equivalent shares outstanding, which
include options and warrants, and in the case of fully diluted earnings per
share, convertible subordinated debentures. The earnings per share amounts are
based on the combined historical weighted average common and dilutive common
equivalent shares of GranCare and Evergreen pre-merger adjusted for the .775
exchange ratio. Also, Evergreen's pre-merger historical amounts for periods in
which it was a partnership are based on the equivalent shares of Evergreen
common stock using the terms of the Evergreen exchange transaction described
in Note 3.
 
  Pro forma earnings per share for 1993 is computed by dividing pro forma net
income by the weighted average number of common and common equivalent shares
outstanding for the period.
 
  Pro Forma Income Taxes As indicated in Note 1, prior to June 30, 1993, the
Evergreen predecessor entity consisted of two partnerships and, accordingly,
Evergreen was not subject to federal or state income taxes. The following
table presents unaudited pro forma financial information for the year ended
December 31, 1993, that includes a provision for income taxes as if Evergreen
had been a taxable corporation for the period. Such pro forma calculation was
based on the income tax laws and rates in effect during the period, and FASB
Statement No. 109.
 
<TABLE>
<CAPTION>
                                                               YEAR ENDED
                                                              DECEMBER 31,
                                                                   1993
                                                          ---------------------
                                                          DOLLARS IN THOUSANDS
                                                          EXCEPT PER SHARE DATA
      <S>                                                 <C>
      Pro Forma data (unaudited):
      Income before income taxes and extraordinary
       charge...........................................         $26,178
      Income taxes......................................          10,874
      Income before extraordinary charge................          15,304
      Extraordinary charge..............................           1,285
                                                                 -------
      Net income........................................         $14,019
                                                                 =======
      Net income per common and common equivalent share:
      Primary...........................................         $   .77
                                                                 -------
      Fully diluted.....................................         $   .73
                                                                 =======
</TABLE>
 
  Impact of Recently Issued Accounting Standards In March 1995, the FASB
issued Statement No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to Be Disposed Of," which requires impairment losses
to be recorded on long-lived assets used in operations when indicators of
impairment are present and the undiscounted cash flows estimated to be
generated by those assets are less than the assets' carrying amount. The
impairment loss is measured by comparing the fair value of the asset to its
carrying amount. Statement No. 121 also addresses the accounting for long-
lived assets that are expected to be disposed of. The Company will adopt
Statement No. 121 in the first quarter of 1996 and, based on current
circumstances, does not believe the effect of adoption will be material.
 
NOTE 3. ACQUISITIONS, DISPOSITIONS AND MERGERS
 
  1993 Acquisitions and Dispositions Effective January 1, 1993, GranCare
acquired all of the capital stock of Coordinated Home Health, Inc., and the
operations of Coordinated Nursing Services, Inc. and Infusion Plus, Inc.
(collectively, Coordinated) for $1,600,000 in cash and a promissory note for
$485,000.
 
  On January 28, 1993, GranCare completed the acquisition of Colter Village,
two health care facilities consisting of a skilled nursing facility and a
retirement living center for $6,750,000.
 
  On March 31, 1993, GranCare acquired Bella Vita, a 126-bed skilled nursing
facility in Colorado, for $3,740,000.
 
                                     F-11
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  On April 1, 1993, GranCare acquired all of the capital stock of Pacific
Therapies, Inc., and the operations of Pacific Therapies Co. (collectively,
Pacific Therapies), which provide physical, occupational and speech therapy
services, for $1,000,000 in cash and a promissory note for $384,000.
 
  On April 19, 1993, GranCare acquired the operations of Patient Therapy
Systems, Inc., which provides therapy beds and therapy services to patients
directly and under agreements and arrangements with nursing facilities, for
$400,000 in cash.
 
  On April 30, 1993, GranCare acquired four skilled nursing facilities located
in Wisconsin for $3,500,000 in cash and $13,000,000 in mortgage notes.
 
  On June 23, 1993, GranCare acquired all of the capital stock of Brim Medical
Equipment and Supplies, Inc., an enteral and urological supply company, for
$1,400,000, payable in installments of various amounts, without interest
through July 1, 1998.
 
  On June 30, 1993, GranCare acquired all of the capital stock of Winyah
Dispensary, LTC of North Carolina and Winyah Dispensary-Midlands, Inc., for
$2,500,000 in convertible promissory notes, and the operations of Winyah
Dispensary for $3,650,000 in cash and promissory notes in the aggregate sum of
$2,600,000 (collectively, Winyah). Winyah provides institutional pharmacy
services in North and South Carolina. In connection with these transactions,
GranCare recorded $8,218,000 in goodwill.
 
  On September 30, 1993, CompuPharm acquired the operations of Medication
Delivery Systems, Inc. (MDS), an institutional pharmacy, for a purchase price
of $1,750,000 plus transaction costs.
 
  NHI Reverse Acquisition Effective June 30, 1993, Evergreen became a public
company and acquired the remaining 90% common stock ownership of NHI, an
existing public company, in a reverse acquisition transaction. (Note:
Evergreen had previously acquired 10% of NHI in October 1992.) The following
transactions were part of the reverse acquisition:
 
  . The partners of the Evergreen partnerships (i.e., ELP and OLP as referred
    to in Note 1) and an affiliated partnership under common control (ERP)
    received 5,032,108 common shares (restated to GranCare equivalent
    shares), which was net of 1,240,000 shares held in treasury that were
    retired, in exchange for their partnership interests in the three
    partnerships.
 
  . The ERP partnership, which previously was not part of the historical
    Evergreen entity, transferred its assets to Evergreen as part of the
    exchange. Such assets consisted of: (i) a limited partnership interest in
    the Evergreen partnerships, and (ii) a 48% ownership in NHI. (Note: ERP
    had also acquired its interest in NHI in October 1992.)
 
  . The remaining 42% owners of NHI received 2,141,325 common shares
    (restated to GranCare equivalent shares), excluding shares held in
    treasury by NHI.
 
  The exchange of common stock for partnership interests in predecessor
partnerships (i.e., ELP and OLP) was recorded at book value, because it was
merely a legal restructuring. The receipt of ERP assets for common stock also
was recorded at book value, because this was a transfer among entities under
common control. ERP's book value included $2,100,000 in goodwill recorded in
connection with its purchase of a 48% interest in NHI.
 
  The acquisition of the NHI 42% minority stockholders' interests was
accounted for as a purchase and, in connection therewith, $2,691,000 in
goodwill was recorded. The operations of NHI have been included in the
consolidated results of Evergreen from June 30, 1993 forward.
 
  The 1993 acquisitions described above were all accounted for as purchases
and, accordingly, the consolidated financial statements of the Company include
the operations of such acquired entities since the respective dates of their
acquisition.
 
                                     F-12
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  During 1993, GranCare also divested nine facilities.
 
  1994 Acquisitions and Dispositions On March 1, 1994, GranCare acquired the
operations of PPCP, Inc. (PPCP), which provides institutional pharmacy
services, for $3,800,000 in cash and adjustable subordinated promissory notes
in the aggregate sum of $1,449,000. In connection with this transaction,
$4,518,000 was recorded as goodwill.
 
  On April 1, 1994, GranCare acquired the operations of Merit Pharmacy, Inc.
(Merit), which provides institutional pharmacy services, for $600,000 in cash
and a subordinated promissory note for $1,184,000. In connection with this
transaction, GranCare recorded $1,817,000 in goodwill.
 
  On June 7, 1994, Evergreen acquired substantially all of the assets of two
Illinois limited partnerships, Health Care Fund Limited Partnership and Health
Care Fund II Limited Partnership, as well as two related companies, H.S.
Healthcare, Inc. and H.S. Systems, Inc. (collectively referred to as HS
Healthcare). Evergreen paid approximately $22,571,000 cash (of which
$7,687,000 was financed through revolving credit borrowings) in exchange for
the assets acquired and liabilities assumed. The Company also paid $3,000,000
in cash and issued 77,500 shares (restated) of common stock valued at
$1,000,000 to the general partners of the partnerships and sole shareholders
of the related companies in consideration for their agreement not to compete
with the Company for a period of ten years.
 
  Effective July 1, 1994, GranCare acquired substantially all of the assets
and assumed certain liabilities of Long Term Care Pharmaceutical Services
Corporation I and Long Term Care Pharmaceutical Services Corporation III
(collectively, LTC), an institutional pharmacy business based in Indiana, for
$16,000,000 cash and 1,000,000 shares of GranCare common stock valued at $20
per share, or $20,000,000. In the event the market price of the common stock
was not at least equal to $20 per share at a specified date in 1995, the
Company was obligated to issue additional consideration to bring the value of
the common stock to $20,000,000. The purchase agreement also contains a
contingent earnout provision, in the form of a subordinated promissory note,
under which an additional $5,500,000 could be paid-provided certain future
operating results are attained. In connection with this transaction, GranCare
recorded $27,402,000 goodwill.
 
  Also effective July 1, 1994, GranCare acquired the operations of Ricketts
Drug, Inc., an institutional pharmacy based in Virginia, for $4,111,000 in
cash. In connection with this transaction, GranCare recorded $2,355,000 in
goodwill.
 
  Effective July 25, 1994, GranCare acquired leasehold interests in two long-
term health care facilities in South Carolina for $38,000.
 
  Effective September 30, 1994, GranCare acquired leasehold interests in five
additional long-term health care facilities in South Carolina for $150,000.
 
  The above-described 1994 acquisitions were all accounted for as purchases
and, accordingly, the financial statements of the Company include the
operations of such acquired entities since the respective dates of their
acquisition.
 
  During 1994, GranCare also divested three facilities (exclusive of the
restructuring described in Note 12) and Pacific Therapies, acquired in 1993.
The sale of Pacific Therapies to an unrelated entity for approximately
$11,700,000 in cash and assumption of approximately $1,100,000 in debt and
certain other liabilities resulted in a gain of approximately $8,800,000. The
gain is reported in investment and other income in the Consolidated Statements
of Income.
 
  1995 Acquisitions and Dispositions In January 1995, GranCare acquired a
leasehold interest in a long-term facility in Arizona for $150,000.
 
                                     F-13
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  In April 1995, GranCare acquired Cornerstone Health Management Company
(Cornerstone), a management company specializing in the implementation and
management of geriatric specialty programs for acute care hospitals, for
$53,213,000.
 
  In November 1995, GranCare acquired Innovative Pharmacy Services, Inc., an
institutional pharmacy based in Wisconsin, for $10,000,000 in cash and stock.
 
  In December 1995, GranCare acquired the operations of both Pharmcare, Inc.
and American Pharmaceutical Inc., two institutional pharmacies based in
Northern California, for $4,700,000 and $1,200,000, respectively.
 
  During 1995, GranCare also divested one facility (exclusive of the
restructuring described in Note 12).
 
  In July 1995, in accordance with contractual obligation to the former owners
of LTC, the Company repurchased 715,000 shares of its common stock.
 
  Summarized below are the unaudited pro forma consolidated results of
operations for GranCare had the 1995 Cornerstone acquisition occurred as of
January 1, 1994, and the 1994 LTC and HS Healthcare acquisitions and the June
30, 1993 NHI reverse acquisition occurred as of January 1, 1993:
 
<TABLE>
<CAPTION>
                                                        YEAR ENDED DECEMBER 31,
                                                        -----------------------
                                                           1994        1993
                                                        ----------- -----------
                                                         DOLLARS IN THOUSANDS
                                                         EXCEPT PER SHARE DATA
      <S>                                               <C>         <C>
      Total revenues................................... $   786,846 $   711,622
      Income before extraordinary charge...............      26,738      19,926
      Net income.......................................      26,738      18,641
      Net income per share:
        Primary........................................        1.15         .91
        Fully diluted..................................        1.15         .87
</TABLE>
 
  Pro forma information for other 1995, 1994 and 1993 acquisitions and
divestitures is not presented because their operating results, either
individually or in the aggregate, do not have a material effect on the pro
forma operating results presented above.
 
  The above results are based upon certain assumptions and estimates which the
Company believes are reasonable, and do not reflect any benefit which might be
achieved from combined operations. The unaudited pro forma results do not
necessarily represent results which would have occurred if the acquisitions
had taken place on the basis assumed above, nor are they indicative of the
results of future combined operations.
 
MERGERS
 
  CompuPharm Merger On December 28, 1993, GranCare acquired, through merger,
all of the outstanding common stock of CompuPharm, Inc. ("CompuPharm") in
exchange for 2,462,795 shares of GranCare's common stock. CompuPharm is a
provider of institutional pharmacy services.
 
  GranCare's merger with CompuPharm was accounted for as a pooling-of-
interests business combination and, accordingly, the consolidated financial
statements for all periods prior to the merger have been restated to include
the historical balances of GranCare and CompuPharm as if the two companies had
always been combined. For purposes of restating the December 31, 1992
financial statements to reflect the merger, CompuPharm's annual financial
statements for the fiscal year ended April 30, 1993 were used. The 1993
consolidated financial statements, however, include CompuPharm balances as of,
and for the year ended, December 31, 1993. As such, both the 1993 and 1992
consolidated financial statements include operating results
 
                                     F-14
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
and cash flows relating to CompuPharm for the four months ended April 30,
1993, (consisting of revenues and net income of $24,200,000 and $1,300,000,
respectively) which are adjusted through a separate line item in the
consolidated statements of shareholders' equity and cash flows.
 
  A reconciliation of consolidated total revenues, income before extraordinary
charge and net income to amounts applicable to the separate companies prior to
the date of combination (effectively, December 31, 1993) is presented together
with the Evergreen merger table included below.
 
  Evergreen Merger On July 20, 1995, GranCare acquired, through merger,
substantially all of the outstanding common stock of Evergreen in exchange for
approximately 9,673,000 shares of GranCare common stock based on a .775
exchange ratio. The Evergreen merger is accounted for as a pooling-of-
interests business combination and, accordingly, the consolidated financial
statements of all periods prior to the merger have been restated to include
the historical balances of GranCare and Evergreen as if the two companies had
always been combined.
 
  The Company incurred certain costs relating to completion of the Merger and
other one-time costs and recognized an $11.8 million charge in the third
quarter of 1995, as required under the pooling-of-interests accounting method.
The following is a summary of the Merger and other one-time costs:
 
<TABLE>
<CAPTION>
                                                                     YEAR ENDED
                                                                    DECEMBER 31,
                                                                        1995
                                                                    ------------
                                                                     DOLLARS IN
                                                                      THOUSANDS
      <S>                                                           <C>
      Merger costs:
        Investment banking fees....................................   $ 4,100
        Legal and other fees.......................................     1,469
        Executive severance........................................     1,100
        Planned divestitures of certain facilities.................     1,500
      Other one-time costs:
        Relocation.................................................     1,626
        Integration................................................       850
        Other deferred acquisition costs...........................     1,105
                                                                      -------
      Total........................................................   $11,750
                                                                      =======
</TABLE>
 
  As of December 31, 1995, the remaining reserve balance relating to the
Merger and other one-time costs was $2.4 million.
 
                                     F-15
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  A reconciliation of consolidated total revenues, income before extraordinary
charge, and net income to amounts applicable to the separate pooled companies
prior to the dates of combination (including both the December 1993 CompuPharm
and July 1995 Evergreen mergers) is as follows:
 
<TABLE>
<CAPTION>
                                                        YEAR ENDED DECEMBER 31,
                                                        -----------------------
                                                           1994        1993
                                                        ----------- -----------
                                                         DOLLARS IN THOUSANDS
                                                         EXCEPT PER SHARE DATA
<S>                                                     <C>         <C>
TOTAL REVENUES
  GranCare............................................. $   549,220 $   434,117
  CompuPharm...........................................         --       73,853
                                                        ----------- -----------
  GranCare, pre-Evergreen merger.......................     549,220     507,970
  Evergreen............................................     168,251     103,719
                                                        ----------- -----------
                                                        $   717,471 $   611,689
                                                        =========== ===========
INCOME BEFORE EXTRAORDINARY CHARGE(1)
  GranCare............................................. $    15,179 $    10,697
  CompuPharm...........................................         --        1,472
                                                        ----------- -----------
  GranCare, pre-Evergreen merger.......................      15,179      12,169
  Evergreen(2).........................................       9,111       3,920
                                                        ----------- -----------
                                                        $    24,290 $    16,089
                                                        =========== ===========
NET INCOME
  GranCare............................................. $    15,179 $    10,697
  CompuPharm...........................................         --          187
                                                        ----------- -----------
  GranCare, pre-Evergreen merger.......................      15,179      10,884
  Evergreen(2).........................................       9,111       3,920
                                                        ----------- -----------
                                                        $    24,290 $    14,804
                                                        =========== ===========
NET INCOME PER SHARE (FULLY-DILUTED BASIS)
  GranCare............................................. $      1.08 $      1.03
  CompuPharm(3)........................................         n/a         n/a
  GranCare, pre-Evergreen merger.......................        1.08         .83
  Evergreen(4).........................................         .82         n/a
                                                        ----------- -----------
                                                        $      1.07 $       .77
                                                        =========== ===========
</TABLE>
- --------
(1) After non-recurring merger costs of $2,149,000 for GranCare and $2,424,000
    for CompuPharm in 1993.
(2) Evergreen's income before extraordinary charge and net income exclude
    Merger and other costs of approximately $11,750,000. This charge was
    recorded by the Company in the third quarter of 1995.
(3) Earnings per share for CompuPharm prior to the merger was not applicable
    because it was not a public company.
(4) Earnings per share for Evergreen prior to June 30, 1993 was not applicable
    because it was not a public company.
 
                                     F-16
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
NOTE 4. DEBT
 
  Debt consists of the following:
 
<TABLE>
<CAPTION>
                                                         YEAR ENDED DECEMBER 31,
                                                         -----------------------
                                                            1995        1994
                                                         ----------- -----------
                                                          DOLLARS IN THOUSANDS
<S>                                                      <C>         <C>
SENIOR DEBT
  Mortgage notes payable:
    Omega..............................................  $    58,800 $    58,800
    Other (principally HRPT and FINOVA) in installments
     which include interest ranging from 8% to 11.5%...       32,376      31,477
  Revolving loan under bank credit facility bearing
   interest based on LIBOR or prime rate...............       37,700      45,900
  Evergreen Credit Facility............................          --       12,686
  Evergreen revenue bonds..............................       13,445      13,850
  Notes payable in installments which include interest
   ranging from 6.9% to 13.75%; final maturities in
   1996 through 2010...................................       28,991      10,788
  Capitalized lease obligations (less imputed interest
   of $570 in 1995 and $421 in 1994)...................        4,622       4,964
  Other................................................        2,400       3,385
                                                         ----------- -----------
    Total senior debt..................................      178,334     181,850
SUBORDINATED DEBT
  Senior subordinated notes; interest due semi-annually
   at 9 3/8%, principal due September 15, 2005.........      100,000         --
  Convertible subordinated debentures; interest due
   semi-annually at 6.5%, principal due January 15,
   2003................................................       60,000      60,000
  Other notes payable..................................        1,271       1,381
                                                         ----------- -----------
Total subordinated debt................................      161,271      61,381
                                                         ----------- -----------
Total debt.............................................      339,605     243,231
Less short-term notes payable and current maturities of
 long-term debt........................................        4,937      11,566
                                                         ----------- -----------
                                                         $   334,668 $   231,665
                                                         =========== ===========
</TABLE>
 
  On August 14, 1992, PHCM entered into a $58,800,000 loan agreement with
Omega Healthcare Investors, Inc. (Omega). The loan is secured by mortgages on
certain health care facilities, and by the personal property used in
connection with the operation of those facilities, as well as certain other
intangibles, including the licenses for these facilities, to the extent
permitted by Michigan law, and accounts receivable in excess of $1,000,000.
The minimum interest rate on the loan is 13% per year, of which 12% is payable
monthly in cash and 1% is deferred. The cash interest rate will increase in
each subsequent year based upon a specified formula tied to either; (i) the
percentage change in the Consumer Price Index published by the United States
Department of Labor, or; (ii) the change in Gross Revenues (as defined in the
loan agreement); however, the increase cannot be more than the interest for
the prior fiscal year multiplied by 1.05. The 1% of deferred interest will
accrue on an annual basis and will be cumulative on an annual basis as long as
the loan remains outstanding. Quarterly principal payments of $1,470,000 are
required beginning October 1, 2002, with the remaining balance plus the
deferred interest due in August 2007. The loan agreement also contains certain
restrictive covenants, including, but not limited to, restrictions on PHCM
incurring additional debt, prepayment and minimum net worth requirements. As
of December 31, 1995, the interest rate was 13.9%, including the 1% deferred
interest.
 
  In conjunction with a 1990 acquisition, GranCare borrowed $15,000,000 under
a promissory note agreement with HRPT. The note is secured by mortgages on two
facilities and 1,000,000 shares of HRPT common stock
 
                                     F-17
<PAGE>
 
owned by GranCare. The HRPT note had a balance of $8,750,000, with an interest
rate of 13.75% at December 31, 1994.
 
  During 1995, GranCare renegotiated the note with HRPT, whereby the principal
balance of the promissory note was increased to $11,500,000, resulting in
additional proceeds to GranCare. Minimum interest on the note is 11.5% per
year payable monthly in arrears. Additional interest is payable commencing on
January 1, 1996, in an amount equal to 75% of the percentage increase in the
Consumer Price Index, with certain defined limitations. Principal payments
will begin two years after the date of the note on a 30-year direct reduction
basis, with the remaining balance due December 31, 2010.
 
  On January 29, 1993, GranCare completed a public offering of $60,000,000
aggregate principal amount of its 6.5% Convertible Subordinated Debentures due
2003 (the Debentures). The Debentures are convertible into common stock of
GranCare at any time prior to redemption or final maturity, at a conversion
price of $27.145 per share, subject to adjustment upon the occurrence of
certain events. Interest on the Debentures is payable semi-annually on January
and July 15th. Approximately $15,600,000 of the net proceeds of $57,700,000
was used to repay certain indebtedness, and the remaining $42,100,000 was used
for general corporate purposes, including the further expansion of specialty
medical services and acquisitions.
 
  In conjunction with the 1993 acquisition of four skilled nursing facilities
in Wisconsin, as described in Note 3, GranCare entered into an $11,000,000
mortgage loan agreement with FINOVA. Interest accrues on the mortgage note at
an adjustable rate of 2% over prime, with installments of principal and
interest due monthly through April 2001, with final payment due May 2001. The
mortgage note cannot be prepaid until 90 days prior to the end of the term
without a prepayment penalty.
 
  At the end of 1993, a subsidiary of GranCare, GranCare Health Services, Inc.
entered into a $50,000,000 revolving credit agreement with a syndicate of
banks. In 1994, the agreement was amended to increase the line of credit to
$80,000,000. This credit agreement terminated on March 29, 1995.
 
  On March 29, 1995, the Company entered into an agreement with First Union
National Bank of North Carolina (First Union) pursuant to which First Union
provided the Company with a $175 million revolving line of credit (the Credit
Facility). The Company has used the proceeds from the Credit Facility to pay
off its previous line of credit, fund the acquisition of Cornerstone and for
general working capital purposes. In September 1995, concurrent with the High
Yield Debt offering the Credit Facility was reduced to $150 million. Amounts
outstanding under the Credit Facility bear interest based on LIBOR or prime
rates (7.6% and 8.85%, respectively, at December 31, 1995). Amounts
outstanding as of June 30, 1998 may convert to a term loan with equal
quarterly installments due through the final maturity date of June 30, 2002.
No principal payments are required under the Credit Facility prior to the June
30, 1998 conversion date.
 
  Evergreen maintained a revolving credit facility and a working capital
facility (the Evergreen Credit Facility) in the aggregate maximum amount of
$55,000,000 from a syndicate of banks, $45,000,000 of which was to be used for
acquisitions and $10,000,000 of which was to be used for working capital
purposes. The Evergreen Credit facility was terminated at the merger. Six
nursing home facilities were refinanced via mortgage debt in March 1995 for
$16,500,000, including the facilities held as collateral under the revolving
credit facility. Therefore, the Company has classified the borrowings under
the revolving credit facility as long-term debt in the Company's consolidated
balance sheet at December 31, 1994. The Evergreen Credit Facility described
above was entered into on June 7, 1994, as a refinancing of an existing
$6,000,000 revolving credit facility with the same bank.
 
  On September 29, 1995, the Company closed the sale of $100 million aggregate
principal amount of its 9 3/8% Senior Subordinated Notes due 2005 (Notes) in
an underwritten public offering (Notes Offering). After paying underwriter
fees and commissions, the approximately $96 million realized by the Company
from the sale of the Notes was used to pay outstanding indebtedness under its'
Credit Facility.
 
  The Evergreen revenue bonds include a $9,100,000 Series 1993A taxable
adjustable demand issue that requires semiannual interest payments at a
variable rate (5.95% at December 31, 1995) and annual principal
 
                                     F-18
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
payments through August 15, 2013. The remaining revenue bonds bear interest at
fixed rates ranging from 7.75% to 9.5% through 2001--2002, and which are
subject to change after such dates. These bonds mature in 2015; however, they
may be redeemed by the bondholders on various dates in the years 2001, 2002,
2011 and 2012.
 
  Certain of these notes payable and related agreements contain covenant
restrictions on additional debt, intercompany loans, dividends and the
maintenance of certain financial ratios. The Company has pledged certain
accounts receivable, leasehold interests and substantially all property and
equipment as collateral under the various debt agreements.
 
  Maturities of debt and obligations under capital leases at December 31,
1995, are summarized as follows:
 
<TABLE>
<CAPTION>
                                                 DEBT   CAPITAL LEASES  TOTAL
                                               -------- -------------- --------
                                                     DOLLARS IN THOUSANDS
   <S>                                         <C>      <C>            <C>
   Year ending December 31,
     1996..................................... $  3,331     $2,053     $  5,384
     1997.....................................    2,477      1,302        3,779
     1998.....................................    6,443      1,140        7,583
     1999.....................................    1,785        659        2,444
     2000.....................................    8,959         38        8,997
   Thereafter.................................  311,988        --       311,988
                                               --------     ------     --------
   Total minimum payments.....................  334,983      5,192      340,175
   Less amounts representing interest.........      --         570          570
                                               --------     ------     --------
   Total obligations.......................... $334,983     $4,622     $339,605
                                               ========     ======     ========
</TABLE>
 
NOTE 5. OPERATING LEASES
 
  The Company has operating leases for 24 facilities, including land,
buildings, and equipment from HRPT under two Master Lease Documents.
Subsequent to December 31, 1994, the existing Master Lease Documents were
amended. Under the amended lease arrangements, minimum rent for the aggregate
facilities is the annual sum of $11,550,000, payable in equal monthly
installments. In addition, beginning January 1, 1996, the amended lease
agreement provides for additional rent to be paid monthly, in advance, based
on 75% of the increase in the Consumer Price Index multiplied by the minimum
rent due, provided, however, that the maximum rent (minimum rent plus
additional rent) each January shall be limited to a 2% increase over the total
monthly rent paid in the prior December. The operating leases for 17
facilities expire on December 28, 2010, and there are two 10 year renewal
options. The leases for seven facilities expire in June 2006 and there are two
10 1/2-year renewal options. The Company has subleased seven of the 24
facilities to unrelated parties.
 
  The Company leases additional health care facilities, certain other
facilities, office space, and equipment from other unrelated parties.
Substantially all the leases are operating leases which expire at various
dates and generally contain options to renew for various terms. Certain leases
also contain purchase options. Rents generally are subject to increase based
on the Consumer Price Index, occupancy rates, Medicaid reimbursement rates or
at stated amounts specified in the lease agreements.
 
 
                                     F-19
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  A summary of GranCare's minimum commitments under operating leases at
December 31, 1995, follows:
 
<TABLE>
<CAPTION>
     YEAR ENDING                                                      DOLLARS IN
     DECEMBER 31,                                                     THOUSANDS
     ------------                                                     ----------
     <S>                                                              <C>
      1996...........................................................  $ 43,310
      1997...........................................................    43,069
      1998...........................................................    42,331
      1999...........................................................    37,510
      2000...........................................................    26,175
     Thereafter......................................................   179,066
                                                                       --------
     Total minimum lease payments....................................  $371,461
                                                                       ========
</TABLE>
 
  Aggregate future minimum lease payments to be received under noncancelable
subleases are $5,263,000 for the year ended December 31, 1996 and $43,675,000
thereafter.
 
  Total rent expense for all operating leases, net of sublease income,
aggregated $41,058,000, $35,632,000 and $34,872,000 for the years ended
December 31, 1995, 1994 and 1993, respectively.
 
  The Company is currently having discussions with the landlord of 18 of its'
skilled nursing facilities. The Company expects to receive a favorable
adjustment to current lease commitments in return for an additional capital
investment and extension of the lease term.
 
NOTE 6. COMMITMENTS AND CONTINGENCIES
 
  The Company is involved in legal proceedings arising in the normal course of
business. Management believes, based in part upon discussions with legal
counsel, the ultimate resolution of these matters will not have a material
adverse effect on the Company's consolidated financial position or results of
operations.
 
  The Company, through its wholly-owned subsidiary, GCI Indemnity, Inc.,
maintains a captive insurance company for the purpose of paying worker's
compensation claims. The Company maintains reinsurance contracts to minimize
its insurance exposure.The Company accepts the first $350,000 of loss and loss
adjustment expense liability per occurrence for worker's compensation risks.
The Company estimates this liability on case-basis estimates of losses
reported prior to the date of the balance sheets and includes estimates of
losses for claims incurred but not reported. The Company's estimated liability
for worker's compensation claims is reported in the accompanying balance
sheets as other long term liabilities. Investments held by the captive
insurance company are reported in other assets section of the accompanying
balance sheets.
 
NOTE 7. INCOME TAXES
 
  Effective January 1, 1993, the Company, except for CompuPharm and Evergreen,
prospectively adopted FASB Statement of Financial Accounting Standards No. 109
(Statement No. 109), "Accounting for Income Taxes." CompuPharm and Evergreen
adopted Statement No. 109 on May 1, 1991 and July 1, 1993, respectively. The
Company (excluding CompuPharm and Evergreen) previously accounted for income
taxes under FASB Statement No. 96. There was no cumulative effect of adopting
Statement No. 109.
 
  As described in Note 1, prior to June 30, 1993, the predecessor Evergreen
entities were partnerships and as such were not subject to corporate income
taxes. Accordingly, the accompanying 1993 Consolidated Statement of Income
does not include any income tax expense relating to $1,970,000 of pre-tax
income earned by these partnerships.
 
 
                                     F-20
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
  The provision for income taxes consists of the following for the years ended
December 31:
 
<TABLE>
<CAPTION>
                                                        YEAR ENDED DECEMBER 31,
                                                        ------------------------
                                                         1995    1994     1993
                                                        ------- -------  -------
                                                         DOLLARS IN THOUSANDS
     <S>                                                <C>     <C>      <C>
     CURRENT
     Federal........................................... $11,880 $11,025  $ 7,388
     State.............................................   1,714   2,832    1,779
                                                        ------- -------  -------
                                                         13,594  13,857    9,167
     DEFERRED
     Federal...........................................   1,133    (317)     778
     State.............................................      38     (16)     144
                                                        ------- -------  -------
                                                          1,171    (333)     922
                                                        ------- -------  -------
                                                        $14,765 $13,524  $10,089
                                                        ======= =======  =======
</TABLE>
 
  At December 31, 1995, the Company and its subsidiaries have approximately
$19,900,000 of federal net operating loss carryforwards (including the
remaining $970,000 NHI NOL acquired by Evergreen) and various state income tax
net operating loss carryforwards expiring at various dates through 2008.
Approximately $11,340,000 of such amount represents acquired federal net
operating loss carryforwards, the use of which is subject to both annual
dollar limitations and the general requirements that such carryforwards be
offset only against the taxable income of the acquired operations. The portion
of the net operating loss carryforwards not relating to acquired operations is
also subject to various limitations because of previous ownership changes. The
valuation allowance at December 31, 1995, pertains to nonacquired net
operating loss carryforwards.
 
  Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. The tax effects of the
cumulative temporary differences are as follows:
 
<TABLE>
<CAPTION>
                                                     YEAR ENDED DECEMBER 31,
                                                     ------------------------
                                                        1995         1994
                                                     -----------  -----------
                                                      DOLLARS IN THOUSANDS
   <S>                                               <C>          <C>
   DEFERRED INCOME TAX LIABILITIES
     Fixed asset basis differences.................. $    17,318  $    16,687
     Workers' compensation insurance................         --           359
     Deferred rent..................................         --           349
     Investments....................................       3,276        2,250
     Intangible asset basis differences.............       1,648          --
     Deferred gain on sale of assets................       1,263          --
     Other..........................................         266          690
                                                     -----------  -----------
   Total deferred income tax liabilities............      23,771       20,335
   DEFERRED INCOME TAX ASSETS
     Vacation and compensation accruals.............       4,103        2,630
     Deferred gain on sale of assets................         --         1,382
     Accounts receivable reserves...................       5,981        1,351
     Deferred rent..................................         426          587
     Voluntary employees' benefit association.......         507          190
     Net operating loss carryforwards...............       7,367        8,124
     Intangible asset basis differences.............         --           117
     Accrued merger costs...........................         886          --
     Workers' compensation and other insurance......       2,088          --
     Other..........................................         --         1,567
                                                     -----------  -----------
   Total deferred income tax assets.................      21,358       15,948
   Valuation allowance for deferred income tax
    assets..........................................      (3,389)      (3,714)
                                                     -----------  -----------
   Net deferred income tax assets...................      17,969       12,234
                                                     -----------  -----------
   Net deferred income tax liabilities.............. $     5,802  $     8,101
                                                     ===========  ===========
</TABLE>
 
                                     F-21
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  The valuation allowance decreased as shown below:
 
<TABLE>
<CAPTION>
                                                      YEAR ENDED DECEMBER 31,
                                                     -------------------------
                                                      1995     1994     1993
                                                     ------- -------- --------
                                                       DOLLARS IN THOUSANDS
<S>                                                  <C>     <C>      <C>
Recognition of NOL carryforwards as a reduction in
 income tax expense................................. $   325 $    325 $  1,370
Initial recognition of deductible temporary
 differences as a reduction in income tax expense...     --       665      --
Recognition of acquired NOLs and deductible
 temporary differences as a reduction to goodwill...     --     2,548    1,200
                                                     ------- -------- --------
                                                     $   325 $  3,538 $  2,570
                                                     ======= ======== ========
</TABLE>
 
  Differences between GranCare's income tax expense and the amount calculated
utilizing the federal statutory rate are as follows:
 
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,  1995 AMOUNT PERCENT 1994 AMOUNT PERCENT 1993 AMOUNT PERCENT
- -----------------------  ----------- ------- ----------- ------- ----------- -------
                                            DOLLARS IN THOUSANDS
<S>                      <C>         <C>     <C>         <C>     <C>         <C>
Income tax at statutory
 rate...................   $12,365    35.0%    $13,236    35.0%    $ 9,163    35.0%
State tax, net of
 federal benefit........     1,135     3.2       1,958     5.2       1,384     5.2
Nontaxable partnership
 income.................       --      --          --      --         (690)   (2.6)
Merger costs............     1,435     4.1         --      --        1,600     6.1
Federal NOL--current....      (277)    (.8)       (277)    (.7)       (681)   (2.6)
Federal NOL--deferred...       --      --          --      --         (689)   (2.6)
Reduction in valuation
 allowance..............       --      --         (665)   (1.8)        --      --
State NOL, net of
 federal benefit........       (48)    (.1)        (48)    (.1)       (131)    (.5)
Federal tax credits.....       (88)    (.3)       (458)   (1.2)       (290)   (1.1)
Other...................       243      .7        (222)    (.6)        423     1.6
                           -------    ----     -------    ----     -------    ----
                           $14,765    41.8%    $13,524    35.8%    $10,089    38.5%
                           =======    ====     =======    ====     =======    ====
</TABLE>
 
NOTE 8. SHAREHOLDERS' EQUITY, STOCK OPTIONS AND WARRANTS
 
  The 2,462,795 shares of GranCare's common stock issued upon completion of
the December 28, 1993, merger with CompuPharm consisted of the following:
 
<TABLE>
   <S>                                                                <C>
   Outstanding shares of CompuPharm prior to merger.................    601,885
   Convertible CompuPharm debt converted to stock simultaneously
    with the merger.................................................    736,648
   Convertible CompuPharm preferred stock converted to stock
    simultaneously with the merger..................................    283,816
   CompuPharm common stock options exercised simultaneously with the
    merger..........................................................    195,891
   CompuPharm common stock warrants exercised simultaneously with
    the merger......................................................    644,555
                                                                      ---------
                                                                      2,462,795
                                                                      =========
</TABLE>
 
  In connection with the Evergreen merger, 9,672,806 shares of GranCare common
stock were issued in the exchange.
 
  Also in connection with the CompuPharm and Evergreen mergers, CompuPharm and
Evergreen stock options that remained outstanding were exchanged for options
to purchase GranCare stock with the same terms, except as adjusted for the
common stock exchange ratio. The GranCare options issued in connection with
the CompuPharm and Evergreen exchanges totaled approximately 587,200 and
214,000, respectively, and are included in the option table presented below,
based on their original issuance date by CompuPharm and Evergreen.
 
 
                                     F-22
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  The warrants and options exercised at the time of the CompuPharm merger are
also shown in the accompanying warrant and option tables presented below based
on their converted share values.
 
  On June 30, 1993, in connection with Evergreen's NHI acquisition, warrants
to purchase 46,500 common shares at $6.45 per share were issued to a former
NHI executive. These warrants are exercisable at any time prior to June 30,
1996. Through December 31, 1995, all had been exercised.
 
  During 1989, 1990 and 1991, GranCare issued warrants to purchase shares of
common stock exercisable over periods from four to ten years after date of
issuance. The exercise prices are to be adjusted automatically upon the
occurrence of certain dilutive events. The following summarizes the warrants'
activity for the three years ended December 31, 1995 (including the CompuPharm
and NHI warrants described above):
 
<TABLE>
<CAPTION>
                                         YEAR ENDED DECEMBER 31,
                             -------------------------------------------------
                                  1995             1994             1993
                             ---------------  ---------------  ---------------
<S>                          <C>              <C>              <C>
Warrants outstanding at
 beginning of year.........          765,033          890,016        1,549,355
Warrant price..............  $.001 to $10.00  $.001 to $10.00  $.001 to $10.00
Warrant issued.............              --               --            46,500
Warrant price..............              --               --             $6.45
Warrants exercised.........         (413,161)        (124,983)        (705,839)
Warrant price..............   $.10 to $10.00    $.10 to $6.77   $1.00 to $6.77
Warrants outstanding at end
 of year...................          351,872          765,033          890,016
Warrant price..............   $.001 to $6.77  $.001 to $10.00  $.001 to $10.00
Warrants exercisable at end
 of year...................          351,872          765,033          890,016
</TABLE>
 
  GranCare has a Stock Incentive Plan, adopted in 1991 and amended in 1992
(the 1991 Plan), which provides for the direct sale of shares, the granting of
stock options and the granting of limited stock appreciation rights to
selected employees, officers, directors and consultants of GranCare. The total
number of common shares that may be issued under the 1991 Plan is 2,500,000.
The direct sale of common shares under the 1991 Plan shall be at a price not
less than 85% of the fair market value of the common stock on the date the
right to purchase shares is granted.
 
  Under the 1991 Plan, options are granted at an exercise price of not less
than 100% of fair market value at the date of grant, except for nonstatutory
options which are granted at an exercise price of not less than 85% of the
fair market value on the date of the grant.
 
  Certain options are exercisable immediately, while others are subject to
vesting provisions whereby the options will be fully vested three to four
years after the date of grant. All options are non-transferable and expire
five to 10 years from the date of the grant. The Board of Directors, or a
committee appointed by the Board of Directors, may grant limited stock
appreciation rights in tandem with any stock options granted under the 1991
Plan. Limited stock appreciation rights are only exercisable with the consent
of the Board of Directors on and for the 60-day period following certain
events as defined in the 1991 Plan, and are payable in cash. No limited stock
appreciation rights have been issued under the 1991 Plan.
 
  On May 3, 1994, GranCare adopted a Stock Option/Stock Issuance Plan (the
1994 Plan) which provides for the granting of incentive stock options, the
granting of limited stock appreciation rights, a salary reduction grant
program, and a stock issuance program for selected employees of GranCare. The
1994 Plan has an automatic grant program for the granting of options to non-
employee directors. The total number of common shares issuable under the 1994
Plan is 1,135,623 shares. The 1994 Plan contains a provision that provides
that each year, commencing with the 1995 calendar year, the common stock
available for grant under the 1994 Plan will automatically increase by an
amount equal to 1% of the shares of common stock outstanding on December 31st
of the immediately preceding calendar year.
 
                                     F-23
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  The exercise price per share for incentive stock options cannot be less than
100% of the fair market value per share of GranCare's common stock on the
grant date. For non-statutory options, the exercise price per share may not be
less than 85% of such fair market value. No option shall have a maximum term
in excess of ten years from the grant date. The Plan Administrator, as
designated by the Board of Directors, will have complete discretion to grant
incentive stock options and limited stock appreciation rights, and to choose
individuals to participate in the salary reduction grant program. The Plan
Administrator may, at its discretion, sell shares of GranCare's common stock
at a price per share not less than 85% of fair market value in accordance with
the stock issuance program. Shares may also be issued solely as a bonus for
past services.
 
  The Plan Administrator may, at its discretion, grant an employee with
incentive stock options the right to surrender all or part of an unexercised
option in exchange for a distribution from GranCare, or "limited stock
appreciation rights." The distribution will be an amount equal to the excess
of the fair market value of the number of shares on the surrender date, over
the aggregate price payable for such vested shares. No limited stock
appreciation rights have been issued under the 1994 Plan.
 
  A summary of the activity under the plans (including the exchanged
CompuPharm and Evergreen options mentioned above) for the three years ended
December 31, 1995, is as follows:
 
<TABLE>
<CAPTION>
                                       YEAR ENDED DECEMBER 31,
                          ---------------------------------------------------
                                1995              1994             1993
                          ----------------  ----------------  ---------------
<S>                       <C>               <C>               <C>
Options outstanding at
 beginning of year.......        2,267,618         1,808,742        1,172,092
Exercise price........... $ 0.76 to $21.00  $ 0.76 to $21.00  $0.76 to $12.50
Options granted..........          387,000           583,681          957,541
Exercise price........... $13.00 to $17.33  $12.90 to $20.50  $1.61 to $21.00
Options cancelled........         (155,605)          (28,133)         (16,000)
Exercise price........... $9.875 to $21.00  $9.875 to $13.25           $9.875
Options exercised........         (356,638)          (96,672)        (304,891)
Exercise price........... $ 1.53 to $16.50  $ 1.53 to $16.50  $0.76 to $9.875
Options outstanding at
 end of year.............        2,142,375         2,267,618        1,808,742
Exercise price........... $ 0.76 to $21.00  $ 0.76 to $21.00  $0.76 to $21.00
Options exercisable......        1,185,709         1,116,869          700,769
Exercise price........... $ 0.76 to $21.00  $ 0.76 to $21.00  $0.76 to $21.00
</TABLE>
 
  At December 31, 1995, an aggregate of 1,097,921 shares was available for
future grant under GranCare's stock incentive plans. Together with the
2,142,375 stock options and 351,872 warrants outstanding on that date, and the
2,210,351 issuable upon the conversion of GranCare's 6.5% convertible
subordinated debentures (see Note 4), approximately 5,800,000 shares of common
stock were reserved for future issuance.
 
NOTE 9. EMPLOYEE BENEFIT PLANS
 
  The Company currently has two separate benefit plans covering employees of
GranCare. The defined benefit plan, which was amended as of December 31, 1986
to freeze benefits for all but certain unionized employees, covers certain
employees after reaching age 21 and completion of one year of service. During
1990, the accrual of benefits was suspended for the employees who continued to
accrue benefits after December 31, 1986.
 
  At December 31, 1995 and 1994, the projected benefit obligations were
$588,000 and $497,000 respectively. Adjustments to recognize minimum pension
liability have been reflected in the Consolidated Statements of Shareholders'
and Partners' Equity.
 
  Other employees of the Company are covered by various defined contribution
plans. Company contributions are based on a certain percentage of wages, a
matching percentage of the participants' voluntary contributions,
 
                                     F-24
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
or at the Company's discretion. During 1995, 1994 and 1993, the Company
recognized $1,645,000, $1,145,000 and $914,000, respectively, of expense
related to these plans.
 
NOTE 10. RELATED-PARTY TRANSACTIONS
 
  In connection with various acquisitions, GranCare has incurred debt payable
to former owners who are now employees of GranCare. Such debt totaled
$3,779,000 and $3,856,000 at December 31, 1995 and 1994, respectively.
 
  In 1994, GranCare sold three of its long-term care facilities to a former
employee of GranCare at an aggregate sales price of $3,000,000. GranCare
provided financing of $2,550,000 on these sales and recognized a total gain of
$2,373,000. In 1993, GranCare sold two of its long-term care facilities to an
individual previously engaged by GranCare as a consultant on various
acquisitions and divestitures. The sales price of the facilities sold in 1993
was $1,250,000, for which GranCare provided financing of $1,050,000 and
recognized a gain of $841,000.
 
  Included in other assets in the accompanying Consolidated Balance Sheets at
December 31, 1995 and 1994, is a $2,850,000 and $1,500,000 note receivable,
respectively, resulting from working capital advances made to the owner of
certain facilities currently managed by the Company. The Company can advance
up to $3,000,000 under the agreement. The loan bears interest payable monthly
at 1% above the prime rate and is secured by the accounts receivable,
inventory and equipment of the managed facilities.
 
  Evergreen had a management contract with NHI for the period from October 14,
1992 to June 30, 1993. Total amounts received from NHI under this management
contract approximated $1,000,000 for the six months ended June 30, 1993 and
are included in the 1993 Consolidated Statement of Income. This agreement
terminated upon consummation of the reverse acquisition on June 30, 1993, as
discussed in Note 3.
 
NOTE 11. FAIR VALUES OF FINANCIAL INSTRUMENTS AND INVESTMENTS
 
  The following methods and assumptions were used by the Company in estimating
its fair value disclosures for financial instruments.
 
  Cash and Cash Equivalents The carrying amount reported in the balance sheet
for cash and cash equivalents approximates fair value. Cash equivalents at
December 31, 1994 include $1,200,000 in commercial paper securities. There
were no commercial paper securities at December 31, 1995.
 
  Investments The carrying amount reported in the balance sheet for
investments approximates fair value. The investments in municipal bonds are
held by GranCare's captive insurance subsidiary and are restricted to use by
only that subsidiary, and are not available for general corporate purposes.
All investments are classified as "available for sale" for accounting purposes
and, therefore, are carried at fair value with unrealized gains and losses
recorded directly in equity.
 
  In 1994, a gain of $1,561,000 was realized on the sale of an Evergreen
equity security that had no carrying value. There were no significant realized
gains or losses on sales of investments during 1995 and 1993. The investments
in municipal bonds generally mature within six years (e.g., 2000 to 2001).
 
  Notes Payable and Long-Term Debt The carrying amounts of GranCare's
borrowing under the revolving loan and various mortgages and notes payable
approximate fair value. The fair value of GranCare's convertible subordinated
debentures and senior subordinated notes is based on their quoted market
price.
 
                                     F-25
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  The cost basis and estimated fair values of GranCare's financial instruments
at December 31 are as follows:
 
<TABLE>
<CAPTION>
  FINANCIAL INSTRUMENT   1995 COST BASIS ESTIMATED FAIR VALUE 1994 COST BASIS ESTIMATED FAIR VALUE
  --------------------   --------------- -------------------- --------------- --------------------
                                                   DOLLARS IN THOUSANDS
<S>                      <C>             <C>                  <C>             <C>
Cash and cash
 equivalents............    $ 17,738           $17,738           $ 28,611           $ 28,611
Investments:
  Marketable equity
   securities...........       9,506            17,695              7,750             13,375
  Municipal bonds.......      12,166            12,610              6,978              6,978
                            --------           -------           --------           --------
                              21,672            30,305             14,728             20,353
Notes payable and long-
 term debt:
  Revolving loan and
   other debt...........     179,605           179,605            183,231            183,231
  Convertible
   subordinated
   debentures...........      60,000            52,200             60,000             50,400
  Senior Subordinated
   Notes................     100,000           103,000                --                 --
</TABLE>
- --------
Note: The cost basis is the carrying amount for all financial instruments
except for investments, as noted above.
 
NOTE 12. RESTRUCTURING
 
  In August 1994, GranCare adopted and publicly announced a formal plan of
restructuring which includes the reorganization of GranCare's operations and
the sale of certain under-performing and non-strategic long-term health care
facilities. In connection with its commitment to this formal plan, GranCare
recognized an $8,200,000 restructuring charge in the third quarter of 1994,
consisting of the following components:
 
<TABLE>
   <S>                                                                <C>
   Actual and projected net operating losses of the facilities to be
    sold, from the commitment date to their anticipated disposal
    dates...........................................................  $2,620,000
   Less: Estimated gains from the sale of the facilities............   2,250,000
                                                                      ----------
                                                                         370,000
   Personnel costs--termination and severance.......................   3,700,000
   Professional fees--legal, accounting and appraisals--and other
    exit costs......................................................   1,100,000
   Write-off of unamortized financing fees resulting from
    restructuring...................................................   2,400,000
   Other............................................................     630,000
                                                                      ----------
   Total restructuring costs........................................  $8,200,000
                                                                      ==========
</TABLE>
 
  The termination and severance benefits cover approximately 50 employees who
work or worked in the facilities to be divested or GranCare's corporate or
regional offices. As of the end of 1995, substantially all termination and
severance benefits have been paid to those employees.
 
  Charges against the restructuring reserve in 1995 and 1994 included the
write-off of unamortized financing fees and operating gains and losses of the
facilities sold.
 
  At December 31, 1995, the Company believes that the provisions for the
restructuring continue to be adequate and will not require material adjustment
in future periods.
 
NOTE 13. SUBSEQUENT EVENTS
 
  In January 1996, the Company completed the acquisition of RN Services for
$2,350,000 in cash. RN Services provides home health services in the metro
Detroit area.
 
  In February 1996, the Company, through its pharmacy divisions, regained a
major contract with the state of New Jersey to provide pharmaceuticals to
7,800 beds.
 
                                     F-26
<PAGE>
 
                                 GRANCARE, INC.
 
                 SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
 
                             (DOLLARS IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                      ADDITIONS
                           BALANCE    CHARGED TO CHARGED TO              BALANCE
                         AT BEGINNING COSTS AND    OTHER                 AT END
      DESCRIPTION          OF YEAR     EXPENSES   ACCOUNTS   DEDUCTIONS  OF YEAR
      -----------        ------------ ---------- ----------  ----------  -------
<S>                      <C>          <C>        <C>         <C>         <C>
Year ended December 31,
 1993:
 Allowance for doubtful
 accounts..............     2,404       4,254      2,830(2)    2,429(1)   7,059
Year ended December 31,
 1994:
 Allowance for doubtful
 accounts..............     7,059       8,290      1,182(2)    6,639(1)   9,892
 Restructuring reserve
  for estimated losses
  on
  reorganization and
  divestiture of facil-
  ities................       --        8,200        --        3,658(3)   4,542
Year ended December 31,
 1995:
 Allowance for doubtful
 accounts..............     9,892       6,281        572(2)    5,889(1)  10,856
 Restructuring reserve
  for estimated losses
  on
  reorganization and
  divestiture of facil-
  ities................     4,542         --         --        4,042(3)     500
</TABLE>
- --------
(1) Uncollectible accounts written off, net of recoveries.
(2) Allowances recorded at date of acquisition.
(3) Writeoff of deferred loan and other related costs, operating results of the
    facilities to be divested and gain or loss on the sale of those facilities.
 
                                      F-27
<PAGE>
 
                                 GRANCARE, INC.
 
                      CONDENSED CONSOLIDATED BALANCE SHEET
                             (DOLLARS IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                                   SEPTEMBER 30,
                                                                       1996
                                                                   -------------
                                                                    (UNAUDITED)
<S>                                                                <C>
                              ASSETS
Current assets:
 Cash and cash equivalents........................................   $ 25,750
 Accounts receivable, less allowance for doubtful accounts
  (1996--$13,848).................................................    218,529
 Inventories......................................................     17,833
 Prepaid expenses and other current assets........................     41,034
 Deferred income taxes............................................     11,599
                                                                     --------
  Total current assets............................................    314,745
Property and equipment............................................    276,441
 Less accumulated depreciation....................................    (67,111)
                                                                     --------
                                                                      209,330
Other assets:
 Investments, at fair value.......................................     36,359
 Goodwill, less accumulated amortization
  (1996--$9,184)..................................................    129,863
 Other intangibles, less accumulated amortization
  (1996--$9,788)..................................................      8,573
 Other............................................................     39,068
                                                                     --------
  Total assets....................................................   $737,938
                                                                     ========
</TABLE>
 
See Notes to Condensed Consolidated Financial Statements.
 
                                      F-28
<PAGE>
 
                                 GRANCARE, INC.
 
                      CONDENSED CONSOLIDATED BALANCE SHEET
                             (DOLLARS IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                                  SEPTEMBER 30,
                                                                      1996
                                                                  -------------
                                                                   (UNAUDITED)
<S>                                                               <C>
              LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
 Accounts payable and accrued expenses...........................   $ 84,291
 Accrued wages and related liabilities...........................     20,461
 Interest payable................................................      5,137
 Income taxes payable............................................      7,059
 Notes payable and current maturities of long-term debt..........      4,219
                                                                    --------
  Total current liabilities......................................    121,167
Long-term debt...................................................    384,905
Deferred income taxes............................................     15,628
Other............................................................     14,564
Shareholders' equity:
 Common stock; no par value; 50,000,000 shares authorized
  (shares issued: 1996--23,401,992)..............................    125,401
 Treasury stock (1996--200,000 shares)...........................     (5,030)
 Equity component of minimum pension liability...................       (465)
 Unrealized gain on investments net of income taxes (1996--
  $3,963)........................................................      5,747
 Retained earnings...............................................     76,021
                                                                    --------
                                                                     201,674
                                                                    --------
Total liabilities and shareholders' equity.......................   $737,938
                                                                    ========
</TABLE>
 
See Notes to Condensed Consolidated Financial Statements.
 
                                      F-29
<PAGE>
 
                                 GRANCARE, INC.
 
                  CONDENSED CONSOLIDATED STATEMENTS OF INCOME
                                  (UNAUDITED)
            (Dollars And Shares In Thousands, Except Per Share Data)
 
<TABLE>
<CAPTION>
                                                             NINE MONTHS ENDED
                                                               SEPTEMBER 30,
                                                             -----------------
                                                               1996     1995
                                                             -------- --------
<S>                                                          <C>      <C>
Revenues:
 Net patient revenues....................................... $722,074 $600,195
 Investment and other revenue...............................   23,579    4,374
                                                             -------- --------
  Net revenues..............................................  745,653  604,569
Expenses:
 Operating expenses.........................................  642,654  534,906
 Depreciation and amortization..............................   19,400   14,785
 Interest expense and financing charges.....................   26,228   19,557
 Merger and other one-time charges..........................   18,400   11,750
                                                             -------- --------
  Total expenses............................................  706,682  580,998
                                                             -------- --------
Income before income taxes..................................   38,971   23,571
Income taxes................................................   14,809   10,297
                                                             -------- --------
  Net income................................................ $ 24,162 $ 13,274
                                                             ======== ========
Net income per common and common equivalent share:
 Primary.................................................... $   1.01 $   0.55
                                                             ======== ========
 Fully diluted.............................................. $   0.98 $   0.55
                                                             ======== ========
Weighted average number of common and common equivalent
 shares outstanding:
 Primary....................................................   24,021   24,226
                                                             ======== ========
 Fully diluted..............................................   26,653   24,267
                                                             ======== ========
</TABLE>
 
See Notes to Condensed Consolidated Financial Statements.
 
                                      F-30
<PAGE>
 
                                 GRANCARE, INC.
 
                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  (UNAUDITED)
                             (Dollars In Thousands)
 
<TABLE>
<CAPTION>
                                                           NINE MONTHS ENDED
                                                             SEPTEMBER 30,
                                                          --------------------
                                                            1996       1995
                                                          ---------  ---------
<S>                                                       <C>        <C>
OPERATING ACTIVITIES
 Net income..............................................  $ 24,162   $ 13,274
 Adjustments to reconcile net income to net cash
  (used in) provided by operating activities:
  Provision for doubtful accounts........................     5,132      4,321
  Depreciation and amortization..........................    19,400     14,785
  Gain on sale of investments and other assets...........   (19,077)      (600)
  Non-cash one-time charges..............................    17,100        --
  Amortization of deferred financing costs...............       689        481
  Changes in assets and liabilities net of effect of
   acquisitions:
   Accounts receivable...................................   (55,785)   (24,073)
   Other current assets..................................    (8,604)    (3,571)
   Other noncurrent assets...............................    (8,614)   (11,901)
   Accounts payable and accrued expenses.................    (1,785)    15,933
   Accrued wages and related liabilities.................    (3,896)    (1,587)
   Interest payable......................................    (1,656)       579
   Income taxes payable..................................     7,591       (487)
   Other noncurrent liabilities..........................        27      1,799
                                                          ---------  ---------
    Net cash (used in) provided by operating activities..   (25,316)     8,953
INVESTING ACTIVITIES
 Acquisition of businesses...............................   (11,231)   (54,287)
 Purchases of property and equipment.....................   (24,014)   (17,022)
 Proceeds from disposition of property and equipment.....       994      4,155
 Repayments of notes receivable..........................       --         943
 Net purchases and sales of investments..................    (3,365)    (5,077)
 Proceeds from sale of investment in unconsolidated
  affiliate..............................................    24,600        --
 Other...................................................    (1,581)      (435)
                                                          ---------  ---------
    Net cash used in investing activities................   (14,597)   (71,723)
FINANCING ACTIVITIES
 Proceeds from exercise of warrants and options..........     2,284      1,242
 Purchase of treasury stock..............................       --     (13,670)
 Long-term debt payments.................................    (5,259)  (176,303)
 Proceeds from long-term debt borrowings.................    51,150    256,350
 Payment of debt issuance costs..........................      (250)    (4,447)
                                                          ---------  ---------
    Net cash provided by financing activities............    47,925     63,172
                                                          ---------  ---------
 Net increase in cash and cash equivalents...............     8,012        402
 Cash and cash equivalents at beginning of period........    17,738     28,611
                                                          ---------  ---------
 Cash and cash equivalents at end of period.............. $  25,750  $  29,013
                                                          =========  =========
</TABLE>
 
See Notes to Condensed Consolidated Financial Statements
 
                                      F-31
<PAGE>
 
                                GRANCARE, INC.
 
                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  (UNAUDITED)
 
                            (DOLLARS IN THOUSANDS)
 
SUPPLEMENTAL SCHEDULE OF INVESTING ACTIVITIES:
 
  In January 1996, the Company completed the acquisition of RN Health Care
Services, Inc. ("RN Services"), a home health care business located in
Detroit, Michigan, for $2,350 in cash. In conjunction with the acquisition,
the Company advanced $2,500 to the former owners in the form of a short-term
note secured by RN Services' accounts receivable.
 
  In April 1996, the Company completed the acquisition of Jennings Visiting
Nurse Association, Inc. ("Jennings"), a home health care business based in
North Vernon, Indiana, for $937 in cash and a promissory note for $250.
 
  In July 1996, the Company completed the acquisition of Emery Pharmacy, Inc.
("Emery"), an institutional pharmacy located in Utica, New York, for $3,672 in
cash and a promissory note in the amount of $1,488.
 
  In September 1996, the Company completed the acquisition of RX Corporation,
an institutional pharmacy located in southern California, for $1,800 in cash
and a promissory note for $925.
 
  The above 1996 acquisitions had the following effect on cash:
 
<TABLE>
<CAPTION>
 
<S>                                     <C>
      Fair value of assets acquired     $(14,531)
      Fair value of liabilities assumed    3,300
                                        --------
      Net effect on cash                $(11,231)
                                        ========
</TABLE>
 
  In conjunction with the sale of four long-term health care facilities
located in Michigan in the first quarter of 1996, the Company provided
purchase money financing in the amount of $17,550 evidenced by an interest-
bearing promissory note, due and payable in 1997.
 
See Notes to Condensed Consolidated Financial Statements.
 
                                     F-32
<PAGE>
 
                                GRANCARE, INC.
 
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
                                  (UNAUDITED)
 
NOTE A - BASIS OF PRESENTATION
 
  The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with the instructions to Form 10-Q and Rule 10-01
of Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. Operating results for the nine month period
ended September 30, 1996 are not necessarily indicative of the results that
may be expected for the year ending December 31, 1996. For further
information, refer to the consolidated financial statements and the footnotes
thereto included in the Company's annual report on Form 10-K for the year
ended December 31, 1995.
 
NOTE B - CHANGE IN ACCOUNTING PRINCIPLE
 
  During the first quarter of 1996, the Company adopted as required FASB
Statement No. 121 ("Statement No. 121"), Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of. In accordance
with Statement No. 121, the Company records impairment losses on long-lived
assets used in operations when events and circumstances indicate the assets
might be impaired and the undiscounted cash flows estimated to be generated by
those assets may be less than the carrying amounts of those assets. This new
standard had no effect on the financial statements.
 
NOTE C - TREASURY STOCK
 
  During the second quarter of 1996, the Company cancelled 715,000 shares of
treasury stock which the Company had repurchased in July, 1995.
 
NOTE D - CONTINGENT EARN-OUT PROVISION
 
  The purchase agreement with respect to the 1994 acquisition of Long Term
Care Pharmaceutical Services Corporation I and Long Term Care Pharmaceutical
Services Corporation III (collectively, "LTC"), contains a contingent earnout
provision for the two year period ended June 30, 1996. An additional $5.5
million could be paid to LTC provided certain operating results were obtained
for this period. Management has completed its analysis of the amount payable
under this provision and believes that the amount owing to LTC is $2.1
million, which amount has been disputed by LTC.
 
NOTE E - EXIT, MERGER AND OTHER ONE-TIME CHARGES
 
  During the third quarter of 1996, management decided to close five
facilities which are operated under long term operating leases, as these
facilities did not fit the Company's operating strategies. The plan to exit
these activities, including providing appropriate notice as required by
regulations to residents, employees and authorities has commenced. The
facilities will be closed and operating activities will cease. The remaining
net book value of leasehold improvements at the dates of closure and the
remaining rent due to the landlord for periods after the dates of closure have
been charged to operations. Management expects to complete these closings in
the first quarter of 1997. The revenues and net operating losses of these
facilities are not significant. In addition, in the third quarter of 1996, the
Company recorded other charges as set forth in the following table, including
a charge for additional bad debt expense related to TeamCare. The charge for
bad debt expense is attributable to the increased risk of collection resulting
from the deterioration in the financial condition of certain customers. The
notes receivable written off are for loans made by the Company to a sublease
lessee to fund working capital. Accounts receivable from the facility under
lease serve as collateral for the working capital loans. During the third
quarter of 1996, the loans to the lessee began to significantly exceed the
collateral,
 
                                     F-33
<PAGE>
 
                                GRANCARE, INC.
 
       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
                                  (UNAUDITED)
indicating that the loan would not be recoverable. Accordingly, the Company
decided to terminate the sublease arrangement and to write off the loans which
it concluded would not be recoverable. The write-off of leasehold
improvements, notes receivable and bad debt expense are reflected in the
accompanying balance sheet as a direct reduction of the related asset. Rent
expense and costs related to the termination of the frozen pension plan and
other items has been reflected in accrued expenses as the accompanying balance
sheet. The following is a summary of the exit and other one-time charges
(dollars in thousands):
 
<TABLE>
     <S>                                                                <C>
     Exit costs:
       Rent expense for periods subsequent to closing.................. $ 9,400
       Book value of leasehold improvements at date of closing.........   1,200
     Other:
       TeamCare bad debt expense.......................................   2,900
       Write-off of notes receivable...................................   3,000
       Termination of frozen pension plan and other items..............   1,900
                                                                        -------
                                                                        $18,400
                                                                        =======
</TABLE>
 
NOTE F - PROPOSED TRANSACTION
 
  The Company has entered into an Agreement and Plan of Merger between
Vitalink and the Company dated as of September 3, 1996. The form of the
proposed transactions are (1) the Company's skilled nursing facilities, along
with its contract management and home health businesses are to be reorganized
into New GranCare, Inc., a wholly-owned subsidiary of the Company ("New
GranCare"), and all of the shares of common stock of New GranCare are to be
distributed to the Company's shareholders in a tax-free spin-off; (2) the
Company (then consisting solely of the institutional pharmacy and related
business known as TeamCare) would merge into and be acquired by Vitalink
through a tax-free exchange of shares of common stock of Vitalink for shares
of common stock of the Company; and (3) New GranCare would become a public
company upon the effectiveness of its initial registration statement.
Notwithstanding the legal structure of the proposed transactions, for
accounting/financial reporting purposes such transactions will be treated as
the spin-off of TeamCare and reorganization/recapitalization of the Company
into New GranCare as New GranCare will continue the majority of the Company's
businesses. New GranCare will change its name to "GranCare, Inc." and be
treated as the continuation of the Company. The closing under the Agreement
and Plan of Merger is subject to a number of conditions, including approval of
the transactions by the Company's shareholders.
 
                                     F-34
<PAGE>
 
                        REPORT OF INDEPENDENT AUDITORS
 
To the Board of Directors
New GranCare, Inc.
 
  We have audited the accompanying balance sheet of New GranCare, Inc. (a
wholly-owned subsidiary of GranCare, Inc., the "Company") as of September 30,
1996. This financial statement is the responsibility of the Company's
management. Our responsibility is to express an opinion on this financial
statement based on our audit.
 
  We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the balance sheet is free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the balance sheet. An audit also
includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall balance sheet
presentation. We believe that our audit of the balance sheet provides a
reasonable basis for our opinion.
 
  In our opinion, such balance sheet presents fairly, in all material
respects, the financial position of New GranCare, Inc. as of September 30,
1996, in conformity with generally accepted accounting principles.
 
                                          Ernst & Young LLP
 
Atlanta, Georgia
October 7, 1996
 
                                     F-35
<PAGE>
 
                               NEW GRANCARE, INC.
                 (A WHOLLY-OWNED SUBSIDIARY OF GRANCARE, INC.)
 
                                 BALANCE SHEET
                               SEPTEMBER 30, 1996
 
<TABLE>
<S>                                                                      <C>
                                 ASSETS
Current assets:
  Cash.................................................................. $1,000
                                                                         ------
  Total assets.......................................................... $1,000
                                                                         ======
                          STOCKHOLDER'S EQUITY
Stockholder's Equity:
  Common stock--$0.001 par value; issued and outstanding, 1,000 shares
   (Note 1)............................................................. $1,000
                                                                         ------
  Total stockholder's equity............................................ $1,000
                                                                         ======
</TABLE>
 
See Note to Balance Sheet.
 
                                      F-36
<PAGE>
 
                             NOTE TO BALANCE SHEET
                              SEPTEMBER 30, 1996
 
1. New GranCare, Inc. ("New GranCare") was incorporated in September 1996, as
   a wholly-owned subsidiary of GranCare, Inc. ("GranCare"). New GranCare was
   formed in connection with the execution of an Agreement and Plan of
   Distribution (the "Distribution Agreement") by and between New GranCare and
   GranCare dated as of September 3, 1996. The form of the proposed
   transactions contemplated by the Distribution Agreement are: (1) the
   skilled nursing facilities, along with the contract management; assisted
   living and home health services businesses of GranCare are to be
   reorganized into New GranCare and shares of New GranCare distributed to the
   GranCare shareholders in a tax-free spin-off; (2) GranCare (then consisting
   solely of the institutional pharmacy and related business known as
   TeamCare) would merge into and be acquired by Vitalink Pharmacy Services,
   Inc. ("Vitalink") through a tax-free exchange of shares of common stock of
   Vitalink for GranCare shares of common stock, all as contemplated by an
   Agreement and Plan of Merger by and between GranCare and Vitalink dated as
   of September 3, 1996 (the "Merger Agreement"); and (3) New GranCare would
   become a public company upon the effectiveness of this registration
   statement. Notwithstanding the legal structure of the proposed
   transactions, for accounting/financial reporting purposes such transactions
   will be treated as the spin-off of TeamCare and a
   reorganization/recapitalization of GranCare into New GranCare as New
   GranCare will continue the majority of the GranCare businesses. No gain
   will be recognized as a result of the spin-off for the difference between
   the market value of the Vitalink shares received and the carrying value of
   the net assets of TeamCare. New GranCare will continue to reflect the
   historical cost basis of assets and liabilities of GranCare. New GranCare
   will then change its name to, and be treated as the continuation of,
   GranCare. The closing under the Merger Agreement is subject to a number of
   conditions, including approval of GranCare's shareholders.
 
 
 
                                     F-37


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