NEXTHEALTH INC, 10-K405, 1996-04-16

NEXTHEALTH INC
10-K405, 1996-04-16
HOSPITALS

Previous: GENERAL PARCEL SERVICE INC, 10KSB, 1996-04-16

Next: WICHITA RIVER OIL CORP/DE/, 10KSB, 1996-04-16

<PAGE> 1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)

[X] Annual Report Pursuant to Section 13 or 15(d) of The Securities Exchange
Act of 1934 (Fee Required) for the Fiscal Year Ended December 31, 1995 or

[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 (No Fee Required) for the transition period from
__________ to __________

Commission File Number: 0-17969

NEXTHEALTH, INC.
(Exact Name of Registrant as Specified in its Charter)

Delaware 86-0589712
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)

16600 N. Lago Del Oro Parkway, Tucson, Arizona 85739
(Address of Principal Executive Offices) (Zip Code)

(520) 792-5800
(Registrant's Telephone Number, including Area Code)

Securities registered pursuant to Section 12(b) of the Act: Common Stock, $.01
par value
Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.

[X] YES [ ] NO

On April 1, 1996, the aggregate market value of voting common stock held by
non-affiliates of the registrant was $17,971,371 based on the closing price of
the registrant's common stock as reported on the NASDAQ/National Market System
on such date. For purposes of the preceding sentence only, all directors and
executive officers of the registrant are assumed to be affiliates.

On April 1, 1996, there were 8,554,938 shares of the registrant's common stock
outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

The information required by Part III of this Report (Items 10, 11, 12 and 13) is
incorporated by reference from the registrant's proxy statement to be filed
pursuant to Regulation 14A with respect to the annual meeting of stockholders
scheduled to be held on May 31, 1996.

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

Reference is made to the listing beginning on page 35 of all exhibits filed as a
part of this report.

<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I Page
----
<S> <C> <C>
Item 1. Business ........................................................................................... 3
Item 2. Properties ......................................................................................... 6
Item 3. Legal Proceedings .................................................................................. 6
Item 4. Submission of Matters to a Vote of Security Holders ................................................ 7

PART II

Item 5. Market for Registrant's Common Equity and Related Shareholder Matters .............................. 7
Item 6. Selected Financial Data ............................................................................ 8
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations............... 9
Item 8. Financial Statements and Supplementary Data ........................................................ 14
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure................ 33

PART III

Item 10. Directors and Executive Officers of the Registrant ................................................. 33
Item 11. Executive Compensation ............................................................................. 33
Item 12. Security Ownership of Certain Beneficial Owners and Management ..................................... 33
Item 13. Certain Relationships and Related Transactions ..................................................... 33

PART IV

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K ................................... 33
</TABLE>

2
<PAGE> 3
PART I

ITEM 1. BUSINESS

NEXTHEALTH, INC.

NextHealth, Inc. is a leading provider of wellness and preventive
health care services in diverse retail markets. For over ten years, the Company
has developed effective treatment models which address individual wellness and
quality of life issues through a whole person, mind-body approach.

NextHealth, Inc. (the "Company"), formerly Sierra Tucson Companies,
Inc., was incorporated in Delaware in August 1989, and as the result of a merger
effective in September 1989, is the successor to an Arizona corporation which
was originally formed in 1983. In September 1995, the Company changed its name
to NextHealth, Inc., to reflect an expanded scope of operations and health care
programs. It conducts business through separate divisions and wholly-owned
subsidiaries. The Company currently operates health, wellness and therapeutic
treatment programs pursuant to a business strategy which concentrates on
identifying emerging revenue and growth opportunities.

The Company operates in two distinct business segments. The
Treatment segment includes Sierra Tucson, Inc. ("Sierra Tucson Hospital"), a
state licensed, special psychiatric hospital and behavioral health care center
for the treatment of substance abuse and mental health disorders, including
eating disorders and dual diagnosis, and Onsite Workshops, Inc. ("Onsite"),
acquired in 1995, which offers short-term therapeutic experiences and workshops.
The Health and Leisure segment includes Miraval(TM), a unique vacation
experience blending stress management and self-discovery programs in a luxury
health resort environment, which opened in late 1995. Also, effective March 1,
1996, the Company acquired Hilton Head Health Institute, Inc. ("HHHI"), a
provider of weight management programs for the development and maintenance of
healthy lifestyles. HHHI will be included in the Health and Leisure segment
beginning in 1996.

The Company operates its various lines of business at separate
locations northwest of Tucson, Arizona, in the foothills of the Santa Catalina
Mountains. Sierra Tucson currently has 70 inpatient beds at one facility, the
result of consolidation from 1992-1994. Onsite currently has 55 beds at a
separate facility for its workshop programs. Miraval also operates at a separate
facility, presently comprised of 106 guest rooms. The Company owns or leases a
total of approximately 400 acres of land at these locations. Effective March 1,
1996, the Company also operates HHHI which is located at Hilton Head Island,
South Carolina.

In October 1989, the Company and certain officers of the Company
offered 2.5 million shares of common stock in an initial public offering and was
traded on the NASDAQ exchange under the symbol "STSN." As a result of the
Company's name change in 1995, it is now listed under the trading symbol "NEXT."
The Company's principal offices are located at 16600 N. Lago del Oro Parkway,
Tucson, Arizona 85739 and its telephone number is 520-792-5800.

MIRAVAL

Miraval combines elements of stress management, self discovery and
recreational activities in a luxury health resort environment, providing guests
with tools to achieve and maintain wellness in everyday life. By incorporating
educational programs such as mind/body and lifestyle management,
fitness/recreation activities and personal workshops, Miraval offers an
alternative to the traditional luxury resort vacation. Programs are individually
tailored to the particular requirements of each guest.

With the commencement of operations at Miraval, the Company
entered the wellness and preventive health services category, a strategic
diversification focusing on upscale, retail consumer markets with a demonstrated
interest in alternative wellness services and therapies. The Company's decision
to enter these markets was based upon, market research, concept development and
consumer testing.

3
<PAGE> 4
SIERRA TUCSON HOSPITAL

Sierra Tucson Hospital is a licensed special psychiatric hospital
and behavioral health center engaged in the treatment of addictions and mental
health disorders. Sierra Tucson Hospital provides medical services and programs
that reach beyond standard alcohol and drug addiction treatments. These programs
include the treatment of dual diagnosis, eating disorders, major depression,
post-traumatic stress disorder, and treatment for gambling and sexual disorders.

The treatment philosophy at Sierra Tucson Hospital, as expressed in
the Sierra Model(TM), treats the whole person with integrated, individualized
therapies rooted in the Twelve Steps program recovery process. Experiential in
nature, Sierra Tucson Hospital's individualized treatment plans are developed
and maintained by experienced, clinical professionals. They integrate
philosophies and methodologies from psychological, family systems and self- help
approaches into comprehensive and effective treatment experiences. Since its
inception in 1984, over 12,000 patients and nearly 30,000 family members have
participated in Sierra Tucson Hospital programs, with a 70 percent success rate
based on outcome studies performed by a third party research entity on behalf of
the Company. Sierra Tucson Hospital is licensed by the Arizona Department of
Health Services and accredited by the Joint Commission of Accreditation of
Healthcare Organizations.

ONSITE

Onsite offers intensive, experienced-based programs designed to
provide professional development, life enhancing and personal and family
issues-related workshops. Onsite also trains professionals in the uses of
experiential therapeutic and educational techniques in healing and life
improvement.

HHHI

Effective March 1, 1996, the Company acquired substantially all of
the assets and liabilities of HHHI which provides clinically-proven, weight
management programs offering long-term approaches for the development and
maintenance of healthy lifestyles. In addition to weight control programs, HHHI
also offers health and fitness, nutrition, stress management and other lifestyle
change programs.

SOURCES OF REVENUE

The Company's revenue depends upon occupancy levels. At Sierra
Tucson Hospital, an inclusive rate for services is charged, ranging from $650 to
$900 per day. Effective March 1, 1996, these rates were increased 5%. Patient
revenue is derived from private insurance reimbursement and patient payments,
none of which, individually, represents a significant portion of revenue. Most
commercial insurance plans reimburse their subscribers or make direct payment to
Sierra Tucson Hospital. No revenue is derived from Medicare or Medicaid.

In 1995, Sierra Tucson Hospital and its patients continued to
experience significant pressure from third-party payors and managed care
organizations to restrict access to and payment for treatment services. The
Company expects this trend to continue in 1996. In response to this pressure,
the Company has aggressively pursued self-pay referral provider markets. For
1995, approximately 65% of patient revenue was derived from individual patient
payments, and approximately 35% was derived from insurance companies and other
third party payors.

Onsite charges an inclusive rate for its programs, which range in
length from five to eight days. Rates run from $600 to $1,595 per program,
depending on the nature of the workshop. Onsite receives substantially all of
its revenues directly from participants.

Miraval's individual guest rates vary depending on the season and
length of stay, beginning at $510 per day in peak season (September to June) to
off-peak season rates beginning at $355 per day. Daily rates include luxury
accommodations, three gourmet meals, use of all resort amenities, participation
in workshops and one

4
<PAGE> 5
personal service treatment. Gratuities, taxes and airport transfers are also
included in the daily rate. Typical stays range from 3 to 6 days. Miraval
currently generates substantially all of its revenue from guest bookings and
retail store sales.

Set forth below are the Company's total revenues by segment (000s, except
percentages):
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------------
1995 % 1994 % 1993 %
------- ----- ------- ----- ------- -----
<S> <C> <C> <C> <C> <C> <C>
Treatment segment $12,765 85.8 $10,391 94.7 $22,150 94.7
Health & leisure segment 530 3.6 -- -- -- --
Other, net 1,578 10.6 587 5.3 1,230 5.3
------- ----- ------- ----- ------- -----
Total revenue $14,873 100.0 $10,978 100.0 $23,380 100.0
======= ===== ======= ===== ======= =====
</TABLE>

EMPLOYEES

On December 31, 1995, the Company and its subsidiaries employed
approximately 390 full time equivalent employees. The Company's businesses have
not experienced material difficulty in recruiting and retaining employees. The
Company considers relations with employees to be excellent.

COMPETITION

Sierra Tucson Hospital competes with psychiatric and behavioral
health hospitals as wells as with other specialty psychiatric hospitals.
Non-profit or government-owned competitors may have certain financial advantages
such as endowments, charitable contributions and tax-exempt financing not
available to Sierra Tucson Hospital. The competitive position of Sierra Tucson
Hospital is, to a significant degree, dependent upon its reputation, historical
success in treating the patient, and price. The Company also believes that the
competitive position of Sierra Tucson Hospital is dependent upon the breadth of
services offered by the facility and the ability to implement programs best
suited to the needs of patients and payors in the marketplace.

Miraval competes for national and international consumer's
discretionary income typically expended upon luxury hotel and resort spas,
holistic health and other related upscale vacation experiences. The Company
considers that the criteria for competition is based upon price, program
offerings and location.

INSURANCE

The Company maintains professional malpractice liability coverage
for the professionals it employs in addition to coverage for the customary risks
inherent in the operation of health care and resort facilities and business in
general. While the Company believes its insurance policies are adequate in
amount and coverage for its current operations, there is no assurance that
coverage will continue to be available in adequate amounts or at a reasonable
cost.

LICENSING AND REGULATION

The activities of Sierra Tucson Hospital are regulated by federal
and state governments. Sierra Tucson Hospital holds a behavioral health
residential license from the State of Arizona to operate a mental health and
substance abuse facility and a special hospital/psychiatric license from the
State of Arizona to operate a psychiatric hospital.

Sierra Tucson Hospital is also accredited by the Joint Commission
on Accreditation of Healthcare Organizations ("JCAHO"), a voluntary national
accrediting organization responsible for accrediting health care

<PAGE> 6
providers. JCAHO accreditation is important to Sierra Tucson Hospital's
operations as most insurance companies require such accreditation in order for
the treatment of patients to qualify for insurance payment or reimbursement. In
1993, Sierra Tucson Hospital was reaccredited by the JCAHO for a three-year
period, the longest accreditation period available. The next scheduled survey
for Sierra Tucson Hospital by JCAHO is in May 1996.

Each of the businesses operated by the Company is subject to
extensive state and local regulations and, on a periodic basis, must obtain
various licenses and permits, including those required to sell alcoholic
beverages at Miraval. Management believes that the Company has obtained all
required licenses and permits and its businesses are conducted in substantial
compliance with applicable laws.

ITEM 2. PROPERTIES

The Company's primary facilities are located on approximately 400
acres of owned or leased land northwest of Tucson, Arizona, in the foothills of
the Santa Catalina Mountains.

The Sierra Tucson Hospital facilities are contained within a campus
setting and are located on approximately 30 acres. Onsite operates on
approximately 160 acres of land leased from the State of Arizona and in
buildings leased from a related party, ODE, LLC, Inc. The land lease expires in
2001 and contains preferential rights of renewal; the lease agreement with ODE,
LLC, Inc. grants the Company both the option to repurchase the Onsite buildings
at fair market value and to renew the lease for an additional ten year period.
The facility also has fitness and recreation areas, riding stables and other
administrative and support offices. The Onsite buildings were sold and leased
back by the Company in 1994.

The Miraval facility was reconstructed from existing Company
facilities and is located on a separate 130 acre parcel of property.

Remaining property is unimproved open space, some of which is
unbuildable either because of its terrain or its location in the flood plain.

HHHI is located at the Cottages, Shipyard Plantation, Hilton Head
Island, South Carolina. In addition, the Company has agreed to purchase certain
real property from the owner of HHHI at a price equal to fair market value which
is estimated to be approximately $1.5 million to $2.0 million. The Company will
lease this real property on a monthly basis until such purchase occurs.

ITEM 3. LEGAL PROCEEDINGS

In September 1992, a class action lawsuit was filed by stockholders
against the Company and certain of its officers and directors. Another suit was
subsequently filed and consolidated with the first suit in December 1992. These
suits alleged the Company and certain officers and directors violated federal
and state securities laws and made false and misleading statements about its
financial condition and business prospects in past periods. The Company
vigorously defended the action from its inception.

The Company established a reserve of $6.0 million in the fourth
quarter of 1993 to cover the estimated costs to fund and administer the
settlement of this suit, which occurred in the first quarter of 1994. The
negotiated settlement required the Company's insurance carrier to contribute an
amount equal to that which the Company was required to pay. The settlement
contained no admission of wrong doing or liability on the part of any defendant.
Management and the Board of Directors believed that the settlement was in the
Company's best interest and the best interest of its stockholders. In June 1994,
the court entered a final judgement to the action. The judgment dismissed and
released all claims against all parties. There are no active pending appeals.

<PAGE> 7
individually or in the aggregate, have a material adverse effect on the
Company's financial position, results of operations or cash flows.

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

The Company did not submit any matters to a vote of security
holders in the fourth quarter of the fiscal year ended December 31, 1995.

PART II

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

The Company's common stock has been traded in the over-the-counter
market and quoted on the National Association of Securities Dealers Automated
Quotations/National Market System (NASDAQ/NMS) since October 19, 1989. On April
1, 1996, there were approximately 235 shareholders of record of the Company's
stock. The high and low bid prices set forth below, derived from data prepared
by the National Association of Securities Dealers, Inc., represent quotations by
dealers and may not reflect applicable markups, markdowns or commissions, and do
not necessarily represent actual transactions.
<TABLE>
<CAPTION>
1995 1994
------------------------------ -----------------------
High Low High Low
<S> <C> <C> <C> <C>
First Quarter 3 7/8 2 7/8 4 3/8 3 7/8
Second Quarter 4 7/8 3 4 3
Third Quarter 4 3/4 3 3/8 4 3
Fourth Quarter 4 3/4 2 7/8 3 5/8 2 3/4
</TABLE>

On April 1, 1996, the closing bid price on the NASDAQ/NMS was
$3.00 per share.

The Company did not pay a cash dividend on its common stock in 1995
or 1994 and does not intend to pay any in the foreseeable future. Any future
declaration and payment of dividends will be determined by the Board of
Directors based upon the conditions existing at the time, including the
Company's earnings, financial condition, capital requirements, applicable legal
restrictions and other factors.

7
<PAGE> 8
ITEM 6. SELECTED FINANCIAL DATA

The following table sets forth selected consolidated financial and operating
data for the Company. Certain prior year amounts have been reclassified to
conform to the presentation used in 1995. The data for the three years ended
December 31, 1995, should be read in conjunction with the Company's Consolidated
Financial Statements included elsewhere in this document. The selected
consolidated financial and operating data for the two years ended December 31,
1992, is derived from the Company's historical Consolidated Financial
Statements. See Item 7 "Management's Discussion and Analysis of Financial
Condition and Results of Operations." (000s, except per share amounts and
operating data).
<TABLE>
<CAPTION>

YEAR ENDED DECEMBER 31,

1995 1994 1993 1992 1991
------------ ------------ ------------ ------------ --------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA

Total revenue .......................... $14,873 $10,978 $23,380 $35,953 $44,879
Income (loss) before income
taxes ............................... (11,967) (5,407) (13,780) 16 14,668
Income tax benefit (provision) - 2,590 2,972 350 (5,558)
Net income (loss) ...................... (11,967) (2,817) (10,808) 366 9,110
Net income (loss) per share (1) (1.40) ( .33) (1.27) .04 1.18

CASH FLOW DATA
Net cash provided by (used in)
Operating activities ................ 4,624 (5,641) 2,969 6,440 2,124
Capital expenditures ................... 20,891 550 716 2,461 9,676

BALANCE SHEET DATA (at period end)
Total assets ........................... 47,942 50,972 59,566 64,409 64,512
Long-term debt ......................... 985 1,182 210 215 226
Shareholders equity .................... 36,578 47,955 51,172 61,980 61,877

OPERATING DATA
Patient days-Sierra Tucson 17,650 15,955 31,874 48,927 64,348
Average daily census ................... 48 44 87 134 176
Participant days-Onsite ................ 7,554 - - - -
Average daily census ................... 21 - - - -
Guest days-Miraval (2) (3) 2,062 - - - -
Average daily guest count (2) 67 - - - -

FINANCIAL STATISTICS
Current ratio .......................... .65:1 11:1 3:1 12:1 12:1
Days outstanding in accounts
receivable .......................... 38 41 95 98 107
</TABLE>

(1) Net income per share for the year ended December 31, 1991 includes an
extraordinary item equal to $.05 per share.

(2) The average daily guest count for the year ended December 31, 1995, is
calculated based on the number of days from the commencement of operations
on December 1, 1995 to December 31, 1995.

(3) Guest days include both paying (1,632) and complimentary (430) stays.

8
<PAGE> 9
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following discussion and analysis relates to factors which have
affected the consolidated financial condition and results of operations of the
Company for the three years ended December 31, 1995. Certain prior year amounts
have been reclassified to conform to the presentation used in 1995. Reference
should also be made to the Company's Consolidated Financial Statements and
related notes thereto and the Selected Financial Data included elsewhere in this
document.

GENERAL

The Company, as part of its long range plan, believes that it has
positioned itself to capitalize on the newly emerging health and leisure segment
of the health care services industry by developing Miraval, a luxury health
resort providing a full range of self-discovery, stress management and
recreational activities. The Company is also seeking additional opportunities to
increase market share for its existing Treatment segment; a state licensed,
inpatient psychiatric hospital providing service for the treatment of substance
abuse, as well as a broad range of mental health and behavioral disorders and
short-term therapeutic group experiences addressing a wide variety of personal
and family issues. For the year ended December 31, 1995, the Treatment segment
accounted for substantially all of the Company's operating revenues and
approximately 45% of expenses; however, the Company believes that the Health and
Leisure segment will make significant contributions to the Company's operating
results in the future.

RESULTS OF OPERATIONS

YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994

The significant changes in results of operations and net cash
provided by (used in) operating activities for the year ended December 31, 1995,
compared to the same period in 1994 are discussed below. Unless otherwise
stated, all comparisons are for the same period.

For the year ended December 31, 1995, net loss increased $9.2
million to $12.0 million, loss before income tax benefit increased $6.6 million
to $12.0 million and net cash provided by operating activities increased $10.3
million to $4.6 million compared to the same period in 1994. Excluding $7.2
million in pre-opening costs and $1.7 million in retirement and dismantlement of
certain assets associated with the development of Miraval, net loss increased
$213,000 to $3.0 million, loss before income tax benefit decreased $2.4 million
to $3.0 million and net cash provided by operating activities increased $19.2
million to $13.6 million compared to the same period in 1994.

Total revenue increased $3.9 million to $14.9 million, an increase
of 35% when compared to the same period in 1994. These results reflect a
significant increase in Sierra Tucson Hospital patient census levels resulting
from intensified marketing efforts, the acquisition of Onsite and commencement
of operations at Miraval.

Salaries and related benefits increased $849,000 to $8.4 million,
an increase of 11% when compared to the same period in 1994. The increase was
due to staffing requirements related to the commencement of operations at
Miraval and the acquisition of Onsite. While salaries and related benefits
increased in total, they declined as a percentage of total revenue. Salaries and
related benefits as a percentage of total revenue for 1995 were 56% compared to
68% in 1994.

General and administrative expense increased $1.0 million to $8.4
million, an increase of 14% when compared to the same period in 1994. The
increase was due to advertising and operational costs related to the
commencement of operations at Miraval, and costs related to the promotion and
operations of existing lines of business. These increases were partially offset
by a decrease in the provision for bad debts to reflect Sierra Tucson Hospital's
current collection experience. Although there was an overall increase in this
category, it has declined as a percentage of total revenue. General and
administrative expense as a percentage of total revenue for the year ended
December 31, 1995, was 56% compared to 67% for the year ended December 31, 1994.

9
<PAGE> 10
In 1995, the Company incurred $7.2 million in pre-opening costs
related to the development of Miraval. The pre-opening costs included
advertising, labor related costs, pilot program research and development
activities, and other related operating expenses.

In 1995, the Company renovated and expanded certain existing
facilities to accommodate Miraval's lodging, program and activities
requirements. As a result of this process, approximately $1.7 million of
previously existing facility-related assets were dismantled and replaced.

The Company recognized a pre-tax loss of $12.0 million for the year
ended December 31, 1995. There was no income tax benefit recognized in 1995, as
the Company recorded a 100% valuation reserve against deferred tax assets.
However, the Company will be able to carry forward the current period loss to
offset future tax liabilities.

YEAR ENDED DECEMBER 31, 1994 COMPARED TO YEAR ENDED DECEMBER 31, 1993

Total revenue decreased in 1994 as a result of the overall
deterioration in the inpatient psychiatric and behavioral health care industry.
Patient days decreased by 15,919, or 50% in 1994. Total revenue decreased by
$12.4 million, or 53%. The industry has been adversely impacted by pressures
from traditional indemnity as well as government payor sources. These payor
sources have limited both the length of stay and amount of reimbursement for
inpatient psychiatric/behavioral health care services, as they have shifted
their focus toward outpatient treatment of these illnesses. Management expects
the trend from these payor sources to continue; however, management has
responded by consolidating operations, redefining the treatment program, and
focusing on payor sources willing to pay for quality treatment. The Company is
also researching and developing potential new revenue streams which are geared
more toward prevention of illness as opposed to treatment of illness.

Salaries and related benefits decreased as a result of management's
efforts to respond to the decrease in total revenue. Salaries and related
benefits decreased $4.6 million, or 38% in 1994. Management was able to achieve
these significant cost savings, in part, as a result of the consolidation of
operations. Salaries and related benefits also included severance pay of
$475,000 in 1994.

General and administrative expense decreased as a result of cost
control measures that were implemented in response to the decrease in total
revenue. General and administrative expense decreased $4.4 million, or 38% in
1994. The decrease was due to a decrease in professional services, contract
labor, advertising and other operational expenses.

Depreciation and amortization expense decreased $234,000 in 1994.
Approximately $155,000 of this decrease is the result of the Adolescent Care
Facility closing in June 1993.

A provision for litigation of $6.0 million was established in the
fourth quarter of 1993 as a result of a class action lawsuit. Tentative
settlement of this lawsuit was reached in the first quarter of 1994, with final
court approval on June 13, 1994. The negotiated settlement required the
Company's insurance company to fund an amount equal to the company's
contribution. This $5.5 million settlement was funded by the Company in the
first quarter of 1994. An additional $400,000 in legal fees and expenses was
paid during 1994 related to the defense of the class action.

An income tax benefit of approximately $2.6 million related to a
pre-tax loss of approximately $5.4 million was recorded in 1994. The Company was
able to carry-back the loss and received a cash refund of approximately $4.5
million during 1995. In 1994, the Company received an actual cash refund of $1.3
million. In 1993, the Company recorded an income tax benefit of approximately
$3.0 million related to a pre-tax loss of approximately $13.8 million. In 1993,
the Company received a cash refund of approximately $485,000. The Company did
not record any income tax benefit in 1994 or 1993 related to the Adolescent Care
Facility write-down of $5.5 million.

10
<PAGE> 11
LIQUIDITY AND CAPITAL RESOURCES

The Company's primary sources of liquidity and capital resources
have typically been cash provided by the Treatment segment's operating
activities, funds generated from the sale of investments and proceeds from
public equity offerings. Historically, these sources have been sufficient to
meet the needs and finance the growth of the Company's business. Net cash
provided by the Treatment segment's operating activities has been primarily
affected by census levels and net revenue per patient day. This segment
contributed positive cash flow to the Company's operations in 1995.

In 1995, the Company had capital expenditures of approximately
$20.9 million, of which $19.9 million was related to the construction of
Miraval. Additionally, the Company incurred $7.2 million in pre-opening costs
for the development of Miraval. Primarily as a result of these expenditures, the
Company's cash reserves have decreased significantly. At December 31, 1995, the
Company's cash and investments were $4.5 million, all of which was applied to
existing trade and construction payables.

The Treatment segment's 1995 operational results reflect the
segment's focus on attracting a high percentage of retail patients. In 1995, 65%
of patient revenue was derived from retail payments and the remaining 35% from
third party payors. Sierra Tucson Hospital continues to experience pressure from
third party payors and managed care organizations to restrict patient access to
and payment for treatment services. Onsite derives its revenues almost entirely
from retail payments by participants. Based on current census levels and
operating expenses, Sierra Tucson Hospital believes that it will generate
adequate cash flows to sustain the Treatment segment's ongoing operational
requirements.

Miraval, the Company's Health and Leisure segment's primary line of
business, commenced operations in December 1995. This segment's results are
primarily affected by volume (as measured by occupancy), pricing (as measured by
average annual room rates) and the segment's ability to manage costs. Miraval
operates in a unique niche in an emerging health and leisure market. Marketing
and advertising initiatives for creating marketplace awareness and demand for
Miraval's services resulted in a room occupancy rate of approximately 41%
through December 31, 1995 of which 65% was comprised of paying guests and 35%
nonpaying guests. As part of the segment's marketing strategy, media, travel
and trade representatives as well as other key influencers have been invited to
experience Miraval with the expectation that Miraval will be promoted in the
marketplace. Management believes the Health and Leisure segment will, in time,
make a significant contribution to the Company's financial condition. However,
until such time that it generates positive cash flow, short-and long-term
financing and the implementation of cost containment measures will be necessary
for sustaining its operations. The Company believes it has adequate unencumbered
assets available for securing the short-term capital necessary until such time
that Miraval is self sufficient and for securing long-term capital commitments
to meet future liquidity needs and to fund additional growth opportunities.

To meet its current liquidity requirements, the Company obtained a
$2.0 million line of credit (the "LOC") from the National Bank of Arizona on
April 10, 1996. The LOC has a variable interest rate based upon the Prime rate
as published in the Western Edition of the Wall Street Journal plus 1 percent
and has a minimum interest rate of 9.25% and a maximum rate of 15%. The initial
interest rate is 9.25%, payable in monthly installments, for a term of six
months. The LOC is secured by certain real estate owned by the Company. In
addition, the Company negotiated an agreement with Sundt Corporation ("Sundt"),
the general contractor of the Miraval project, for the payment of approximately
$3.7 million, which represents the remaining balance due Sundt for the
construction of Miraval. This agreement has a term of eighteen months and bears
interest at an annual rate equal to the Prime rate as established by Bank One,
N.A. plus 4 percent. Sundt received a $300,000 payment at the closing of the LOC
and will receive payments of $125,000 per month for a period of eleven months
commencing in May 1996. The balance remaining after the aforementioned payments
will be paid evenly in six monthly installments. Sundt has agreed to subordinate
the master Mechanics' Lien recorded against Miraval's real property on March 28,
1996 to the LOC and additional borrowings up to $5.0 million. Additionally, as
part of this agreement, if the Company were to obtain secured borrowings in
excess of $5.0 million or unsecured borrowings in excess of $3.0 million, the
unpaid balance due Sundt would immediately become due. The Company believes that
the combination of these transactions will provide the liquidity necessary to
sustain operations over the next three to six months. The Company is actively
exploring additional financing alternatives which it believes will be adequate
to maintain operations through 1996.

Effective March 1, 1996, the Company acquired certain operating
assets and liabilities from Hilton Head Health Institute, Inc. ("HHHI"). The
acquisition price was not material to the Company's financial position, results

11
<PAGE> 12
of operations and cash flows at December 31, 1995. In addition, the Company has
agreed to purchase certain real property from the former owner of HHHI at a
price equal to fair market value which is estimated to be approximately $1.5
million to $2.0 million. The Company will lease this real property until the
purchase closes. The Company does not expect HHHI to require significant
capital resources in 1996. However, HHHI will require approximately $150,000
in capital for the retirement of certain outstanding obligations which were
assumed by the Company as part of the acquisition.

To satisfy the Company's operational liquidity requirements, it is
necessary for the Company to increase occupancy levels and to implement
additional cost controls. Insufficient occupancy levels at Miraval or any
significant decrease in Sierra Tucson Hospital's patient levels would adversely
affect the Company's financial position, results of operations and cash flows.
Management does not anticipate any significant impact upon operations as a
result of inflation, nor has the Company historically experienced any such
impact.

BUSINESS OUTLOOK

In 1996, the Treatment segment is projected to contribute
significantly to the net income and cash flow of the Company. In order to meet
this goal, management has implemented marketing initiatives focusing on
increasing the average daily census ("ADC") for Sierra Tucson Hospital's and
Onsite's programs. Additionally, a 5% rate increase was implemented by Sierra
Tucson Hospital on March 1, 1996. To ensure that cash receipts continue to
follow historical trends, Sierra Tucson Hospital will continue to focus on the
retail segment and will enhance existing utilization review procedures to
improve reimbursement through third party payors.

In 1995, cost containment efforts were an important factor in the
Treatment segment's results of operations, and as a result, these efforts will
continue in 1996. In order to reduce the cost per patient and participant day,
the segment will focus on managing labor and labor related costs. This will be
affected through the increased use of variable staffing which expands or
contracts as determined by the ADC, the combination of certain positions and
functions and the reduction or elimination of the use of consultants and
contract labor. In addition, Sierra Tucson Hospital and Onsite are developing
long-range plans for assessing the feasibility of changing certain components of
their fixed cost structures.

Miraval commenced operations in December, 1995. As an early entrant
into this emerging market niche, there are no industry-specific financial
benchmarks from which the Company can draw conclusions for projecting future
performance. Management's objective is to increase short- and long-term
occupancy. In order to achieve this objective, Miraval will continue to
implement marketing initiatives aimed primarily at upscale consumers predisposed
to similar types of vacation experiences through travel/trade sources, news
media, direct mail initiatives and with other entities and individuals in
positions to influence consumers' vacation decisions. In addition, the
implementation of cost containment measures in 1996 will be a critical factor in
the Company's efforts to establish positive operating results. This will be
effected through the increased use of variable staffing relative to any seasonal
fluctuations in occupancy and the evaluation of all other operating expenditures
in an effort to identify areas where efficiencies can be realized.

The Company continually monitors the economic performance of each
operating entity to see that it meets desired cash flow objectives. If an
operating entity is not generating the expected cash flows or does not fit with
the Company's long-term strategic plans, the Company will explore various
options such as consolidation of operations, closing the operating entity or
outright sale. The Company expects each operating entity to meet cash flow
objectives in 1996. However, should conditions change, the Company will
reevaluate its position and take the appropriate corrective action.

FACTORS THAT MAY AFFECT FUTURE RESULTS

Management's Discussion and Analysis of Results of Operations and
Financial Condition contains forward looking statements within the meaning of
Private Securities Litigation Reform Act of 1995 that involve a number of risks
and uncertainties. While management believes that such forward looking
statements are accurate as of the date hereof, the actual results and conditions
could differ materially from the statements contained herein.

<PAGE> 13
The information below should be read in conjunction with the Company's
Consolidated Financial Statements and related notes thereto included elsewhere
and in other portions of this document.

In addition, the following other factors could cause actual results
and conditions relating to liquidity and capital resources to differ materially.

Miraval represents a new and significant line of business for the
Company. Miraval represents the Company's entry into a unique niche in an
emerging health and leisure market for which there is little, if any, industry
market data available. Its products and services are different than those of
traditional destination resorts or destination "spa" facilities. The Company has
little experience in the marketing, management or operation of a facility of
this nature, although it has hired qualified and experienced personnel from
related operations.

The Company is unable to project with any degree of accuracy the
future occupancy levels or revenues of Miraval because the facility is in its
first year of operation. The Company has no historical operating data for
projecting occupancy levels during peak and non-peak periods, marketing,
operating or maintenance costs and expenses. Although the Company believes that
there is strong consumer demand for Miraval's products and services because it
represents a unique vacation alternative, the Company cannot be certain that its
current marketing strategy will successfully attract the targeted clientele.

The Company cannot be certain that Miraval will generate sufficient
revenues to cover its operating expenses. Management believes that if the
existing capital resources of the Company are insufficient to meet its capital
needs, additional capital may be available through short - and long-term
financing; however, the Company cannot predict the terms or availability of such
financing.

Miraval will be competing in the competitive resort hotel/spa
industry. In many instances, its competitors have greater name recognition
and financial resources as well as long-standing relationships with travel
agents and tour and trip planners.

Miraval offers a variety of indoor and outdoor athletic and other
physical activities for its guests. Because of its lack of operating history,
the Company cannot predict what impact the summer climate in Tucson, Arizona,
will have on its occupancy levels and pricing structures.

The Company's Treatment segments, Sierra Tucson Hospital and
Onsite, participate in the highly competitive mental and behavioral health
industry characterized by intense competition for market share resulting from
aggressive pricing practices and increasing competition from companies with
greater resources, including tax exempt, non-profit status, government
subsidized or endowment-related financial support which may provide lower costs
of capital.

While the Company anticipates continued growth in revenues and is
committed to a return to profitability, operating results could be adversely
impacted if the businesses are unable to anticipate customer demand accurately,
are unable to differentiate their products from those of their competitors, are
unable to offer services expeditiously in response to customer demand, or are
negatively impacted by managed care restrictions on payor reimbursement.

<PAGE> 14
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Index to Consolidated Financial Statements

NextHealth, Inc.'s Consolidated Financial statements as of December 31, 1995 and
1994 and for the three years ended December 31, 1995.
<TABLE>
<CAPTION>

PAGE
----
<S> <C>
Report of Management ................................................. 15
Report of Independent Auditors ....................................... 16
Consolidated Balance Sheets .......................................... 17
Consolidated Statements of Operations ............................... 18
Consolidated Statements of Cash Flows ............................... 19
Consolidated Statements of Changes in Stockholders' Equity ........... 20
Notes to Consolidated Financial Statements ........................... 21
</TABLE>

<PAGE> 15
REPORT OF MANAGEMENT

The financial statements and other financial information included in this Annual
Report on Form 10-K are the responsibility of management. The financial
statements have been prepared in conformity with generally accepted accounting
principles appropriate in the circumstances and include amounts that are based
on management's informed judgments and estimates.

Management relies on the Company's system of internal accounting controls to
provide reasonable assurance that assets are safeguarded and that transactions
are properly recorded and executed in accordance with management's
authorization. The concept of reasonable assurance is based on the recognition
that there are inherent limitations in all systems of internal accounting
control and that the cost of such systems should not exceed the benefits to be
derived. The internal accounting controls in place during the periods presented
are considered adequate to provide such assurance.

The Company's financial statements are audited by Ernst & Young LLP, independent
auditors. Their report states that they have conducted their audit in accordance
with generally accepted auditing standards. These standards include an
evaluation of the system of internal accounting controls for the purpose of
establishing the scope of audit testing necessary to allow them to render an
independent professional opinion on the fairness of the Company's financial
statements.

The Audit committee of the Board of Directors, composed solely of directors who
are not employees of the Company, reviews the Company's financial reporting and
accounting practices. The Audit Committee meets periodically with the
independent auditors and management to review the work of each and to ensure
that each is properly discharging its responsibilities.

/S/ JOHN H. SCHMITZ
- ------------------------------
John H. Schmitz
President and Chief Executive Officer

/S/ WAYNE M. MORRISON
- ------------------------------
Wayne M. Morrison
Chief Financial Officer
(Principal Financial and Accounting Officer)

<PAGE> 16
REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and Stockholders of NextHealth, Inc.:

We have audited the accompanying consolidated balance sheets of NextHealth,
Inc., as of December 31, 1995 and 1994, and the related consolidated statements
of operations, changes in stockholders' equity, and cash flows for each of the
three years in the period ended December 31, 1995. Our audits also included the
financial statement schedule listed in the Index at Item 14(a). These financial
statements and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.

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

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
NextHealth, Inc., at December 31, 1995 and 1994, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1995, in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information therein.

ERNST & YOUNG LLP

Tucson, Arizona
January 26, 1996,
Except for the note entitled Subsequent Events, as to which the date is
April 10, 1996

<PAGE> 17
NEXTHEALTH, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

(000s, except share and per share amounts)
<TABLE>
<CAPTION>

December 31,
---------------------
1995 1994
------- --------
<S> <C> <C>
ASSETS
Current Assets:
Cash and equivalents .................................... $ 2,864 $ 1,227
Short-term investments .................................. 1,635 10,514
Accounts receivable, less allowance for doubtful accounts
of $431 and $694, respectively ....................... 1,340 2,783
Income taxes receivable ................................. -- 4,508
Deferred income taxes ................................... -- 315
Prepaid expenses ........................................ 476 379
Other current assets .................................... 478 184
-------- --------
Total current assets ................................. 6,793 19,910

Property and equipment, net ................................. 40,158 22,075
Long-term investments ....................................... -- 8,800
Long-term receivables, less allowance for doubtful accounts
of $70 and $33, respectively ........................... 211 185
Intangible assets, less amortization of $33 in 1995 ......... 704 --
Other assets ................................................ 76 2
-------- --------
Total assets ......................................... $ 47,942 $ 50,972
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable, trade ................................. $ 2,410 $ 378
Accounts payable, construction .......................... 4,517 --
Accrued expenses and other liabilities .................. 3,452 1,457
-------- --------
Total current liabilities ............................ 10,379 1,835
Long-term debt and financing obligation ................... 985 1,182
-------- --------
Total liabilities .................................... 11,364 3,017
-------- --------
Stockholders' Equity:
Preferred stock, $.01 par value, 4,000,000 shares
authorized; no shares issued and outstanding .......... -- --
Common stock, $.01 par value, 16,000,000 shares
authorized; 8,554,938 and 8,496,884 shares
outstanding at December 31, 1995 and 1994,
respectively .......................................... 86 85
Additional paid-in capital .............................. 43,453 43,263
Unrealized investment losses ............................ -- (399)
Retained earnings (accumulated deficit) ................. (6,961) 5,006
-------- --------
Total stockholders' equity ........................... 36,578 47,955
-------- --------
Total liabilities and stockholders' equity ........... $ 47,942 $ 50,972
======== ========
</TABLE>

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

<PAGE> 18
NEXTHEALTH, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS

(000s, except share and per share amounts)
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------------
1995 1994 1993
----------- ----------- -----------
<S> <C> <C> <C>
Revenue:
Net operating revenue ............. $ 12,967 $ 9,829 $ 21,354
Investment income ................. 1,293 560 1,230
Other revenue ..................... 613 589 796
----------- ----------- -----------
Total revenue ............... 14,873 10,978 23,380
----------- ----------- -----------
Operating expenses:
Salaries and related benefits ..... 8,362 7,513 12,105
General and administrative ........ 8,396 7,377 11,813
Pre-opening costs ................. 7,242 -- --
Provision for litigation .......... -- -- 6,000
Provision for closure of facilities -- -- 5,510
Retirement of assets .............. 1,695 -- --
Interest expense .................. 87 12 15
Depreciation and amortization ..... 1,058 1,483 1,717
----------- ----------- -----------
Total operating expenses .... 26,840 16,385 37,160
----------- ----------- -----------
Loss before income tax benefit ....... (11,967) (5,407) (13,780)
Income tax benefit ................... -- 2,590 2,972
----------- ----------- -----------
Net loss ............................. $ (11,967) $ (2,817) $ (10,808)
=========== =========== ===========
Weighted average shares of common
stock outstanding ................. 8,547,490 8,496,884 8,496,884
=========== =========== ===========
Net loss per share of common stock ... $ (1.40) $ (.33) $ (1.27)
=========== =========== ===========
</TABLE>

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

18
<PAGE> 19
NEXTHEALTH, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(000s)

<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------
1995 1994 1993
-------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss ....................................... $(11,967) $ (2,817) $(10,808)
Adjustments to reconcile net loss to cash
provided by (used in) operating activities:
Depreciation and amortization ............ 1,058 1,483 1,717
Retirement of assets ..................... 1,695 -- --
Provision for bad debts .................. 50 661 1,537
Provision for litigation ................. -- -- 6,000
Provision for closure of facilities ...... -- -- 5,510
Provision (benefit) for deferred income
taxes .................................. 315 1,935 (2,250)
Changes in operating assets and liabilities
net of effects from acquisitions:
Decrease (increase) in assets:
Accounts receivable ...................... 1,366 2,292 2,086
Other assets ............................. (844) 416 (237)
Income taxes receivable .................. 4,508 (3,261) (237)
Increase (decrease) in liabilities:
Accounts payable, accrued expenses,
other liabilities and litigation reserve 8,443 (6,350) (349)
-------- -------- --------
Net cash provided by (used in)
operating activities ................... 4,624 (5,641) 2,969
-------- -------- --------
Cash flows from investing activities:
Purchase of property and equipment .......... (20,761) (550) (716)
Business acquisitions, net of cash
acquired ............................... (130) -- --
Sale of long-term investments ............... 23,361 13,156 6,966
Purchase of long-term investments ........... (14,163) (10,186) (11,540)
-------- -------- --------
Net cash provided by (used in) investing
activities ............................. (11,693) 2,420 (5,290)
-------- -------- --------
Cash flows from financing activities:
Proceeds from financing obligation .......... -- 1,000 --
Reduction of long-term debt and financing
obligation ............................. (208) (28) (11)
Exercise of common stock options ............ 35 -- --
-------- -------- --------
Net cash provided by (used in) financing

activities ............................. (173) 972 (11)
-------- -------- --------
Net decrease in cash and equivalents ............. (7,242) (2,249) (2,332)
Cash and equivalents at beginning of year ........ 11,741 13,990 16,322
-------- -------- --------
Cash and equivalents at end of year .............. $ 4,499 $ 11,741 $ 13,990
======== ======== ========
</TABLE>

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

<PAGE> 20
NEXTHEALTH, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(000s, except share amounts)

<TABLE>
<CAPTION>
Retained Total
Common Stock Additional Earnings Unrealized Stock-
------------ Paid-in (Accumulated Loss on holders'
Cost Shares Capital Deficit) Investments Equity
---- --------- ---------- ------------ ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1993 ..... $85 8,496,884 $43,263 $ 18,631 $-- $ 61,979
Net loss for the year ended
December 31, 1993 ........... -- -- -- (10,808) -- (10,808)
--- --------- ------- -------- ----- --------
Balance at December 31, 1993 ... 85 8,496,884 43,263 7,823 -- 51,171
Net loss for the year ended
December 31, 1994 ........... -- -- -- (2,817) -- (2,817)
Unrealized loss on investments . -- -- -- -- (399) (399)
--- --------- ------- -------- ----- --------
Balance at December 31, 1994 ... 85 8,496,884 43,263 5,006 (399) 47,955
Net loss for the year ended
December 31, 1995 ........... -- -- -- (11,967) -- (11,967)
Issuance of common stock for
business acquisition ........ 1 50,000 155 -- -- 156
Exercise of common stock
options ..................... -- 8,054 35 -- -- 35
Sale of investments ............ -- -- -- -- 399 399
--- --------- ------- -------- ----- --------
Balance at December 31, 1995 ... $86 8,554,938 $43,453 $ (6,961) $-- $ 36,578
=== ========= ======= ======== ===== ========
</TABLE>

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

20
<PAGE> 21
NEXTHEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(000s, except share and per share amounts)
December 31, 1995

ORGANIZATION

NextHealth, Inc.'s, and subsidiaries (collectively, the "Company") operations
are categorized in two principal business segments; Health and Leisure and
Treatment through which it provides both wellness and preventive health and
health care services. The Health and Leisure segment, or Miraval(TM), is a
luxury health resort providing a full range of self discovery, stress management
and recreational activities. The Treatment segment includes Sierra Tucson, Inc.
("Sierra Tucson"), an inpatient, state licensed psychiatric hospital and
behavioral health center providing service for the treatment of substance abuse
and a broad range of mental health and behavioral disorders; and Onsite
Workshops, Inc. ("Onsite"), which offers intensive, therapeutic group
experiences addressing a wide variety of personal and family issues. The current
operations of the Company are located in Tucson, Arizona.

Effective September 28, 1995, the Company changed its name from Sierra Tucson
Companies, Inc. to NextHealth, Inc. This change was effected through a short
form merger pursuant to Delaware law whereby Sierra Tucson Companies, Inc.
merged with Sierra Tucson / Arizona Holdings, Inc. (a wholly owned subsidiary of
Sierra Tucson Companies, Inc.). As part of the merger, the surviving entity's
name was changed to NextHealth, Inc. The sole purpose of the name change was to
establish separate identities for the parent company and each of its operating
subsidiaries.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The consolidated financial statements include the accounts of NextHealth, Inc.
and its subsidiaries, all of which are wholly owned. All material intercompany
accounts and transactions have been eliminated in consolidation.

Basis of Accounting

The accompanying financial statements have been prepared assuming the Company is
a going concern. The Company has incurred substantial operating losses in the
last three years and has expended the majority of its liquid assets constructing
Miraval, which will continue to require cash until such time as it gains market
acceptance. In April of 1996, the Company obtained a $2,000 line of credit and
negotiated the conversion of certain construction payables into an eighteen
month note payable, (see note entitled Subsequent Events) both of which
management believes should address the working capital deficiency at December
31, 1995. Positive cash flow from Miraval's operations is dependent upon a
substantial increase in occupancy levels and implementation of additional cost
control measures. The Company believes its real estate can be sufficiently
financed on a long-term basis to sustain future operations. The Company is
pursuing all options available to secure long-term financing. Failure to obtain
significant long-term financing will adversely impact the Company's ability to
operate as a going concern in 1996.

Use of Estimates

The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.

<PAGE> 22
NEXTHEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(000s, except share and per share amounts)
December 31, 1995

Cash and Equivalents

Cash and equivalents include all cash balances and highly liquid investments
with an original maturity of three months or less. Cash and equivalents are
stated at cost which approximates market value. Short-term investments are
considered cash equivalents for statement of cash flow purposes.

Pre-opening Costs

Costs associated with the opening of new properties or major additions to
existing properties are expensed as incurred.

Investments

Short-term investments consist of money market funds, short-term commercial
paper, repurchase agreements, municipal bonds and other debt securities with an
original maturity of one year or less. Long-term investments consist primarily
of U.S. government and agency obligations, municipal bonds, collateralized
mortgage obligations and other debt securities. At December 31, 1995 and 1994,
all investments were classified as available-for-sale and reported at fair
value.

New Accounting Standards

The Company adopted Statement of Financial Accounting Standards No. 115,
Accounting for Certain Investments in Debt and Equity Securities, in 1994. At
the date of adoption, the fair value of the Company's securities exceeded their
cost.

In March 1995, the FASB issued Statement of Financial Accounting Standards No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of ("SFAS No. 121"), which requires impairment losses to
be recorded on long-lived assets used in operations when indicators of
impairment are present and the undiscounted cash flows estimated to be generated
by those assets are less than the assets' carrying amount. SFAS No. 121 also
addresses the accounting for long-lived assets that are expected to be disposed
of. The Company will adopt SFAS No. 121 in the first quarter of 1996 and, based
on current circumstances, does not believe the effect of adoption will be
material.

Advertising Expense

The cost of advertising is expensed as incurred. The Company incurred
approximately $3,600, $425 and $980 in advertising costs during 1995, 1994 and
1993, respectively.

Property and Equipment

Property and equipment is stated at cost. Interest incurred during the
construction of facilities is capitalized and amortized over the life of the
asset. Costs of improvements are capitalized. Costs of normal repairs and
maintenance are charged to expense as incurred. Upon the sale or retirement of
property and equipment, the cost and related accumulated depreciation are
removed from the respective accounts, and the resulting gain or loss, if any, is
included in income. Depreciation is provided on a straight-line basis over the
estimated useful lives of the assets. The service lives of the Company's
property and equipment ranges from 3 to 31 years.

<PAGE> 23
NEXTHEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(000s, except share and per share amounts)
December 31, 1995

Intangible Assets

Included in intangible assets is goodwill incurred in connection with the
acquisition of Onsite in January 1995. This acquisition was accounted for as a
purchase. Such goodwill is being amortized over 10 years. The Company assesses
recoverability of goodwill based on undiscounted cash flows of Onsite and other
relevant information.

Income Taxes

The company accounts for income taxes in accordance with Statement of Financial
Accounting Standards No. 109, Accounting for Income Taxes.

Net Operating Revenue

Net operating revenue consists of revenue derived from guests, patients and
participants, based on the billing rates established for each line of business,
less any applicable discounts or contractual allowances. For the three years
ended December 31, 1995, contractual allowances and discounts granted were
approximately $1,423, $1,500 and $3,200, respectively.

Stock Based Compensation

The Company grants stock options for a fixed number of shares to employees with
an exercise price equal to or greater than the fair market value of the shares
on the date of grant. The Company accounts for stock option grants in accordance
with APB Opinion No. 25, Accounting for Stock Issued to Employees, and,
accordingly, recognizes no compensation expense for the stock option grants.

Net Income (Loss) Per Share

Net income (loss) per share is based on the weighted average shares outstanding,
as the potential dilution from exercisable stock options is not material. The
computation of fully diluted earnings per share for the three years ended
December 31, 1995, was not dilutive; therefore, only primary earnings per share
is presented.

Credit Risk

A significant portion of the Company's accounts receivable are due from
individuals (self-pay), insurance companies, other entities which provided
health care benefits and credit card companies. Management performs credit
evaluations and believes its allowance for doubtful accounts is adequate.

Reclassifications

The consolidated financial statements for prior years reflect certain
reclassifications to conform with classifications adopted in 1995.

<PAGE> 24
NEXTHEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(000s, except share and per share amounts)
December 31, 1995

INVESTMENTS

The estimated fair value of the Company's available for sale securities at
December 31, 1995 and 1994 are as follows:

<TABLE>
<CAPTION>
1995 1994
----------------- -------------------
Fair Fair
Cost Value Cost Value
------ ------ ------- -------
<S> <C> <C> <C> <C>
U.S. Treasury Securities
and obligations of U.S.
government agencies ..... $ -- $ -- $ 7,980 $ 7,887
Certificate of deposit ...... 1,538 1,538 -- --
Money market funds .......... 97 97 -- --
Commercial paper ............ -- -- 2,736 2,736
Other debt securities ....... -- -- 8,997 8,691
------ ------ ------- -------
Total investments ........... $1,635 $1,635 $19,713 $19,314
====== ====== ======= =======
</TABLE>

For the years ended December 31, 1995 and 1994, gross unrealized losses were $0
and $399, respectively; proceeds from the sale of securities classified as
available-for-sale were $38,545 and $23,065, respectively; gross gains
recognized were $404 and $95, respectively; and gross losses recognized were $80
and $375, respectively.

PROPERTY AND EQUIPMENT

Property and equipment at December 31, 1995 and 1994 are as follows:

<TABLE>
<CAPTION>
1995 1994
------- -------
<S> <C> <C>
Land and improvements ........... $ 2,898 $ 2,535
Buildings and improvements ...... 36,102 21,139
Furniture and equipment ......... 9,005 5,272
------- -------

Total property and equipment .... 48,005 28,946

Less: accumulated depreciation
and amortization ............ 7,847 6,871
------- -------

Total property and
equipment, net .............. $40,158 $22,075
======= =======
</TABLE>

24
<PAGE> 25
NEXTHEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(000s, except share and per share amounts)
December 31, 1995

ACCRUED EXPENSES AND OTHER LIABILITIES

At December 31, 1995 and 1994, accrued expenses and other liabilities were
comprised of the following account balances:

<TABLE>
<CAPTION>
1995 1994
------ ------
<S> <C> <C>
Payroll and related taxes .. $ 925 $ 785
Professional fees .......... 553 360
Deposits and patient refunds 267 231
Reimbursement liability .... 1,018 --
Other ...................... 689 81
------ ------

Total accrued expenses and
other liabilities ...... $3,452 $1,457
====== ======
</TABLE>

LONG-TERM DEBT AND FINANCING OBLIGATION

Long-term debt and financing obligation at December 31, 1995 and 1994 are as
follows:

<TABLE>
<CAPTION>
1995 1994
------ ------
<S> <C> <C>
Financing obligation ............. $ 903 $1,000
Secured debt with an interest
rate of 8.625% at December 31,
1995 maturing through 2017 ... 183 199
------ ------

1,086 1,199

Less: current portion ............ 101 17
------ ------

Total long-term debt and financing
obligation ................... $ 985 $1,182
====== ======
</TABLE>

In December 1994, the Company sold a facility for $1,000 (the facility's
appraised value) to an entity controlled by the Chairman of the Company's Board
of Directors. The Company simultaneously leased this facility for a term of
seven years, at an annual cost of $150, payable in quarterly installments. The
Company has the option of extending the lease term for an additional ten-year
period or to repurchase the facility at fair market value on any date, one year
after the date of the sale-leaseback agreement. This transaction has been
accounted for as a financing as a result of the Company's continuing involvement
with the facility.

25
<PAGE> 26
NEXTHEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(000s, except share and per share amounts)
December 31, 1995

Approximate future maturities of long-term debt and financing obligation at the
date indicated are as follows:

<TABLE>
<CAPTION>
December 31,
1995
------------
<S> <C>
1996 ................................. $ 101
1997 ................................. 107
1998 ................................. 117
1999 ................................. 126
2000 ................................. 137
Thereafter ........................... 498
------
$1,086
======
</TABLE>

For the three years ended December 31, 1995, interest paid was $87, $12 and $15,
respectively.

SEGMENT INFORMATION

The Company operates in two principal business segments; Health and Leisure and
Treatment through which it provides both wellness and preventive health and
health care services. The Health and Leisure segment presently consists of a
luxury health resort providing a full range of self discovery, stress management
and recreational activities. Substantially all revenues result from guest
bookings and retail charges. The Treatment segment includes an inpatient, state
licensed psychiatric hospital providing service for the treatment of substance
abuse and a broad range of mental health and behavioral disorders; and
short-term therapeutic group experiences addressing a wide variety of personal
and family issues. Substantially all revenues result from group therapy, medical
assessments and stabilization, pharmacy, workshop and room and board charges.
For the year ended December 31, 1995, no single customer accounted for more than
10% of either of the principal business segments' revenue. Prior to 1995, the
Company operated in only the treatment segment.

The results of operations for the Company's principal business segments are
reported in the Consolidated Statements of Operations. For the year ended
December 31, 1995, there was no intersegment revenue and all reported segment
operating expenses are those directly related to the operation of its business.
Unusual and infrequently occurring items reported as operating expenses for the
Health and Leisure segment include pre-opening costs of $7,242 and a charge for
the retirement or dismantlement of certain assets of $1,695. The current
operations of each principal business segment are located in Tucson, Arizona.

26
<PAGE> 27
NEXTHEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(000s, except share and per share amounts)
December 31, 1995

Information about the Company's operations by business segment for the year
ended December 31, 1995 is as follows:

<TABLE>
<CAPTION>
Corporate
Health and and
Treatment Leisure Other Items Consolidated
--------- ---------- ----------- ------------
<S> <C> <C> <C> <C>
Total revenue ............... $12,765 $ 530 $ 1,578 $ 14,873
Income (loss) before income
tax benefit ............. 765 (10,280) (2,452) (11,967)
Identifiable assets ......... 7,191 32,291 8,460 47,942
Capital expenditures ........ 540 19,900 451 20,891
Depreciation and amortization
expense ................. 515 196 347 1,058
</TABLE>

STOCK OPTION PLANS

At December 31, 1995, 1,243,000 shares of common stock were reserved for the
exercise of options under the Company's stock option plans. Options to purchase
shares of common stock are granted with an exercise price equal to or greater
than the fair market value on the date of grant, and are exercisable over
periods ranging from three to ten years. Options may be exercised in
installments commencing one year after the date of grant. All options become
fully vested upon the acquisition of the Company or a merger in which the
Company is not the surviving entity.

The following table summarizes the cumulative activity under the Company's
incentive stock option plans:

<TABLE>
<CAPTION>
Options Fully Vested Option Price
Outstanding Options Range (Per Share)
----------- ------------ -----------------
<S> <C> <C> <C>
Balance at January 1, 1993 . 807,004 344,807 $4.50 - 28.75
Granted .................... 330,034 3.88 - 5.13
Canceled ................... (226,201) 4.50 - 28.75
Exercised .................. - -
---------
Balance at December 31, 1993 910,837 458,620 3.88 - 28.75
Granted .................... 402,959 2.88 - 4.25
Canceled ................... (488,661) 3.88 - 28.75
Exercised .................. - -
---------
Balance at December 31, 1994 825,135 315,251 2.88 - 23.25
Granted .................... 575,750 2.94 - 6.19
Canceled ................... (226,080) 2.88 - 10.75
Exercised .................. (8,054) 2.88 - 4.00
---------
Balance at December 31, 1995 1,166,751 377,945 $2.88 - 23.25
========= ======= =============
</TABLE>

27
<PAGE> 28
NEXTHEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(000s, except share and per share amounts)
December 31, 1995

In 1993, the Company established a Non-Employee Director Stock Option Plan (the
"DSO Plan"), which provides for the automatic granting of fully vested options
to members of the Board of Directors who are not officers or employees of the
Company to purchase shares of common stock. At December 31, 1995, 300,000 shares
of common stock were reserved for issuance under the DSO Plan. The following
table summarizes the cumulative activity under the Company's DSO Plan:

<TABLE>
<CAPTION>
Options Fully Vested Option Price
Outstanding Options Range (Per Share)
----------- ------------ -----------------
<S> <C> <C> <C>
Balance at January 1, 1993 . - - $ -
Granted .................... 25,500 25,500 4.88
Canceled ................... - - -
Exercised .................. - - -
------ ------
Balance at December 31, 1993 25,500 25,500 4.88
Granted .................... 36,500 36,500 2.88 - 4.00
Canceled ................... - - -
Exercised .................. - - -
------ ------
Balance at December 31, 1994 62,000 62,000 2.88 - 4.88
Granted .................... 33,000 33,000 2.88
Canceled ................... - - -
Exercised .................. - - -
------ ------
Balance at December 31, 1995 95,000 95,000 $2.88 - 4.88
====== ====== ============
</TABLE>

INCOME TAXES

The provision (benefit) for income taxes for the three years ended December 31,
1995 are as follows:

<TABLE>
<CAPTION>
1995 1994 1993
----- ------- -------
<S> <C> <C> <C>
Current:
Federal $(315) $(4,525) $ (722)
State .. - - -
Deferred 315 1,935 (2,250)
----- ------- -------
Total ..... $ - $(2,590) $(2,972)
===== ======= =======
</TABLE>

28
<PAGE> 29
NEXTHEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(000s, except share and per share amounts)
December 31, 1995

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying value of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. The components of the
deferred tax assets at December 31, 1995 and 1994 are as follows:

<TABLE>
<CAPTION>
1995 1994
----------------------- --------------------------
Current Noncurrent Current Noncurrent
------- ---------- ------- ----------
<S> <C> <C> <C> <C>
Capitalized business expansion costs .. $ - $ 2,636 $ - $ -
Tax basis of fixed assets in excess of
book basis ......................... - 678 - 1,699
Unrealized losses on investments ...... - - - 146
State net operating loss carryforward . - 1,343 - 921
Federal net operating loss carryforward - 922 - -
Minimum tax credit .................... - 258 168 -
Other, net ............................ - 513 348 110
---- ------- ----- -------
Total deferred tax assets ............. - 6,350 516 2,876
Valuation allowance ................... - (6,350) (201) (2,876)
---- ------- ----- -------
Net deferred tax assets ............... $ - $ - $ 315 $ -
==== ======= ===== =======
</TABLE>

Management has established a valuation allowance equal to the deferred tax
assets at December 31, 1995, based upon the likelihood that such deferred tax
assets will not be realized.

At December 31, 1995, the Company had approximately $2,700 and $24,000 of
federal and state net operating loss carryforwards, respectively, which expire
for federal purposes during the years 2005 through 2011 and for state purposes
during the years 1998 through 2001. In addition, at December 31, 1995, the
Company had approximately $258 in Alternative Minimum Tax Credits for federal
tax purposes which do not expire.

The differences between the income tax benefit at the statutory rate and the
actual income tax benefit is as follows:

<TABLE>
<CAPTION>
1995 1994 1993
---- ---- ----
<S> <C> <C> <C>
Federal income tax rate .................. (35.0)% (34.0)% (34.0)%
Increase (decrease) in taxes:
State taxes, net of federal tax benefit - (5.6) (5.6)
Change in valuation allowance ......... 27.3 0.3 22.2
Other, net ............................ 7.7 (8.6) (4.2)
---- ---- ----
Effective tax rate ....................... 0.0 % (47.9)% (21.6)%
==== ==== ====
</TABLE>

For the three years ended December 31, 1995, no income tax payments were made.

29
<PAGE> 30
NEXTHEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(000s, except share and per share amounts)
December 31, 1995

OPERATING LEASES

The Company leases land and equipment under operating leases. Future annual
minimum lease payments under noncancelable operating leases at the date
indicated, are as follows:

<TABLE>
<CAPTION>
December 31,
1995
------------
<S> <C>
1996 ............................... $120
1997 ............................... 105
1998 ............................... 106
1999 ............................... 109
2000 ............................... 115
Thereafter ......................... 24
----
Total minimum payments ............. $579
====
</TABLE>

Total rental expense recognized under operating leases for the three years ended
December 31, 1995, was $160, $124 and $180, respectively.

EMPLOYEE RETIREMENT PLAN

The Company has a defined contribution plan that provides for discretionary
employer contributions and for optional employee contributions which are matched
by the Company at a maximum rate of 50% of the employees contributions up to
amounts prescribed by law. All employees who meet minimum age and service
requirements are eligible to participate in the plan. It is the Company's policy
to fund plan contributions as accrued. For the three years ended December 31,
1995, employer matching and discretionary contributions to the plan were
approximately $126, $63 and $81, respectively.

UNUSUAL CHARGES

In 1995, in conjunction with the development of Miraval, certain of the
Company's facilities were renovated and expanded to accommodate the lodging
requirements, programs and activities offered by Miraval. Because of the nature
of the construction activities, certain existing assets and components of
existing assets were retired or dismantled. Accordingly, the Company recognized
a charge of $1,695 in the fourth quarter of 1995.

In 1993 the company closed its Adolescent Center treatment facility and
recognized a charge of $5,510 to write-down the related assets, principally
buildings and improvements, to estimated net realizable value and to provide for
severance pay for employees.

RELATED PARTY TRANSACTIONS

A Member of the Company's Board of Directors is a member of an investment firm
that provided investment management services to the Company. In addition, an
entity which owned approximately 8% of the Company's common stock at December
31, 1995 and in excess of 10% of the Company's common stock at December 31, 1994
and 1993, is affiliated with an investment firm that provides investment
management services to the Company. For the three years ended December 31, 1995,
approximately $97, $17,000 and $20,800, respectively, of the Company's
investments were managed by these firms. For the three years ended December 31,
1995, fees paid for these services amounted to approximately $50, $41 and $46,
respectively.

30
<PAGE> 31
NEXTHEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(000s, except share and per share amounts)
December 31, 1995

Management believes such fees are reasonable and comparable to those of other
institutions providing similar services. The Company also leases a facility from
an entity controlled by the Chairman of the Company's Board of Directors. See
note entitled Long-Term Debt and Financing Obligation for additional
information. In addition, effective January 1, 1995, an individual related to a
Director entered into a one year consulting arrangement with the Company for
total compensation of $100.

CONTINGENCIES

In September 1992, a class action lawsuit was filed by stockholders against the
Company and certain of its officers and directors. Another suit was subsequently
filed and consolidated with the first suit in December 1992. These suits alleged
the Company and certain officers and directors violated federal and state
securities laws and made false and misleading statements about its financial
condition and business prospects in past periods.

The Company vigorously defended the action from its inception.

The Company established a reserve of $6,000 in the fourth quarter of 1993 to
cover the estimated costs to fund and administer the settlement of this suit,
which occurred in the first quarter of 1994. The negotiated settlement required
the Company's insurance carrier to contribute an amount equal to that which the
Company was required to pay. The settlement contained no admission of wrong
doing or liability on the part of any defendant. Management and the Board of
Directors believed that the settlement was in the Company's best interest and
the best interest of its stockholders. In June 1994, the court entered a final
judgment to the action. The judgment dismissed and released all claims against
all parties. There are no active pending appeals.

The Company is involved in various other litigation and administrative
proceedings arising in the normal course of business. In the opinion of
management, any liabilities that may result from these claims will not,
individually or in the aggregate, have a material adverse effect on the
Company's financial position, results of operations or cash flows.

QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

The following table summarizes certain quarterly financial data:

<TABLE>
<CAPTION>
Loss Net Loss
Total Before Per Share
Total Operating Income of Common
Revenue Expenses Tax Benefit Net Loss Stock
------- -------- ----------- -------- ---------
<S> <C> <C> <C> <C> <C>
1995 quarter ended:
March 31 ....... $ 3,935 $ 4,343 $ (409) $ (409) $(.05)
June 30 ........ 3,806 5,055 (1,248) (1,248) (.15)
September 30 ... 3,338 6,870 (3,532) (3,532) (.41)
December 31 .... 3,794 10,572 (6,778) (6,778) (.79)
------- -------- -------- -------- -----
$14,873 $ 26,840 $(11,967) $(11,967) $(1.40)
======= ======== ======== ======== =====
1994 quarter ended:
March 31 ....... $ 2,812 $ 4,132 $ (1,321) $ (803) $(.09)
June 30 ........ 3,150 3,977 (827) (632) (.07)
September 30 ... 2,730 4,141 (1,412) (950) (.11)
December 31 .... 2,286 4,135 (1,847) (432) (.06)
------- -------- -------- -------- -----
$10,978 $ 16,385 $ (5,407) $ (2,817) $(.33)
======= ======== ======== ======== =====
</TABLE>

31
<PAGE> 32
The financial data disclosed for the quarters ended June 30, 1995, and September
30, 1995, include pre-opening costs of $828 and $2,602, respectively. The
financial data disclosed for the quarter ended December 31, 1995, includes
pre-opening costs of $3,812 and charges related to the retirement and
dismantlement of certain of the Company's assets of $1,695.

SUBSEQUENT EVENTS

Effective March 1, 1996, the Company acquired the operating assets and
liabilities of Hilton Head Health Institute, Inc. ("HHHI") located at the
Cottages in Shipyard Plantation, Hilton Head, South Carolina. HHHI is a provider
of clinically-proven weight management programs. The cost of the acquisition,
which will be accounted for as a purchase, was not material to the Company's
financial position, results of operations and cash flows at December 31, 1995.
In addition, the Company agreed to purchase certain real property from the
former owner of HHHI at a price equal to fair market value which is estimated to
be approximately $1,500 to $2,000. The Company will lease this real
property until such purchase occurs.

On April 10, 1996, the Company obtained a $2,000 line of credit (the "LOC")
from the National Bank of Arizona. The LOC has a variable
interest rate based upon the Prime rate as published in the Western Edition of
the Wall Street Journal plus 1 percent and has a minimum interest rate of 9.25%
and a maximum rate of 15%. The initial interest rate is 9.25%, payable in
monthly installments, for a term of six months. The LOC is secured by certain
real estate owned by the Company.

On April 10, 1996, the Company negotiated an agreement with Sundt Corporation
("Sundt"), the general contractor for the Miraval project, for the payment of
approximately $3,700, which represents the remaining balance due Sundt for the
construction of Miraval. This agreement has a term of eighteen months and bears
interest at an annual rate equal to the Prime rate as established by Bank One,
N.A. plus 4 percent. Sundt received a $300 payment at the closing of the LOC and
will receive payments of $125 per month for a period of eleven months commencing
in May 1996. The balance remaining after the aforementioned payments will be
paid evenly in six monthly installments. Sundt has agreed to subordinate the
master Mechanics' Lien recorded against Miraval's real property on March 28,
1996 to the LOC and additional borrowings up to $5,000. Additionally, as part of
this agreement, if the Company were to obtain secured borrowings in excess of
$5,000 or unsecured borrowings in excess of $3,000, the unpaid balance due Sundt
would immediately become due.

32
<PAGE> 33
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE

None

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

ITEM 11. EXECUTIVE COMPENSATION

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Pursuant to instruction G(3) to Form 10-K, Items 10, 11, 12 and 13 are omitted
because the Company will file a definitive proxy statement (the "Proxy
Statement") pursuant to Regulation 14A under the Securities Exchange Act of 1934
no later than 120 days after the close of the fiscal year. The information
required by such items will be included in the definitive proxy statement to be
so filed for the Company's annual meeting of stockholders scheduled for May 31,
1996 and is hereby incorporated by reference.

PART IV

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

(a) The following documents are filed as part of this report:

(1) Financial Statements:

Reference is made to the listing on page 14 for a list
of all financial statements filed as a part of this
report.

(2) Financial Statement Schedules. The following financial
statement schedule is required by Item 14(d). All
other schedules are omitted because they are not
applicable, or not required, or because the required
information is included in the consolidated financial
statements or notes thereto.

Schedule II. Valuation and Qualifying Accounts

(3) Exhibits. The following exhibits are incorporated by
reference as indicated or are filed as part of this
Annual Report on Form 10-K:

33
<PAGE> 34
Exhibit
Number Document
- ------ --------

3.1 Certificate of Incorporation(1)

3.2 Amended Restated By-Laws(5)

4.1 Specimen Common Stock Certificate(1)

10.26 Stock Bonus and Repurchase Agreement, dated November 18, 1988,
between John H. Schmitz and Rita F. Schmitz and Sierra
Tucson/Properties, Inc., as amended on August 31, 1989(1)

10.27 Buy-Sell Agreement, dated November 18, 1988, between John H.
Schmitz and Rita F. Schmitz and Sierra Tucson/Properties, Inc., as
amended on August 31, 1989(1)

10.33 1989 Stock Option Plan(1)

10.47 1990 Stock Option Plan(2)

10.49 Commercial lease dated as of March 15, 1991, between the State of
Arizona and Sierra Tucson AC, Inc., relating to lease of
Adolescent Care facility site(3)

10.51 Form of Indemnity Agreement*(4)

10.52 First Amendment to Stock Bonus and Repurchase Agreement dated May
22, 1991, between John H. Schmitz and Rita F. Schmitz and Sierra
Tucson Companies, Inc.(4)

10.53 1992 Stock Option Plan(3)

10.54 Non-Employee Directors Stock Option Plan(5)

10.55 Shareholder Class Action Stipulation of Settlement dated March 21,
1994(6)

10.56 Real Estate Sale Agreement and industrial Building Lease for
Sierra Tucson AC, Inc. Adolescent Center dated December 28, 1994,
and December 29, 1994, respectively.(6)

10.57 Onsite Training and Consulting, Inc. Stock Purchase Agreement
dated January 13, 1995(6)

10.58 Severance Agreement, General Release, Covenant Not to Sue between
the Company and William T. O'Donnell, Jr., dated January 20,
1995(6)

10.59 Elements of compensation--Wayne M. Morrison, Vice President/Chief
Financial Officer

22.1 Subsidiaries(4)

24.1 Consent of Ernst & Young LLP, Independent Auditors

(1) Incorporated by reference from Company's Form S-1 Registration
Statement, File No. 33- 31020, declared effective in October 1989.

(2) Incorporated by reference from the Company's Form 10-K for the
year ended December 31, 1990.

(3) Incorporated by reference from the Company's Form 10-Q for the
year ended March 31, 1991.

34
<PAGE> 35
(4) Incorporated by reference from the Company's Form S-1 Registration
Statement declared effective on June 20, 1991.

(5) Incorporated by reference from the Company's Form 10-K for the
year ended December 31, 1992.

(6) Incorporated by reference from the Company's Form 10-K for the
year ended December 31, 1994.

* The Company has entered into indemnification agreements with each
of its five current directors, one of whom is an executive
officer, and two former directors. Pursuant to the Instructions
accompanying Item 601 of Regulation S-K, the Company has not filed
each such indemnification agreement.

(b) Reports on Form 8-K.

None

See (a)(3) above

<PAGE> 36
NEXTHEALTH, INC. AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(000s)

<TABLE>
<CAPTION>
Column A Column B Column C Column D Column E
- ------------------------------------- -------- -------- -------- --------
Additions
Balance at (Charged to Balance at
Beginning of Costs and End of
Description Period Expenses) Deductions Period
- ------------------------------------- ------------ ----------- ---------- ----------
<S> <C> <C> <C> <C>
Year ended December 31, 1995:
Allowance for doubtful
accounts ......................... $ 727 $ 50 $ 276 $ 501
====== ====== ====== ======
Year ended December 31, 1994:
Allowance for doubtful
accounts ......................... $2,887 $ 661 $2,821 $ 727
====== ====== ====== ======
Year ended December 31, 1993:
Allowance for doubtful
accounts ......................... $3,341 $1,537 $1,991 $2,887
====== ====== ====== ======
</TABLE>

36
<PAGE> 37
SIGNATURES

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

NEXTHEALTH, INC.
---------------------------
Registrant

Dated: April 12, 1996 BY: /s/ John H. Schmitz
------------------------
JOHN H. SCHMITZ
President and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the Registrant and in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
Signature Capacity Date
- --------- -------- ----
<S> <C> <C>
/s/ William T. O'Donnell, Jr. Chairman of the Board of Directors April 12, 1996
- -----------------------------
William T. O'Donnell, Jr.

/s/ John H. Schmitz President and Chief Executive Officer April 12, 1996
- ----------------------------
John H. Schmitz and Director (Principal Executive Officer)

/s/ Ronald E. Robison Director April 12, 1996
- ----------------------------
Ronald E. Robison

/s/ Joseph R. Cruse Director April 12, 1996
- ----------------------------
Joseph R. Cruse

/s/ Neil E. Jenkins Director April 12, 1996
- ----------------------------
Neil E. Jenkins

/s/ Wayne M. Morrison Chief Financial Officer April 12, 1996
- ----------------------------
Wayne M. Morrison (Principal Financial and Accounting Officer)
</TABLE>

<PAGE> 1
ATTACHMENT "A"

NEXTHEALTH

ELEMENTS OF COMPENSATION - WAYNE MORRISON
VICE PRESIDENT/CHIEF FINANCIAL OFFICER

BASE SALARY: $137,500

(Your employment may be terminated by the Company for cause, at any time, and
without notice. If your employment is terminated for cause, there shall be no
continuing obligation on the Company's part to perform under the terms of this
agreement. If your employment is terminated for any other reason during the
first year of employment, you shall receive a severance payment of up to twelve
months reduced by the number of months actually worked, but in any case, no
less than six months. At the completion of your first full year of employment,
any termination benefit will be in accordance with the corporate policy in
effect at that time.)

BONUS OPPORTUNITY: Up to 25% of base, based on the Executive Incentive Plan
administered by the Compensation Committee of the Board of Directors. (A copy
will be available to you in Tucson or sooner if you wish.)

STOCK OPTIONS: 50,000

Option to acquire stock, one-half (1/2) of the award at the market price on
1st day of employment; and, one-half (1/2) at a 50% premium to the market
price on that day. Vesting at 25% of the award per year. Options have a ten
(10) year term.

You will be eligible to participate in the annual options grants which are
typically awarded after the conclusion of each fiscal year - again governed by
Executive Incentive Plan provisions.

BENEFITS:
(Consistent with executives at your level)

* Premium paid for the Company-sponsored family medical insurance program

* 401(k) plan (eligible to enter plan after six months of continuous
service). The plan calls for corporate matching of employee
contributions of 50% up to 6% of compensation and 25% on contributions
over 6% up to the Federal allowable maximum.

* A term life insurance policy, based on three (3) times your annual
salary, contingent upon successfully passing a physical examination.

* Company paid long-term disability

* Four weeks annual vacation

* Right to the use of the Company condominium at Snowmass, Colorado.

Exhibit 10.59
<PAGE> 2
* Participate as one of the named executives in the Company's country club
memberships.

RELOCATION AND MISCELLANEOUS:

House hunting trips for your wife and yourself. Our policy is two (2) trips,
but we can do what is necessary to support the transition.

Temporary living expenses of $1500 per month for up to 180 days or until you
find a home, whichever is earlier.

Cover actual costs of the household move not to exceed $10,000. We will also
cover other incidental move costs as documented.

HOME SALE AND PURCHASE:

NextHealth will cover up to $15,000 in costs associated with the sale of your
home in North Carolina (commission) and the acquisition of your home in Tucson
(closing costs).

MISCELLANEOUS COSTS:

Payment of one month's salary in advance ($10,416.67) for the purpose of
covering miscellaneous and incidental costs associated with your move.

Accepted:

/s/ WAYNE M. MORRISON
- ---------------------
Name

<PAGE> 1
Consent of Ernst & Young LLP, Independent Auditors

We consent to the incorporation by reference in the Registration Statement
(Form S-8 No. 33-44620) pertaining to the Sierra Tucson Companies, Inc., 1992
Stock Option Plan and in the Registration Statement (Form S-8 No. 33-38608)
pertaining to the Sierra Tucson Companies, Inc., 1990 Stock Option Plan of our
report dated January 26, 1996 (except for the note entitled Subsequent Events,
as to which the date is April 10, 1996), with respect to the consolidated
financial statements and schedule in this Annual Report (Form 10-K) for the
year ended December 31, 1995.

ERNST & YOUNG LLP

Tucson, Arizona
April 10, 1996

Exhibit 24.1

<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1995 AND THE
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS FOR THE YEAR ENDED
DECEMBER 31, 1995 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-END> DEC-31-1995
<CASH> 2,864
<SECURITIES> 1,635
<RECEIVABLES> 1,771
<ALLOWANCES> (431)
<INVENTORY> 449
<CURRENT-ASSETS> 6,793
<PP&E> 48,005
<DEPRECIATION> (7,847)
<TOTAL-ASSETS> 47,942
<CURRENT-LIABILITIES> 10,379
<BONDS> 985
0
0
<COMMON> 86
<OTHER-SE> 36,492
<TOTAL-LIABILITY-AND-EQUITY> 47,942
<SALES> 12,967
<TOTAL-REVENUES> 14,873
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 26,702
<LOSS-PROVISION> 51
<INTEREST-EXPENSE> 87
<INCOME-PRETAX> (11,967)
<INCOME-TAX> 0
<INCOME-CONTINUING> (11,967)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (11,967)
<EPS-PRIMARY> (1.40)
<EPS-DILUTED> (1.40)

</TABLE>