UNIVERSAL HEALTH SERVICES INC - 10-K Annual Report

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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

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(MARK ONE)
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1998
OR
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File No. 1-10765
UNIVERSAL HEALTH SERVICES, INC.
(Exact name of registrant as specified in its charter)

Delaware 23-2077891
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)

UNIVERSAL CORPORATE CENTER
367 South Gulph Road P.O. Box 61558
King of Prussia, Pennsylvania
(Address of principal executive 19406-0958
offices) (Zip Code)

Registrant's telephone number, including area code: (610) 768-3300

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Securities registered pursuant to Section 12(b) of the Act:

Title of each Class Name of each exchange on which
Class B Common Stock, $.01 par value registered
New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:
Class D Common Stock, $.01 par value
(Title of each Class)

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Indicate by check mark whether the registrant (1) has filed all reports to be
filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No _____
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. [_]

The number of shares of the registrant's Class A Common Stock, $.01 par value,
Class B Common Stock, $.01 par value, Class C Common Stock, $.01 par value,
and Class D Common Stock, $.01 par value, outstanding as of January 31, 1999,
was 2,057,928, 29,943,797, 207,230, and 28,708, respectively.

The aggregate market value of voting stock held by non-affiliates at January
31, 1999 was $1,343,163,946. (For purpose of this calculation, it was assumed
that Class A, Class C, and Class D Common Stock, which are not traded but are
convertible share-for-share into Class B Common Stock, have the same market
value as Class B Common Stock.)

DOCUMENTS INCORPORATED BY REFERENCE:

Portions of the registrant's definitive proxy statement for its 1999 Annual
Meeting of Stockholders, which will be filed with the Securities and Exchange
Commission within 120 days after December 31, 1998 (incorporated by reference
under Part III).

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PART I

ITEM 1. Business

The principal business of Universal Health Services, Inc. (together with its
subsidiaries, the "Company") is owning and operating acute care hospitals,
behavioral health centers, ambulatory surgery centers, radiation oncology
centers and women's centers. Presently, the Company operates 44 hospitals,
consisting of 21 acute care hospitals, 20 behavioral health centers, and three
women's centers, in Arkansas, California, the District of Columbia, Florida,
Georgia, Illinois, Louisiana, Massachusetts, Michigan, Missouri, Nevada,
Oklahoma, Pennsylvania, Puerto Rico, South Carolina, Texas and Washington. The
Company, as part of its Ambulatory Treatment Centers Division, owns outright,
or in partnership with physicians, and operates or manages 24 surgery and
radiation oncology centers located in 12 states and the District of Columbia.

Services provided by the Company's hospitals include general surgery,
internal medicine, obstetrics, emergency room care, radiology, oncology,
diagnostic care, coronary care, pediatric services and behavioral health
services. The Company provides capital resources as well as a variety of
management services to its facilities, including central purchasing,
information services, finance and control systems, facilities planning,
physician recruitment services, administrative personnel management, marketing
and public relations.

The Company selectively seeks opportunities to expand its base of operations
by acquiring, constructing or leasing additional hospital facilities. Such
expansion may provide the Company with access to new markets and new health
care delivery capabilities. The Company also seeks to increase the operating
revenues and profitability of owned hospitals by the introduction of new
services, improvement of existing services, physician recruitment and the
application of financial and operational controls. Pressures to contain health
care costs and technological developments allowing more procedures to be
performed on an outpatient basis have led payors to demand a shift to
ambulatory or outpatient care wherever possible. The Company is responding to
this trend by emphasizing the expansion of outpatient services. In addition,
in response to cost containment pressures, the Company intends to implement
programs designed to improve financial performance and efficiency while
continuing to provide quality care, including more efficient use of
professional and paraprofessional staff, monitoring and adjusting staffing
levels and equipment usage, improving patient management and reporting
procedures and implementing more efficient billing and collection procedures.
The Company also continues to examine its facilities and to dispose of those
facilities which it believes do not have the potential to contribute to the
Company's growth or operating strategy.

The Company is involved in continual development activities. Applications to
state health planning agencies to add new services in existing hospitals are
currently on file in states which require certificates of need (e.g.,
Washington, D.C.). Although the Company expects that some of these
applications will result in the addition of new facilities or services to the
Company's operations, no assurances can be made for ultimate success by the
Company in these efforts.

Recent and Proposed Acquisitions and Development Activities

In 1998, the Company proceeded with its development of new facilities and
consummated a number of acquisitions.

In April 1998, the Company officially opened Hospital San Pablo del Este, a
180-bed hospital in Fajardo, Puerto Rico, one of the three hospitals acquired
in Puerto Rico by the Company in February 1998.

In October 1998, the Company signed a letter of intent with The Cooper
Companies, Inc. for the purchase of three behavioral health facilities: the
Hampton Hospital and Hampton Academy in Westhampton, New Jersey, Hartgrove
Hospital in Chicago, Illinois, and The Midwest Center for Youth and Families
in Kouts, Indiana. This acquisition, subject to regulatory approval, is
scheduled to close in the second quarter of 1999.

1

In November 1998, the Company signed a letter of intent with Columbia/HCA
Healthcare Corporation for the purchase of two behavioral health facilities:
Riveredge Hospital and Lakeshore Hospital, both located in Chicago, Illinois.
This acquisition is scheduled to close in the second quarter of 1999.

Also in November, the Company received favorable regulatory recommendation
to construct a 371-bed acute care replacement facility for the current 501-bed
George Washington University Hospital in Washington, D.C., in which the
Company purchased an 80 percent partnership interest in July 1997. The
replacement facility is scheduled to be completed in 2001.

The Company is currently in the process of obtaining the necessary permits
and approvals to construct a new medical office building on the campus of
Summerlin Hospital Medical Center. Construction, which is expected to start in
April 1999 is scheduled to be completed by January 2000, for a total cost of
approximately $13 million.

The Company also selectively expanded its operations at certain of its
existing facilities. A 40-bed long-term care unit was opened in the newly
renovated Universal Pavilion in Edinburg, Texas. The Company acquired land
adjacent to Auburn Regional Medical Center in Auburn, Washington for future
expansion of the Hospital's surgical capacity. Additional land was also acquired
adjacent to Valley Hospital Medical Center in Las Vegas, Nevada for future
expansion of its surgical and critical care capacity. A second cardiac
catheterization lab and expanded outpatient surgery facilities were opened at
Aiken Regional Medical Center in Aiken, South Carolina. Summerlin Hospital
Medical Center in Las Vegas, Nevada opened a cardiac catheterization/angiography
lab and expanded surgical facilities. The Company acquired land adjacent to
Desert Springs hospital in Las Vegas, Nevada for future bed expansion. A newly
renovated emergency room and patient wing were opened at Hospital San Pablo in
Puerto Rico. Chalmette Medical Center in Chalmette, Louisiana opened a new 20-
bed patient wing, Two Rivers Psychiatric Hospital in Kansas City, Missouri
opened a neuro-psychiatric program, and Edinburg Regional Medical Center in
Edinburg, Texas, opened a new 20-bed psychiatric unit.

2

Bed Utilization and Occupancy Rates

The following table shows the historical bed utilization and occupancy rates
for the hospitals operated by the Company for the years indicated.
Accordingly, information related to hospitals acquired during the five year
period has been included from the respective dates of acquisition, and
information related to hospitals divested during the five year period has been
included up to the respective dates of divestiture.

1998 1997 1996 1995 1994
------- ------- ------- ------- -------

Average Licensed Beds:
Acute Care Hospitals.... 4,696 3,389 3,018 2,638 2,398
Behavioral Health
Centers................ 1,782 1,777 1,565 1,238 1,145
Average Available Beds(1):
Acute Care Hospitals.... 3,985 2,951 2,641 2,340 2,099
Behavioral Health
Centers................ 1,767 1,762 1,540 1,223 1,142
Admissions:
Acute Care Hospitals.... 187,833 128,020 111,244 91,298 75,923
Behavioral Health
Centers................ 32,400 28,350 22,295 15,329 13,033
Average Length of Stay
(Days):
Acute Care Hospitals.... 4.7 4.8 4.9 5.1 5.2
Behavioral Health
Centers................ 11.3 11.9 12.4 12.8 13.8
Patient Days(2):
Acute Care Hospitals.... 884,966 616,965 546,237 462,054 394,490
Behavioral Health
Centers................ 365,935 336,850 275,667 195,961 179,821
Occupancy Rate--Licensed
Beds(3):
Acute Care Hospitals.... 52% 50% 49% 48% 45%
Behavioral Health
Centers................ 56% 52% 48% 43% 43%
Occupancy Rate--Available
Beds(3):
Acute Care Hospitals.... 61% 57% 57% 54% 51%
Behavioral Health
Centers................ 57% 52% 49% 44% 43%

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(1) "Average Available Beds" is the number of beds which are actually in
service at any given time for immediate patient use with the necessary
equipment and staff available for patient care. A hospital may have
appropriate licenses for more beds than are in service for a number of
reasons, including lack of demand, incomplete construction, and
anticipation of future needs.

(2) "Patient Days" is the aggregate sum for all patients of the number of days
that hospital care is provided to each patient.

(3) "Occupancy Rate" is calculated by dividing average patient days (total
patient days divided by the total number of days in the period) by the
number of average beds, either available or licensed.

The number of patient days of a hospital is affected by a number of factors,
including the number of physicians using the hospital, changes in the number
of beds, the composition and size of the population of the community in which
the hospital is located, general and local economic conditions, variations in
local medical and surgical practices and the degree of outpatient use of the
hospital services. Current industry trends in utilization and occupancy have
been significantly affected by changes in reimbursement policies of third
party payors. A continuation of such industry trends could have a material
adverse impact upon the Company's future operating performance. The Company
has experienced growth in outpatient utilization over the past several years.
The Company is unable to predict the rate of growth and resulting impact on
the Company's future revenues because it is dependent upon developments in
medical technologies and physician practice patterns, both of which are
outside of the Company's control. The Company is also unable to predict the
extent to which other industry trends will continue or accelerate.

3

Sources of Revenue

The Company receives payment for services rendered from private insurers,
including managed care plans, the federal government under the Medicare
program, state governments under their respective Medicaid programs and
directly from patients. All of the Company's acute care hospitals and most of
the Company's behavioral health centers are certified as providers of Medicare
and Medicaid services by the appropriate governmental authorities. The
requirements for certification are subject to change, and, in order to remain
qualified for such programs, it may be necessary for the Company to make
changes from time to time in its facilities, equipment, personnel and
services. The costs for recertification are not material as many of the
requirements for recertification are integrated with the Company's internal
quality control processes. If a facility loses certification, it will be
unable to receive payment for patients under the Medicare or Medicaid
programs. Although the Company intends to continue in such programs, there is
no assurance that it will continue to qualify for participation.

The sources of the Company's hospital revenues are charges related to the
services provided by the hospitals and their staffs, such as radiology,
operating rooms, pharmacy, physiotherapy and laboratory procedures, and basic
charges for the hospital room and related services such as general nursing
care, meals, maintenance and housekeeping. Hospital revenues depend upon the
occupancy for inpatient routine services, the extent to which ancillary
services and therapy programs are ordered by physicians and provided to
patients, the volume of outpatient procedures and the charges or negotiated
payment rates for such services. Charges and reimbursement rates for inpatient
routine services vary depending on the type of bed occupied (e.g.,
medical/surgical, intensive care or psychiatric) and the geographic location
of the hospital.

McAllen Medical Center located in McAllen, Texas and Edinburg Regional
Medical Center located in Edinburg, Texas operate within the same market. On a
combined basis, these two facilities contributed 13% in 1998, 16% in 1997 and
19% in 1996 of the Company's consolidated net revenues and 23% in 1998, 25% in
1997 and 32% in 1996 of the Company's consolidated earnings before
depreciation, amortization, interest, income taxes and nonrecurring charges
(after deducting an allocation of corporate overhead) ("EBITDA"). During the
first quarter of 1998, the Company contributed substantially all of the
assets, liabilities and operations of Valley Hospital Medical Center and its
newly-constructed Summerlin Hospital Medical Center in exchange for a 72.5%
interest in a series of newly-formed limited liability corporations ("LLCs").
Quorum Health Group, Inc. ("Quorum") holds the remaining 27.5% interest in the
LLCs. Quorum obtained its interest by contributing substantially all of the
assets, liabilities and operations of Desert Springs Hospital and $11 million
of net cash to the LLCs. All three acute care facilities, operate within the
Las Vegas, Nevada market. On a combined basis, these three facilities
contributed 18% of the Company's consolidated net revenues and 15% of the
Company's consolidated EBITDA during 1998. During 1997 and 1996, Valley
Hospital Medical Center and Summerlin Hospital Medical Center (which opened
during the fourth quarter of 1997) contributed 13% in 1997 and 13% in 1996 of
the Company's consolidated net revenues and 18% in 1997 and 17% in 1996 of the
Company's consolidated EBITDA.

The following table shows approximate percentages of net patient revenue
derived by the Company's hospitals owned as of December 31, 1998 since their
respective dates of acquisition by the Company from third party sources,
including the additional Medicaid reimbursements received at three of the
Company's acute care facilities located in Texas and one in South Carolina
totaling $36.5 million in 1998, $33.4 million in 1997, $17.8 million in 1996,
$12.6 million in 1995 and $12.7 million in 1994, and from all other sources
during the five years ended December 31, 1998.

PERCENTAGE OF NET PATIENT REVENUES
--------------------------------------
1998 1997 1996 1995 1994
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Third Party Payors:
Medicare............................ 34.3% 35.6% 35.6% 35.1% 32.5%
Medicaid............................ 11.3% 14.5% 15.3% 13.7% 13.4%
------ ------ ------ ------ ------
TOTAL............................... 45.6% 50.1% 50.9% 48.8% 45.9%
Other Sources (including patients and
private insurance carriers).......... 54.4% 49.9% 49.1% 51.2% 54.1%
------ ------ ------ ------ ------
100% 100% 100% 100% 100%

4

Regulation and Other Factors

Within the statutory framework of the Medicare and Medicaid programs, there
are substantial areas subject to administrative rulings, interpretations and
discretion which may affect payments made under either or both of such
programs and reimbursement is subject to audit and review by third party
payors. Management believes that adequate provision has been made for any
adjustments that might result therefrom.

The Federal government makes payments to participating hospitals under its
Medicare program based on various formulae. The Company's general acute care
hospitals are subject to a prospective payment system ("PPS"). PPS pays
hospitals a predetermined amount per diagnostic related group ("DRG") based
upon a hospital's location and the patient's diagnosis.

Behavioral health facilities, which are excluded from PPS, are cost
reimbursed by the Medicare program, but are subject to a per discharge
ceiling, calculated based on an annual allowable rate of increase over the
hospital's base year amount under the Medicare law and regulations. Capital
related costs are exempt from this limitation. In the Balanced Budget Act of
1997, Congress significantly revised the Medicare payment provisions for PPS-
excluded hospitals, including psychiatric hospitals. Effective for Medicare
cost reporting periods beginning on or after October 1, 1997, different caps
are applied to psychiatric hospitals' target amounts depending whether a
hospital was excluded from PPS before or after that date. Congress also
revised the rate-of-increase percentages for PPS-excluded hospitals and
eliminated the new provider PPS-exemption for psychiatric hospitals. In
addition, the Health Care Financing Administration has implemented
requirements applicable to psychiatric hospitals that share a facility or
campus with another hospital.

On August 30, 1991, the Health Care Financing Administration issued final
Medicare regulations establishing a PPS for inpatient hospital capital-related
costs. These regulations apply to hospitals which are reimbursed based upon
the prospective payment system and took effect for cost report years beginning
on or after October 1, 1991. For most of the Company's hospitals, the new
methodology began on January 1, 1992.

The regulations provide for the use of a 10-year transition period in which
a blend of the old and new capital payment provisions will be utilized. One of
two methodologies will apply during the 10-year transition period: if the
hospital's hospital-specific capital rate exceeds the federal capital rate,
the hospital will be paid on the basis of a "hold harmless" methodology, which
is a blend of a portion of old capital and an amount of new capital and a
prospectively determined national federal capital rate; or, with limited
exceptions, if the hospital-specific rate is below the federal capital rate,
the hospital will receive payments based upon a "fully prospective"
methodology, which is a blend of the hospital's hospital-specific capital rate
and a prospectively determined national federal capital rate. Each hospital's
hospital-specific rate was determined based upon allowable capital costs
incurred during the "base year", which, for most of the Company's hospitals,
is the year ended December 31, 1990. Most of the Company's hospitals are paid
under the "'hold harmless" methodology except for five hospitals, which are
paid under the "fully prospective" methodology. Updated amounts and factors
necessary to determine PPS rates for Medicare hospital inpatient services for
operating costs and capital related costs are published annually and were last
published on July 31, 1998. In fiscal 1999, hospitals receive an inpatient PPS
inflation update factor of market-basket minus 1.9 percent, as mandated by
Congress in the Balanced Budget Act.

The Company can provide no assurances that the reductions in the PPS update,
and other changes required by the Balanced Budget Act, will not adversely
affect its operations. However, within certain limits, a hospital can manage
its costs, and, to the extent this is done effectively, a hospital may benefit
from the DRG system. However, many hospital operating costs are incurred in
order to satisfy licensing laws, standards of the Joint Commission on the
Accreditation of Healthcare Organizations and quality of care concerns. In
addition, hospital costs are affected by the level of patient acuity,
occupancy rates and local physician practice patterns, including length of
stay judgments and number and type of tests and procedures ordered. A
hospital's ability to control or influence these factors which affect costs
is, in many cases, limited.

5

In addition to the trends described above that continue to have an impact on
the operating results, there are a number of other more general factors
affecting the Company's business. The Balanced Budget Act calls for the
government to trim the growth of federal spending on Medicare by $115 billion
and on Medicaid by $13 billion over the next five years. The act also calls
for reductions in the future rate of increases to payments made to hospitals
and reduces the amount of reimbursement for outpatient services, bad debt
expense and capital costs. It is likely that future budgets will contain
certain further reductions in the rate of increase of Medicare and Medicaid
spending, as evidenced by the Clinton Administration's proposed fiscal year
2000 budget which includes a proposal to freeze Medicare hospital payment
rates.

In addition to Federal health reform efforts, several states have adopted or
are considering healthcare reform legislation. Several states are planning to
consider wider use of managed care for their Medicaid populations and
providing coverage for some people who presently are uninsured. The enactment
of Medicaid managed care initiatives is designed to provide low-cost coverage.
The Company currently operates three behavioral health centers with a total of
268 beds in Massachusetts, which has mandated hospital rate-setting. The
Company also operates three hospitals containing an aggregate of 688 beds in
Florida that are subject to a mandated form of rate-setting if increases in
hospital revenues per admission exceed certain target percentages.

In 1991, the Texas legislature authorized the LoneSTAR Health Initiative, a
pilot program in two areas of the state, to establish for Medicaid
beneficiaries a health care delivery system based on managed care principles.
The program is now known as the STAR Program, which is short for State of
Texas Access Reform. Since 1995, the Texas Health and Human Services
Commission, with the help of other Texas agencies such as the Texas Department
of Health, has been rolling out STAR Medicaid managed care pilot programs in
various geographic areas of the state. Under the STAR program, the Texas
Department of Health either contracts with health maintenance organizations in
each area to arrange for covered services to Medicaid beneficiaries, or
contracts directly with health care providers and oversees the furnishing of
care in the role of the case manager. Texas has implemented STAR + PLUS in
Harris County, which includes the provision of long term care to elderly and
disabled Medicaid beneficiaries. Texas also plans to implement another unique
pilot program known as NorthSTAR in the Dallas County area in July 1999.
NorthSTAR is a behavioral health carve-out managed care program. Texas plans
to continue implementing Medicaid managed care pilot programs over the next
three years or so until it achieves statewide coverage. The Company is unable
to predict the effect on the Company's business of such pilot programs.

Upon meeting certain conditions, and serving a disproportionately high share
of Texas' and South Carolina's low income patients, three of the Company's
facilities located in Texas and one facility located in South Carolina became
eligible and received additional reimbursement from each state's
disproportionate share hospital fund. Included in the Company's financial
results was an aggregate of $36.5 million in 1998, $33.4 million in 1997, and
$17.8 million in 1996, received pursuant to the terms of these programs. These
programs are scheduled to terminate in the third quarter of 1999, and,
although these programs have been renewed annually in the past, the Company
cannot predict whether these programs will continue beyond their scheduled
termination date. However, failure to renew these programs at their current
reimbursement levels, or further changes in the Medicare and Medicaid
programs, could have a material adverse effect on the Company's future
operating results.

The federal self-referral and payment prohibitions (codified in 42 U.S.C.
Section 1395nn, Section 1877 of the Social Security Act) generally forbid,
absent qualifying for one of the exceptions, a physician from making referrals
for the furnishing of any "designated health services," for which payment may
be made under the Medicare or Medicaid programs, to any entity with which the
physician (or an immediate family member) has a "financial relationship." The
legislation was effective January 1, 1992 for clinical laboratory services
("Stark I") and January 1, 1995 for ten other designated health services
("Stark II"). A "financial relationship" under Stark I and II includes any
direct or indirect "compensation arrangement" with an entity for payment of
any remuneration, and any direct or indirect "ownership or investment
interest" in the entity. The legislation

6

contains certain exceptions including, for example, where the referring
physician has an ownership interest in a hospital as a whole or where the
physician is an employee of an entity to which he or she refers. The Stark I
and II self-referral and payment prohibitions include specific reporting
requirements providing that each entity providing covered items or services
must provide the Secretary with certain information concerning its ownership,
investment, and compensation arrangements. In August 1995, HCFA published a
final rule regarding physician self-referrals for clinical lab services. On
January 9, 1998, HCFA published a proposed rule regarding physician self
referrals for the ten other designated health services. A final rule for Stark
II remains in the planning stages. Penalties for violating Stark I and Stark
II include denial of payment for any services rendered by an entity in
violation of the prohibitions, civil money penalties of up to $15,000 for each
offense, and exclusion from the Medicare and Medicaid programs.

Starting in 1991, the Inspector General of the Department of Health and
Human Services ("HHS") issued regulations which provide for "safe harbors"
from the federal anti-kickback statute; if an arrangement or transaction meets
each of the standards established for a particular safe harbor, the
arrangement will not be subject to challenge by the Inspector General. If an
arrangement does not meet the safe harbor criteria, it will be subject to
scrutiny under its particular facts and circumstances to determine whether it
violates the federal anti-kickback statute which prohibits, in general,
fraudulent and abusive practices, and enforcement action may be taken by the
Inspector General. In addition to the investment interests safe harbor, other
safe harbors include space rental, equipment rental, personal
service/management contracts, sales of a physician practice, referral
services, warranties, employees, discounts and group purchasing arrangements,
among others. The criminal sanctions for a conviction under the anti-kickback
statute include imprisonment, fines, or both. Civil sanctions include
exclusion from federal and state health care programs.

The Company does not anticipate that either the Stark provisions or the safe
harbor regulations to the federal anti-kickback statute will have material
adverse effects on its operations.

Congress made significant changes to various health care fraud provisions in
the Health Insurance Portability and Accountability Act of 1996 ("HIPAA").
HIPAA called upon the Secretary of HHS to establish a program aimed at
controlling fraud and abuse. HIPAA also expanded the criminal laws and
sanctions to strengthen the enforcement capabilities of the government in
attempting to prevent fraus and abuse. HIPAA in addition created a federal
crime of health care fraud, which applies to anyone who defrauds any health
care benefit program, including any public or private plan or contract, under
which any medical benefit, item or service is provided to any individual. The
Company does not anticipate that the fraud provisions enacted under HIPAA will
have a material effect on its operation.

Several states, including Florida and Nevada, have passed legislation which
limits physician ownership in medical facilities providing imaging services,
rehabilitation services, laboratory testing, physical therapy and other
services. This legislation is not expected to significantly affect the
Company's operations. Many states have laws and regulations which prohibit
payments for referral of patients and fee-splitting with physicians. The
Company does not make any such payments or have any such arrangements.

All hospitals are subject to compliance with various federal, state and
local statutes and regulations and receive periodic inspection by state
licensing agencies to review standards of medical care, equipment and
cleanliness. The Company's hospitals must comply with the conditions of
participation and licensing requirements of federal, state and local health
agencies, as well as the requirements of municipal building codes, health
codes and local fire departments. In granting and renewing licenses, a
department of health considers, among other things, the physical buildings and
equipment, the qualifications of the administrative personnel and nursing
staff, the quality of care and continuing compliance with the laws and
regulations relating to the operation of the facilities. State licensing of
facilities is a prerequisite to certification under the Medicare and Medicaid
programs. Various other licenses and permits are also required in order to
dispense narcotics, operate pharmacies, handle radioactive materials and
operate certain equipment. All the Company's eligible hospitals have been
accredited by the Joint Commission on

7

the Accreditation of Healthcare Organizations. The JCAHO reviews each
hospital's accreditation once every three years. The review period for each
state's licensing body varies, but generally ranges from once a year to once
every three years.

The Social Security Act and regulations thereunder contain numerous
provisions which affect the scope of Medicare coverage and the basis for
reimbursement of Medicare providers. Among other things, this law provides
that in states which have executed an agreement with the Secretary of the
Department of Health and Human Services (the "Secretary"), Medicare
reimbursement may be denied with respect to depreciation, interest on borrowed
funds and other expenses in connection with capital expenditures which have
not received prior approval by a designated state health planning agency.
Additionally, many of the states in which the Company's hospitals are located
have enacted legislation requiring certificates of need ("CON") as a condition
prior to hospital capital expenditures, construction, expansion, modernization
or initiation of major new services. Failure to obtain necessary state
approval can result in the inability to complete an acquisition or change of
ownership, the imposition of civil or, in some cases, criminal sanctions, the
inability to receive Medicare or Medicaid reimbursement or the revocation of a
facility's license. The Company has not experienced and does not expect to
experience any material adverse effects from those requirements.

Health planning statutes and regulatory mechanisms are in place in many
states in which the Company operates. These provisions govern the distribution
of healthcare services, the number of new and replacement hospital beds,
administer required state CON laws, contain healthcare costs, and meet the
priorities established therein. Significant CON reforms have been proposed in
a number of states, including increases in the capital spending thresholds and
exemptions of various services from review requirements. The Company is unable
to predict the impact of these changes upon its operations.

Federal regulations provide that admissions and utilization of facilities by
Medicare and Medicaid patients must be reviewed in order to insure efficient
utilization of facilities and services. The law and regulations require Peer
Review Organizations ("PROs") to review the appropriateness of Medicare and
Medicaid patient admissions and discharges, the quality of care provided, the
validity of DRG classifications and the appropriateness of cases of
extraordinary length of stay. PROs may deny payment for services provided,
assess fines and also have the authority to recommend to HHS that a provider
that is in substantial non-compliance with the standards of the PRO be
excluded from participating in the Medicare program. The Company has
contracted with PROs in each state where it does business as to the scope of
such functions.

The Company's healthcare operations generate medical waste that must be
disposed of in compliance with federal, state and local environmental laws,
rules and regulations. In 1988, Congress passed the Medical Waste Tracking
Act. Infectious waste generators, including hospitals, now face substantial
penalties for improper arrangements regarding disposal of medical waste,
including civil penalties of up to $25,000 per day of noncompliance, criminal
penalties of $150,000 per day, imprisonment, and remedial costs. The
comprehensive legislation establishes programs for medical waste treatment and
disposal in designated states. The legislation also provides for sweeping
inspection authority in the Environmental Protection Agency, including
monitoring and testing. The Company believes that its disposal of such wastes
is in compliance with all state and federal laws.

Medical Staff and Employees

The Company's hospitals are staffed by licensed physicians who have been
admitted to the medical staff of individual hospitals. With a few exceptions,
physicians are not employees of the Company's hospitals and members of the
medical staffs of the Company's hospitals also serve on the medical staffs of
hospitals not owned by the Company and may terminate their affiliation with
the Company's hospitals at any time. Each of the Company's hospitals is
managed on a day-to-day basis by a managing director employed by the Company.
In addition, a Board of Governors, including members of the hospital's medical
staff, governs the medical, professional and ethical practices at each
hospital. The Company's facilities had approximately 19,200 employees at
December 31, 1998, of whom 14,639 were employed full-time.

8

Approximately Eight Hundred Fifty (850) of the Company's employees at six of
its hospitals are unionized. At Valley Hospital, unionized employees belong to
the Culinary Workers and Bartenders Union and the International Union of
Operating Engineers. Registered nurses at Auburn Regional Medical Center
located in Washington State, are represented by the United Staff Nurses Union,
the technical employees are represented by the United Food and Commercial
Workers, and the service employees are represented by the Service Employees
International Union. At The George Washington University Hospital, unionized
employees are represented by the Service Employees International Union and the
Hospital Police Association. Nurses at Desert Springs Hospital are represented
by the Service Employees International Union. The registered nurses, licensed
practical nurses, certain technicians and therapists, and housekeeping
employees at HRI Hospital in Boston are represented by the Service Employees
International Union. Unionized employees at Hospital San Fransisco in Puerto
Rico are represented by the Labor Union of Nurses and Health Employees. The
Company believes that its relations with its employees are satisfactory.

Competition

In all geographical areas in which the Company operates, there are other
hospitals which provide services comparable to those offered by the Company's
hospitals, some of which are owned by governmental agencies and supported by
tax revenues, and others of which are owned by nonprofit corporations and may
be supported to a large extent by endowments and charitable contributions.
Such support is not available to the Company's hospitals. Certain of the
Company's competitors have greater financial resources, are better equipped
and offer a broader range of services than the Company. Outpatient treatment
and diagnostic facilities, outpatient surgical centers and freestanding
ambulatory surgical centers also impact the healthcare marketplace. In recent
years, competition among healthcare providers for patients has intensified as
hospital occupancy rates in the United States have declined due to, among
other things, regulatory and technological changes, increasing use of managed
care payment systems, cost containment pressures, a shift toward outpatient
treatment and an increasing supply of physicians. The Company's strategies are
designed, and management believes that its facilities are positioned, to be
competitive under these changing circumstances.

Liability Insurance

Effective January 1, 1998, the Company is covered under commercial insurance
policies which provide for a self-insured retention limit for professional and
general liability claims for most of its subsidiaries up to $1 million per
occurrence, with an average annual aggregate for covered subsidiaries of $4
million through 2001. These subsidiaries maintain excess coverage up to $100
million with major insurance carriers. The Company's remaining facilities are
fully insured under commercial policies with excess coverage up to $100
million maintained with major insurance carriers. During 1996 and 1997, most
of the Company's subsidiaries were self-insured for professional and general
liability claims up to $5 million per occurrence, with excess coverage
maintained up to $100 million with major insurance carriers. From 1986 to
1995, these subsidiaries were self-insured for professional and general
liability claims up to $25 million and $5 million per occurrence,
respectively. Since 1993, certain of the Company's subsidiaries, including one
of its larger acute care facilities, have purchased general and professional
liability occurrence policies with commercial insurers. These policies include
coverage up to $25 million per occurrence for general and professional
liability risks.

Relations with Universal Health Realty Income Trust

The Company serves as advisor to Universal Health Realty Income Trust
("UHT"), which leases to the Company the real property of 7 facilities
operated by the Company with terms expiring in 2000 through 2006. These leases
contain up to six 5-year renewal options. During 1998, the Company exercised
five-year renewal options on four hospitals leased from the Trust which were
scheduled to expire in 1999 through 2001. The leases on these facilities were
renewed at the same lease rates and terms as the initial leases. In addition,
UHT holds interests in properties owned by unrelated companies. The Company
receives a fee for its advisory services based on the value of UHT's assets.
In addition, certain of the directors and officers of the Company serve as
trustees and officers of UHT. As of January 31, 1999, the Company owned 8% of
UHT's outstanding shares and the Company currently has an option to purchase
UHT shares in the future at fair market value to enable it to maintain a 5%
interest.

9

Executive Officers of the Registrant

The executive officers of the Company, whose terms will expire at such time
as their successors are elected, are as follows:

Name and Age Present Position with the Company
------------ ---------------------------------

Alan B. Miller (61)....................... Director, Chairman of the Board,
President and Chief Executive Officer
Kirk E. Gorman (48)....................... Senior Vice President and Chief
Financial Officer
Michael G. Servais (52)................... Senior Vice President
Richard C. Wright (51).................... Vice President
Thomas J. Bender (46)..................... Vice President
Steve G. Filton (41)...................... Vice President and Controller
Sidney Miller (72)........................ Director and Secretary

Mr. Alan B. Miller has been Chairman of the Board, President and Chief
Executive Officer of the Company since its inception. Prior thereto, he was
President, Chairman of the Board and Chief Executive Officer of American
Medicorp, Inc.

Mr. Gorman was elected Senior Vice President and Chief Financial Officer in
December 1992, and has served as Vice President and Treasurer of the Company
since April 1987. From 1984 until then, he served as Senior Vice President of
Mellon Bank, N.A. Prior thereto, he served as Vice President of Mellon Bank,
N.A.

Mr. Servais was elected Senior Vice President of the Company in January
1996, and has served as Vice President of the Company since January 1994,
Assistant Vice President of the Company since January 1993, and Group Director
since December 1990. Prior thereto, he served as President of Jupiter Hospital
Corporation, and Vice President of Operations of American Health Group
International.

Mr. Wright was elected Vice President of the Company in May 1986. He has
served in various capacities with the Company since 1978, including Senior
Vice President of its Acute Care Division since 1985.

Mr. Bender was elected Vice President of the Company in March 1988. He has
served in various capacities with the Company since 1982, including
responsibility for the Psychiatric Care Division since November 1985.

Mr. Filton was elected Vice President and Controller of the Company in
November 1991, and had served as Director of Accounting and Control since July
1985.

Mr. Sidney Miller has served as Secretary of the Company since 1990 and
Director of the Company since 1978. He served in various capacities with the
Company, until his retirement in 1994, including Executive Vice President,
Vice President, and Assistant to the President. Prior thereto, he was Vice
President-Financial Services and Control of American Medicorp, Inc.

ITEM 2. Properties

Executive Offices

The Company owns an office building with 68,000 square feet available for
use located on 11 acres of land in King of Prussia, Pennsylvania.

Facilities

The following tables set forth the name, location, type of facility and, for
acute care hospitals and behavioral health centers, the number of beds, for
each of the Company's facilities:

10

Acute Care Hospitals

Number Ownership
Name of Facility Location of Beds Interest
- ---------------- -------- ------- ---------

Aiken Regional Medical
Centers................ Aiken, South Carolina 225 Owned
Auburn Regional Medical
Center................. Auburn, Washington 149 Owned
Chalmette Medical
Center(1).............. Chalmette, Louisiana 118 Leased
Desert Springs
Hospital(2)............ Las Vegas, Nevada 233 Owned
Doctors' Hospital of
Shreveport(3).......... Shreveport, Louisiana 136 Leased
Edinburg Regional
Medical Center......... Edinburg, Texas 169 Owned
The George Washington
University
Hospital(4)............ Washington, D.C. 501 Owned
Hospital San Francisco.. Rio Piedras, Puerto Rico 160 Owned
Hospital San Pablo...... Bayamon, Puerto Rico 430 Owned
Hospital San Pablo del
Este................... Fajardo, Puerto Rico 180 Owned
Inland Valley Regional
Medical Center(1)...... Wildomar, California 80 Leased
Manatee Memorial
Hospital............... Bradenton, Florida 512 Owned
McAllen Medical
Center(1).............. McAllen, Texas 490 Leased
Northern Nevada Medical
Center(4).............. Sparks, Nevada 100 Owned
Northwest Texas
Healthcare System...... Amarillo, Texas 357 Owned
River Parishes
Hospitals(5)........... LaPlace and Chalmette, Louisiana 152 Leased/Owned
Summerlin Hospital
Medical Center(2)...... Las Vegas, Nevada 148 Owned
Valley Hospital Medical
Center(2).............. Las Vegas, Nevada 417 Owned
Victoria Regional
Medical Center......... Victoria, Texas 147 Owned
Wellington Regional
Medical Center(1)...... West Palm Beach, Florida 120 Leased

Behavioral Health Centers

Number Ownership
Name of Facility Location of Beds Interest
- ---------------- -------- ------- ---------

The Arbour Hospital..... Boston, Massachusetts 118 Owned
The BridgeWay(1)........ North Little Rock, Arkansas 70 Leased
Clarion Psychiatric
Center................. Clarion, Pennsylvania 70 Owned
Del Amo Hospital........ Torrance, California 166 Owned
Forest View Hospital.... Grand Rapids, Michigan 62 Owned
Fuller Memorial
Hospital............... South Attleboro, Massachusetts 82 Owned
Glen Oaks Hospital...... Greenville, Texas 54 Owned
The Horsham Clinic...... Ambler, Pennsylvania 146 Owned
HRI Hospital............ Brookline, Massachusetts 68 Owned
KeyStone Center(6)...... Wallingford, Pennsylvania 100 Owned
La Amistad Residential
Treatment Center....... Maitland, Florida 56 Owned
The Meadows Psychiatric
Center................. Centre Hall, Pennsylvania 101 Owned
Meridell Achievement
Center(1).............. Austin, Texas 114 Leased
The Pavilion............ Champaign, Illinois 46 Owned
River Crest Hospital.... San Angelo, Texas 80 Owned
River Oaks Hospital..... New Orleans, Louisiana 126 Owned

11

Behavioral Health Centers, continued

Number Ownership
Name of Facility Location of Beds Interest
- ---------------- -------- ------- ---------

Roxbury(6).................. Shippensburg, Pennsylvania 75 Owned
Timberlawn Mental Health
System..................... Dallas, Texas 124 Owned
Turning Point Care
Center(6).................. Moultrie, Georgia 59 Owned
Two Rivers Psychiatric
Hospital................... Kansas City, Missouri 80 Owned

Ambulatory Surgery Centers

Name of Facility(7) Location
------------------- --------

Arkansas Surgery Center of Fayetteville.......... Fayetteville, Arkansas
Corona Outpatient Surgery Center................. Corona, California
Goldring Surgical and Diagnostic Center.......... Las Vegas, Nevada
Northwest Texas Surgery Center................... Amarillo, Texas
Outpatient Surgical Center of Ponca City......... Ponca City, Oklahoma
Plaza Surgery Center............................. Las Vegas, Nevada
St. George Surgical Center....................... St. George, Utah
Hope Square Surgery Center....................... Rancho Mirage, California
Surgery Center of Littleton...................... Littleton, Colorado
Surgery Center of Midwest City................... Midwest City, Oklahoma
Surgery Center of Springfield.................... Springfield, Missouri
Surgical Center of New Albany.................... New Albany, Indiana

Radiation Oncology Centers

Name of Facility Location
---------------- --------

Auburn Regional Center for Cancer Care........... Auburn, Washington
Bluegrass Cancer Center(8)....................... Frankfort, Kentucky
Bowling Green Radiation Therapy(9)............... Bowling Green, Kentucky
Cancer Institute of Nevada(10)................... Las Vegas, Nevada
Carolina Cancer Center........................... Aiken, South Carolina
Columbia Radiation Oncology Center............... Washington, D.C.
Danville Radiation Therapy Center(8)............. Danville, Kentucky
Glasgow Radiation Therapy(9)..................... Glasgow, Kentucky
Louisville Radiation Oncology Center(8).......... Louisville, Kentucky
Madison Radiation Therapy(10).................... Madison, Indiana
Southern Indiana Radiation Therapy(10)........... Jeffersonville, Indiana
Radiation Therapy Medical Associates of
Bakersfield(11)................................. Bakersfield, California

Specialized Women's Health Centers

Name of Facility Location
---------------- --------

Renaissance Women's Center of Edmond(10)......... Edmond, Oklahoma
Renaissance Women's Center of Austin(10)......... Austin, Texas
Lakeside Women's Center(10)...................... Oklahoma City, Oklahoma

- --------
(1) Real property leased from UHT.
(2) Desert Springs Hospital, Summerlin Hospital Medical Center and Valley
Hospital Medical Center are owned by a limited liability company in which
the Company has a 72.5% interest and Quorum's subsidiary, NC-DSH, Inc.,
has a 27.5% interest. All hospitals are managed by the Company.
(3) Real property leased with an option to purchase.
(4) General partnership interest in limited partnership.

12

(5) Includes Chalmette Hospital, a 118-bed rehabilitation facility. The
Company owns the LaPlace real property and leases the Chalmette real
property from UHT.
(6) Addictive disease facility.
(7) Each facility, other than Goldring Surgical and Diagnostic Center and
Northwest Texas Surgery Center, is owned in partnership form with the
Company owning general and limited partnership interests in a limited
partnership. The real property is leased from third parties.
(8) Majority interest in a limited liability partnership.
(9) Managed facility, not included in the Company's consolidated financial
statements. A partnership, in which the Company is the general partner,
owns the real property.
(10) Membership interest in limited liability company.
(11) Managed facility, not included in the Company's consolidated financial
statements. A limited liability company, in which the Company is the sole
member, owns the equipment, but the property is leased.

Some of these facilities are subject to mortgages, and substantially all the
equipment located at these facilities is pledged as collateral to secure long-
term debt. The Company owns or leases medical office buildings adjoining
certain of its hospitals.

The Company believes that the leases or liens on the facilities leased or
owned by the Company do not impose any material limitation on the Company's
operations.

The aggregate lease payments on facilities leased by the Company aggregated
$22.8 million in 1998.

ITEM 3. Legal Proceedings

The Company is subject to claims and suits in the ordinary course of
business, including those arising from care and treatment afforded at the
Company's hospitals and is party to various other litigation. However,
management believes the ultimate resolution of these pending proceedings will
not have a material adverse effect on the Company.

ITEM 4. Submission of Matters to a Vote of Security Holders

Inapplicable. No matter was submitted during the fourth quarter of the
fiscal year ended December 31, 1998 to a vote of security holders.

13

PART II

ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters

See Item 6, Selected Financial Data

ITEM 6. Selected Financial Data

Year Ended December 31
--------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
--------------- ---------------- --------------- ---------------- ----------------

Summary of Operations
(in thousands)
Net revenues........... $ 1,874,487 $ 1,442,677 $ 1,174,158 $ 919,193 $ 773,475
Net income............. $ 79,558 $ 67,276 $ 50,671 $ 35,484 $ 28,720
Net margin............. 4.2% 4.7% 4.3% 3.9% 3.7%
Return on average
equity................ 13.1% 13.5% 13.0% 12.4% 11.8%
Financial Data (in
thousands)
Cash provided by
operating activities.. $ 151,684 $ 174,170 $ 145,991 $ 91,749 $ 60,624
Capital
expenditures(1)....... $ 96,808 $ 132,258 $ 107,630 $ 65,695 $ 48,652
Total assets........... $ 1,448,095 $ 1,085,349 $ 965,795 $ 748,051 $ 521,492
Long-term borrowings... $ 418,188 $ 272,466 $ 275,634 $ 237,086 $ 85,125
Common stockholders'
equity................ $ 627,007 $ 526,607 $ 452,980 $ 297,700 $ 260,629
Percentage of total
debt to total
capitalization........ 40% 35% 38% 45% 26%
Operating Data--Acute
Care Hospitals
Average licensed beds.. 4,696 3,389 3,018 2,638 2,398
Average available
beds.................. 3,985 2,951 2,641 2,340 2,099
Hospital admissions.... 187,833 128,020 111,244 91,298 75,923
Average length of
patient stay.......... 4.7 4.8 4.9 5.1 5.2
Patient days........... 884,966 616,965 546,237 462,054 394,490
Occupancy rate for
licensed beds......... 52% 50% 49% 48% 45%
Occupancy rate for
available beds........ 61% 57% 57% 54% 51%
Operating Data--
Behavioral Health
Facilities
Average licensed beds.. 1,782 1,777 1,565 1,238 1,145
Average available
beds.................. 1,767 1,762 1,540 1,223 1,142
Hospital admissions.... 32,400 28,350 22,295 15,329 13,033
Average length of
patient stay.......... 11.3 11.9 12.4 12.8 13.8
Patient days........... 365,935 336,850 275,667 195,961 179,821
Occupancy rate for
licensed beds......... 56% 52% 48% 43% 43%
Occupancy rate for
available beds........ 57% 52% 49% 44% 43%
Per Share Data
Net income--basic(2)... $ 2.45 $ 2.08 $ 1.69 $ 1.28 $ 1.03
Net income--
diluted(2)............ $ 2.39 $ 2.03 $ 1.65 $ 1.26 $ 1.01
Other Information (in
thousands)
Weighted average number
of shares
outstanding--
basic(2).............. 32,511 32,321 30,054 27,691 27,972
Weighted average number
of shares and share
equivalents
outstanding--
diluted(2)............ 33,293 33,098 30,798 28,103 28,775
Common Stock Performance
Market price of common
stock
High-Low, by quarter(3)
1st.................... 58 1/8 -47 1/16 34 5/8 -27 7/8 26 7/8-21 11/16 13 -11 3/8 13 5/16- 9 5/8
2nd.................... 59 5/8 -53 40 1/2 -31 5/8 30 1/8-24 3/8 14 13/16-12 7/16 13 7/16-11 1/4
3rd.................... 58 1/2 -38 3/4 47 1/16-39 1/16 27 1/4-22 3/4 17 11/16-14 14 3/4 -12 15/16
4th.................... 54 5/16-40 7/16 50 3/8 -40 11/16 29 1/4-24 1/2 22 3/16 -16 1/8 14 1/16-10 11/16

- --------
(1) Amount includes non-cash capital lease obligations.
(2) In April 1996, the Company declared a two-for-one stock split in the form
of a 100% stock dividend which was paid in May 1996. All classes of common
stock participated on a pro rata basis. The weighted average number of
common shares and equivalents and earnings per common and common
equivalent share for all years presented have been adjusted to reflect the
two-for-one stock split. The 1994 diluted earnings per share and diluted
average number of shares outstanding have been adjusted to reflect the
assumed conversion of the Company's convertible debentures. In April 1994,
the Company redeemed the debentures which reduced the diluted number of
shares outstanding by 902,466.
(3) These prices are the high and low closing sales prices of the Company's
Class B Common Stock as reported by the New York Stock Exchange (all
periods have been adjusted to reflect the two-for-one stock split in the
form of a 100% stock dividend paid in May 1996). Class A, C and D common
stock are convertible on a share-for-share basis into Class B Common
Stock.

14

Number of shareholders of record as of January 31, 1999, were as follows:

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

Class A Common 9
Class B Common 579
Class C Common 7
Class D Common 250
- -------------------

ITEM 7. Management's Discussion and Analysis of Operations and Financial
Condition

Forward-Looking Statements

The matters discussed in this report as well as the news releases issued
from time to time by the Company include certain statements containing the
words "believes", "anticipates", "intends", "expects" and words of similar
import, which constitute "forward-looking statements" within the meaning of
the Private Securities Litigation Reform Act of 1995. Such forward-looking
statements involve known and unknown risks, uncertainties and other factors
that may cause the actual results, performance achievements of the Company or
industry results to be materially different from any future results,
performance or achievements expressed or implied by such forward-looking
statements. Such factors include, among other things, the following: that the
majority of the Company's revenues are produced by a small number of its total
facilities; possible changes in the levels and terms of reimbursement for the
Company's charges by government programs, including Medicare or Medicaid or
other third party payers; industry capacity; demographic changes; existing
laws and government regulations and changes in or failure to comply with laws
and governmental regulations; the ability to enter into managed care provider
agreements on acceptable terms; liability and other claims asserted against
the Company; competition; the loss of significant customers; technological and
pharmaceutical improvements that increase the cost of providing, or reduce the
demand for healthcare; the ability to attract and retain qualified personnel,
including physicians, the ability of the Company to successfully integrate its
recent acquisitions; the Company's ability to finance growth on favorable
terms; the impact of Year 2000 issues; and, other factors referenced in the
Company's 1998 Form 10-K or herein. Given these uncertainties, prospective
investors are cautioned not to place undue reliance on such forward-looking
statements. The Company disclaims any obligation to update any such factors or
to publicly announce the result of any revisions to any of the forward-looking
statements contained herein to reflect future events or developments.

Results of Operations

Net revenues increased 30% to $1.9 billion in 1998 as compared to 1997 and
23% to $1.4 billion in 1997 as compared to 1996. The $432 million increase in
net revenues during 1998 as compared to 1997 was due primarily to: (i) the
acquisition of three acute care facilities located in Puerto Rico (one of
which opened in April, 1998) and one acute care facility located in Las Vegas
which were acquired during the first quarter of 1998, the acquisition of an
80% interest in a 501-bed acute care facility during the third quarter of 1997
and a newly constructed 148-bed acute care facility which opened during the
fourth quarter of 1997 ($344 million), and; (ii) revenue growth at facilities
owned during both periods ($58 million). The $269 million increase in net
revenues during 1997 as compared to 1996 was due primarily to: (i) revenue
growth at acute care facilities owned during both years ($100 million); (ii)
the acquisition during the third quarter of 1997 of an 80% interest in a
partnership which owns a 501-bed acute care hospital located in Washington, DC
($59 million), and; (iii) the acquisitions of a 357-bed medical complex
located in Amarillo, Texas during the second quarter of 1996 and five
behavioral health centers located in Pennsylvania and Texas during the second
and third quarters of 1996 ($82 million).

Earnings before interest, income taxes, depreciation, amortization, lease
and rental expense and $4.1 million of nonrecurring transactions recorded in
1996 (see Other Operating Results) (before deducting minority interests in
earnings of consolidated entities) ("EBITDAR") increased to $311 million in
1998 from $245 million in 1997 and $214 million in 1996. Overall operating
margins were 16.6% in 1998, 17.0% in 1997 and 18.2% in 1996. The decrease in
the Company's overall operating margin in 1998 as compared to 1997 was due
primarily to: (i)

15

lower operating margins experienced at three acute care hospitals located in
Puerto Rico (one of which opened in April 1998) and one acute care hospital
located in Las Vegas, Nevada which were acquired during the first quarter of
1998; (ii) lower operating margins experienced at the 501-bed acute care
facility of which the Company acquired an 80% interest in during the third
quarter of 1997; (iii) the opening of a newly constructed 129-bed acute care
facility located in Edinburg, Texas during the third quarter of 1997 and the
opening of a newly constructed 148-bed acute care facility in Summerlin,
Nevada which opened during the fourth quarter of 1997, and; (iv) $2.5 million
of pre-tax adverse financial effects of Hurricane Georges which damaged
property and curtailed business at three hospitals in Puerto Rico and four
hospitals in Louisiana during the third quarter of 1998. The $2.5 million
adverse pre-tax financial effects resulting from the hurricane were comprised
of $1.7 million of estimated lost revenue due to partial evacuation of seven
facilities and $800,000 of net operating costs (after insurance recoveries)
consisting primarily of storm preparations, supply expenses and temporary
help. The decrease in the Company's overall operating margin in 1997 as
compared to 1996 was due primarily to losses incurred at the 501-bed acute
care facility of which the Company acquired an 80% interest in during the
third quarter of 1997 and the opening of a newly constructed 129-bed acute
care facility during the third quarter of 1997 and a 148-bed acute care
facility during the fourth quarter of 1997.

Acute Care Services

Net revenues from the Company's acute care hospitals, ambulatory treatment
centers and specialized women's health centers accounted for 87%, 85% and 85%
of consolidated net revenues in 1998, 1997 and 1996, respectively. Net
revenues at the Company's acute care facilities owned in both 1998 and 1997
increased 4% in 1998 as compared to 1997 due primarily to a 4% increase in
admissions and a 1% increase in patient days. The average length of stay at
these facilities decreased 3% to 4.7 days in 1998 as compared to 4.8 days in
1997. Net revenues at the Company's acute care facilities owned in both 1997
and 1996 increased 10% in 1997 as compared to 1996 due primarily to an
increase in admissions and patient days at these facilities. Each of the
Company's acute care facilities owned in both years experienced an increase in
admissions in 1997 as compared to 1996 which amounted to a 5% increase in
admissions for the acute care division in 1997 as compared to 1996. Patient
days at these facilities increased 4% in 1997 as compared to 1996 while the
average length of stay at these facilities decreased to 4.8 days in 1997
compared to 4.9 days in 1996.

The decrease in the average length of stay at the Company's facilities
during the past three years was due primarily to improvement in case
management of Medicare and Medicaid patients and an increasing shift of
patients into managed care plans which generally have shorter lengths of stay.
The increase in net revenues at the Company's acute care facilities was caused
primarily by an increase in inpatient admissions and an increase in outpatient
activity. Outpatient activity continues to increase as gross outpatient
revenues at the Company's acute care facilities owned in both 1998 and 1997
increased 14% in 1998 as compared to 1997 and comprised 27% of the Company's
acute care gross patient revenue in 1998 as compared to 26% in 1997. Gross
outpatient revenues at the Company's acute care facilities owned in both 1997
and 1996 increased 10% in 1997 as compared to 1996 and comprised 26% of gross
patient revenues in 1997 as compared to 25% in 1996.

The increase in outpatient revenues is primarily the result of advances in
medical technologies and pharmaceutical improvements, which allow more
services to be provided on an outpatient basis, and increased pressure from
Medicare, Medicaid, managed care companies and other insurers to reduce
hospital stays and provide services, where possible, on a less expensive
outpatient basis. The hospital industry in the United States as well as the
Company's acute care facilities continue to have significant unused capacity
which has created substantial competition for patients. Inpatient utilization
continues to be negatively affected by payor-required, pre-admission
authorization and by payor pressure to maximize outpatient and alternative
healthcare delivery services for less acutely ill patients. The Company
expects the increased competition, admission constraints and payor pressures
to continue. The Company's ability to maintain its historical rate of net
revenue growth and operating margins is dependent upon its ability to
successfully respond to these trends as well as reductions in spending on
governmental health care programs.

16

To accommodate the increased utilization of outpatient services, the Company
has expanded or redesigned several of its outpatient facilities and services.
Additionally, the Company has invested in the acquisition and development of
outpatient surgery centers, radiation therapy centers and specialized women's
health centers. As of December 31, 1998, the Company operated or managed
twenty-seven outpatient surgery, radiation and specialized women's health
centers which generated net revenues of $56 million in 1998, $38 million in
1997 and $32 million in 1996. The Company expects the growth in outpatient
services to continue due to increased focus on managed care and advances in
technology.

At the Company's acute care facilities, operating expenses (operating
expenses, salaries and wages and provision for doubtful accounts) as a
percentage of net revenues were 79.9% in 1998, 78.7% in 1997 and 77.2% in
1996. Operating margins (EBITDAR) at these facilities were 20.1% in 1998,
21.3% in 1997 and 22.8% in 1996. The decrease in the operating margins over
the last three years was due primarily to: (i) lower operating margins
experienced at three acute care hospitals located in Puerto Rico (one of which
opened in April 1998) and one acute care hospital located in Las Vegas, Nevada
which were acquired during the first quarter of 1998; (ii) lower operating
margins experienced at the 501-bed acute care facility of which the Company
acquired an 80% interest in during the third quarter of 1997; (iii) the
opening of a newly constructed 129-bed acute care facility located in
Edinburg, Texas during the third quarter of 1997 and the opening of a newly
constructed 148-bed acute care facility in Summerlin, Nevada which opened
during the fourth quarter of 1997; (iv) changes in Medicare payments mandated
by the Balanced Budget Act of 1997 which became effective October 1, 1997,
and; (v) $2.5 million of pre-tax adverse financial effects of Hurricane
Georges ($2.3 million of which affected acute care facilities) which damaged
property and curtailed business at three acute care hospitals in Puerto Rico
and four hospitals in Louisiana (three of which were acute care facilities)
during the third quarter of 1998.

The Company's facilities continue to experience a shift in payor mix
resulting in an increase in revenues attributable to managed care payors and
unfavorable general industry trends which include pressures to control
healthcare costs. Providers participating in managed care programs agree to
provide services to patients for a discount from established rates which
generally results in pricing concessions by the providers and lower margins.
Additionally, managed care companies generally encourage alternatives to
inpatient treatment settings and reduce utilization of inpatient services. In
response to increased pressure on revenues, the Company continues to implement
cost control programs at its facilities including more efficient staffing
standards and re-engineering of services. The Company has also implemented
cost control measures at its newly acquired facilities in an effort to improve
operating margins at these facilities from their pre-acquisition levels. On a
same facility basis, operating expenses (operating expenses, salaries and
wages and provision for doubtful accounts) at the Company's facilities owned
in both 1998 and 1997 were 77.4% of net revenues in 1998 as compared to 78.5%
in 1997. Operating margins at the Company's acute care facilities owned in
both 1998 and 1997 were 22.6% in 1998 as compared to 21.5% in 1997. Operating
expenses at the Company's facilities owned in both 1997 and 1996 were 77.0% in
1997 as compared to 77.2% in 1996. Operating margins at the Company's
facilities owned in both 1997 and 1996 were 23.0% in 1997 and 22.8% in 1996.
Pressure on operating margins is expected to continue due to, among other
things, the changes in Medicare payments mandated by the Balanced Budget Act
of 1997 which became effective October 1, 1997 and the industry-wide trend
towards managed care which limits the Company's ability to increase its
prices.

Behavioral Health Services

Net revenues from the Company's behavioral health services facilities
accounted for 12%, 14% and 14% of consolidated net revenues in 1998, 1997 and
1996, respectively. Net revenues at the Company's behavioral health services
facilities owned in both 1998 and 1997 increased 7% in 1998 as compared to
1997 due to a 14% increase in admissions and a 9% increase in patient days.
The average length of stay at these facilities decreased 5% to 11.3 days in
1998 as compared to 11.9 days in 1997. Net revenues at the Company's
behavioral health services facilities owned in both 1997 and 1996 increased 3%
in 1997 as compared to 1996. Admissions at these facilities increased 8% in
1997 as compared to 1996. Patient days at the Company's behavioral health
services facilities owned during both years increased 4% in 1997 as compared
to 1996 and the average length of stay decreased 4% to 11.9 days in 1997 as
compared to 12.4 days in 1996.

17

The reduction in the average length of stay during the last three years is a
result of continued practice changes in the delivery of behavioral health
services and continued cost containment pressures from payors, including
managed care companies, which includes a greater emphasis on the utilization
of outpatient services. Providers participating in managed care programs agree
to provide services to patients for a discount from established rates which
generally results in pricing concessions by the providers and lower margins.
Additionally, managed care companies generally encourage alternatives to
inpatient treatment. Management of the Company has responded to these trends
by continuing to develop and market new outpatient treatment programs. The
shift to outpatient care is reflected in higher revenues from outpatient
services, as gross outpatient revenues at the Company's behavioral health
services facilities owned in both 1998 and 1997 increased 12% in 1998 as
compared to 1997 and comprised 20% of gross patient revenues in both years.
Gross outpatient revenues at the Company's behavioral health services
facilities owned in both 1997 and 1996 increased 24% in 1997 as compared to
1996 and comprised 20% of gross patient revenues in 1997 as compared to 18% in
1996.

Operating expenses (operating expenses, salaries and wages and provision for
doubtful accounts) as a percentage of net revenues at the Company's behavioral
health services facilities were 83.5% in 1998, 82.8% in 1997 and 82.0% in
1996. The Company's behavioral health services division generated operating
margins (EBITDAR) of 16.5% in 1998, 17.2% in 1997 and 18.0% in 1996. On a same
facility basis, operating expenses (operating expenses, salaries and wages and
provision for doubtful accounts) at the Company's behavioral health services
facilities owned in both 1998 and 1997 were 82.4% in 1998 and 82.2% in 1997.
Operating margins (EBITDAR) at the Company's behavioral health services
facilities owned in both 1998 and 1997 were 17.6% in 1998 and 17.8% in 1997.
Operating expenses at the Company's behavioral health services facilities
owned in both 1997 and 1996 were 81.1% in 1997 and 80.7% in 1996. Operating
margins (EBITDAR) at the facilities owned in both 1997 and 1996 were 18.9% in
1997 and 19.3% in 1996. The decline in operating margins during the last three
years was caused primarily by the continued reduction in length of stay and
pricing pressures caused by the increasing shift toward managed care.
Management continues to implement cost controls in response to the managed
care environment, however, pressure on operating margins is expected to
continue in the future.

Other Operating Results

Depreciation and amortization expense increased $24 million to $105 million
in 1998 as compared to $81 million in 1997. The increase was due primarily to
the four acute care hospitals acquired/opened during the first four months of
1998 (three in Puerto Rico and one in Las Vegas) and a full year of
depreciation expense on two acute care facilities opened during the third and
fourth quarters of 1997. Depreciation and amortization expense increased $9
million to $81 million in 1997 as compared to $72 million in 1996. The
increase was due primarily to the opening of two newly constructed acute care
facilities during the third and fourth quarters of 1997 and the acquisitions
of an acute care facility and five behavioral health centers during the second
and third quarters of 1996.

Interest expense increased $8 million to $27 million in 1998 as compared to
$19 million in 1997 due primarily to increased borrowings used to finance the
1998 purchase of the three acute care hospitals located in Puerto Rico.
Interest expense decreased $2 million to $19 million in 1997 as compared to
$21 million in 1996 due primarily to a slight reduction in the average
outstanding borrowings and the $1 million of interest income earned during
1997 on the $40 million investment of funds restricted for construction of a
new acute care facility in Washington, DC.

During 1996, the Company recorded $4.1 million of nonrecurring charges which
consisted of a $2.9 million loss recorded on the anticipated divestiture of an
ambulatory treatment center (which was divested during the first quarter of
1997) and a $1.2 million charge recorded to fully reserve the carrying value
of a behavioral health center owned by the Company and leased to an
unaffiliated third party, which is currently in default under the terms of the
lease agreement.

18

The effective tax rate was 35.3%, 36.5% and 36.7% in 1998, 1997 and 1996,
respectively. The reduction in the effective tax rate during 1998 as compared
to the prior years was due to a reduction in the effective state income tax
rate and benefits related to wage tax credits.

General Trends

A significant portion of the Company's revenue is derived from fixed payment
services, including Medicare and Medicaid, which accounted for 46%, 50% and
51% of the Company's net patient revenues during 1998, 1997 and 1996,
respectively. The Medicare program reimburses the Company's hospitals
primarily based on established rates by a diagnosis related group for acute
care hospitals and by cost based formula for behavioral health facilities.
Historically, rates paid under Medicare's prospective payment system ("PPS")
for inpatient services have increased, however, these increases have been less
than cost increases. Pursuant to the terms of The Balanced Budget Act of 1997
(the "1997 Act"), there were no increases in the rates paid to hospitals for
inpatient care through September 30, 1998. The Company expects that the modest
rate increases which became effective on October 1, 1998 will be more than
offset by the negative impact of converting reimbursement on skilled nursing
facility patients from a cost based reimbursement to a prospective payment
system and from lower DRG payments on certain patient transfers mandated by
the 1997 Act. Reimbursement for bad debt expense and capital costs as well as
other items have been reduced. Outpatient reimbursement for Medicare patients
is scheduled to convert to a PPS during the second quarter of 2000. Since
final provisions of the outpatient Medicare PPS are not yet available, the
Company can not completely estimate the resulting impact on its future results
of operations.

During the first quarter of 1999, the President submitted a proposal which
included additional reductions in Medicare payments to hospitals, nursing
homes and other providers amounting to $9.5 billion over a five year period.
Approximately $4.5 billion of the proposed Medicare reductions would cut the
growth of Medicare payments to hospitals over a five year period. While the
Company is unable to predict whether this most recent proposal, or any other
future health reform legislation, will ultimately be enacted at the federal or
state level, the Company expects continuing pressure to limit expenditures by
governmental healthcare programs. Further changes in the Medicare or Medicaid
programs and other proposals to limit healthcare spending could have a
material adverse impact upon the Company's results of operations and the
healthcare industry.

The healthcare industry is subject to numerous laws and regulations which
include, among other things, matters such as government healthcare
participation requirements, various licensure and accreditations,
reimbursement for patient services, and Medicare and Medicaid fraud and abuse.
Recently, government action has increased with respect to investigations
and/or allegations concerning possible violations of fraud and abuse and false
claims statutes and/or regulations by healthcare providers. Providers that are
found to have violated these laws and regulations may be excluded from
participating in government healthcare programs, subjected to fines or
penalties or required to repay amounts received from the government for
previously billed patient services. While management of the Company believes
its policies, procedures and practices comply with governmental regulations,
no assurance can be given that the Company will not be subjected to
governmental inquiries or actions.

In Texas, a law has been passed which mandates that the state senate apply
for a waiver from current Medicaid regulations to allow the state to require
that certain Medicaid participants be serviced through managed care providers.
The Company is unable to predict whether Texas will be granted such a waiver
or the effect on the Company's business of such a waiver. Upon meeting certain
conditions, and serving a disproportionately high share of Texas' and South
Carolina's low income patients, three of the Company's facilities located in
Texas and one facility located in South Carolina became eligible and received
additional reimbursement from each state's disproportionate share hospital
fund. Included in the Company's financial results was an aggregate of $36.5
million in 1998, $33.4 million in 1997 and $17.8 million in 1996 received
pursuant to the terms of these programs. These programs are scheduled to
terminate in the third quarter of 1999 and although these programs have been
renewed annually in the past, the Company cannot predict whether these
programs will continue beyond their scheduled termination date. However,
failure to renew these programs at their current reimbursement levels could
have a material adverse effect on the Company's future results of operations.

19

In addition to the Medicare and Medicaid programs, other payors, including
managed care companies, continue to actively negotiate the amounts they will
pay for services performed. In general, the Company expects the percentage of
its business from managed care programs, including health maintenance
organizations and preferred provider organizations to grow. The consequent
growth in managed care networks and the resulting impact of these networks on
the operating results of the Company's facilities vary among the markets in
which the Company operates.

Year 2000 Issue

The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. The Company's
computer programs, certain building infrastructure components (including
elevators, alarm systems and certain HVAC systems) and certain computer aided
medical equipment that have time-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in system
failures or miscalculations causing disruption of operations or medical
equipment malfunctions that could affect patient diagnosis and treatment.

The Company has undertaken steps to inventory and assess applications and
equipment at risk to be affected by Year 2000 issues and to convert, remediate
or replace such applications and equipment. The Company has completed its
assessment of its major financial and clinical software and believes that such
software is substantially Year 2000 compliant. As to certain peripheral
software, the Company has scheduled upgrades to be completed by June, 1999.
For its biomedical equipment, the Company expects to complete the assessment
phase of its Year 2000 analysis by early in the second quarter of 1999. The
Company believes that Year 2000 related remediation costs incurred through
December 31, 1998 have not had a material impact on its results of operations.
However, the Company is not able to reasonably estimate the total capital
costs to be incurred for equipment replacement since the equipment analysis
phase has not yet been completed. Some replacement or upgrade of systems and
equipment would take place in the normal course of business. Several systems,
key to the Company's operations, have been scheduled to be replaced through
vendor supplied systems before Year 2000. The costs of repairing existing
systems is expensed as incurred. The Company has allocated a portion of its
1999 capital budget as Year 2000 contingency funds and expects that all of the
capital costs can be accommodated within that budget. The Company presently
believes that with modifications to existing software and conversions to new
software, the Year 2000 issue will not pose material operational problems for
its computer systems. However, if such modifications and conversions are not
made, or are not completed timely, the Year 2000 issue could have a material
impact on the operations of the Company.

The majority of the software used by the Company is purchased from third
parties. The Company is relying on software (including the Company's major
outsourcing vendor which provides the financial and clinical applications for
the majority of the Company's acute care facilities), hardware and other
equipment vendors to verify Year 2000 compliance of their products. The
Company also depends on: fiscal intermediaries which process claims and make
payments for the Medicare program; health maintenance organizations, insurance
companies and other private payors; vendors of medical supplies and
pharmaceuticals used in patient care; and, providers of utilities such as
electricity, water, natural gas and telephone services. As part of its Year
2000 strategy, the Company intends to seek assurances from these parties that
their services and products will not be interrupted or malfunction due to the
Year 2000 problem. Failure of third parties to resolve their Year 2000 issues
could have a material adverse effect on the Company's results of operations
and its ability to provide health care services.

Each of the Company's hospitals has a disaster plan which will be reviewed
as part of the Company's Year 2000 contingency planning process. However, no
assurance can be given that the Company will be able to develop contingency
plans which will enable each of its facilities to continue to operate in all
circumstances.

This Year 2000 assessment is based on information currently available to the
Company and the Company will revise its assessment at it implements its Year
2000 strategy. The Company can provide no assurance that applications and
equipment the Company believes to be Year 2000 compliant will not experience
difficulties or

20

that the Company will not experience difficulties obtaining resources needed
to make modifications to or replace the Company's affected systems and
equipment. Failure by the Company or third parties on which it relies to
resolve Year 2000 issues could have a material adverse effect on the Company's
results of operations and its ability to provide health care services.
Consequently, the Company can give no assurances that issues related to Year
2000 will not have a material adverse effect on the Company's financial
condition or results of operations.

Market Risks Associated With Financial Instruments

The Company's interest expense is sensitive to changes in the general level
of domestic interest rates. To mitigate the impact of fluctuations in domestic
interest rates, a portion of the Company's debt is fixed rate accomplished by
either borrowing on a long-term basis at fixed rates or by entering into
interest rate swap transactions. The interest rate swap agreements are
contracts that require the Company to pay a fixed and receive a floating
interest rate over the life of the agreements. The floating-rates are based on
LIBOR and the fixed-rate is determined at the time the swap agreement was
consummated. The interest rate swap agreements do not constitute positions
independent of the underlying exposures. The Company does not hold or issue
derivative instruments for trading purposes and is not a party to any
instruments with leverage features. Certain swap agreements allow the
counterparty a one-time option to cancel the agreement one year prior to
maturity. The Company is exposed to credit losses in the event of
nonperformance by the counterparties to its financial instruments. The
counterparties are creditworthy financial institutions, rated AA or better by
Moody's Investor Services and the Company anticipates that the counterparties
will be able to fully satisfy their obligations under the contracts. For the
year ended December 31, 1998, the Company received a weighted average rate of
5.7% and paid a weighted average rate on its interest rate swap agreements of
5.8%. At December 31, 1997 and December 31, 1996, the Company had no active
interest rate swap agreements.

The table below presents information about the Company's derivative
financial instruments and other financial instruments that are sensitive to
changes in interest rates, including long-term debt and interest rate swaps as
of December 31, 1998. For debt obligations, the table presents principal cash
flows and related weighted-average interest rates by contractual maturity
dates. For interest rate swap agreements, the table presents notional amounts
by expected maturity date (assuming the options to cancel early are not
exercised) and weighted average interest rates based on rates in effect at
December 31, 1998. The fair values of long-term debt and interest rate swaps
were determined based on market prices quoted at December 31, 1998, for the
same or similar debt issues.

Maturity Date, Fiscal Year Ending December 31
----------------------------------------------------------
There-
1999 2000 2001 2002 2003 after Total
------ ------ ------- -------- ---- -------- --------
(Dollars in thousands)

Long-term debt:
Fixed rate-Fair
value................ $4,082 $3,438 $ 286 $ 1,381 $0 $141,021 $150,208
Fixed rate-Carrying
value................ 4,082 3,438 286 1,256 0 134,268 143,330
Average interest rates.. 7.19% 7.38% 8.60% 10.00% 9.20%
Variable rate long-term
debt................... 0 0 0 260,740 0 18,200 278,940
Interest rate swaps:
Pay fixed/receive
variable notional
amounts.............. 50,000 75,000 125,000
Average pay rate...... 5.784% 6.75%
Average receive rate.. 3 month 6 month
LIBOR LIBOR

Effects of Inflation and Changing Prices

The healthcare industry is very labor intensive and salaries and benefits
are subject to inflationary pressures as are supply costs which tend to
escalate as vendors pass on the rising costs through price increases.
Inflation

21

has not had a material impact on the results of operations during the last
three years. Although the Company cannot predict its ability to continue to
cover future cost increases, management believes that through the adherence to
cost containment policies, labor management and reasonable price increases,
the effects of inflation on future operating margins should be manageable.
However, the Company's ability to pass on these increased costs associated
with providing healthcare to Medicare and Medicaid patients is limited due to
various federal, state and local laws which have been enacted, that, in
certain cases, limit the Company's ability to increase prices. Under the terms
of the Balanced Budget Act of 1997, there were no increases in the rates paid
to hospitals for inpatient care through September 30, 1998. The Company
expects that the modest rate increases which became effective on October 1,
1998 will be more than offset by the negative impact of converting
reimbursement on skilled nursing facility patients from a cost based
reimbursement to a prospective payment system and from lower DRG payments on
certain patient transfers mandated by the 1997 Act. Reimbursement for bad debt
expense and capital costs as well as other items have been reduced. In
addition, as a result of increasing regulatory and competitive pressures and a
continuing industry wide shift of patient into managed care plans, the
Company's ability to maintain margins through price increases to non-Medicare
patients is limited.

Liquidity and Capital Resources

Net cash provided by operating activities was $152 million in 1998, $174
million in 1997 and $146 million in 1996. The $22 million net decrease in 1998
as compared to 1997 was primarily attributable to: (i) a $37 million favorable
increase in net income plus the addback of depreciation and amortization
expense; (ii) an unfavorable $18 million increase in income tax payments, net
of refunds; (iii) an unfavorable $14 million change in accrued insurance
expense less commercial premiums paid and payments made in settlement of self-
insurance claims; (iv) an unfavorable $22 million increase in other working
capital accounts; (v) an $8 million increase in payments made to the Company's
non-contributory retirement plan, and; (vi) $3 million of other net favorable
changes. The unfavorable change in accrued insurance less commercial premiums
paid and payments made in settlement of self-insurance claims was due to the
January, 1998 purchase of commercial insurance policies for general and
professional liability coverage at most of the Company's subsidiaries. These
policies provide for coverage in excess of $1 million per occurrence, with an
average annual aggregate of $4 million through 2001. Prior to January 1998,
most of the Company's subsidiaries were self-insured for professional and
general liability claims up to $5 million per occurrence, with excess coverage
maintained up to $100 million with major insurance carriers. Other working
capital accounts as of December 31, 1998 (net of effects from acquisitions)
increased $9 million as compared to December 31, 1997 while other working
capital accounts as of December 31, 1997 decreased $13 million as compared to
December 31, 1996. The changes in other working capital accounts were caused
primarily by the timing of payments of accounts payable and other accrued
expenses.

The $28 million increase in 1997 as compared to 1996 was primarily
attributable to a $25 million increase in the net income plus the addback of
the non-cash charges (depreciation, amortization, provision for self-insurance
reserves and other non-cash charges) and a $20 million increase in other net
working capital changes partially offset by a $9 million increase in income
tax payments and an $8 million increase in payments made in settlement of
self-insurance claims. During each of the last three years, the net cash
provided by operating activities substantially exceeded the scheduled
maturities of long-term debt.

During the first quarter of 1998, the Company completed its acquisition of
three acute care hospitals located in Puerto Rico for a combined purchase
price of $187 million. The hospitals acquired are located in Bayamon (430-
beds), Rio Piedras (160-beds) and Fajardo (180-beds). These acquisitions were
financed with funds borrowed under the Company's revolving credit facility.
Also during the first quarter of 1998, the Company contributed substantially
all of the assets, liabilities and operations of Valley Hospital Medical
Center, a 417-bed acute care facility, and its newly-constructed Summerlin
Hospital Medical Center, a 148-bed acute care facility in exchange for a 72.5%
interest in a series of newly-formed limited liability companies ("LLCs").
Quorum Health Group, Inc. ("Quorum") holds the remaining 27.5% interest in the
LLCs. Quorum obtained its interest by contributing substantially all of the
assets, liabilities and operations of Desert Springs Hospital, a 241-bed acute
care facility and $11 million of net cash. The assets and liabilities
contributed by the Company were recorded by the LLCs at carryover value. The
LLCs applied purchase accounting to the assets and liabilities provided by
Quorum and

22

recorded them at fair market value. As a result of this partial sale
transaction, the Company recorded a pre-tax gain of $55.1 million ($34.7
million after-tax) that was recorded as a capital contribution to the Company.
This merger did not have a material impact on the 1998 results of operations.
Also during 1998, the Company spent $2 million to purchase the property of a
radiation therapy center located in California.

During the third quarter of 1998, the Company's Board of Directors approved
a stock repurchase program under which the Company is authorized to purchase
up to two million shares or approximately 6% of its outstanding Class B Common
Stock. As of December 31, 1998, the Company repurchased 580,500 shares at an
average repurchase price of $42.90 per share ($24.9 million in the aggregate)
pursuant to this program.

During 1997 the Company acquired an 80% interest in a partnership which owns
and operates The George Washington University Hospital, a 501-bed acute care
facility located in Washington, DC. The George Washington University ("GWU")
holds a 20% interest in the partnership. In connection with this acquisition,
the Company provided an immediate commitment of $80 million, consisting of $40
million in cash which has been invested and is restricted for construction
(balance of $43.4 million as of December 31, 1998) and a $40 million letter of
credit. The Company and GWU are planning to build a newly constructed 371-bed
acute care facility which is scheduled to be completed in 2001. The total cost
of this new facility is estimated to be approximately $96 million, of
which the Company intends to finance a total of $83 million (including the $80
million immediate commitment mentioned above) with the remainder being
financed by GWU and the interest earnings on the $40 million of
funds restricted for construction. During the third and fourth quarters of
1997, the Company completed construction and opened the following facilities:
(i) a 129-bed acute care facility located in Edinburg, Texas; (ii) a medical
complex located in Summerlin, Nevada including a 148-bed acute care facility,
and; (iii) two newly constructed specialized women's health centers located in
Austin, Texas and Lakeside, Oklahoma of which the Company owns interests in
limited liability companies ("LLC") which own and operate the facilities.
During 1997, the LLC which operates the specialized women's health center in
Lakeside, Oklahoma sold the real and personal property of this facility which
was then leased-back pursuant to the terms of a 20-year lease. The Company
spent $71 million during the year (net of $8 million of proceeds received for
sale-leaseback of the specialized women's health center located in Oklahoma
and $4 million received for sale of a minority interest in the specialized
women's health center located in Austin, Texas) for completion of these newly
constructed facilities. Also during the year, the Company spent an additional
$11 million to acquire various behavioral healthcare related businesses.

During 1996 the Company acquired the following facilities for total
consideration of $168 million: (i) substantially all the assets and operations
of a 357-bed medical complex located in Amarillo, Texas for $126 million in
cash; (ii) substantially all the assets and operations of four behavioral
health centers located in Pennsylvania and management contracts to seven other
behavioral health centers for $39 million in cash, and; (iii) substantially
all the assets and operations of a 164-bed behavioral health facility located
in Texas for $3 million in cash. Also during 1996, the Company spent $53
million on the construction of the new acute care facilities located in
Edinburg, Texas and Summerlin, Nevada which opened during 1997 as mentioned
above. In connection with the acquisition of the 357 bed medical complex
located in Amarillo, Texas, the Company is also required to pay additional
consideration to the seller equal to 15% of any amount of the hospital's
earnings before depreciation, interest and taxes in excess of $24 million in
each year of the seven-year period ending March 31, 2003. The additional
consideration paid in 1997 and 1998, which totaled approximately $600,000, was
accounted for as an increase to the previously recorded excess of cost over
face value of net assets acquired when determined in accordance with paragraph
79 of APB No. 16. In addition, under the terms of the agreement, the seller
will pay the Company $8 million per year for the first four years and $6
million per year (subject to certain adjustments for inflation) for up to an
additional 36 years to help support the cost of medical services to indigent
patients.

Capital expenditures, net of proceeds received from sale or disposition of
assets, were $91 million in 1998 (excluding $11 million of net cash
contributed by Quorum as mentioned above), $114 million in 1997 (including $71
million spent on the newly constructed facilities mentioned above) and $106
million in 1996 (including $53 million spent on the newly constructed
facilities mentioned above). Capital expenditures for capital equipment,

23

renovations and new projects at existing hospitals and completion of major
construction projects in progress at December 31, 1998 are expected to total
approximately $125 million in 1999. The Company believes that its capital
expenditure program is adequate to expand, improve and equip its existing
hospitals.

Total debt as a percentage of total capitalization was 40% at December 31,
1998, 35% at December 31, 1997 and 38% at December 31, 1996. The increase
during 1998 was due primarily to the 1998 purchase transactions mentioned
above, which were financed with borrowings under the Company's revolving
credit facility. To partially finance the 1996 purchase transactions mentioned
above, the Company issued four million shares of its Class B Common Stock at a
price of $26 per share during the second quarter of 1996. The total net
proceeds of $99.1 million generated from this stock issuance were used to
partially finance the 1996 purchase transactions mentioned above while the
excess of the purchase price over the net proceeds generated from the stock
issuance ($69 million) were financed from operating cash flows and borrowings
under the Company's commercial paper and revolving credit facilities.

During 1998, the Company amended its revolving credit agreement to increase
the borrowing capacity to $400 million from $300 million. The agreement
includes a $50 million sublimit for letters of credit. Also during 1998, the
banks participating in the Company's revolving credit agreement agreed to
fully discharge the obligation of the Company's subsidiaries to guarantee the
parent company's obligations under the revolving credit agreement. The
agreement, which matures in July 2002, provides for interest at the Company's
option at the prime rate, certificate of deposit plus 3/8% to 5/8%, Euro-
dollar plus 1/4% to 1/2% or money market. A facility fee ranging from 1/8% to
3/8% is required on the total commitment. The margins over the certificate of
deposit, the Euro-dollar rates and the facility fee are based upon the
Company's leverage ratio. As of December 31, 1998, the Company had $184
million of unused borrowing capacity available under the terms of the
revolving credit agreement.

Also during 1998, the Company amended its commercial paper credit facility
to increase the borrowing capacity to $100 million from $75 million. A large
portion of the Company's accounts receivable are pledged as collateral to
secure this commercial paper program. This annually renewable program, which
began in 1993, is scheduled to expire on October 30, 1999. As of December 31,
1998, the Company had $15 million of unused borrowing capacity under the terms
of the commercial paper facility.

The Company has two interest rate swap agreements that fix the rate of
interest on a notional principal amount of $50 million for a period of three
years expiring December 2001. The average fixed rate obtained through these
interest rate swaps is 6.2% including the Company's current borrowing spread
of .425%. The counterparties to these two interest rate swaps have the right
to terminate the swaps after the second year. The Company is also a party to
three forward starting interest rate swaps to hedge a total notional principal
amount of $75 million. The starting date on the interest rate swaps is August
2000 and they mature in August 2010. The average fixed rate including the
Company's current borrowing spread of .425% is 7.2%. At December 31, 1997 and
December 31, 1996 there were no active interest rate swap agreements.

The effective interest rate on the Company's revolving credit, demand and
commercial paper program, including the interest rate swap expense incurred on
existing and now expired interest rate swaps was 6.4%, 6.8% and 6.9% during
1998, 1997 and 1996, respectively. Additional interest expense recorded as a
result of the Company's hedging activity was $75,000, $0 and $47,000 in 1998,
1997 and 1996, respectively. The Company is exposed to credit loss in the
event of non-performance by the counterparty to the interest rate swap
agreements. All of the counterparties are major financial institutions rated
AA or better by Moody's Investor Service and the Company does not anticipate
non-performance. The cost to terminate the swap obligations at December 31,
1998 was approximately $6.9 million.

The Company expects to finance all capital expenditures and acquisitions
with internally generated funds and borrowed funds. Additional borrowed funds
may be obtained either through refinancing the existing revolving credit
agreement, the commercial paper facility or the issuance of securities.

24

ITEM 8. Financial Statements and Supplementary Data

The Company's Consolidated Balance Sheets, Consolidated Statements of
Income, Consolidated Statements of Common Stockholders' Equity, and
Consolidated Statements of Cash Flows, together with the report of Arthur
Andersen LLP, independent public accountants, are included elsewhere herein.
Reference is made to the "Index to Financial Statements and Financial
Statement Schedule."

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

There is hereby incorporated by reference the information to appear under
the caption "Election of Directors" in the Company's Proxy Statement, to be
filed with the Securities and Exchange Commission within 120 days after
December 31, 1998. See also "Executive Officers of the Registrant" appearing
in Part I hereof.

ITEM 11. Executive Compensation

There is hereby incorporated by reference the information to appear under
the caption "Executive Compensation" in the Company's Proxy Statement to be
filed with the Securities and Exchange Commission within 120 days after
December 31, 1998.

ITEM 12. Security Ownership of Certain Beneficial Owners and Management

There is hereby incorporated by reference the information to appear under
the caption "Security Ownership of Certain Beneficial Owners and Management"
in the Company's Proxy Statement, to be filed with the Securities and Exchange
Commission within 120 days after December 31, 1998.

ITEM 13. Certain Relationships and Related Transactions

There is hereby incorporated by reference the information to appear under
the caption "Certain Relationships and Related Transactions" in the Company's
Proxy Statement, to be filed with the Securities and Exchange Commission
within 120 days after December 31, 1998.

PART IV

ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K

(a) 1. and 2. Financial Statements and Financial Statement Schedule.

See Index to Financial Statements and Financial Statement Schedule on page
31.

(b) Reports on Form 8-K

None.

(c) Exhibits

3.1 Company's Restated Certificate of Incorporation, and Amendments thereto,
previously filed as Exhibit 3.1 to Registrant's Quarterly Report on Form 10-Q
for the quarter ended June 30, 1997, are incorporated herein by reference.

25

3.2 Bylaws of Registrant as amended, previously filed as Exhibit 3.2 to
Registrant's Annual Report on Form 10-K for the year ended December 31, 1987,
is incorporated herein by reference.

4.1 Authorizing Resolution adopted by the Pricing Committee of Universal
Health Services, Inc. on August 1, 1995, related to $135 million principal
amount of 8 3/4% Senior Notes due 2005, previously filed as Exhibit 10.1 to
Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30,
1995, is incorporated herein by reference.

4.2 Indenture dated as of July 15, 1995, between Universal Health Services,
Inc. and PNC Bank, National Association, Trustee, previously filed as Exhibit
10.2 to Registrant's Quarterly Report on Form 10-Q for the quarter ended June
30, 1995, is incorporated herein by reference.

10.1 Restated Employment Agreement, dated as of July 14, 1992, by and
between Registrant and Alan B. Miller, previously filed as Exhibit 10.3 to
Registrant's Annual Report on Form 10-K for the year ended December 31, 1993,
is incorporated herein by reference.

10.2 Form of Employee Stock Purchase Agreement for Restricted Stock Grants,
previously filed as Exhibit 10.12 to Registrant's Annual Report on Form 10-K
for the year ended December 31, 1985, is incorporated herein by reference.

10.3 Advisory Agreement, dated as of December 24, 1986, between Universal
Health Realty Income Trust and UHS of Delaware, Inc., previously filed as
Exhibit 10.2 to Registrant's Current Report on Form 8-K dated December 24,
1986, is incorporated herein by reference.

10.4 Agreement, effective January 1, 1999, to renew Advisory Agreement,
dated as of December 24, 1986, between Universal Health Realty Income Trust
and UHS of Delaware, Inc.

10.5 Form of Leases, including Form of Master Lease Document for Leases,
between certain subsidiaries of the Registrant and Universal Health Realty
Income Trust, filed as Exhibit 10.3 to Amendment No. 3 of the Registration
Statement on Form S-11 and Form S-2 of Registrant and Universal Health Realty
Income Trust (Registration No. 33-7872), is incorporated herein by reference.

10.6 Share Option Agreement, dated as of December 24, 1986, between
Universal Health Realty Income Trust and Registrant, previously filed as
Exhibit 10.4 to Registrant's Current Report on Form 8-K dated December 24,
1986, is incorporated herein by reference.

10.7 Corporate Guaranty of Obligations of Subsidiaries Pursuant to Leases
and Contract of Acquisition, dated December 24, 1986, issued by Registrant in
favor of Universal Health Realty Income Trust, previously filed as Exhibit
10.5 to Registrant's Current Report on Form 8-K dated December 24, 1986, is
incorporated herein by reference.

10.8 1990 Employees' Restricted Stock Purchase Plan, previously filed as
Exhibit 10.24 to Registrant's Annual Report on Form 10-K for the year ended
December 31, 1990, is incorporated herein by reference.

10.9 1992 Corporate Ownership Program, previously filed as Exhibit 10.24 to
Registrant's Annual Report on Form 10-K for the year ended December 31, 1991,
is incorporated herein by reference.

10.10 1992 Stock Bonus Plan, previously filed as Exhibit 10.25 to
Registrant's Annual Report on Form 10-K for the year ended December 31, 1991,
is incorporated herein by reference.

10.11 Sale and Servicing Agreement dated as of November 16, 1993 between
Certain Hospitals and UHS Receivables Corp., previously filed as Exhibit 10.16
to Registrant's Annual Report on Form 10-K for the year ended December 31,
1993, is incorporated herein by reference.

26

10.12 Amendment No. 2 dated as of August 31, 1998, to Sale and Servicing
Agreements dated as of various dates between each hospital company and UHS
Receivables Corp., previously filed as Exhibit 10.1 to Registrant's Quarterly
Report on Form 10-Q for the quarter ended September 30, 1998, is incorporated
herein by reference.

10.13 Servicing Agreement dated as of November 16, 1993, among UHS
Receivables Corp., UHS of Delaware, Inc. and Continental Bank, National
Association, previously filed as Exhibit 10.17 to Registrant's Annual Report
on Form 10-K for the year ended December 31, 1993, is incorporated herein by
reference.

10.14 Pooling Agreement dated as of November 16, 1993, among UHS Receivables
Corp., Sheffield Receivables Corporation and Continental Bank, National
Association, previously filed as Exhibit 10.18 to Registrant's Annual Report
on Form 10-K for the year ended December 31, 1993, is incorporated herein by
reference.

10.15 Amendment No. 1 to the Pooling Agreement dated as of September 30,
1994, among UHS Receivables Corp., Sheffield Receivables Corporation and Bank
of America Illinois (as successor to Continental Bank N.A.) as Trustee,
previously filed as Exhibit 10.1 to Registrant's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1994, is incorporated herein by reference.

10.16 Amendment No. 2, dated as of April 17, 1997 to Pooling Agreement dated
as of November 16, 1993, among UHS Receivables Corp., a Delaware corporation,
Sheffield Receivables Corporation, a Delaware corporation, and First Bank
National Association, a national banking association, as trustee, previously
filed as Exhibit 10.2 to Registrant's Quarterly Report on Form 10-Q for the
quarter ended March 30, 1997, is incorporated herein by reference.

10.17 Form of Amendment No. 3, dated as of August 31, 1998, to Pooling
Agreement dated as of November 16, 1993, among UHS Receivables Corp.,
Sheffield Receivables Corporation and U.S. Bank National Association
(successor to First Bank National Association and Continental Bank, National
Association).

10.18 Agreement, dated as of August 31, 1998, by and among each hospital
company signatory hereto, UHS Receivables Corp., a Delaware Corporation,
Sheffield Receivables Corporation and U.S. Bank National Association, as
Trustee, previously filed as Exhibit 10.2 to Registrant's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1998, is incorporated herein by
reference.

10.19 Guarantee dated as of November 16, 1993, by Universal Health Services,
Inc. in favor of UHS Receivables Corp., previously filed as Exhibit 10.19 to
Registrant's Annual Report on Form 10-K for the year ended December 31, 1993,
is incorporated herein by reference.

10.20 Amendment No. 1 to the 1992 Stock Bonus Plan, previously filed as
Exhibit 10.21 to Registrant's Annual Report on Form 10-K for the year ended
December 31, 1993, is incorporated herein by reference.

10.21 1994 Executive Incentive Plan, previously filed as Exhibit 10.22 to
Registrant's Annual Report on Form 10-K for the year ended December 31, 1993,
is incorporated herein by reference.

10.22 Credit Agreement, dated as of July 8, 1997 among Universal Health
Services, Inc., various banks and Morgan Guaranty Trust Company of New York,
as agent, previously filed as Exhibit 10.1 to Registrant's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1997, is incorporated herein by
reference.

10.23 Amendment No. 1, dated as of June 29, 1998, to the Credit Agreement
dated as of July 8, 1997, among Universal Health Services, Inc., the Banks
party thereto and Morgan Guaranty Trust Company of New York, as the Agent,
previously filed as Exhibit 10.1 to Registrant's Quarterly Report on Form 10-Q
for the quarter ended June 30, 1998, is incorporated herein by reference.

27

10.24 Amended and Restated 1989 Non-Employee Director Stock Option Plan,
previously filed as Exhibit 10.24 to Registrant's Annual Report on Form 10-K
for the year ended December 31, 1994, is incorporated herein by reference.

10.25 Asset Purchase Agreement dated as of February 6, 1996, among Amarillo
Hospital District, UHS of Amarillo, Inc. and Universal Health Services, Inc.,
previously filed as Exhibit 10.28 to Registrant's Annual Report on Form 10-K
for the year ended December 31, 1995, is incorporated herein by reference.

10.26 1992 Stock Option Plan, As Amended, previously filed as Exhibit 10.32
to Registrant's Annual Report on Form 10-K for the year ended December 31,
1997, is incorporated herein by reference.

10.27 Stock Purchase Plan, previously filed as Exhibit 10.27 to Registrant's
Annual Report on Form 10-K for the year ended December 31, 1995, is
incorporated herein by reference.

10.28 Asset Purchase Agreement dated as of April 19, 1996 by and among UHS
of PENNSYLVANIA, INC., a Pennsylvania corporation, and subsidiary of UNIVERSAL
HEALTH SERVICES, INC., a Delaware corporation, UHS, UHS OF DELAWARE, INC., a
Delaware corporation and subsidiary of UHS, WELLINGTON REGIONAL MEDICAL
CENTER, INC., a Florida corporation and subsidiary of UHS, FIRST HOSPITAL
CORPORATION, a Virginia corporation, FHC MANAGEMENT SERVICES, INC., a Virginia
corporation, HEALTH SERVICES MANAGEMENT, INC., a Pennsylvania corporation,
HORSHAM CLINIC, INC., d/b/a THE HORSHAM CLINIC, a Pennsylvania corporation,
CENTRE VALLEY MANAGEMENT, INC. d/b/a THE MEADOWS PSYCHIATRIC CENTER, a
Pennsylvania corporation, CLARION FHC, INC. d/b/a CLARION PSYCHIATRIC CENTER,
a Pennsylvania corporation, WESTCARE, INC., d/b/a ROXBURY, a Virginia
corporation and FIRST HOSPITAL CORPORATION OF FLORIDA, a Florida corporation,
previously filed as Exhibit 10.1 to Registrant's Quarterly Report on Form 10-Q
for the quarter ended March 31, 1996, is incorporated herein by reference.

10.29 $36.5 million Term Note dated May 3, 1996 between Universal Health
Services, Inc., a Delaware corporation, and First Hospital Corporation,
Horsham Clinic, Inc. d/b/a Horsham Clinic, Centre Valley Management, Inc.
d/b/a The Meadows Psychiatric Center, Clarion FHC, d/b/a/ Clarion Psychiatric
Center, Westcare, Inc. d/b/a Roxbury, FHC Management Services, Inc., Health
Services Management, Inc., First Hospital Corporation of Florida, previously
filed as Exhibit 10.2 to Registrant's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1996, is incorporated herein by reference.

10.30 Agreement of Limited Partnership of District Hospital Partners, L.P.
(a District of Columbia limited partnership) by and among UHS of D.C., Inc.
and The George Washington University, previously filed as Exhibit 10.1 to
Registrant's Quarterly Report on Form 10-Q for the quarters ended March 30,
1997, and June 30, 1997, is incorporated herein by reference.

10.31 Contribution Agreement between The George Washington University (a
congressionally chartered institution in the District of Columbia) and
District Hospital Partners, L.P. (a District of Columbia limited partnership),
previously filed as Exhibit 10.3 to Registrant's Quarterly Report on Form 10-Q
for the quarter ended June 30, 1997, is incorporated herein by reference.

10.32 Deferred Compensation Plan for Universal Health Services Board of
Directors, previously filed as Exhibit 10.1 to Registrant's Quarterly Report
on Form 10-Q for the quarter ended September 30, 1997, is incorporated herein
by reference.

10.33 Stock Purchase Agreement dated as of December 15, 1997, by and among
the Stockholders of Hospital San Pablo, Inc. and Universal Health Services,
Inc., and UHS of Puerto Rico, Inc., previously filed as Exhibit 10.29 to
Registrant's Annual Report on Form 10-K for the year ended December 31, 1997,
is incorporated herein by reference.

28

10.34 Valley/Desert Contribution Agreement dated January 30, 1998, by and
among Valley Hospital Medical Center, Inc. and NC-DSH, Inc. previously filed
as Exhibit 10.30 to Registrant's Annual Report on Form 10-K for the year ended
December 31, 1997, is incorporated herein by reference.

10.35 Summerlin Contribution Agreement dated January 30, 1998, by and among
Summerlin Hospital Medical Center, L.P. and NC-DSH, Inc., previously filed as
Exhibit 10.31 to Registrant's Annual Report on Form 10-K for the year ended
December 31, 1997, is incorporated herein by reference.

10.36 Supplemental Indenture Dated as of January 1, 1998 to Indenture Dated
as of July 15, 1995 between Universal Health Services, Inc. and PNC BANK,
National Association, Trustee, previously filed as Exhibit 10.1 to
Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31,
1998, is incorporated herein by reference.

10.37 1992 Corporate Ownership Program, as Amended.

22. Subsidiaries of Registrant.

24. Consent of Independent Public Accountants.

27. Financial Data Schedule.

Exhibits, other than those incorporated by reference, have been included in
copies of this Report filed with the Securities and Exchange Commission.
Stockholders of the Company will be provided with copies of those exhibits
upon written request to the Company.

29

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.

Universal Health Services, Inc.

/s/ Alan B. Miller
By: _________________________________
Alan B. Miller
President

March 10, 1999

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.

Signatures Title Date

/s/ Alan B. Miller Chairman of the March 10, 1999
- ------------------------------------- Board, President
Alan B. Miller and Director
(Principal
Executive Officer)

/s/ Sidney Miller Secretary and March 17, 1999
- ------------------------------------- Director
Sidney Miller

/s/ Anthony Pantaleoni Director March 17, 1999
- -------------------------------------
Anthony Pantaleoni

/s/ Robert H. Hotz Director March 17, 1999
- -------------------------------------
Robert H. Hotz

/s/ John H. Herrell Director March 17, 1999
- -------------------------------------
John H. Herrell

/s/ Paul R. Verkuil Director March 17, 1999
- -------------------------------------
Paul R. Verkuil

/s/ Leatrice Ducat Director March 17, 1999
- -------------------------------------
Leatrice Ducat

/s/ Kirk E. Gorman Senior Vice March 10, 1999
- ------------------------------------- President and Chief
Kirk E. Gorman Financial Officer

/s/ Steve Filton Vice President, March 10, 1999
- ------------------------------------- Controller and
Steve Filton Principal
Accounting Officer

30

UNIVERSAL HEALTH SERVICES, INC.

INDEX TO FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULE

(ITEM 14(a))

Consolidated Financial Statements:
Report of Independent Public Accountants on Consolidated Financial
Statements and Schedule................................................. 32
Consolidated Statements of Income for the three years ended December 31,
1998.................................................................... 33
Consolidated Balance Sheets as of December 31, 1998 and 1997............. 34
Consolidated Statements of Common Stockholders' Equity for the three
years ended December 31, 1998........................................... 35
Consolidated Statements of Cash Flows for the three years ended December
31, 1998................................................................ 36
Notes to Consolidated Financial Statements............................... 37
Supplemental Financial Statement Schedule II: Valuation and Qualifying
Accounts................................................................ 53

31

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Stockholders and Board of Directors of Universal Health Services, Inc.:

We have audited the accompanying consolidated balance sheets of Universal
Health Services, Inc. (Delaware corporation) and subsidiaries as of December
31, 1998 and 1997, and the related consolidated statements of income, common
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1998. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Universal
Health Services, Inc. and subsidiaries as of December 31, 1998 and 1997, and
the consolidated results of their operations and their cash flows for each of
the three years in the period ended December 31, 1998 in conformity with
generally accepted accounting principles.

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

Arthur Andersen LLP

Philadelphia, Pennsylvania
February 11, 1999

32

UNIVERSAL HEALTH SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

Year Ended December 31
--------------------------------
1998 1997 1996
---------- ---------- ----------
(In thousands, except per share
data)

Net revenues................................ $1,874,487 $1,442,677 $1,174,158
Operating charges
Operating expenses........................ 752,651 574,837 459,210
Salaries and wages........................ 671,140 514,407 420,525
Provision for doubtful accounts........... 139,526 108,790 80,820
Depreciation & amortization............... 105,442 80,686 71,941
Lease and rental expense.................. 46,516 38,401 37,484
Interest expense, net..................... 27,117 19,382 21,258
Nonrecurring charges...................... -- -- 4,063
---------- ---------- ----------
Total operating charges................. 1,742,392 1,336,503 1,095,301
---------- ---------- ----------
Income before minority interests and income
taxes...................................... 132,095 106,174 78,857
Minority interests in earnings (losses) of
consolidated entities...................... 9,083 251 (1,147)
---------- ---------- ----------
Income before income taxes.................. 123,012 105,923 80,004
Provision for income taxes.................. 43,454 38,647 29,333
---------- ---------- ----------
Net income.................................. $ 79,558 $ 67,276 $ 50,671
========== ========== ==========
Earnings per common share--basic............ $ 2.45 $ 2.08 $ 1.69
========== ========== ==========
Earnings per common & common share
equivalents--diluted....................... $ 2.39 $ 2.03 $ 1.65
========== ========== ==========
Weighted average number of common shares--
basic...................................... 32,511 32,321 30,054
Weighted average number of common share
equivalents................................ 782 777 744
---------- ---------- ----------
Weighted average number of common shares and
equivalents--diluted....................... 33,293 33,098 30,798
========== ========== ==========

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

33

UNIVERSAL HEALTH SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

December 31,
---------------------
1998 1997
---------- ----------
(Dollar amounts
in thousands)

ASSETS
Current Assets
Cash and cash equivalents................................ $ 1,260 $ 332
Accounts receivable, net................................. 256,354 180,252
Supplies................................................. 38,842 28,214
Deferred income taxes.................................... 10,838 11,105
Other current assets..................................... 12,321 10,119
---------- ----------
Total current assets.................................... 319,615 230,022

Property and Equipment
Land..................................................... 96,331 66,406
Buildings and improvements............................... 647,108 538,326
Equipment................................................ 364,978 308,695
Property under capital lease............................. 25,579 27,712
---------- ----------
1,133,996 941,139
Less accumulated depreciation............................ 396,530 328,881
---------- ----------
737,466 612,258
Funds restricted for construction........................ 43,413 41,031
Construction-in-progress................................. 27,943 9,822
---------- ----------
808,822 663,111

Other Assets
Excess of cost over fair value of net assets acquired.... 279,141 149,814
Deferred charges......................................... 13,533 10,852
Other.................................................... 26,984 31,550
---------- ----------
319,658 192,216
---------- ----------
$1,448,095 $1,085,349
========== ==========
LIABILITIES AND COMMON STOCKHOLDERS' EQUITY
Current Liabilities
Current maturities of long-term debt..................... $ 4,082 $ 5,655
Accounts payable......................................... 83,130 70,807
Accrued liabilities
Compensation and related benefits....................... 29,224 35,498
Interest................................................ 6,141 4,682
Taxes other than income................................. 9,858 9,586
Other................................................... 37,365 32,521
Federal and state taxes................................. 253 1,707
---------- ----------
Total current liabilities............................... 170,053 160,456

Other Noncurrent Liabilities............................. 80,172 90,593
Minority Interest........................................ 129,423 34,693
Long-Term Debt........................................... 418,188 272,466
Deferred Income Taxes.................................... 23,252 534
Commitments and Contingencies
Common Stockholders' Equity
Class A Common Stock, voting, $.01 par value; authorized
12,000,000 shares; issued and outstanding 2,057,929
shares in 1998 and 2,059,929 in 1997.................... 21 21
Class B Common Stock, limited voting, $.01 par value;
authorized 75,000,000 shares; issued and outstanding
29,901,218 shares in 1998 and 30,122,479 in 1997........ 299 301
Class C Common Stock, voting, $.01 par value; authorized
1,200,000 shares; issued and outstanding 207,230 shares
in 1998 and 207,230 in 1997............................. 2 2
Class D Common Stock, limited voting, $.01 par value;
authorized 5,000,000 shares; issued and outstanding
28,788 shares in 1998 and 32,063 in 1997................ -- --
Capital in excess of par value, net of deferred
compensation of $185 in 1998 and $295 in 1997........... 221,500 200,656
Retained earnings........................................ 405,185 325,627
---------- ----------
627,007 526,607
---------- ----------
$1,448,095 $1,085,349
========== ==========

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

34

UNIVERSAL HEALTH SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY

For the Years Ended December 31, 1998, 1997, and 1996

Capital in
Class A Class B Class C Class D Excess of Retained
Common Common Common Common Par Value Earnings Total
------- ------- ------- ------- ---------- -------- --------
(Amounts in thousands)

Balance January 1,
1996................... $ 11 $127 $ 1 -- $ 89,881 $207,680 $297,700
Common Stock
Issued................ -- 42 -- -- 103,871 -- 103,913
Converted............. (1) 1 -- -- -- -- --
Stock dividend........ 11 128 1 -- (140) -- --
Amortization of deferred
compensation........... -- -- -- -- 696 -- 696
Net income.............. -- -- -- -- -- 50,671 50,671
---- ---- ---- ---- -------- -------- --------
Balance January 1,
1997................... 21 298 2 -- 194,308 258,351 452,980
Common Stock
Issued................ -- 3 -- -- 6,141 -- 6,144
Amortization of deferred
compensation........... -- -- -- -- 286 -- 286
Cancellation of stock
grant.................. -- -- -- -- (79) -- (79)
Net income.............. -- -- -- -- -- 67,276 67,276
---- ---- ---- ---- -------- -------- --------
Balance January 1,
1998................... 21 301 2 -- 200,656 325,627 526,607
Common Stock
Issued................ -- 4 -- -- 10,791 -- 10,795
Repurchased........... -- (6) -- -- (24,900) -- (24,906)
Amortization of deferred
compensation........... -- -- -- -- 216 -- 216
After-tax gain on
partial sale of
subsidiary............. -- -- -- -- 34,737 -- 34,737
Net income.............. -- -- -- -- -- 79,558 79,558
---- ---- ---- ---- -------- -------- --------
Balance December 31,
1998................... $ 21 $299 $ 2 -- $221,500 $405,185 $627,007
==== ==== ==== ==== ======== ======== ========

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

35

UNIVERSAL HEALTH SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

Year Ended December 31
-------------------------------
1998 1997 1996
--------- --------- ---------
(Amounts in thousands)

Cash Flows from Operating Activities:
Net income................................... $ 79,558 $ 67,276 $ 50,671
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization............... 105,442 80,686 71,941
Other non-cash charges...................... -- -- 4,063
Changes in assets and liabilities, net of
effects from acquisitions and dispositions:
Accounts receivable........................ (20,060) (14,434) (93)
Accrued interest........................... 1,459 (217) (614)
Accrued and deferred income taxes.......... 3,541 16,241 15,699
Other working capital accounts............. (8,327) 13,315 3,434
Other assets and deferred charges.......... (6,220) 334 (5,125)
Earnings (losses) of minority partners,
net....................................... 9,083 251 (1,147)
Other...................................... (2,837) 6,947 (840)
Accrued insurance expense, net of
commercial premiums paid.................. 8,933 20,003 15,874
Payments made in settlement of self-
insurance claims.......................... (18,888) (16,232) (7,872)
--------- --------- ---------
Net cash provided by operating
activities............................... 151,684 174,170 145,991
--------- --------- ---------
Cash Flows from Investing Activities:
Property and equipment additions............. (96,808) (129,199) (105,728)
Acquisition of businesses.................... (189,332) (10,525) (168,429)
Proceeds received from merger, sale or
disposition of assets....................... 16,404 15,230 1,765
Funds restricted for construction related to
acquisition of business..................... -- (41,031) --
Note receivable related to acquisition....... -- -- (7,000)
--------- --------- ---------
Net cash used in investing activities..... (269,736) (165,525) (279,392)
--------- --------- ---------
Cash Flows from Financing Activities:
Additional borrowings........................ 152,199 25,000 41,800
Reduction of long-term debt.................. (8,050) (34,510) (7,699)
Distributions to minority partners........... (1,751) (671) (735)
Issuance of common stock..................... 1,488 1,580 100,289
Repurchase of common shares.................. (24,906) -- --
--------- --------- ---------
Net cash provided by (used in) financing
activities............................... 118,980 (8,601) 133,655
--------- --------- ---------
Increase in Cash and Cash Equivalents......... 928 44 254
Cash and Cash Equivalents, Beginning of
Period....................................... 332 288 34
--------- --------- ---------
Cash and Cash Equivalents, End of Period...... $ 1,260 $ 332 $ 288
========= ========= =========
Supplemental Disclosures of Cash Flow
Information:
Interest paid................................ $ 25,658 $ 19,599 $ 21,872
Income taxes paid, net of refunds............ $ 39,913 $ 22,265 $ 13,634
Supplemental Disclosures of Non-cash Investing and Financing Activities:
See Notes 2 and 6

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

36

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The consolidated financial statements include the accounts of Universal
Health Services, Inc. (the "Company"), its majority-owned subsidiaries and
partnerships controlled by the Company as the managing general partner. All
significant intercompany accounts and transactions have been eliminated. The
more significant accounting policies follow:

Nature of Operations: The principal business of the Company is owning and
operating acute care hospitals, behavioral health centers, ambulatory surgery
centers, radiation oncology centers and women's centers. At December 31, 1998,
the Company operated 44 hospitals, consisting of 21 acute care hospitals, 20
behavioral health centers and 3 specialized women's health centers, in 15
states, the District of Columbia and Puerto Rico. The Company, as part of its
Ambulatory Treatment Centers Division owns outright, or in partnership with
physicians, and operates or manages 24 surgery and radiation oncology centers
located in 12 states and the District of Columbia. As of December 31, 1998,
the Company held majority interests in three separate partnerships/limited
liability companies which own the property of, and manage, three radiation
therapy centers located in Kentucky and California. Since the Company does not
control the operations of these centers, the operating results of these
centers are not included in the Company's consolidated financial statements.

Services provided by the Company's hospitals include general surgery,
internal medicine, obstetrics, emergency room care, radiology, diagnostic
care, coronary care, pediatric services and behavioral health services. The
Company provides capital resources as well as a variety of management services
to its facilities, including central purchasing, information services, finance
and control systems, facilities planning, physician recruitment services,
administrative personnel management, marketing and public relations.

Net revenues from the Company's acute care hospitals, ambulatory and
outpatient treatment centers and women's center accounted for 87%, 85% and 85%
of consolidated net revenues in 1998, 1997 and 1996, respectively.

Net Revenues: Net revenues are reported at the estimated net realizable
amounts from patients, third-party payors, and others for services rendered,
including estimated retroactive adjustments under reimbursement agreements
with third-party payors. These net revenues are accrued on an estimated basis
in the period the related services are rendered and adjusted in future periods
as final settlements are determined. Medicare and Medicaid net revenues
represented 46%, 50% and 51% of net patient revenues for the years 1998, 1997
and 1996, respectively.

Concentration of Revenues: Valley Hospital Medical Center and McAllen
Medical Center each contributed 10% of the Company's 1998 consolidated net
revenues.

Accounts Receivable: Accounts receivable are recorded at the estimated net
realizable amounts from patients, third-party payors and others for services
rendered, net of contractual allowances and net of allowance for doubtful
accounts of $60.5 million and $46.6 million in 1998 and 1997, respectively.

Property and Equipment: Property and equipment are stated at cost.
Expenditures for renewals and improvements are charged to the property
accounts. Replacements, maintenance and repairs which do not improve or extend
the life of the respective asset are expensed as incurred. The Company removes
the cost and the related accumulated depreciation from the accounts for assets
sold or retired and the resulting gains or losses are included in the results
of operations. The Company capitalized $1.1 million and $800,000 of interest
costs related to construction in progress in 1997 and 1996, respectively. No
interest was capitalized in 1998.

37

Depreciation is provided on the straight-line method over the estimated
useful lives of buildings and improvements (twenty to forty years) and
equipment (five to fifteen years).

Other Assets: The excess of cost over fair value of net assets acquired in
purchase transactions, net of accumulated amortization of $72.2 million in
1998 and $53.5 million in 1997, is amortized using the straight-line method
over periods ranging from five to forty years. As of December 31, 1998, the
weighted average amortization period is approximately eighteen years.

During 1994, the Company established an employee life insurance program
covering approximately 2,200 employees. At December 31, 1998 and 1997, the
cash surrender value of the policies ($103 million in both years) were
recorded net of related loans ($102 million in both years) and is included in
other assets.

Long-Lived Assets: It is the Company's policy to review the carrying value
of long-lived assets for impairment whenever events or changes in
circumstances indicate that the carrying value of such assets may not be
recoverable.

Measurement of the impairment loss is based on fair value of the asset.
Generally, fair value will be determined using valuation techniques such as
the present value of expected future cash flows.

During 1996, the Company recorded a $2.9 million charge to write-down the
carrying value of an ambulatory treatment center (which was divested in 1997)
to its net realizable value. Also during 1996, the Company recorded a $1.2
million charge to fully reserve the carrying value of a behavioral health
center property which is leased to an unaffiliated third party, which was in
default under terms of the lease agreement.

Income Taxes: The Company and its subsidiaries file consolidated federal
tax returns. Deferred taxes are recognized for the amount of taxes payable or
deductible in future years as a result of differences between the tax bases of
assets and liabilities and their reported amounts in the financial statements.

Other Noncurrent Liabilities: Other noncurrent liabilities include the
long-term portion of the Company's professional and general liability,
workers' compensation reserves and pension liability.

Minority Interest Liabilities: As of December 31, 1998, the $129.4 million
minority interest balance consists primarily of a 27.5% outside ownership
interest in three acute care facilities located in Las Vegas, Nevada and a 20%
outside ownership interest in an acute care facility located in Washington,
DC.

Earnings per Share: Basic earnings per share are based on the weighted
average number of common shares outstanding during the year. Diluted earnings
per share are based on the weighted average number of common shares
outstanding during the year adjusted to give effect to common stock
equivalents. All per share amounts for all periods presented have been
restated to conform to Statement of Financial Accounting Standards No. 128.

Stock-Based Compensation: SFAS No. 123 encourages a fair value based method
of accounting for employee stock options and similar equity instruments, which
generally would result in the recording of additional compensation expense in
the Company's financial statements. The Statement also allows the Company to
continue to account for stock-based employee compensation using the intrinsic
value for equity instruments using APB Opinion No. 25. The Company has adopted
the disclosure-only provisions of SFAS No. 123. Accordingly, no compensation
cost has been recognized for the stock option plans in the accompanying
financial statements.

Statement of Cash Flows: For purposes of the consolidated statements of
cash flows, the Company considers all highly liquid investments purchased with
maturities of three months or less to be cash equivalents. Interest expense in
the consolidated statements of income is net of interest income of $2.6
million, $1.3 million and $173,000 in 1998, 1997 and 1996, respectively.

38

Interest Rate Swap Agreements: In managing interest rate exposure, the
Company at times enters into interest rate swap agreements. When interest
rates change, the differential to be paid or received is accrued as interest
expense and is recognized over the life of the agreements. Gains and losses on
terminated interest rate swap agreements are amortized into income over the
remaining life of the underlying debt obligation or the remaining life of the
original swap, if shorter.

Fair Value of Financial Instruments: The fair values of the Company's
registered debt, interest rate swap agreements and investments are based on
quoted market prices. The carrying amounts reported in the balance sheet for
cash, accrued liabilities, and short-term borrowings approximates their fair
values due to the short-term nature of these instruments. Accordingly, these
items have been excluded from the fair value disclosures included elsewhere in
these notes to consolidated financial statements.

Comprehensive Income: In June 1997, the Financial Accounting Standards
Board ("FASB") issued SFAS No. 130, "Reporting Comprehensive Income". The
standard establishes additional disclosure for the elements of comprehensive
income and a total comprehensive income calculation. Net income as reported by
the Company reflects total comprehensive income for the years ended December
31, 1998, 1997 and 1996.

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

Reclassifications: Certain prior year amounts have been reclassed to
conform with the current year presentation.

Accounting Pronouncement Not Yet Adopted: In June 1998, the FASB issued
SFAS No 133, "Accounting Derivative Instruments and Hedging Activities". The
Statement establishes accounting and reporting standards requiring that every
derivative instrument (including certain derivative instruments embedded in
other contracts) be recorded in the balance sheet as either and asset or
liability measured at its fair value. The Statement requires that changes in
the derivative's fair value be recognized currently in earnings unless
specific hedge accounting criteria are met. Special accounting for qualifying
hedges allows a derivative's gains and losses to offset related results on the
hedged item in the income statement, and requires that a company must formally
document, designate, and assess the effectiveness of transactions that receive
hedge accounting.

SFAS No 133 is effective as of the beginning of fiscal years beginning after
June 15, 1999. A company may also implement the SFAS No. 133 as of the
beginning of any fiscal quarter after the issuance. SFAS No. 133 cannot be
applied retroactively. SFAS No. 133 must be applied to: (a) derivative
instruments, and; (b) certain derivative instruments embedded in hybrid
contracts that were issued, acquired, or substantially modified after December
31, 1997 (and at the Company's election, before January 1, 1998).

The Company has not yet quantified the impact of adopting SFAS No. 133 on
its financial statements and has not determined the timing of or method of
adoption of SFAS No. 133. However, SFAS No. 133 could increase the volatility
in earnings and other comprehensive income.

2) ACQUISITIONS AND DIVESTITURES

1999 -- The Company executed a letter of intent to purchase three behavioral
health services facilities located in Illinois, Indiana and New Jersey. Also,
the Company executed a letter of intent to purchase two additional behavioral
health services facilities located in Illinois. Both of these transactions,
which are subject to regulatory approval, are expected to be completed in the
second quarter of 1999 for a combined purchase price of approximately $46
million.

39

1998 -- During the first quarter of 1998, the Company acquired three
hospitals located in Puerto Rico for an aggregate purchase price of $187
million. The hospitals acquired were Hospital San Pablo located in Bayamon
(430-beds), Hospital San Francisco located in Rio Piedras (160-beds) and
Hospital San Pablo del Este located in Fajardo (180-beds). The Hospital San
Pablo del Este, which had been closed prior to acquisition, was reopened in
April, 1998 after completion of renovations.

Also during the first quarter of 1998, the Company contributed substantially
all of the assets, liabilities and operations of Valley Hospital Medical
Center, a 417-bed acute care facility, and its newly-constructed Summerlin
Hospital, a 148-bed acute care facility in exchange for a 72.5% interest in a
series of newly-formed limited liability corporations ("LLCs"). Quorum Health
Group, Inc. ("Quorum") holds the remaining 27.5% interest in the LLCs. Quorum
obtained its interest by contributing substantially all of the assets,
liabilities and operations of Desert Springs Hospital, a 241-bed acute care
facility, and $11 million of net cash to the LLCs. The assets and liabilities
contributed by the Company were recorded by the LLCs at carryover value. The
LLCs applied purchase accounting to the assets and liabilities provided by
Quorum and recorded them at fair market value. As a result of this partial
sale transaction, the Company recorded a pre-tax gain of $55.1 million ($34.7
million after-tax) that was recorded as a capital contribution to the Company.
The Company elected the option of recording the gain to capital in excess of
par value in the consolidated balance sheet. The option must be consistently
applied to all future gains and losses arising from similar transactions and
is adopted as a company accounting policy. Also during 1998, the Company spent
$2 million to purchase the property of a radiation therapy center located in
California.

The aggregate net purchase price of the transactions mentioned above of $178
million ($189 million cash paid less $11 million of net cash received), was
allocated to assets and liabilities based on their estimated fair values as
follows:

Amount
(000s)
--------

Working capital, net............................................... $ 34,000
Land............................................................... 23,000
Buildings & equipment.............................................. 110,000
Goodwill........................................................... 152,000
Minority interest liability........................................ (85,000)
Deferred income taxes.............................................. (21,000)
Additional paid in capital......................................... (35,000)
--------
Total Purchase Price............................................. $178,000
========

Assuming the 1998 acquisition of Hospital San Pablo and Hospital San
Francisco had been completed as of January 1, 1998, the effect on the December
31, 1998 unaudited pro forma net revenues, net income and basic and diluted
earnings per share would have been immaterial, as the acquisitions occurred
early in 1998. Assuming the above mentioned 1998 acquisitions and the 1997
acquisition of The George Washington University Hospital ("GWUH") had been
completed as of January 1, 1997, the unaudited pro forma net revenues and net
income for the year ended December 31, 1997 would have been approximately $1.6
billion and $63.9 million, respectively. In addition, the unaudited pro forma
basic and diluted earnings per share would have been $1.98 and $1.93,
respectively.

1997 -- During the third quarter of 1997 the Company acquired an 80%
interest in a partnership which owns and operates GWUH, a 501-bed acute care
facility located in Washington, DC. The George Washington University ("GWU")
holds a 20% interest in the partnership. In connection with this acquisition,
theCompany provided an immediate commitment of $80 million, consisting of $40
million in cash (which has been invested and is restricted for construction)
and a $40 million letter of credit. The Company and GWU are planning to build
a newly constructed 371-bed acute care facility which is scheduled to be
completed in 2001. The total cost of this new facility is estimated to be
approximately $96 million, of which the Company intends

40

to finance a total of $83 million (including the $80 million immediate
commitment mentioned above) with the remainder being financed by GWU and the
interest earnings on the $40 million of funds restricted for construction.

In addition, during the third and fourth quarter of 1997 the Company
completed construction and opened the following facilities: (i) a 129-bed
acute care facility located in Edinburg, Texas; (ii) a medical complex located
in Summerlin, Nevada including a 148-bed acute care facility, and; (iii) two
newly constructed specialized women's health centers located in Austin, Texas
and Lakeside, Oklahoma of which the Company owns interests in limited
liability companies ("LLC") which own and operate the facilities. The Company
spent a total of $71 million during 1997 for completion of these newly
constructed facilities. Also during 1997, the Company spent an additional $11
million to acquire various behavioral healthcare related businesses.

Assuming the 1997 acquisition of GWUH had been completed as of January 1,
1997, the unaudited pro forma net revenues would have been $1.5 billion and
the effect on net income and basic and diluted earnings per share would have
been immaterial.

1996 -- During the second quarter, the Company completed the acquisition of
Northwest Texas Healthcare System, a 357-bed medical complex located in
Amarillo, Texas for $126 million in cash. The assets acquired include the real
and personal property, working capital and tangible assets. The Company also
will be required to pay additional consideration to the seller equal to 15% of
any amount of the hospital's earnings before depreciation, interest and taxes
in excess of $24 million in each year of the seven-year period ending March
31, 2003. The additional consideration paid in 1997 and 1998, which totaled
approximately $600,000, was accounted for as an increase to the previously
recorded excess of cost over face value of net assets acquired when determined
in accordance with paragraph 79 of APB No. 16. In addition, under the terms of
the agreement, the seller will pay the Company $8 million per year for the
first four years and $6 million per year (subject to certain adjustments for
inflation) for up to an additional 36 years to help support the cost of
medical services to indigent patients.

During the second quarter, the Company acquired four behavioral health
centers located in Pennsylvania, management contracts for seven other
behavioral health centers and 33 acres of land adjacent to the Company's
Wellington Regional Medical Center, for $39 million. In 1997, the Company paid
additional consideration of $8 million, based upon the facilities' combined
earnings, as defined, for the 12-month period ending April 30, 1997. This
additional consideration was recorded as additional goodwill in the 1997
financial statements.

During the third quarter of 1996, the Company acquired a 164-bed behavioral
health center located in Texas for $3 million. Also during the fourth quarter
of 1996, as a result of divestiture negotiations with a third party regarding
one of the Company's ambulatory treatment centers, the Company recorded a $2.9
million charge to write-down the carrying value of the center to its net
realizable value. The divestiture of this facility was completed during the
first quarter of 1997.

The aggregate purchase price for these acquisitions of $168 million,
excluding the additional contingent consideration recorded in 1997 and 1998,
was allocated to assets and liabilities based on their estimated fair values
as follows:

Amount
(000s)
--------

Working capital, net................................................ $ 25,000
Land................................................................ 9,000
Buildings & equipment............................................... 110,000
Goodwill............................................................ 24,000
--------
Total Purchase Price.............................................. $168,000
========

41

Assuming the 1996 acquisitions had been completed as of January 1, 1996, the
unaudited pro forma net revenues and net income for the year ended December
31, 1996 would have been approximately $1.3 billion and $53.4 million,
respectively. In addition, the unaudited pro forma basic and diluted earnings
per share would have been $1.78 and $1.73, respectively.

The acquisitions mentioned above have been accounted for using the purchase
method of accounting. The excess of cost over fair value of net tangible
assets relating to these acquisitions is being amortized over periods ranging
from fifteen to thirty-five years. Operating results from all of the
businesses acquired have been included in the financial statements from their
respective dates of acquisitions. The unaudited pro forma financial
information presented above may not be indicative of results that would have
been reported if the acquisitions had occurred at the beginning of the
earliest period presented and may not be indicative of future operating
results.

3) LONG-TERM DEBT

A summary of long-term debt follows:

December 31
-----------------
1998 1997
-------- --------
(000s)

Long-term debt:
Notes payable and Mortgages payable (including
obligations under capitalized leases of $4,185 in 1998
and $8,020 in 1997) with varying maturities through
2001; weighted average interest at 6.8% in 1998 and
6.7% in 1997 (see Note 6 regarding capitalized
leases)............................................... $ 9,062 $ 14,764
Revolving credit and demand notes...................... 175,740 36,000
Commercial paper....................................... 85,000 75,000
Revenue bonds:
Interest at floating rates ranging from 3.4% to 3.6%
at December 31, 1998 with varying maturities through
2015................................................ 18,200 18,200
8.75% Senior Notes due 2005, net of the unamortized
discount of $732 in 1998 and $843 in 1997............... 134,268 134,157
-------- --------
422,270 278,121
Less-Amounts due within one year......................... 4,082 5,655
-------- --------
$418,188 $272,466
======== ========

The Company has $135 million of Senior Notes which have an 8.75% coupon rate
and which mature on August 15, 2005. The Notes can be redeemed in whole or in
part, at any time on or after August 15, 2000, initially at a price of 102%,
declining ratably to par on or after August 15, 2002. The interest on the
bonds is paid semi-annually in arrears on February 15 and August 15 of each
year. In anticipation of the Senior Note issuance, the Company entered into
interest rate swap agreements having a total notional principal amount of $100
million to hedge the interest rate on the Notes. These interest rate swaps
were terminated simultaneously with the issuance of the Notes at which time
the Company paid a net termination fee of $5.4 million which is being
amortized ratably over the ten year term of the Senior Notes. The effective
rate on the Notes including the amortization of swap termination fees and bond
discount is 9.2%.

The Company has an unsecured non-amortizing revolving credit agreement,
which expires on July 8, 2002. Borrowing capacity under the agreement was
increased in April, 1998 from $300 million to $400 million. The agreement
includes a $50 million sublimit for letters of credit. Also during 1998, the
banks participating in the Company's revolving credit agreement agreed to
fully discharge the obligation of the Company's subsidiaries to guarantee the
parent company's obligations under the revolving credit agreement. The
interest rate on borrowings

42

is determined at the Company's option at the prime rate, certificate of
deposit rate plus 3/8% to 5/8%, Euro-dollar plus 1/4% to 1/2% or a money
market rate. A facility fee ranging from 1/8% to 3/8% is required on the total
commitment. The margins over the certificate of deposit, the Euro-dollar rates
and the facility fee are based upon the Company's leverage ratio. At December
31, 1998 the applicable margins over the certificate of deposit and the Euro-
dollar rate were .55% and .425%, respectively, and the commitment fee was
.20%. There are no compensating balance requirements. At December 31, 1998,
the Company had $184 million of unused borrowing capacity available under the
revolving credit agreement.

The average amounts outstanding during 1998, 1997 and 1996 under the
revolving credit and demand notes and commercial paper program were $234.2
million, $100.3 million, and $108.1 million, respectively, with corresponding
effective interest rates of 6.4%, 6.8%, and 6.9% including commitment and
facility fees. The maximum amounts outstanding at any month-end were, $289.6
million, $124.2 million, and $220.7 million during 1998, 1997 and 1996,
respectively.

Also during 1998, the Company amended its commercial paper credit facility
to increase the borrowing capacity to $100 million from $75 million. A large
portion of the Company's accounts receivable are pledged as collateral to
secure this commercial paper program. A commitment fee of .40% is required on
the used portion and .20% on the unused portion of the commitment. This
annually renewable program, which began in November, 1993, is scheduled to
expire on October 30, 1999. Outstanding amounts of commercial paper that can
be refinanced through available borrowings under the Company's revolving
credit agreement are classified as long-term. As of December 31, 1998, the
Company had $15 million unused borrowing capacity under the terms of the
commercial paper facility.

The Company has two interest rate swap agreements that fix the rate of
interest on a notional principal amount of $50 million for a period of three
years expiring December, 2001. The average fixed rate obtained through these
interest rate swaps is 6.20% including the Company's current borrowing spread
of .425%. The counterparties to these two interest rate swaps have the right
to terminate the swaps after the second year. The Company is also a party to
three forward starting interest rate swaps to hedge a total notional principal
amount of $75 million. The starting date on the interest rate swaps is August
2000 and they mature in August 2010. The average fixed rate including the
Company's current borrowing spread of .425% is 7.2%. At December 31, 1997 and
December 31, 1996 there were no active interest rate swap agreements. The
effective interest rate on the Company's revolving credit, demand notes and
commercial paper program, including the interest rate swap expense incurred on
existing and now expired interest rate swaps, was 6.4%, 6.8%, and 6.9% during
1998, 1997 and 1996, respectively. Additional interest expense recorded as a
result of the Company's hedging activity was $75,000, $0, and $47,000 in 1998,
1997 and 1996, respectively. The Company is exposed to credit loss in the
event of non-performance by the counterparty to the interest rate swap
agreements. All of the counterparties are creditworthy financial institutions
rated AA or better by Moody's Investor Service and the Company does not
anticipate non-performance. The cost to terminate the swap obligations at
December 31, 1998 was approximately $6.9 million.

Covenants relating to long-term debt require maintenance of a minimum net
worth, specified debt to total capital and fixed charge coverage ratios. The
Company is in compliance with all required covenants as of December 31, 1998.

The fair value of the Company's long-term debt at December 31, 1998 and 1997
was approximately $429.0 million and $285.9 million, respectively.

Aggregate maturities follow:

(000s)
--------

1999................................................................ $ 4,082
2000................................................................ 3,438
2001................................................................ 286
2002................................................................ 261,996
2003................................................................ 0
Later............................................................... 152,468
--------
Total............................................................. $422,270
========

43

4) COMMON STOCK

In April 1996 the Company declared a two-for-one stock split in the form of
a 100% stock dividend which was paid on May 17, 1996 to shareholders of record
as of May 6, 1996. All classes of common stock participated on a pro rata
basis. All references to share quantities and share prices shown below have
been adjusted to reflect the two-for-one stock split. In June 1996, the
Company issued four million shares of its Class B Common Stock at a price of
$26 per share. The total net proceeds of approximately $99.1 million generated
from this offering were used to partially finance the purchase transactions
mentioned in Note 2.

During the third quarter of 1998, the Company's Board of Directors approved
a stock repurchase program under which the Company is authorized to purchase
up to two million shares or approximately 6% of its outstanding Class B Common
Stock. As of December 31, 1998, the Company repurchased 580,500 shares at an
average repurchase price of $42.90 per share ($24.9 million in the aggregate)
pursuant to this program.

At December 31, 1998, 5,393,733 shares of Class B Common Stock were reserved
for issuance upon con- version of shares of Class A, C and D Common Stock
outstanding, for issuance upon exercise of options to purchase Class B Common
Stock, and for issuance of stock under other incentive plans. Class A, C and D
Common Stock are convertible on a share for share basis into Class B Common
Stock.

SFAS No. 123 requires the Company to disclose pro-forma net income and pro-
forma earnings per share as if compensation expense were recognized for
options granted beginning in 1995. Using this approach, the Company's net
earnings and earnings per share would have been the pro forma amounts
indicated below:

Year Ended December 31
--------------------------------
1998 1997 1996
---------- ---------- ----------
(000s, except per share amounts)

Net Income:
As Reported............................... $ 79,558 $ 67,276 $ 50,671
Pro Forma................................. $ 78,362 $ 66,672 $ 50,217
Earnings Per Share:
As Reported:
Basic .................................. $ 2.45 $ 2.08 $ 1.69
Diluted................................. $ 2.39 $ 2.03 $ 1.65
Pro Forma:
Basic .................................. $ 2.41 $ 2.06 $ 1.67
Diluted................................. $ 2.35 $ 2.01 $ 1.63

The fair value of each option grant was estimated on the date of grant using
the Black-Scholes option-pricing model with the following range of assumptions
used for the nine option grants that occurred during 1998, 1997 and 1996:

Year Ended December 31 1998 1997 1996
- ---------------------- ------ ------ ------

Volatility.............................................. 21%-28% 21%-23% 26%-30%
Interest rate........................................... 5%-6% 6%-7% 6%-7%
Expected life (years)................................... 4.1 4.2 4.1
Forfeiture rate......................................... 2% 2% 3%

Stock-based compensation costs on a pro forma basis would have reduced
pretax income by $1.9 million ($1.2 million after-tax) in 1998, $1.0 million
($604,000 after-tax) in 1997 and $735,000 ($454,000 after-tax) in 1996.
Because the SFAS 123 method of accounting has not been applied to options
granted prior to January 1, 1995, the resulting pro forma disclosures may not
be representative of that to be expected in future years.

Stock options to purchase Class B Common Stock have been granted to
officers, key employees and directors of the Company under various plans.

44

Information with respect to these options is summarized as follows:

Average
Number Option Range
Outstanding Options of Shares Price (High-Low)
- ------------------- --------- ------- ----------------

Balance, January 1, 1996................... 1,969,522 $12.14 $17.00-$ 5.56
Granted.................................. 54,100 $24.40 $25.13-$22.94
Exercised................................ (467,974) $ 9.43 $16.56-$ 5.56
Cancelled................................ (21,600) $ 9.76 $11.13-$ 6.94
- -------------------------------------------------------------------------------
Balance, January 1, 1997................... 1,534,048 $13.43 $25.13-$ 5.69
Granted.................................. 243,250 $41.22 $44.56-$37.88
Exercised................................ (319,225) $11.30 $25.13-$ 5.69
Cancelled................................ (42,500) $12.54 $25.13-$ 9.81
- -------------------------------------------------------------------------------
Balance, January 1, 1998................... 1,415,573 $18.71 $44.56-$ 7.44
Granted.................................. 448,000 $51.73 $56.56-$47.81
Exercised................................ (262,511) $14.46 $41.25-$ 7.44
Cancelled................................ (8,500) $37.89 $47.81-$23.25
- -------------------------------------------------------------------------------
Balance, December 31, 1998................. 1,592,562 $28.60 $56.5625-$9.8125
- -------------------------------------------------------------------------------

Outstanding Options at December 31, 1998:

Average Option Range
Number of Shares Price (High-Low) Contractual Life
- ---------------- -------------- ------------- ----------------

711,413 $46.92 $56.56-$23.25 4.3
881,150 $13.80 $ 22.94-$9.81 1.4
---------
1,592,563
=========

All stock options were granted with an exercise price equal to the fair
market value on the date of the grant. Options are exercisable ratably over a
four-year period beginning one year after the date of the grant. The options
expire five years after the date of the grant. The outstanding stock options
at December 31, 1998 have an average remaining contractual life of 2.7 years.
At December 31, 1998, options for 321,699 shares were available for grant. At
December 31, 1998, options for 791,447 shares of Class B Common Stock with an
aggregate purchase price of $12.0 million (average of $15.15 per share) were
exercisable. In connection with the stock option plan, the Company provides
the optionee with a three year loan to cover the tax liability incurred upon
exercise of the options. The loan is forgiven on the maturity date if the
optionee is employed by the Company on that date. The Company recorded
compensation expense over the service period and recognized compensation
expense of $8.4 million in 1998, $5.1 million in 1997 and $3.9 million in 1996
in connection with this loan program.

In addition to the stock option plan the Company has the following stock
incentive and purchase plans: (i) a Stock Compensation Plan which expires in
November, 2004 under which Class B Common Shares may be granted to key
employees, consultants and independent contractors (officers and directors are
ineligible); (ii) a Stock Bonus Plan pursuant to the terms of which eligible
employees may elect to receive all or part of their annual bonus in shares of
restricted stock and whereby the Company will provide a 20% match on the
portion of the bonus received in shares of restricted stock; (iii) a Stock
Ownership Plan whereby eligible employees may purchase shares of Class B
Common Stock directly from the Company at current market value and the Company
will loan each eligible employee 90% of the purchase price for the shares,
subject to certain limitations, (loans are partially recourse to the
employees); (iv) a Restricted Stock Purchase Plan which allows eligible
participants to purchase shares of Class B Common Stock at par value, subject
to certain restrictions, and; (v) a Stock Purchase Plan which allows eligible
employees to purchase shares of Class B Common Stock at a ten percent
discount. The Company has reserved 2 million shares of Class B Common Stock
for issuance under these various plans and has issued 842,127 shares pursuant
to the terms of these plans as of December 31, 1998, of which 42,010, 41,196
and 74,871 became fully vested during 1998, 1997 and 1996, respectively.
Compensation expense of $488,000 in 1998, $5.2 million in 1997 and $2.8
million in 1996 was recognized in connection with these plans.

45

5) INCOME TAXES

Components of income tax expense are as follows:

Year Ended December 31 (000s)
-----------------------------
1998 1997 1996
--------- --------- ---------

Currently payable
Federal......................................... $ 18,731 $ 23,923 $ 13,888
State........................................... 1,738 2,989 1,479
--------- --------- ---------
20,469 26,912 15,367
Deferred
Federal......................................... 21,122 10,201 12,140
State........................................... 1,863 1,534 1,826
--------- --------- ---------
22,985 11,735 13,966
--------- --------- ---------
Total......................................... $ 43,454 $ 38,647 $ 29,333
========= ========= =========

The Company accounts for income taxes under the provisions of Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes," (SFAS
109). Under SFAS 109, deferred taxes are required to be classified based on
the financial statement classification of the related assets and liabilities
which give rise to temporary differences. Deferred taxes result from temporary
differences between the financial statement carrying amounts and the tax bases
of assets and liabilities.

The components of deferred taxes are as follows:

Year Ended
December 31
------------------
1998 1997
-------- --------
(000s)

Self-insurance reserves.................................. $ 31,984 $ 36,079
Doubtful accounts and other reserves..................... (1,699) (694)
State income taxes....................................... 766 (800)
Other deferred tax assets................................ 7,532 4,654
Depreciable and amortizable assets....................... (50,997) (28,668)
-------- --------
Total deferred taxes................................... $(12,414) $ 10,571
======== ========

A reconciliation between the federal statutory rate and the effective tax
rate is as follows:

Year Ended
December 31
----------------
1998 1997 1996
---- ---- ----

Federal statutory rate..................................... 35.0% 35.0% 35.0%
Deductible depreciation, amortization and other............ (1.6) (1.3) (1.0)
State taxes, net of federal income tax benefit............. 1.9 2.8 2.7
---- ---- ----
Effective tax rate....................................... 35.3% 36.5% 36.7%
==== ==== ====

46

In 1998 and 1997, the Company reviewed its deferred state tax balances and
as a result reduced its tax provision by $390,000 in each year. The net
deferred tax assets and liabilities are comprised as follows:

Year Ended
December 31
------------------
1998 1997
-------- --------
(000s)

Current deferred taxes
Assets................................................. $ 12,315 $ 11,799
Liabilities............................................ (1,477) (694)
-------- --------
Total deferred taxes--current........................ 10,838 11,105
Noncurrent deferred taxes
Assets................................................. 27,967 28,934
Liabilities............................................ (51,219) (29,468)
-------- --------
Total deferred taxes--noncurrent..................... (23,252) (534)
-------- --------
Total deferred taxes..................................... $(12,414) $ 10,571
======== ========

The assets and liabilities classified as current relate primarily to the
allowance for uncollectible patient accounts and the current portion of the
temporary differences related to self-insurance reserves. Under SFAS 109, a
valuation allowance is required when it is more likely than not that some
portion of the deferred tax assets will not be realized. Realization is
dependent on generating sufficient future taxable income. Although realization
in not assured, management believes it is more likely than not that all the
deferred tax assets will be realized. Accordingly, the Company has not
provided a valuation allowance. The amount of the deferred tax asset
considered realizable, however, could be reduced if estimates of future
taxable income during the carry forward period are reduced.

6) LEASE COMMITMENTS

Certain of the Company's hospital and medical office facilities and
equipment are held under operating or capital leases which expire through 2006
(See Note 8). Certain of these leases also contain provisions allowing the
Company to purchase the leased assets during the term or at the expiration of
the lease at fair market value.

A summary of property under capital lease follows:

Year Ended December 31
-----------------------
1998 1997
----------- -----------
(000s)

Land, buildings and equipment....................... $ 25,579 $ 27,712
Less: accumulated amortization...................... 22,084 20,592
----------- -----------
$ 3,495 $ 7,120
=========== ===========

47

Future minimum rental payments under lease commitments with a term of more
than one year as of December 31, 1998, are as follows:

Capital Operating
Year Leases Leases
---- ------- ---------
(000s)

1999....................................................... $2,967 $ 21,180
2000....................................................... 1,321 18,949
2001....................................................... 136 16,864
2002....................................................... -- 10,947
2003....................................................... -- 10,065
Later Years................................................ -- 30,003
------ --------
Total minimum rental..................................... $4,424 $108,008
========
Less: Amount representing interest......................... 239
------
Present value of minimum rental commitments................ 4,185
Less: Current portion of capital lease obligations......... 2,631
------
Long-term portion of capital lease obligations............. $1,554
======

Capital lease obligations of $160,000, $3.1 million and $1.9 million in
1998, 1997, and 1996, respectively, were incurred when the Company entered
into capital leases for new equipment.

7) COMMITMENTS AND CONTINGENCIES

Effective January 1, 1998, the Company is covered under commercial insurance
policies which provide for a self-insured retention limit for professional and
general liability claims for most of its subsidiaries up to $1 million per
occurrence, with an average annual aggregate for covered subsidiaries of $4
million through 2001. These subsidiaries maintain excess coverage up to $100
million with major insurance carriers. The Company's remaining facilities are
fully insured under commercial policies with excess coverage up to $100
million maintained with major insurance carriers. During 1996 and 1997, most
of the Company's subsidiaries were self-insured for professional and general
liability claims up to $5 million per occurrence, with excess coverage
maintained up to $100 million with major insurance carriers. From 1986 to
1995, these subsidiaries were self-insured for professional and general
liability claims up to $25 million and $5 million per occurrence,
respectively. Since 1993, certain of the Company's subsidiaries, including one
of its larger acute care facilities, have purchased general and professional
liability occurrence policies with commercial insurers. These policies include
coverage up to $25 million per occurrence for general and professional
liability risks.

As of December 1998 and 1997 the reserve for professional and general
liability claims was $65.0 million and $74.2 million, respectively, of which
$5.5 million and $12.0 million in 1998 and 1997, respectively, is included in
current liabilities. Self-insurance reserves are based upon actuarially
determined estimates. These estimates are based on historical information
along with certain assumptions about future events. Changes in assumptions for
such things as medical costs as well as changes in actual experience could
cause these estimates to change in the near term.

The Company has outstanding letters of credit totaling $53.6 million
consisting of: (i) a $40.0 million letter of credit related to the Company's
1997 acquisition of an 80% interest in The George Washington University
Hospital (see note 2); (ii) $7.0 million related to the Company's self
insurance programs; (iii) $5.8 million as support for a loan guarantee for an
unaffiliated party, and; (iv) $800,000 as support for various debt
instruments.

48

The Company has entered into a long-term contract with a third party to
provide certain data processing services for its acute care and behavioral
health facilities. This contract expires in 2002.

Various suits and claims arising in the ordinary course of business are
pending against the Company. In the opinion of management, the outcome of such
claims and litigation will not materially affect the Company's consolidated
financial position or results of operations.

8) RELATED PARTY TRANSACTIONS

At December 31, 1998, the Company held approximately 8% of the outstanding
shares of Universal Health Realty Income Trust (the "Trust"). Certain officers
and directors of the Company are also officers and/or Directors of the Trust.
The Company accounts for its investment in the Trust using the equity method
of accounting. The Company's pre-tax share of income from the Trust was $1.1
million in each year ended December 31, 1998, 1997 and 1996, and is included
in net revenues in the accompanying consolidated statements of income. The
carrying value of this investment at December 31, 1998 and 1997 was $8.2
million and $8.3 million, respectively, and is included in other assets in the
accompanying consolidated balance sheets. The market value of this investment
at December 31, 1998 and 1997 was $13.7 million and $15.3 million,
respectively.

As of December 31, 1998, the Company leased seven hospital facilities from
the Trust with terms expiring in 2000 through 2006. These leases contain up to
six 5-year renewal options. During 1998, the Company exercised five-year
renewal options on four hospitals leased from the Trust which were scheduled
to expire in 1999 through 2001. The leases on these facilities were renewed at
the same lease rates and terms as the initial leases. Future minimum lease
payments to the Trust are included in Note 6. Total rent expense under these
operating leases was $16.5 million in 1998, $16.3 million in 1997 and $16.2
million in 1996. The terms of the lease provide that in the event the Company
discontinues operations at the leased facility for more than one year, the
Company is obligated to offer a substitute property. If the Trust does not
accept the substitute property offered, the Company is obligated to purchase
the leased facility back from the Trust at a price equal to the greater of its
then fair market value or the original purchase price paid by the Trust. The
Company received an advisory fee of $1.2 million in 1998, $1.1 million in
1997, and $1.0 million in 1996 from the Trust for investment and
administrative services provided under a contractual agreement which is
included in net revenues in the accompanying consolidated statement of income.

A member of the Company's Board of Directors is a partner in the law firm
used by the Company as its principal outside counsel. Another member of the
Company's Board of Directors is a managing director of one of the underwriters
who performed investment banking services related to the Common Stock issued
during 1996.

9) PENSION PLAN

The Company maintains a contributory and non-contributory retirement plan
for eligible employees. The Company's contributions to the contributory plan
amounted to $4.6 million, $3.6 million, and $2.0 million in 1998, 1997 and
1996, respectively. The non-contributory plan is a defined benefit pension
plan which covers employees of one of the Company's subsidiaries. The benefits
are based on years of service and the employee's highest compensation for any
five years of employment. The Company's funding policy is to contribute
annually at least the minimum amount that should be funded in accordance with
the provisions of ERISA.

49

The following table shows reconciliations of the defined benefit pension
plan for the Company as of December 31, 1998 and 1997:

1998 1997
-------- --------
(000s)

Change in benefit obligation:
Benefit obligation at beginning of year.............. $ 43,573 $ 37,709
Service cost......................................... 904 854
Interest cost........................................ 3,001 2,783
Benefits paid........................................ (1,381) (1,563)
Actuarial loss....................................... 3,188 3,790
-------- --------
Benefit obligation at end of year.................. 49,285 43,573
Change in plan assets:
Fair value of plan assets at beginning of year....... $ 33,974 $ 26,220
Actual return on plan assets......................... 7,998 6,964
Company contributions................................ 10,203 2,398
Benefits paid........................................ (1,381) (1,563)
Administrative expenses.............................. (92) (45)
-------- --------
Fair value of plan assets at end of year........... $ 50,702 $ 33,974
Funded status of the plan............................ $ 1,417 $ (9,599)
Unrecognized actuarial (gain)........................ (3,559) (2,157)
-------- --------
Net amount recognized.............................. (2,142) (11,756)
Total amounts recognized in the balance sheet consist
of:
Accrued benefit liability............................ $ (2,142) $(11,756)
Weighted average assumptions as of December 31
Discount rate........................................ 6.75% 7.00%
Expected long-term rate of return on plan assets..... 9.00% 9.00%
Rate of compensation increase........................ 4.00% 4.00%

1998 1997 1996
------- ------- -------
(000s)

Components of net periodic benefit cost
Service cost.................................... $ 905 $ 854 $ 1,111
Interest cost................................... 3,001 2,783 2,574
Expected return on plan assets.................. (3,316) (2,446) (1,919)
------- ------- -------
Net periodic benefit cost..................... $ 590 $ 1,191 $ 1,766
======= ======= =======

The projected benefit obligation, accumulated benefit obligation and fair
value of plan assets for the pension plan with benefit obligations in excess
of plan assets were, $43.6 million, $40.0 million and $34.0 million,
respectively, as of December 31, 1997. As of December 31, 1998, the fair value
of plan assets exceeded the benefit obligations of the plan.

10) SEGMENT REPORTING (unaudited)

The Company adopted SFAS No. 131, "Disclosures About Segments of an
Enterprise and Related Information", in 1998. SFAS No. 131 established
standards for reporting information about operating segments in annual
financial statements and requires selected information about operating
segments in interim financial reports issued to stockholders. Operating
segments are defined as components of an enterprise about which separate
financial information is available that is evaluated regularly by the chief
operating decision maker, or decision making group, in deciding how to
allocate resources and in assessing performance.

The Company's reportable operating segments consist of acute care services
and behavioral health care services. The "Other" segment column below includes
centralized services including information services,

50

purchasing, reimbursement, accounting, taxation, legal, advertising, design
and construction, and patient accounting. Also included are the operating
results of the Company's other operating entities including the outpatient
surgery and radiation therapy centers and specialized women's health centers.
The chief operating decision making group for the Company's acute care
services and behavioral health care services is comprised of the Company's
President and Chief Executive Officer, and the lead executives of each of the
Company's two primary operating segments. The lead executive for each
operating segment also manages the profitability of each respective segment's
various hospitals. The operating segments are managed separately because each
operating segment represents a business unit that offers different types of
healthcare services. The accounting policies of the operating segments are the
same as those described in the summary of significant accounting policies.

Acute Behavioral
Care Health Total
1998 Services Services Other Consolidated
---- ---------- ---------- -------- ------------
(Dollar amounts in thousands)

Gross inpatient revenues....... $2,440,526 $341,592 $ 21,774 $2,803,892
Gross outpatient revenues...... $ 846,698 $ 91,465 $ 80,621 $1,018,784
Total net revenues............. $1,576,107 $233,010 $ 65,370 $1,874,487
EBITDAR(a)..................... $ 316,263 $ 38,556 $(43,649) $ 311,170
Total assets................... $1,217,363 $127,500 $103,232 $1,448,095
Licensed beds.................. 4,696 1,782 -- 6,478
Available beds................. 3,985 1,767 -- 5,752
Patient days................... 884,966 365,935 -- 1,250,901
Admissions..................... 187,833 32,400 -- 220,233
Average length of stay......... 4.7 11.3 -- 5.7

Acute Behavioral
Care Health Total
1997 Services Services Other Consolidated
---- ---------- ---------- -------- ------------

Gross inpatient revenues....... $1,737,092 $312,663 $ 7,011 $2,056,766
Gross outpatient revenues...... $ 608,470 $ 78,118 $ 57,791 $ 744,379
Total net revenues............. $1,189,043 $205,640 $ 47,994 $1,442,677
EBITDAR(a)..................... $ 252,839 $ 35,333 $(43,529) $ 244,643
Total assets................... $ 847,854 $128,662 $108,833 $1,085,349
Licensed beds.................. 3,389 1,777 -- 5,166
Available beds................. 2,951 1,762 -- 4,713
Patient days................... 616,965 336,850 -- 953,815
Admissions..................... 128,020 28,350 -- 156,370
Average length of stay......... 4.8 11.9 -- 6.1

Acute Behavioral
Care Health Total
1996 Services Services Other Consolidated
---- ---------- ---------- -------- ------------

Gross inpatient revenues....... $1,449,014 $249,684 $ 2,569 $1,701,267
Gross outpatient revenues...... $ 494,716 $ 55,314 $ 50,545 $ 600,575
Total net revenues............. $ 970,158 $165,613 $ 38,387 $1,174,158
EBITDAR(a)..................... $ 220,918 $ 29,431 $(36,746) $ 213,603
Total assets................... $ 716,355 $114,862 $134,578 $ 965,795
Licensed beds.................. 3,018 1,565 -- 4,583
Available beds................. 2,641 1,540 -- 4,181
Patient days................... 546,237 275,667 -- 821,904
Admissions..................... 111,244 22,295 -- 133,539
Average length of stay......... 4.9 12.4 -- 6.1

- --------
(a) EBITDAR--Earnings before interest, income taxes, depreciation,
amortization, lease & rental, minority interest expense and nonrecurring
transactions.

51

11) QUARTERLY RESULTS (unaudited)

The following tables summarize the Company's quarterly financial data for
the two years ended December 31, 1998.

First Second Third Fourth
1998 Quarter Quarter Quarter Quarter
---- -------- -------- -------- --------
(000s, except per share amounts)

Net revenues............................ $463,117 $474,558 $456,090 $480,722
Income before income taxes.............. $ 39,879 $ 31,669 $ 20,428 $ 31,036
Net income.............................. $ 25,650 $ 20,461 $ 13,393 $ 20,054
Earnings per share--basic............... $ 0.79 $ 0.63 $ 0.41 $ 0.62
Earnings per share--diluted............. $ 0.77 $ 0.61 $ 0.40 $ 0.61

Net revenues in 1998 include $36.5 million of additional revenues received
from special Medicaid reimbursement programs. Of this amount, $8.6 million was
recorded in the first and second quarters, $9.2 million in the third quarter
and $10.1 million in the fourth quarter. These amounts were recorded in the
periods that the Company met all of the requirements to be entitled to these
reimbursements. These programs are scheduled to terminate in the third quarter
of 1999 and although these programs have been renewed annually in the past,
the Company can not predict whether these programs will continue beyond their
scheduled termination date. However, failure to renew these programs at their
current reimbursement levels could have a material adverse effect on the
Company's future operating results.

During the third quarter of 1998, the Company suffered property damage and
curtailed business at its three hospitals in Puerto Rico and its four
hospitals in Louisiana as a result of Hurricane Georges. As a result, the
Company incurred pre-tax adverse financial effects related to the Hurricane
totaling $5.5 million ($3.5 million after-tax) or $.11 share (diluted) during
the third quarter of 1998. During the fourth quarter of 1998, the Company
recorded pre-tax insurance recoveries related to Hurricane Georges of $3.0
million ($1.9 million after-tax) or $.06 per share (diluted). The net pre-tax
adverse financial effect of the Hurricane on the Company's 1998 results of
operations was $2.5 million ($1.6 million after-tax) or $.05 per share.

First Second Third Fourth
1997 Quarter Quarter Quarter Quarter
---- -------- -------- -------- --------
(000s, except per share amounts)

Net revenues............................ $340,170 $343,826 $362,377 $396,304
Income before income taxes.............. $ 33,981 $ 26,467 $ 21,879 $ 23,596
Net income.............................. $ 21,530 $ 16,907 $ 13,819 $ 15,020
Earnings per share--basic............... $ 0.67 $ 0.52 $ 0.43 $ 0.46
Earnings per share--diluted............. $ 0.65 $ 0.51 $ 0.42 $ 0.45

Net revenues in 1997 include $33.4 million of additional revenues received
from special Medicaid reimbursement programs. Of this amount, $8.2 million was
recorded in the first quarter, $8.3 million was recorded in each of the second
and third quarters and $8.6 million in the fourth quarter.

52

UNIVERSAL HEALTH SERVICES, INC. AND SUBSIDIARIES

SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS

Additions
------------------------
Balance at Charges to Write-Off of Balance
Beginning Costs and Acquisitions Uncollectible at End
Description of Period Expenses of Businesses Accounts of Period
----------- ---------- ---------- ------------- ------------- ---------
(000s)

ALLOWANCE FOR DOUBTFUL
ACCOUNTS RECEIVABLE:
Year ended December
31, 1998............. $46,615 $139,526 $ 7,377 $(133,038) $60,480
======= ======== ======= ========= =======
Year ended December
31, 1997............. $30,398 $108,790 $ 7,200 $ (99,773) $46,615
======= ======== ======= ========= =======
Year ended December
31, 1996............. $49,016 $ 96,872 $10,324 $(125,814) $30,398
======= ======== ======= ========= =======

53

INDEX TO EXHIBITS

10.4 Agreement, effective January 1, 1999, to renew Advisory Agreement, dated
as of December 24, 1986, between Universal Health Realty Income Trust
and UHS of Delaware, Inc.
10.17 Form of Amendment No.3, dated as of August 31, 1998, to Pooling
Agreement dated as of November 16, 1993, among UHS Receivables Corp.,
Sheffield Receivables Corporation and U.S. Bank National Association
(successor to First Bank National Association and Continental Bank,
National Association).
10.37 1992 Corporate Ownership Program, as Amended.
22. Subsidiaries of Registrant
24. Consent of Independent Public Accountants.
27. Financial Data Schedule