CAPSTONE PHARMACY SERVICES INC, 424B4, 1996-09-20

CAPSTONE PHARMACY SERVICES INC
424B4, 1996-09-20
DRUGS, PROPRIETARIES & DRUGGISTS' SUNDRIES

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<PAGE> 1
Filed Pursuant to Rule 424(b)(4)
Registration No. 333-08403

9,000,000 SHARES

CAPSTONE PHARMACY SERVICES [LOGO]

COMMON STOCK

All of the shares of Common Stock of Capstone Pharmacy Services, Inc. (the
"Company" or "Capstone") offered hereby (the "Offering") are being offered by
the Company. The Common Stock of the Company (the "Common Stock") is quoted on
The Nasdaq Stock Market's National Market (the "Nasdaq Stock Market") under the
symbol "DOSE." On September 16, 1996, the last sale price of the Company's
Common Stock as reported by the Nasdaq Stock Market was $12.625 per share.
---------------------

SEE "RISK FACTORS" BEGINNING ON PAGE 7 FOR CERTAIN FACTORS THAT SHOULD BE
CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK OFFERED HEREBY.
---------------------

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.

<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------
PRICE TO UNDERWRITING PROCEEDS TO
PUBLIC DISCOUNT(1) COMPANY(2)
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Share......................... $11.00 $.55> $10.45
- -------------------------------------------------------------------------------------------------
Total(3).......................... $99,000,000 $4,950,000 $94,050,000
- -------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------
</TABLE>

(1) See "Underwriting" for a description of the indemnification arrangements
with the Underwriters.
(2) Before deducting expenses of the Offering, payable by the Company, estimated
at $600,000.
(3) The Company has granted the Underwriters a 45-day over-allotment option to
purchase up to an additional 1,350,000 shares of Common Stock on the same
terms and conditions as set forth above, solely to cover over-allotments,
if any. If such option is exercised in full, the total Price to Public,
Underwriting Discount and Proceeds to Company will be $113,850,000,
$5,692,500 and $108,157,500, respectively. See "Underwriting."
---------------------

The Common Stock is offered by the several Underwriters named herein,
subject to prior sale, when, as and if delivered to and accepted by them and
subject to approval of certain legal matters by counsel for the Underwriters.
The Underwriters reserve the right to reject orders in whole or in part and to
withdraw, to cancel or to modify the offer without notice. It is expected that
delivery of certificates representing the Common Stock will be made on or about
September 24, 1996.

EQUITABLE SECURITIES CORPORATION
LEHMAN BROTHERS
BT SECURITIES CORPORATION
WHEAT FIRST BUTCHER SINGER
VOLPE, WELTY & COMPANY

The date of this Prospectus is September 18, 1996.
<PAGE> 2

COMBINED LOCATIONS MAP

[Map of the United States depicting Company locations.]

IN CONNECTION WITH THE OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS THAT STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK
OFFERED HEREBY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN
MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ NATIONAL MARKET, IN THE
OVER-THE-COUNTER MARKET OR OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE
DISCONTINUED AT ANY TIME.

IN CONNECTION WITH THE OFFERING CERTAIN UNDERWRITERS MAY ENGAGE IN PASSIVE
MARKET MAKING TRANSACTIONS IN THE COMMON STOCK ON THE NASDAQ STOCK MARKET IN
ACCORDANCE WITH RULE 10B-6A UNDER THE SECURITIES EXCHANGE ACT OF 1934, AS
AMENDED (THE "EXCHANGE ACT"). SEE "UNDERWRITING."

FOR UNITED KINGDOM PURCHASERS: The shares of Common Stock offered hereby
may not be offered or sold in the United Kingdom other than to persons whose
ordinary activities involve them in acquiring, holding, managing or disposing of
investments, whether as principal or agent (except in circumstances that do not
constitute an offer to the public in the United Kingdom within the meaning of
the Public Offers of Securities Regulations 1995) (except for purposes of their
business or otherwise) and this Prospectus may only be issued or passed on in
the United Kingdom to a person who is of a kind described in Article 11(3) of
the Financial Services Act 1986 (Investment Advertisements) (Exemptions) Order
1995 or is a person to whom this Prospectus may otherwise lawfully be passed on.

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<PAGE> 3

PROSPECTUS SUMMARY

The following summary is qualified in its entirety by reference to the more
detailed information and financial statements, including the notes thereto,
appearing elsewhere or incorporated by reference in this Prospectus. Investors
should carefully consider the information set forth under the heading "Risk
Factors." Except as otherwise indicated, all information presented assumes no
exercise of the Underwriters' over-allotment option. All references in this
Prospectus to the "Company" or "Capstone" refer to Capstone Pharmacy Services,
Inc., a Delaware corporation, and its subsidiaries.

THE COMPANY

Capstone is a leading provider of institutional pharmacy services to
long-term care facilities and correctional institutions throughout the United
States. On July 29, 1996, Capstone acquired the institutional pharmacy services
business of Symphony Pharmacy Services, Inc. ("Symphony"), a subsidiary of
Integrated Health Services, Inc. ("IHS"). The acquisition of Symphony (the
"Symphony Acquisition") increases the number of long-term care beds served by
Capstone from approximately 44,000 in seven states to approximately 84,000 in 13
states, making Capstone the second largest independent institutional pharmacy
company in the United States. Management believes the Symphony Acquisition is a
major strategic step in positioning Capstone as a leading provider of
institutional pharmacy services in numerous metropolitan markets nationwide. The
Symphony Acquisition significantly increases Capstone's client base and
geographic scope and establishes relationships between Capstone and IHS as well
as other large operators of long-term care facilities not previously served by
Capstone. In addition, management believes that Capstone's expanded national
presence will enable it to compete more effectively for larger customers who
operate multiple facilities while achieving purchasing efficiencies and other
economies of scale.

Capstone provides long-term care facilities with comprehensive
institutional pharmacy services that include the purchasing, repackaging and
dispensing of pharmaceuticals, infusion therapy and Medicare Part B services,
and pharmacy consulting services, all of which are supported by computerized
record keeping and third-party billing services. The Company serves its
long-term care clients primarily through regional pharmacies that are open 24
hours, seven days a week. By establishing regional pharmacies that each have the
capability to serve in excess of 10,000 patients, management believes that the
Company can provide a broader range of services to its long-term care clients on
a more cost-effective basis than many of its competitors. In the correctional
business, where it currently is the largest non-captive provider of pharmacy
services in the United States, the Company provides pharmaceuticals under
capitated contracts to correctional institutions that have privatized their
inmate health care services. Management believes the Company's experience in
managing capitated correctional contracts, which involves the utilization of
closed formularies, generic substitution, rigorous drug utilization review and
proactive physician education, will provide a significant competitive advantage
as managed care becomes more prevalent in the long-term care industry.

In connection with an investment by Counsel Corporation ("Counsel") in
December 1994, the Company installed a new management team, refocused its
operating strategy on its core institutional pharmacy business and initiated an
aggressive acquisition strategy. As a result of these efforts, the Company's net
sales increased to $107.1 million on a pro forma basis for the six months ended
June 30, 1996 from $23.1 million for the six months ended June 30, 1995.
Capstone's profitability also improved during the same time period, with income
from continuing operations of $4.6 million on a pro forma basis for the six
months ended June 30, 1996 compared to a loss from continuing operations of $3.0
million for the six months ended June 30, 1995.

Industry analysts estimate that the provision of institutional pharmacy
services is a $4.0 billion industry that is highly fragmented and undergoing
rapid consolidation. It is estimated that independent institutional pharmacy
companies such as Capstone currently serve approximately 43% of long-term care
facilities in the United States, while retail and in-house pharmacies serve
approximately 40% and 17%, respectively. The growth in institutional pharmacy
services, which is estimated to be 13% per year, is being driven in part by an
increase in the demand for nursing home beds, with occupancy projected to
increase from approximately 1.6 million residents in 1995 to approximately 2.3
million residents by the year 2000. While the majority of long-term care
facilities previously met their pharmaceutical needs through retail pharmacies,
the portion of

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the market served by institutional pharmacy services providers has increased as
long-term care facilities and third-party payors have recognized the need for
integrated, patient-specific pharmacy services. Increasing pressure by
governmental and private payors on acute care hospitals to discharge patients
into lower cost long-term care settings as early as possible has resulted in
those facilities having to treat higher acuity patients who require more
intensive clinical and pharmaceutical services. The Company believes long-term
care providers and payors recognize that sophisticated pharmacy services
represent the most cost-effective treatment for chronic patients who typically
reside in long-term care facilities. Management also believes the correctional
system demand for sophisticated pharmacy services is increasing due to the trend
toward privatization of prison health care services. As the market demand for
high-quality, cost-effective institutional pharmacy services is reinforced by
growth in managed care and correctional privatization, management believes that
many existing independent pharmacy providers will be increasingly receptive to
the prospect of consolidating with larger companies such as Capstone.

Capstone's strategy is to enhance its position as a leading provider of
institutional pharmacy services by: (i) acquiring institutional pharmacy
companies in metropolitan markets; (ii) achieving regional market density in
order to enhance its operating leverage; (iii) positioning itself as the
provider of choice to managed care payors in the markets in which it operates;
and (iv) emphasizing internal growth through the addition of new clients and the
expansion of ancillary services. Since the beginning of 1995, the Company has
focused on expanding operations in major metropolitan markets, concentrating
initially on the urban corridor from Baltimore to Boston and more recently
acquiring operations in Chicago. As a result of the Symphony Acquisition,
Capstone also operates in metropolitan markets including Los Angeles, Dallas,
New Orleans, Minneapolis-St. Paul and Tampa-St. Petersburg. Since December 31,
1994, Capstone has increased its long-term care bed count from approximately
16,200 to approximately 84,000 and the number of inmates served in correctional
institutions from approximately 65,000 to approximately 110,000. Growth in the
Company's long-term care business has been achieved through acquisitions in both
existing and new markets and through internal growth, and growth in Capstone's
correctional business has been achieved solely through the addition of new
capitated contracts.

SYMPHONY ACQUISITION

On July 29, 1996, the Company acquired Symphony from IHS. Symphony provides
institutional pharmacy services to approximately 445 long-term care facilities
containing approximately 40,000 beds, with approximately 20% of those beds
located in facilities affiliated with IHS. The Symphony purchase price was
comprised of $125 million in cash and $25 million in Common Stock. Capstone
financed the cash portion of the Symphony Acquisition with a $25 million
investment by Counsel and the proceeds from a $100 million bridge loan (the
"Bridge Loan").

RECENT DEVELOPMENTS

Since the closing of the Symphony Acquisition, Capstone has entered into
preferred provider agreements with Community Care of America, Inc. ("CCA"),
Retirement Care Associates Inc. ("RCA") and EMI Enterprises, Inc. ("EMI").
Pursuant to these agreements, Capstone has the right, subject to various terms
and conditions, to provide certain institutional pharmacy services to CCA, RCA
and EMI. These companies currently operate an aggregate of approximately 17,700
beds.

Capstone recently entered into a letter agreement to purchase substantially
all of the assets of an institutional pharmacy company located in Tennessee. In
addition Capstone recently entered into a letter of intent to purchase
substantially all of the assets of an institutional pharmacy company located in
Florida. These companies service approximately 3,500 and 900 beds, respectively.

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THE OFFERING

Common Stock offered by the
Company............................. 9,000,000 shares

Common Stock to be outstanding after
the Offering........................ 29,714,889 shares(1)

Use of proceeds..................... To repay the Bridge Loan in part, to
repay in full or in part other
outstanding indebtedness and for
general corporate purposes, which may
include potential future acquisitions.
See "Use of Proceeds."

Nasdaq Stock Market symbol.......... DOSE
- ---------------

(1) Excludes vested and unvested stock options to purchase 1,857,000 shares of
Common Stock and outstanding warrants to purchase 4,013,344 shares of
Common Stock.

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SUMMARY CONSOLIDATED FINANCIAL DATA
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY TEN MONTHS PRO FORMA SIX MONTHS ENDED JUNE 30,
28, ENDED YEAR ENDED ------------------------------------
--------------------- DECEMBER 31, DECEMBER 31, PRO FORMA
1994 1995 1995 1995(1) 1995 1996 1996(1)
--------- --------- ------------ ------------ --------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Net sales............... $ 51,254 $ 43,608 $ 48,841 $ 191,816 $ 23,140 $ 46,147 $ 107,141
Cost of sales........... 32,441 27,970 30,654 109,244 14,847 28,846 61,119
--------- --------- ------------ ------------ --------- ---------- ----------
Gross profit.......... 18,813 15,638 18,187 82,572 8,293 17,301 46,022
Total operating
expenses.............. 18,741 26,084 18,855 79,052 11,278 15,861 39,544
--------- --------- ------------ ------------ --------- ---------- ----------
Income (loss) from
operations............ 72 (10,446) (668) 3,520 (2,985) 1,440 6,478
Income (loss) from
continuing
operations............ (521) (10,781) (645) 518 (2,961) 779 4,598
Fully diluted income
(loss) from continuing
operations per
share................. $ (0.08) $ (1.67) $ (0.05) $ 0.02(2) $ (0.35) $ 0.04(3) $ 0.14(2)
Fully diluted weighted
average shares
outstanding........... 6,071,687 6,458,891 12,398,401 27,666,073 8,505,854 18,264,102 32,092,832
</TABLE>

<TABLE>
<CAPTION>
JUNE 30, 1996
----------------------------
PRO FORMA
ACTUAL AS ADJUSTED(4)
------- --------------
<S> <C> <C>
BALANCE SHEET DATA:
Working capital.......................................................... $23,513 $ 37,760
Total assets............................................................. 69,776 245,322
Long-term debt........................................................... 19,785 35,325
Stockholders' equity..................................................... 41,030 181,480
</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31,
------------------ PRO FORMA
1994 1995 JUNE 30, 1996(4)
------ ------- -----------------
<S> <C> <C> <C>
STATISTICAL DATA:
Long-term care pharmacy beds served at period-end.................. 16,200 34,218 83,532
Correctional inmates served at period-end.......................... 63,658 112,956 109,721
</TABLE>

- ---------------

(1) Pro forma to give effect to the Company's acquisitions of Premier Pharmacy,
Inc. ("Premier") in May 1995, Geri-Care Systems, Inc. and Scripts & Things,
Inc. ("Geri-Care") in January 1996, IMD Corporation ("IMD") in February
1996, DCMed, Inc. (DCMed, Inc. is the parent company of Medidyne Corp. and
is referred to hereinafter, together with Medidyne Corp., as "Medidyne") in
July 1996 and the Symphony Acquisition, as well as the Offering at a public
offering price of $11.00 per share, as if all had occurred on January 1 of
each respective period, if applicable. See "Pro Forma Unaudited Consolidated
Financial Data."
(2) No federal tax provision has been reflected due to assumed utilization of
federal net operating loss carryforwards. If those carryforwards were not
available, pro forma fully diluted income from continuing operations per
share for the year ended December 31, 1995 and the six months ended June 30,
1996 would have been $0.01 and $0.09, respectively.
(3) The Company was able to utilize net operating loss carryforwards to offset
federal income taxes during the period. If these net operating loss
carryforwards were not available, fully diluted income from continuing
operations per share would have been $0.03.
(4) Pro forma to give effect to the Symphony Acquisition, the Medidyne
acquisition and the Offering at a public offering price of $11.00 per share
as if all had occurred as of June 30, 1996. See "Pro Forma Unaudited
Consolidated Financial Data."

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RISK FACTORS

In evaluating the Company and its business, prospective investors should
carefully consider the following factors in addition to those discussed
elsewhere or incorporated by reference in this Prospectus. Information contained
or incorporated by reference in this Prospectus may contain "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995, which can be identified by the use of forward-looking terminology such
as "may," "will," "expect," "anticipate," "estimate" or "continue", or the
negative thereof, or other variations thereon or comparable terminology. The
following matters constitute cautionary statements identifying important factors
with respect to any such forward-looking statements, including certain risks and
uncertainties, that could cause actual results to differ materially from those
reflected in any such forward-looking statements.

NO ASSURANCE OF SUCCESSFUL INTEGRATION OF ACQUISITIONS. The Symphony
Acquisition approximately doubles the number of beds served by the Company, the
number of Company employees and the Company's net sales in 1996. The Company has
made four significant acquisitions in 1996, including the Symphony Acquisition.
The integration of all of the acquisitions is critical to the Company's success.
Potential obstacles to successful integration include, but are not limited to:
cost containment; elimination of redundancies at the corporate and field level;
consolidation of financial and managerial reporting functions; coordination of
field managerial activities with corporate management; achievement of purchasing
efficiencies; expansion of the customer base of the combined entity; roll-out of
new products and services to acquired facilities; and addition and integration
of key personnel. There can be no assurance that Symphony or any other
acquisition will be integrated successfully into the Company's operations or
will not have a material adverse effect upon the Company's results of
operations, financial condition or prospects. In addition, there can be no
assurance that the Symphony Acquisition or any other acquisition will achieve
net sales and earnings that justify the Company's investment therein or expenses
related thereto.

MANAGEMENT OF GROWTH; DEPENDENCE ON KEY PERSONNEL. In addition to growth
resulting from the Symphony Acquisition, the Company has experienced growth that
has placed, and is likely to continue to place, significant pressure on its
management resources. The Company's successful implementation of its growth
strategy depends upon its ability to attract and retain qualified corporate,
financial, clinical, operating and regional management personnel. The loss of
the services of one or more of the Company's key executives, could have a
material adverse effect on the Company's results of operations, financial
condition or prospects. The Company does not have employment agreements with
certain of its key executives. There can be no assurances that the Company will
be able to attract and retain sufficient numbers of qualified personnel.

DEPENDENCE ON ACQUISITIONS FOR GROWTH. A significant component of the
Company's historical growth has come through acquisitions of institutional
pharmacy companies, and the success of the Company's growth strategy is
dependent on additional acquisitions. The Company will compete for acquisition
candidates with buyers who may have greater financial and other resources than
the Company and may be able to pay higher acquisition prices than the Company.
No assurance can be given that the Company will be able to identify suitable
acquisition candidates or to consummate acquisitions on terms acceptable to the
Company. To the extent that the Company is unable to acquire institutional
pharmacy companies, or to integrate such acquisitions successfully, its ability
to expand its business would be reduced significantly. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources" and "Business -- Growth
Strategy."

GROWTH STRATEGY; NEED FOR ADDITIONAL FINANCING. In order to implement its
growth strategy, the Company will require substantial capital resources and will
need to incur, from time to time, additional bank indebtedness. The Company also
may need to issue equity or debt securities, in public or private transactions,
the terms of which will depend on market and other conditions. There can be no
assurance that any such additional financing will be available on terms
acceptable to the Company if at all. As a result, the Company may not be able to
implement fully its growth strategy. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Liquidity and Capital
Resources."

NASDAQ STOCK MARKET NET TANGIBLE ASSET CRITERIA. In order for the Nasdaq
Stock Market to continue to quote prices for the Company's Common Stock, the
Company must maintain a certain minimum level of

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net tangible assets. The calculation of net tangible assets excludes the value
of goodwill, which typically represents a substantial part of the assets
acquired by the Company, insofar as most institutional pharmacy companies
maintain relatively low levels of fixed assets. Should the Company continue to
acquire substantial goodwill and/or increase its liabilities without increasing
its stockholders' equity, it may, from time to time, fail to comply with
Nasdaq's net tangible asset criteria. Such failure, if not remedied, could
result in the Company's Common Stock no longer being quoted on the Nasdaq Stock
Market. Such a result could have a material adverse effect on the liquidity and
price of the Company's Common Stock.

LIMITED HISTORY OF PROFITABILITY. The Company has incurred net losses in
its last three fiscal years. For the years ended February 28, 1995 and 1994,
losses from continuing operations were approximately $10.8 million and $521,000,
respectively, and for the ten months ended December 31, 1995, the Company had a
loss from continuing operations of approximately $645,000. While the Company has
been profitable for the past four consecutive quarters, there can be no
assurance that it will continue to be profitable in the future. See "Selected
Historical Consolidated Financial Data" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations."

DEPENDENCE ON REIMBURSEMENT BY THIRD-PARTY PAYORS. The Company derives,
directly or indirectly, a majority of its net sales from government-sponsored
reimbursement programs. The Company's net sales and profitability are, and will
continue to be, affected by the efforts of all payors to contain or reduce the
costs of health care by lowering reimbursement rates, narrowing the scope of
covered services, increasing case management review of service, and negotiating
reduced contract pricing. Any changes in reimbursement levels under Medicare,
Medicaid, or private pay programs, including managed care contracts, could have
a material adverse effect on the Company's results of operations, financial
condition and prospects. Changes in the mix of patients among Medicare, Medicaid
and different types of private pay sources may adversely affect the Company's
net sales and profitability. See "Business -- Reimbursement."

HEALTH CARE REFORM. The health care industry is subject to changing
political, economic and regulatory influences that may affect the institutional
pharmacy industry. In recent years, several comprehensive national health care
reform proposals were introduced in the United States Congress. While none of
the proposals were adopted, health care reform may again be addressed by the
United States Congress. Several states also are considering health care reforms
through Medicaid managed care demonstration projects. Although these projects
generally exempt institutional pharmacy services and long-term care facilities,
no assurance can be given that such projects or other proposals will not change
the Medicaid reimbursement system in a manner that would affect the Company's
operations. The Company cannot predict which, if any, federal or state
modifications or reform proposals will be adopted, when they may be adopted or
what their impact on the Company may be if adopted. There can be no assurance
that the adoption of certain modifications or proposals will not have a material
adverse effect on the Company's results of operations, financial condition or
prospects. See "Business -- Government Regulation."

ROLE OF MANAGED CARE. As managed care assumes an increasingly significant
role in the health care industry, Capstone's future success will, in part, be
dependent on obtaining and retaining managed care contracts. Competition for
such contracts is intense and, in most cases, will require Capstone to compete
based on breadth of services offered, pricing, ability to track and report
patient outcomes and cost data and provision of value-added pharmacy consulting
services, among other factors. In addition, reimbursement rates under managed
care contracts typically are significantly lower than those paid by other
private third-party payors. There can be no assurance that the Company will
retain or continue to obtain such managed care contracts or that the managed
care contracts it obtains will be on terms as favorable to the Company as those
of its current managed care and other contracts. See "Business -- Growth
Strategy."

COMPETITION. The long-term care pharmacy markets in which Capstone
operates are highly fragmented, and the majority of competition in such markets
comes from small to mid-size local operators whose primary advantage is market
familiarity. Capstone's competition in the correctional pharmacy market comes
primarily from other large providers. Management believes that the primary
competitive factor in its industry is breadth and quality of service. Additional
competitive factors include reputation, ease of doing business with

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the specific providers, ability to develop and to maintain relationships with
referral sources and competitive pricing. Some of the Company's present and
potential competitors are significantly larger than Capstone and have, or may
obtain, greater financial and marketing resources than Capstone. See
"Business -- Competition."

GOVERNMENT REGULATION. Capstone is subject to extensive federal, state and
local regulation. Federal laws governing the Company's activities include
regulations covering the repackaging, storing and dispensing of drugs, Medicare
reimbursement and certification, and certain financial relationships with
physicians and other health care providers. Capstone is subject to state laws
governing Medicaid, professional training, pharmacy licensure, payment of
remuneration in exchange for patient referrals and the dispensing and storage of
pharmaceuticals. The pharmacies operated by the Company must comply with all
applicable laws, regulations and licensing standards. Many of the Company's
employees must maintain certain licenses in order to provide services. The
long-term care facilities which contract for the Company's pharmacy services are
also subject to federal, state and local regulations and are required to be
licensed in the states in which they are located. The failure by these
institutions to comply with such regulations or to obtain or renew any required
licenses could result in the loss of the Company's ability to provide pharmacy
services to their residents. There can be no assurance that federal, state or
local governments will not change existing standards or impose additional
standards, compliance with which may require the Company to incur additional
expense. Any significant additional expense incurred in connection with such
compliance or any failure to comply with existing or future standards could have
a material adverse effect upon Capstone's results of operation, financial
condition or prospects. See "Business -- Government Regulation."

INFLUENCE OF PRINCIPAL STOCKHOLDER. Upon completion of the Offering the
Company's principal stockholder, Counsel and its affiliates will beneficially
own approximately 27.9% of the outstanding shares of the Common Stock of the
Company (26.8% if the Underwriters' over-allotment option is exercised in full).
As a condition of Counsel's initial investment in Capstone, the Company agreed
contractually to use its good faith efforts to have elected as directors up to
four Counsel nominees, subject to certain conditions. As a result of its equity
ownership in the Company and its nominees on the Company's Board of Directors,
Counsel can significantly influence the management and policies of the Company,
including the election of the Company's directors and the outcome of matters
submitted to stockholders of the Company for approval. See "Security Ownership
of Directors, Executive Officers and Principal Holders."

SHARES ELIGIBLE FOR FUTURE SALE. Upon completion of the Offering, and
assuming no exercise of the Underwriters' over-allotment option, the Company
will have 29,714,889 shares of Common Stock outstanding. Of these shares,
20,448,747 will be freely tradeable and the remaining 9,266,142 will be
"restricted securities" as that term is defined in Rule 144 promulgated under
the Securities Act. Of these restricted securities, 8,132,579 shares are subject
to certain "piggyback" and demand registration rights that are currently
exercisable, and 1,035,000 shares are subject to certain currently exercisable
"piggyback" registration rights and to certain demand rights that are
exercisable beginning in October 1996. An additional 1,857,000 shares are
issuable upon the exercise of outstanding stock options, and 4,013,344 shares
are issuable upon the exercise of certain outstanding warrants. Upon the
exercise of such options and warrants, 3,443,618 of these shares will be freely
tradeable, and the remainder will be restricted securities. Of these restricted
securities, 2,336,726 shares are subject to certain demand and piggyback
registration rights that are currently exercisable. Holders of 11,962,944 shares
of Common Stock outstanding or underlying outstanding warrants have agreed not
to sell any of such shares for a period of 120 days after the date of this
Prospectus without the prior written consent of the representatives of the
Underwriters. Following the Offering, sales of substantial amounts of the
Company's Common Stock in the public market pursuant to Rule 144 or otherwise,
or the potential of such sales, could adversely affect the prevailing market
price for the Common Stock and impair the Company's ability to raise additional
capital through the sale of equity securities. See "Description of Capital
Stock -- Shares Eligible for Future Sale."

LIABILITY AND ADEQUACY OF INSURANCE. The provision of health care services
entails an inherent risk of liability. Capstone currently maintains product and
professional liability insurance intended to cover such claims in amounts which
it believes are consistent with industry standards. There can be no assurance
that claims in excess of the insurance coverage or claims not covered by
insurance will not arise. A successful claim

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<PAGE> 10

in excess of its insurance coverage could have a material adverse effect upon
the Company's results of operations, financial condition and future prospects.
Claims, regardless of their merit or eventual outcome, may also have a material
adverse effect upon Capstone's ability to attract customers, to maintain its
insurance policies or to expand its business. There can be no assurance that
Capstone will be able to obtain liability insurance coverage in the future on
acceptable terms, if at all.

USE OF PROCEEDS

The net proceeds to the Company from the sale of 9,000,000 shares of the
Common Stock, at a public offering price of $11.00 per share, are estimated to
be approximately $93.5 million after deduction of underwriting discounts,
commissions and estimated offering expenses (or approximately $107.6 million if
the over-allotment option is exercised in full). The Company intends to use the
net proceeds to repay the Bridge Loan in part (or in full if the over-allotment
option is exercised in full). As of August 16, 1996, amounts outstanding under
the Bridge Loan were approximately $100.0 million. The Bridge Loan bears
interest at a floating interest rate of LIBOR plus a margin ranging from 6.0% to
6.25%. The Bridge Loan, if not paid by July 30, 1997, will convert to a term
loan with a nine year maturity bearing a floating interest rate of the nine-year
treasury rate in effect from time to time plus 6.5%. The remaining net proceeds,
if any, will be used to repay in whole or in part other indebtedness and for
general working capital purposes, including potential future acquisitions.

Pending the above uses, such net proceeds will be placed in short-term,
interest-bearing, investment-grade securities, certificates of deposit or direct
or guaranteed obligations of the United States of America.

DIVIDEND POLICY

The Company has never declared or paid a cash dividend on its Common Stock
and does not anticipate paying any cash dividends in the foreseeable future. In
addition, the Company's revolving credit facility prohibits the payment of
dividends as long as there is indebtedness outstanding.

10
<PAGE> 11

CAPITALIZATION

The following table sets forth the short-term indebtedness and consolidated
capitalization (unaudited) of the Company (i) as of June 30, 1996, (ii) pro
forma to give effect to the acquisitions of Symphony and Medidyne as if they had
occurred as of June 30, 1996 and (iii) pro forma as adjusted to give effect to
the Offering at a public offering price of $11.00 per share and the application
of the net proceeds therefrom as set forth under "Use of Proceeds." This table
should be read in conjunction with the Company's Consolidated Financial
Statements and related notes appearing elsewhere in this Prospectus.

<TABLE>
<CAPTION>
JUNE 30, 1996
--------------------------------------------
PRO FORMA
ACTUAL PRO FORMA(1) AS ADJUSTED
-------- ------------ --------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Short-term indebtedness............................... $ -- $ 100,000 $ --
======== ========== ===========
Long-term debt and capital leases, net of current
portion............................................. $ 19,785 $ 28,775 $ 35,325
-------- ------------ --------------
Stockholders' equity:
Common stock, $0.01 par value; 30,000,000 shares
authorized; 15,836,565 shares issued and
15,498,103 outstanding; 19,723,083 outstanding
pro forma; 28,723,083 outstanding pro forma, as
adjusted......................................... 155 197 287
Capital in excess of par......................... 52,378 102,336 195,696
Accumulated deficit.............................. (11,503) (14,503) (14,503)
-------- ------------ --------------
Total stockholders' equity.................. 41,030 88,030 181,480
-------- ------------ --------------
Total capitalization................... $ 60,815 $ 116,805 $ 216,805
======== ========== ===========
</TABLE>

- ---------------

(1) Reflects the pro forma capitalization prior to the Offering after giving
effect to (i) the Symphony Acquisition, (ii) the Bridge Loan and (iii) the
Medidyne acquisition. See "Pro Forma Unaudited Consolidated Financial
Data."

11
<PAGE> 12

SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

The following selected financial data for the years ended February 28, 1994
and 1995, and the ten months ended December 31, 1995 are derived from the
audited consolidated financial statements of the Company. The financial data for
the six months ended June 30, 1996 and 1995 are derived from unaudited financial
statements. The unaudited financial statements include all adjustments,
consisting of normal recurring items, which the Company considers necessary for
a fair presentation of the financial position and the results of operations for
these periods. Operating results for the six months ended June 30, 1996 are not
necessarily indicative of the results that may be expected for the entire year
ending December 31, 1996. The data should be read in conjunction with the
Company's Consolidated Financial Statements, related notes and other financial
information included in this Prospectus.

<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY TEN MONTHS SIX MONTHS ENDED JUNE
28, ENDED 30,
--------------------- DECEMBER 31, ----------------------
1994 1995 1995 1995 1996
--------- --------- ------------ --------- ----------
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Net sales.............................. $ 51,254 $ 43,608 $ 48,841 $ 23,140 $ 46,147
Cost of sales.......................... 32,441 27,970 30,654 14,847 28,846
--------- --------- ------------ --------- ----------
Gross profit................. 18,813 15,638 18,187 8,293 17,301
--------- --------- ------------ --------- ----------
Operating expenses:
Selling, general and
administrative expenses......... 17,241 18,637 17,469 8,651 14,453
Depreciation and amortization..... 1,037 989 1,146 563 1,162
Costs relating to pharmacy
closure......................... -- -- -- -- 246
Costs in connection with
litigation...................... 463 4,389 -- -- --
Restructuring charges............. -- 2,069 240 2,064 --
--------- --------- ------------ --------- ----------
Total operating expenses..... 18,741 26,084 18,855 11,278 15,861
--------- --------- ------------ --------- ----------
Income (loss) from
operations................. 72 (10,446) (668) (2,985) 1,440
Total non-operating expense, net....... 644 801 202 95 589
--------- --------- ------------ --------- ----------
Income (loss) before income taxes...... (572) (11,247) (870) (3,080) 851
Provision (benefit) for income taxes... (51) (466) (225) (119) 72
--------- --------- ------------ --------- ----------
Income (loss) from continuing
operations................. $ (521) $ (10,781) $ (645) $ (2,961) $ 779
======== ======== ========== ======== =========
Fully diluted income (loss) from
continuing operations per share...... $ (0.08) $ (1.67) $ (0.05) $ (0.35) $ 0.04
======== ======== ========== ======== =========
Fully diluted weighted average shares
outstanding.......................... 6,071,687 6,458,891 12,398,401 8,505,854 18,264,102
</TABLE>

<TABLE>
<CAPTION>
FEBRUARY 28,
-------------------
1994 1995 DECEMBER 31, 1995 JUNE 30, 1996
------- ------- ----------------- --------------
<S> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital.......................... $ 1,931 $ 5,909 $10,814 $ 23,513
Total assets............................. 24,360 19,212 42,131 69,776
Long-term debt, less current portion..... 2,358 7,650 2,692 19,785
Stockholders' equity..................... 8,316 4,778 26,840 41,030
</TABLE>

12
<PAGE> 13

PRO FORMA UNAUDITED CONSOLIDATED FINANCIAL DATA

The following pro forma financial data may not be indicative of the future
results of operations or what the actual results of operations would have been
had the transactions described previously actually been effective January 1 of
each respective period. The following pro forma financial data are presented on
a condensed and annualized basis. See the Company's Form 8-K dated July 30,
1996, as amended by Form 8-K/A, for additional pro forma information.

PRO FORMA INCOME STATEMENT DATA
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1995
-------------------------------------------------------
ACQUIRED
ACTUAL(1) OPERATIONS(2) ADJUSTMENTS PRO FORMA
---------- ------------- ----------- ----------
<S> <C> <C> <C> <C>
Net sales.................................. $ 55,894 $ 135,922 $ -- $ 191,816
Cost of sales.............................. 35,182 74,062 -- 109,244
---------- ------------- ----------- ----------
Gross profit............................. 20,712 61,860 -- 82,572
---------- ------------- ----------- ----------
Operating expenses:
Selling, general and administrative
expenses.............................. 20,031 49,718 -- 69,749
Depreciation and amortization............ 1,352 3,318 2,324(3) 6,994
Restructuring charges.................... 2,309 -- -- 2,309
---------- ------------- ----------- ----------
Total operating expenses......... 23,692 53,036 2,324 79,052
---------- ------------- ----------- ----------
Income (loss) from operations.............. (2,980) 8,824 (2,324) 3,520
---------- ------------- ----------- ----------
Non-operating expense, net:
Interest expense, net.................... 776 3,042 (347)(4) 3,471
Other income............................. (475) (36) -- (511)
---------- ------------- ----------- ----------
Total non-operating expense,
net............................ 301 3,006 (347) 2,960
---------- ------------- ----------- ----------
Income (loss) before income taxes.......... (3,281) 5,818 (1,977) 560
Provision (benefit) for income taxes....... (344) 1,767 (1,381)(5) 42
---------- ------------- ----------- ----------
Income (loss) from continuing operations... $ (2,937) $ 4,051 $ (596) $ 518
========= ========== ========= =========
Fully diluted income (loss) from continuing
operations per share..................... $ 0.02
=========
Pro forma weighted average number of shares 27,666,073 (16)
outstanding..............................
</TABLE>

- ---------------

(1) Reflects the Company's actual results of operations for the ten months ended
December 31, 1995 plus results of operations for January and February 1995.
(2) Reflects the acquisitions of Premier, Geri-Care, IMD, Medidyne and the
Symphony Acquisition as if they had been completed on January 1, 1995.
(3) Reflects the additional amortization of goodwill related to the Premier,
Geri-Care, IMD and Medidyne acquisitions and the Symphony Acquisition over
a period of 40 years.
(4) Reflects the net effect of (i) a reduction of interest expense incurred by
Symphony on debt which will not be assumed by Capstone as part of the
Symphony Acquisition, (ii) an increase in interest expense related to an
assumed $6.5 million portion of the Bridge Loan not repaid by the Offering
and the long-term debt incurred to finance the Bridge Loan Fees and (iii)
additional interest expense on the long-term debt related to the IMD and
Medidyne acquisitions, at an annual interest rate of 7.5%.
(5) Reflects an adjustment to the provision for income taxes to reflect an
effective state tax rate of 7.5%. No federal tax provision has been
reflected due to assumed full utilization of federal net operating loss
carryforwards.
(6) Reflects the fully diluted weighted average number of shares outstanding for
the ten months ended December 31, 1995 plus (i) 1,007,692 shares issued in
conjunction with the Geri-Care acquisition, (ii) 1,035,000 shares issued at
a price of $8.50 per share in a private placement consummated on April 18,
1996 (the "April 1996 Private Placement"), (iii) 4,224,980 shares issued to
IHS and Counsel in conjunction with the Symphony Acquisition and (iv)
9,000,000 shares contemplated by the Offering at a price of $11.00 per
share.

13
<PAGE> 14

PRO FORMA UNAUDITED CONSOLIDATED FINANCIAL DATA

PRO FORMA INCOME STATEMENT DATA
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30, 1996
---------------------------------------------------------
ACQUIRED
ACTUAL OPERATIONS(1) ADJUSTMENTS PRO FORMA
----------- ------------- ----------- -----------
<S> <C> <C> <C> <C>
Net sales.................................. $ 46,147 $ 60,994 $ -- $ 107,141
Cost of sales.............................. 28,846 32,273 -- 61,119
----------- ------------- ----------- -----------
Gross profit............................. 17,301 28,721 -- 46,022
Operating expenses:
Selling, general and administrative
expenses.............................. 14,452 21,268 -- 35,720
Depreciation and amortization............ 1,162 1,431 985(2) 3,578
Costs relating to pharmacy closure....... 246 -- -- 246
Restructuring charges.................... -- -- -- --
----------- ------------- ----------- -----------
Total operating expenses................. 15,860 22,699 985 39,544
----------- ------------- ----------- -----------
Income from operations..................... 1,441 6,022 (985) 6,478
----------- ------------- ----------- -----------
Non-operating expense, net:
Interest expense, net.................... 685 1,262 (484)(3) 1,463
Other income............................. (95) 139 -- 44
----------- ------------- ----------- -----------
Total non-operating expense,
net............................ 590 1,401 (484) 1,507
----------- ------------- ----------- -----------
Income (loss) before income taxes.......... 851 4,621 (501) 4,971
Provision for income taxes................. 72 1,581 (1,280)(4) 373
----------- ------------- ----------- -----------
Income from continuing operations.......... $ 779 $ 3,040 $ (779) $ 4,598
========== ========== ========= ==========
Fully diluted income from continuing
operations per share..................... $ 0.04 $ 0.14
========== ==========
Pro forma weighted average number of common
shares outstanding....................... 18,264,102 32,092,832(5)
</TABLE>

- ---------------

(1) Reflects the acquisitions of IMD and Medidyne and the Symphony Acquisition
as if they had occurred on January 1, 1996.
(2) Reflects the additional amortization of goodwill related to the IMD and
Medidyne acquisitions and the Symphony Acquisition over a period of 40
years.
(3) Reflects the net effect of (i) a reduction of interest expense incurred by
Symphony on debt which will not be assumed by Capstone as part of the
Symphony Acquisition, (ii) an increase in interest expense related to an
assumed $6.5 million portion of the Bridge Loan not repaid by the Offering
and the long-term debt incurred to finance the Bridge Loan fees and (iii)
additional interest expense on the long-term debt related to the IMD and
Medidyne acquisitions at an annual interest rate of 7.5%.
(4) Reflects the adjustment to pro forma provision for income taxes to reflect
an effective state tax rate of 7.5%. No federal tax provision has been
reflected due to assumed utilization of federal net operating loss
carryforwards.
(5) Reflects the fully diluted weighted average number of shares outstanding for
the six months ended June 30, 1996 plus (i) the impact of the 1,035,000
shares of Common Stock issued in the April 1996 Private Placement as if it
had occurred on January 1, 1996, (ii) 4,224,980 shares issued to IHS and
Counsel in connection with the Symphony Acquisition and (iii) the 9,000,000
shares contemplated by this Offering at a price of $11.00 per share.

14
<PAGE> 15

PRO FORMA UNAUDITED CONSOLIDATED FINANCIAL DATA

PRO FORMA BALANCE SHEET DATA
(DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
JUNE 30, 1996
-----------------------------------------------------
ACQUIRED
ACTUAL OPERATIONS(1) ADJUSTMENTS PRO FORMA
-------- ------------- ----------- ---------
<S> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents.................... $ 1,392 $ 768 $ -- $ 2,160
Accounts receivable, net of allowance for
doubtful accounts......................... 21,082 25,962 -- 47,044
Inventories.................................. 7,408 5,916 -- 13,324
Other current assets......................... 1,442 1,157 -- 2,599
-------- ------------- ----------- ---------
Total current assets................. 31,324 33,803 -- 65,127
Property, equipment and other assets........... 4,610 9,981 -- 14,591
Goodwill, net of accumulated amortization...... 33,842 54,965 76,797(2) 165,604
-------- ------------- ----------- ---------
Total assets......................... $ 69,776 $ 98,749 $ 76,797 $ 245,322
======== ========== ========= ========
Current liabilities:
Accounts payable............................. $ 3,338 $ 8,091 $ 500 $ 11,929
Other current liabilities.................... 4,473 10,965 -- 15,438
-------- ------------- ----------- ---------
Total current liabilities............ 7,811 19,056 500 27,367
-------- ------------- ----------- ---------
Other long-term liabilities.................... 1,150 -- -- 1,150
Long-term debt, net of current portion......... 19,785 41,756 (26,216)(3) 35,325
-------- ------------- ----------- ---------
20,935 41,756 (26,216) 36,475
-------- ------------- ----------- ---------
Stockholders' equity:
Common stock and capital in excess of par.... 52,533 30,761 112,689(4) 195,983
Retained earnings (accumulated deficit)...... (11,503) 7,176 (10,176)(5) (14,503)
-------- ------------- ----------- ---------
41,030 37,937 102,513 181,480
-------- ------------- ----------- ---------
Total liabilities and stockholders'
equity............................. $ 69,776 $ 98,749 $ 76,797 $ 245,322
======== ========== ========= ========
</TABLE>

- ---------------

(1) Reflects the acquisition of Medidyne and the Symphony Acquisition as if they
had occurred as of June 30, 1996.
(2) Reflects the additional goodwill recorded as part of the Medidyne
acquisition and the Symphony Acquisition as part of the purchase price
allocations.
(3) Reflects the net effect of (i) the additional long-term debt incurred
related to the Medidyne acquisition, (ii) a reduction of long-term debt on
the books of Symphony at June 30, 1996, which is not being assumed by
Capstone, (iii) an increase in long-term debt related to an assumed $6.5
million portion of the Bridge Loan not repaid by the Offering and (iv) the
additional long-term debt incurred to finance the $3.0 million in fees
relating to the Bridge Loan.
(4) Reflects $50.0 million of additional equity raised in connection with the
Symphony Acquisition and $93.5 million in estimated net proceeds from the
Offering (assuming no exercise of the Underwriters' over-allotment option),
net of intercompany eliminations.
(5) Reflects intercompany eliminations and $3.0 million in fees relating to the
Bridge Loan.

15
<PAGE> 16

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION

The following discussion should be read in conjunction with the information
contained in the Consolidated Financial Statements, including the related notes,
and the other financial information incorporated by reference herein.

GENERAL

Capstone is a leading provider of institutional pharmacy services to
long-term care facilities and correctional institutions throughout the United
States. The Company provides its long-term care clients with comprehensive
institutional pharmacy services that include (i) the purchasing, repackaging and
dispensing of pharmaceuticals, (ii) infusion therapy and Medicare Part B
services, which are comprised of enteral nutrition and urologic supplies, and
(iii) pharmacy consulting services, all of which are supported by computerized
record keeping and third-party billing services. The Company serves its
long-term care clients primarily through regional pharmacies that are open 24
hours, seven days a week. In the correctional business, the Company provides
pharmaceuticals primarily under capitated contracts at correctional institutions
that have privatized inmate health care services.

In the first quarter of 1995, Capstone implemented a corporate
restructuring plan that included installation of a new management team,
refocusing the Company's operations on core institutional pharmacy businesses
and the initiation of an aggressive acquisition strategy. In conjunction with
the restructuring, the Company exited certain non-strategic, unprofitable lines
of business. The Company sold its medical/surgical supply operations, closed a
long-term care pharmacy in Missouri, discontinued its long-term care mail order
pharmacy operations and sold its computer software division. Capstone took
certain charges and realized certain gains relating to the discontinuation of
these operations. The Company anticipates that certain additional one-time
charges related to the Symphony Acquisition will be taken in the third and
fourth quarter of 1996.

The acquisition of institutional pharmacy companies has resulted in a
significant change in the Company's financial profile. Between May 1, 1995 and
June 30, 1996, the Company completed three acquisitions that added approximately
$49,000,000 in 1995 annualized net sales. The Company acquired, effective July
1, 1996, Medidyne, a provider of Medicare Part B services. On July 29, 1996, the
Company acquired Symphony from IHS, adding approximately 445 long-term care
facilities containing over 40,000 beds. The Symphony Acquisition significantly
increases the Company's client base and geographic scope. All of the these
acquisitions have been accounted for using the purchase method of accounting
and, as a result, the Company will incur significant future amortization expense
associated with goodwill.

On a pro forma basis for all acquisitions, including the Symphony
Acquisition, the Company's net sales and income from continuing operations for
the 12 months ended December 31, 1995 were $191,816,000 and $518,000,
respectively, compared to actual net sales of $43,608,000 and an actual loss
from continuing operations of $10,781,000 in the prior fiscal year ended
February 28, 1995, and the Company's pro forma net sales and income from
continuing operations for the six months ended June 30, 1996 were approximately
$107,141,000 and $4,598,000, respectively, compared to actual net sales of
approximately $23,140,000 and an actual loss from continuing operations of
$2,961,000 for the six months ended June 30, 1995.

RESULTS OF OPERATIONS

SIX MONTHS ENDED JUNE 30, 1996 COMPARED WITH THE SIX MONTHS ENDED JUNE 30, 1995

Net Sales. Net sales increased to $46,147,000 in the 1996 period from
$23,140,000 in the 1995 period, an increase of $23,007,000, or 99.4%. Of this
increase, approximately $22,049,000 was attributable to the acquisitions of
Premier, Geri-Care, and IMD.

16
<PAGE> 17

Cost of Sales. Cost of sales includes the cost of pharmaceuticals sold to
patients and institutions. Cost of sales increased to $28,846,000 in the 1996
period from $14,847,000 in the 1995 period, an increase of $13,999,000, or
94.3%. Of this increase, approximately $13,517,000 was attributable to
acquisitions, and the remainder resulted from increased sales volumes in
existing operations. As a percentage of net sales, cost of sales was 62.5% in
the 1996 period compared to 64.2% in the 1995 period.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses include salaries, benefits, facility expenses and other
administrative overhead. Selling, general and administrative expenses increased
to $14,453,000 in the 1996 period from $8,651,000 in the 1995 period, an
increase of $5,802,000, or 67.1%. Of this increase, approximately $7,647,000 was
attributable to acquisitions. As a percentage of net sales, selling, general and
administrative expenses were 31.3% in the 1996 period compared to 37.4% in the
1995 period. The decrease as a percentage of net sales was due to the sale of
the medical/surgical supply business, reduced costs as a result of the
corporate restructuring discussed above and expense reimbursements associated
with a pre-acquisition management agreement related to Medidyne.

Depreciation and Amortization. Depreciation and amortization increased to
$1,162,000 in the 1996 period from $563,000 in the 1995 period, an increase of
$599,000, or 106.4%. Of this increase, approximately $309,000 was attributable
to depreciation related to acquisitions. Amortization of goodwill increased by
$310,000 in the 1996 period as a result of acquisitions.

Interest Expense. Net interest expense increased to $685,000 in the 1996
period from $465,000 in the 1995 period, an increase of $220,000, or 47.3%. This
increase primarily resulted from interest expense related to bank borrowings to
fund the acquisition of IMD.

Income Taxes. Income taxes in the 1996 and 1995 periods consisted of
accruals for estimated state and local income taxes based upon apportioned state
taxable income, offset by estimated refundable federal income taxes resulting
from the benefit of net operating loss carrybacks and the utilization of net
operating loss carryforwards.

Income (Loss) from Continuing Operations. Income from continuing
operations increased to $779,000 in the 1996 period from a loss of $2,961,000 in
the 1995 period, an increase of $3,740,000. This increase was attributable to
restructuring charges in the amount of $2,064,000 incurred in the 1995 period,
increased sales primarily as the result of acquisitions and to the reduction of
cost of sales and selling, general and administrative expenses as a percentage
of net sales.

TEN MONTHS ENDED DECEMBER 31, 1995 COMPARED TO FISCAL YEAR ENDED FEBRUARY 28,
1995

Net Sales. Net sales for the ten months ended December 31, 1995 were
$48,841,000 compared to $43,608,000 for the fiscal year ended February 28, 1995.
Of this difference, approximately $13,815,000 was attributable to the
acquisition of Premier. Net sales decreased substantially due to sale of the
medical/surgical supply business, partially offset by the addition of new
correctional contracts.

Cost of Sales. Cost of sales for the ten months ended December 31, 1995
was $30,654,000 compared to $27,970,000 for the fiscal year ended February 28,
1995. Of this difference, approximately $8,184,000 was attributable to the
Premier acquisition. As a percentage of net sales, cost of sales for the ten
months ended December 31, 1995 was 62.8% compared to 64.1% for fiscal 1995. The
decrease as a percentage of net sales was primarily due to the sale of the lower
margin medical/surgical supply business. In addition, the Company renegotiated
its purchasing contracts during the 1995 period, lowering its cost of sales.
Cost of sales was not materially affected by price changes in products purchased
during the period.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the ten months ended December 31, 1995 were
$17,469,000 compared to $18,637,000 for the fiscal year ended February 28, 1995.
As a percentage of net sales, selling, general and administrative expenses for
the ten months ended December 31, 1995 were 35.8% compared to 42.7% for fiscal
1995. The decrease as a percentage of net sales was due to the sale of the
medical/surgical supply business and reduced costs as a

17
<PAGE> 18

result of the corporate restructuring discussed above. The Premier acquisition
added approximately $4,800,000 of additional selling, general and administrative
expense.

Interest Expense. Net interest expense for the ten months ended December
31, 1995 was $634,000 compared to $905,000 for the fiscal year ended February
28, 1995. This decrease primarily resulted from the reduction of the Company's
debt using proceeds from private placements and the difference between the ten
month and 12 month periods.

Other Income. Other income for the ten months ended December 31, 1995 was
$432,000 compared to $104,000 for the fiscal year ended February 28, 1995. The
difference primarily resulted from a gain on the sale of assets from the
Company's medical/surgical supply business.

Income Taxes. Benefit for income taxes for the ten months ended December
31, 1995 was $225,000 compared to $466,000 for the fiscal year ended February
28, 1995. The benefit for income taxes for the ten months ended December 31,
1995, primarily resulted from the carry back of a prior year taxable loss to
prior periods.

Income (Loss) from Continuing Operations. The loss from continuing
operations for the ten months ended December 31, 1995 was $645,000 compared to a
loss of $10,781,000 for the fiscal year ended February 28, 1995. This difference
was attributable partially to the inclusion in the prior period of nonrecurring
costs in connection with claims and litigation of $4,389,000 and restructuring
charges of $2,069,000. The remaining difference was due to the acquisition of
Premier and to the corporate restructuring discussed above.

LIQUIDITY AND CAPITAL RESOURCES

The Company requires capital primarily for the acquisition of institutional
pharmacy companies, to finance its working capital requirements and for the
purchase of equipment for existing pharmacies.

The Company's net cash used in operating activities was $4,492,000,
$3,588,000 and $1,123,000 for the six months ended June 30, 1996, the ten months
ended December 31, 1995 and the fiscal year ended February 28, 1995,
respectively. Generally, the cash used in operating activities in each of the
periods resulted from increased working capital requirements. Specifically, net
cash from operating activities was impacted by a $3,387,000 decrease in accounts
payable and a $2,424,000 increase in inventories and accounts receivable in the
six months ended June 30, 1996, and by a $11,420,000 net loss and a $3,500,000
litigation settlement payment by the Company in the fiscal year ended February
28, 1995.

The Company's net cash provided by (used in) investing activities was
($18,075,000), ($6,559,000) and $9,000 for the six months ended June 30, 1996,
the ten months ended December 31, 1995 and the fiscal year ended February 28,
1995, respectively. Net cash from investing activities was impacted by
$17,428,000 of acquisition spending for Geri-Care and IMD in the six months
ended June 30, 1996 and by $4,169,000 of acquisition spending for Premier and a
$2,243,000 advance in the ten months ended December 31, 1995.

Net cash provided by financing activities was approximately $21,195,000,
$12,364,000 and $1,218,000 for the six months ended June 30, 1996, the ten
months ended December 31, 1995 and the fiscal year ended February 28, 1995,
respectively. Net cash from financing activities was impacted by an equity
offering for net proceeds of $8,382,000 and $20,483,000 of borrowings in the six
months ended June 30, 1996; by equity offerings for net proceeds of $21,682,000
and long-term debt repayments of $10,885,000 in the ten months ended December
31, 1995; and by an equity offering for net proceeds of $7,281,000 and long-term
debt repayments of $5,903,000 in the fiscal year ended February 28, 1995.

The Company's current ratio was 4.0:1, 2.0:1 and 2.0:1 at June 30, 1996,
December 31, 1995 and February 28, 1995, respectively. The increased current
ratio at June 30, 1996 was due primarily to an increase in accounts receivable,
inventories and prepaid expenses coupled with a reduction in accounts payable
and current portion of long-term debt.

During January 1996, Creditanstalt Corporate Finance, Inc.
("Creditanstalt") agreed to amend the Company's revolving line of credit (the
"Line of Credit") to provide for an increase in borrowings available under the
Line of Credit to $15,000,000 and to add a new term loan facility in the amount
of $10,000,000 (the

18
<PAGE> 19

"Term Loan"). Upon completion of a private placement in April 1996, maximum
availability under the Line of Credit and the Term Loan was increased pursuant
to the terms thereof to $21,000,000 and $14,000,000, respectively, subject to
certain borrowing base limitations. Borrowings under the Line of Credit and Term
Loan are secured by substantially all of the assets of the Company, bear
interest at rates of either prime plus 0.25% or LIBOR plus 1.25% (8.25% and
6.875%, respectively, as of July 20, 1996) and are subject to other restrictions
and loan covenants, all as defined by the underlying agreements. As of August
12, the Company had outstanding borrowings of $13,422,852 under the Line of
Credit and $14,000,000 under the Term Loan. Following the Offering, the Company
intends to seek an increase in borrowings available under the Line of Credit to
approximately $75,000,000.

On December 16, 1994, Counsel purchased from the Company in a private
placement transaction 2,000,000 shares of Common Stock at a price of $3.65 per
share for net proceeds to the Company of approximately $7,191,000, and received
warrants for the purchase of an additional 1,800,000 shares of Common Stock
exercisable at any time over a three-year period. On May 22, 1995, the Company
completed a private placement of 1,600,000 units (the "Units") at a price of
$3.65 per Unit. Net proceeds to the Company were approximately $5,760,000. Each
Unit consists of one share of Common Stock, a three-year warrant to acquire 0.5
shares of Common Stock at the exercise price of $4.50 per share, and a
three-year warrant to acquire 0.4 shares of Common Stock at the exercise price
of $5.50 per share. Counsel acquired 596,362 Units, and officers and directors
of the Company acquired 261,780 Units. On August 29, 1995, the Company completed
a private placement of 3,500,000 shares of Common Stock at a price of $4.38 per
share for net proceeds of approximately $15,080,000. Counsel Corporation
purchased 1,311,237 shares in the August 1995 Private Placement. On April 18,
1996, the Company completed a private placement of 1,035,000 shares of Common
Stock at a price of $8.50 per share for net proceeds of approximately $8,370,000
(the "April 1996 Private Placement"). The net proceeds from these four private
placements were used primarily to repay indebtedness related to acquisitions of
Premier in May 1995, Geri-Care in January 1996 and IMD in February 1996. On July
29, 1996, Counsel purchased from the Company in a private placement transaction
2,112,490 shares of Common Stock at a price of approximately $11.83 per share
for net proceeds to the Company of $25,000,000. The proceeds were used as part
of the purchase price for the Symphony Acquisition. As an additional part of
such purchase price, the Company issued 2,112,490 shares of Common Stock valued
at approximately $11.83 per share to IHS.

In connection with the Symphony Acquisition, Capstone entered into a senior
subordinated credit agreement with Bankers Trust Company as agent and lender and
Canadian Imperial Bank of Commerce as lender, pursuant to which the lenders
funded the $100.0 million Bridge Loan. The Bridge Loan bears interest at a
floating interest rate of LIBOR plus a margin of from 6.0% to 6.25%. The Bridge
Loan, if not paid by July 30, 1997, will convert to a term loan with a nine year
maturity at a floating interest rate of the nine-year treasury rate plus 6.5%.
The proceeds of the Bridge Loan were used to pay a portion of the Symphony
Acquisition purchase price. In connection with the Bridge Loan, the Company
incurred a commitment fee of $2,750,000, which together with certain other
one-time charges, will be recognized as an expense in the quarter ending
September 30, 1996.

During August 1996, the Company registered the shares underlying its
outstanding Series A and B warrants. Series A warrants representing 643,344 of a
total of 650,000 shares of Common Stock were exercised before expiring, at an
exercise price of $6.00 per share. Holders of the exercised Series A warrants
received 643,344 shares of Common Stock and 643,344 newly-issued Series B
warrants which can be exercised through August 1997 at a price of $10.00 per
share. Proceeds from the Series A warrants were approximately $3,850,000 and
will be used for general working capital purposes.

The Company believes its existing Line of Credit is sufficient to fund its
working capital needs. In order to implement its growth strategy, the Company
will require substantial capital resources and will need to incur, from time to
time, additional bank indebtedness. The Company also may need to issue, in
public or private transactions, equity or debt securities, the availability and
terms of which will depend on market and other conditions. There can be no
assurance that any such additional financing will be available on terms
acceptable to the Company, if at all.

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BUSINESS

GENERAL

Capstone is a leading provider of institutional pharmacy services to
long-term care facilities and correctional institutions throughout the United
States. On July 29, 1996, Capstone acquired the institutional pharmacy services
business of Symphony, a subsidiary of IHS. The Symphony Acquisition increases
the number of long-term care beds served by Capstone from approximately 44,000
in seven states to approximately 84,000 in 13 states, making Capstone the second
largest independent institutional pharmacy company in the United States.
Management believes the Symphony Acquisition is a major strategic step in
positioning Capstone as a leading provider of institutional pharmacy services in
numerous metropolitan markets nationwide. The Symphony Acquisition significantly
increases Capstone's client base and geographic scope and establishes
relationships between Capstone and IHS as well as other large operators of
long-term care facilities not previously served by Capstone. In addition,
management believes that Capstone's expanded national presence will enable it to
compete more effectively for larger customers who operate multiple facilities
while achieving purchasing efficiencies and other economies of scale.

INDUSTRY OVERVIEW

Institutional pharmacies purchase, repackage and dispense pharmaceuticals
to residents of long-term care facilities such as nursing homes, sub-acute
facilities, assisted living facilities and, in certain instances, to inmates in
correctional institutions. Unlike acute care hospitals, most long-term care
facilities do not maintain on-site pharmacies because they do not generally
require a volume of prescribed medications sufficient to make a pharmacy
cost-effective. Prior to the 1970s, the pharmacy needs of long-term care
facilities generally were fulfilled by local retail pharmacies. In response to
increasingly strict nursing home regulations, changes in the reimbursement
environment and the increasing acuity of long-term care patients, the breadth of
pharmacy services required by long-term care facilities has increased
substantially. In addition to providing oral medications, many institutional
pharmacies provide infusion therapy services and supplies, Medicare Part B
services such as enteral nutrition services and urologic supplies, and pharmacy
consulting services, including monitoring the control and administration of
pharmaceuticals within a facility, assistance in complying with applicable
regulations, therapeutic monitoring and drug utilization review services. The
Company believes that institutional pharmacy companies are best positioned to
meet evolving market demands in the long-term care industry and to assume a
proactive role in influencing the effectiveness and cost of health care.

Industry analysts estimate that the provision of institutional pharmacy
services is a $4.0 billion industry that is growing approximately 13% per year.
Management believes this growth is being driven by two primary factors: (i) the
increasing number of patients receiving treatment in long-term care or other
institutional settings and (ii) the increasing number of medications taken per
day by patients in long-term care and correctional institutions. Management
believes that several factors will continue to influence the increase in the
number of patients residing in long-term care settings including the aging of
the population, earlier discharge of patients from acute care settings into
lower cost institutional settings, growth in the number of

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assisted living beds and a decreasing tendency for families to maintain the role
as primary care giver for elderly relatives. Factors influencing the increase in
medications administered to institutional patients include advances in medical
technology, which have resulted in the availability of new drug therapy
regimens, and the increasing acuity level of nursing home and sub-acute patients
as a result of quicker discharge following acute care procedures. Management
believes that the average long-term care patient receives approximately six to
eight medications per day.

The long-term care segment of the institutional pharmacy industry is highly
fragmented, with small retail pharmacies serving approximately 40% of long-term
care facilities, independent institutional pharmacy companies serving
approximately 43% of long-term care facilities and in-house captive pharmacies
serving the remaining 17% of such facilities. Management believes that
consolidation will accelerate as long-term care providers migrate from
traditional retail pharmacies to larger institutional pharmacy companies.
Factors driving consolidation in the institutional pharmacy industry include:

- Economies of Scale. Larger institutional pharmacies are able to leverage
corporate purchasing agreements to reduce supply costs. Management
believes that industry-wide drug costs average between 50% and 60% of
sales, making purchasing efficiencies critical to controlling costs.
Industry participants purchase the majority of their drug supplies from
large drug wholesalers, and larger industry participants have greater
bargaining power to reduce costs associated with such purchases.

- Ability to Provide a Broad Range of Services. As a result of their
ability to serve multiple facilities from a single location, larger
pharmacies generally are able to offer more services at a lower cost per
bed. These services include 24 hours, seven days per week coverage,
clinical pharmacists, registered nurses and more frequent deliveries.

- Regulatory Expertise and Systems Capabilities. Long-term care facilities
are demanding more sophisticated and specialized services from pharmacy
providers due, in part, to increasingly complex government regulations
requiring enhanced planning, monitoring and reporting capabilities
regarding patient care. As a result, long-term care administrators seek
experienced institutional pharmacy providers which offer computerized
information and documentation systems designed to monitor patient care and
to assist in controlling facility and payor costs.

GROWTH STRATEGY

Capstone's objective is to enhance its position as a leading provider of
high-quality, cost-effective institutional pharmacy services. The Company
provides comprehensive pharmacy services primarily in metropolitan areas in
order to develop the regional market penetration and critical mass necessary to
position the Company as the pharmacy services provider of choice to long-term
care facilities and third-party payors. Following are the key elements of the
Company's growth strategy:

- Acquire Institutional Pharmacy Companies in Metropolitan Markets. The
acquisition of high-quality institutional pharmacy companies in targeted
metropolitan markets has been the primary contributor to the Company's
growth. Capstone focuses on acquisitions in metropolitan markets because
of the relatively higher number of long-term care beds available to be
served compared to non-metropolitan markets. The Company has implemented
this strategy successfully in the Baltimore to Boston corridor and is
adopting a similar approach in the Chicago market. As a result of the
Symphony Acquisition, Capstone also has operations in metropolitan markets
including Los Angeles, Dallas, New Orleans, Minneapolis-St. Paul and
Tampa-St. Petersburg.

- Achieve Regional Market Density. Capstone identifies acquisition
candidates that solidify its position in a market and enable it to develop
a critical mass of long-term care clients. By establishing regional
pharmacies that each have the capability to serve in excess of 10,000
patients, management believes the Company can provide a broader range of
services to its long-term care clients on a more cost-effective basis than
many of its competitors. This strategy of developing regional market
density around a single pharmacy location allows the Company to serve
long-term care facilities within a 150-mile

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radius. In addition, this strategy enables the Company to consolidate
smaller individual pharmacies, capitalizing on operating efficiencies and
economies of scale in marketing and corporate overhead.

- Position for Managed Care. Capstone provides pharmacy services under
capitated contracts to correctional institutions across the United States.
Management believes its experience in managing capitated contracts, which
utilize closed formularies, generic substitution, rigorous drug
utilization review and proactive physician education, will provide the
Company with a significant competitive advantage as managed care becomes
more prevalent in the long-term care industry. In conjunction with the
strategy of achieving regional market density, management believes the
Company's capitation expertise will position Capstone to be the provider
of choice to managed care payors in the markets in which it operates.

- Emphasize Internal Growth. The Company seeks to generate internal growth
by adding new clients and expanding the range of services offered to
existing clients. The Symphony Acquisition significantly increases
Capstone's client base and geographic scope and establishes relationships
between Capstone and IHS as well as other large operators of long-term
care facilities not previously serviced by Capstone. Management believes
there are attractive opportunities to increase the number of IHS-
affiliated beds served, as well as opportunities to add beds in long-term
care facilities that previously were unwilling to consider Symphony as a
provider because of its status as an in-house captive of an industry
competitor. Once a client relationship is established, the Company seeks
to increase net sales by offering infusion therapy and Medicare Part B
services. Because of the recent addition of these ancillary services to
the Company's product line, management believes substantial growth
opportunities exist within the current client base.

SERVICES

Capstone provides institutional pharmacy services to long-term care
facilities, correctional institutions and a limited number of hospital
pharmacies. Management believes that the primary competitive factor in its
industry is breadth and quality of service. In addition to providing oral
medications to its clients, the Company provides ancillary services that
generate incremental sales. Following is a description of each of the Company's
primary lines of business.

Pharmacy Services. Capstone's core business is providing pharmaceutical
dispensing services to residents of long-term care facilities and correctional
institutions. The Company purchases pharmaceuticals in bulk quantities from
wholesalers and manufacturers and dispenses both prescription and
non-prescription drugs in patient-specific unit dose or blister packages in
accordance with physician orders. Prescription and non-prescription medications
are delivered at least daily to long-term care facilities for administration to
residents by the nursing staffs of such facilities. Capstone's pharmacists
package drugs to meet each patient's needs for either single-day or multi-day
dosage requirements. Each drug is dispensed by either individually sealing the
required unit dose or sealing such dose in an individual cavity within a blister
package. Capstone can customize the timing and packaging of its delivery system
to meet specific client needs.

Capstone uses an order processing system that enables its long-term care
clients to order pharmaceuticals using either a pre-printed label or monthly
order forms. Clients generally take delivery of routine orders within 24 hours;
however, most of the Company's pharmacies are open 24 hours to provide emergency
service when needed. Once a physician order is received by Capstone, it is
entered into one of the Company's pharmacy computer systems where information is
screened for drug and food interactions, allergies, and refill limitations. Upon
entry, the prescription becomes part of the permanent patient record, and a
label is printed for application to the Company's blister package. The package
label contains specific patient information as well as physician name,
medication, dosage information and cautionary messages. Prior to delivery to the
long-term care facility, the completed prescription with patient-specific label
attached is reviewed by one of the Company's pharmacists and re-verified against
the original order entry data. Following this final quality assurance check, the
prescription is delivered by courier service to the facility.

As an additional service, the Company furnishes its clients with customized
information from its computerized medical records and documentation system. This
system aggregates and organizes detailed

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patient medical records, facility drug usage and monthly management and quality
assurance reports. Management believes this system of client-tailored
information management, combined with the Company's patient-specific unit dose
delivery system, results in improved efficiency and accuracy in the
administration of medications and reduces the likelihood of drug-related adverse
consequences.

In addition to its core long-term care and correctional business, the
Company also provides pharmacy management services to 12 acute care hospitals
pursuant to management contracts on either a single-year or multi-year basis.

Pharmacy Consulting Services. Capstone provides value-added consulting
services that help clients comply with federal and state regulations applicable
to long-term care facilities, manage medication costs more effectively and
maximize the efficacy of drug regimens. These pharmacy consulting services
include (i) a review of each patient's medical record and drug regimen to
facilitate the monitoring of potential adverse drug reactions, (ii)
recommendation of therapeutic alternatives, where appropriate, (iii) monthly
evaluation of facility-wide drug usage and drug costs and (iv) maintenance of
drug administration records that assist the long-term care facility with
regulatory compliance.

Ancillary Services. Capstone provides long-term care facilities with
infusion therapies and Medicare Part B services, which consist of enteral
nutrition and urologic supplies, as well as counseling and assistance with
regulatory compliance in connection with such services. The Company's registered
nurses provide on-site training to client facility staff members in the use of
infusion and enteral supplies and equipment. Prior to the acquisition of
Medidyne and the Symphony Acquisition in July 1996, ancillary services did not
comprise a material component of Capstone's net sales.

OPERATIONS

Organization. Capstone's long-term care operations are divided into five
geographic regions, each headed by a regional vice president. Management
believes this regional organizational structure provides the flexibility to
accommodate continued growth. Capstone believes that the institutional pharmacy
business is dependent in large part on personal service and encourages its
pharmacists to develop personal relationships and to be responsive to local
market demands. The Company uses more centralized financial and inventory
control systems support than typically available to small, independent pharmacy
operators. Additional services performed at the corporate level include quality
improvement oversight, financial and accounting functions, group purchasing,
acquisitions and development.

Pharmacy Distribution Model. In the long-term care business, the Company
typically provides services through regional pharmacies that have the capability
to serve long-term care facilities via courier within a 150-mile radius. These
regional pharmacies are open 24 hours, seven days a week and are staffed with
clinical pharmacists, registered nurses and pharmacy technicians. The Company
provides services from 34 pharmacies in 13 states. In the correctional business,
the Company dispenses pharmaceuticals via overnight delivery primarily from a
centralized mail service pharmacy operation located in Baltimore.

Formulary Management. Capstone utilizes a closed formulary management
system in its capitated correctional business. Under the Company's closed
formulary, Capstone pharmacists assist prescribing physicians in selecting the
most appropriate drug among therapeutic alternatives, including generic
substitutions, and in the use of more cost-effective dosage amounts.

Management believes that its experience with formulary management in its
correctional business, combined with Symphony's newly established long-term care
formulary program, should enhance Capstone's ability to implement an effective
formulary management system that will be attractive to long-term care providers
and third-party payors.

Sales & Marketing. The Company's marketing efforts are directed at
long-term care facility operators and providers of health care services to
correctional institutions. While pricing is an important factor in the selection
of pharmacy providers, Capstone's experience is that the primary factor,
particularly among long-term care operators, is the quality and range of
services offered. Consequently, the Company strives to provide

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high-quality services that are tailored to each client's needs. Once a
relationship is established, Capstone then attempts to expand the range of
services it provides.

Capstone's marketing efforts are conducted by five regional salespersons
with support from 34 pharmacy managers. The Company's consultant pharmacists and
nurse consultants also are integral to the marketing effort because of their
daily contact with the facility managers and the residents in those facilities.

Purchasing. Capstone purchases substantially all of its pharmaceutical
inventories from wholesalers and manufacturers. In order to lower its costs,
Capstone has entered into a primary wholesaler agreement with a single supplier
from which the Company receives twice-daily deliveries of inventory. Capstone
also has in place secondary wholesale agreements to minimize its purchasing
channels while maximizing inventory quality and cost savings. Because of readily
available alternatives, Capstone is not dependent on any one supplier. In
November 1995, Capstone negotiated a new supplier contract with terms that are
more favorable to Capstone than its previous contracts. With the Symphony
Acquisition, management believes a more favorable primary wholesaler agreement
as well as more favorable pricing from drug manufacturers will be available to
the Company.

COMPETITION

The institutional pharmacy market is highly fragmented and competition
varies significantly from market to market. The Company's competitors include
small retail pharmacies, large chain pharmacies, in-house captive pharmacies and
a small number of national institutional pharmacies. Management believes that
the competitive factors most important in the Company's lines of business are
quality and range of service offered, reputation with referral sources, ease of
doing business with the provider, ability to develop and to maintain
relationships with referral sources and competitive prices. Some of the
Company's present and potential competitors are significantly larger than the
Company and have, or may obtain, greater financial and marketing resources than
the Company. In addition, there are relatively few barriers to entry in the
local markets served by the Company, and it may encounter substantial
competition from local market entrants.

REIMBURSEMENT

The Company is reimbursed, directly or indirectly, by government-sponsored
programs for a majority of its institutional pharmacy services.

The Medicaid program is a federal-state cooperative program designed to
enable states to provide medical assistance to aged, blind or disabled
individuals, or to members of families with dependent children whose income and
resources are insufficient to meet the costs of necessary medical services.
State participation in the Medicaid program is voluntary. To become eligible to
receive federal funds, a state must submit a Medicaid "state plan" to the
Secretary of HHS for approval. The federal Medicaid statute specifies a variety
of requirements which the state plan must meet, including requirements relating
to eligibility, coverage of services, payment and administration. For residents
eligible for Medicaid, the Company bills the individual state Medicaid program.
Medicaid programs are funded jointly by the federal government and individual
states and are administered by the states. The reimbursement rates for pharmacy
services under Medicaid are determined on a state-by-state basis subject to
review by the Health Care Financing Administration and applicable federal law.
Federal regulations and the regulations of certain states establish "upper
limits" for reimbursement for prescription drugs under Medicaid. Pharmacy
services are priced on a state-by-state basis at the lower of "usual and
customary" charges or cost (which generally is defined as a function of average
wholesale price and may include a profit percentage) plus a fixed dispensing fee
which is adjusted to reflect associated costs on an annual or less frequent
basis. State Medicaid programs generally have long-established programs for
reimbursement which have been revised and refined over time and have not had a
material adverse effect on the pricing policies or receivables collection for
long-term care facility pharmacy services. Any future changes in such
reimbursement program or in regulations relating thereto, such as reductions in
the allowable reimbursement levels or the timing of processing of payments,
could adversely affect the Company's business. The U.S. Congress has passed a
fiscal year 1996 budget reconciliation bill that provides for substantial
reductions in the rate of spending increases in the Medicare program and in the
federal share of

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the Medicaid program over the next seven years. The annual increase in the
federal share would vary from state to state based on a variety of factors. Such
provisions, if ultimately signed into law, could adversely affect the Company's
business.

Medicare, a federally-funded health insurance program, consists of two
parts: Medicare Part A, which covers, among other things, pharmaceutical costs
for eligible long-term patients; and Medicare Part B, which covers certain items
and services provided by medical suppliers, including enteral nutrition and
urologic supplies. Medicare Part A requires long-term care facilities to submit
all of their costs for patient care, including pharmaceutical costs, in a
unified bill. Thus, fees for pharmaceuticals provided to Medicare Part A
patients are paid to the Company by the long-term care facility on a monthly
basis. Pricing is consistent with that of private pay residents or is set
between private pay rates and Medicaid rates. Medicare Part A has a cost-sharing
arrangement under which patients must pay a portion of their costs. These
non-covered co-payments are billed by the facility directly to the residents or
the state Medicaid plan, as the case may be.

Payment for Medicare Part B is based on a fee schedule, which varies
depending on the state in which the patient receiving the items resides, and is
made on a per-item basis directly to the supplier. The Company either bills
Medicare directly for Medicare Part B covered products for each patient or,
alternatively, assists the long-term care facility in meeting Medicare Part B
eligibility requirements and prepares bills on behalf of the facility. Medicare
Part B also has an annual deductible as well as a co-payment obligation on
behalf of the patient, and the portion not covered by Medicare is billed
directly to the patient or appropriate secondary payor.

The Medicare and Medicaid programs are subject to statutory and regulatory
changes, retroactive and prospective rate adjustments, administrative rulings,
and freezes and funding reductions, all of which may adversely affect the
Company's business. There can be no assurance that payments for pharmaceutical
supplies and services under governmental reimbursement programs will continue to
be based on the current methodology or remain comparable to present levels. In
this regard, the Company may be subject to rate reductions as a result of
federal budgetary legislation related to the Medicare and Medicaid programs. In
addition, various state Medicaid programs periodically experience budgetary
shortfalls which may result in Medicaid payment delays to the Company. To date,
the Company has not experienced any material adverse effect due to any such
budgetary shortfall.

In addition, the failure, even if inadvertent, of Capstone and/or its
client institutions to comply with applicable reimbursement regulations could
adversely affect Capstone's business. Additionally, changes in such
reimbursement programs or in regulations related thereto, such as reductions in
the allowable reimbursement levels, modifications in the timing or processing of
payments and other changes intended to limit or decrease the growth of Medicaid
and Medicare expenditures, could adversely affect the Company's business.

For patients carrying third-party insurance, the patient's individual
insurance plan is billed monthly. For those patients who are ineligible for the
Medicaid and Medicare programs and are not covered by private insurance, the
Company bills the individual or another responsible party monthly based on
prevailing regional market rates or "usual and customary" charges. In New York,
the Company receives payment directly from the long-term care facilities it
serves, regardless of the patients' or facilities' reimbursement sources.

GOVERNMENT REGULATION

Institutional pharmacies, as well as the long-term care facilities they
serve, are subject to extensive federal, state and local regulation. These
regulations cover required qualifications, day-to-day operations, reimbursement
and the documentation of activities. Capstone continuously monitors the effects
of regulatory activity on its operations.

States generally require that companies operating a pharmacy within the
state be licensed by the state board of pharmacy. The Company currently has its
pharmacies licensed in each state in which it operates a pharmacy. In addition,
the Company currently delivers prescription drugs from its licensed pharmacies
to many states in which the Company does not operate a pharmacy. Most of these
states regulate the delivery by

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out-of-state pharmacies of prescription drugs to patients in such states, and
Capstone's pharmacies hold these requisite licenses. In addition, Capstone's
pharmacies are registered with the appropriate state and federal authorities
pursuant to statutes governing the regulation of controlled substances.

Long-term care facilities are also required to be licensed in the states in
which they operate and, if serving Medicare or Medicaid patients, must be
certified to be in compliance with applicable program participation
requirements. Long-term care facilities are also subject to state and federal
nursing home regulations which impose strict compliance standards relating to
quality of care for long-term care facilities operations, including extensive
documentation and reporting requirements. In addition, pharmacists, nurses and
other health care professionals who provide services on the Company's behalf are
in most cases required to obtain and maintain professional licenses and are
subject to state regulation regarding professional standards of conduct.

Federal and state laws impose certain repackaging, labeling, and packing
insert requirements on pharmacies that repackage drugs for distribution beyond
the regular practice of dispensing or selling drugs directly to patients at
retail. A drug repackager must be registered with the Food and Drug
Administration. The Company holds all required registration and licenses, and
its repackaging operations are in material compliance with applicable state and
federal requirements.

The long-term care pharmacy business operates under regulatory and cost
containment pressures from state and federal legislation primarily affecting
Medicaid and, to a lesser extent, Medicare. As is the case for nursing home
services generally, Capstone receives reimbursement from both the Medicaid and
Medicare programs, directly from individual residents (private pay), and from
other payors such as third-party insurers. The Company believes that its
reimbursement mix is in line with long-term care expenditures nationally.

Federal regulations contain a variety of requirements relating to the
furnishing of prescription drugs under Medicaid. First, states are given broad
authority, subject to certain standards, to limit or specify conditions to the
coverage of particular drugs. Second, federal Medicaid law establishes standards
affecting pharmacy practice. These standards include general requirements
relating to patient counseling and drug utilization review and more specific
requirements for long-term care facilities relating to drug regimen reviews for
Medicaid patients in such facilities. Recent regulations clarify that, under
federal law, a pharmacy is not required to meet the general standards for drugs
dispensed to long-term care facility residents if the long-term care facility
complies with the drug regimen review requirements. However, the regulations
indicate that states may nevertheless require pharmacies to comply with the
general standards, regardless of whether the long-term care facility satisfies
the drug regimen review requirement, and the states in which the Company
operates currently do require its pharmacies to comply therewith. Third, federal
regulations impose certain requirements relating to reimbursement for
prescription drugs furnished to Medicaid patients.

In addition to requirements imposed by federal law, states have substantial
discretion to determine administrative, coverage, eligibility and payment
policies under their state Medicaid programs which may affect the Company's
operations. For example, some states have enacted "freedom of choice"
requirements which may prohibit a long-term care facility from requiring its
residents to purchase pharmacy or other ancillary medical services or supplies
from particular providers. Such limitations may increase the competition which
the Company faces in providing services to long-term care patients.

The Company is subject to federal and state laws that govern financial and
other arrangements between health care providers. These laws include the federal
anti-kickback statute and physician self-referral prohibitions. The
anti-kickback statute was originally enacted in 1977 and amended in 1987, and
which prohibits, among other things, knowingly and willfully soliciting,
receiving, offering or paying any remuneration directly or indirectly in return
for or to induce the referral of an individual to a person for the furnishing of
any item or service for which payment may be made in whole or in part under
Medicare or Medicaid. Many states have enacted similar statutes which are not
necessarily limited to items and services for which payment is made by Medicare
or Medicaid. Violations of these laws may result in fines, imprisonment, and
exclusion from the Medicare and Medicaid programs or other state-funded
programs. Federal and state court decisions interpreting these statutes are
limited, but have generally construed the statutes to apply if "one purpose" of
remuneration is to induce referrals or other conduct within the statute. In
August 1994, the Office of Inspector General ("OIG") of the Department of Health
and Human Services, issued a Special Fraud Alert regarding

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prescription drug marketing schemes which it believes may violate the
anti-kickback statute. Among the specific activities identified in the Fraud
Alert were a "product conversion" program in which a drug company offered cash
awards to pharmacies who changed from another company's drug product to their
product. The Fraud Alert also targets marketing programs in which drug companies
offer cash or other benefits to pharmacists in exchange for marketing tasks in
the course of pharmacy practice related to Medicare or Medicaid.

The physician self-referral prohibition, commonly referred to as the
"Stark" law, prohibits a physician from referring Medicare or Medicaid patients
to "designated health services" in which the physician (or family member) has a
financial interest, either through ownership or compensation arrangements.
Prohibited referrals will not be reimbursed by Medicare or Medicaid, and the
statute makes it illegal to seek reimbursement from any other source. In
addition, violations may result in fines and/or civil penalties and exclusion
from the Medicare and Medicaid programs. The list of "designated health
services" includes outpatient prescription drugs. Some states have also passed
similar "anti-self referral" legislation. The Company does not believe that the
Stark law or similar state laws, have had, or will have, a significant adverse
impact on the operations of the Company.

In addition, a number of states have recently undertaken enforcement
actions against pharmaceutical manufacturers involving pharmaceutical marketing
programs, including programs containing incentives to pharmacists to dispense
one particular product rather than another. These enforcement actions arose
under state consumer protection laws which generally prohibit false advertising,
deceptive trade practices, and the like. Further, a number of states involved in
these enforcement actions have requested that the Federal Food and Drug
Administration ("FDA") exercise greater regulatory oversight in the area of
pharmaceutical promotional activities by pharmacists. It is not possible to
determine whether FDA will act in this regard or what effect, if any, FDA
involvement would have on the Company's operations.

The Company believes its contract arrangements with other health care
providers, its pharmaceutical suppliers and its pharmacy practices are in
compliance with these laws. There can be no assurance that such laws will not,
however, be interpreted in the future in a manner inconsistent with the
Company's interpretation and application.

LITIGATION

A lawsuit, Marvin Levine, Gloria Levine, and John McBay v. Capstone
Pharmacy Services, Inc., Premier Pharmacy, Inc., and Compuscript, Inc., was
filed in the Supreme Court of the State of New York, County of Westchester (No.
19238/95) on November 15, 1995. The plaintiffs sold the stock of Compuscript,
Inc. ("Compuscript") to Premier in 1993 pursuant to the terms of a purchase
agreement (the "Agreement") and claim that Premier, which the Company has
acquired, and Compuscript owe them approximately $1,000,000 under promissory
notes delivered to them as part of the consideration for their Compuscript
stock. Plaintiffs also claim that Compuscript and Premier owe them an additional
$1,100,000 because of the alleged occurrence of certain events that would give
rise to such an obligation under the Agreement. Finally, the plaintiffs claim
the Company is liable for tortiously interfering with their rights under the
Agreement and under the promissory notes. The complaint seeks total judgments of
$7,100,000, plus interest and costs against the defendants. The defendants,
including Capstone, have answered the complaint and are vigorously contesting
the plaintiffs' claims. In addition, Premier has filed a counterclaim against
the plaintiffs for breaches of certain representations and warranties in the
Agreement. Capstone does not believe that this litigation is likely to have a
material adverse effect on it.

The Company is from time to time subject to claims and suits arising in the
ordinary course of business, including claims for repayment of monies paid to
the Company under Medicare or Medicaid. Although the Company and its
subsidiaries are not parties to any such litigation in which, in management's
opinion, an adverse determination would have a material effect on the Company's
financial position, there can be no assurance that the Company will not become
involved in such litigation in the future.

27
<PAGE> 28

MANAGEMENT

EXECUTIVE OFFICERS AND DIRECTORS

The table below sets forth certain information concerning each of the
executive officers and directors of the Company.

<TABLE>
<CAPTION>
NAME AGE POSITION
-------------------------------- --- ------------------------------------------------------
<S> <C> <C>
R. Dirk Allison................. 40 President, Chief Executive Officer and Director
Donald W. Hughes................ 46 Vice President, Chief Financial Officer and Secretary
Robert Della Valle.............. 45 Vice President, Chief Operating Officer
Allan C. Silber................. 47 Chairman
Morris A. Perlis(1)............. 47 Vice Chairman
Joseph F. Furlong, III(1)....... 47 Director
John Haronian(2)(3)............. 63 Director
Albert Reichmann(1)............. 67 Director
J. Brendan Ryan(3).............. 53 Director
Edward Sonshine, Q.C.(2)........ 49 Director
Gail Wilensky, Ph.D.(3)......... 53 Director
John Zuccotti(2)................ 59 Director
</TABLE>

- ---------------

(1) Member of Compensation Committee.
(2) Member of Audit Committee.
(3) Member of Disinterested Stock Option Plan Committee.

Mr. Allison has served as President and Chief Executive Officer of the
Company since May 1995 and a Director since August 1995. He served as President
and Chief Executive Officer of Premier from July 1993 to May 1995. Mr. Allison
served as President and Chief Executive Officer of Allied Pharmacy Management,
Inc. from February 1988 to June 1993.

Mr. Hughes has served as Vice President, Chief Financial Officer and
Secretary of the Company since December 1995. Prior to joining the Company, Mr.
Hughes was Executive Vice President and Chief Financial Officer of Broventure
Company, Inc., a closely-held investment management company. He had been
employed by Broventure since July 1984 and held the position of Chief Financial
Officer since January 1988 and Executive Vice President since November 1990.

Mr. Della Valle joined the Company as Vice President and Chief Operating
Officer in July 1996. Prior to joining the Company, Mr. Della Valle was
President and Chief Executive Officer and Vice-President of Allied Pharmacy
Management, Inc. ("Allied Pharmacy"). He had been employed by Allied Pharmacy
since August 1991 and held the position of President and Chief Operating Officer
from July 1993 to July 1996.

Mr. Silber has served as Chairman since February 1995 and as a Director of
the Company since December 1994. Mr. Silber has been Chairman, Chief Executive
Officer and a director of Counsel since August 1979. He served as President of
Counsel from August 1979 until January 1994. Mr. Silber has served as a director
of Advocat Inc., a nursing home operator ("Advocat"), since January 1994 and as
a director of American HomePatient, Inc. ("American HomePatient") since
September 1991. Mr. Silber served as Chairman of American HomePatient from
September 1991 to May 1994.

Mr. Perlis has served as Vice Chairman of the Company since May 1995 and as
a Director of the Company since December 1994. Mr. Perlis served as interim
Chief Executive Officer of the Company from December 1994 to May 1995. He has
served as a director of and consultant to Counsel since September 1992, and as
President of Counsel since January 1994. Mr. Perlis has served as a director of
American HomePatient since March 1993 and as its Chairman since May 1994. Mr.
Perlis was President of Morris A. Perlis & Assoc.,

28
<PAGE> 29

an executive management consulting firm, from September 1992 until January 1994
and President of American Express Canada, Inc. from September 1988 until
September 1992.

Mr. Furlong has served as a Director of the Company since December 1994.
Mr. Furlong has served as President of Adirondack Capital Advisors, L.L.C., a
financial advisory/consulting firm, since May 1996. Mr. Furlong was a partner of
Colman Furlong & Co., a merchant banking firm, from February 1991 until April
1996. Prior to that he was a partner of Robertson Stephens & Company, an
investment banking firm, from November 1984 to January 1991. Mr. Furlong has
served as a director of American HomePatient since June 1994.

Mr. Haronian has served as a Director of the Company since January 1994.
Mr. Haronian has served as Chairman of Vision World, Inc. and President of
Tri-State Leasing, Inc. since April 1991. Mr. Haronian has served as President
of Peoples Liquor, Inc. since November 1991. From May 1965 until November 1990,
Mr. Haronian served as President of Douglas Drug, Inc.

Mr. Reichmann has served as a Director of the Company since August 1995. He
has served as Chairman and a director of Olympia & York Developments, Limited, a
privately held Canadian real estate company, for at least five years prior to
February 1993. Mr. Reichmann currently participates in major philanthropic
activities in addition to serving on the boards of several major hospitals in
Canada.

Mr. Ryan has served as a Director of the Company since August 1995. Mr.
Ryan is Chairman and Chief Executive Officer of Foote Corne & Belding, a
worldwide advertising and communications firm. He formerly served as President
and Chief Executive Officer of FCB/Leber Katz Partners and FCB Direct ("FCB") in
New York, a diversified advertising firm, since 1991. Prior to that, he was
Executive Vice President of Ogilvy & Mather, an advertising firm from 1977 to
1991 and a director and department head of OMW from 1986 to 1991. Mr. Ryan has
served as a member of the Citizens Crime Commission of New York City since 1985.
He is a director of True North Communications, Inc., the parent corporation of
FCB.

Mr. Sonshine has served as a Director of the Company since December 1994.
He has been President and Chief Executive Officer of RioCan Real Estate
Investment Trust of Toronto, Canada since July 1995. Mr. Sonshine has served as
a director of American HomePatient since September 1991. Mr. Sonshine has served
as Vice Chairman of Counsel since January 1994, as a director of Counsel since
August 1979, and as Chairman, President and Chief Executive Officer of Counsel
Management Services, Inc. since October 1993. Mr. Sonshine served as Executive
Vice President of Counsel from February 1987 until January 1994. Mr. Sonshine
served as President and Chief Executive Officer of Icarus Realty Corp. from
February 1987 until September 1993. Mr. Sonshine has been a director of Advocat
since May 1995.

Dr. Wilensky has served as a Director of the Company since August 1995. She
has served as Chair, Physician Payment Review Commission, Senior Fellow since
May 1995, and as John M. Olin Senior Fellow, Project HOPE since January 1993.
Dr. Wilensky served as Deputy Assistant to the President for Policy Development
from March 1992 to January 1993. She was Administrator of the Health Care
Financing Administration of the Department of Health and Human Services from
January 1990 to March 1992. Dr. Wilensky has also served as a director of
Advanced Tissue Sciences, a tissue engineering company, since 1993; Coram
Healthcare, a provider of alternate site infusion therapy services, since 1994;
St. Jude Medical, a manufacturer of heart valves, since 1995; Syncor
International, a radiopharmaceutical products company, since 1993; United
Healthcare Corporation, a health care coverage company, since 1993; NEOPATH,
Inc., a medical diagnostic company, since August 1996; and Shared Medical
Systems, a provider of health information services, since August 1996.

Mr. Zuccotti has served as a Director of the Company since August 1995. He
has served as President and Chief Executive Officer of Olympia & York Companies
(U.S.A.), since January 1990 and has served as a director since the inception of
its board of directors in July 1993. He has served as a director of Dreyfus
Strategic Municipal Bond Fund, Inc. since November 1989. Mr. Zuccotti also
serves as director of Dreyfus Calif. Tax Exempt Money Market, Dreyfus Capital
Value Fund, Inc., Dreyfus Insured Municipal Bond Fund, Dreyfus New Leaders Fund,
Inc., Dreyfus Strategic Municipals, Inc., Dreyfus Municipal Bond Fund, Inc.,
Dreyfus Municipal Money Market Fund, Inc., and Starrett Housing Corporation.

29
<PAGE> 30

SECURITY OWNERSHIP OF DIRECTORS,
EXECUTIVE OFFICERS AND PRINCIPAL HOLDERS

The following table sets forth, as of September 16, 1996, information with
respect to the beneficial ownership of the Company's outstanding Common Stock by
(i) each director of the Company, (ii) each executive officer of the Company,
(iii) all directors and executive officers of the Company as a group and (iv)
each stockholder known by the Company to be the beneficial owner of more than 5%
of the Company's outstanding Common Stock.

<TABLE>
<CAPTION>
NUMBER OF
SHARES PERCENTAGE
BENEFICIALLY OF TOTAL
NAME OWNED(1) OUTSTANDING(2)
- --------------------------------------------------------------------- ------------ --------------
<S> <C> <C>
Counsel Corporation(3)............................................... 8,356,815 36.3%
Exchange Tower
Two First Canadian Place, Suite 1300
Toronto, Ontario, Canada M5X 1E3
Integrated Health Services, Inc...................................... 2,112,490 10.2
10065 Red Run Blvd.
Owings Mills, Maryland 21117
Dirk Allison(4)...................................................... 114,413 *
Donald W. Hughes(5).................................................. 8,333 *
Robert DellaValle.................................................... 0 *
Allan C. Silber(6)................................................... 387,500 1.8
Morris A. Perlis(6).................................................. 387,500 1.8
Joseph F. Furlong, III(7)(8)......................................... 74,500 *
John Haronian(8)(10)................................................. 142,500 *
Edward Sonshine, Q.C.(7)(8).......................................... 74,500 *
Gail Wilensky, Ph.D.(9).............................................. 15,000 *
Albert Reichmann(9).................................................. 15,000 *
J. Brendan Ryan(9)................................................... 15,000 *
John E. Zuccotti(9)(11).............................................. 24,500 *
All directors and executive officers as a group(12) (12 persons)..... 1,258,746 5.8
</TABLE>

- ---------------

* Indicates less than 1%.
(1) Unless otherwise indicated, the persons or entities identified in this
table have sole voting and investment power with respect to all shares
shown as beneficially owned by them, subject to community property laws,
where applicable.
(2) The percentages shown are based on 20,714,889 shares of Common Stock
outstanding on September 16, 1996, plus, as to each individual and group
listed, the number of shares of Common Stock deemed to be owned by such
holder pursuant to Rule 13d-3 under the Securities Exchange Act of 1934
(the "Exchange Act"), which includes shares subject to stock options and
warrants held by such holder which are exercisable within sixty days of
such date.
(3) Includes 1,298,181 and 1,038,545 shares issuable upon the exercise of
warrants at $4.50 and $5.50 per share respectively. Directors Silber,
Sonshine and Perlis are directors of Counsel and director Silber
beneficially owns or controls approximately 18% of the common stock of
Counsel, a majority of which is pledged to a lender. Directors Sonshine and
Perlis own in the aggregate less than 5% of Counsel's common stock. All of
the directors listed in this footnote (3) disclaim beneficial ownership of
shares of Common Stock in their capacity as directors of Counsel, and Mr.
Silber disclaims beneficial ownership of shares of Common Stock in his
capacity as a significant stockholder of Counsel.
(4) Includes 15,170 and 12,136 shares issuable upon the exercise of warrants at
$4.50 and $5.50 per share, respectively, and 16,667, 15,000 and 25,000
shares issuable upon the exercise of options at $4.31, $4.44 and $8.50 per
share, respectively.
(5) Includes 8,333 shares issuable upon the exercise of options at $8.50 per
share.

30
<PAGE> 31

(6) Includes 25,000 and 20,000 shares issuable upon the exercise of warrants at
$4.50 and $5.50 per share, respectively and 15,000, 2,500, 250,000 and
25,000 shares issuable upon the exercise of options at $4.44, $7.50, $4.31
and $8.50 per share, respectively.
(7) Includes 15,000 and 12,000 shares issuable upon the exercise of warrants at
$4.50 and $5.50 per share, respectively.
(8) Includes 15,000 and 2,500 shares issuable upon the exercise of options at
$4.44 and $7.50 per share, respectively.
(9) Includes 15,000 shares issuable upon the exercise of options at $4.44 per
share.
(10) Includes 15,000 and 15,000 shares issuable upon the exercise of options at
$2.85 and $3.50 per share, respectively, and 25,000 and 20,000 shares
issuable upon the exercise of warrants at $4.50 per share, and $5.50 per
share, respectively.
(11) Includes 2,500 and 2,000 shares issuable upon the exercise of warrants at
$4.50 and $5.50 per share, respectively.
(12) Includes 1,013,306 shares issuable upon the exercise of options and
warrants.

31
<PAGE> 32

DESCRIPTION OF CAPITAL STOCK

GENERAL

The Company is authorized to issue 50,000,000 shares of Common Stock, par
value $.01 per share and 500,000 shares of serial preferred stock, par value
$.01 per share. As of September 16, 1996, 20,714,889 shares of Common Stock and
no shares of preferred stock were issued and outstanding. In addition as of
August 7, 1996 there were options and warrants outstanding to purchase 1,749,500
and 4,013,344 shares of Common Stock, respectively.

SHARES ELIGIBLE FOR FUTURE SALE

Upon completion of the Offering, the Company will have 29,714,889 shares of
Common Stock outstanding. Of these shares, 20,448,747 will be freely tradeable,
and the remaining 9,266,142 will be "restricted securities" as that term is
defined in Rule 144 promulgated under the Securities Act. Of these restricted
securities, 8,132,579 shares are subject to certain piggyback and demand
registration rights that are currently exercisable, and 1,035,000 shares are
subject to certain currently exercisable piggyback registration rights and to
certain demand registration rights that are exercisable beginning in October
1996. An additional 1,857,000 shares are issuable upon the exercise of
outstanding stock options, and 4,013,344 shares are issuable upon the exercise
of certain outstanding warrants. Upon the exercise of such options and warrants,
3,443,618 of these shares will be freely tradeable, and the remainder will be
restricted securities. Of these restricted securities, 2,336,726 shares are
subject to certain demand and piggyback registration rights that are currently
exercisable. Holders of 11,962,944 shares of Common Stock outstanding or
underlying outstanding warrants have agreed not to sell any of their shares for
a period of 120 days after the date of this Prospectus without the prior written
consent of the representatives of the Underwriters.

32
<PAGE> 33

UNDERWRITING

The Underwriters named below (the "Underwriters"), for whom Equitable
Securities Corporation, Lehman Brothers, Inc., BT Securities Corporation, Wheat,
First Securities, Inc. and Volpe, Welty & Company are acting as Representatives,
have severally agreed, subject to the terms and conditions contained in the
Underwriting Agreement, to purchase from the Company the number of shares of
Common Stock set forth below opposite their respective names:

<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITERS SHARES
------------------------------------------------------------------------- ----------
<S> <C>
Equitable Securities Corporation......................................... 1,800,000
Lehman Brothers Inc. .................................................... 1,800,000
BT Securities Corporation................................................ 1,800,000
Wheat, First Securities, Inc. ........................................... 1,800,000
Volpe, Welty & Company................................................... 1,800,000
----------
Total.......................................................... 9,000,000
=========
</TABLE>

The Company is obligated to sell and the Underwriters are obligated to
purchase all of the 9,000,000 shares of Common Stock offered hereby, if any
shares are purchased.

The Underwriters, through their Representatives, have advised the Company
that they propose to offer the shares of Common Stock to the public at the
public offering price set forth on the cover page of this Prospectus; that the
Underwriters may allow to selected dealers at such price less a concession not
in excess of $.32 per share of Common Stock; and that such selected dealers may
reallow a concession not in excess of $.10 per share of Common Stock to certain
other brokers and dealers. After the public offering, the offering price and the
concessions may be changed by the Representatives.

The Company has granted the Underwriters an option, exercisable for 45 days
from the date of this Prospectus, to purchase at the public offering price, less
the underwriting discount, as set forth on the cover page of this Prospectus, up
to 1,350,000 additional shares of Common Stock. If the Underwriters exercise
their option to purchase any of the additional shares of Common Stock, each of
the Underwriters will have a firm commitment, subject to certain conditions, to
purchase approximately the same percentage thereof which the number of shares of
Common Stock to be purchased by each of them as shown in the above table bears
to the Underwriters' initial commitment. The Underwriters may exercise such
options only to cover over-allotments in connection with the sale of Common
Stock offered hereby. The Underwriters, should they exercise their
over-allotment options, will exercise such options on a pro rata basis.

In connection with this Offering, certain Underwriters and selling group
members, if any, or their respective affiliates who are qualified registered
market makers on the Nasdaq Stock Market may engage in passive market making on
the Nasdaq Stock Market in accordance with Rule 10b-6A under the Exchange Act
during the two business day period before the commencement of the offers or
sales of the Common Stock. The passive market making transactions must comply
with applicable volume and price limits and be identified as such. In general, a
passive market maker may display its bid of a price not in excess of the highest
independent bid for such security if all independent bids are lowered when
certain purchase limits are exceeded.

The Company and the Company's directors and executive officers have agreed
that they will not offer, pledge, issue, sell, contract to sell, grant any
option for the sale of or otherwise dispose of any shares of Common Stock or any
securities convertible into, or exercisable or exchangeable for, any shares of
Common Stock for a period of 120 days after the date of this Prospectus without
the prior written consent of the Representatives, subject to certain exceptions.

The Underwriting Agreement provides that the Company will indemnify the
several Underwriters against certain liabilities, including civil liabilities
under the Securities Act, or will contribute to payments the Underwriters may be
required to make in respect thereof.

33
<PAGE> 34

Bankers Trust Company, an affiliate of BT Securities Corporation, an
Underwriter, is the agent and a lender under the Bridge Loan for which it is
receiving interest income and customary fees.

Some of the proceeds to the Company from this Offering will be applied to
reduce indebtedness on the Bridge Loan. See "Use of Proceeds." Because more than
10% of the net proceeds of the Offering will be paid to an affiliate of BT
Securities Corporation, a member of the National Association of Securities
Dealers, Inc. (the "NASD") and a participant in the distribution of the Common
Stock being offered hereby, this Offering is being made pursuant to the
provisions of Rule 2710(c)(8) of the NASD Conduct Rules.

Equitable Securities Corporation performed investment banking services for
the Company in connection with the April 1996 Private Placement for which they
received customary fees.

The Underwriters have represented and agreed that (i) they have not offered
or sold and will not offer to sell any shares of Common Stock to persons in the
United Kingdom, except to persons whose ordinary activities involve them in
acquiring, holding, managing or disposing of investments (as principal or agent)
for the purpose of their businesses or otherwise in circumstances which have not
resulted and will not result in an offer to the public in the United Kingdom
within the meaning of the Public Offers of Securities Regulations 1995, (ii)
they have complied and will comply with all applicable provisions of the
Financial Services Act (the "Act") with respect to anything done by them in
relation to the shares of Common Stock in, from or otherwise involving the
United Kingdom and (iii) they have only issued or passed on, and will only issue
or pass on, in the United Kingdom, any document received by them in connection
with this issue of Common Stock to a person who is of a kind described in
Article 11(3) of the Financial Services Act of (Investment Advertisements)
(Exemptions) Order 1995 or is a person to whom the document may otherwise
lawfully be issued or passed on.

LEGAL MATTERS

The validity of the shares of the Common Stock offered hereby will be
passed upon for the Company by Harwell Howard Hyne Gabbert & Manner, P.C.,
Nashville, Tennessee. Certain legal matters relating to the sale of Common Stock
will be passed upon for the Underwriters by Stroock & Stroock & Lavan, New York,
New York.

EXPERTS

The audited consolidated financial statements and schedules of the Company,
included or incorporated by reference herein have been audited by Arthur
Andersen LLP, independent public accountants, and the consolidated financial
statements and schedules of Symphony included herein, have been audited by KPMG
Peat Marwick LLP, independent public accountants, as indicated in their reports
with respect thereto, and are included herein in reliance upon the authority of
said firms as experts in giving said reports.

AVAILABLE INFORMATION

The Company's principal executive offices are located at 2930 Washington
Boulevard, Baltimore, Maryland 21230, phone number (410) 646-7373. The Company
is subject to the informational requirements of the Securities Exchange Act of
1934, as amended (the "Exchange Act"), and, in accordance therewith, files
reports, proxy and information statements and other information with the
Securities and Exchange Commission (the "Commission"). Copies of such reports
and other information filed by the Company can be obtained, at prescribed rates,
from the Public Reference Section of the Commission at Room 1024, 450 Fifth
Street, N.W., Judiciary Plaza, Washington, D.C. 20549. In addition, such reports
and other information can be inspected at the Public Reference Section referred
to above and at the Regional Offices of the Commission at Northwest Atrium
Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661; and 75
Park Place, 14th Floor, New York, New York 10007. Copies of such material can be
obtained by mail from the

34
<PAGE> 35

Public Reference Section of the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549 at prescribed rates. The Commission also maintains a web
site (http://www.sec.gov) that contains reports, proxy and information
statements and other information filed electronically with the Commission. In
addition, reports, proxy material and other information concerning the Company
may be inspected at the offices of the Nasdaq Stock Market at the following
address: Nasdaq Market Surveillance, Fourth Floor, 9513 Key West Avenue,
Rockville, Maryland 20850.

The Company has filed with the Commission a registration statement on Form
S-3 (together with all amendments and exhibits thereto, the "Registration
Statement") under the Securities Act of 1933. This Prospectus does not contain
all of the information set forth in the Registration Statement, certain parts of
which are omitted in accordance with the rules and regulations of the
Commission. For further information, reference is hereby made to the
Registration Statement.

INCORPORATION OF CERTAIN INFORMATION BY REFERENCE

The following documents filed by the Company with the Commission are
incorporated herein by reference:

1. The Company's Annual Report on Form 10-K for the ten months ended
December 31, 1995, as amended by Form 10-K/A-2;

2. The Company's Registration Statement on Form 8-A relating to the
Company's Common Stock dated June 18, 1986, as amended by a Form
8-A/A dated July 18, 1996;

3. The Company's Current Report on Form 8-K dated December 31, 1995, as
amended by Form 8-K/A;

4. The Company's Current Report on Form 8-K dated February 29, 1996, as
amended by Forms 8-K/A and 8-K/A2;

5. The Company's Current Report on Form 8-K dated March 20, 1996;

6. The Company's Quarterly Report on Form 10-Q for the quarter ended
March 31, 1996;

7. The Company's Quarterly Report on Form 10-Q for the quarter ended
June 30, 1996;

8. The Company's Current Report on Form 8-K dated July 18, 1996;

9. The Company's Current Report on Form 8-K dated July 30, 1996, as
amended by Form 8-K/A; and

10. The Company's Current Report on Form 8-K/A-2 dated May 22, 1995.

All documents subsequently filed by the Company with the Commission
pursuant to Section 13(a), (c), 14 or 15(d) of the Exchange Act and prior to the
termination of this offering shall be deemed to be incorporated by reference in
this Prospectus. Any statement contained in a document incorporated or deemed to
be incorporated by reference herein shall be deemed to be modified or superseded
for purposes of this Prospectus to the extent that a statement contained herein,
or in any other subsequently filed document that also is or is deemed to be
incorporated by reference herein, modifies or supersedes such statement. Any
such statement so modified or superseded shall not be deemed, except as so
modified or superseded, to constitute a part of this Prospectus.

The Company will provide without charge to each person, including any
beneficial owner, to whom this Prospectus is delivered, upon the request of such
person, a copy of any or all of the documents which are incorporated by
reference in this Prospectus, but not delivered herewith, other than exhibits to
such documents (unless such exhibits are specifically incorporated by reference
into the information that this Prospectus incorporates). Written or telephone
requests should be directed to R. Dirk Allison, President, Capstone Pharmacy
Services, Inc., 2930 Washington Boulevard, Baltimore, Maryland 21230, (800)
766-2761.

35
<PAGE> 36

INDEX TO FINANCIAL STATEMENTS

(A) 1. FINANCIAL STATEMENTS:

The following financial statements of the Company and Symphony Pharmacy
Services, Inc. are included herein.

<TABLE>
<CAPTION>
PAGE
-----------
<S> <C>
CAPSTONE PHARMACY SERVICES, INC.
Report of Independent Public Accountants........................................ F-2
Consolidated Balance Sheets -- As of December 31, 1995 and February 28, 1995.... F-3
Consolidated Statements of Operations -- For the ten months ended December 31,
1995 and the years ended February 28, 1995 and 1994........................... F-4
Consolidated Statements of Changes in Stockholders' Equity -- For the ten months
ended December 31, 1995 and the years ended February 28, 1995 and 1994........ F-5
Consolidated Statements of Cash Flows -- For the ten months ended December 31,
1995 and years ended February 28, 1995 and 1994............................... F-6
Notes to Consolidated Financial Statements...................................... F-7 - F-18
SYMPHONY PHARMACY SERVICES, INC.
Independent Auditors' Report.................................................... F-19
Consolidated Balance Sheets -- December 31, 1994 and 1995....................... F-20
Consolidated Statements of Earnings -- Years ended December 31, 1993, 1994 and
1995.......................................................................... F-21
Consolidated Statements of Changes in Stockholders' Equity -- Years ended
December 31, 1993, 1994 and 1995.............................................. F-22
Consolidated Statements of Cash Flows -- Years ended December 31, 1993, 1994 and
1995.......................................................................... F-23
Notes to Consolidated Financial Statements -- December 31, 1993, 1994 and
1995.......................................................................... F-24 - F-30
</TABLE>

F-1
<PAGE> 37

CAPSTONE PHARMACY SERVICES, INC. AND SUBSIDIARIES

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors
And Stockholders of Capstone
Pharmacy Services, Inc.:

We have audited the accompanying consolidated balance sheets of Capstone
Pharmacy Services, Inc. (a Delaware corporation and formerly Choice Drug
Systems, Inc.) and subsidiaries as of December 31, 1995 and February 28, 1995,
and the related consolidated statements of operations, changes in stockholders'
equity and cash flows for the ten months ended December 31, 1995, and the years
ended February 28, 1995 and 1994. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Capstone Pharmacy Services,
Inc. and subsidiaries as of December 31, 1995 and February 28, 1995, and the
results of their operations and their cash flows for the ten months ended
December 31, 1995, and the years ended February 28, 1995 and 1994, in conformity
with generally accepted accounting principles.

/s/ ARTHUR ANDERSEN LLP
--------------------------------------
Arthur Andersen LLP

Baltimore, Maryland
March 11, 1996 (except with respect to
the matters discussed in Notes 16 and 17,
as to which the date is July 29, 1996)

F-2
<PAGE> 38

CAPSTONE PHARMACY SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1995 AND FEBRUARY 28, 1995

DECEMBER 31, FEBRUARY 28,
1995 1995
------------ ------------
(NOTE 1)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents (Note 1).............................. $ 2,763,416 $ 546,898
Accounts receivable, net of allowance for doubtful accounts of
$1,294,000 as of December 31, 1995 and $1,561,000 as of
February 28, 1995............................................ 12,646,087 6,169,272
Inventories (Note 1)............................................ 5,023,008 3,888,163
Refundable income taxes (Note 8)................................ 828,628 500,000
Prepaid expenses and other current assets....................... 688,549 350,568
Net assets of discontinued operations (Note 7).................. -- 302,820
------------ ------------
21,949,688 11,757,721
------------ ------------
Equipment and leasehold improvements, net (Notes 1 and 3)......... 2,692,298 1,329,093
------------ ------------
Other assets:
Notes receivable, less current portion.......................... 77,289 94,435
Advances to affiliates (Note 15)................................ 2,242,841 --
Security deposits and other assets.............................. 587,915 509,498
Goodwill, net of accumulated amortization of $1,554,000 as of
December 31, 1995 and $1,117,000 as of February 28, 1995
(Notes 1 and 2).............................................. 14,580,564 5,521,512
------------ ------------
17,488,609 6,125,445
------------ ------------
Total assets............................................ $ 42,130,595 $ 19,212,259
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................................ $ 4,671,435 $ 2,664,143
Accrued expenses and other current liabilities.................. 1,465,837 1,702,711
Current portion of long-term debt (Notes 4 and 9)............... 4,222,608 765,387
Current portion of non-compete agreements....................... 200,000 --
Accrued restructuring charges (Note 6).......................... 575,349 716,173
------------ ------------
11,135,229 5,848,414
------------ ------------
Deferred income taxes (Note 8).................................... 542,787 --
Non-compete agreements, net of current portion.................... 400,000 --
Long-term debt, net of current portion (Notes 4 and 9)............ 2,692,202 7,650,455
Long-term portion of accrued restructuring charges (Note 6)....... 520,640 935,860
------------ ------------
4,155,629 8,586,315
------------ ------------
Commitments and contingencies (Notes 9, 10 and 17)
Stockholders' equity (Note 11):
Common stock: $.01 par value; 30,000,000 shares authorized at
December 31, 1995 and 15,000,000 shares authorized at
February 28, 1995; 13,610,810 shares issued and outstanding
as of December 31, 1995 and 8,120,810 shares issued and
outstanding as of February 28, 1995.......................... 136,108 81,208
Capital in excess of par........................................ 38,985,006 17,200,050
Accumulated deficit............................................. (12,281,377) (12,503,728)
------------ ------------
26,839,737 4,777,530
------------ ------------
Total liabilities and stockholders' equity.............. $ 42,130,595 $ 19,212,259
=========== ===========
</TABLE>

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

F-3
<PAGE> 39

CAPSTONE PHARMACY SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE TEN MONTHS ENDED DECEMBER 31, 1995 AND
THE YEARS ENDED FEBRUARY 28, 1995 AND 1994

TEN MONTHS
ENDED YEARS ENDED FEBRUARY 28,
DECEMBER 31, --------------------------
1995 1995 1994
------------ ------------ -----------
(NOTE 1)
<S> <C> <C> <C>
Net sales (Note 1)..................................... $ 48,841,443 $ 43,607,946 $51,253,713
Cost of sales (Note 12)................................ 30,654,118 27,969,532 32,440,841
------------ ------------ -----------
Gross profit................................. 18,187,325 15,638,414 18,812,872
------------ ------------ -----------
Operating expenses:
Selling, general and administrative expenses......... 17,468,930 18,637,213 17,240,810
Depreciation and amortization........................ 1,145,669 988,974 1,037,425
Costs in connection with litigation (Notes 4 and
9)................................................ -- 4,389,163 463,207
Restructuring charges (Note 6)....................... 240,000 2,069,432 --
------------ ------------ -----------
Total operating expenses..................... 18,854,599 26,084,782 18,741,442
------------ ------------ -----------
(Loss) income from operations................ (667,274) (10,446,368) 71,430
------------ ------------ -----------
Non-operating expense (income):
Interest expense, net (Note 4)....................... 634,232 905,404 670,425
Other income, net (Note 13).......................... (431,900) (104,076) (26,366)
------------ ------------ -----------
Total non-operating expense, net............. 202,332 801,328 644,059
------------ ------------ -----------
Loss before income taxes, discontinued
operations and extraordinary item.......... (869,606) (11,247,696) (572,629)
Benefit for income taxes (Note 8)...................... (225,082) (466,214) (51,495)
------------ ------------ -----------
Loss from continuing operations.............. (644,524) (10,781,482) (521,134)
Discontinued Operations (Note 7):
Gain (loss) from operations of discontinued business
segments, net of tax benefits of $-0-, $-0- and
$175,000 for the ten months ended December 31,
1995 and the years ended February 28, 1995 and
1994, respectively................................ 18,667 (135,430) (340,416)
Gain (loss) on disposal of business segments, net.... 564,844 (503,067) --
------------ ------------ -----------
Loss before extraordinary item......................... (61,013) (11,419,979) (861,550)
Extraordinary item (Note 5):
Discount on repayment of vendor debt................. 283,364 -- --
------------ ------------ -----------
Net Income (loss)............................ $ 222,351 $(11,419,979) $ (861,550)
========== =========== ==========
Earnings per share data:
Primary
Continuing operations................................ $ (0.06) $ (1.67) $ (0.08)
Discontinued operations.............................. 0.05 (0.10) (0.06)
Extraordinary item................................... 0.03 -- --
------------ ------------ -----------
Net income (loss)............................ $ 0.02 $ (1.77) $ (0.14)
========== =========== ==========
Fully Diluted
Continuing operations................................ $ (0.05) $ (1.67) $ (0.08)
Discontinued operations.............................. 0.05 (0.10) (0.06)
Extraordinary item................................... 0.02 -- --
------------ ------------ -----------
Net income (loss)............................ $ 0.02 $ (1.77) $ (0.14)
========== =========== ==========
Weighted average number of common shares outstanding:
Primary.............................................. 11,337,997 6,458,891 6,071,687
========== =========== ==========
Fully Diluted........................................ 12,398,401 6,458,891 6,071,687
========== =========== ==========
</TABLE>

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

F-4
<PAGE> 40

CAPSTONE PHARMACY SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE TEN MONTHS ENDED DECEMBER 31, 1995 AND
THE YEARS ENDED FEBRUARY 28, 1995 AND 1994

<TABLE>
<CAPTION>
COMMON STOCK CAPITAL
--------------------- IN EXCESS ACCUMULATED
SHARES AMOUNT OF PAR DEFICIT
---------- -------- ----------- ------------
<S> <C> <C> <C> <C>
Balance, February 28, 1993.................... 6,026,810 $ 60,268 $ 9,238,690 $ (222,199)
Issuance of common stock in connection with
exercise of stock warrants.................. 60,000 600 100,650 --
Net loss for the year ended February
28, 1994.......................... -- -- -- (861,550)
---------- -------- ----------- ------------
Balance, February 28, 1994.................... 6,086,810 60,868 9,339,340 (1,083,749)
Issuance of common stock:
Stock issued to Counsel Corporation in
connection with stock purchase agreement,
net of related issuance costs (Note 5)... 2,000,000 20,000 7,171,300 --
Stock issued in connection with exercise of
stock options (Note 11).................. 34,000 340 89,410 --
Stock to be issued in settlement of
litigation (Note 9)...................... -- -- 600,000 --
Net loss for the year ended February
28, 1995.......................... -- -- -- (11,419,979)
---------- -------- ----------- ------------
Balance, February 28, 1995.................... 8,120,810 81,208 17,200,050 (12,503,728)
Issuance of common stock:
Stock issued in connection with private
placements, net of related issuance costs
(Note 5)................................. 5,100,000 51,000 20,769,231 --
Stock issued in connection with the
acquisition of PremierPharmacy, Inc.
(Note 2)................................. 35,000 350 157,150 --
Stock issued in connection with exercise of
stock options (Note 11).................. 355,000 3,550 858,575 --
Net income for the ten months ended
December 31, 1995................. -- -- -- 222,351
---------- -------- ----------- ------------
Balance, December 31, 1995 (Note 1)........... 13,610,810 $136,108 $38,985,006 $(12,281,377)
========= ======== ========== ===========
</TABLE>

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

F-5
<PAGE> 41

CAPSTONE PHARMACY SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE TEN MONTHS ENDED DECEMBER 31, 1995 AND
THE YEARS ENDED FEBRUARY 28, 1995 AND 1994

TEN MONTHS
ENDED YEARS ENDED FEBRUARY 28,
DECEMBER 31, --------------------------
1995 1995 1994
------------ ------------ -----------
(NOTE 1)
<S> <C> <C> <C>
Cash flows from (to) operating activities:
Net income (loss)................................... $ 222,351 $(11,419,979) $ (861,550)
Adjustments to reconcile net income (loss) to net
cash (used in) provided by operating activities:
Depreciation and amortization.................... 1,145,669 988,974 1,037,425
(Gain) loss on disposal of business segments..... (564,844) 503,067 --
Settlement of litigation......................... -- 3,500,000 --
Change in assets and liabilities, net of effects
from acquisition/disposal of businesses:
(Increase) decrease in accounts receivable..... (2,644,719) 2,161,906 184,737
Decrease in inventories........................ 357,029 1,297,829 754,674
(Increase) decrease in refundable income
taxes....................................... (238,168) (108,699) 482,969
(Increase) decrease in prepaid expenses and
other current assets........................ (51,870) 779,825 (31,159)
(Increase) decrease in other assets............ (133,629) (333,011) 17,135
Increase (decrease) in accounts payable........ 821,665 (282,502) (1,023,784)
(Decrease) increase in accrued expenses and
other current liabilities................... (1,810,162) 137,441 1,259,862
(Decrease) increase in accrued restructuring
charges..................................... (691,200) 1,652,033 --
------------ ------------ -----------
Net cash (used in) provided by operating
activities..................................... (3,587,878) (1,123,116) 1,820,309
------------ ------------ -----------
Cash flows from (to) investing activities:
Purchase of equipment and leasehold improvements.... (1,076,976) (252,943) (316,737)
Acquisition of PremierPharmacy, Inc. net of cash
acquired......................................... (4,168,872) -- --
Proceeds from sale of business segment.............. 700,000 -- --
Advances to affiliates.............................. (2,242,841) -- --
Repayments of notes receivable...................... 229,571 261,555 372,088
------------ ------------ -----------
Net cash (used in) provided by investing
activities..................................... (6,559,118) 8,612 55,351
------------ ------------ -----------
Cash flows from (to) financing activities:
Loan proceeds from Creditanstalt.................... 11,600,000 -- --
Loan repayments to Creditanstalt.................... (9,650,000) -- --
Proceeds from issuance of common stock, net......... 21,682,356 7,281,050 101,250
Loan proceeds from Counsel Corporation.............. 1,268,250 -- --
Loan repayments to Counsel Corporation.............. (1,268,250) -- --
Non-compete agreement payments...................... (200,000) -- --
Repayments of long-term debt, net................... (10,884,850) (5,902,723) (1,715,698)
Principal payments of capital lease obligations..... (183,992) (160,183) (140,379)
------------ ------------ -----------
Net cash provided by (used in) financing
activities..................................... 12,363,514 1,218,144 (1,754,827)
------------ ------------ -----------
Net increase in cash and cash equivalents............. 2,216,518 103,640 120,833
Cash and cash equivalents, beginning of year.......... 546,898 443,258 322,425
------------ ------------ -----------
Cash and cash equivalents, end of year................ $ 2,763,416 $ 546,898 $ 443,258
=========== =========== ==========
Supplemental Disclosure of Cash Flows Information
Cash paid for:
Interest......................................... $ 659,184 $ 887,691 $ 741,705
=========== =========== ==========
Taxes............................................ $ 144,149 $ 224,477 $ 24,349
=========== =========== ==========
</TABLE>

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

F-6
<PAGE> 42

CAPSTONE PHARMACY SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Business

Capstone Pharmacy Services, Inc. (formerly known as Choice Drug Systems,
Inc.) together with its subsidiaries (the "Company"), a Delaware corporation, is
principally engaged in the business of providing pharmaceuticals and related
services to long-term care facilities, correctional institutions, hospitals and
health maintenance organizations. The Company's long-term care and health
maintenance organization customers are primarily located in New York, New
Jersey, Maryland, Pennsylvania and Delaware, while the Company's hospital and
correctional facility customers are located throughout the United States.

On August 28, 1995, the Company changed its state of incorporation from New
York to Delaware. Effective October 2, 1995, the Company changed its name from
Choice Drug Systems, Inc. to Capstone Pharmacy Services, Inc. Additionally,
effective December 31, 1995, the Company changed its year-end from February 28
to December 31.

As of December 31, 1995, Counsel Corporation, an Ontario corporation
("Counsel"), owned approximately 3,908,000 shares of the Company's common stock
together with warrants to purchase approximately 2,337,000 additional shares.
Counsel is a management and business development company operating primarily in
the United States health care industry (See Note 5).

Principles of Consolidation

The consolidated financial statements include the accounts of Capstone
Pharmacy Services, Inc. and its wholly-owned subsidiaries. All material
intercompany accounts and transactions have been eliminated.

Use of Estimates

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

Reclassifications

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

Cash and Cash Equivalents

The Company considers all highly liquid debt instruments purchased with a
maturity of three months or less to be cash equivalents.

Inventories

Inventories are stated at the lower of cost (first-in, first-out method) or
market. Inventories consist principally of purchased pharmaceuticals.

F-7
<PAGE> 43

CAPSTONE PHARMACY SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Equipment and Leasehold Improvements

Equipment and leasehold improvements are recorded at cost. Depreciation and
amortization are computed using the straight-line method over the following
estimated useful lives or with respect to leasehold improvements, over the term
of the lease if shorter.

<TABLE>
<S> <C>
Furniture, fixtures and equipment................................ 3-10 years
Automobiles and trucks........................................... 3-4 years
Leasehold improvements........................................... 5-10 years
Equipment under capital leases................................... 3-5 years
</TABLE>

Equipment and leasehold improvements obtained in acquisitions of
subsidiaries are depreciated or amortized based on their remaining useful lives
at the acquisition date.

Goodwill

Costs in excess of fair values of businesses acquired are recorded as
goodwill and amortized using the straight-line method over periods of twenty to
forty years. Amortization of goodwill amounted to approximately $460,000,
$384,000 and $408,000 for the ten months ended December 31, 1995 and the years
ended February 28, 1995 and 1994, respectively.

The Company monitors the individual financial performance of each of the
acquired businesses and continually evaluates the realizability of goodwill and
the potential for any impairment to its recoverability based on the projected
future net income of the respective acquired businesses.

401(K) Benefit Plan

Effective May 22, 1995, employees of the Company may participate in a
supplemental retirement program established under Section 401(K) of the Internal
Revenue Code of 1986, as amended. Contributions by the Company may be made to
the plan subject to the discretion of the Board of Directors. No Company
contribution was made for the ten months ended December 31, 1995.

Revenue Recognition

Revenues are recorded as products are shipped and services are rendered. A
portion of the Company's sales are covered by various state and Federal
reimbursement programs, which are subject to review and/or audit. Reimbursement
programs are also subject to change from time to time.

Income Taxes

The Company files a consolidated Federal income tax return. Income tax
expense is based on reported earnings before income taxes. Effective March 1,
1993, the Company adopted Statement of Financial Accounting Standards ("SFAS")
No. 109, "Accounting for Income Taxes". Under this Statement, deferred taxes on
income are provided for those items for which the reporting period and methods
used for income tax purposes differ from those used for financial statement
purposes, using the asset and liability method. Deferred income taxes are
recognized for the tax consequences of "temporary differences" by applying
enacted statutory rates applicable to future years to differences between the
financial statement carrying amounts and the tax bases of existing assets and
liabilities. The impact of initially adopting SFAS No. 109 for the year ended
February 28, 1994 was $0.

Earnings Per Share

Net loss per common share for the years ended February 28, 1995 and 1994,
was computed by dividing the net loss by the weighted average number of common
shares outstanding. For the ten months ended

F-8
<PAGE> 44

CAPSTONE PHARMACY SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

December 31, 1995, primary and fully diluted earnings per common share were
computed by dividing net income by the weighted average number of shares of
common stock and common stock equivalents outstanding. The amount of common
stock equivalents outstanding was computed using the treasury stock method.

2. ACQUISITIONS

In May 1995, the Company acquired Premier Pharmacy, Inc. ("Premier"), an
institutional pharmacy, for a purchase price of $4,250,000 in cash. Premier's
operations generate annualized revenues of approximately $24,000,000, primarily
from pharmacy services provided to long-term care facilities located in the New
York metropolitan area and hospitals located in the southeastern United States.

The Premier acquisition has been accounted for under the purchase method of
accounting with the assets and liabilities of Premier recorded at their
estimated fair market values at the date of acquisition. The operations of
Premier, since the acquisition, are included in the accompanying consolidated
statement of operations for the ten months ended December 31, 1995. Goodwill of
approximately $9,350,000, representing the excess of acquisition costs over the
fair market value of acquired net assets, is being amortized over forty years.

The following proforma information reflects the combined results of
operations of the Company as if the acquisition of Premier was consummated on
March 1, 1994:

<TABLE>
<CAPTION>
TEN MONTHS ENDED YEAR ENDED
DECEMBER 31, FEBRUARY 28,
1995 1995
---------------- ------------
(IN THOUSANDS, EXCEPT FOR
PER SHARE AMOUNTS)
<S> <C> <C>
Net sales............................................. $ 54,834 $ 68,503
Cost of sales......................................... 34,531 42,704
---------------- ------------
Gross profit........................................ 20,303 25,799
Operating expenses including interest and taxes....... 22,330 37,493
---------------- ------------
Loss from continuing operations....................... (2,027) (11,694)
Discontinued operations............................... 584 (638)
Extraordinary items................................... 283 --
---------------- ------------
Net loss.................................... $ (1,160) $(12,332)
============== =========
Net loss per share.......................... $ (.10) $ (1.53)
============== =========
</TABLE>

These proforma operating results reflect certain adjustments, including
amortization of goodwill acquired and related income tax effects. The proforma
results are not necessarily indicative of the operating results that would have
occurred had the Premier acquisition been consummated on March 1, 1994, nor are
they necessarily indicative of future results.

The Company is obligated to pay the former stockholders of certain
subsidiaries acquired by Premier $200,000 per year for the next three years
under non-compete agreements.

F-9
<PAGE> 45

CAPSTONE PHARMACY SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

3. EQUIPMENT AND LEASEHOLD IMPROVEMENTS

Equipment and leasehold improvements are comprised of the following:

<TABLE>
<CAPTION>
DECEMBER 31, FEBRUARY 28,
1995 1995
------------ ------------
<S> <C> <C>
Leasehold improvements.................................... $ 544,272 $ 749,468
Furniture, fixtures and equipment......................... 3,945,149 3,181,738
Data processing equipment................................. 1,512,500 910,377
Automobiles and trucks.................................... 258,379 161,454
------------ ------------
6,260,300 5,003,037
Accumulated depreciation and amortization................. (3,568,002) (3,673,944)
------------ ------------
$ 2,692,298 $ 1,329,093
========== ==========
</TABLE>

Depreciation and amortization of equipment and leasehold improvements
amounted to approximately $686,000, $605,000 and $629,000 for the ten months
ended December 31, 1995 and the years ended February 28, 1995 and 1994,
respectively.

4. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS

Long-term debt at December 31, 1995 and February 28, 1995, consisted of the
following:

<TABLE>
<CAPTION>
DECEMBER 31, FEBRUARY 28,
1995 1995
------------ ------------
<S> <C> <C>
Loan payable to United Jersey Bank, interest at prime plus
1.5%, repaid on May 22, 1995............................... $ -- $ 2,983,303
Borrowings under a $10,000,000 revolving loan with
Creditanstalt, interest at prime plus 0.5%, secured by
substantially all assets of the Company, due on demand..... 1,950,000 --
Unsecured note payable to relative of former stockholder,
payable in quarterly installments with interest at 9%
through January 2000....................................... 297,938 355,372
Subordinated promissory note payable to major supplier,
payable in equal monthly installments, interest at prime
plus 3%, repaid on May 22, 1995............................ -- 1,533,333
Promissory note payable to major supplier, payable monthly
with interest at prime plus 3%, repaid on May 22, 1995..... -- 242,730
Amounts due under a Medicare settlement with the United
States Government, payable in quarterly installments with
interest at 7.75% through 2001............................. 2,537,500 2,900,000
Unsecured notes payable to former stockholders of a Premier
subsidiary, interest at 6%, currently payable.............. 1,000,000 --
</TABLE>

F-10
<PAGE> 46

CAPSTONE PHARMACY SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

<TABLE>
<CAPTION>
DECEMBER 31, FEBRUARY 28,
1995 1995
------------ ------------
<S> <C> <C>
Unsecured notes payable to former stockholders of a Premier
subsidiary, due in monthly installments of $14,898,
including interest at 6% through October 31, 1998.......... $ 464,752 --
Unsecured note payable to former stockholder of a Premier
subsidiary, interest at 7%, due August 11, 1996............ 153,334 --
Unsecured notes payable to former stockholders of a Premier
subsidiary, interest at 7%, due in annual installments of
$30,000 through June 30, 1999.............................. 120,000 --
Capital lease obligations (Note 9)........................... 364,844 401,104
Other........................................................ 26,442 --
------------ ------------
6,914,810 8,415,842
Less: Current portion........................................ (4,222,608) (765,387)
------------ ------------
Long-term portion............................................ $2,692,202 $ 7,650,455
========== =========
</TABLE>

Future maturities of long-term debt, exclusive of capital lease
obligations, at December 31, 1995, follow:

The Company's agreement with Creditanstalt requires that the Company
provide certain information and maintain certain financial ratios and minimum
net worth and earnings levels. The average interest rate on amounts outstanding
under this agreement was 8.75%. A letter of credit fee of 1.25% is paid on a
monthly basis. Amounts available to be borrowed under this agreement are based
upon levels of accounts receivable and inventories. The Company had unused
credit available under this agreement as of December 31, 1995 of $7,450,000.

On November 1, 1995, the Company elected not to make a scheduled
installment payment on a note payable to former stockholders of a Premier
subsidiary in the aggregate principal amount of $1,000,000, due to a dispute
with these former stockholders. This amount is recorded as current portion of
long-term debt in the accompanying consolidated balance sheet as of December 31,
1995.

On October 31, 1994, the Company entered into an agreement with the United
States Government settling an investigation conducted by the U.S. Attorney for
the Eastern District of Pennsylvania into claims for reimbursement made by
certain of the Company's subsidiaries to the Medicare Program. The subject of
the investigation was the Company's claims documentation and Medicare
reimbursement practices for December 1993 and prior. Under the terms of the
settlement, without admitting any liability, the Company has agreed to repay, as
a return of revenue previously received, over a six-year period, $3,400,000 to
settle the Government's claims. Initially, $100,000 was paid upon the execution
of the agreement and $400,000 was paid on December 31, 1994. Thereafter,
$2,900,000 plus interest at an annual rate of 7.75% is payable in quarterly
installments over a six-year period ending January 1, 2001. The full amount of
the settlement, including related legal fees, is included in costs in connection
with litigation in the accompanying consolidated statement of operations for the
year ended February 28, 1995.

F-11
<PAGE> 47

CAPSTONE PHARMACY SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Based on the borrowing rates currently available to the Company, the fair
value of long-term debt, exclusive of capital lease obligations, as of December
31, 1995, is approximately $5,942,000.

5. PRIVATE PLACEMENTS

On December 16, 1994, the Company entered into a Stock Purchase Agreement
with Counsel. Pursuant to the Stock Purchase Agreement, Counsel acquired
2,000,000 shares of the Company's common stock for net proceeds of approximately
$7,191,000. Counsel was also granted two three-year warrants, the first of which
grants Counsel the right to purchase up to 1,000,000 shares of the Company's
common stock at the exercise price of $4.50 per share, and the second of which
grants Counsel the right to acquire up to 800,000 shares of the Company's common
stock at the exercise price of $5.50 per share.

On May 22, 1995, the Company completed a private placement of 1,600,000
units (the "Units"). Each Unit consisted of one share of common stock, a
three-year warrant to acquire 0.5 shares of common stock at the exercise price
of $4.50 per share, and a three-year warrant to acquire 0.4. shares of common
stock at the exercise price of $5.50 per share. The offering of Units raised
proceeds of approximately $5,759,000, net of related costs, at a price of $3.65
per Unit. The proceeds of the private placement were used to fund the
acquisition of Premier and to retire the debt to a major vendor in the amount of
approximately $1,776,000, resulting in a gain on the discount of debt of
approximately $283,000. The gain on the discount of debt is reflected in the
accompanying consolidated statement of operations for the ten months ended
December 31, 1995 as an extraordinary item.

On August 29, 1995, the Company completed a second private placement of its
common stock. This offering consisted of 3,500,000 shares at a price of $4.38
per share. The net proceeds of this private placement were approximately
$15,061,000, net of related costs including placement commissions. There were no
warrants issued in connection with this second private placement. The proceeds
of this private placement were used to retire outstanding debt of $9,650,000 due
to Creditanstalt and for general working capital purposes.

The Company has granted certain registration rights with respect to the
common stock issued under these private placements and the common stock
underlying the related warrants.

6. RESTRUCTURING CHARGES

In February 1995, the Company adopted a formal plan of restructuring in
order to realign and consolidate businesses, concentrate resources, and better
position itself to achieve its strategic growth objectives. This plan included
the termination and sale of the medical/surgical supply operations of a wholly
owned subsidiary, B.T. Smith, Inc., and the closing of the Company's long-term
care pharmacy operation in Missouri, Choice Drug Systems of Missouri, Inc., on
June 30, 1995.

Prior to the closing and ultimate sale of its medical/surgical supply
operations, the Company consolidated the medical/surgical supply operation of
B.T. Smith, Inc. with the medical/surgical supply division of J&J Drug & Medical
Service, Inc. in its Baltimore, Maryland pharmacy location. Accounting and
administration functions previously based at the Inwood, New York and Teaneck,
New Jersey pharmacy locations were also consolidated and moved to the Baltimore
office location. The effect of this consolidation was to refocus the Inwood and
Teaneck pharmacies on the core long-term care business; to consolidate the
Company's medical/surgical supply business in one location in anticipation of
its sale; and to consolidate accounting functions at the Company's Baltimore
headquarters location. The Company initiated these actions to streamline and
reduce the cost of operating its medical/surgical supply business and its
accounting function and to exit the unprofitable Missouri long-term care market.

The Company recorded restructuring charges of $2,069,432 for the year ended
February 28, 1995, which includes the write-down of accounts receivable,
inventories and fixed assets to net realizable value and the accrual for the
termination of leases, employee severance costs, and the estimated
administrative costs of

F-12
<PAGE> 48

CAPSTONE PHARMACY SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

terminating operations. Also included in the restructuring costs are amounts due
to former executives of the Company under consulting agreements which expire in
May 1997 and other long-term contractual obligations related to the restructured
business. During the ten months ended December 31, 1995, the Company recorded,
as a change in estimate, an additional $100,000 write-down of accounts
receivable for the medical/surgical supply operations.

The net sales and (loss) income from continuing operations of the
medical/surgical supply operations and the Missouri location follow:

<TABLE>
<CAPTION>
TEN MONTHS
ENDED YEARS ENDED FEBRUARY 28,
DECEMBER 31, ------------------------
1995 1995 1994
------------ ----------- ----------
<S> <C> <C> <C>
Net sales........................................ $ 854,018 $ 3,983,533 $5,466,810
========== ========== =========
(Loss) income from continuing operations......... $ (157,218) $(2,406,438) $ 9,569
========== ========== =========
</TABLE>

In December 1995, the Company adopted a formal plan of restructuring in
order to consolidate certain of its satellite locations. The Company recorded
restructuring costs of $140,000 for the ten months ended December 31, 1995,
which includes the write-down of fixed assets to net realizable value, the
accrual for employee severance costs and the termination of leases.

7. DISCONTINUED OPERATIONS

In February 1995, in connection with adoption of its formal restructuring
plan, the Company decided to discontinue the operations of its mail order and
computerized health care software businesses. The mail order business was closed
effective August 1, 1995 and the assets of the computerized health care software
business were sold to an unrelated party on June 30, 1995 for $700,000, which
resulted in a gain in the amount of $564,844, net of related income taxes of
$38,000.

The net gains or losses of these operations for the ten months ended
December 31, 1995 and the year ended February 28, 1995 and 1994 are included in
the consolidated statements of operations under gain (loss) from operations of
discontinued business segments. The loss on disposal of $503,067 reflected on
the consolidated statement of operations for the year ended February 28, 1995,
includes the write-down of the assets of the mail order and computer software
businesses to estimated net realizable value and the estimated costs of
disposing of these operations, including a pro-rata share of the Company's
expense for office space in Baltimore.

The Company had net sales from discontinued operations of approximately
$909,000, $2,731,000 and $3,123,000 for the ten months ended December 31, 1995
and the years ended February 28, 1995 and 1994, respectively.

Net assets of discontinued operations have been included in the
accompanying consolidated balance sheet as of February 28, 1995, and consist of
the following:

<TABLE>
<CAPTION>
MAIL ORDER SOFTWARE
BUSINESS BUSINESS TOTAL
---------- --------- ---------
<S> <C> <C> <C>
Accounts receivable.............................. $170,848 $ 227,158 $ 398,006
Fixed assets..................................... 2,856 22,539 25,395
Current liabilities.............................. (19,246) (101,335) (120,581)
---------- --------- ---------
Net.................................... $154,458 $ 148,362 $ 302,820
======== ========= =========
</TABLE>

F-13
<PAGE> 49

CAPSTONE PHARMACY SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

8. INCOME TAXES

The benefit for income taxes consisted of the following:

<TABLE>
<CAPTION>
TEN MONTHS YEARS ENDED
ENDED FEBRUARY 28,
DECEMBER 31, ---------------
1995 1995 1994
------------ ----- -----
(IN THOUSANDS)
<S> <C> <C> <C>
Federal:
Current............................................. $ (219) $(466) $(102)
Deferred............................................ (46) -- --
----- ----- -----
(265) (466) (102)
State and local....................................... 40 -- 51
----- ----- -----
Total....................................... $ (225) $(466) $ (51)
===== ===== =====
</TABLE>

For the ten months ended December 31, 1995, the Federal benefit for income
taxes is primarily due to the carryback of a prior year taxable loss to prior
periods and represents a change in estimate of the amount refundable upon final
preparation of the return.

The actual income tax benefit for the ten months ended December 31, 1995
and for the fiscal years ended February 28, 1995 and 1994 is different from the
amounts computed by applying the statutory Federal income tax rates to losses
from continuing operations before income taxes. The reconciliation of these
differences, follow:

<TABLE>
<CAPTION>
TEN MONTHS YEARS ENDED
ENDED FEBRUARY 28,
DECEMBER 31, -----------------
1995 1995 1994
------------ ------- -----
(IN THOUSANDS)
<S> <C> <C> <C>
Tax benefit at statutory rate........................ $ (296) $(3,824) $(194)
Additional refunds received.......................... (219) -- --
Increase resulting from:
State income taxes, net of federal income tax
effect.......................................... 26 -- 33
Current loss not available for carryback........... 172 3,206 --
Tax effect of permanent differences................ 68 152 123
Other items, net................................... 24 -- (13)
----- ------- -----
Benefit for income taxes................... $ (225) $ (466) $ (51)
===== ======= =====
</TABLE>

At December 31, 1995, the Company had a net operating loss carry forward of
approximately $10,506,000 for Federal income tax purposes, expiring in
increments through 2011. The utilization of approximately $2,903,000 of such
losses is restricted to offset only future taxable income generated by Choice
Maryland and Premier.

F-14
<PAGE> 50

CAPSTONE PHARMACY SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The tax effect of cumulative temporary differences at December 31, 1995 and
February 28, 1995, follow:

<TABLE>
<CAPTION>
DECEMBER FEBRUARY
31, 28,
1995 1995
----------- -----------
(IN THOUSANDS)
<S> <C> <C>
Current Deferred Tax Assets:
Tax carry forwards............................................. $ 4,172 $ 1,868
Accounts receivable allowances................................. 413 625
Accrued litigation costs....................................... 1,255 1,400
Accrued restructuring charges.................................. 536 828
Accrued liabilities............................................ 280 420
Other.......................................................... 254 144
----------- -----------
6,910 5,285
Less: Valuation allowance...................................... (6,910) (5,285)
----------- -----------
Net deferred tax asset............................... $ -- $ --
========= =========
</TABLE>

<TABLE>
<CAPTION>
DECEMBER FEBRUARY
31, 28,
1995 1995
----------- -----------
(IN THOUSANDS)
<S> <C> <C>
Puerto Rico withholding tax.................................... $ 425 $ --
Depreciation and other......................................... 118 --
----------- -----------
Net deferred tax liability........................... $ 543 $ --
========= =========
</TABLE>

9. COMMITMENTS

Leases

The Company leases office and warehouse space, automobiles and equipment.
Rental expense under these leases aggregated approximately $781,000, $719,000,
and $1,120,000 for the ten months ended December 31, 1995 and the years ended
February 28, 1995 and 1994, respectively.

Future minimum lease payments, follow:

<TABLE>
<CAPTION>
YEAR ENDING CAPITAL OPERATING
DECEMBER 31, LEASES LEASES
- ------------ --------- ----------
<S> <C> <C> <C>
1996......................................................... $ 249,404 $1,051,641
1997......................................................... 90,587 932,029
1998......................................................... 42,644 695,988
1999......................................................... 30,241 533,824
2000......................................................... -- 401,423
Thereafter................................................... -- 600,677
--------- ----------
Total minimum lease payments................................. 412,876 $4,215,582
=========
Less: Amounts representing interest.......................... (48,032)
---------
Present value of net minimum lease payments.................. 364,844
Less: Current portion........................................ (220,934)
---------
Long-term portion............................................ $ 143,910
=========
</TABLE>

Other

In connection with the settlement of a class action law suit filed in June
1993, the parties have agreed to accept in full settlement $600,000 in common
stock to be issued by the Company and $650,000 in cash, which was previously
paid by the Company's directors and officers liability insurance carrier. The
common stock is issuable upon final approval of an escrow agreement and the
number of shares to be issued will be based upon

F-15
<PAGE> 51

CAPSTONE PHARMACY SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

a specified formula, which will result in the issuance of approximately 98,500
common shares. The Company's portion of the proposed settlement ($600,000), is
included in costs in connection with litigation in the accompanying consolidated
statement of operations, for the year ended February 28, 1995.

10. CONTINGENCIES

The Company is subject to various claims and litigation in the ordinary
course of its business. In the opinion of management and outside counsel,
settlement of these claims and litigation will not have a material adverse
effect on the financial position or future operating results of the Company.

11. STOCKHOLDERS' EQUITY

Common Stock Authorized

On August 28, 1995, the Company's stockholders approved an increase in the
authorized common stock of the Company from 15,000,000 shares to 30,000,000
shares.

Stock Option Plans

The Company has eight stock option plans and an employee stock purchase
plan covering up to 2,655,000 shares of the Company's common stock, pursuant to
which officers, directors and employees of the Company are eligible to receive
either incentive or non-qualified options. Stock options generally expire five
or ten years from the date of grant. The exercise price of an incentive stock
option is equal to the fair market value of the Company's common shares on the
date such option was granted. The exercise price of non-qualified stock options
may be less than the fair market value on the date of grant.

A summary of option transactions during the ten months ended December 31,
1995 and the years ended February 28, 1995 and 1994, follow:

<TABLE>
<CAPTION>
NUMBER OF SHARES
---------------------------------
TEN MONTHS YEARS ENDED
ENDED FEBRUARY 28,
DECEMBER 31, ------------------
1995 1995 1994
------------ -------- -------
<S> <C> <C> <C>
Shares under option at beginning of period............ 994,500 818,500 832,000
Granted ($2.86-$7.50)................................. 949,500 564,000 51,500
Canceled ($2.87-$6.00)................................ (125,000) (354,000) (65,000)
Exercised ($1.88-$4.50)............................... (355,000) (34,000) --
------------ -------- -------
Options outstanding at end of period ($2.85-$7.50).... 1,464,000 994,500 818,500
========== ======== =======
Shares available for future grant..................... 693,750 568,250 778,250
========== ======== =======
Options exercisable at end of period.................. 1,289,000 994,500 818,500
========== ======== =======
</TABLE>

Warrants

In August 1995, the Company's Board of Directors extended the expiration
date of certain outstanding redeemable warrants issued as part of the Company's
initial public offering (the "IPO Warrants") to March 31, 1996. Subsequent to
year-end, the expiration date of the IPO Warrants was extended further to June
30, 1996. The exercise price of the 650,000 IPO Warrants is $6.00 per share. The
expiration date of the 650,000 Class B Warrants (which are exercisable at $10.00
per share) to be issued upon exercise of the IPO Warrants was also extended
subsequent to year-end to June 30, 1997. The other terms of the IPO Warrants
remain the same.

F-16
<PAGE> 52

CAPSTONE PHARMACY SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

In connection with the private placements discussed in Note 5, the Company
issued warrants to purchase 3,240,000 shares of stock at prices ranging from
$4.50 to $5.50 per share. These warrants expire through May 1998.

Total warrants for 3,990,000 shares were outstanding at December 31, 1995,
including the IPO Warrants, warrants issued in connection with private
placements and 100,000 warrants issued in connection with prior acquisitions, at
exercise prices ranging from $4.50 to $5.50 per share. No warrants were
exercised during the year.

12. MAJOR VENDOR

The Company utilizes a primary supplier arrangement for its purchases of
pharmaceuticals. In light of the financial and operating significance of
purchases, the Company routinely monitors the performance of its primary
supplier and negotiates settlements and future service levels based thereon.
Anticipated settlement amounts are recorded based upon management's estimates.
The Company changed its primary supplier in December 1995. Purchases of
inventory under the primary supplier relationships during the ten months ended
December 31, 1995 and the years ended February 28, 1995 and 1994, were
approximately 87%, 55% and 57%, respectively, of the Company's total inventory
purchases.

13. OTHER INCOME

The components of other income, follow:

<TABLE>
<CAPTION>
YEARS ENDED FEBRUARY
TEN MONTHS ENDED 28,
DECEMBER 31, ----------------------
1995 1995 1994
----------------- --------- --------
<S> <C> <C> <C>
(Gain) loss on sale of assets.................. $(289,865) $ (5,222) $ 3,860
Contract delivery fees......................... (60,655) (50,666) --
Other, net..................................... (81,380) (48,188) (30,226)
----------------- --------- --------
$(431,900) $(104,076) $(26,366)
============= ========= ========
</TABLE>

14. NEW ACCOUNTING STANDARDS

In March 1995, the Financial Accounting Standards Board issued SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets To Be Disposed Of". This Statement requires that long-lived assets and
certain intangibles be reviewed for impairment under certain circumstances, and
that an impairment loss be recorded if the sum of expected future cash flows is
less than the carrying amount of the assets. The amount of any impairment loss
is based on the fair market value of the assets. The Statement also requires
that long-lived assets and intangibles to be disposed of be recorded at the
lower of cost or fair value, less costs to sell. The Company will be required to
adopt this standard for the year ending December 31, 1996.

In October 1995, the Financial Accounting Standards Board issued SFAS No.
123, "Accounting for Stock-Based Compensation". This Statement encourages
companies to record compensation costs for stock options granted to employees on
the date of grant based on the fair value of these options. Alternatively, it
allows companies to continue to measure compensation based on the difference
between the option exercise price and the fair market value of the stock on the
date of grant. Companies electing to continue with this method must provide
proforma disclosures of net income and earnings per share as if the fair value
based method of accounting was used. The Company will be required to adopt this
standard for the year ending December 31, 1996.

F-17
<PAGE> 53

CAPSTONE PHARMACY SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The impact, if any, that the adoption of these standards will have on the
Company's financial statements is not presently determinable.

15. SUBSEQUENT EVENTS

During January 1996, Creditanstalt agreed to amend the existing line of
credit to provide for an increase in borrowings available under the line of
credit to $15,000,000 and to add a term loan facility in the amount of
$10,000,000. Availability under the line of credit and the term loan will be
increased to $21,000,000 and $14,000,000, respectively, in the event the Company
raises at least $7,500,000 of additional common equity. Borrowings under the
amended line of credit and term loan are secured by substantially all of the
assets of the Company, bear interest at rates of either prime plus .25% or LIBOR
plus 1.25% and are subject to other restrictions and loan covenants, all as
defined by the underlying agreements.

On January 3, 1996, the Company entered into an Agreement and Plan of
Merger with Geri-Care Systems, Inc. and Scripts & Things, Inc. (Geri-Care), by
which the Company acquired the operations of Geri-Care. The purchase price was
approximately $6,400,000, payable $1,350,000 in cash and promissory notes, and
the remainder in common stock of the Company. The agreement also includes an
additional contingent incentive payment of $1,500,000 as compensation for
certain new business to be generated through 1998 by the selling shareholders of
Geri-Care. The Company has made advances to Geri-Care under the terms of the
Agreement of approximately $2,243,000.

Geri-Care is a privately held provider of pharmacy services to nursing
homes in the New York metropolitan area and generates annualized revenues of
approximately $7,000,000.

On February 29, 1996, the Company entered into an Asset Purchase Agreement
with IMD Corporation (IMD) by which the Company acquired the operations of IMD.
The purchase price was approximately $15,500,000 in cash.

IMD is a privately held institutional pharmacy business in the State of
Illinois and has annualized revenues of approximately $18,000,000.

The Company has paid fees totaling $570,000 to a company affiliated with a
member of the Board of Directors for certain services rendered in connection
with the Geri-Care and IMD acquisitions.

16. SUBSEQUENT EVENT -- PRIVATE PLACEMENT

In April 1996, the Company completed a private placement of 1,035,000
shares of common stock. The private placement generated proceeds of
approximately $8,400,000, net of related costs.

17. SUBSEQUENT EVENT -- ACQUISITION

On July 29, 1996, the Company acquired Symphony Pharmacy Services, Inc.
(Symphony), an institutional pharmacy provider, from Integrated Health Services,
Inc. (IHS). The Symphony purchase price was comprised of $125,000,000 in cash
and $25,000,000 in common stock issued to IHS. The Company financed the cash
portion of the Symphony acquisition with a $25,000,000 investment by Counsel and
a $100,000,000 bridge loan. Management expects that the Symphony acquisition
will almost double the number of beds served by the Company, the number of
Company employees and the Company's net sales. There can be no assurance that
Symphony will be integrated successfully into the Company's operations.

In conjunction with the Symphony acquisition, the Company is currently
contemplating a secondary offering of approximately 9,000,000 shares of common
stock at an assumed offering price of $12.00 per share. The secondary offering
is expected to generate net proceeds of approximately $102,000,000 which will be
used to refund the bridge loan and certain other long-term indebtedness.

F-18
<PAGE> 54

INDEPENDENT AUDITORS' REPORT

The Board of Directors and Stockholder
Symphony Pharmacy Services, Inc.:

We have audited the accompanying consolidated balance sheets of Symphony
Pharmacy Services, Inc. and subsidiaries (wholly-owned by Integrated Health
Services, Inc.) as of December 31, 1994 and 1995 and the related consolidated
statements of earnings, stockholder's equity and cash flows for each of the
years in the three-year period ended December 31, 1995. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audit.

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

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Symphony
Pharmacy Services, Inc. (wholly-owned by Integrated Health Services, Inc.) as of
December 31, 1994 and 1995 and the results of their operations and their cash
flows for each of the years in the three-year period ended December 31, 1995, in
conformity with generally accepted accounting principles.

KPMG Peat Marwick LLP

Baltimore, Maryland
July 16, 1996

F-19
<PAGE> 55

SYMPHONY PHARMACY SERVICES, INC. AND SUBSIDIARIES
(WHOLLY-OWNED BY INTEGRATED HEALTH SERVICES, INC.)

CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1994 AND 1995

(DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
1994 1995
------- -------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................................ $ 1,342 $ 1,017
Accounts receivable, net of allowance for doubtful accounts of $3,798 in
1994 and $3,223 in 1995 (note 7)...................................... 15,407 19,597
Inventories.............................................................. 5,429 5,321
Other current assets..................................................... 514 466
------- -------
Total current assets............................................. 22,692 26,401
------- -------
Property and equipment, net (note 3)....................................... 9,760 9,875
Intangible assets of businesses acquired, net of accumulated amortization
of $1,073 in 1994 and $2,521 in 1995..................................... 53,567 55,694
Deferred income taxes (note 6)............................................. 3,335 2,640
------- -------
$89,354 $94,610
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses (note 4)........................... $ 7,276 $ 5,465
Advances from parent company............................................. 7,575 5,448
Income taxes payable to parent company (note 6).......................... 4,353 5,188
Interest payable to parent company (note 7).............................. 1,871 4,418
------- -------
Total current liabilities........................................ 21,075 20,519
------- -------
Notes payable to parent company (note 7)................................... 42,058 41,848
Commitments and contingencies (Notes 5 and 8)
Stockholders' equity:
Common stock: $.01 par value. Authorized 1,000 shares;
issued and outstanding 100 shares..................................... -- --
Additional paid-in capital............................................... 24,836 28,361
Retained earnings........................................................ 1,385 3,882
------- -------
Total stockholder's equity....................................... 26,221 32,243
------- -------
$89,354 $94,610
======= =======
</TABLE>

See accompanying notes to consolidated financial statements.

F-20
<PAGE> 56

SYMPHONY PHARMACY SERVICES, INC. AND SUBSIDIARIES
(WHOLLY-OWNED BY INTEGRATED HEALTH SERVICES, INC.)

CONSOLIDATED STATEMENTS OF EARNINGS
YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995

(DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
1993 1994 1995
------ ------- -------
<S> <C> <C> <C>
Sales (note 7)..................................................... $9,461 $52,295 $91,016
Cost of sales...................................................... 4,815 27,865 48,837
------ ------- -------
Gross profit............................................. 4,648 24,430 42,179
------ ------- -------
Operating expenses (note 7):
Salaries, wages and benefits..................................... 2,913 12,148 20,642
Depreciation and amortization.................................... 288 1,479 2,682
Other selling, general and administrative expenses............... 1,137 6,835 12,279
------ ------- -------
Total operating expenses................................. 4,338 20,462 35,603
------ ------- -------
Operating income................................................... 308 3,968 6,576
Interest expense -- parent company (note 7)........................ 103 1,768 2,547
------ ------- -------
Earnings before income taxes....................................... 205 2,200 4,029
Federal and state income taxes (note 6)............................ 79 941 1,532
------ ------- -------
Net earnings............................................. $ 126 $ 1,259 $ 2,497
====== ======= =======
</TABLE>

See accompanying notes to consolidated financial statements.

F-21
<PAGE> 57

SYMPHONY PHARMACY SERVICES, INC. AND SUBSIDIARIES
(WHOLLY-OWNED BY INTEGRATED HEALTH SERVICES, INC.)

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995

(DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
COMMON ADDITIONAL RETAINED
STOCK PAID-IN CAPITAL EARNINGS
------- --------------- --------
<S> <C> <C> <C>
Balance at January 1, 1993..................................... $ -- $ -- $ --
Net earnings for 1993.......................................... -- -- 126
Contribution of capital -- representing payments by parent
company in connection with business acquisitions............. -- 9,840 --
------- --------------- --------
Balance at December 31, 1993................................... -- 9,840 126
Net earnings for 1994.......................................... -- -- 1,259
Contribution of capital -- representing payments by parent
company in connection with business acquisitions............. -- 14,996 --
------- --------------- --------
Balance at December 31, 1994................................... -- 24,836 1,385
Net earnings for 1995.......................................... -- -- 2,497
Contribution of capital -- representing payments by parent
company in connection with prior business acquisitions....... -- 3,525 --
------- --------------- --------
Balance at December 31, 1995................................... $ -- $26,381 $3,882
======= ========== ======
</TABLE>

See accompanying notes to consolidated financial statements.

F-22
<PAGE> 58

SYMPHONY PHARMACY SERVICES, INC. AND SUBSIDIARIES
(WHOLLY-OWNED BY INTEGRATED HEALTH SERVICES, INC.)

CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995

(DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
1993 1994 1995
------- ------- -------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings.................................................... $ 126 $ 1,259 $ 2,497
Adjustments to reconcile net earnings to net cash provided by
operating activities:
Depreciation and amortization................................ 288 1,479 2,682
Deferred income taxes........................................ -- 413 695
Increase in accounts receivable.............................. (2,655) (3,522) (4,190)
Decrease (increase) in inventories........................... (174) (584) 108
Decrease (increase) in other current assets.................. 526 (249) 80
Decrease in accounts payable and accrued expenses............ (461) (1,458) (1,811)
Increase in income taxes payable to parent company........... 79 526 837
Increase in interest expense payable to parent company....... 103 1,768 2,547
Other........................................................ 11 53 (33)
------- ------- -------
Net cash provided (used) by operating activities.................. (2,157) (315) 3,412
------- ------- -------
Cash flows from financial activities:
Advances from (repayments to) parent company.................... 5,790 1,785 (2,127)
Proceeds (payments) of notes payable to parent company.......... -- 9,573 (211)
Payment on long-term debt....................................... (2,433) (474) --
------- ------- -------
Net cash provided (used) by financing activities.................. 3,357 10,884 (2,338)
------- ------- -------
Cash flows from investing activities:
Business acquisitions (note 1).................................. (560) (6,425) --
Property and equipment additions................................ (640) (2,802) (1,399)
------- ------- -------
Net cash used by investing activities............................. (1,200) (9,227) (1,399)
------- ------- -------
Increase (decrease) in cash....................................... -- 1,342 (325)
Cash, beginning of year........................................... -- -- 1,342
------- ------- -------
Cash, end of year................................................. $ -- $ 1,342 $ 1,017
======= ======= =======
Noncash investing and financing activities:
Net assets of businesses acquired (note 1)...................... $31,532 $25,790 $ 3,525
Contribution of capital and issuance of notes payable to parent
company -- representing payments by parent company in
connection with business acquisitions (note 1)............... $31,532 $25,790 $ 3,525
======= ======= =======
</TABLE>

See accompanying notes to consolidated financial statements.

F-23
<PAGE> 59

SYMPHONY PHARMACY SERVICES, INC. AND SUBSIDIARIES
(WHOLLY-OWNED BY INTEGRATED HEALTH SERVICES, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 1993, 1994 AND 1995
(DOLLARS IN THOUSANDS)

(1) DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION

Symphony Pharmacy Services, Inc. (the Company), a Delaware corporation
established on May 9, 1995, is a wholly-owned subsidiary of Symphony Health
Services, Inc., which is wholly-owned by Integrated Health Services, Inc. (IHS
or the parent company). In a corporate reorganization on May 9, 1995, certain
subsidiaries of IHS or its subsidiaries became subsidiaries of Symphony Pharmacy
Services, Inc. These subsidiaries, which formerly operated as the Allied Health
Services division of IHS, are as follows:

Patient Care Pharmacy, Inc.
Patient Care Pharmacy of Colorado Springs, Inc.
Healthcare Pharmacy Services of Florida, Inc.
Healthcare Pharmacy Services of Pennsylvania, Inc.
Healthcare Pharmacy Services of Texas, Inc.
Amcare, Inc.
Amcare Health Services, Inc.
Amcare Santa Barbara, Inc.
Pharmaceutical Dose Services, Inc.
Suncoast Pharmacy Services, Inc.

Such corporations are engaged primarily in the business of selling
pharmaceutical related products and providing institutional pharmacy services to
long-term care and other institutions and their patients. The consolidated
financial statements represent the historical accounts of the Company and the
aforementioned subsidiaries and reflect the elimination of significant
intercompany balances and transactions among such entities.

The aforementioned corporations were acquired by IHS (or its subsidiaries)
at various dates in 1993 and 1994, as discussed more fully below. The new basis
of accounting, reflecting IHS's cost of the businesses acquired, has been
"pushed down" to the accounts of the Company. Such cost basis has been allocated
to the identifiable assets and liabilities acquired based on their respective
fair values at the dates of acquisition. Cost in excess of such aggregate fair
value (goodwill) is being amortized over 40 years using the straight-line
method. Such estimated useful life of goodwill of the pharmacy businesses
acquired gives recognition to the plans of IHS to develop post-acute health care
networks using IHS's long-term care facilities as platforms to provide other
services, including pharmaceutical products and services.

In June 1993, IHS acquired all of the outstanding capital stock of Patient
Care Pharmacy, Inc. (PCP), a business providing pharmacy services to geriatric
care facilities and other health care providers in Southern California. The
total cost for PCP was $10,400, including $9,840 representing 425,674 shares of
IHS common stock. In addition, IHS agreed to make contingent payments in shares
of common stock following each of the next three years based upon the earnings
of PCP. However, in March 1995, the PCP stockholders terminated all rights to
contingent payments in consideration for $3,525 representing 92,434 shares of
IHS common stock.

In December 1993, IHS acquired the capital stock of Central Park Lodges,
Inc. (CPL), a wholly-owned subsidiary of Trizec Corporation, Ltd. (Trizec), a
publicly-held Canadian real estate company. IHS acquired substantially all of
the United States operations of CPL, consisting of 30 geriatric care facilities
located in Florida, Pennsylvania and Texas and nine retirement facilities
located in Florida, with an aggregate of 5,210 beds; the Healthcare Pharmacy
Services division (HPS), which provides pharmacy consulting services and
supplies prescription drugs and intravenous medications to geriatric care
facilities through five pharmacies in Florida, Pennsylvania and Texas; and other
operations. The total purchase price was $185,300, which was

F-24
<PAGE> 60

SYMPHONY PHARMACY SERVICES, INC. AND SUBSIDIARIES
(WHOLLY-OWNED BY INTEGRATED HEALTH SERVICES, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

DECEMBER 31, 1993, 1994 AND 1995
(DOLLARS IN THOUSANDS)

allocated primarily based on the appraised value of the respective businesses
acquired. The allocated cost of the HPS acquisition was $21,692.

On August 8, 1994, the Company acquired substantially all of the assets of
Pikes Peak Pharmacy, Inc. (Pikes), a company which provides pharmacy services to
patients at nine facilities in Colorado Springs, Colorado which have an
aggregate of 625 beds. The total purchase price was $600.

On October 7, 1994, the Company acquired all of the outstanding stock of
Amcare, Inc. (Amcare), an institutional pharmacy serving approximately 135
skilled nursing facilities in California, Minnesota, New Jersey and
Pennsylvania. The purchase price was $21,000, including $10,500 representing the
issuance of 291,101 shares of IHS common stock. In addition, the Company
incurred direct costs of the acquisition of $4,550, representing legal and other
transaction costs of $600, integration costs principally for systems conversion
of $1,850, and severance and other termination costs of $2,100.

On October 11, 1994, the Company acquired substantially all of the assets of
Pharmaceutical Dose Service of La, Inc. (PDS), an institutional pharmacy serving
14 facilities. The purchase price was $4,190, including $3,900 representing the
issuance of 122,117 shares of IHS common stock. In addition, the Company
incurred direct costs of the acquisition of $1,875, representing legal and other
transaction costs of $300, integration costs principally for systems conversion
of $1,175, and severance and other termination costs of $400.

The total cost of the aforementioned acquisitions has been allocated as
follows:

<TABLE>
<CAPTION>
PCP HPS PIKES AMCARE PDS
------- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C>
Current assets.................................. $ 2,667 3,175 183 8,029 638
Property and equipment.......................... 1,001 3,000 -- 3,011 --
Intangible assets............................... 15,595 16,221 417 20,300 5,697
Current liabilities............................. (2,905) (704) -- (5,316) (270)
Long-term debt.................................. (2,433) -- -- (474) --
------- ------ ----- ------ -----
Net assets acquired............................. $13,925 21,692 600 25,550 6,065
======= ====== ==== ====== =====
Equities recorded:
Notes payable to parent company............... $ -- 21,692 -- 10,500 294
Contribution of capital:
1993....................................... 9,840 -- -- -- --
1994....................................... -- -- 600 10,500 3,896
1995....................................... 3,525 -- -- -- --
------- ------ ----- ------ -----
$13,365 21,692 600 21,000 4,190
======= ====== ==== ====== =====
</TABLE>

(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The Company applies the same significant accounting policies as established
by its parent company, which policies are summarized as follows:

Cash Equivalents

Cash equivalents consist of highly liquid instruments with an original
maturity of three months or less.

F-25
<PAGE> 61

SYMPHONY PHARMACY SERVICES, INC. AND SUBSIDIARIES
(WHOLLY-OWNED BY INTEGRATED HEALTH SERVICES, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

DECEMBER 31, 1993, 1994 AND 1995
(DOLLARS IN THOUSANDS)

Inventories

Inventories consist primarily of purchased pharmaceuticals and medical
supplies held for sale to customers and are stated at the lower of cost or
market. Cost is determined using a pricing convention which approximates the
first-in, first-out method.

Property and Equipment

Property and equipment are stated at cost. Depreciation is provided on the
straight-line basis over the estimated useful life of the assets, generally 10
years for equipment and the term of the lease for costs of leasehold
improvements.

Development Costs

Direct and incremental costs incurred to initiate and implement new
pharmacy locations are deferred during the start-up period (not exceeding six
months) and amortized on a straight-line basis over five years.

Income Taxes

The Company and its subsidiaries are included in the parent company's
consolidated Federal income tax return. The income tax provisions reported in
the financial statements are an allocation of the parent company's total income
tax provision. The Company's allocation was determined based on a calculation of
income taxes as if the Company were a separate taxpayer, in accordance with
Statement of Financial Accounting Standards No. 109 (SFAS No. 109), Accounting
for Income Taxes.

Deferred income taxes are recognized for the tax consequences of temporary
differences between financial statement carrying amounts and the related tax
bases of assets and liabilities as required by SFAS No. 109. Such tax effects
are measured by applying enacted statutory tax rates applicable to future years
in which the differences are expected to reverse, and any change in tax rates
will be recognized in the period that includes the date of enactment. Valuation
allowances are recorded for deferred tax assets when it is more likely than not
that such deferred tax assets will not be realized.

Intangible Assets

Intangible assets arise from business combinations accounted for as
purchase transactions and are amortized using the straight-line method over an
estimated useful life of forty years.

Management regularly evaluates whether events or changes in circumstances
have occurred that could indicate an impairment in the value of intangible
assets. In December 1995, the Company adopted SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,
which had no effect on the financial statements. In accordance with the
provisions of SFAS No. 121, if there is an indication that the carrying value of
an asset is not recoverable, the Company determines the amount of impairment
loss by comparing the carrying amount of the assets to their estimated fair
value. Intangible assets acquired in business combinations accounted for using
the purchase method are included as part of the carrying value in determining
recoverability. Goodwill also is evaluated for recoverability by estimating the
projected undiscounted cash flows, excluding interest, of the related business
activities, and any excess of carrying value over such estimates is written off.

In addition to consideration of impairment upon the events or changes in
circumstances described above, management regularly evaluates the remaining
lives of its long-lived assets. If estimates are changed, the

F-26
<PAGE> 62

SYMPHONY PHARMACY SERVICES, INC. AND SUBSIDIARIES
(WHOLLY-OWNED BY INTEGRATED HEALTH SERVICES, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

DECEMBER 31, 1993, 1994 AND 1995
(DOLLARS IN THOUSANDS)

carrying value of affected assets is allocated over the remaining lives.
Estimation of value and future benefits of intangible assets is made based upon
the related projected undiscounted future cash flows, excluding interest
payments.

Revenue Recognition

Revenue is recognized when products or services are provided. A significant
portion of the Company's revenues from sales of pharmaceutical and medical
products are reimbursable from Medicare and state Medicaid programs. Receivables
under these reimbursement programs and related revenues are reported at the net
realizable amount expected to be received from these third-party payors.

Business and Credit Concentrations

The Company's sales are provided through 26 pharmacies as of December 31,
1995, located in California, Colorado, Texas, Minnesota, Pennsylvania, New
Jersey, Florida and Louisiana. The Company generally does not require collateral
or other security in extending credit to long-term care and other institutions
and their patients; however, the Company routinely obtains assignments of (or is
otherwise entitled to receive) benefits receivable under the health insurance
programs, plans or policies of patients (e.g., Medicare, Medicaid, commercial
insurance and managed care organizations).

Use of Estimates

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

Disclosures About Fair Value of Financial Instruments

The carrying amounts of cash, accounts receivable and accounts payable
approximate their fair value because of the short-term nature of these
instruments. It is not practicable to estimate the fair value of notes payable
to the parent company because there are no specified due dates for these
instruments.

(3) PROPERTY AND EQUIPMENT

Property and equipment consist of the following at December 31, 1994 and
1995:

<TABLE>
<CAPTION>
1994 1995
------- -------
<S> <C> <C>
Equipment........................................................ $ 9,461 $10,736
Furniture, fixtures and leasehold improvements................... 545 618
Development costs................................................ 448 448
------- -------
10,454 11,802
Less accumulated depreciation and amortization................... 694 1,927
------- -------
Net property and equipment....................................... $ 9,760 $ 9,875
======= =======
</TABLE>

F-27
<PAGE> 63

SYMPHONY PHARMACY SERVICES, INC. AND SUBSIDIARIES
(WHOLLY-OWNED BY INTEGRATED HEALTH SERVICES, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

DECEMBER 31, 1993, 1994 AND 1995
(DOLLARS IN THOUSANDS)

(4) ACCOUNTS PAYABLE AND ACCRUED EXPENSES

Accounts payable and accrued expenses consist of the following at December
31, 1994 and 1995:

<TABLE>
<CAPTION>
1994 1995
------ ------
<S> <C> <C>
Accounts payable -- trade.......................................... $5,556 $2,423
Accrued salaries, wages and benefits............................... 1,720 2,842
Other accrued expenses............................................. -- 200
------ ------
$7,276 $5,465
====== ======
</TABLE>

(5) LEASES

As of December 31, 1995, the Company had operating leases as lessee or
sublessee of 26 distribution facilities and pharmacy units within long-term care
facilities expiring at various dates through June 30, 2002. Minimum rent
payments due under noncancellable operating leases in effect at December 31,
1995 are summarized as follows for the years ended December 31:

<TABLE>
<S> <C>
1996........................................................................ $1,044
1997........................................................................ 960
1998........................................................................ 937
1999........................................................................ 881
2000........................................................................ 479
Thereafter.................................................................. 286
------
$4,587
======
</TABLE>

Eight leases provide renewal options for various terms at fair market
rentals at the expiration of the initial term. The leases generally include
additional rental obligations for real estate taxes, utilities, insurance and
repairs. The Company's rental expense was $257 in 1993, $816 in 1994 and $1,227
in 1995.

(6) INCOME TAXES

The Company is included in the parent company's consolidated federal income
tax return. The allocated provision for income taxes is summarized below for
years ended December 31:

<TABLE>
<CAPTION>
1993 1994 1995
----- ----- ------
<S> <C> <C> <C>
Federal...................................................... $65 $ 768 $1,250
State........................................................ 14 173 282
----- ----- ------
$79 $ 941 $1,532
==== ==== ======
Current...................................................... $79 $ 528 $ 837
Deferred..................................................... -- 413 695
----- ----- ------
$79 $ 941 $1,532
==== ==== ======
</TABLE>

F-28
<PAGE> 64

SYMPHONY PHARMACY SERVICES, INC. AND SUBSIDIARIES
(WHOLLY-OWNED BY INTEGRATED HEALTH SERVICES, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

DECEMBER 31, 1993, 1994 AND 1995
(DOLLARS IN THOUSANDS)

The provision for income taxes is reconciled to the amount computed by
applying the Federal corporate tax rate of 35% to earnings before income taxes
as follows:

<TABLE>
<CAPTION>
1993 1994 1995
----- ------- -------
<S> <C> <C> <C>
Income tax computed at statutory rate.................... $72 $ 770 $ 1,410
State income taxes, net of Federal tax benefit........... 9 112 183
Other.................................................... (2) 59 (61)
----- ------- -------
$79 $ 941 $ 1,532
==== ======= =======
</TABLE>

Deferred income tax (assets) liabilities at December 31, 1994 and 1995 are
as follows:

<TABLE>
<CAPTION>
1994 1995
------- -------
<S> <C> <C>
Excess of book over tax basis of assets.......................... $ 353 $ 853
Allowance for doubtful accounts.................................. (1,462) (1,241)
Pre-acquisition separate company net operating loss
carryforward................................................... (2,790) (2,175)
Other............................................................ 564 (77)
------- -------
$(3,335) $(2,640)
======= =======
</TABLE>

(6) INCOME TAXES

The provision for Federal and state income taxes is recorded using the
overall effective tax rate of the consolidated group applied to the Company's
pre-tax earnings before adjustment for permanent differences related to
nondeductible amortization of goodwill of $210 in 1993, $835 in 1994 and $1,297
in 1995. Deferred income tax (assets) liabilities are recorded for the Company's
temporary differences using the same effective tax rate. The difference between
the total provision for income tax and the deferred income tax provision, both
determined as discussed above, represents income taxes currently payable to the
parent company. The provision for income taxes, deferred income taxes and income
taxes currently payable may vary from such amounts that would have been computed
on a stand-alone basis.

At December 31, 1995, certain subsidiaries of the Company had
pre-acquisition net operating loss carryforwards available for Federal and state
income tax purposes of approximately $5,649 which expire in 2008. The annual
utilization of these net operating loss carryforwards is subject to certain
limitations under the Internal Revenue Code.

Management believes no valuation reserves are needed for deferred income
tax assets and there has been no valuation allowance during the three-year
period ended December 31, 1995. It is the Company's belief that it is more
likely than not that the results of future operations will generate sufficient
taxable income to realize the deferred tax assets.

(7) RELATED PARTY TRANSACTIONS

Notes Payable to Parent Company

The Company had various unsecured notes payable to the parent company of
$42,058 and $41,848 as of December 31, 1994 and 1995, respectively. The notes
were incurred primarily for the Company's business acquisitions during 1994 and
1993, as described in note 1. The notes have no specified due dates, but
management of the parent company has indicated that repayment will not be sought
for at least the next twelve months or until the occurrence of the closing of a
sale of a significant portion of the Company's assets.

F-29
<PAGE> 65

SYMPHONY PHARMACY SERVICES, INC. AND SUBSIDIARIES
(WHOLLY-OWNED BY INTEGRATED HEALTH SERVICES, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

DECEMBER 31, 1993, 1994 AND 1995
(DOLLARS IN THOUSANDS)

The notes bear interest ranging from 5.75% to 8.50% as of December 31, 1994 and
1995. The Company incurred interest expense to the parent company of $103 in
1993, $1,768 in 1994 and $2,547 in 1995.

Advances from Parent Company

Under a cash management facility provided by the parent company, the
Company's accounts payable are transferred to a centralized account and applied
to increase the intercompany account. The Company's available cash is similarly
provided to the parent company through a decrease in the intercompany balance.
Such advances bear no interest. Also, advances from the parent company include
direct costs of business acquisitions discussed in note 1, which bear no
interest.

Corporate Expenses Charged by Parent Company

The consolidated financial statements reflect charges for certain corporate
general and administrative expenses from the IHS corporate office to the Company
and its subsidiaries. Such corporate office charges represent allocations based
on determinations that management believes to be reasonable. However, IHS has
operated certain other businesses and has provided certain services to the
Company and its subsidiaries, including financial, legal, risk management
(workers' compensation and general liability) and other services. Accordingly,
expense allocations to the Company and its subsidiaries may not be
representative of costs of such services if the Company operated on a stand
alone basis.

Costs charged by IHS were insignificant in 1993, and were approximately
$437 in 1994 and $1,088 in 1995.

Accounts Receivable from and Sales to Parent Company

The Company provides pharmaceutical products and services to subsidiaries
of the parent company which operate long-term healthcare facilities and their
patients. Accounts receivable include balances due from such subsidiaries of
approximately $4,576 and $3,215 at December 31, 1994 and 1995, respectively.
Sales to such subsidiaries were approximately $2,300 in 1993, $15,000 in 1994
and $17,500 in 1995.

(8) COMMITMENTS AND CONTINGENCIES

The Company is from time to time subject to claims and suits arising in the
ordinary course of business. In the opinion of management, the ultimate
resolution of pending legal proceedings will not have a material adverse effect
on the Company's financial statements.

(9) SUBSEQUENT EVENTS

On June 19, 1996, the Company and its subsidiaries entered into an Asset
Purchase Agreement with Capstone Pharmacy Services, Inc. (the buyer), pursuant
to which the Company and its subsidiaries have agreed to sell substantially all
their business assets to the buyer. The selling price is $150 million (which is
subject to adjustment in certain circumstances) of which approximately $25
million will be in common stock of the buyer and the remainder will be in cash.
Closing is expected to occur by August 1, 1996.

F-30
<PAGE> 66

- ------------------------------------------------------
- ------------------------------------------------------

NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS IN CONNECTION WITH THIS OFFERING OTHER THAN THOSE CONTAINED IN
THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST
NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ANY OF THE
UNDERWRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL, OR A
SOLICITATION OF AN OFFER TO BUY, THE SHARES OF COMMON STOCK BY ANYONE IN ANY
JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT AUTHORIZED, OR IN WHICH
THE PERSON MAKING THE OFFER OR SOLICITATION IS NOT QUALIFIED TO DO SO, OR TO ANY
PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. UNDER NO
CIRCUMSTANCES SHALL THE DELIVERY OF THIS PROSPECTUS OR ANY SALE MADE PURSUANT TO
THIS PROSPECTUS CREATE ANY IMPLICATION THAT INFORMATION CONTAINED IN THIS
PROSPECTUS IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE OF THIS PROSPECTUS.

------------------

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.................. 3
Risk Factors........................ 7
Use of Proceeds..................... 10
Dividend Policy..................... 10
Capitalization...................... 11
Selected Historical Consolidated
Financial Data.................... 12
Pro Forma Unaudited Consolidated
Financial Data.................... 13
Management's Discussion and Analysis
of Financial Condition and Results
of Operation...................... 16
Business............................ 20
Management.......................... 28
Security Ownership of Directors,
Executive Officers and Principal
Holders........................... 30
Description of Capital Stock........ 32
Underwriting........................ 33
Legal Matters....................... 34
Experts............................. 34
Available Information............... 34
Incorporation of Certain Information
by Reference...................... 35
Index to Financial Statements....... F-1
Consolidated Financial Statements of
Capstone Pharmacy Services,
Inc............................... F-2
Consolidated Financial Statements of
Symphony Pharmacy Services,
Inc............................... F-19
</TABLE>

- ------------------------------------------------------
- ------------------------------------------------------

9,000,0000 SHARES

[CAPSTONE PHARMACY SERVICES LOGO]

COMMON STOCK

---------------------------

PROSPECTUS

---------------------------

EQUITABLE SECURITIES CORPORATION

LEHMAN BROTHERS

BT SECURITIES CORPORATION

WHEAT FIRST BUTCHER SINGER

VOLPE, WELTY & COMPANY

September 18, 1996

- ------------------------------------------------------
- ------------------------------------------------------