COMPREHENSIVE CARE CORP, 10-Q, 1997-01-14

COMPREHENSIVE CARE CORP
10-Q, 1997-01-14
HOSPITALS

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<PAGE> 1

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q

[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934

For the period ended November 30, 1996

[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934

For the transition period from _____________ to ______________

Commission File Number 0-5751

COMPREHENSIVE CARE CORPORATION
(Exact name of registrant as specified in its charter)

Delaware 95-2594724
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organi-
zation)

1111 Bayside Drive, Suite 100, Corona del Mar, California 92625
(Former address of the principal executive offices and zip code)

(714) 222-2273
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]

Indicate the number of shares outstanding of each of the issuer's
classes of Common Stock, as of the latest practicable date:

Classes Outstanding at January 14, 1997

Common Stock, par value $.01 per share 3,262,855

<PAGE> 2
COMPREHENSIVE CARE CORPORATION AND SUBSIDIARIES

Index

<TABLE>
<CAPTION>
Page

<S> <C>
Part I - Financial Information

Item 1. - Condensed Consolidated Financial Statements

Condensed consolidated balance sheets,
November 30, 1996 and May 31, 1996................................. 3

Condensed consolidated statements of operations for
the three and six months ended November 30, 1996 and 1995.......... 4

Condensed consolidated statements of cash flows for
the six months ended November 30, 1996 and 1995.................... 5

Notes to condensed consolidated financial statements................... 6

Item 2. - Management's discussion and analysis of financial condition and
results of operations......................................... 14

Part II - Other Information..................................................... 30

Item 1. - Legal Proceedings............................................... 30

Item 3. - Defaults Upon Senior Securities................................. 31

Item 4. - Submission of Matters to a Vote of Security Holders............. 31

Item 6. - Exhibits and Reports on Form 8-K................................ 31

Signatures................................................................. 33
</TABLE>

2
<PAGE> 3
PART I. - FINANCIAL INFORMATION

ITEM 1. - CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

COMPREHENSIVE CARE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share amounts)

<TABLE>
<CAPTION>
Pro forma
May 31, November 30, November 30,
1996 1996 1996
(Note) (Unaudited) (Unaudited)
(Note 2)
------- ------------ ------------
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ........................................... $ 4,433 $ 7,578 $ 2,964
Accounts receivable, less allowance for
doubtful accounts of $877 and $1,097 ........................... 2,476 3,274 3,274
Other receivables ................................................... 1,478 2,477 2,477
Property and equipment held for sale ................................ 1,233 1,221 1,221
Other current assets ................................................ 352 343 128
--------
Total current assets ...................................................... 9,972 14,893 10,064
-------- -------- --------

Property and equipment, at cost ........................................... 9,863 9,912 9,912
Less accumulated depreciation and amortization ............................ (3,590) (3,624) (3,624)
-------- -------- --------
Net property and equipment ................................................ 6,273 6,288 6,288
-------- -------- --------
Property and equipment held for sale ...................................... 6,915 4,708 4,708
Notes receivable .......................................................... 212 1,978 1,978
Other assets .............................................................. 1,746 2,773 2,773
-------- --------
Total assets .............................................................. $ 25,118 $ 30,640 $ 25,811
======== ======== ========

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Accounts payable and accrued liabilities ............................ $ 10,714 $ 13,381 $ 11,318
Long-term debt in default (see Note 3) .............................. 9,538 9,538 --
Current maturities of long-term debt ................................ 2,464 2,072 2,072
Unbenefitted tax refunds received ................................... 7,018 12,092 12,092
Income taxes payable ................................................ 410 382 382
-------- --------
Total current liabilities ................................................. 30,144 37,465 25,864
-------- -------- --------

Long-term debt, excluding current maturities .............................. 24 -- 2,692
Other liabilities ......................................................... 749 688 688
Minority interest ......................................................... 1,000 1,060 1,060
Commitments and contingencies (see Notes 3 and 7) Stockholders' equity:
Preferred Stock, $50.00 par value; authorized 60,000 shares ......... -- -- --
Common Stock, $.01 par value; authorized 12,500,000 shares;
issued and outstanding 2,848,685 and 3,069,929 shares
(Pro Forma 3,234,233 shares) ................................... 28 31 33
Additional paid-in capital .......................................... 43,931 44,921 46,809
Accumulated deficit ................................................. (50,758) (53,525) (51,335)
-------- -------- --------
Total stockholders' equity(deficit) ............................ (6,799) (8,573) (4,493)
-------- -------- --------
Total liabilities and stockholders' equity ................................ $ 25,118 $ 30,640 $ 25,811
======== ======== ========
</TABLE>

Note: The balance sheet at May 31, 1996 has been derived from the audited
financial statements at that date, but does not include all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements.

See accompanying notes.

3
<PAGE> 4
COMPREHENSIVE CARE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Dollars in thousands, except per share amounts)

<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
November 30, November 30,
------------------------ ------------------------
1996 1995 1996 1995
-------- -------- -------- --------

<S> <C> <C> <C> <C>
Revenues and gains:
Operating revenues .................. $ 9,710 $ 7,605 $ 18,703 $ 16,380

Costs and expenses:
Direct healthcare expenses .......... 8,420 7,091 16,589 14,806
General and administrative expenses.. 2,156 2,435 3,810 3,705
Provision for doubtful accounts ..... 154 389 201 669
Depreciation and amortization ....... 176 335 338 683
Restructuring expenses .............. -- -- 195 --
-------- -------- -------- --------
10,906 10,250 21,133 19,863
-------- -------- -------- --------

Loss from operations ..................... (1,196) (2,645) (2,430) (3,483)

Gain on sale of assets .............. 20 1,036 26 1,067
Loss on sale of assets .............. (12) -- (12) (31)
Non-recurring loss .................. -- -- (250) --
Interest income ..................... 105 54 150 64
Interest expense .................... (260) (289) (596) (743)
-------- -------- -------- --------

Loss before income taxes ................. (1,343) (1,844) (3,112) (3,126)

Benefit for income taxes ................. 344 2,562 345 2,536
-------- -------- -------- --------

Net earnings/(loss) ................. $ (999) $ 718 $ (2,767) $ (590)
======== ======== ======== ========

Earnings/(loss) per share:

Net earnings/(loss) ................. $ (0.34) $ 0.27 $ (0.96) $ (0.22)
======== ======== ======== ========

Supplemental earnings/(loss) per
Share (Note 8):

Net earnings/(loss) ................. $ 0.43 $ 0.27 $ (0.16) $ (0.22)
======== ======== ======== ========
</TABLE>

See accompanying notes.

4
<PAGE> 5
COMPREHENSIVE CARE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(Dollars in thousands)
<TABLE>
<CAPTION>
Six Months Ended
----------------
November 30,
1996 1995
------- -------
<S> <C> <C>
Cash flows from operating activities:
Net loss ................................................................ $(2,767) $ (590)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization ........................................... 338 683
Provision for doubtful accounts ......................................... 201 669
Gain on sale of assets .................................................. (26) (1,067)
Loss on sale of assets .................................................. 12 31
Carrying costs incurred on property and equipment held for sale ......... -- (240)
Decrease(increase) in accounts receivable ............................... (937) 2,873
Increase in other receivables ........................................... (1,015) (1,400)
Increase in other current assets and other assets ....................... (10) (308)
Increase in accounts payable and accrued liabilities .................... 2,103 392
Increase in unbenefitted tax refunds received ........................... 5,074 7,066
Decrease in income taxes payable ........................................ (28) --
Decrease in other liabilities ........................................... (188) (481)
------- -------

Net cash provided by operating activities .......................... 2,757 7,628
------- -------

Cash flows from investing activities:
Net proceeds(loss) from sale of property and equipment (operating and
held for sale) .......................................................... 405 (42)
Additions to property and equipment ..................................... (196) (290)
------- -------
Net cash provided by(used in) investing activities ................. 209 (332)
------- -------

Cash flows from financing activities:
Bank and other borrowings ............................................... -- 1,000
Proceeds from the issuance of Common Stock .............................. 873 930
Repayment of debt ....................................................... (694) (4,885)
------- -------
Net cash provided by(used in) financing activities ................. 179 (2,955)
------- -------

Net increase in cash and cash equivalents ..................................... 3,145 4,341

Cash and cash equivalents at beginning of period .............................. 4,433 1,542
------- -------

Cash and cash equivalents at end of period .................................... $ 7,578 $ 5,883
======= =======

Supplemental schedule of noncash operating, investing and financing activities:
Purchase of HMS:
Operating activities:
Accounts receivable ............................................. $ 51
Goodwill ........................................................ 1,048
Other assets .................................................... 227
Accounts payable and accrued expenses ........................... 624
Other liabilities ............................................... 399
-------
Total operating activities ......................................... $ 2,349
=======

Investing activities:
Property plant and equipment .................................... $ 95
=======

Financing activities:
Current maturities of long term debt ............................ $ 278
Stock issued for purchase ....................................... 120
-------
Total financing activities ......................................... $ 398
=======
</TABLE>

See accompanying notes.

5
<PAGE> 6
COMPREHENSIVE CARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1996
(unaudited)

NOTE 1 -- BASIS OF PRESENTATION

The condensed consolidated balance sheet as of November 30, 1996, and
the related condensed consolidated statements of operations and cash flows for
the three and six month periods ended November 30, 1996 and 1995 are unaudited
and have been prepared in accordance with generally accepted accounting
principles for interim financial information and with the instructions to Form
10-Q and Article 10 of Regulation S-X. In the opinion of management, all
adjustments necessary for a fair presentation of such financial statements have
been included. Such adjustments consisted only of normal recurring items. The
results of operations for the three and six months ended November 30, 1996 are
not necessarily indicative of the results to be expected during the balance of
the fiscal year.

The condensed consolidated financial statements do not include all
information and footnotes necessary for a complete presentation of financial
position, results of operations and cash flows in conformity with generally
accepted accounting principles. Notes to consolidated financial statements
included in Form 10-K for the year ended May 31, 1996, on file with the
Securities and Exchange Commission, provide additional disclosures and a further
description of accounting policies.

The Company's financial statements are presented on the basis that it
is a going concern which contemplates the realization of assets and satisfaction
of liabilities in the normal course of business. The Company incurred
significant losses from operations in fiscal 1996 and continues to report losses
for fiscal 1997. The continuation of the Company's business is dependent upon
the resolution of operating and short-term liquidity problems and the
realization of the Company's plan of operations. The consolidated financial
statements do not include any adjustments that might result from an unfavorable
outcome of this uncertainty (see Note 3-- "Operating Losses and Liquidity").

The weighted average number of shares outstanding used to compute loss
per share were 2,935,000 and 2,628,000 for the three months ended November 30,
1996 and 1995, respectively; and 2,895,000 and 2,628,000 for the six months
ended November 30, 1996 and 1995, respectively.

NOTE 2 -- DEBENTURE EXCHANGE OFFER

On November 14, 1996, the Company commenced a consent solicitation
pursuant to a proxy statement addressed to its Debentureholders (the "Consent
Solicitation"). The Company simultaneously initiated an exchange offer (the
"Debenture Exchange Offer").

The Debenture Exchange Offer offered to the holders of Debentures to
exchange $500 in cash plus sixteen (16) shares of Common Stock designated
aggregately as payment of principal, plus $80 in cash plus eight (8) shares of
Common Stock, designated aggregately as a payment of interest for each $1,000 of
the outstanding principal amount of its Debentures and the waiver by the
Debentureholder of all interest accrued and unpaid on such principal amount as
of the date of the Exchange

On December 30, 1996, the Company completed the Debenture Exchange
Offer with its Debentureholders. The Company was advised by the Exchange Agent
that affirmative consents of Debentureholders in excess of 82% had been
received, and that all propositions had been consented to and approved by
Debentureholders. An aggregate of $6,846,000 of principal amount of Convertible
Subordinated Debentures (the "Debentures") (the "Tendered Debentures"),
representing 72% of the issued and outstanding Debentures, were tendered for
exchange to the Company pursuant to the terms of the Exchange Offer. With
respect to the Tendered Debentures, the Company paid the Exchange Agent, on
behalf of tendering Debentureholders, an aggregate amount of $3,970,680 and
requisitioned for issue 164,304 shares of the Company's Common Stock,
representing the stock portion of the Exchange Offer. The distribution of the
exchange consideration to tendering Debentureholders was made by the Exchange
Agent within five days after the closing date of December 30, 1996. With respect
to the $2,692,000 of principal amount of Debentures which were not tendered for
exchange, the Company paid an aggregate of $552,701 of interest and default
interest to such non-tendering Debentureholders. Due to the affirmative result
of the Consent Solicitation and the payment by the Company of interest and
default interest with respect to all Debentures which have not been tendered for
exchange, the Company is no longer in default with respect to such Debentures.

6
<PAGE> 7
COMPREHENSIVE CARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1996
(unaudited)

Based upon the closing price of the Company's Common Stock on December
30, 1996 of $11.50 per share, the resulting gain on the Debenture Exchange was
$2.5 million less approximately $0.3 million in related costs and expenses for a
net gain of $2.2 million with the remaining amount of $1.9 million being
recorded to additional paid in capital. The aggregate principal amount of
Debentures which were not tendered was $2,692,000 and is reflected in long-term
debt. The effect of these transactions on the Company's consolidated financial
position as of November 30, 1996 has been reflected in the accompanying pro
forma Condensed Consolidated Balance Sheet.

NOTE 3 -- OPERATING LOSSES AND LIQUIDITY

At November 30, 1996, the Company had cash and cash equivalents of $7.6
million. The Company provided $2.8 million from its operating activities,
provided $0.2 million from its investing activities and provided $0.2 million in
its financing activities. The Company reported a net loss of $1.0 million for
the quarter ended November 30, 1996, versus net income of $0.7 million for the
quarter ended November 30, 1995. Included in the results for the second quarters
of fiscal 1996 and 1997 is a tax benefit of $2.6 million and $0.3 million,
respectively (see Note 6-- "Income Taxes"). As a result, the Company has an
accumulated deficit of $53.5 million and a total stockholders' deficiency of
$8.6 million as of November 30, 1996. Additionally, the Company's current assets
at November 30, 1996 amounted to approximately $14.9 million and current
liabilities were approximately $37.5 million, resulting in a working capital
deficiency of approximately $22.6 million and a negative current ratio of 1:2.5.
The Company's primary use of available cash resources is to expand its
behavioral medicine managed care and contract management businesses and fund
operations while it seeks to dispose of certain of its freestanding facilities.

Included in current and non-current assets are three hospital
facilities designated as property and equipment held for sale with a total
carrying value of $5.9 million. In August 1996, the Company sold one of its
non-operating facilities and also closed an operating facility due to poor
performance. The Company used the proceeds from the sale of the facility to pay
off secured debt and for other working capital purposes. As part of the
transaction related to this sale, the Company took back a note on the property.
The provisions of the note allow the buyer a discount if the note is redeemed in
the first six months. In the event the buyer exercises this option, the proceeds
to the Company would be an additional $1.55 million. In the first quarter of
fiscal 1997, the Company entered into escrow for the sale of another facility
which is scheduled to close during the third quarter. Accordingly, this
non-operating property is classified as current property held for sale.

Included in current liabilities are $9.5 million of Debentures in
default, immediately due and payable on account of acceleration and $2.0 million
of accrued interest as a result of the Company's failure to make scheduled
payments of interest on the Debentures commencing in October 1994. On November
14, 1996, the Company commenced a Consent Solicitation addressed to its
Debentureholders. The Company simultaneously initiated the Debenture Exchange
Offer to exchange cash and Common Stock of the Company for its Debentures, as
discussed below and in Note 2 -- "Debenture Exchange Offer".

7
<PAGE> 8
COMPREHENSIVE CARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1996
(unaudited)

The Debenture Exchange Offer required the holders of a majority of the
Debentures to give their approval to rescind the acceleration and the Company to
expend approximately $4.5 million of cash during the third quarter of fiscal
1997, over and above cash required to fund other financing, operating and
investing needs. The Debenture exchange offered to the holders of Debentures to
exchange $500 in cash plus sixteen (16) shares of Common Stock, designated
aggregately as payment of principal, plus $80 in cash plus eight (8) shares of
Common Stock, designated aggregately as a payment of interest for each $1,000 of
the outstanding principal amount of its Debentures and the waiver by the
Debentureholder of all interest accrued and unpaid on such principal amount as
of the date of the Exchange. Accomplishment of the Debenture Exchange will
reduce the Debenture's debt service requirement and will decrease the Company's
future cash flow requirements. As a result of the completion of the Debenture
Exchange Offer, the Company's debt obligations will be reduced by $6,846,000 in
the third quarter of fiscal 1997. Subsequently, $2,692,000 of the Company's debt
obligations represented by untendered Debentures will be reclassified to long
term debt during the third quarter of fiscal 1997.

Also included in current maturities of long-term debt is approximately
$2.0 million which represents the Company's obligation pursuant to its Secured
Convertible Note due in January 1997. The Company has requested and has received
a thirty day extension on the maturity of this Note, and is currently in
negotiation to convert this Note and the outstanding accrued interest into
non-voting Preferred Stock. The holder of the Note has agreed in principle to
the exchange of the Note for shares of a newly designated non-voting Preferred
Stock and to accept additional shares of Preferred Stock in lieu of
approximately $63,000 of accrued interest. While the Company does not believe
that such exchange will not be effected, no assurance can be made that an
ultimate agreement will be completed.

These conditions raise doubt about the Company's ability to continue as
a going concern. The accompanying Condensed Consolidated Financial Statements do
not include any adjustments to reflect the possible future effects on the
recoverability and classification of assets or the amount and classification of
liabilities that may result from the outcome of this uncertainty.

In fiscal 1993, the Company established a restructuring reserve to
address the Company's operational issues. One purpose of such reserve was for
the realignment of the Company's focus and business and the settlement and
disposition of certain non-performing and under-utilized assets. Many of the
Company's inpatient freestanding facilities have been sold or are in the process
of being closed or sold as management continues to implement plans for expanding
the Company's managed care and behavioral medicine contract management
operations. During fiscal 1996, the Company established an additional
restructuring reserve of $0.1 million for severance and other cash outlays
related to the planned facility closure and disposition which occurred during
the first quarter of fiscal 1997. In addition, in July 1996, the Company closed
the administrative offices of Comprehensive Care Integration ("CCI") located in
San Ramon, California. Closure of this office and several non-performing
contract units was part of the planned restructuring of these operations. The
impact of this restructuring was approximately $0.2 million and was recorded
during the first quarter of fiscal 1997. The following table sets forth the
activity to the restructuring reserve during the second quarter of fiscal 1997:

<TABLE>
<CAPTION>
CHARGES
AUGUST 31, ----------------- NOVEMBER 30,
1996 INCOME EXPENSE PAYMENTS 1996
---- ------ ------- -------- ----
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Restructuring Reserve:
Severance ..................... $104 $ -- $ -- $ (17) $ 87
Operations/corporate relocation 365 -- -- (40) 325
---- ---- ---- ----- ----
$469 $ -- $ -- $ (57) $412
==== ==== ==== ===== ====
</TABLE>

8
<PAGE> 9
COMPREHENSIVE CARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1996
(unaudited)

negative cash flow requirements associated with such facilities. Based upon a
projection of actual performance during fiscal 1997 with adjustments for reduced
cash flow requirements associated with facilities closed and/or sold in fiscal
1996 and 1997, known contract and cyclical changes, and also giving
consideration to cash on hand at November 30, 1996 of $7.6 million, management
expects the Company to be able to meet its cash obligations required by
operations during the next year, including the Company's obligations under the
Debentures. However, the cash needs of the Company may vary from month to month
depending upon the actual level of business activity. Therefore, no assurance
can be given that the Company will generate adequate cash flows to meet cash
obligations required by operations.

At the time of the commencement of the Debenture Exchange Offer, the
Company had sufficient cash resources available to fund the cash portion of the
Exchange. As of the completion of the Exchange, the Company utilized an
aggregate of $4.5 million to fund the cash portion of the Exchange and the
payment of interest due with respect to Debentures not tendered. Such cash
resources represented approximately 60% of the Company's available cash
resources as of November 30, 1996. Based upon current levels of operation and
cash anticipated to be internally generated from operations, the Company
believes that it has sufficient working capital, however, the occurrence of
business or economic conditions beyond the control of the Company or the loss of
existing contracts which cash from operations is internally generated or the
inability to conclude pending contract proposals may adversely affect the
adequacy of such working capital. Such anticipated cash resources to fund
additional operating needs include:

- The Company has received a firm commitment from a mutual fund to
purchase in a private placement at least $5.0 million of 15% fully
secured Company notes due no earlier than April 1998 if offered by
the Company.

- The Company filed its fiscal 1995 Federal tax return, and a Form
1139 "Corporate Application for Tentative Refund" in the amount of
$9.4 million. The Company received the full refund claim for
fiscal 1995 in October 1995. In September 1996, the Company filed
its fiscal 1996 Federal tax return and also filed a Form 1139. The
Company received a refund in the amount of $5.4 million during the
second quarter of fiscal 1997. The Company has also filed amended
Federal tax returns for prior years to claim refunds for an
additional $7.7 million. These refund claims have been made under
Section 172(f) of the Internal Revenue Code, an area of the tax
law without significant precedent, and there may be substantial
opposition by the IRS to the Company's refund claims. The Company
is currently under audit by the IRS regarding its 1995 Federal tax
return and the amended returns for prior years. Accordingly, no
assurances can be made to the Company's entitlement to such
refunds or the timing of the receipt thereof (see Note 6-- "Income
Taxes").

- Included in property and equipment held for sale is one hospital
facility currently under contract to be sold. The sale of this
facility is scheduled to close during the third quarter of fiscal
1997. The proceeds from the sale are expected to be $1.3 million.

- Included in assets held for sale (non-current) are two hospital
facilities designated as property and equipment held for sale with
a total carrying value of $4.7 million. The Company expects to
sell these facilities during fiscal 1997. In addition, the Company
sold a non-operating facility during the first quarter of fiscal
1997. As part of this transaction, the Company took back a note on
the property with provisions that allow the buyer a discount if
the note is redeemed in the first six months. In the event the
buyer exercises this option, the proceeds to the Company would be
$1.55 million. Proceeds from the sales of such assets will not be
available by the time of the completion of the Debenture Exchange
Offer. Accordingly, management expects to use such cash
proceeds, if received during fiscal 1997, to fund expansion of
the Company's operations.

All of these potential sources of additional cash in fiscal 1997 are
subject to variation due to business and economic influences outside the
Company's control. There can be no assurance that during fiscal 1997 the Company

9
<PAGE> 10
COMPREHENSIVE CARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1996
(unaudited)

will complete the transactions required to fund its working capital deficit.

NOTE 4 -- ACQUISITIONS AND DISPOSITIONS

On July 25, 1996, the Company consented to closing the acquisition of
Healthcare Management Services, Inc., Healthcare Management Services of Ohio,
Inc., Healthcare Management Services of Michigan Inc. and Behavioral Healthcare
Management, Inc. (hereafter collectively referred to as "HMS"). The Company
consented to the closing reserving its rights to assert certain claims against
the former owners (the "Sellers") and others (see Note 6-- "Commitments and
Contingencies"). HMS contracts with commercial and governmental agencies to
provide managed behavioral health care programs to patients in Michigan and
Ohio. Additionally, HMS provides the following on a contract basis: case
management (precertification, concurrent review, quality assurance,
retrospective chart reviews, peer review and clinical audits as requested by
their clients), claims review, network development, credentialing and management
of clinical services for hospitals and community providers. The Company recorded
the acquisition using the purchase method of accounting. The Company's Condensed
Consolidated Financial Statements for the six months ended November 30, 1996
reflect the results of operations for HMS for the period of July 25, 1996
through November 30, 1996. In conjunction with this acquisition, the Company
issued 16,000 shares of its Common Stock. In addition, certain provisions of the
employment agreements with the Sellers provide for an additional earn out of
stock warrants based on performance. The Company recorded $1.0 million in
goodwill related to the acquisition which will be amortized on a straight line
basis over 20 years.

On August 12, 1996, the Company sold a non-operating facility in Costa
Mesa, California. As part of this transaction, the Company took back a note
equal to 83% of the selling price. This note provides the buyer with an
incentive option should the note be paid off in full on or before six months
from closing. In the event the buyer elects this option, he will receive a 21%
discount on the note. Given this sale is highly leveraged, the Company has
elected not to recognize any income on this sale. In the event the buyer
exercises this option, the proceeds to the Company would be $1.55 million and
the Company would recognize a loss of approximately $273,000. If the buyer does
not exercise this option, the Company will recognize a gain on the sale of
$127,000 using the installment method of accounting. Under the installment
method, the Company would have recognized a gain on the disposal of assets of
approximately $21,600 for the first six months of fiscal 1997.

NOTE 5 -- PROPERTY AND EQUIPMENT HELD FOR SALE

The Company has decided to dispose of certain freestanding facilities
and other assets (see Note 3-- "Operating Losses and Liquidity"). Property and
equipment held for sale, consisting of land, building, equipment and other fixed
assets with a historical net book value of approximately $11.4 million at
November 30, 1996, is carried at estimated net realizable value of approximately
$5.9 million. Direct healthcare expenses for the facilities designated for
disposition were approximately $0.2 million for the three months ended November
30, 1996. There were no operating revenues for this period.

Property and equipment held for sale, which are under contract and
expected to be sold within the next twelve month period, are shown as current
assets on the consolidated balance sheets. Gains and losses on facilities have
been reflected in the statement of operations. Any impairments to the net
realizable value of property and equipment held for sale have also been recorded
in the statement of operations. One of the three closed freestanding facilities
included in property and equipment held for sale is currently under a sales
contract.

A summary of the transactions affecting the carrying value of current
and non-current property and equipment held for sale for the three months ended
November 30, 1996, is as follows (in thousands):

10
<PAGE> 11
COMPREHENSIVE CARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1996
(unaudited)

<TABLE>
<S> <C>
Balance as of August 31, 1996 ............. $ 5,937

Carrying value of assets sold ............. (8)
-------

Balance as of November 30, 1996 ........... $ 5,929
=======
</TABLE>

NOTE 6 -- INCOME TAXES

On July 20, 1995, the Company filed its Federal income tax return for
fiscal 1995. On August 4, 1995, the Company filed form 1139 "Corporate
Application for Tentative Refund" to carry back losses under Section 172(f)
requesting a refund to the Company in the amount of $9.4 million. On August 30,
1995, the Company also filed amended Federal tax returns for several prior years
to carry back losses under Section 172(f). The refunds requested on the amended
returns are approximately $6.2 million for 1986; $0.4 million for 1985; $0.7
million for 1983 and $0.4 million for 1982. On September 20, 1996, the Company
filed its Federal income tax return for fiscal 1996, and subsequently filed form
1139 "Corporate Application for Tentative Refund" to carry back losses described
in Section 172(f) requesting a refund to the Company in the amount of $5.5
million. The Company has requested refunds totalling $22.6 million as follows:
$7.7 million for amended prior years' returns, $9.4 million for fiscal year
1995, and $5.5 million for fiscal year 1996. There may be opposition by the
Internal Revenue Service ("IRS") as to the Company's ability to obtain benefits
from refunds claimed under Section 172(f). Therefore, no assurances can be made
as to the Company's entitlement to all claimed refunds.

In October 1995, the Company received a $9.4 million tentative refund
for fiscal 1995. Of this refund, $2.4 million was recognized as a tax benefit
during the second quarter of fiscal 1996. In September 1996, the Company
received a $5.4 million tentative refund for fiscal 1996. Of this refund, $0.3
million has been recognized as a tax benefit during the second quarter of fiscal
1997. Receipt of the 1995 and 1996 Federal tax refunds does not imply IRS
approval. Due to the lack of legal precedent regarding Section 172(f), the
unbenefitted amounts from fiscal 1995 and 1996 of $7.0 million and $5.1 million,
respectively, are reflected on the Company's consolidated balance sheet in
unbenefitted tax refunds received. In connection with the refund claims, the
Company paid contingency fees of $1.9 million and $1.1 million relating to the
fiscal 1995 and 1996 refunds, respectively. The Company expensed a pro rata
portion of the contingency fees as related tax benefits were recognized. The
remaining amount of $2.4 million is reflected in the Company's consolidated
balance sheet as other receivables. In the event the IRS Appeals Office
determines that the Company is not entitled to all or a portion of the
deductions under Section 172(f), this fee is reimbursable to the Company
proportionately.

The Company is currently under audit by the IRS related to its fiscal
1995 Federal income tax return and the amended returns for prior years. Neither
the Company nor the IRS will be foreclosed from raising other tax issues in
regard to any audits of such returns, which also could ultimately affect the
Company's tax liability.

NOTE 7 -- COMMITMENTS AND CONTINGENCIES

11
<PAGE> 12
COMPREHENSIVE CARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1996
(unaudited)

its entirety. On March 8, 1995, the jury returned its verdict awarding the
Company $2,681,250 in damages, plus interest and the costs of the action against
RehabCare for securities fraud and for breach of contract. RehabCare has posted
a bond in the amount of $3.0 million and filed a motion for new trial or in the
alternative, for judgment as a matter of law, which the court denied in its
entirety on August 4, 1995. On September 1, 1995, RehabCare filed a notice of
appeal with the District Court indicating its intent to appeal the matter to the
United States Court of Appeals. RehabCare filed its first brief to set forth
argument on January 29, 1996, the Company filed its brief on March 19, 1996 and
RehabCare filed its reply on April 6, 1996. Verbal argument was heard by the
District Court in June 1996. On October 22, 1996, The U.S. Court of Appeals for
the Eighth Circuit reversed the judgment in favor of the Company and against
RehabCare entered by the District Court following the jury's verdict in favor of
the Company. On November 5, 1996, the Company filed a Petition for Rehearing
with the Eighth Circuit. Any effect from the outcome of this lawsuit will not
have a material adverse impact on the Company's results of operations.

On December 27, 1995, AGCA, Inc. and Merit Behavioral Care Systems
Corporation filed a lawsuit against a subsidiary of the Company, one of its
employees, and other non-related parties. The cause, originally filed in Travis
County, has been moved to the 101st District Court of Dallas County (Case No.
962970E). On January 29, 1996, AGCA, Inc. also filed a lawsuit against a
subsidiary of the Company and one of its employees in the U.S. District Court,
Tampa Division (Case No. 95-15768). Both lawsuits seek injunctive relief and the
Texas action includes a claim of conspiracy. Plaintiffs agreed to mediate both
the Texas and Florida actions, on September 3, 1996, in Tampa, Florida. On
September 4, 1996, the Company settled this dispute. The settlement agreement
and release requires a payment by the Company's subsidiary and its employee of
$325,000. In addition, the subsidiary's employee agreed not to solicit certain
customers until after May 15, 1997. The Company recorded a charge of $250,000
during the first quarter of fiscal 1997 which represents the net amount paid by
the Company. The Company paid the settlement amount on September 21, 1996.

The Company entered into a Stock Purchase Agreement on April 30, 1996
to purchase the outstanding stock of HMS (see Note 4-- "Acquisitions and
Dispositions"). The Stock Purchase Agreement was subject to certain escrow
provisions and other contingencies which were not completed until July 25, 1996.
In conjunction with this transaction, HMS initiated an arbitration against The
Emerald Health Network, Inc. ("Emerald") claiming breach of contract and seeking
damages and other relief. In August 1996, Emerald, in turn, initiated action in
the U.S. District Court for the Northern District of Ohio, Eastern Division,
against the Company claiming, among other things, interference with the contract
between Emerald and HMS and seeking unspecified damages and other relief.
Discovery has been initiated by all parties and the Company believes it has good
and meritorious defenses and that HMS has meritorious claims in its arbitration.
In November 1996, Emerald moved the court for summary judgment. The hearing on
such motion has been adjourned and the Company's response is pending. The
Company believes that it has claims arising from this transaction against the
accountants and legal counsel of HMS as well as HMS's lending bank. On October
1, 1996, the Company filed a claim of malpractice against the legal counsel of
HMS. These claims are presently being investigated and have not as yet been
quantified. The Company does not believe that the impact of these claims will
have a material adverse effect on the Company's financial position, results of
operations and cash flows.

On September 6, 1996, the Company instituted an arbitration against the
Sellers of HMS with the American Arbitration Association in Orange County,
California seeking, among other things, damages from the Sellers which the
Company sustained by reason of the inaccuracies of the representations and
warranties made by the Sellers and for the indemnification from each of the
Sellers as provided for under the terms of the Stock Purchase Agreement. The
Sellers have not interposed their answers to the arbitration, and the
arbitration is therefore in its formative stages. The Company does not believe
that the impact of these claims will have a material adverse effect on the
Company's financial position, results of operations and cash flows.

12
<PAGE> 13
COMPREHENSIVE CARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1996
(unaudited)

Company's progress toward returning to continuing listing standards and has so
indicated in approving the Company's most recent Listing Application on December
30, 1996. Management believes, though no assurance may be given, that the recent
completion of the Company's Debenture Exchange Offer will enable the Company to
seek additional equity and thereby satisfy the Committee of the Company's
progress. No assurance may be given that additional equity may be obtained on
terms favorable to the Company. No assurance may be given as to the actions that
the NYSE may take or that the steps of the restructuring will be successfully
completed.

An involuntary bankruptcy petition was dismissed on March 6, 1995
pursuant to an agreement dated March 3, 1995 between the Company and a
representative of the petitioners. Under such agreement the Company has agreed,
subject to the conditions therein, to offer to exchange for its outstanding 7
1/2% Convertible Subordinated Debentures a combination of cash and shares. See
Note 3 to the Company's Condensed Consolidated Financial Statements for a
discussion of the Company's default in the payment of interest on its 7 1/2%
Convertible Subordinated Debentures, the acceleration of the full principal
amount thereof, and the affirmative consents of Debentureholders to waive the
default and acceleration (see Note 2-- "Debenture Exchange Offer").

From time to time, the Company and its subsidiaries are also parties
and their property is subject to ordinary routine litigation incidental to their
business. In some pending cases, claims exceed insurance policy limits and the
Company or a subsidiary may have exposure to a liability that is not covered by
insurance. Management believes that the outcome of such lawsuits will not have a
material adverse impact on the Company's financial statements.

NOTE 8 -- SUPPLEMENTAL EARNINGS/(LOSS) PER SHARE

The supplemental earnings/(loss) per share information gives effect to
the Debenture Exchange Offer as if it had occurred at the beginning of the
period presented (see Note 2 -- "Debenture Exchange Offer").

13
<PAGE> 14
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

IMPORTANT FACTORS RELATED TO FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS

This Quarterly Report on Form 10-Q contains certain forward-looking
statements that are based on current expectations and involve a number of risks
and uncertainties. Factors that may materially affect revenues, expenses and
operating results include, without limitation, the Company's success in (i)
completing its exchange with the holder of the Secured Convertible Note for
shares of Preferred Stock, (ii) disposing of certain remaining facilities on
acceptable terms, (iii) expanding the behavioral medicine managed care and
contract management portions of the Company's business, (iv) securing and
retaining certain refunds from the IRS and certain judgments from adverse
parties in the legal proceedings described above, (v) maintaining the listing of
the Company's Common Stock on the NYSE, (vi) obtaining additional equity capital
as to which no assurance can be given that such additional equity may be
obtained on terms favorable to the Company; and (vii) securing any requisite
stockholder approval and consent to the transactions described above.

The forward-looking statements included herein are based on current
assumptions including that competitive conditions within the healthcare industry
will not change materially or adversely, that the Company will retain existing
key management personnel, that the Company's forecasts will accurately
anticipate market demand for its services, and that there will be no material
adverse change in the Company's operations or business. Assumptions relating to
the foregoing involve judgments that are difficult to predict accurately and are
subject to many factors that can materially affect results. Budgeting and other
management decisions are subjective in many respects and thus susceptible to
interpretations and periodic revisions based on actual experience and business
developments, the impact of which may cause the Company to alter its budgets,
which may in turn affect the Company's results. In light of the factors that can
materially affect the forward-looking information included herein, the inclusion
of such information should not be regarded as a representation by the Company or
any other person that the objectives or plans of the Company will be achieved.

General

In response to continuing changes in the behavioral health care
industry, the Company has made significant changes in its operations, including
the divestiture of many freestanding facilities, so that the Company can focus
on its network solutions related to managed care and behavioral medicine
contract management operations. During fiscal 1996, managed care operations
experienced significant growth through internal development and the expansion
into new managed care behavioral health markets and products. In addition,
during the first quarter of fiscal 1997 the Company acquired four companies in
Michigan which provide managed care behavioral health services. The following
table sets forth operating revenues of the Company's managed care, behavioral
medicine contracts and hospital operations for the selected quarterly periods:

<TABLE>
<CAPTION>
Three months ended
---------------------------------------------
November 30, May 31, November 30,
1996 1996 1995
------------ ------- ------------

<S> <C> <C> <C>
Comprehensive Behavioral Care operations.... 64% 56% 42%
Comprehensive Care Integration operations... 16 17 17
Freestanding operations..................... 18 26 40
Corporate services... ...................... 2 1 1
--- --- ---

100% 100% 100%
=== === ===
</TABLE>

As a result of the Company's continued negative results from
operations, the Company has had difficulty generating sufficient cash flows from
operations to meet its obligations and sustain its operations. During the second
quarter of fiscal 1997, the Company has utilized the proceeds from income tax
refunds and available cash on hand to fund its working capital deficit.

14
<PAGE> 15
Global Restructuring

In early fiscal 1995, Management developed a "global restructuring"
plan intended to address the Company's immediate challenges and to return to a
base of profitability for future success. Management has achieved all of the
stated objectives in the global restructuring plan. The restructuring of the
Company's financial obligations represented by the Company's 7 1/2% Convertible
Subordinated Debentures (the "Debentures") occurred during the third quarter of
fiscal 1997 (see Note 2 to the Company's Condensed Consolidated Financial
Statements included herein).

During fiscal 1996, the Company recorded $0.1 million in restructuring
charges related to the Company's planned closure and disposition of its
freestanding facility in Cincinnati, Ohio which occurred during the first
quarter of fiscal 1997. The components of this charge are predominately
severance to hospital employees. Closure of this facility is consistent with the
Company's global restructuring plans and will eliminate the funding of operating
losses and cash flow deficits required by this facility.

In addition, in July 1996, the Company closed the administrative
offices of Comprehensive Care Integration located in San Ramon, California.
Closure of this office and several non-performing contract units was part of the
planned restructuring of these operations. The impact of this restructuring was
approximately $0.2 million and was recorded during the first quarter of fiscal
1997. The following table sets forth the activity to the restructuring reserve
during the second quarter of fiscal 1997:

<TABLE>
<CAPTION>
CHARGES
AUGUST 31, ----------------- NOVEMBER 30,
1996 INCOME EXPENSE PAYMENTS 1996
---- ------ ------- -------- ----
(AMOUNTS IN THOUSANDS)

<S> <C> <C> <C> <C> <C>
Restructuring Reserve:
Severance ........................ $104 $ -- $ -- $ (17) $ 87
Operations/corporate relocation .. 365 -- -- (40) 325
---- ---- ---- ----- ----
$469 $ -- $ -- $ (57) $412
==== ==== ==== ===== ====
</TABLE>

In August 1996, the Company sold its non-operating freestanding
facility in Costa Mesa, California which had been closed in November 1995 due to
poor performance. The Company utilized the proceeds received from the sale to
reduce secured debt and other working capital purposes. One of the three
non-operating freestanding facilities is currently under contract to be sold and
is scheduled to close escrow during the third quarter of fiscal 1997.

The Company has been seeking to restructure its obligations under the
Debentures, and was in default as a result of the Company's failure to make
scheduled payments of interest (see Note 3 to the Company's Condensed
Consolidated Financial Statements included herein). On November 14, 1996, the
Company commenced a Consent Solicitation pursuant to a proxy statement addressed
to its Debentureholders. The Company simultaneously initiated the Debenture
Exchange Offer to exchange cash and Common Stock of the Company for its
Debentures. As a result of the completion of the Debenture Exchange Offer, the
Company's debt obligations have been reduced by $6,846,000. Subsequently,
$2,692,000 of the Company's debt obligations represented by untendered
Debentures will be reclassified to long term debt during the third quarter of
fiscal 1997.

RESULTS OF OPERATIONS

Statistical Information

The following utilization statistics include data from all operations
including closures during the periods, joint ventures and closed facilities:

15
<PAGE> 16
<TABLE>
<CAPTION>
Three months ended Six months ended
--------------------------------------------- ----------------------------
November 30, August 31, November 30, November 30, November 30,
1996 1996 1995 1996 1995
------------ ---------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Managed care operations:
Covered lives .................... 1,331,155 1,147,664 693,220 1,331,155 693,220

Patient days:
Freestanding facilities .......... 1,591 1,516 2,033 3,107 5,811
Behavioral medicine contracts .... 2,256 2,986 4,383 5,170 9,917

Freestanding facilities:
Occupancy rate ................... 47% 29% 14% 36% 11%
Admissions ....................... 301 312 353 613 926
Average length of stay (days) .... 5 5 6 5 6

Behavioral medicine contracts:
Average occupied beds per contract 5 5 6 5 7
Admissions ....................... 358 464 584 822 1,354
Average length of stay (days) .... 6 6 8 6 7

Total beds available at end of period:
Freestanding facilities .......... 38 58 84 38 84
Behavioral medicine contracts .... 55 82 114 67 114
</TABLE>

Three Months Ended November 30, 1996 Compared to Three Months Ended November 30,
1995

The Company reported a pretax loss of approximately $1.3 million for
the second quarter of fiscal 1997, an improvement of approximately $0.5 million
or 28% from the pretax loss of approximately $1.8 million reported for the
second quarter of fiscal 1996. Included in revenues for the second quarter of
fiscal 1996 is a gain of $1.0 million related to the sale of an operating
facility in October 1995.

Operating revenues for the second quarter of fiscal 1997 increased by
$2.1 million or 28% from the second quarter of fiscal 1996. The second quarter
of fiscal 1997 reflects an increase in managed care operating revenues of $3.0
million or 86% as compared to the second quarter of fiscal 1996. This increase
in managed care operating revenues was offset by the decline in operating
revenues from freestanding facilities due to the closure of one freestanding
facility during the first quarter of fiscal 1997.

Direct healthcare expenses increased by approximately $1.3 million or
19% from the second quarter of fiscal 1996 compared to the second quarter of
fiscal 1997. The increase in direct healthcare expenses is primarily
attributable to an increase of 93% in direct healthcare expenses related to
managed care operations which was partially offset by the 49% decline in direct
healthcare expenses for freestanding operations. General and administrative
expenses decreased by approximately $0.3 million from the second quarter of
fiscal 1996 as a result of a decline in corporate overhead expenses. The second
quarter of fiscal 1996 includes $0.5 million in fees related to the Company's
fiscal 1995 Federal income tax refund. The second quarter of fiscal 1997
includes $0.1 million in fees related to the Company's fiscal 1996 Federal
income tax refund (see Note 6 to the Company's Condensed Consolidated Financial
Statements included herein). The provision for doubtful accounts decreased by
$0.2 million or 60% during the second quarter of fiscal 1997 compared to the
same period for fiscal 1996 as a result of the significant decline in
freestanding operations.

16
<PAGE> 17
Managed Care Operations

The following table reflects covered lives by major product provided:

<TABLE>
<CAPTION>
November 30, August 31, November 30,
1996 1996 1995
------------ ---------- ------------
<S> <C> <C> <C>
Carve-out (capitated) ..... 1,184,324 1,039,372 598,086
Blended products .......... 4,585 4,601 5,128
EAP services .............. 66,343 69,915 83,599
ASO services .............. 75,903 33,776 6,407
--------- --------- -------
Total covered lives .. 1,331,155 1,147,664 693,220
========= ========= =======
</TABLE>

At November 30, 1996, the number of covered lives increased to
1,331,155 from 693,220 a year ago or by 92%. This increase is primarily
attributable to new contracts added during the period in South Florida,
Michigan, Puerto Rico and Texas. Comprehensive Behavioral Care ("Comprehensive
Behavioral") distinguishes itself from its competition by being the
"science-based" provider of care and manages all clinical programs based upon
proven treatment technologies.

In the second quarter of fiscal 1997, operating revenues increased by
$3.0 million compared to the second quarter of fiscal 1996. Direct healthcare
expenses also increased by $2.7 million in the second quarter of fiscal 1997
compared to the same period a year ago. In addition, general and administrative
expenses increased to $1.0 million or by $0.6 million in the second quarter of
fiscal 1997 as compared to the second quarter of fiscal 1996. Included in the
results for the second quarter of fiscal 1997 are $0.4 million in legal fees
related to litigation. As a result, the net operating loss for managed care
operations for the second quarter of fiscal 1997 was $0.7 million, an increase
of $0.3 million from the same quarter a year ago which reported a net operating
loss of $0.4 million.

Behavioral Medicine Contracts

In the second quarter of fiscal 1997, Comprehensive Care Integration
("CCI") operating revenues increased by $0.2 million or by 15% from the second
quarter of fiscal 1996, and direct healthcare expenses decreased 3%. In
addition, general and administrative expenses decreased $0.2 million or 62% in
the second quarter of fiscal 1997 compared to the second quarter of fiscal 1996.
The increase in operating revenues during the second quarter of fiscal 1997
combined with the decrease in expenses and resulted in a net operating loss of
$0.3 million, an improvement of $0.3 million as compared to the same period for
fiscal 1996.

During the second quarter of fiscal 1997, CCI closed five contract
units. These units were closed due to poor performance or were at the end of the
term of their contract. As a result, during the second quarter of fiscal 1997,
patient days of service for behavioral medicine contracts declined by
approximately 49% from 4,383 patient days to 2,256 patient days. Units which
were operational for both the second quarter of fiscal 1997 and 1996 experienced
a 17% decrease in utilization to 1,319 patient days. Average net revenue per
patient day at these units increased by 28% from the same quarter a year ago
resulting in an increase in overall net inpatient operating revenues of 7% to
$0.2 million. Net outpatient revenues for programs operational for both quarters
at these units increased 24% from approximately $727,000 in the second quarter
of fiscal 1996 to approximately $901,000 in the second quarter of fiscal 1997.
The increase in net outpatient revenues is predominately a result of an increase
in utilization of partial hospitalization programs.

The following table sets forth quarterly utilization data on a "same
store" basis:

<TABLE>
<CAPTION>
Same Store Utilization
-------------------------
Fiscal 1997 Fiscal 1996
2nd Quarter 2nd Quarter
----------- -----------

<S> <C> <C>
Admissions.............................. 315 314
Average length of stay.................. 4 5
Patient days............................ 1,319 1,581
Average occupancy rate.................. 26% 32%
</TABLE>

17
<PAGE> 18
For units which were operational for the second quarters of fiscal 1997
and 1996, direct healthcare expenses increased 20%, which was offset by a 20%
increase in operating revenues. This resulted in an increase in operating income
at the unit level by 34%.

Freestanding Operations

Operating revenues for freestanding operations decreased by $1.1
million or by 39% during the second quarter of fiscal 1997 compared to the
second quarter of fiscal 1996. In addition, direct healthcare expenses declined
49% or $1.5 million in the second quarter of fiscal 1997 and general and
administrative expenses declined by $0.1 million. The decrease in operating
revenues when combined with the significant decrease in direct healthcare
expenses, resulted in an improvement in hospital operations net operating loss
for the second quarter of fiscal 1997 of $0.1 million compared to the loss of
$0.5 million reported for the same quarter a year ago.

Admissions in the second quarter of fiscal 1997 decreased to 301 from
353 in the second quarter of fiscal 1996, an overall decline of 15%. This
decline is primarily due to the closure of an operating facility during the
first quarter of fiscal 1997.

The following table sets forth selected quarterly utilization data on a
"same store" basis.

<TABLE>
<CAPTION>
Same Store Utilization
-------------------------
Fiscal 1997 Fiscal 1996
2nd Quarter 2nd Quarter
----------- -----------

<S> <C> <C>
Admissions.............................. 301 182
Average length of stay.................. 5 5
Patient days............................ 1,591 926
</TABLE>

Net revenue per patient day for "same store" facilities decreased to
$1,001 for the second quarter of fiscal 1997 from $1,676 for the second quarter
of fiscal 1996. Admissions increased for the quarter from 182 in the second
quarter of fiscal 1996 to 301 in the second quarter of fiscal 1997. In addition,
patient days increased from 926 in the second quarter of fiscal 1996 to 1,591 in
the second quarter of fiscal 1997. The increase in admissions and patient days
resulted in an increase in net operating revenues for the second quarter of
fiscal 1997 of $41,000.

The following table illustrates revenues in outpatient and day care
programs offered by the "same store" facilities:

<TABLE>
<CAPTION>
Net Outpatient/Daycare Revenues
-------------------------------
(Dollars in thousands)
Fiscal 1997 Fiscal 1996
2nd Quarter 2nd Quarter
----------- -----------

<S> <C> <C>
Facilities offering............................... 1 1
Net outpatient/daycare revenues................... $1,363 $908
% of total "same store" net operating revenues.... 83% 72%
</TABLE>

Direct healthcare expenses at the Company's freestanding facilities on
a "same store" basis increased $0.2 million and bad debt expense decreased $0.1
million in the second quarter of fiscal 1997 from the second quarter of fiscal
1996. Net operating income decreased $57,000 in the second quarter of fiscal
1997 from the same period a year ago. This is primarily due to a Medicare cost
report settlement of $287,000 received in November 1995.

Three Months Ended November 30, 1996 Compared to Three Months Ended August 31,
1996

The Company reported a net loss of approximately $1.0 million or $0.34
per share for the quarter ended November 30, 1996, an improvement of
approximately $0.8 million or $0.28 per share from the loss reported for the
quarter ended August 31, 1996. Included in the three months ended November 30,
1996 is an income tax benefit of $0.3 million related to the carryback of fiscal
1996 losses defined under Section 172(f) (see Note 6 to the Company's

18
<PAGE> 19
Condensed Consolidated Financial Statements included herein).

Operating revenues increased to $9.7 million in the second quarter of
fiscal 1997 from $9.0 million in the first quarter of fiscal 1997 or by 8%. This
increase is predominately related to an increase in revenues for managed care
operations. In addition, revenues for behavioral medicine contract operations
increased slightly during the second quarter of fiscal 1997. Direct healthcare
expenses increased in the second quarter of fiscal 1997 by 3% or $0.3 million.
This increase was the result of an increase in direct healthcare expenses for
managed care operations, which was offset by a decrease from behavioral medicine
contracts.

General and administrative expenses increased by $0.5 million during
the second quarter of fiscal 1997 compared to the first quarter. The increase in
general and administrative expenses during the second quarter of fiscal 1997 is
attributable to an increase in managed care and corporate expenses. Corporate
general and administrative expenses for the quarter ended November 30, 1996
included $0.1 million for the fees paid related to the Company's fiscal 1995
Federal tax refund. Also included in the first quarter of fiscal 1997 is $0.3
million related to a legal settlement (see Note 7 to the Company's Condensed
Consolidated Financial Statements included herein). Included in the results for
the second quarter of fiscal 1997 are fees and expenses of $0.1 million related
to the Exchange Offer of the Company's Debentures. The provision for doubtful
accounts increased by $0.1 million for the second quarter of 1997 versus the
first quarter as a result of an increase in bad debts related to contract
operations.

Managed Care Operations

During the second quarter of fiscal 1997, the number of covered lives
increased to 1,331,155 or by 16%. This increase is primarily attributable to new
members under existing contracts and new contracts added in Texas.

In the second quarter of fiscal 1997, operating revenues increased 18%
to $6.5 million compared to the first quarter of $5.5 million. Direct healthcare
expenses also increased by $0.8 million or 16% in the second quarter of fiscal
1997. In addition, general and administrative expenses increased by $0.5 million
in the second quarter of fiscal 1997 as compared to the first quarter. Also
included in the first quarter of fiscal 1997 is $0.3 million related to a legal
settlement (see Note 7 to the Company's Condensed Consolidated Financial
Statements included herein). As a result, the net operating loss for
managed care operations for the second quarter of fiscal 1997 was $0.6 million,
an increase of $0.1 million from the prior quarter.

Behavioral Medicine Contracts

In the second quarter of fiscal 1997, CCI operating revenues increased
slightly from the first quarter of fiscal 1997 and direct healthcare expenses
declined by 9%. In addition, general and administrative expenses declined $0.2
million in the second quarter as compared to the prior quarter. The provision
for doubtful accounts increased by $0.3 million during the second quarter of
fiscal 1997 as compared to the prior quarter. The slight increase in operating
revenues during the second quarter of fiscal 1997 combined with the decrease in
operating and general and administrative expenses resulted in a decrease in
CCI's net operating loss by $0.2 million from the first quarter to $0.3 million.

During the second quarter of fiscal 1997, patient days of service at
behavioral medicine contracts declined by approximately 23% from 2,914 patient
days to 2,256 patient days. Units which were operational for both the first and
second quarters of fiscal 1997 experienced a 28% decrease in utilization to
1,319 patient days. Average net revenue per patient day at these units increased
by 37% from the previous quarter resulting in a slight decline in overall net
inpatient operating revenues to $0.2 million. Net outpatient revenues for
programs operational for both quarters at these units increased slightly from
approximately $923,000 in the first quarter of 1997 to approximately $926,000 in
the second quarter of fiscal 1997.

The following table sets forth quarterly utilization data on a "same
store" basis:

19
<PAGE> 20
<TABLE>
<CAPTION>
Same Store Utilization
-------------------------
Fiscal 1997 Fiscal 1997
2nd Quarter 1st Quarter
----------- -----------

<S> <C> <C>
Admissions.............................. 315 389
Average length of stay.................. 4 5
Patient days............................ 1,319 1,820
Average occupancy rate.................. 26% 36%
</TABLE>

For units operational for both quarters, direct healthcare expenses
increased 14%. The increase in expenses, combined with the slight increase in
operating revenues, resulted in net operating income at the unit level
decreasing by 79% from the first quarter of fiscal 1997.

Freestanding Operations

Operating revenues for freestanding operations decreased slightly to
$1.6 million or by 2% during the second quarter of fiscal 1997 compared to the
prior quarter. During the first quarter of fiscal 1997, the Company sold one
freestanding facility which had been closed during the second quarter of fiscal
1996 and closed another due to poor performance. In addition, direct healthcare
expenses declined 2% in the second quarter of fiscal 1997, and the provision for
doubtful accounts declined by $0.2 million. As a result, the net operating loss
for hospital operations decreased by $0.2 million to $0.1 million for the second
quarter of fiscal 1997 compared to the previous quarter.

Admissions in the second quarter of fiscal 1997 decreased to 301 from
312 in the first quarter, an overall decline of 4%. The following table sets
forth selected quarterly utilization data on a "same store" basis:

<TABLE>
<CAPTION>
Same Store Utilization
-------------------------
Fiscal 1997 Fiscal 1997
2nd Quarter 1st Quarter
----------- -----------

<S> <C> <C>
Admissions.............................. 301 312
Average length of stay.................. 5 5
Patient days............................ 1,591 1,516
</TABLE>

Net revenue per patient day for "same store" facilities decreased to
$1,001 for the second quarter of fiscal 1997 from $1,005 for the first quarter
of fiscal 1997. Admissions decreased for the quarter from 312 in the first
quarter to 301 in the second quarter of fiscal 1997. The slight decrease in
admissions combined with no change in length of stay resulted in a decrease in
net operating revenues for the second quarter of fiscal 1997 of $82,000. The
Company believes that the increasing role of HMO's, reduced benefits from
employers and indemnity companies, and a shifting to outpatient programs
continue to impact utilization. The Company continues to focus its efforts
toward providing effective, lower cost outpatient, partial hospitalization and
daycare programs, obtaining psychiatric treatment licenses for its freestanding
facilities, and toward establishing and maintaining relationships and contracts
with managed care and other organizations which pay for or broker such services.

The following table illustrates revenues in outpatient and daycare
programs offered by the "same store" facilities:

<TABLE>
<CAPTION>
Net Outpatient/Daycare Revenues
-------------------------------
(Dollars in thousands)
Fiscal 1997 Fiscal 1997
2nd Quarter 1st Quarter
----------- -----------

<S> <C> <C>
Facilities offering.............................. 1 1
Net outpatient/daycare revenues.................. $1,363 $1,453
% of total "same store" net operating revenues... 83% 87%
</TABLE>

Direct healthcare expenses at the Company's freestanding facilities on
a "same store" basis decreased $33,000 and the provision for doubtful accounts
decreased $7,000 in the second quarter from the first quarter of fiscal 1997.
Operating revenues decreased $82,000 in the second quarter. As a result, net
operating income decreased $43,000 in

20
<PAGE> 21
the second quarter from the first quarter of fiscal 1997.

The Company is taking steps to increase revenues, primarily through
relicensing facilities to provide psychiatric treatment and the continued
development of its behavioral medicine managed care business. The Company is
also implementing cost reduction measures, including the closure of selected
facilities. In August 1996, the Company sold one non-operating facility and
closed one operating facility due to poor performance. The Company owns four
freestanding facilities. One of the four owned facilities is currently
operating. The Company will continue to evaluate the performance of these
facilities in their respective markets and, if circumstances warrant, may
increase or reduce the number of facilities designated for disposition.

Six Months Ended November 30, 1996 Compared to Six Months Ended November 30,
1995

The Company reported a pretax loss of approximately $3.1 million for
the six months ended November 30, 1996 which was comparable to the pretax loss
of $3.1 million reported for the same period for fiscal 1996. Included in the
results for fiscal 1996 is a gain of $1.0 million related to the sale of an
operating facility in October 1995 and a credit of $0.4 million related to a
settlement with the Company's fidelity bond carrier. Included in the results for
fiscal 1997 is a restructuring charge of $0.2 million, a legal settlement of
$0.3 million and $0.1 million in fees and expenses relating to the Company's
restructure and Exchange Offer of its Debentures. Exclusive of these
non-recurring items, the pretax loss for the six months ended November 30, 1996
was $2.5 million compared to the pretax loss of $4.5 million for the same period
a year ago.

Operating revenues increased by 14% or $2.3 million for the six months
ended November 30, 1996 compared to the six months ended November 30, 1995. The
increase in operating revenues is primarily attributable to an increase in
managed care operations of $5.1 million which was offset by a decline of $ 3.2
million related to freestanding operations. Direct healthcare expenses increased
by 12% or $1.8 million for the six months ended November 30, 1996 as compared to
the same period for fiscal 1996. This decline is attributable to a decrease in
direct healthcare expenses for hospital operations of 55% or $3.6 million which
was offset by an increase in direct healthcare expenses for managed care of $4.8
million. General and administrative expenses for the six months ended November
30, 1996 increased $0.1 million from the six months ended November 30, 1995. The
increase in general and administrative expenses for the six months ended
November 30, 1996 includes an increase in managed care operations of $0.6
million, a decrease of $0.1 million in contract operations general and
administrative expenses, an increase in hospital general and administrative
expenses of $0.3 million, and a decrease in corporate general and administrative
expenses of $0.7 million and which included $0.1 million for fees paid related
to the Company's fiscal 1996 Federal tax refund. The provision for doubtful
accounts declined $0.5 million or 70% for the six months ended November 30, 1996
as compared to the same period a year ago and is attributable to the decline in
hospital operations. In addition, interest expense decreased by $0.1 million or
20% for the six months ended November 30, 1996 compared to the six months ended
November 30, 1995.

Managed Care Operations

The number of covered lives increased to 1,331,155 or by 92% as of
November 30, 1996 compared to 693,220 for the same period a year ago. Covered
lives for contracts existing at November 30, 1995 increased by 108,000 lives or
16%. In addition, new contracts implemented after November 30, 1995 contributed
an additional 530,000 lives increasing total covered lives as of November 30,
1996 by 76% as compared to a year ago. The majority of growth in covered lives
is predominately related to new contracts implemented in Florida, Puerto Rico
and Texas. During fiscal 1997, Comprehensive Behavioral added approximately
70,000 lives under Administrative Service Organization ("ASO") contracts. Under
an ASO contract, Comprehensive Behavioral provides overall care management
services; however, Comprehensive Behavioral is not at risk.

Operating revenues increased by $5.1 million to $12.0 million for the
six months ended November 30, 1996 compared to the six months ended November 30,
1995. Direct healthcare expenses also increased for the six months ended
November 30, 1996 by $4.8 million compared to the same period a year ago. In
addition, general and administrative expenses increased by $0.7 million for the
six months ended November 30, 1996. Included in general and administrative
expenses for the six months ended November 30, 1996 is a legal settlement of
$0.3 million and $0.4 million in non-recurring legal expenses. As a result, the
net operating loss for managed care operations for the six months ended
November 30, 1996 was $1.2 million, an increase of $0.7 million from the six
month period for fiscal 1996.

21
<PAGE> 22
Behavioral Medicine Contracts

CCI operating revenues increased by $0.2 million for the six months
ended November 30, 1996 or 8% from the same period of fiscal 1996 and direct
healthcare expenses remained constant. In addition, general and administrative
expenses decreased $0.1 million to $0.4 million, compared to the same fiscal
period a year ago. In addition, a restructuring charge of $0.2 million was
recorded in the six months ended November 30, 1996. The net result of these
items was a net operating loss of $0.8 million compared to the loss for the same
period a year ago of $0.9 million.

Patient days of service at behavioral medicine contracts for the six
months ended November 30, 1996 declined by approximately 48% from 9,917 patient
days to 5,170 patient days for the same period a year ago. Units which were
operational for both the six months ended November 30, 1996 and November 30,
1995, experienced a 13% decrease in utilization to 3,139 patient days. Average
net revenue per patient day at these units increased by 10% from the previous
period resulting in a decline in overall net inpatient operating revenues of 5%
to $0.5 million. Net outpatient revenues for programs operational for both
periods at these units increased 33% from approximately $0.8 million for the six
months ended November 30, 1995 to approximately $1.1 million for the six months
ended November 30, 1996.

The following table sets forth quarterly utilization data on a "same
store" basis:

<TABLE>
<CAPTION>
Same Store Utilization
----------------------------
Six Months Six Months
Ended Ended
Nov. 30, 1996 Nov. 30, 1995
------------- -------------

<S> <C> <C>
Admissions.............................. 704 683
Average length of stay.................. 4 5
Patient days............................ 3,139 3,623
Average occupancy rate.................. 31% 36%
</TABLE>

For units operational for both periods, direct healthcare expenses
increased slightly and when combined with the 19% increase in operating
revenues, resulted in operating income at the unit level increasing by 144% for
the six months ended November 30, 1996 compared to the six months ended November
30, 1995. This increase is due to an increase in the utilization for the partial
hospitalization program.

Freestanding Operations

Operating revenues for freestanding operations decreased by $3.2
million or 49% for the six months ended November 30, 1996 compared to the six
months ended November 30, 1995. During the first quarter of fiscal 1997, the
Company sold one non-operating facility and closed one operating facility due to
poor performance. In addition, direct healthcare expenses declined 55% or $3.6
million in the six months ended November 30, 1996. The provision for doubtful
accounts declined by $0.6 million. The decrease in operating revenues combined
with the decline in expenses resulted in a net operating loss from hospital
operations for the six months ended November 30, 1996 of $0.3 million, an
improvement of 74% or $0.3 million from the six months ended November 30, 1995.

Admissions for the six months ended November 30, 1996 decreased to 613
from 926 for the six months ended November 30, 1995, an overall decline of 34%.

The following table sets forth quarterly utilization data on a "same
store" basis:

<TABLE>
<CAPTION>
Same Store Utilization
----------------------------
Six Months Six Months
Ended Ended
Nov. 30, 1996 Nov. 30, 1995
------------- -------------

<S> <C> <C>
Admissions.............................. 613 286
Average length of stay.................. 5 5
Patient days............................ 3,107 1,511
</TABLE>

22
<PAGE> 23
Net revenue per patient day for "same store" facilities decreased to
$1,052 for the six months ended November 30, 1996 from $1,789 for the six months
ended November 30, 1995. Admissions increased for the period from 286 in the six
months ended November 30, 1995 to 613 for the six months ended November 30,
1996. The increase in admissions combined with no changes in length of stay, and
an increase in outpatient revenues, resulted in an increase in net operating
revenues for the six months ended November 30, 1996 of $155,000 as compared to
the same period for fiscal 1996. The Company believes that the increasing role
of HMO's, reduced benefits from employers and indemnity companies, and a
shifting to outpatient programs continue to impact utilization. The Company
continues to focus its efforts toward providing effective, lower cost
outpatient, partial hospitalization and daycare programs, obtaining psychiatric
treatment licenses for its freestanding facilities, and toward establishing and
maintaining relationships and contracts with managed care and other
organizations which pay for or broker such services.

The following table illustrates revenues in outpatient and day care
programs offered by the "same store" facilities:

<TABLE>
<CAPTION>
Net Outpatient/Daycare Revenues
-------------------------------
(Dollars in thousands)
Six Months Six Months
Ended Ended
Nov. 30, 1996 Nov. 30, 1995
------------- -------------

<S> <C> <C>
Facilities offering............................... 1 1
Net outpatient/daycare revenues................... $2,971 $1,780
% of total "same store" net operating revenues.... 85% 74%
</TABLE>

Direct healthcare expenses at the Company's freestanding facilities on
a "same store" basis increased $0.6 million and bad debt expense decreased $0.2
million for the six months ended November 30, 1996 compared to the same period
for fiscal 1996. As a result, the net operating income increased $0.2 million
for the six months ended November 30, 1996 compared to the six months ended
November 30, 1995.

LIQUIDITY AND CAPITAL RESOURCES

At November 30, 1996, the Company had cash and cash equivalents of $7.6
million. The Company provided $2.8 million from its operating activities,
provided $0.2 million from its investing activities and provided $0.2 million
from its financing activities. The Company reported a net loss of $1.0 million
for the quarter ended November 30, 1996, versus net income of $0.7 million for
the quarter ended November 30, 1995. Included in the results for the second
quarters of fiscal 1996 and 1997 is a tax benefit of $2.6 million and $0.3
million, respectively (see Note 6 to the Company's Condensed Consolidated
Financial Statements included herein). As a result, the Company has an
accumulated deficit of $53.5 million and a total stockholders' deficiency of
$8.6 million as of November 30, 1996. Additionally, the Company's current assets
at November 30, 1996 amounted to approximately $14.9 million and current
liabilities were approximately $37.5 million, resulting in a working capital
deficiency of approximately $22.6 million and a negative current ratio of 1:2.5.
The Company's primary use of available cash resources is to expand its
behavioral medicine managed care and contract management businesses and fund
operations while it seeks to dispose of certain of its freestanding facilities.

Included in the Company's investing activities for the first six months
of fiscal 1997 are the proceeds from the sale of property and equipment of $0.4
million which was offset by the additions to property and equipment of $0.2
million. These proceeds are related to the sale of the Company's freestanding
facility in Costa Mesa, California in August 1996. Included in operating
activities for the first six months of fiscal 1997 is an increase in accounts
receivable of $0.9 million, and an increase in other receivables of $1.0
million. Also included in operating activities for the first six months of
fiscal 1997 is an increase in accounts payable and accrued liabilities of $2.1
million and an increase in unbenefitted tax refunds received of $5.1 million.
The increase in other receivables and unbenefitted tax refunds received is
related to the Company's 1996 Federal income tax refund (see Note 6 to the
Company's Condensed Consolidated Financial Statements included herein).

Included in the cash flows from financing activities is repayment of
debt in the amount of $0.7 million which is primarily related to debt secured by
the Company's freestanding facility which was sold in August 1996. Also included
in financing activities is the proceeds from the issuance of the Company's
Common Stock of $0.9 million.

23
<PAGE> 24
These issuances are related to the exercise of employee stock options. The
cumulative effect of the above resulted in an ending cash position for the
Company on November 30, 1996 of $7.6 million, an increase of $3.1 million from
May 31, 1996.

During the first six months of fiscal 1996, the Company provided $7.6
million from its operating activities and utilized $0.3 million and $3.0 million
from its investing and financing activities, respectively. Included in the funds
from financing activities is $0.9 million from the proceeds from the issuance of
the Company's Common Stock in private transactions. The Company utilized these
proceeds to assist with funding the repayment of debt of $4.9 million during the
six-month period. This debt repayment is primarily related to the IRS settlement
agreement. Included in operating activities is the decrease in accounts
receivables of $0.9 million, a decrease in other receivables of $1.0 million, an
increase in unbenefitted tax refunds received of $7.1 million, and the gain on
the sale of assets of $1.0 million. This decrease is the result of the repayment
of the Company's note receivable related to the sale of the freestanding
facility in Sacramento, California which was sold in March 1995. The Company
received the balance due on this note in July 1995. The cumulative effect of
these items resulted in an ending cash position for the Company on November 30,
1995 of $5.9 million.

During the first six months of fiscal 1997, the Company recorded
non-cash operating activities of $2.3 million on its acquisition of HMS. This
was comprised of goodwill of $1.0 million, accounts payable and accrued expenses
of $0.6 million, other liabilities of $0.4 million, other assets of $0.2 million
and accounts receivable of $0.1 million. In addition, the Company recorded
additional property, plant and equipment of $0.1 million. The Company also
recorded non-cash financing activities of $0.4 million. This was comprised of
current maturities of long-term debt of $0.3 million and issuance of the
Company's Common Stock of $0.1 million.

Current assets as of November 30, 1996 increased by $4.9 million as
compared to May 31, 1996. This increase is predominately related to an increase
in cash and cash equivalents, accounts receivable and other receivables.
Non-current property and equipment held for sale declined by $2.2 million and
non-current notes receivable increased by $1.9 million. These changes are
related to the sale of the Company's non-operating facility in Costa Mesa,
California, which occurred in August 1996. As part of the transaction, the
Company took back a note on the property with provisions that allow the buyer a
discount if the note is redeemed in the first six months. The increase in other
assets as of November 30, 1996 is related to the goodwill recorded in
conjunction with the acquisition of HMS.

Current liabilities as of November 30, 1996 increased $7.3 million as
compared to May 31, 1996. This increase is primarily a result of an increase in
accounts payable and accrued liabilities of $2.7 million and unbenefitted tax
refunds received of $5.1 million. In October 1996, the Company received a refund
of $5.4 million related to its 1996 Federal tax return (see Note 6 to the
Company's Condensed Consolidated Financial Statements included herein).

Included in current and non-current assets are three hospital
facilities designated as property and equipment held for sale with a total
carrying value of $5.9 million. In August 1996, the Company sold one of its
non-operating facilities and also closed an operating facility due to poor
performance. The Company used the proceeds from the sale of the facility to pay
off secured debt and for other working capital purposes. As part of the
transaction related to this sale, the Company took back a note on the property.
The provisions of the note allow the buyer a discount if the note is redeemed in
the first six months. In the event the buyer exercises this option, the proceeds
to the Company would be an additional $1.55 million. In the first quarter of
fiscal 1997, the Company entered into escrow for the sale of another facility
which is scheduled to close during the third quarter of fiscal 1997.
Accordingly, this non-operating property is classified as current property held
for sale.

24
<PAGE> 25
fiscal 1997, over and above cash required to fund other financing, operating and
investing needs. The Debenture Exchange offered to the holders of Debentures to
exchange $500 in cash plus sixteen (16) shares of Common Stock, designated
aggregately as payment of principal, plus $80 in cash plus eight (8) shares of
Common Stock, designated aggregately as a payment of interest for each $1,000 of
the outstanding principal amount of its Debentures and the waiver by the
Debentureholder of all interest accrued and unpaid on such principal amount as
of the date of the Exchange. Accomplishment of the Debenture Exchange will
reduce the Debenture's debt service requirement and will decrease the Company's
future cash flow requirements. As a result of the completion of the Debenture
Exchange Offer, the Company's debt obligations will be reduced by $6,846,000 in
the third quarter of fiscal 1997. Subsequently, $2,692,000 of the Company's debt
obligations represented by untendered Debentures will be reclassified to long
term debt during the third quarter of fiscal 1997.

These conditions raise doubt about the Company's ability to
continue as a going concern. The accompanying Condensed Consolidated Financial
Statements do not include any adjustments to reflect the possible future effects
on the recoverability and classification of assets or the amount and
classification of liabilities that may result from the outcome of this
uncertainty.

In fiscal 1993, the Company established a restructuring reserve to
address the Company's operational issues. One purpose of such reserve was for
the realignment of the Company's focus and business and the settlement and
disposition of certain non-performing and under-utilized assets. Many of the
Company's inpatient freestanding facilities have been sold or are in the process
of being closed or sold as management continues to implement plans for expanding
the Company's managed care and behavioral medicine contract management
operations. During fiscal 1996, the Company established an additional
restructuring reserve of $0.1 million for severance and other cash outlays
related to the planned facility closure and disposition which occurred during
the first quarter of fiscal 1997. In addition, in July 1996, the Company closed
the administrative offices of Comprehensive Care Integration located in
San Ramon, California. Closure of this office and several non-performing
contract units was part of the planned restructuring of these operations. The
impact of this restructuring was approximately $0.2 million and was recorded
during the first quarter of fiscal 1997. The following table sets forth the
activity to the restructuring reserve during the second quarter of fiscal 1997:

<TABLE>
<CAPTION>
CHARGES
AUGUST 31, ----------------- NOVEMBER 30,
1996 INCOME EXPENSE PAYMENTS 1996
---- ------ ------- -------- ----
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Restructuring Reserve:
Severance ........................ $104 $ -- $ -- $ (17) $ 87
Operations/corporate relocation .. 365 -- -- (40) 325
---- ---- ---- ----- ----
$469 $ -- $ -- $ (57) $412
==== ==== ==== ===== ====
</TABLE>

In previous years, the Company was obligated to support and fund
certain poorly performing freestanding facilities that now have been closed,
including two such facilities closed in fiscal 1996 and another in fiscal 1997
(see Note 5-- "Property and Equipment Held for Sale"). As a result, the Company
will no longer be burdened with the negative cash flow requirements associated
with such facilities. Based upon a projection of actual performance during
fiscal 1997 with adjustments for reduced cash flow requirements associated with
facilities closed and/or sold in fiscal 1996 and 1997, known contract and
cyclical changes, and also giving consideration to cash on hand at November 30,
1996 of $7.6 million, management expects the Company to be able to meet its cash
obligations required by operations during the next year, including the Company's
obligations under the Debentures. However, the cash needs of the Company may
vary from month to month depending upon the actual level of business activity.
Therefore, no assurance can be given that the Company will generate adequate
cash flows to meet cash obligations required by operations.

At the time of the commencement of the Debenture Exchange Offer, the
Company had sufficient cash resources available to

25
<PAGE> 26
fund the cash portion of the Exchange. As of the completion of the Exchange, the
Company utilized an aggregate of $4.5 million to fund the cash portion of the
Exchange and the payment of interest due with respect to Debentures not
tendered. Such cash resources represented approximately 60% of the Company's
available cash resources as of November 30, 1996. Based upon current levels of
operation and cash anticipated to be internally generated from operations, the
Company believes that it has sufficient working capital, however, the occurrence
of business or economic conditions beyond the control of the Company or the loss
of existing contracts which cash from operations is internally generated or the
inability to conclude pending contract proposals may adversely affect the
adequacy of such working capital. Such anticipated cash resources to fund
additional operating needs include:

- Included in assets held for sale (non-current) are two hospital
facilities designated as property and equipment held for sale with
a total carrying value of $4.7 million. The Company expects to
sell these facilities during fiscal 1997. In addition, the Company
sold a non-operating facility during the first quarter of fiscal
1997. As part of this transaction, the Company took back a note on
the property with provisions that allow the buyer a discount if
the note is redeemed in the first six months. In the event the
buyer exercises this option, the proceeds to the Company would be
$1.55 million. Proceeds from the sales of such assets will not be
available by the time of the completion of the Debenture Exchange
Offer. Accordingly, management expects to use such cash proceeds,
if received during fiscal 1997, to fund expansion of the Company's
operations.

RISK FACTORS

This Quarterly Report on Form 10-Q includes forward-looking statements,
the realization of which may be impacted by certain important factors discussed
under "Item 2-- Management's Discussion and Analysis of Financial Conditions."

HISTORY OF LOSSES AND ANTICIPATED FUTURE LOSSES; UNCERTAINTY OF FUTURE
PROFITABILITY

As of November 30, 1996, the Company had a stockholders' deficiency of
$8.6 million, a working capital deficiency of approximately $22.6 million and a
negative current ratio of 1:2.5. The loss from operations for the quarter ended
November 30, 1996 was $1.0 million.

There can be no assurance that the Company will be able to achieve
profitability and maintain positive cash

26
<PAGE> 27
flows from operations or that profitability and positive cash flow from
operations can be sustained on an ongoing basis. Moreover, if achieved, the
level of that profitability or that positive cash flow cannot accurately be
predicted.

The Company's lack of profitability results also in its failing to
satisfy listing standards of the NYSE. No assurance can be made that the Common
Stock will continue to trade on the NYSE or that the Company can satisfy the
comparable requirements of any other stock exchange or the NASDAQ stock market.

NEED FOR ADDITIONAL FUNDS; UNCERTAINTY OF FUTURE FUNDING

The Company's negative cash flow from operations has consumed
substantial amounts of cash. Also, the Completion of the Exchange Offer of the
Debentures required substantial amounts of cash for the payment of up to $4.5
million of default interest and/or payment in exchange for surrender of
Debentures which resulted in a depletion of the Company's cash resources
(see Note 2 to the Company's Condensed Consolidated Financial Statements
included herein).

During prior fiscal years, a principal source of liquidity has been the
private sale of equity securities and debt securities convertible into equity.
Under the shareholder policies of the NYSE, the Company may not be able to
effect large placements of equity without shareholder approval, which, if not
obtained, may adversely affect the Company with respect to future capital
formation. In addition, issuance of additional equity securities by the Company
could result in substantial dilution to stockholders.

The Company has received tax refunds for fiscal 1995 and 1996 in the
amounts of $9.4 million and $5.4 million, respectively. Such refunds are based
on loss carrybacks under Section 172(f) of the Internal Revenue Code. Any IRS
claim for return of all or any portion thereof could have an adverse effect on
the Company's cash flows. The IRS payment of such refunds does not follow
confirmation of the validity thereof by the IRS. Section 172(f) is an area of
tax law without any significant legal precedents. Although the Company is
currently under audit by the IRS, no assurances can be made to the Company's
entitlement to such refunds.

DISPOSITION OF ASSETS

The Company has been required to dispose of various properties in order
to raise working capital, and no assurance can be made that such dispositions
will not have adverse effects on the Company's financial condition or that the
Company has additional assets that could be disposed of or utilized as
collateral in order to fund its capital requirements.

A secured promissory note has been issued by the Company aggregating
$2.0 million in principal amount, the collateral for which are two of the
Company's freestanding facilities.

TAXES

The Company has received tax refunds of approximately $9.4 million and
$5.4 million from the carry back of specified losses for fiscal 1995 and 1996,
respectively, as defined in Section 172(f). Receipt of the 1995 and 1996 tax
refunds does not imply IRS approval. The proceeds to the Company of the 1995
refund were reduced by a $2.5 million offset for the Company's outstanding
payroll tax obligation to the Internal Revenue Service ("IRS"), including
interest, pursuant to a settlement agreement relating to tax years 1983 through
1991. Also, $1.9 million and $1.1 million contingency fees were paid to Deloitte
& Touche, LLP from the refund proceeds for fiscal 1995 and 1996, respectively.
Section 172(f) is an area of the tax law without significant legal precedent.
There may be substantial opposition by the IRS to all or a substantial portion
of such claims, and no assurances can be made as to the ability to retain tax
refunds based on such deductions. Although the Company is currently being
audited by the IRS, neither the Company nor the IRS will be precluded in any
resultant tax audit from raising these and additional issues.

The Company may be unable to utilize some or all of its allowable tax
deductions or losses, which depends upon factors including the availability of
sufficient net income from which to deduct such losses during limited carryback
and carryover periods. Further, the Company's ability to use any Net Operating
Losses may be subject to limitation in the event that the Company issues or
agrees to issue substantial amounts of additional equity. The Company monitors
the potential for "change of ownership" and believes that its financing plans as
contemplated will not cause a "change of ownership;" however, no assurances can
be made that future events will not act to limit the Company's tax benefits.

27
<PAGE> 28
DEPENDENCE ON REIMBURSEMENT BY THIRD-PARTY PAYORS

The Company's ability to succeed in increasing revenues may depend in
part on the extent to which reimbursement of the cost of such treatment will be
available from government health administration authorities, private health
insurers and other organizations. Third-party payors are increasingly
challenging the price of medical products and services. As a result of
reimbursement changes and competitive pressures, the contractual obligations of
the Company have been subject to intense evaluation.

UNCERTAINTY OF PRICING; HEALTHCARE REFORM AND RELATED MATTERS

Managed care operations are at risk for costs incurred to supply agreed
upon levels of service. Failure to anticipate or control costs could materially
adversely affect the Company.

The levels of revenues and profitability of healthcare companies may be
affected by the continuing efforts of governmental and third party payors to
contain or reduce the costs of healthcare through various means. In the United
States, there have been, and the Company expects that there will continue to be,
a number of federal and state proposals to implement governmental controls on
the price of healthcare. It is uncertain what legislative proposals will be
adopted or what actions federal, state or private payors for healthcare goods
and services may take in response to any healthcare reform proposals or
legislation. The Company cannot predict the effect healthcare reforms may have
on its business, and no assurance can be given that any such reforms will not
have a material adverse effect on the Company.

SHARES ELIGIBLE FOR FUTURE SALE

As of November 30, 1996, the Company has issued or committed
approximately 249,912 shares for future issuances related to business
transactions, debt convertible or exchangeable into approximately 565,612
shares, and options or other rights to purchase approximately 1,174,725 shares
and contemplates issuing additional amounts of equity in private transactions.
Issuance of additional equity, and such shares becoming free of restrictions on
resale pursuant to Rule 144 or upon registration thereof pursuant to
registration rights granted on almost all of these shares, and additional sales
of equity, could adversely affect the trading prices of the Common Stock.

PRICE VOLATILITY IN PUBLIC MARKET

The securities markets have from time to time experienced significant
price and volume fluctuations that may be unrelated to the operating performance
of particular companies. Trading prices of securities of companies in the
healthcare and managed care sectors have experienced significant volatility.

ANTI-TAKEOVER PROVISIONS

The Company's Restated Certificate of Incorporation provides for 60,000
authorized shares of Preferred Stock, the rights, preferences, qualifications,
limitations and restrictions of which may be fixed by the Board of Directors
without any vote or action by the stockholders, which could have the effect of
diluting the Common Stock or reducing working capital that would otherwise be
available to the Company. The Company's Restated Certificate of Incorporation
also provides for a classified board of directors, with directors divided into
three classes serving staggered terms. In addition, the Company's stock option
plans generally provide for the acceleration of vesting of options granted under
such plans in the event of certain transactions which result in a change of
control of the Company. In addition, Section 203 of the General Corporation Law
of Delaware prohibits the Company from engaging in certain business combinations
with interested stockholders. In addition each share of the Company's Common
Stock includes one right on the terms, and subject to the conditions, of the
Rights Agreement between the Company and Continental Stock Transfer & Trust
Company. These provisions may have the effect of delaying or preventing a change
in control of the Company without action by the stockholders, and therefore
could adversely affect the price of the Company's Common Stock or the
possibility of sale of shares to an acquiring person.

CONTINUED LISTING ON NYSE

The Company has been below certain continued listing criteria of the
NYSE since prior to October 1994. The continued listing of the Company's Common
Stock on the NYSE is subject to continual review and possible delisting

28
<PAGE> 29
upon notices from the Listing and Compliance Committee of the NYSE.

CERTAIN CONDITIONS WHICH MAY IMPACT MARKET FOR COMPANY'S COMMON STOCK

The Company has determined, based upon inquiry made to the NYSE, that a
"short position" has existed with respect to the Company's Common Stock. This
"short position" has varied from time to time and the Company has been advised
that the net of "short position" as of December 31, 1996 was approximately
697,227 shares. The Company cannot predict the effect, if any, that such "short
position" may have on either the market or prices for the Company's Common
Stock.

ABILITY OF THE COMPANY TO CONTINUE AS A GOING CONCERN

The Company's independent auditors have included an explanatory
paragraph in their report that states that the Company's history of losses,
consolidated financial position and uncertainties resulting from the Company's
default in the terms of its Debentures raise substantial doubt about its ability
to continue as a going concern.

29
<PAGE> 30
PART II. - OTHER INFORMATION

ITEM 1. - LEGAL PROCEEDINGS

On October 30, 1992, the Company filed a complaint in the United States
District Court for the Eastern District of Missouri against RehabCare
Corporation ("RehabCare") seeking damages for violations by RehabCare of the
securities laws of the United States, for common law fraud and for breach of
contract (Case No. 4:92CV002194 CAS). The Company sought damages for the lost
benefit of certain stockholder appreciation rights in an amount in excess of
$3.6 million and punitive damages. RehabCare filed a counterclaim in the case
seeking a declaratory judgment with respect to the rights of both parties under
the Stock Redemption Agreement, an injunction enjoining the Company from taking
certain action under the Stock Redemption or Restated Shareholders Agreements
and damages in the form of attorneys' fees and costs allegedly incurred by
RehabCare with respect to its issuance of certain preferred stock and with
respect to prior litigation between the parties. The case was tried before a
jury commencing on February 21, 1995. Prior to the presentation of evidence to
the jury, the Court struck RehabCare's counterclaim in its entirety. On March 8,
1995, the jury returned its verdict awarding the Company $2,681,250 in damages,
plus interest and the costs of the action against RehabCare for securities fraud
and for breach of contract. RehabCare has posted a bond in the amount of $3.0
million and filed a motion for new trial or in the alternative, for judgment as
a matter of law, which the court denied in its entirety on August 4, 1995. On
September 1, 1995, RehabCare filed a notice of appeal with the District Court
indicating its intent to appeal the matter to the United States Court of
Appeals. RehabCare filed its first brief to set forth argument on January 29,
1996, the Company filed its brief on March 19, 1996 and RehabCare filed its
reply on April 6, 1996. Verbal argument was heard by the District Court in June
1996. On October 22, 1996, The U.S. Court of Appeals for the Eighth Circuit
reversed the judgment in favor of the Company and against RehabCare entered by
the District Court following the jury's verdict in favor of the Company. On
November 5, 1996, the Company filed a Petition for Rehearing with the Eighth
Circuit. Any effect from the outcome of this lawsuit will not have a material
adverse impact on the Company's results of operations.

30
<PAGE> 31
have not interposed their answers to the arbitration, and the arbitration is
therefore in its formative stages. The Company does not believe that the impact
of these claims will have a material adverse effect on the Company's financial
position, results of operations and cash flows.

ITEM 3. - DEFAULTS UPON SENIOR SECURITIES

See the discussion contained in the ninth paragraph under "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Liquidity and Capital Resources" for a discussion of the Company's default in
the payment of interest on its 7 1/2% Convertible Subordinated Debentures, the
acceleration thereof, and the affirmative consents of Debentureholders to waive
the default and acceleration.

In October 1994, the New York Stock Exchange, Inc. ("NYSE") notified
the Company that it was below certain quantitative and qualitative listing
criteria in regard to net tangible assets available to Common Stock and three
year average net income. The Listing and Compliance Committee of the NYSE has
determined to monitor the Company's progress toward returning to continuing
listing standards and has so indicated in approving the Company's most recent
Listing Application on December 30, 1996. Management believes, though no
assurance may be given, that the recent completion of the Company's Debenture
Exchange Offer will enable the Company to seek additional equity and thereby
satisfy the Committee of the Company's progress.

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

The results of the Company's Annual Shareholders' Meeting were reported
in the Company's Report on Form 8-K dated December 10, 1996.

ITEM 6. - EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

27 Financial Data Schedules (filed herewith).

(b) Reports on Form 8-K

1) The Company filed a current report on Form 8-K dated September 6,
1996, to report under Item 5, the Stock Purchase Agreement between
the Company and Healthcare Management Services, Inc. and three
sister corporations (hereafter referred to as "HMS") and the
commencement of arbitration with the Emerald Health Network, Inc.
and the sellers of HMS.

2) The Company filed a current report on Form 8-K dated October 15,
1996, to report under Item 5, the resignation of Ronald G. Hersch,
Ph.D., Vice President of Strategic Planning and Development.

3) The Company filed a current report on Form 8-K dated October 22,
1996, under Item 5, to report that the

31
<PAGE> 32
U.S. Court of Appeals for the 8th Circuit Court reversed the
judgment in favor of the Company and against RehabCare.

4) The Company filed a current report on Form 8-K dated November 18,
1996, under Item 5, to report that it had commenced an exchange
offer to the holders of its 7 1/2% Convertible Subordinated
Debentures due April 15, 2010.

32
<PAGE> 33
SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934,
the Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

COMPREHENSIVE CARE CORPORATION

January 14, 1997 By /s/ CHRISS W. STREET
--------------------------------
Chriss W. Street
President and
Chief Executive Officer
(Principal Executive Officer)

January 14, 1997 By /s/ KERRI RUPPERT
--------------------------------
Kerri Ruppert
Senior Vice President
and Chief Financial Officer
(Principal Financial Officer)
(Principal Accounting Officer)

33
<PAGE> 34
EXHIBIT INDEX

SECOND QUARTER ENDED NOVEMBER 30, 1996

EXHIBIT NO. DESCRIPTION

27 Financial Data Schedules (filed herewith).

<ARTICLE> 5
<MULTIPLIER> 1000
<CURRENCY> U.S. DOLLARS

<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> MAY-31-1997
<PERIOD-START> JUN-01-1996
<PERIOD-END> NOV-30-1996
<EXCHANGE-RATE> 1,000
<CASH> 7,578
<SECURITIES> 0
<RECEIVABLES> 3,274
<ALLOWANCES> 1,097
<INVENTORY> 0
<CURRENT-ASSETS> 14,893
<PP&E> 9,912
<DEPRECIATION> 3,624
<TOTAL-ASSETS> 30,640
<CURRENT-LIABILITIES> 37,465
<BONDS> 0
0
0
<COMMON> 31
<OTHER-SE> (8,604)
<TOTAL-LIABILITY-AND-EQUITY> 30,640
<SALES> 18,703
<TOTAL-REVENUES> 18,853
<CGS> 16,589
<TOTAL-COSTS> 21,133
<OTHER-EXPENSES> 236
<LOSS-PROVISION> 201
<INTEREST-EXPENSE> 596
<INCOME-PRETAX> (3,112)
<INCOME-TAX> (345)
<INCOME-CONTINUING> (2,767)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,767)
<EPS-PRIMARY> (0.96)
<EPS-DILUTED> (0.96)

</TABLE>