<PAGE>   1
                                      LOGO
================================================================================


                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                 ---------------

                                    FORM 10-K

                ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934

                     FOR THE FISCAL YEAR ENDED JUNE 30, 1999

                        COMMISSION FILE NUMBER 000-23343
                        NOVACARE EMPLOYEE SERVICES, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

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<S>                                                                                        <C>
                    DELAWARE                                                                            23-2866146
            (STATE OF INCORPORATION)                                                       (I.R.S. EMPLOYER IDENTIFICATION NO.)

          VALLEY FORGE CORPORATE CENTER
              2621 VAN BUREN AVENUE
                 NORRISTOWN, PA                                                                            19403
     (ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)                                                            (ZIP CODE)
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       REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (610) 650-4700

        SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE

           SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

                               TITLE OF EACH CLASS
                               -------------------
                     COMMON STOCK, PAR VALUE $.01 PER SHARE

     INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS.

                                    YES X NO

     INDICATE 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. [X]

     AS OF SEPTEMBER 14, 1999, 30,273,782 SHARES OF COMMON STOCK WERE
OUTSTANDING, AND THE AGGREGATE MARKET VALUE OF THE SHARES OF COMMON STOCK HELD
BY NON-AFFILIATES WAS APPROXIMATELY $20,863,937. (DETERMINATION OF STOCK
OWNERSHIP BY NON-AFFILIATES WAS MADE SOLELY FOR THE PURPOSE OF RESPONDING TO
THIS REQUIREMENT AND THE REGISTRANT IS NOT BOUND BY THIS DETERMINATION FOR ANY
OTHER PURPOSE.)

                       DOCUMENTS INCORPORATED BY REFERENCE

PART III INCORPORATES INFORMATION BY REFERENCE FROM PORTIONS OF THE REGISTRANT'S
   PROXY STATEMENT FOR THE 1999 ANNUAL MEETING OF SHAREHOLDERS TO BE HELD ON
                               DECEMBER 14, 1999.
================================================================================



<PAGE>   2



                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
                  FORM 10-K -- FISCAL YEAR ENDED JUNE 30, 1999

                       CONTENTS AND CROSS REFERENCE SHEET
           FURNISHED PURSUANT TO GENERAL INSTRUCTION G(4) OF FORM 10-K

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      FORM 10-K       FORM 10-K                                                                                           FORM 10-K
       PART NO.        ITEM NO.                                        DESCRIPTION                                        PAGE NO.
       --------        --------        --------------------------------------------------------------------------         --------
<S>                      <C>           <C>                                                                                    <C>
          I              1             Business                                                                               1
                                              The Company.............................................................        1
                                              Professional Employer Organization Industry.............................        2
                                              Company Strategy........................................................        3
                                                 Growth Strategy......................................................        4
                                                 Operating Strategy...................................................        6
                                              Business Profile........................................................        7
                                                 Contractual Arrangement with Parent..................................        9
                                                 Information Technology...............................................       10
                                                 Marketing and Sales..................................................       11
                                                 Workers' Compensation and Health Care Program........................       13
                                              Competition.............................................................       13
                                              Regulation..............................................................       14
                                              Employees...............................................................       18
                                              Insurance...............................................................       18
                                              Executive Officers of the Registrant....................................       18
                         2             Properties.....................................................................       20
                         3             Legal Proceedings..............................................................       20
                         4             Submission of Matters to a Vote of Security Holders............................       20
          II             5             Market for Registrant's Common Equity and Related
                                               Stockholder Matters....................................................       20
                         6             Selected Financial Data........................................................       22
                         7             Management's Discussion and Analysis of Financial
                                               Condition and Results of Operations....................................       24
                         8             Financial Statements and Supplementary Data....................................       35
                         9             Changes in and Disagreements with Accountants on
                                               Accounting  and Financial Disclosures..................................       56
         III            10             Directors and Executive Officers of the Registrant.............................       56
                        11             Executive Compensation.........................................................       56
                        12             Security Ownership of Certain Beneficial Owners and
                                              Management..............................................................       56
                        13             Certain Relationships and Related Transactions.................................       56
                        14             Exhibits, Financial Statement Schedules and Reports on
          IV                                   Form 8-K...............................................................       57
SIGNATURES............................................................................................................       58
</TABLE>


<PAGE>   3



                                     PART I




ITEM 1. BUSINESS

THE COMPANY

            NovaCare Employee Services, Inc (the "Company") is one of the
largest (measured by number of worksite employees) professional employer
organizations ("PEOs") in the United States. The Company is an employee services
company that provides small-to medium-sized businesses with comprehensive, fully
integrated outsourcing solutions to human resource needs, including payroll
management, workers' compensation risk management, benefits management,
unemployment management and human resource management and consulting services.
The Company believes it offers better solutions at the best value by providing a
convenient, integrated complement of services which enable small and
medium-sized businesses to cost-effectively manage and enhance the employment
relationship by: (i) controlling the risks and costs associated with workers'
compensation, workplace safety and employee-related litigation; (ii) providing
employees with high quality health care coverage and related benefits; (iii)
managing the increasingly complex legal and regulatory environment affecting
employment; (iv) providing payroll and human resource administrative services
that are reliable, accurate and delivered in a friendly and caring way; and (v)
achieving scale advantages typically available to larger organizations. As of
June 30, 1999, the Company provided PEO services to 4,084 clients with 54,313
employees in 46 states, primarily in ten different industries.

            The Company was established by NovaCare, Inc. (the "Parent"), in
September 1996, as a subsidiary and commenced operations on October 1, 1996,
concurrent with the acquisition of one PEO business. In February 1997, the
Company acquired three additional PEO businesses and entered into a contract
with the Parent to provide traditional PEO services to principally all of the
Parent's worksite employees (the "NovaCare Contract"). During fiscal 1998, the
Company completed three additional acquisitions - NovaPro, a temporary staffing
business acquired from the Parent on July 1, 1997; AmeriCare Employers Group,
Inc. ("AmeriCare"), a PEO based in Arizona, acquired on December 1, 1997; and
Staff Leasing Systems, Inc. (" SLS"), a PEO based in Maryland, acquired on May
1, 1998. In addition, in November 1997 and June 1998, the Company expanded via
start-up operations into two new markets, Atlanta and Philadelphia,
respectively. See "Contractual Arrangement With Parent" for subsequent changes
to the NovaCare Contract effective July 1, 1999. The Company acquired two
additional PEO's during fiscal 1999, Pay America, Inc. ("Pay America"), a PEO
based in Utah, on August 1, 1998 and Payday Professional Employer ("Payday"), a
PEO based in New Mexico, on October 1, 1998.

            On September 8, 1999, the Company signed a definitive agreement to
sell the Company to an investment group comprised of Patricof & Co. Ventures
Inc., Fidelity Ventures Limited and AFLAC Incorporated (the "Investors"). Under
the terms of the agreement, a new private company established by the Investors
will acquire all of the outstanding common stock of the Company at a price of
$2.50 per share. The purchase will be effected through a cash tender offer to
the Company's stockholders and subsequent merger of the Company into a new
private company managed by the Investors. The Parent also executed a definitive
agreement, subject to certain conditions, to tender its shares in the tender
offer at the price of $2.50 per share. The tender offer was approved by the
Parent's stockholders on September 21, 1999 and is subject to the satisfaction
of customary closing conditions. The tender offer commenced on September 15,
1999 and is expected to close during October 1999. See "Overview" section of
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" for additional details.



                                       1
<PAGE>   4







            The Company contractually assumes certain administrative, regulatory
and financial employer responsibilities with respect to worksite employees in a
"co-employment" relationship. The Company believes its clients benefit from the
Company's services by: (i) improving profitability through lowering or
controlling costs associated with workers' compensation, health insurance, other
benefit coverage and regulatory compliance; (ii) improving productivity through
reducing the time and effort expended by business owners and executives to deal
with the complexities of employment management, enabling them to focus on their
business core competencies and growth; and (iii) improving employee satisfaction
and performance. The Company helps employers improve job satisfaction and
performance of worksite employees by providing improved health care and related
benefits, delivering training programs and providing dependable payroll and
benefits administration.

            As co-employer of worksite employees, the Company assumes
responsibility for and manages the risks associated with: (i) worksite employee
payroll; (ii) employee-related benefits, such as workers' compensation and
health care insurance coverage; and (iii) compliance with certain
employment-related governmental regulations that can be effectively managed
offsite from the client's business. The client retains responsibility for
supervision and direction of the worksite employees' services in its business
and generally remains responsible for compliance with other employment-related
governmental regulations that are more closely related to worksite employee
supervision. The service fee charged by the Company to its clients includes the
cost of certain employment-related taxes, workers' compensation insurance
coverage and risk management services, administrative and field services, wages
of worksite employees and the client's portion of health and retirement benefit
plan costs. The Company also provides other value-added services such as
temporary staffing, recruiting, training and human resource consulting.

PROFESSIONAL EMPLOYER ORGANIZATION INDUSTRY

     According to industry analysts, the PEO industry had approximately $22
billion in annual revenues during 1997 with an historical growth rate over the
last five years of approximately 28% per year. According to the U. S. Small
Business Administration, there are nearly six million businesses in the United
States with fewer than 500 employees, employing over 52 million persons and with
$1.2 trillion in aggregate annual payroll. The National Association of
Professional Employer Organizations ("NAPEO") estimates that the PEO industry
co-employs fewer than three million worksite employees. The Company believes,
therefore, that approximately 49 million of these employees are currently
unserved by the PEO industry.

     The PEO industry is highly fragmented. NAPEO data suggest that there are
approximately 2,000 PEOs currently in operation. According to industry analysts,
the ten largest PEOs account for approximately 39% of existing revenues in the
industry. The Company believes that significant consolidation opportunities
exist within the PEO industry due to increasing industry regulatory complexity
and capital requirements associated with developing larger service delivery
infrastructures, more diversified services and more sophisticated management
information systems.

Demand for Services. The PEO industry evolved in the early 1980s in response to
increasing employment and benefit costs, and the complexities of the legal and
regulatory environment for the rapidly expanding small-to medium-sized business
sector. The Company believes demand for PEO services will continue to increase
as: (i) employment-related governmental regulation grows more complex; (ii)
growth continues within the small-to medium-sized business community; (iii) the
need to provide health and retirement benefits in a cost-effective convenient
manner increases; and (iv) the business and regulatory communities accept and
recognize the PEO industry. While various service


                                       2
<PAGE>   5





providers, such as payroll processing firms, benefits and safety consultants and
temporary services firms, are available to assist these businesses with specific
tasks, such organizations do not typically provide the more comprehensive range
of services generally offered by PEOs. PEOs enter into agreements with numerous
small-to medium-sized employers, and can therefore achieve economies of scale as
professional employers and offer benefits packages and human resource services
at a level typically available only to larger companies which have greater
resources to devote to human resources management. The Company believes PEO
services will continue to experience growing demand because of the increasing
trend among small-to medium-sized employers to: (i) outsource non-core
competencies; (ii) seek to reduce employee benefit costs; (iii) manage
employee-related risks and regulatory complexities; and (iv) attract better
employees and retain them through improved benefit plans.

            Effectiveness of Services. According to estimates by the U.S. Small
Business Administration, the management of an average small-to medium-sized
business devotes from 7% to 25% of its time to employee-related matters, leaving
management with less time to focus on core competencies. Work-related injuries
cost employers over $53 billion in medical expenses and lost employee
productivity each year, according to industry estimates. A PEO can manage these
costs through effective workers' compensation injury prevention, medical
management, rehabilitation and return to work programs. Employees are typically
attracted to small and medium-sized businesses that provide employees with human
resource benefits and services more characteristic of large employers. An
industry analyst's study indicated that 40% of the companies that outsourced
services to a PEO upgraded their employee benefits offerings and one-fourth of
those clients offered health care and other benefits for the first time.

COMPANY STRATEGY

   VALUES-BASED BUSINESS

        The Company believes that the most important and differentiating quality
of outstanding organizations is a set of values that inspires, unites and
sustains them. Values are constant and enduring, and precede and underlie
business plans, policies, procedures, practices, performance and outcomes. The
Company's Values are:


                  Credo    Helping Make Life a Little Better
                  Beliefs  Respect for the Individual
                           Service to the Customer
                           Pursuit of Excellence
                           Commitment to Personal Integrity
                  Purpose  To effectively provide better human resource
                           solutions at the best value to our customers through
                           service leadership.

        It is management's belief that these Values unify the Company and
mandate an open participation and empowered environment. The Company's strong
commitment to these Values by all employees enables the Company to provide a
unique level of service to its customers thereby enabling employees to build the
business and enhance their careers. The pursuit of the Company's Values unlocks
an inherent capacity to drive change, creating substantial opportunity. It is
management's opinion that the Company's greatest strengths and competitive
advantages are its people, values driven culture and capacity for change.



                                       3
<PAGE>   6



STRATEGY STATEMENT

     OVERALL

     The Company's strategy is to be the preferred human resources partner by
     leveraging operational excellence, technology and strategic alliances to
     achieve market leadership. This strategy is based on management's beliefs
     that:

     -    PEO services will continue to experience growing demand because of the
          trend among small-to medium-sized employers to: (i) outsource non-core
          competencies; (ii) reduce employee benefit costs; (iii) avoid
          employee-related risks and regulatory complexities; and (iv) attract
          better employees through improved benefit plans.

     -    The market for PEO services, based on analyst reports, is
          approximately 94% unserved and is expected to grow at the rate of 28%
          per year for the next five years.

     -    The PEO industry is highly fragmented with significant consolidation
          opportunities for companies with access to capital, larger service
          delivery infrastructures, and sophisticated management information
          systems.

     -    PEOs typically take a transaction processing approach to their
          services and do not emphasize the improved workforce performance
          characteristics of satisfied employees.

     -    In selecting PEO providers, small-to medium-sized businesses will
          increase their emphasis on cost-effectiveness, service excellence and
          breadth of services provided.

     -    Employees are attracted to small and medium-sized businesses that
          provide employees with human resources services more characteristic of
          large employers.

     -    Strategic alliances will enable PEOs to enhance endorsement
          opportunities, expand the distribution channel and broaden the
          service/product offering.

GROWTH STRATEGY

            The Company intends to grow through: (i) increasing investment in
marketing and sales; (ii) focusing on geographic expansion; (iii) targeting high
potential industries and services; (iv) acquiring PEOs and other employee
service providers; and (v) entering into strategic alliances.

            Increasing Investment in Marketing and Sales. The Company's
management is experienced in building businesses utilizing focused marketing
strategies and professional sales forces. A significant part of the Company's
marketing strategy is the continued development of its brand identity. A
recognized brand name is a valuable marketing tool. The Company believes that
its marketing efforts will benefit from its brand strategy. The Company's brand
promise is to provide better human resource solutions at the best value. The
Company seeks to create a more satisfying and more productive relationship
between its worksite employees and clients by "caring for and about people." By
effectively and consistently delivering against this service commitment, the
Company believes it will attain a brand name reputation for operational
excellence among existing and potential clients.

            The Company has invested heavily in improving the quality of its
sales force over the past year. Investments included recruiting and training
strong professional sales people and sales management from inside and outside
the PEO industry. These investments have resulted in the Company doubling its
sales productivity over the past year, as measured by monthly sales closed per
salesperson.


                                       4
<PAGE>   7



            Focusing on Geographic Expansion. The Company has identified key
attractive geographic target markets and has established a plan for entering
those markets in a disciplined manner. The Company believes its market
development model will enable it to penetrate new markets quickly. This market
development model consists of a highly structured sales management control
system and an efficient selling process. The model includes market research to
identify potential client businesses and a direct mail and telemarketing
campaign to reach those businesses. In certain cases, the Company may rely on
platform acquisitions to achieve scale in a market.

            Entry priority for specific markets is determined by the number and
growth of small-to medium-sized businesses, the state regulatory environment and
access to infrastructure to support operations. Once a market is selected, the
Company executes an entry plan which includes defining benefit plans and service
offerings, recruiting a manager and sales team, site selection, training and
orientation and launching a specific marketing plan to begin the selling
process.

            Targeting High Potential Industries and Accounts. Targeted
industries vary from market to market depending on the economic characteristics
and business demographics of each geographic location. The Company intends to
focus on industries with high gross profit per worksite employee and significant
workers' compensation profit opportunities. High potential industries are those,
such as health care and construction, that the Company believes could benefit
most from the Company's risk management expertise (e.g., traditional high
workers' compensation classifications) and the Company's offering of an
extensive benefits package (e.g., industries facing a shortage of workers).
Other high potential industries include those characterized by rapid growth or
change. The sales force is expected to utilize the key industry strategy and
become expert in one or more select industries in the markets in which they
operate. The Company plans to target larger accounts where it can leverage its
unique capabilities and expertise gained from servicing the Parent.

            Acquiring PEOs and Other Employee Service Providers. The Company
believes that the opportunities for PEO consolidation are substantial with
approximately 2,000 PEOs (according to an estimate by NAPEO) operating in a
highly fragmented industry. The Company believes that industry consolidation
will be driven by increasing industry and regulatory complexity, increasing
capital requirements and the significant economies of scale available to PEOs
with a concentration of clients and employees in target markets. The Company
intends to make opportunistic acquisitions where appropriate to achieve greater
density in targeted geographic markets or expand its service offering.

            Entering into Strategic Alliances. The Company is creating strategic
alliances with service providers to small and medium-sized businesses. For
example, in March 1999, the Company entered into a strategic alliance with AFLAC
Incorporated, the nation's largest provider of supplemental insurance products
with approximately 130,000 clients, whereby products and services are cross-sold
among each firm's existing and targeted client base. The Florida Home Builders
Association, an organization that has approximately 17,000 members with 450,000
worksite employees, has endorsed the Company as the PEO of choice for its
members. Additionally, the Greater Philadelphia Chamber of Commerce has endorsed
the Company as the exclusive PEO of choice for its approximately 6,000 business
client members.

            With the trend toward outsourcing non-core competencies, small and
medium-sized businesses typically have service relationships with accountants,
attorneys, banks, trade associations and other business advisors. Alliances with
these service providers offer cross-selling opportunities for the Company's
employee services. Other potential alliances being pursued include additional
product or service offerings, as well as creating additional sales distribution
channels. The Company intends to develop such alliance opportunities as an
extension of its existing marketing and sales capability.


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<PAGE>   8



OPERATING STRATEGY

            The Company has developed an operating strategy designed to control
costs while supporting growth. The operating strategy encompasses implementing a
sophisticated business model, which monitors performance while delivering
customer intimacy with efficiency.

            Implementing a Sophisticated Business Model. The Company's business
model includes a portfolio based management control system and an efficient
operating model that is designed around best demonstrated practices for service
industries.

            Management Control System. The Company has implemented a portfolio
based management control system designed to control and improve its performance
in the selection of new business, assurance in meeting its brand promise with
respect to existing customers and analyzing lapsed business. The new business
criteria include target industries with high gross profit per worksite employee
and acceptable underwriting risk. The criteria include number of worksite
employees, credit rating, three-year workers' compensation loss ratios, state
unemployment experience, expected administrative fee and predicted gross profit
per employee.

            The current business portfolio component of the management control
system enables management to monitor new client start-ups, review
client-specific financial and risk performance and employee and employer
satisfaction. By focusing management attention on key business variables, the
system permits day-to-day management to direct actions consistent with the
Company's strategy and business plan. The business variables measured are the
same as those used to assess new business, and include service delivery
performance metrics, accounts receivable, at-risk clients and employer and
employee satisfaction. The Company believes that attention to these variables
increases gross profit per worksite employee. Lapsed business is analyzed to
facilitate identification of service delivery system issues and to improve
future client retention.

            Efficient Operating Model. The Company believes it has established
an operating model that delivers customer intimacy with efficiency. The
operating model facilitates customer responsiveness while maximizing
administrative support productivity. The Company's local service center delivers
the customer intimate activities including sales management, personalized
customer care, new client and employee orientation and enrollment, temporary
staffing and local risk management services. Local risk management services
include worksite safety evaluations, safety promotion, client meetings, early
intervention of workers' compensation reported claims and early return to work
monitoring. Economies of scale are achieved through centralized activities
including nationally directed telemarketing, branding, marketing material
development and benefits procurement. Efficiencies are also gained regionally
where the Company performs customer care management, payroll processing,
benefits and human resource administration, underwriting and claims management.

            Staffing of the local service centers and the centralized regional
centers is based on metrics identifying the number of worksite employees or
other applicable customers who can be adequately served by each kind of service
representative, including customer care representatives, payroll technicians,
benefits specialists, human resources consultants, workers' compensation
specialists, safety consultants and underwriters. These staffing metrics are
designed to provide efficient service at a carefully controlled cost. The
Company believes it can achieve its strategic objectives by implementing the
local service model in each strategic market it enters.



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BUSINESS PROFILE

            In order to implement its strategy to provide better solutions at
the best value, the Company provides six primary categories of employee
services: (i) workers' compensation and safety management; (ii) unemployment
insurance management; (iii) employee benefits procurement and administration;
(iv) human resource and compliance management; (v) payroll management; and (vi)
other value-added services. By engaging the Company to provide these services,
clients can focus on their core competencies.

            These services are provided under the Company's PEO client service
agreement, which typically has an initial one-year term; thereafter, the
agreement is renewed periodically. The agreement is subject to termination by
the Company or the client upon 30 days' prior written notice. Service revenues,
billed to clients along with each periodic payroll, are based on a pricing model
that takes into account the gross pay of each employee and a mark-up that
includes the estimated costs of employment-related taxes, providing insurance
coverage and benefit plans, performing human resource administration, payroll,
benefits and compliance management and other services and an administration fee.
The specific mark-up varies by client based principally on the workers'
compensation classification of the worksite employees, their human resource
needs and the size of the client. Accordingly, the Company's average mark-up
percentage will fluctuate based on client mix.

            Clients are required to pay the Company its total fee concurrent
with the applicable payroll date. Although the Company is ultimately liable as
the co-employer to pay employees for work previously performed, it retains the
right to terminate the PEO client service agreement as well as the worksite
employees upon non-payment by a client, which limits any future liability. This
right and the periodic nature of payroll, combined with client credit
verifications and the Company's client selection process, are used to control
this exposure.

            Workers' Compensation and Safety Management. Workers' compensation
is a state-mandated, comprehensive insurance program that requires employers to
fund medical expenses, lost wages and other costs that result from work-related
injuries and illnesses, regardless of fault and without any co-payment by
employees. See "Regulation" below for a discussion of workers' compensation.
Pursuant to the Company's PEO client service agreement, the Company assumes the
obligations of its clients to pay workers' compensation claims. The Company
seeks to control its workers' compensation costs through comprehensive risk
evaluation of prospective clients, the prevention of workplace injuries, timely
intervention with employee injuries, aggressive management of the medical costs
related to such injuries and the prompt return of employees to work. The Company
seeks to prevent workplace injuries by implementing a wide variety of training
and safety programs. The Company's efforts to return employees to work quickly
involve both rehabilitation services and the placement of employees in
transitional, light-duty positions until they are able to resume their former
positions.

            Unemployment Insurance Management. Pursuant to the Company's PEO
client service agreement, the Company also assumes the obligation of its clients
to pay unemployment insurance costs. The Company manages its unemployment
insurance costs by establishing employee termination procedures, responding on a
timely basis to unemployment claims, attending unemployment hearings and
attempting to reassign employees to other worksites when a reduction in force
occurs at any one worksite location.


                                       7
<PAGE>   10



            Employee Benefits Procurement and Administration. Pursuant to the
Company's PEO client service agreement, the Company is required to provide
mandated employee benefits to worksite employees. Additionally the Company
offers worksite employees a voluntary benefits package that includes several
health care options, such as point-of-service, preferred provider organizations,
health maintenance organizations ("HMOs") and indemnity plans. Supplemental
benefit programs offer dental care, prescription drugs, and life and disability
insurance options. The Company also offers 401(k) retirement savings and
cafeteria style plans to its eligible employees. The Company believes that its
ability to provide and administer a wide variety of employee benefits on behalf
of its clients tends to mitigate the competitive disadvantage small and
medium-sized businesses normally face in the areas of employee benefit cost
control and employee recruiting and retention.

            Human Resources and Compliance Management. Pursuant to the Company's
PEO client service agreement, the Company provides comprehensive human resources
services to its clients. These services reduce the employment-related
administrative burdens faced by its clients, and provide worksite employees with
a wide array of benefits typically offered by large employers. The Company
develops and administers human resource policies and procedures for each of its
clients, relating to, among other things, recruiting, retention programs,
performance management, discipline and terminations. The Company also provides
orientation, training and development, counseling and substance abuse awareness
for worksite employees.

            By contract, the Company generally assumes responsibility for
complying with many employment-related regulatory requirements. In addition, the
Company assists its clients in understanding and complying with other
employment-related laws for which the Company does not assume responsibility.
Laws and regulations applicable to employers include state and Federal tax laws,
state workers' compensation laws, state unemployment laws, safety and health
laws, immigration laws, and discrimination, sexual harassment and other civil
rights laws.

            Payroll Management. Pursuant to the PEO client service agreement,
the Company is responsible for payroll processing, check preparation,
distribution and recordkeeping, payroll tax deposits, payroll tax reporting,
employee file maintenance, unemployment claims and monitoring and responding to
changing regulatory requirements. The Company indemnifies the client against the
Company's failure to comply with regulatory requirements. Payroll reports are
prepared for clients for financial and other recordkeeping purposes. The
provision of these services by the Company generally reduces the client's
employment liabilities and allows clients to focus on their core business.

            Other Value-Added Services. Since the acquisition of NovaPro on July
1, 1997, the Company has offered rehabilitation temporary staffing in the health
care industry. The rehabilitation temporary staffing service currently can draw
on a pool of approximately 6,000 rehabilitation clinicians to provide staff to
health care providers. This business is supported by technology which provides
detailed recruitment and sales productivity information for management purposes.
It also generates billing and utilization reports for clients.

            The Company also plans to offer additional value-added services to
clients and worksite employees. Such services may include employee recognition
programs, travel discount arrangements, vision care, credit union membership,
smart cards, warehouse club memberships and various financial services. Some of
these services may generate fee income or commissions for the Company.


                                       8
<PAGE>   11


The Company's standard PEO client service agreement also establishes the
division of responsibilities between the Company and the client as co-employers.
The division of responsibilities is generally as follows:


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             THE COMPANY                                   CLIENT                                      SHARED
------------------------------------        ------------------------------------             -------------------------
<S>                                         <C>                                              <C>
-  Payment of payroll                       -  Supervision of                                -  Implementation of
                                               job-specific activities of                       policies and practices
-  Tax reporting and payment                   worksite employees,                              relating to the
   (state and Federal                          including designation of                         employer-employee
   withholding, Federal                        job descriptions and                             relationship
   Insurance Contributions                     duties and
   Act ("FICA"), Federal                       responsibilities                              -  Selection of fringe
   Unemployment Tax Act                                                                         benefits,  including employee
   ("FUTA") and state                       -  Assignment to, and                               leave policies (other
   unemployment insurance                      ownership of, all                                than as controlled by the
   administration)                             intellectual property                            Family and Medical Leave
                                                                                                Act of 1993 or other
-  Workers' compensation                    -  Product liability                                laws)
   compliance, procurement,
   management, payment and                  -  Professional liability or                     -  Compliance with
   reporting                                   malpractice                                      provisions of the Internal
                                                                                                Revenue Code of 1986, as
-  Employee benefit                         -  Compliance with OSHA                             amended (the "Code"),
   procurement,                                regulations, state and                           regarding benefits
   administration and                          local government                                 discrimination
   payment                                     contracting provisions,
                                               professional licensing                        -  Hiring, terminating and
-  Compliance with                             requirements and fidelity                        disciplining worksite
   Immigration Reform and                      bonding requirements                             employees
   Control Act and Consumer
   Credit Protection Act, as                -  Negligent or tortious                         -  Compliance with Title VII
   well as monitoring                          conduct of worksite employees                    of the Civil Rights Act of
   changes in other                            acting under the                                 1964, the Age
   government regulations                      direction and control of                         Discrimination in
   governing the                               the client                                       Employment Act, the
   employer-employee                                                                            Americans with
   relationship and updating                -  Determination of                                 Disabilities Act, the
   the client when necessary                   compensation of worksite                         Fair Labor Standards Act
                                               employees                                        and similar state or
                                                                                                local legislation

                                                                                             -  Safety management and
                                                                                                training
</TABLE>

CONTRACTUAL ARRANGEMENT WITH PARENT

            The Parent and the Company entered into the NovaCare Contract in
February 1997, whereby principally all of the Parent's employees became
co-employed by the Company. Under the NovaCare Contract, the Company had
provided traditional PEO services such as payroll and benefits management,
worksite safety evaluation, employment-related risk management and compensation
and benefits consultation. In January 1998, the Parent initiated a restructuring
plan to favorably position its long-term care services segment for recent
changes in the Medicare reimbursement system as mandated by the Balanced Budget
Act of 1997. The intent of the plan was to substantially reduce the cost of its
workforce by transitioning to a lower cost operating model for providing quality
therapy services. In support of this transition and to address the increased
demand from the Parent for additional human resource services, the Company and
the Parent amended the NovaCare Contract. The amended contract was a four-year
agreement which became effective July 1, 1998.


                                       9
<PAGE>   12





            On March 31, 1999, the Parent announced that, due primarily to lower
reimbursement rates and declines in rehabilitation caseloads at long-term care
services customer facilities, resulting principally from the new reimbursement
structure for therapy under the Medicare program, the Parent was forced to exit
selected long-term care markets and facilities, and to continue to lower
expenses by reducing labor costs. On June 1, 1999, the Parent sold its remaining
long-term care services segment business to Chance Murphy, Inc., an independent
company managed by a subsidiary of Integrated Health Services, Inc. In addition,
on July 1, 1999, the Parent sold its orthotics and prosthetics services business
to a subsidiary of Hanger Orthopedic Group, Inc. ("Hanger"). The Company entered
into a six-month transition services agreement with Hanger.

            Based on these announcements, the Company and the Parent have
negotiated new contract terms to reflect changes in the Parent's ongoing service
needs. The new contract terms, which became effective July 1, 1999, consist of a
four-year services agreement relative to the Parent's physical rehabilitation
and occupational health (PROH) business and a six-month agreement relative to
the Parent's corporate support services personnel. In addition, the Parent
assumed certain costs associated with the Company's downsizing to adjust to the
revised service needs.

            The Company evaluated the implications of these events on its
organizational structure, and recorded a provision for restructure in the fourth
quarter of fiscal 1999. The provision consisted principally of employee
severance costs, which represent the accumulation of termination benefits as set
forth in the Company's severance policy, and facility lease costs.

INFORMATION TECHNOLOGY

     The Company's nationwide information systems network connects its local
customer service centers, regional processing centers, worksite employees,
clients and service providers. These technologies include, but are not limited
to, a combined Internet/Intranet access and electronic mail system, client
server-based expertise, which provides distributed processing and rapid
implementation of business changes and telecopier to data technology (which
eliminates the need for manual data entry). The regional processing centers
serve as disaster recovery backup sites, having the capability to handle the
Company's operations for a short period of time.

            The Company currently uses commercially available software to manage
information related to payroll processing, benefits administration, human
resource management and employee enrollment. The Company has also developed the
requirements to create a proprietary information management system to handle the
expected growth in worksite employees. In July 1999, the Company entered into
agreements with a nationally recognized software and technology provider and a
leading information management consulting firm to develop and implement an
enterprise-wide-information system for operating and financial applications. The
cost of this commitment, including computer hardware, software and other related
costs, approximates $2.7 million and is projected to be expended during fiscal
2000.



                                       10
<PAGE>   13


MARKETING AND SALES

            The Company's client base as of June 30, 1999 consisted of 4,084
client companies, representing 54,313 worksite employees. The Parent represented
approximately 44% of the Company's fiscal 1999 revenues. The Company's clients,
excluding the Parent, have an average of 11 worksite employees. As of June 30,
1999, the Company's approximate distribution of worksite employees by major
Standard Industrial Classification ("SIC") code industry grouping was:

 <TABLE>
 <CAPTION>
                                                                                        WITHOUT               WITH
                                                                                      THE PARENT           THE PARENT
                                                                                      ----------           ----------
<S>                                                                                       <C>                  <C>
 Wholesale/Retail Trade.......................................................            29%                  24%
 Construction.................................................................            19                   16
 Restaurants..................................................................            10                    8
 Health Care..................................................................             9                   25
 Hospitality..................................................................             8                    6
 Finance, Insurance and Real Estate...........................................             7                    6
 Manufacturing................................................................             5                    4
 Agriculture..................................................................             5                    4
 Transportation...............................................................             5                    4
 Property Management..........................................................             3                    3
 </TABLE>

            The Company is focused on serving clients in targeted industries
that generate high gross profit per worksite employee. See "Growth Strategy"
above. All prospective clients are evaluated individually on the basis of
workers' compensation risk, group medical history, unemployment history and
operating stability.

            The Company's marketing and sales efforts are focused on the
Company's target markets and industries. The Company currently markets its
services through 74 sales professionals who specialize in one or more of the
Company's target industries. All sales representatives are direct employees.
Employed sales representatives are paid a combination of salary and incentive
compensation. The incentive is based on the gross profit projected to be earned
with respect to a customer contract and is paid after the contract has been in
effect for one full calendar month. The incentive is required to be repaid by
the sales representative if the applicable contract is terminated within 120
days after inception. The Company's sales materials are client specific and
communicate the Company's broad range of high quality services and the potential
benefits to employers and employees.

            The Company utilizes professional marketing tools and strategies,
including public relations and advertising, to communicate its brand promise and
performance to target audiences. First, the Company will seek to identify target
audiences through market research. The Company uses market research firms to
assist in designing the messages to be delivered to the target audiences.
Referrals from existing clients and professionals, as well as telemarketing and
direct mail, are used to generate qualified customer leads. The sales force will
then deliver targeted presentations to qualified prospects using industry and
customer-specific marketing materials. These activities are intended to
supplement and enhance the effectiveness of the Company's marketing efforts and
reinforce brand loyalty on the part of employees and clients. Brand loyalty is
expected to generate referrals, improve client retention and thereby improve
profitability. The Company plans to survey the marketplace, its worksite
employees and potential clients on a continuous basis to measure satisfaction
and the effectiveness of its marketing efforts.

            For its worksite employees, the Company believes its brand promise
is fulfilled by: (i) establishing a respectful and trusting relationship between
the Company and its worksite employees through clearly defined policies and
procedures, and competitive health care and related benefits; (ii) providing a
positive work environment by way of risk prevention and safety and recognition
programs; (iii) consistently rendering dependable and responsive employee
services, most notably payroll and benefits administration and management; and
(iv) providing reassignment during cyclical changes in its client's businesses.


                                       11
<PAGE>   14


            For its clients, the Company seeks to: (i) improve employee
satisfaction and thereby improve workforce performance and productivity; (ii)
reduce the time and effort required by business owners and executives to deal
with the complexities of employment and payroll management; (iii) improve client
business performance by enabling management to focus on core competencies,
increasing workforce productivity through training, recognition, risk prevention
and safety programs, and lowering costs associated with workers' compensation,
health insurance, other benefit coverage, and regulatory compliance; and (iv)
establish a respectful and trusting relationship between the Company and its
clients through expert, responsive and dependable service and accountability for
performance.

            The Company has historically benefited from a high level of client
retention resulting in a recurring revenue stream. The Company's client
attrition is attributable to a variety of factors, including: (i) client
business failure; (ii) sale or acquisition of the client company; (iii)
termination by the Company resulting from the client's inability to make timely
payments or implement safety recommendations; (iv) the Company implementing
health plan participation and employee contribution minimum requirements; and
(v) client nonrenewal due to price or dissatisfaction with service. The Company
believes that only a small percentage of nonrenewing clients withdrew due to
dissatisfaction with service or to retain the services of a competitor. The
Company's portfolio management approach, utilizing a management control system
focused on key operating variables, is designed to reduce further the incidence
of non-renewal.

            The Company plans to enter new geographic markets on a regular
basis. The Company believes its market development model, which consists of a
structured sales management control system and selling process, will enable it
to penetrate new markets quickly.

            Each new salesperson attends the Company's NovaCare University
training program. The Company provides at least three weeks of training for new
sales people to familiarize them with the Company's services, policies and
procedures. The training focuses on the Company's values, business model and
target market approach. The composition of the sales force assigned to each
target market is determined by business objectives related to worksite
employees, profit, client growth and individual sales productivity.

            The Company's sales management control system, which monitors
activity both on an individual and a consolidated basis, is designed to ensure
an efficient sales process in support of the Company's objectives. The
measurement criteria used in the sales management process include the number of
qualified sales leads generated, proposals presented, contract close ratio,
number of worksite employees covered by signed contracts, profit per worksite
employee and client retention.

            Referrals from existing clients and professionals (such as
accountants, bankers and lawyers) are a primary source of sales leads. Each
sales person visits his or her clients periodically in order to maintain an
ongoing relationship and to benefit from referrals. Referrals are also expected
to result from the Company's brand recognition and the Company's strategic
alliances with other outsourcing service providers to small and medium-sized
businesses, including the Company's relationship with the Parent.

            The sales leads result in initial presentations to prospective
clients. The Company's sales executives then gather information about the
prospective client, employees, workers' compensation job classifications and
claims history, state unemployment experience, health insurance claims history,
compatibility with the Company's workplace safety program philosophy, salary and
the desired level of employee benefits and credit history. These various factors
are reviewed in the context of the Company's pricing model and client selection
profile. A client proposal is prepared for potential clients. This prospective
client screening process plays a vital role in controlling the Company's cost
and limiting exposure to liability.


                                       12
<PAGE>   15



            Once a prospective client accepts the Company's proposal, the new
client is incorporated into the Company's system by a new account start-up team.
A customer service manager then assumes responsibility for ensuring service
performance for the client and its employees.

WORKERS' COMPENSATION AND HEALTH CARE PROGRAM

            The majority of the Company's controllable direct costs relate to
workers' compensation benefits and health care. Consequently, the Company's
ability to manage these worksite employee costs is critical to its success and
profitability. To effectively manage its workers' compensation and health care
costs, the Company utilizes: (i) careful underwriting and selection of new
clients; (ii) effective workers' compensation injury prevention, medical
management, rehabilitation and return to work techniques; and (iii) health care
provider networks in key markets.

            If an injury occurs, the Company's goal is to take control of the
claim within 24 hours after receipt of the injury report, aggressively medically
manage the injury by coordinating with the worksite employer, employee and
provider, and return the employee to work as early as is safe and feasible. This
approach substantially lowers injury-related costs, particularly the most
expensive cost component, lost workdays. Temporarily placing injured employees
in light duty positions until they are able to return to their previous duties
is an opportunity afforded the Company in its more densely penetrated markets.

            The Company's workers' compensation insurance coverage is currently
provided by Liberty Mutual, the largest workers' compensation insurance carrier
in the United States. The coverage is provided under a workers' compensation
deductible program with an aggregate stop loss that limits the liability of the
Company to a capped percentage of the standard premium. Under this program, the
Company receives a benefit if it reduces actual claims experience below the cap.
The Company accrues workers' compensation expense based on management's
evaluation of the nature and severity of individual claims and past claims
experience. Actual claims experience is then recognized against the amount
accrued. The Liberty Mutual arrangement extends through June 30, 2000 and
provides for: (i) a dedicated claims processing unit; (ii) intensive training of
the Company's safety consultants and risk assessors; and (iii) favorable rates
and payment terms.

            When buying health care coverage for its employees, the Company
believes its scale economics will be a source of leverage with insurers.
Accordingly, the Company believes that over time it will be able to achieve
attractive health care rates by forming strategic partnerships with national and
regional providers in each local market.

COMPETITION

     The PEO industry consists of approximately 2,000 companies (according to an
estimate by NAPEO), most of which serve a single market or region. The Company
is the third largest PEO (measured by number of worksite employees) in the
United States. According to industry analysts, the ten largest PEOs account for
approximately 39% of the existing revenues in the industry. The Company
considers its primary competition to include: (i) traditional in-house human
resource departments; (ii) other PEOs; and (iii) providers of unbundled
employment-related services, such as payroll processing firms, temporary
employment firms, commercial insurance brokers, human resource consultants,
workers' compensation insurers, HMOs and other specialty managed care providers.

     Competition in the highly fragmented PEO industry is generally on a local
or regional basis. Management believes that the primary elements of competition
are quality of service, choice and quality of benefits, reputation and price.
The Company believes that brand recognition, regulatory expertise, financial
resources, risk management, information technology capability, strategic
alliances, and economies of scale can distinguish a large-scale PEO from the
rest of the industry. The Company believes that it competes favorably in these
areas.



                                       13
<PAGE>   16

     The Company believes that barriers to entry in the PEO industry are
increasing primarily due to the following factors: (i) the complexity of the PEO
business and the need for expertise in multiple disciplines; (ii) the three to
five years of experience required to establish experience-rates in key cost
areas of workers' compensation, health insurance and state unemployment; and
(iii) the need for sophisticated management information systems to track all
aspects of business in a high growth environment.

REGULATION

            The Company is subject to local, state and Federal regulations,
which include operating, financial and licensing requirements. Adding complexity
to the Company's regulatory environment are: (i) uncertainties resulting from
the non-traditional employment relationships created by PEOs; (ii) variations in
state regulatory schemes; and (iii) the ongoing evolution of regulations
regarding health care and workers' compensation.

            Many of the Federal and state laws and regulations relating to tax,
benefit and employment matters applicable to employers were enacted prior to the
development of non-traditional employment relationships and, accordingly, do not
specifically address the obligations and responsibilities of PEOs or the
co-employment relationship. Moreover, the Company's PEO services are regulated
primarily at the state level. Regulatory requirements regarding the Company's
business therefore vary from state to state, and as the Company enters new
states it will be faced with new regulatory and licensing environments. There
can be no assurance that the Company will be able to: (i) satisfy the licensing
requirements or other applicable regulations of any particular state; (ii)
provide the full range of services currently offered; or (iii) operate
profitably within the regulatory environment of any state in which it does not
obtain regulatory approval. The absence of required licenses would require the
Company to restrict the services it offers. New legislation or new
interpretations of current licensing and regulatory requirements could impose
operating or licensing requirements on the Company which it may not be able to
satisfy or which could have a material adverse effect on the Company's business,
financial condition, results of operations and liquidity. Additionally,
interpretation of such legislation or regulation by regulatory agencies with
broad discretionary powers could require the Company to materially modify its
existing operations in order to comply with applicable regulations.

            The application of many laws to the Company's PEO services will
depend on whether the Company is considered an employer under the relevant
statutes and regulations. The Internal Revenue Service ("IRS") is currently
examining this issue. See "Employee Benefit Plans" below. In addition, from time
to time there have been proposals to expand the statutory definition of employer
to include PEO's for certain purposes of the Code.

            Regulation in the health care and workers' compensation fields
continues to evolve. Numerous reform proposals have been the subject of debate
at both the Federal and state government levels. The Company cannot predict what
effect any such proposed reform will have on its business. If new legislation
results in increased health care or workers' compensation costs, which comprise
a significant portion of the Company's direct costs, and if the Company is not
able to reflect promptly such increased costs in its service fees, such
legislation could have a material adverse impact on the Company's business,
financial condition, results of operations and liquidity.

            PEO Licensing Requirements. A critical aspect of the growth of the
PEO industry has been the increasing recognition and acceptance of PEOs by state
authorities. As the concept of PEO services has become more understood by
regulatory authorities and more brand name companies enter this industry, the
regulatory environment has begun to shift from one of skepticism to one of
recognition. During the mid-to late-1980s, legitimate industry participants were
challenged to overcome well publicized failures of financially unsound and, in
some cases, unscrupulous operators.

                                       14
<PAGE>   17

            While many states do not explicitly regulate PEOs, approximately
one-third have licensing, registration or other regulatory requirements for PEOs
and several additional states, including Pennsylvania, are considering such
regulation. Such laws vary from state to state but generally provide for
monitoring the fiscal responsibility of PEOs. The Company is licensed or
registered in 13 states and expects to be licensed or registered in several more
over the next twelve months. State regulation assists in screening
insufficiently capitalized PEO operations, imposes requirements regarding
payment of wages, taxes, benefits and workers' compensation and resolves issues
concerning an employee's status for specific purposes under applicable state
law. Because existing regulations are relatively new, there is limited
interpretive or enforcement guidance available. The development of additional
regulations and interpretation of existing regulations can be expected to evolve
over time.

            In Florida, the Company's PEO operations are licensed under the
Florida Employee Leasing Licensing Act of 1991 (the "Florida Licensing Act").
The Florida Licensing Act requires PEOs and their controlling persons to be
licensed, mandates reporting requirements and allocates several employer
responsibilities. The Florida Licensing Act also requires licensed PEOs to
submit annual audited financial statements and maintain a tangible accounting
net worth and positive working capital. The Florida Licensing Act also requires
PEOs to, among other things: (i) reserve the right of direction and control over
the leased employees; (ii) enter into a written agreement with the client
company; (iii) pay wages to the leased employees; (iv) pay and collect payroll
taxes; (v) maintain authority to hire, terminate, discipline and reassign
employees; (vi) reserve a right to direct and control the management of safety,
risk and hazard control at the worksite; (vii) promulgate and administer
employment and safety policies; and (viii) manage workers' compensation claims.

            Federal and State Employment Taxes. The Company assumes the
responsibility and liability for the payment of Federal and state employment
taxes with respect to wages and salaries paid to its employees, including
worksite employees. There are essentially three types of Federal employment tax
obligations: (i) income tax withholding requirements; (ii) social security and
Medicare obligations under FICA; and (iii) unemployment obligations under FUTA.
Under the applicable Code sections, the employer has the obligation to remit the
employer portion and, where applicable, to withhold and remit the employee
portion of these taxes.

            To date, the IRS has relied extensively on the common law test of
employment in determining employer status and the resulting liability for
failure to withhold. However, the IRS has formed a Market Segment Study Group
for the stated purpose of examining whether PEOs, such as the Company, are the
employers of the worksite employees under the Code provisions applicable to
Federal employment taxes and, consequently, whether they are exclusively
responsible for payment of employment taxes on wages and salaries paid to such
employees. Another stated purpose of the Market Segment Study Group was to
determine whether owners of client companies can be employees of PEOs under the
Federal employment tax laws.

            IRS officials have reported that the Market Segment Study is near
completion and that the issuance of a tax advice memorandum has been delayed
pending the outcome of legislation to be proposed by the PEO industry. NAPEO is
in the process of drafting federal legislation that will recognize qualified
PEOs as the employer for employment tax and benefit plan purposes. Specifically,
the legislation would establish that a company's PEO would be considered to be
the employer of such company's employees for purposes of tax collection,
reporting and remittance. It would also clarify and establish that as an
employer, a PEO can sponsor employee benefit plans, including defined
contribution plans, such as 401(k) plans. NAPEO believes that this federal
legislation will become law at some point in the future.

            The interpretive uncertainties raised by the Market Segment Study
Group may affect the Company's ability to report employment taxes on its own
account rather than for the accounts of its clients and would increase
administrative burdens on the Company's payroll service function.



                                       15
<PAGE>   18

            Employee Benefit Plans. The Company offers various employee benefit
plans to its worksite employees, including 401(k) plans (a defined contribution
plan with an employer contribution feature), cafeteria plans, group health
plans, group life insurance plans, group disability insurance plans and employee
assistance programs. Generally, employee benefit plans are subject to provisions
of both the Code and the Employee Retirement Income Security Act of 1974, as
amended ("ERISA"). In order to qualify for favorable tax treatment under the
Code, the plans must be established and maintained by an employer for the
exclusive benefit of its employees.

            The Market Segment Study Group was established by the IRS to examine
whether PEOs, such as the Company, are the employers of worksite employees under
Code provisions applicable to certain employee benefit plans and consequently
able to offer to worksite employees benefit plans that qualify for favorable tax
treatment. The Company is unable to predict the actual timing of the release of
any report or nature of the findings of the Market Segment Study Group or the
ultimate outcome of such conclusions or findings. If the IRS study were to
conclude that a PEO is not an employer of its worksite employees for plan
purposes, worksite employees might not be able to continue to make contributions
to the Company's 401(k) plans or cafeteria plans. The Company believes that,
although unfavorable to the Company, a prospective application by the IRS of an
adverse conclusion would not have a material adverse effect on its financial
position and results of operations. If such conclusion were applied
retroactively, employees' vested account balances would become taxable
immediately, the Company would lose its tax deduction to the extent the
contributions were not vested, the plans' trusts would become taxable trusts and
penalties could be assessed. In such a case, the Company would face the risk of
client dissatisfaction as well as potential litigation. A retrospective
application by the IRS could have a material adverse effect on the Company's
business, financial position, results of operations and liquidity. While the
Company believes that a retroactive disqualification is unlikely, there can be
no assurance as to the ultimate resolution of these issues.

            In addition to the employer/employee relationship requirement
described above, pension and profit-sharing plans, including the Company's
401(k) plans, must satisfy certain other requirements under the Code. These
other requirements are generally designed to prevent discrimination in favor of
highly compensated employees to the detriment of non-highly compensated
employees with respect to both the availability of, and the benefits, rights and
features offered in, qualified employee benefit plans. The Company applies the
nondiscrimination requirements of the Code at both a consolidated and client
company level to ensure that its 401(k) plans are in compliance with the
requirements of the Code.

            Employee pension and welfare benefit plans are also governed by
ERISA. ERISA defines the term employer as "any person acting directly as an
employer, or indirectly in the interest of an employer, in relation to an
employee benefit plan." ERISA defines the term employee as "any individual
employed by an employer." The United States Supreme Court has held that the
common law test of employment must be applied to determine whether an individual
is an employee or an independent contractor under ERISA.

            A definitive judicial interpretation of employer in the context of a
PEO or employee leasing arrangement has not been established. If the Company
were found not to be an employer for ERISA purposes, its plans might not comply
with ERISA, the level of services the Company could offer may be materially
adversely affected, and the Company and its plans might not enjoy the preemption
of state laws provided by ERISA and could be subject to varying state laws and
regulations, as well as to claims based upon state common laws.


                                       16
<PAGE>   19



            Workers' Compensation. Workers' compensation is a state-mandated,
comprehensive insurance program that requires employers to fund or insure
medical expenses, lost wages and other costs resulting from work-related
injuries and illnesses. In exchange for providing workers' compensation coverage
for employees, employers are not subject to litigation by employees for benefits
in excess of those provided by the relevant state statute. In most states, the
extensive benefits coverage (for both medical costs and lost wages) is provided
through the purchase of commercial insurance from private insurance companies,
participation in state-run insurance funds or employer self-insurance. Workers'
compensation benefits and arrangements vary on a state-by-state basis and are
often highly complex. These laws establish the rights of workers to receive
benefits and to appeal benefit denials. Workers' compensation laws also regulate
the methods and procedures that the Company may employ in its workers'
compensation managed care programs. For example, workers' compensation laws
prohibit medical co-payment and deductible payment by employees. In addition,
certain states restrict employers' rights to direct health care providers and
establish maximum fee levels for treatment of injured workers.

            As a creation of state law, workers' compensation is subject to
change by each state's legislature and is influenced by the political processes
in each state. Several states have mandated that employers receive coverage only
from state-operated funds. Florida and other states have adopted legislation
requiring that all workers' compensation injuries be treated through a managed
care program. While such legislation may increase the market for the Company's
workers' compensation managed care services, it may also intensify the
competition faced by the Company for such services. In addition, Federal health
care reform proposals include a proposal that may require 24-hour health
coverage, in which the coverage of traditional employer-sponsored health plans
is combined with workers' compensation coverage to provide a single insurance
plan for health problems, whether or not related to work. Incorporating workers'
compensation coverage into conventional health plans may adversely affect the
market for the Company's services and may intensify the competition faced by the
Company from HMOs and other health care providers. Moreover, because workers'
compensation benefits are mandated by law and are subject to extensive
regulation, payers and employers do not have the same flexibility to alter
benefits as they have with other health benefit programs. Finally, because
workers' compensation programs vary from state to state, it is difficult for
payers and multi-state employers to adopt uniform policies to administer, manage
and control the costs of benefits.

            Other Employer-Related Requirements. As an employer, the Company is
subject to a wide variety of Federal, state and local laws and regulations
governing employer-employee relationships, including the Immigration Reform and
Control Act, the Americans with Disabilities Act, the Family and Medical Leave
Act, the Occupational Safety and Health Act, wage and hour regulations, and
comprehensive local, state and Federal civil rights laws and regulations,
including those prohibiting discrimination and sexual harassment. The definition
of employer may be broadly interpreted under these laws.

            Responsibility for complying with various state and Federal laws and
regulations is allocated by agreement between the Company and its clients, or in
some cases is the shared responsibility of both. See "Business Profile" above.
Because the Company acts as a co-employer with the client company, it is
possible that the Company could incur a liability for violations of laws even
though the Company is not contractually or otherwise responsible for the conduct
giving rise to such liability. The Company's standard client service agreement
generally provides that the client will indemnify the Company for liability
incurred as a result of an act of negligence of a worksite employee under the
direction and control of the client or to the extent the liability is
attributable to the client's failure to comply with any law or regulation for
which it has specified contractual responsibility. However, there can be no
assurance that the Company will be able to enforce such indemnification and the
Company may therefore be ultimately responsible for satisfying the liability in
question.


                                       17
<PAGE>   20




CORE (NON-WORKSITE) EMPLOYEES

      At June 30, 1999, the Company had 471 core employees. None of the
Company's core employees are represented by a collective bargaining agreement
and the Company is not aware of any current activity to organize any of its core
employees. The Company considers relations with its core employees to be good.
For information with respect to the Company's worksite employees, see "Marketing
and Sales" above.

INSURANCE

            The Company believes that it maintains the types and amounts of
insurance customary in the industry, including coverage for general liability,
directors and officers, crime, fiduciary and workers' compensation. The Company
considers its insurance coverage to be adequate both as to risks and amounts.

EXECUTIVE OFFICERS OF THE REGISTRANT

     The executive officers of the Company who served during the fiscal year are
as follows:

<TABLE>
<CAPTION>
                  NAME                    AGE                          POSITION
   ----------------------------------   ------  ---------------------------------------------
<S>                                       <C>   <C>
   Loren J. Hulber...................     57    President, Chief Executive Officer and
                                                Director
   Aven A. Kerr......................     53    Executive Vice President and Chief Operating
                                                Officer
   Thomas D. Schubert................     38    Senior Vice President and Chief Financial Officer
   Kenneth J. Jankowski..............     44    Senior Vice President of Client Services and
                                                Chief Information Officer
   Andrew W. Stith...................     31    Senior Vice President of Marketing and Sales
   Christina D. Harris, Esquire......     37    Senior Vice President of Regulatory Affairs
                                                and Compliance and General Counsel
   Ronald N. Shostack................     44    Senior Vice President of Strategic Planning
   Edwin A. Neumann..................     32    Vice President of Finance and Chief Accounting Officer
</TABLE>

            The following is a brief summary of the business experience of each
of the executive officers of the Company:

            Loren J. Hulber. Mr. Hulber has been the President, Chief Executive
Officer and a director of the Company since March 3, 1997. For the previous ten
years, he served in various capacities for Fortune Brands, Inc., most recently
as President and Chief Executive Officer of Day-Timers, Inc., a subsidiary
specializing in time management and personal organization. From 1973 until 1981,
Mr. Hulber was President and Chief Executive Officer of Durand Corporation, an
office products company. Upon Durand Corporation's acquisition by Jostens, Inc.
in 1981 and until 1987, Mr. Hulber was President of that company's Business
Products Group, a provider of business products and services. Mr. Hulber
previously served as Vice Chairman of the Board of Trustees of Lehigh Valley
Hospital and Health Network.

            Aven A. Kerr. Ms. Kerr became Executive Vice President and Chief
Operating Officer of the Company in June 1998. Ms. Kerr was previously Senior
Vice President, Human Resources of the Parent since October 1996. From November
1995 to September 1996, she was Senior Vice President, Administration and
Systems at United Healthcare Corp. She was Senior Vice President, Human
Resources at MetraHealth Care Company from May 1995 to November 1995. Prior to
that, she was employed by Prudential Insurance Company for 27 years in various
positions, most recently as Senior Vice President, Central Atlantic Operations.


                                       18
<PAGE>   21



            Thomas D. Schubert. Mr. Schubert has been the Senior Vice President
and Chief Financial Officer of the Company since June 4, 1997. Prior to joining
the Company, he served in various capacities with Chemical Leaman Tank Lines,
Inc., a transportation and logistics company, since 1991, most recently as Vice
President of Finance. From 1984 to 1990, he worked in the accounting/auditing
practice with the Philadelphia office of Ernst & Young LLP where he managed a
variety of client engagements in the manufacturing and service sectors.

            Kenneth J. Jankowski. Mr. Jankowski became Senior Vice President of
Client Services and Chief Information Officer in January 1998. Prior to joining
the Company, Mr. Jankowski was most recently Vice President and Chief
Information Officer for Whirlpool Financial Corporation from March 1995 to
January 1998, where he was responsible for all information service functions and
system operations worldwide. Prior to this appointment, Mr. Jankowski served in
various corporate and staff management positions with Whirlpool from July 1989
to February 1995. Mr. Jankowski had additional management positions with TRW,
Inc., The First National Bank of Chicago and Baxter International Inc. from
March 1982 through June 1989.

            Andrew W. Stith. Mr. Stith became Senior Vice President of Marketing
and Sales of the Company on March 3, 1997. In 1994, he joined the Parent as
Assistant to the Chairman of the Parent. In 1995, Mr. Stith assumed the position
of Vice President of Sales for the Long-Term Care Services Division of the
Parent. Prior to joining the Parent, from 1992 to 1994, Mr. Stith obtained his
M.B.A. from the Amos Tuck School of Management of Dartmouth College. From 1989
to 1992, he was associated with River Capital, Inc. as a venture capital
associate.

            Christina D. Harris, Esq. Ms. Harris became Senior Vice President of
Regulatory Affairs and Compliance of the Company on July 18, 1997 and assumed
the position of General Counsel on May 1, 1998. Prior to joining the Company,
she was National Vice President of Marketing (Alternative Staffing) for AIG Risk
Management, Inc. ("AIG") from April 1996 to July 1997. Before joining AIG, she
was Vice President for Legal and Regulatory Affairs and General Counsel for The
Vincam Group, Inc., a PEO, from December 1991 to April 1996. Ms. Harris has
served as NAPEO's chief delegate on employment law to its government affairs
committees and as Chairperson of its Legal Advisory Council. She is also the
current President of Mid-Atlantic Association of Professional Employers
("MAAPE") and past president of the Florida Association of Professional Employer
Organizations ("FAPEO"), both chapters of NAPEO. Ms. Harris currently serves on
the Board of Directors of NAPEO.

            Ronald N. Shostack. Mr. Shostack became Senior Vice President of
Strategic Planning in January 1998. Previously, Mr. Shostack was founder,
President, Chief Executive Officer and majority shareholder of AmeriCare, a PEO
based in Phoenix, Arizona, which was established in 1982 and acquired by the
Company in December 1997. Prior to founding AmeriCare, Mr. Shostack was a
Certified Public Accountant with Laventhol and Horwath.

            Edwin A. Neumann. Mr. Neumann became Vice President of Finance and
Chief Accounting Officer on July 1, 1999. Mr. Neumann was previously the
Corporate Controller of the Company since October 1997. From September 1996 to
October 1997, he was Senior Manager of the Corporate Audit department for Crown
Cork & Seal Company, Inc., a global manufacturer of packaging products. From
1993 to 1996, he worked in the accounting/auditing practice with the
Philadelphia office of Ernst & Young LLP, where he managed a variety of client
engagements in the manufacturing, aerospace and defense, and service industries.


                                       19
<PAGE>   22




ITEM 2.  PROPERTIES

     The Company's principal executive offices are located at the Valley Forge
Corporate Center, 2621 Van Buren Avenue, Norristown, Pennsylvania 19403 where
the Company leases approximately 30,000 square feet. The lease for this office
space expires in July 2004. In addition, the Company leases other office space
at approximately 17 locations in various cities within the United States. The
terms of these lease arrangements are typically three to five years in duration.
See Note 11 of Notes to Consolidated Financial Statements for further
information concerning the Company's leases for its facilities.

     The Company does not anticipate that it will experience any difficulty in
renewing any leases upon their expiration or obtaining alternate space on
comparable terms if such leases are not renewed. The Company believes that its
facilities are suitable for operations, are well maintained and are of adequate
size for present needs and planned expansion in the near future.

ITEM 3.  LEGAL PROCEEDINGS

     From time to time, the Company is party to certain claims, suits and
complaints which arise in the ordinary course of business. Currently, there are
no such claims, suits or complaints which, in the opinion of management, would
have a material adverse effect on the Company's business, financial condition,
results of operations and liquidity.

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

     None.

                                     PART II

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

     The Company's common stock is traded on the NASDAQ National Market under
the symbol "NCES".

     The following table sets forth, for the quarters indicated, the high and
low bid prices per share of common stock from November 11, 1997 (the first day
the common stock was publicly traded) as reported on the NASDAQ National Market.

<TABLE>
<CAPTION>
                                                                   COMMON STOCK PRICES
                                                             -------------------------------
                                                                  HIGH                LOW
                                                             ---------------    ------------
YEAR ENDED JUNE 30, 1999:
<S>                                                             <C>                <C>
  First Quarter............................................     $9.38              $3.00
  Second Quarter...........................................      6.19               2.97
  Third Quarter............................................      8.56               5.09
  Fourth Quarter...........................................      6.63               2.75

YEAR ENDED JUNE 30, 1998:
  Second Quarter (beginning November 11, 1997).............     $10.00             $6.31
  Third Quarter............................................       8.00              5.13
  Fourth Quarter...........................................      10.19              6.94
</TABLE>

     As of September 14, 1999, there were approximately 100 shareholders of
record of common stock. This number does not include beneficial owners of the
common stock whose shares are held in "nominee" or "street name" by various
dealers, clearing agencies, banks, brokers and other fiduciaries.


                                       20
<PAGE>   23



     The Company has never paid a cash dividend on its common stock and does not
anticipate paying any cash dividends in the foreseeable future. The payment of
cash dividends in the future will depend on the Company's earnings, financial
condition and capital needs and on other factors deemed pertinent by the
Company's Board of Directors. It is the current policy of the Company's Board of
Directors to retain earnings to finance the operations and expansion of the
Company's business.

     On November 11, 1997, the Company's Registration Statement on Form S-1 (No.
333-35071), covering 5,000,000 shares of Common Stock was declared effective by
the Securities and Exchange Commission. The Company's initial public offering
(the "Offering") was completed on November 14, 1997. Subsequent to the Offering,
the Company issued an additional 750,000 shares pursuant to the exercise of an
over-allotment provision, for a total issuance of 5,750,000 shares. The Offering
was underwritten by BancBoston Robertson Stephens and Salomon Smith Barney Inc.

     The aggregate offering price of the shares sold by the Company, including
the over-allotment provision, approximated $51.8 million. The net proceeds from
the Offering, after deducting offering costs of $6.1 million, amounted to $45.7
million and were used by the Company to pay the Company's outstanding revolving
credit loan of $28.4 million from the Parent and pay $17.2 million to retire
deferred purchase obligations. The remaining proceeds have been allocated for
general corporate purposes.




                                       21
<PAGE>   24


ITEM 6.  SELECTED FINANCIAL DATA

     The selected financial data set forth below have been derived from the
audited financial statements of the Company, and the predecessor company,
Resource One, Inc., which are incorporated by reference to the Company's Annual
Report on Form 10-K for the year ended June 30, 1998. The selected financial
data for the Company and its predecessor should be read in conjunction with the
financial statements and notes thereto, as well as "Management's Discussion and
Analysis of Financial Condition and Results of Operations".



                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES

                                FINANCIAL SUMMARY
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
                                                        THE COMPANY
                               -------------------------------------------------------------- -


                                  FOR THE YEARS  ENDED JUNE 30            PERIOD FROM
                               -------------------------------------     OCTOBER 1, 1996
                                      1999                1998           TO JUNE 30, 1997
                               ----------------      ---------------  ---------------------

<S>                            <C>                   <C>                  <C>
STATEMENT OF OPERATIONS
  DATA:(2)
Revenues(3)..................    $    1,544,622      $    1,271,757        $    394,193
                               ================      ==============        ============
Gross profit.................            64,001              41,547              12,238
Selling, general and
  administrative
  expenses...................            42,479              27,848               8,273
Amortization of excess
  cost of net assets
  acquired...................             3,571               2,801               1,034
Provision for restructure....               910                  --                  --
                               ----------------      --------------         -----------
Income from operations.......            17,041              10,898               2,931
Interest (expense) income,
  net........................              (382)               (699)               (697)
                               -----------------     --------------        ------------
Income before income
  taxes......................            16,659              10,199               2,234
Income taxes.................             7,663               4,743               1,542
                               ----------------      --------------        ------------
Net income...................    $        8,996      $        5,456        $        692
                               ================      ==============        ============
Historical net income
  (loss) per share, with
  accretion adjustment:
  Basic(5)...................    $          .31      $          .17        $       (.02)
  Assuming dilution(5).......    $          .30      $          .17        $       (.02)
Proforma net income per
  share, excluding
  accretion adjustment:
  Basic(5)...................    $          .31      $          .22        $        .04
  Assuming dilution(5).......    $          .30      $          .22        $        .04

                                                        THE COMPANY
                               --------------------------------------------------------------

                                                      AS OF JUNE 30,
                                     1999                 1998               1997
                               ----------------     ----------------   ----------------
BALANCE SHEET DATA:
Current assets.............       $    54,132          $    76,532        $    39,879
Total assets...............           144,614              157,421             95,998
Current liabilities(4).....            60,304               84,431             88,721
Financing
  arrangements(4)..........               425                  739              1,068
Shareholders' equity.......            79,795               61,806                301
</TABLE>

<TABLE>
<CAPTION>
                                                  PREDECESSOR COMPANY
                               ------------------------------------------------------------

                                FOR THE NINE                 FOR THE YEARS ENDED
                                MONTHS ENDED                      DECEMBER 31,
                                SEPTEMBER 30,     ----------------------------------------
                                     1996(1)              1995                1994
                               ------------------  -----------------   --------------------

<S>                                <C>                <C>                 <C>
STATEMENT OF OPERATIONS
  DATA:(2)
Revenues(3)..................      $   23,465         $    18,749         $    11,987
                                   ==========         ===========         ===========
Gross profit.................           1,838               2,096               2,005
Selling, general and
  administrative
  expenses...................           1,767               1,763               1,683
Amortization of excess
  cost of net assets
  acquired...................              --                  --                  --
Provision for restructure....              --                  --                  --
                                  -----------          ----------          ----------
Income from operations.......              71                 333                 322
Interest (expense) income,
  net........................               6                  (5)                  1
                                   ----------         -----------         -----------
Income before income
  taxes......................              77                 328                 323
Income taxes.................              21                  64                  94
                                   ----------         -----------         -----------
Net income...................      $       56         $       264         $       229
                                   ==========         ===========         ===========
Historical net income
  (loss) per share, with
  accretion adjustment:
  Basic(5)...................      $       --         $        --         $        --
  Assuming dilution(5).......      $       --         $        --         $        --
Proforma net income per
  share, excluding
  accretion adjustment:
  Basic(5)...................      $       --         $        --         $        --
  Assuming dilution(5).......      $       --         $        --         $        --

                                                   PREDECESSOR COMPANY
                               ------------------------------------------------------------
                                    AS OF
                                SEPTEMBER 30,                AS OF DECEMBER 31,
                                   1996(1)               1995                1994
                               ---------------     ----------------    --------------------
BALANCE SHEET DATA:
Current assets.............       $   1,320            $     986           $     821
Total assets...............           1,544                1,241               1,006
Current liabilities(4).....           1,087                  748                 591
Financing
  arrangements(4)..........               8                  101                 164
Shareholders' equity.......             449                  393                 345
</TABLE>



                                       22
<PAGE>   25



(1)   The Company commenced operations effective October 1, 1996, concurrent
      with the acquisition of Resource One, Inc., which was accounted for as a
      purchase. In February 1997, the Company acquired three additional PEOs --
      Employee Services of America, Inc., Prostaff Human Resources, Inc. and The
      TPI Group, Ltd. and entered into the NovaCare Contract. The Company
      completed three acquisitions during the year ended June 30, 1998, that
      included NovaPro, a rehabilitation temporary staffing business, acquired
      from the Parent on July 1, 1997, AmeriCare acquired December 1, 1997 and
      SLS acquired on May 1, 1998. During the year ended June 30, 1999, the
      Company acquired Pay America and Payday on August 1, 1998 and October 1,
      1998, respectively. See Note 1 of the Notes to Consolidated Financial
      Statements.

(2)   Results of operations from business combinations and the NovaCare Contract
      are included from the dates of acquisition and the date of contract
      inception, respectively.

(3)   Revenues include all amounts billed to clients for gross salaries and
      wages, related employment taxes and health care and workers' compensation
      coverage of worksite employees.

(4)   The current portion of financing arrangements is included in current
      liabilities.

(5)   For the year ended June 30, 1998 and for the period October 1, 1996 to
      June 30, 1997 historical net income per share is computed by dividing net
      income, net of the accretion of mandatorily redeemable common stock, by
      the weighted average number of shares outstanding. Pro forma net income
      per share excludes the accretion of mandatorily redeemable common stock.
      See Note 1 of the Notes to Consolidated Financial Statements.



                                       23
<PAGE>   26


                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
           MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
                            AND RESULTS OF OPERATIONS

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.

OVERVIEW

     NovaCare Employee Services, Inc. (the "Company") is one of the largest
(measured by number of worksite employees) professional employer organizations
("PEOs") in the United States. The Company is an employee services company that
provides small-to medium-sized businesses with comprehensive, fully integrated
outsourcing solutions to human resource needs, including payroll management,
workers' compensation risk management, health care and other employee benefits
management, unemployment services, temporary staffing and human resource
consulting services. The Company was established by NovaCare, Inc. (the
"Parent"), in September 1996, as a subsidiary and commenced operations on
October 1, 1996, concurrent with the acquisition of Resource One, Inc. In
February 1997, the Company acquired three additional PEO businesses -- Employee
Services of America, Inc.; The TPI Group, Ltd.; and Prostaff Human Resources,
Inc., and entered into a contract with the Parent to provide traditional PEO
services to principally all of the Parent's worksite employees (the "NovaCare
Contract"). During fiscal 1998, the Company completed three additional
acquisitions -- NovaPro, a rehabilitation temporary staffing business acquired
from the Parent on July 1, 1997; AmeriCare Employers Group, Inc. ("AmeriCare"),
a PEO based in Arizona, acquired on December 1, 1997; and Staff Leasing Systems,
Inc. ("SLS"), a PEO based in Maryland, acquired on May 1, 1998. In addition, in
November 1997 and June 1998, the Company expanded via start-up operations into
two new markets, Atlanta and Philadelphia, respectively. During fiscal 1999, the
Company acquired Pay America, Inc. ("Pay America"), a PEO based in Utah, on
August 1, 1998 and Payday Professional Employer ("Payday"), a PEO based in New
Mexico, on October 1, 1998. At June 30, 1999, the Company served 4,084 client
organizations with 54,313 employees in 46 states, principally in ten different
industries.

Strategic Alternative Review and Sale of Company

     On August 13, 1999, the Parent sent a proxy statement ("Proxy Statement")
to the stockholders asking them to consider and vote upon proposals to approve:
(i) the sale of the Parent's outpatient physical rehabilitation and occupational
health business (the "PROH Sale"), (ii) the sale of the Parent's interest in the
Company (the "NCES Sale") and (iii) the adoption of the Plan of Restructuring of
the Parent (the "Restructuring Proposal"). On September 21, 1999 the Parent's
stockholders approved the three proposals noted above.

     On September 8, 1999 the Company signed a definitive agreement to sell the
Company to an investment group comprised of Patricof & Co. Ventures
Incorporated, Fidelity Ventures Limited and AFLAC Incorporated (the
"Investors"). Under the terms of the agreement, a new private company
established by the Investors will acquire all of the outstanding common stock of
the Company at a price of $2.50 per share. The purchase will be effected through
a cash tender offer to the Company's stockholders and subsequent merger of the
Company into a new private company managed by the Investors. The Parent also
executed a definitive agreement, subject to certain conditions, to tender its
shares in the tender offer at the price of $2.50 per share. The tender offer is
subject to the satisfaction of customary closing conditions. The tender offer
commenced on September 15, 1999 and is expected to close during October 1999.

     The Parent is in the process of seeking buyers for its PROH business and
anticipates that PROH will be structured as a stock sale. While, to date, no
definitive agreement has been entered into with respect to the PROH Sale, the
Parent sought stockholder approval via the Proxy Statement to proceed with the
sale when a suitable buyer is identified and a definitive agreement is
negotiated with such buyer. The consummation of the sale would be subject to the
receipt by the Parent of the minimum sales price set forth in the Proxy
Statement, obtaining the opinion of financial advisors in connection with the
sale and approval by the Board of Directors of the Parent of the terms of any
definitive sale agreement. Except as requested in the Proxy Statement, no
further stockholder vote will be solicited by the Parent for the PROH Sale or
the NCES Sale. Accordingly, the Parent's stockholders will not have the
opportunity to vote on the definitive sale agreements.


                                       24
<PAGE>   27


                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
           MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
                     AND RESULTS OF OPERATIONS - (CONTINUED)

     With the approved Plan of Restructuring, the Parent intends to seek to
reinvest the net proceeds to the Parent from the PROH Sale and the NCES Sale,
after the payment of liabilities, in a new business or businesses. Any such
reinvestment would be subject to the further vote and approval of the
stockholders of the Parent. If the Parent is unable, or chooses not, to reinvest
any proceeds in a new business or businesses, the Parent will liquidate.

Initial Public Offering

     In November 1997, the Company completed an initial public offering (the
"Offering") of 5,000,000 shares of its common stock. Subsequent to the Offering
an additional 750,000 shares were issued pursuant to the exercise of an
over-allotment provision for a total issuance of 5,750,000 shares. The net
proceeds from the Offering (including the exercise of the over-allotment
provision), after deducting offering costs of $6.1 million, amounted to $45.7
million and were used by the Company to pay an outstanding revolving credit loan
to the Parent and to retire deferred purchase price obligations due to the
former owners of the businesses acquired. At June 30, 1999, the Parent owned
approximately 67% of the Company's outstanding common stock.

Contractual Arrangement with Parent

     The Parent and the Company entered into the NovaCare Contract in February
1997, whereby principally all of the Parent's employees became co-employed by
the Company. Under the NovaCare Contract, the Company provided traditional PEO
services such as payroll and benefits administration, worksite safety
evaluation, employment-related risk management and compensation and benefits
consultation. In fiscal 1998, the Parent paid the Company a fee for its services
equal to the salary and Federal payroll costs plus an average base fee of 9.7%
of gross earnings of employees, or approximately 117% of the gross earnings of
employees covered under the NovaCare Contract.

In January 1998, the Parent initiated a restructuring plan to favorably position
one of its operating divisions for recent changes in the Medicare reimbursement
system as mandated by the Balanced Budget Act of 1997. The intent of the plan
was to substantially reduce the cost of its workforce by transitioning to a
lower cost operating model for providing quality therapy services. In support of
this transition and to address the increased demand from the Parent for
additional human resource services, the Company and the Parent amended the
NovaCare Contract effective July 1, 1998. The amended contract provided the
existing PEO services and a broader array of services, including recruiting,
employee training and orientation, outplacement and human resource consulting.
The amended contract was principally a fee-for-service contract, replacing the
previous contract, which was priced as a percentage of payroll. Due to the
specialty nature of the additional services, the Company realized increased
gross profit and operating profit margins on the amended contract compared with
the previous arrangement.

     On March 31, 1999, the Parent announced that, due primarily to lower
reimbursement rates and to declines in rehabilitation caseloads at long-term
care facilities resulting from the new reimbursement structure for therapy under
the Medicare program, it would be forced to exit selected long-term care markets
and facilities, and would continue to lower expenses by reducing labor costs. On
June 1, 1999, the Parent sold its remaining long-term care services business
segment to Chance Murphy, Inc. In addition, on July 1, 1999, the Parent sold its
orthotics and prosthetics services business to a subsidiary of Hanger Orthopedic
Group, Inc.

     Based on these events, the Company and the Parent negotiated a new service
arrangement to reflect changes in the Parent's ongoing service needs. The new
arrangements, which became effective July 1, 1999, consists of a four-year
agreement relative to the Parent's physical rehabilitation and occupational
health division (PROH) and provides for PEO services such as payroll and
benefits administration, worksite safety evaluation, employment related risk
management and compensation and benefits consultation. The new contract is
principally a fee-for-service contract. The Company also entered into a
six-month transition service agreement with the Parent's corporate support
services group. In addition, the Parent assumed certain costs associated with
the Company's downsizing to adjust to the revised service needs.

     PROH may not terminate the NovaCare Contract except in the event of (i) the
breach of any of the Company's agreements, duties, or performance standards
under the NovaCare Contract; (ii) the making of false or misleading
representations, warranties, or statements of material fact in documents
submitted by or on behalf of the Company to the Parent; or (iii) the insolvency,
bankruptcy, or receivership of the Company.



                                       25
<PAGE>   28



                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
           MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
                     AND RESULTS OF OPERATIONS - (CONTINUED)

Provision for Restructure

     The events described above in "Contractual Arrangement with Parent" will
have an adverse impact on the future operating results of the NovaCare Contract
and the Company's temporary staffing services business. The Company evaluated
the implications these events will have on its organizational structure, and
recorded a $910,000 ($491,000 net of tax) pre-tax restructure charge in the
fourth quarter of fiscal 1999. The provision consists principally of employee
severance costs and facility lease costs.

Revenues

     The Company enters into a PEO services agreement with its clients,
establishing a three-party relationship among the Company, the client and the
worksite employees. The agreement generally provides for an initial one-year
term, subject to termination without cause on 30 days' notice by either the
Company or the client. Although PEO client service agreements are periodically
canceled, no such termination singly, or in the aggregate, has had a material
adverse effect on the Company's financial position or results of operations. The
PEO client service agreement also sets forth the service fee payable to the
Company. Such service fee, which constitutes the Company's revenues, is based on
the gross earnings of each employee plus a mark-up which includes the estimated
costs of employment-related taxes, providing human resource services, performing
administrative functions, providing insurance coverages and benefit plans and an
administration fee. This structure yields a comprehensive service fee percentage
to be applied to each employee's gross pay. These fees are invoiced along with
each periodic payroll. The Company's revenues are subject to fluctuations as the
result of: (i) changes in the wage base and employment tax rates of worksite
employees serviced by the Company; (ii) changes in the volume of clients and
worksite employees serviced by the Company; (iii) changes in the mark-up charged
by the Company for its services based upon client mix; and (iv) the number of
worksite employees enrolled in benefit plans.

     Pursuant to the PEO client service agreement, the Company has the
obligation to provide the benefits and services enumerated in that agreement as
well as to pay the direct costs associated with such services, regardless of
whether the client company makes timely payment to the Company. Worksite
employees' salaries and wages comprise the largest portion of direct costs
associated with each PEO client service agreement, and are generally disbursed
promptly after the applicable client service fee is received. For a description
of additional costs of services, see "Direct Costs" below.

Direct Costs

     The Company's primary direct costs are: (i) the salaries and wages of
worksite employees (gross earnings) and the employer's portion of Social
Security, Medicare and Federal unemployment taxes; (ii) employee benefit plan
costs; (iii) workers' compensation costs; (iv) state unemployment taxes; and (v)
salaries and benefit costs of employees who provide the new administrative
services to the Parent under the amended NovaCare Contract. Salaries and wages
of worksite employees are affected by the inflationary effects on wage levels
and by differences in the local economies of the Company's markets. Changes in
gross earnings have a proportionate impact on the Company's revenues. The
Company can significantly impact its gross profit margin by actively managing
the direct costs described in clauses (ii), (iii) and (iv) above (hereinafter
referred to as "controllable direct costs").

     Federal employment-related taxes consist of the employer's portion of
payroll taxes required under FICA, which includes Social Security and Medicare,
and Federal unemployment taxes. The Federal tax rates are defined by the
appropriate Federal regulations.

     Employee benefit plan costs consist of medical insurance premiums, payments
of and reserves for claims subject to deductibles, and the costs of dental care,
vision care, disability, employee assistance and other similar benefit plans.
The Company's health care benefit plans consist of guaranteed cost programs,
with third party insurers providing insurance. A portion of the NovaCare
Contract worksite employees are covered by a self-insured plan with reinsurance
for claims that exceed certain levels ("stop loss coverage"). Liabilities for
health care self-insured claims are recorded based on the Company's evaluation
of the nature and severity of individual claims and past claims experience and
include an estimate for incurred but not reported claims. The Company's current
group health care benefit plans are provided by national and regional health
care providers under separate contracts.


                                       26
<PAGE>   29


                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
           MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
                     AND RESULTS OF OPERATIONS - (CONTINUED)

     Workers' compensation costs include premiums, administrative costs and
claims-related expenses under the Company's workers' compensation program.
Currently, the coverage is provided under a workers' compensation deductible
program with an aggregate stop loss that limits the liability to the Company at
a capped percentage of the standard premium. Through June 30, 1997, certain of
the Company's worksite employees were covered by large deductible workers'
compensation policies and certain other worksite employees were covered by
guaranteed cost or low deductible workers' compensation insurance policies.
Costs related to these prior plans include estimates of ultimate claims amounts
that are recorded as accrued workers' compensation claims. Changes in these
estimates are reflected as a component of direct costs in the period of the
change.

     State unemployment taxes are based on rates, which vary from state to
state. Generally they are subject to certain minimum rates, but the aggregate
rates payable by an employer are affected by the employer's claims history. The
Company controls unemployment claims by aggressively contesting unfounded claims
and, when possible, quickly returning employees to work by reassigning them to
other worksites.

Selling, General and Administrative Expenses

     The Company's principal selling, general and administrative expenses are
salaries, wages, benefits and other personnel expenses of administrative
employees and sales associates, general and administrative expenses and
marketing and sales expenses.

Income Taxes

The Company's provision for income taxes differs from the U.S. statutory rate of
35% due primarily to state income taxes and non-deductible goodwill
amortization.

Operating Income

     The Company's operating income is determined in part by its ability to
manage controllable direct costs and its ability to incorporate such costs into
the service fees charged to clients. The Company manages these costs through:
(i) appropriately designed health care benefit plans; (ii) effective risk
management through new client underwriting, effective loss prevention and claims
management of existing clients relative to the fixed cost workers' compensation
program; and (iii) aggressive management of state unemployment tax exposure. The
Company attempts to reflect changes in the controllable direct costs through
adjustments in service fees charged to clients, subject to contractual
arrangements.

     The following table sets forth certain income statement and statistical
data for the years ended June 30, 1999 and 1998 and the period from October 1,
1996 (inception) to June 30, 1997.

<TABLE>
<CAPTION>
                                                                                        FOR THE PERIOD FROM
                                                                ------------------------------------------------------------------
                                                                          JULY 1, 1998                       JULY 1, 1997
                                                                               TO                                 TO
           (TABLE IN THOUSANDS, EXCEPT PERCENTAGES)                       JUNE 30, 1999                      JUNE 30, 1998
                                                                -------------------------------    -------------------------------
                                                                        $                %                 $                  %
                                                                ----------------  -------------    ----------------  -------------
OPERATING RESULTS:
<S>                                                             <C>                   <C>          <C>                   <C>
  Revenues...................................................   $1,544,622              100.0%         $1,271,757         100.0%
  Direct costs:
  Salaries, wages and employment taxes of
    worksite employees.......................................    1,372,560               88.9           1,136,547          89.3
  Health care, workers' compensation, state
     unemployment taxes and other............................      108,061                7.0              93,663           7.4
                                                                -----------       -----------      --------------          ----
     Gross profit............................................       64,001                4.1              41,547           3.3
  Selling, general and administrative
      expenses...............................................       42,479                2.8              27,848           2.2
  Amortization of excess cost of net assets
     acquired................................................        3,571                0.2               2,801           0.2
  Provision for restructure..................................          910                0.0                   -           0.0
                                                                --------------    -----------      --------------      ----------
     Income from operations..................................       17,041                1.1              10,898           0.9
  Interest expense, net......................................         (382)               ---                (699)         (0.1)
                                                                --------------    -----------      --------------          ----
     Income before income taxes..............................       16,659                1.1              10,199           0.8
  Income tax expense.........................................        7,663                0.5               4,743           0.4
                                                                -------------     -----------      --------------          ----
     Net income..............................................    $   8,996                0.6%     $        5,456           0.4%
                                                                ============      ============     ==============          ====
</TABLE>

<TABLE>
<CAPTION>
                                                                      FOR THE PERIOD FROM
                                                                -----------------------------------
                                                                        OCTOBER 1, 1996
                                                                        (INCEPTION), TO
           (TABLE IN THOUSANDS, EXCEPT PERCENTAGES)                      JUNE 30, 1997
                                                                -----------------------------------
                                                                        $                %
                                                                ----------------  -----------------
OPERATING RESULTS:
<S>                                                              <C>                <C>
  Revenues...................................................    $    394,193       100.0%
  Direct costs:
  Salaries, wages and employment taxes of
    worksite employees.......................................         357,238         90.6
  Health care, workers' compensation, state
     unemployment taxes and other............................          24,717          6.3
                                                                 ------------         ----
     Gross profit............................................          12,238          3.1
  Selling, general and administrative
      expenses...............................................           8,273          2.1
  Amortization of excess cost of net assets
     acquired................................................           1,034          0.3
  Provision for restructure..................................               -          0.0
                                                                 ------------     ----------
     Income from operations..................................           2,931          0.7
  Interest expense, net......................................            (697)        (0.2)
                                                                 ------------         ----
     Income before income taxes..............................           2,234          0.5
  Income tax expense.........................................           1,542          0.4
                                                                 ------------         ----
     Net income..............................................    $        692         0.1%
                                                                 ============         ===
</TABLE>



                                       27
<PAGE>   30


                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
           MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
                     AND RESULTS OF OPERATIONS - (CONTINUED)

<TABLE>
<CAPTION>
                                                                                        FOR THE PERIOD FROM
                                                                  ------------------------------------------------------------

                                                                      JULY 1, 1998        JULY 1, 1997          OCTOBER 1, 1996
                                                                           TO                    TO             (INCEPTION) TO
                                                                        JUNE 30,              JUNE 30,             JUNE 30,
                                                                          1999                  1998                 1997
                                                                  -------------------   -------------------  -----------------
STATISTICAL DATA:
<S>                    <C>                                              <C>              <C>                      <C>
  EBITDA (in thousands)(1).................................             $    23,203      $      14,726            $    4,217
                                                                  ================        ============            ==========

  Number of clients at period end..........................                   4,084              3,001                 1,742

  Worksite employees at period end:
     Third parties.........................................                  44,557             34,105                18,634
     Related party.........................................                   9,756             18,747                16,394
                                                                  ------------------         ---------            ----------
          Total............................................                  54,313             52,852                35,028
                                                                  =================          =========            ==========

  Weighted average worksite employees paid during the
     period:
     Third parties.........................................                  39,867             26,728                11,764
     Related party.........................................                  16,109             16,634                15,879
                                                                  -----------------          ---------            ----------
     Weighted average......................................                  55,976             43,362                18,582
                                                                  =================          =========            ==========

  Year-to-date gross profit per weighted average
     worksite employee (in whole $'s):
     Third parties.........................................           $         811        $       783            $      665
     Related party.........................................                   1,967              1,212                   650
     Weighted average......................................                   1,143                958                   659
</TABLE>


(1)   EBITDA is defined as earnings before interest, income taxes, depreciation
      and amortization. EBITDA is presented because it is a widely accepted
      financial indicator of a company's ability to incur and service debt.
      However, EBITDA should not be considered in isolation or as a substitute
      for net income or cash flow data prepared in accordance with generally
      accepted accounting principles or as a measure of a company's
      profitability or liquidity. Also, the EBITDA definition used herein may
      not be comparable to similarly titled measures reported by other
      companies.

Year Ended June 30, 1999 Compared With the Year Ended June 30, 1998

     Revenues totaled $1.545 billion for the year ended June 30, 1999, compared
to $1.272 billion for the year ended June 30, 1998, representing an increase of
$273 million or 21%. During this period, third party revenues increased $359.5
million or 72%, while related party revenues decreased $86.7 million or 11%. The
overall increase is attributable to an increased number of third party clients
and worksite employees served. From June 30, 1998 to June 30, 1999, the number
of third party clients increased 36% from 3,000 to 4,083, while the number of
weighted average worksite employees increased 49% from 26,728 to 39,867. The
increases are attributable to: (i) additions from businesses acquired; (ii)
internal growth in existing markets; and (iii) start-up of new markets. The
Company expects continued third party growth in the number of clients and
worksite employees in fiscal 2000 based upon expansion into new markets through
either platform acquisitions or start-up operations and internal growth in
existing markets. The decline in related party revenues was due to a reduction
in worksite employees caused by the Parent exiting the long-term care market.


                                       28
<PAGE>   31


                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
           MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
                     AND RESULTS OF OPERATIONS - (CONTINUED)

     Gross profit was $64.0 million for the year ended June 30, 1999, compared
to $41.5 million for the year ended June 30, 1998, representing an increase of
$22.5 million or 54%. The increase in gross profit is attributable to: (i)
additional higher margin services provided to the Parent under the amended
NovaCare Contract; (ii) gross profit from newly acquired businesses; (iii)
internal growth resulting from increased clients and worksite employees in the
Company's existing markets; and (iv) growth from the start-up of new markets.
Gross profit as a percentage of revenues increased from 3.3% in the prior year
to 4.1% for the year ended June 30, 1999. The improvement is attributable to:
(i) additional higher margin services provided under the amended NovaCare
Contract which became effective July 1, 1998; (ii) third party business, which
has a higher gross profit margin, comprising a larger portion of the Company's
operations compared to the same period in the prior year; and (iii) the
provision of higher margin temporary staffing services to the Parent. The third
party gross profit per weighted average worksite employee increased to $811 for
fiscal 1999 from $783 for fiscal 1998. The increase is attributable to improved
same market gross profit per worksite employee and the impact of newly acquired
businesses. The related party gross profit per weighted average worksite
employee increased to $1,967 for fiscal 1999 from $1,212 for fiscal 1998 due to:
(i) the higher margin services provided under the amended NovaCare Contract; and
(ii) the provision of higher margin temporary staffing services.

     Selling, general and administrative expenses increased $14.7 million, from
$27.8 million for the year ended June 30, 1998 to $42.5 million for the year
ended June 30, 1999. The increase results from increased staffing and other
expenses associated with: (i) the timing of acquisitions; (ii) the selling,
general and administrative impact of new services provided under the amended
NovaCare Contract; (iii) executing the Company's internal growth strategy; and
(iv) opening new markets. As a percentage of revenue, selling, general and
administrative expenses were 2.8% for the year ended June 30, 1999, compared to
2.2% for the same period in the prior year. The increase in selling, general and
administrative expenses as a percentage of revenues is due primarily to: (i) the
additional services provided under the amended NovaCare Contract; (ii) an
increase in expenses to support the Company's expanding infrastructure; and
(iii) third party operations, which have higher selling, general and
administrative expenses as a percentage of revenue, comprising a larger portion
of the current period's expenses. The Company anticipates that selling, general
and administrative expenses associated with the NovaCare Contract will decrease
in fiscal 2000 due to the reduction in the Parent's worksite employee base.
Expenses associated with the Company's third party business are expected to
increase in future periods to the extent the Company continues to experience
growth and expand its service offerings.

     Amortization of excess cost of net assets acquired increased to $3.6
million for the year ended June 30, 1999 from $2.8 million for the comparable
period in the prior year, principally as a result of fiscal 1999 acquisitions
and the full year effect of businesses acquired in fiscal 1998.

     Interest expense, net of investment income, decreased to $382,000 for the
year ended June 30, 1999 from $699,000 for the comparable period in the prior
year. The decrease is due primarily to a reduction in related party interest
expense. During the second quarter of fiscal 1998, the Company repaid all
outstanding indebtedness to the Parent with a portion of the net proceeds
available from the Offering completed November 14, 1997. The decrease in related
party interest expense is offset by an increase in interest expense through
borrowings from the Company's revolving credit facility. During fiscal 1999 the
average borrowings on the revolving credit facility were increased to finance
acquisitions. See "Liquidity and Capital Resources" for a further discussion of
the Company's revolving credit facility.

     Income tax expense as a percentage of pretax income decreased to 46.0% from
46.5%. The principal reason for the reduction in the tax rate was the relative
impact of non-deductible amortization of excess costs of net assets acquired on
pre-tax income for the year ended June 30, 1999 compared with the prior year.



                                       29
<PAGE>   32


                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
           MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
                     AND RESULTS OF OPERATIONS - (CONTINUED)

Year Ended June 30, 1998 Compared With the Period from October 1, 1996 (date of
inception) to June 30, 1997

     Revenues for the year ended June 30, 1998 were $1.272 billion compared to
$394 million for the period October 1, 1996 to June 30, 1997, representing an
increase of $878 million or 223%. The increase is attributable to an increased
number of clients and worksite employees. From June 30, 1997 to June 30, 1998,
the number of clients increased 72% from 1,742 to 3,001 and the number of
weighted average worksite employees increased 133% from 18,582 to 43,362. The
increases are attributable to: (i) a full year of operations in fiscal 1998 for
the NovaCare Contract and the three PEOs acquired in February 1997 versus five
months of operations in fiscal 1997; (ii) the fiscal 1998 PEO acquisitions of
AmeriCare and SLS completed in December 1997 and May 1998, respectively; (iii)
internal growth in existing markets and start-up of new markets; and (iv) the
acquisition of a rehabilitation temporary staffing business (NovaPro) in July
1997.

     Gross profit for the year ended June 30, 1998 was $41.5 million compared to
$12.2 million for the period October 1, 1996 to June 30, 1997, representing an
increase of $29.3 million or 240%. This increase was due to the higher volume of
salaries and wages paid in fiscal 1998 which was a direct function of the growth
in clients and worksite employees as discussed above. Gross profit as a
percentage of revenues increased from 3.1% in the prior year to 3.3% for the
year ended June 30, 1998. The improvement is attributable to: (i) gross profit
margins realized from fiscal 1998 acquisitions that exceeded the consolidated
gross profit percentage in the prior year; (ii) the provision of temporary
staffing services; and (iii) the relative impact of the NovaCare Contract which
was greater in the prior year, and has a lower gross profit percentage compared
with the traditional PEO businesses, due to a more highly compensated employee
population. The third party gross profit per weighted average worksite employee
increased to $783 for fiscal 1998 from $665 for fiscal 1997. The increase is
attributable to a full year of operations in fiscal 1998 for the three PEOs
acquired in February 1997 compared to five months of operations in fiscal 1997
and the impact of fiscal 1998 acquisitions. The related party gross profit per
weighted average worksite employee increased to $1,212 for fiscal 1998 from $650
for fiscal 1997 due to the full year effect of the NovaCare Contract for the
year ended June 30, 1998 versus five months of activity in the prior year and
the provision of additional temporary staffing services at higher margins.

     Selling, general and administrative expenses increased $19.5 million, from
$8.3 million for the period October 1, 1996 to June 30, 1997 to $27.8 million
for the year ended June 30, 1998. The increased costs resulted primarily from
increases in staffing and other expenses associated with: (i) the timing of
acquisitions and the start-up of the NovaCare Contract; (ii) opening new
markets; and (iii) executing the Company's internal growth strategy. As a
percentage of revenues, selling, general and administrative expenses increased
from 2.1% to 2.2% for the same periods, respectively. The increase is
attributable to: (i) the addition of operating and sales personnel, consistent
with the Company's strategy to increase its client base in its existing and
acquired markets; (ii) operating expenses incurred in the expansion of new
markets, which include compensation related costs, recruiting and training costs
of newly hired sales personnel, advertising and promotion costs and general
office expenses; and (iii) the NovaCare Contract, which has lower selling,
general and administrative expenses as a percentage of revenue, which comprised
a larger portion of fiscal 1997 expenses.

     Amortization of excess cost of net assets acquired increased to $2.8
million for the year ended June 30, 1998 from $1.0 million for the period
October 1, 1996 to June 30, 1997, principally as a result of fiscal 1998
acquisitions and the full year effect of businesses acquired in fiscal 1997.

     Interest expense, net for the year ended June 30, 1998 was $699,000 versus
$697,000 for the period October 1, 1996 to June 30, 1997. Interest expense, net,
for both periods resulted primarily from interest due to the Parent for amounts
loaned to the Company to finance the acquisition of the four PEO businesses
acquired in fiscal 1997. Interest was charged to the Company at the Parent's
borrowing rate (Eurodollar rate plus a range of 0.5% to 1.125%). The weighted
average borrowing rate for fiscal 1998 and 1997 was 6.8% and 6.6%, respectively.
Interest expense for the year ended June 30, 1998 also included interest charges
from borrowings under the Company's revolving credit facility. See "Liquidity
and Capital Resources" for a further discussion of the Company's revolving
credit facility.

     Income tax expense as a percentage of pre-tax income decreased to 46.5% for
the year ended June 30, 1998 from 69.0% for the period from October 1, 1996 to
June 30, 1997. The principal reasons for the reduction in the tax rate were the
relative impact of non-deductible amortization of excess costs of net assets
acquired on pre-tax income for fiscal 1998 compared with fiscal 1997, and lower
effective state income tax rates.


                                       30
<PAGE>   33


                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
           MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
                     AND RESULTS OF OPERATIONS - (CONTINUED)

LIQUIDITY AND CAPITAL RESOURCES

     At June 30, 1999, cash and cash equivalents totaled $5.4 million, a
decrease of $532,000 from June 30, 1998. As of the same date, the Company had a
working capital deficit of $6.2 million compared to a working capital deficit of
$7.9 million at June 30, 1998.

     The Company's cash flows from operating activities in fiscal 1999 were $4.5
million versus $20.0 million in fiscal 1998. The decrease of $15.5 million
resulted principally from a $26.1 million decrease in cash flows related to
workers' compensation and health claim liabilities. During fiscal 1999,
liabilities for workers' compensation and health claims, net of the effects from
acquisitions, decreased by $12.6 million from fiscal 1998 due primarily to the
timing of benefit payments attributable to the NovaCare Contract. During fiscal
1999, the number of worksite employees served under the NovaCare Contract
decreased from 18,747 at June 30, 1998 to 9,756 at June 30, 1999 primarily as a
result of the Parent's exit from the long-term care market. As the number of
worksite employees decreased, liabilities for workers' compensation and health
claims decreased to reflect reduced levels of benefit plan participation and the
liquidation of reserves to pay outstanding claims and premiums for worksite
employees no longer served by the Company. In fiscal 1998, cash flows from
workers' compensation and health claims liabilities were $13.4 million due to an
increase in the number of worksite employees served. The fiscal 1999 decrease in
cash flows from workers' compensation and health claims is partially offset by
the following increases in cash flows from fiscal 1998 to fiscal 1999: (i) $4.0
million for accounts payable and accrued expenses; (ii) a $3.5 million increase
in net income; (iii) a $2.8 million increase in non-cash charges consisting of
amortization, depreciation, provision for restructure and provision for
uncollectible accounts; and (iv) $1.1 million for accounts receivable, net of
changes in accrued wages and payroll taxes.

     The increase in cash flows from operating activities from fiscal 1997 to
fiscal 1998 of $20.1 million is due to: (i) a net increase in cash flows of $9.9
million for accounts receivable and accrued salaries, wages and payroll taxes;
(ii) a $9.3 million increase in worker's compensation and health claim
liabilities; (iii) a $4.8 million increase in net income; and (iv) a $2.8
million increase in non-cash charges consisting of amortization, depreciation
and provision for uncollectible accounts. The above increases in fiscal 1998
were offset by a net cash use of $6.7 million from payment of accounts payable
and accrued expenses, accrued interest related party, income taxes payable and
other current assets.

     Accounts receivable, accrued salaries, wages and payroll taxes and health
benefit premiums payable are subject to fluctuation depending on the correlation
between the financial reporting cycle versus the payroll cycle.

     Cash expended for investing activities was $6.7 million in fiscal 1999
compared with $32.0 million and $25.0 million in fiscal 1998 and 1997,
respectively. Cash paid for acquisitions decreased to $3.6 million in fiscal
1999 compared with $28.7 million and $24.2 million in fiscal 1998 and fiscal
1997, respectively. During fiscal 1999, the Company completed two acquisitions
for $2.8 million and paid $750,000 related to fiscal 1997 acquisitions. During
fiscal 1998, the Company retired $17.2 million of deferred purchase price
obligations related to acquisitions completed in fiscal 1997 and paid cash of
$11.5 million for fiscal 1998 acquisitions. Capital expenditures totaled $3.1
million, $2.8 million and $329,000 in fiscal 1999, 1998 and 1997, respectively.
Capital expenditures in fiscal 1999 relate to computer equipment, software and
furniture to support the Company's internal growth strategy in existing markets
and expansion into new markets. The increase in capital expenditures from fiscal
1997 to fiscal 1998 of $2.5 million related primarily to furniture, leasehold
improvements and computer equipment costs associated with the Company's
relocation to new corporate headquarters.

     Cash flows from financing activities were $1.6 million, $16.1 million and
$26.9 million in fiscal 1999, 1998 and 1997, respectively. The Company's major
financing activities consisted of completing the Offering of 5,750,000 shares of
the Company's common stock and establishing a new revolving credit facility in
fiscal 1998. The proceeds from the Offering were $45.7 million, net of offering
costs. Of the proceeds, $28.4 million was used to retire the outstanding
revolving credit loan borrowed from the Parent in fiscal 1997 to finance the
acquisition of four PEO businesses (see Note 5 and Note 6 of Notes to
Consolidated Financial Statements).


                                       31
<PAGE>   34


                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
           MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
                     AND RESULTS OF OPERATIONS - (CONTINUED)

     In November 1997, the Company entered into a $25.0 million three-year
revolving credit facility with a syndicate of lenders. The credit facility
provides for interest at a variable rate, depending on certain financial ratios,
equal to (a) the Eurodollar rate plus a range of 1.375% to 2.50%, or (b) the
lead lender's prime rate plus a range of 0.125% to 1.25%. In addition, the
Company has agreed to pay a commitment fee ranging from 0.30% to 0.50% per annum
on the unused portion of the commitment. Loans made under the Credit Facility
are collateralized by a pledge of all of the: (i) Company's interest in the
common stock of its subsidiaries; (ii) assets of the Company and its
subsidiaries; and (iii) Parent's interest in the common stock of the Company.
The revolving credit facility requires the maintenance of minimum capitalization
and net worth amounts, capital expenditure thresholds as well as certain
financial ratios. At June 30, 1999, the Company was in compliance with these
requirements. During fiscal 1999 and 1998, the Company borrowed $13.5 million
and $9.3 million, respectively, under the revolving credit facility for
short-term working capital needs and to finance acquisitions. The Company repaid
all outstanding amounts under the revolving credit facility in fiscal 1998,
through cash generated from operations. At June 30, 1999, only $2.0 million
remains outstanding under the revolving credit facility. The unused portion of
the credit facility at June 30, 1999 was $23.0 million.

     The Company's primary short-term liquidity requirements relate to the
payment of accrued payroll and payroll taxes of its worksite and internal
employees, accounts payable and the payment of accrued workers' compensation
expense and health benefit plan premiums. The Company anticipates additional
cash requirements in fiscal 2000 related to cash payments for acquisitions,
capital expenditures to support the Company's internal growth strategy and
expansion into new markets. The Company projects capital expenditures of
approximately $3.9 million in fiscal 2000, which includes $2.7 million committed
for the development and implementation of an enterprise wide information system
for operating and financial applications (see Note 15 of Notes to Consolidated
Financial Statements). The Company believes the cash flows generated by the
Company's operations, together with its existing cash and availability of credit
under the credit facility will be sufficient to meet the Company's short and
long-term cash needs.

Inflation

     A significant portion of the Company's operating expenses and revenues is
subject to inflationary increases, particularly worksite employee salary
increases that are directly reimbursed by the Company's customers. The Company
believes the effects of inflation have not had a significant impact on its
results of operations or its financial condition.

RECENTLY ISSUED ACCOUNTING STANDARDS

     The Company has adopted SFAS No. 132, "Employers' Disclosures about
Pensions and Other Postretirement Benefits." This pronouncement revises
employers' disclosures about pension and other postretirement benefit plans.
SFAS 132 does not change the measurement or recognition of those plans, however,
it does require additional information on changes in the benefit obligations and
fair values of plan assets in order to facilitate financial analysis. The
Company does not have any defined benefit pension plans or postretirement
benefit plans; therefore, the adoption of SFAS 132 did not have a material
impact on the Company's disclosures.

     In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position ("SOP")
98-1 "Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use". The SOP is effective for the year ending June 30, 2000.
Management does not believe the adoption of SOP 98-1 will have a material effect
on the Company's financial position or results of operations.

     In June 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued SOP 98-5 "Reporting on the Cost
of Start-Up Activities" which the Company is required to adopt no later than
June 30, 2000. SOP 98-5 provides the reporting standards for the costs of
start-up activities, including organizational costs, which should be expensed as
incurred. Management does not believe the adoption of SOP 98-5 will have a
material effect on the Company's financial position or results of operations.



                                       32
<PAGE>   35


                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
           MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
                     AND RESULTS OF OPERATIONS - (CONTINUED)


YEAR 2000 READINESS

     The "Year 2000 issue" is the result of historical computer programming of
date sensitive software. Many existing computer programs have been written using
only two digits to define an applicable year (e.g. 98 for 1998), rather than
four digits. On January 1, 2000, any date recording mechanism, including date
sensitive software, may recognize a date using "00" as the year 1900 rather than
the year 2000. This could result in systems failures or create erroneous
results, including among other things, a temporary inability to process
transactions.

     Generally, the scope of the Company's exposure to the Year 2000 issue is
limited to its core business systems (payroll, human resources and financial
reporting systems) and the computer systems used by third party service
providers and suppliers. The Company has completed its initial assessment and
believes that all internal Year 2000 issues will be addressed timely to ensure
that the core business systems are in the appropriate state of readiness.

     In January 1998, the Company launched a Year 2000-review program, which
included a dedicated Year 2000 project team, review process and internal and
external communication activities. At June 30, 1999, all of the core business
systems have been identified, evaluated and risk assessed for Year 2000
readiness. All significant external suppliers, comprised primarily of financial
institutions, third party insurers and service providers and information
technology suppliers, have been contacted to determine the extent to which the
Company is vulnerable to any external Year 2000 issues. While the Company is not
currently aware of any significant Year 2000 issues related to its business with
service providers and suppliers, there can be no guarantee that the Company will
not be adversely affected by the failure of its primary vendors to remediate
their own Year 2000 issues.

     The Company expects to complete all Year 2000 testing and remediation by
October 31, 1999. Remediation activities to date have consisted of developing
new programs to enhance or provide additional functionality to the Company's
core business systems. The next phase of the Company's Year 2000 review program,
testing and validation of external supplier Year 2000 readiness, is expected to
be completed by September 30, 1999. Given the Company's current state of
readiness and limited exposure, the cost of remediation activities should not
exceed $150,000. As of June 30, 1999, the Company's incurred costs related to
Year 2000 readiness have been limited to salary and benefits costs of internal
information systems personnel, and are included as an expense in the fiscal 1998
and 1999 operating results. If the Company is unsuccessful in completing
remediation of non-compliant systems or third party vendors are not capable of
rectifying Year 2000 issues, the Company could be subjected to the following
risks: (i) disruption of payroll, benefits and compensation administration; (ii)
information from internal management control and reporting systems may lack
integrity; (iii) the quality of service to clients could decline, resulting in
higher attrition and loss of business; and (iv) eligibility information from
third party insurers could be compromised resulting in denial of benefits to
health plan participants.

      In the event the Company would be subject to the above risks, an
appropriate contingency plan would be implemented. At June 30, 1999, the
Company's contingency plan includes: (i) a dedicated internal group of
information systems professionals that is primarily focused on system or process
disruption; (ii) the creation of a partnership with external service providers
and suppliers to respond to a disruption; (iii) labor intensive efforts in place
of core business system processing; and (iv) on a selective basis engaging
external consultants.



                                       33
<PAGE>   36



                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
           MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
                     AND RESULTS OF OPERATIONS - (CONTINUED)

MARKETING AGREEMENT

In fiscal 1998, the Company implemented a strategy to identify and evaluate
potential marketing alliances to augment other opportunities for growth. In
March 1999, the Company entered into a three-year marketing agreement with
AFLAC, Incorporated (AFLAC), the leading writer of supplemental insurance in the
United States, to cross-sell products between the two companies' respective
client bases. The marketing agreement will give the Company access to AFLAC's
substantial customer base across the country and will broaden the Company's
reach to prospective customers through AFLAC's national sales organization. In
addition, the Company's existing worksite employees will be offered an enhanced
employee benefits package through AFLAC's wide array of supplemental insurance
products.

     The Company believes that the agreement with AFLAC will enhance its ability
to increase the growth of worksite employees and clients in existing and new
markets. However, there can be no assurance of these results in the future. The
Company intends to continue developing other alliance opportunities as an
extension of its marketing and sales capability.

CAUTIONARY STATEMENT

     Except for historical information, matters discussed above including, but
not limited to, statements concerning future growth and Year 2000 readiness, are
forward-looking statements that are based on management's estimates, assumptions
and projections. Important factors that could cause results to differ materially
from those expected by management include: (i) management retention and
development; (ii) management's success in integrating acquired businesses, in
developing and introducing new products and lines of business and in entering
new markets; (iii) the ability of the Company, its customers and its suppliers
to complete assessment, testing and remediation of Year 2000 issues; (iv)
adverse Internal Revenue Service rulings and state regulations with respect to
the employer status of employee services businesses; (v) the Company's ability
to implement its employee services business model; and (vi) any adverse impact
on the operating results of the NovaCare Contract in the event the Parent
executes a sale of PROH and subsequent Plan of Restructuring.


                                       34
<PAGE>   37



ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEETS
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
                                                                                     AS OF JUNE 30,
                                                                              ----------------------------
                                                                                 1999             1998
                                                                              ----------       -----------
<S>                                                                           <C>              <C>
ASSETS
Current assets:
  Cash and cash equivalents ...........................................       $   5,394        $   5,926
  Accounts receivable:
     Related party ....................................................          13,757           45,083
     Unbilled .........................................................          22,592           13,903
     Third parties, net of allowance for doubtful accounts
      at June 30, 1999 and 1998 of $1,051 and $318, respectively ......           7,143            7,660
  Prepaid assets ......................................................           2,242            1,948
  Deferred income taxes ...............................................           2,393            1,688
  Other current assets ................................................             611              324
                                                                              ---------        ---------
          Total current assets ........................................          54,132           76,532
Property and equipment, net ...........................................           6,223            4,490
Excess cost of net assets acquired, net ...............................          81,971           75,570
Deferred income taxes .................................................           1,669               61
Other assets, net .....................................................             619              768
                                                                              ---------        ---------
                                                                              $ 144,614        $ 157,421
                                                                              =========        =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
  Current portion of financing arrangements ...........................       $   2,226        $     217
  Accounts payable and accrued expenses ...............................           4,668            3,748
  Accrued salaries, wages and payroll taxes ...........................          41,877           59,759
  Current portion of accrued workers' compensation and health claims ..           8,741           17,948
  Current portion of deferred purchase price obligations ..............             600              750
  Income taxes payable ................................................           2,192            2,009
                                                                              ---------        ---------
          Total current liabilities ...................................          60,304           84,431
Financing arrangements, net of current portion ........................             425              739
Accrued workers' compensation and health claims, net of current portion           2,909            4,466
Deferred purchase price obligations, net of current portion ...........             600            5,456
Other .................................................................             581              523
                                                                              ---------        ---------
          Total liabilities ...........................................          64,819           95,615
Commitments and contingencies .........................................              --               --
Shareholders' equity:
  Preferred stock, $.01 par value; authorized 1,000 shares;
     no shares issued or outstanding ..................................              --               --
  Common stock, $.01 par value; authorized 60,000 shares;
     issued 29,109 shares at June 30, 1999 and 27,349 shares
     at June 30, 1998 .................................................             291              273
  Additional paid-in capital ..........................................          66,382           57,365
  Retained earnings ...................................................          13,267            4,271
                                                                              ---------        ---------
                                                                                 79,940           61,909
  Less: Common stock in treasury (at cost), 24 shares at
            June 30, 1999 .............................................             (67)              --
               Deferred compensation, net .............................             (78)            (103)
                                                                              ---------        ---------
            Total shareholders' equity ................................          79,795           61,806
                                                                              ---------        ---------
                                                                              $ 144,614        $ 157,421
                                                                              =========        =========
</TABLE>

The accompanying Notes to Consolidated Financial Statements are an integral part
                              of these statements.


                                       35
<PAGE>   38



                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF OPERATIONS
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>

                                                                          FOR THE YEARS                FOR THE PERIOD
                                                                          ENDED JUNE 30,               OCTOBER 1, 1996
                                                                  -----------------------------        (INCEPTION) TO
                                                                     1999               1998           JUNE 30, 1997
                                                                  -----------        -----------       -------------
Revenues:
<S>                                                               <C>                <C>                <C>
  Related party ...........................................       $   685,487        $   772,168        $   255,289
  Third parties ...........................................           859,135            499,589            138,904
                                                                  -----------        -----------        -----------
       Total revenues .....................................         1,544,622          1,271,757            394,193
Direct costs:
  Related party:
     Salaries, wages and employment taxes of worksite
       employees ..........................................           594,073            689,295            234,182
     Healthcare and workers' compensation, state
       unemployment and other .............................            59,727             61,434             15,368
  Third parties:
     Salaries, wages and employment taxes of worksite
       employees ..........................................           778,487            447,252            123,056
     Healthcare and workers' compensation, state
       unemployment and other .............................            48,334             32,229              9,349
                                                                  -----------        -----------        -----------
       Gross profit .......................................            64,001             41,547             12,238
Selling, general and administrative expenses ..............            42,479             27,848              8,273
Amortization of excess cost of net assets acquired ........             3,571              2,801              1,034
Provision for restructure .................................               910                  -                  -
                                                                  -----------        -----------        -----------
       Income from operations .............................            17,041             10,898              2,931
Investment income .........................................                99                220                 52
Interest expense ..........................................              (481)              (308)               (56)
Interest expense -- related party .........................                 -               (611)              (693)
                                                                  -----------        -----------        -----------
       Income before income taxes .........................            16,659             10,199              2,234
Income taxes ..............................................             7,663              4,743              1,542
                                                                  -----------        -----------        -----------
       Net income .........................................       $     8,996        $     5,456        $       692
                                                                  ===========        ===========        ===========

Historical information, with accretion adjustment (Note 1):
       Net income (loss) applicable to common
          stockholders ....................................       $     8,996        $     4,271        $      (341)
                                                                  ===========        ===========        ===========
       Net income (loss) per share:
          Basic ...........................................       $       .31        $       .17        $      (.02)
                                                                  ===========        ===========        ===========
          Assuming dilution ...............................       $       .30        $       .17        $      (.02)
                                                                  ===========        ===========        ===========
Pro forma information, excluding accretion adjustment
(Note 1):
       Net income .........................................       $     8,996        $     5,456        $       692
                                                                  ===========        ===========        ===========
       Net income per share:
          Basic ...........................................       $        31        $       .22        $       .04
                                                                  ===========        ===========        ===========
          Assuming dilution ...............................       $       .30        $       .22        $       .04
                                                                  ===========        ===========        ===========
Weighted average number of common shares outstanding:
          Basic ...........................................            29,106             24,942             18,078
                                                                  ===========        ===========        ===========
          Assuming dilution ...............................            30,075             25,135             18,078
                                                                  ===========        ===========        ===========
</TABLE>

The accompanying Notes to Consolidated Financial Statements are an integral part
                              of these statements.


                                       36
<PAGE>   39



                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES

                 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>

                                                                                                   COMMON
                                                                   SHARES ISSUED                    STOCK
                                                           -----------------------------------    ($.01 PAR         TREASURY
                                                               COMMON             TREASURY         VALUE)             STOCK
                                                           ----------          -----------     -------------     -------------
Balance at October 1, 1996
<S>                                                       <C>                   <C>               <C>              <C>
  (inception).........................................            --                     --       $    --          $       --
Issued to related party...............................           6,200                   --            62                  --
Issued to employees...................................             430                   --             4                  --
Common stock split....................................          12,000                   --           120                  --
Repurchase of common stock............................             563                (563)             6              (1,080)
Accretion of mandatorily
  redeemable common stock.............................             --                    --            --                  --
Comprehensive income:
  Net income..........................................             --                    --            --                  --
                                                           --------------      ------------    ------------      ------------
Balance at June 30,1997...............................          19,193                (563)       $   192             $(1,080)
Issued through initial public
  offering, net of offering costs  of $6,041..........           5,750                   --            57                  --
Issued in connection with
  acquisitions........................................           1,585                 563             16               1,080
Accretion of mandatorily
  redeemable common stock.............................             --                    --            --                  --
Conversion of mandatorily
  redeemable common stock.............................             813                   --             8                  --
Issued in connection with stock
  option plan.........................................              --                   --            --                  --
Issued upon exercise of stock
  options.............................................               8                   --            --                  --
Amortization of deferred
  compensation........................................              --                   --            --                  --
Comprehensive income:
  Net income..........................................              --                   --            --                  --
                                                           ------------        ------------    ------------      ------------
Balance at June 30, 1998..............................          27,349                   --       $   273          $       --
ISSUED IN CONNECTION WITH
  ACQUISITIONS........................................           1,758                   --            18                  --

ISSUED UPON EXERCISE OF STOCK
  OPTIONS.............................................               2                   --            --                  --
REPURCHASE OF COMMON STOCK............................              --                 (24)            --                 (67)
AMORTIZATION OF DEFERRED
  COMPENSATION........................................              --                   --            --                  --
COMPREHENSIVE INCOME:
  NET INCOME..........................................              --                   --            --                  --
                                                           -----------         ------------    ---------         ------------
BALANCE AT JUNE 30, 1999..............................          29,109                 (24)       $   291          $      (67)
                                                              ========                 ====       =======          ===========

</TABLE>



<TABLE>
<CAPTION>


                                                               ADDITIONAL
                                                                 PAID-IN            DEFERRED                RETAINED
                                                                 CAPITAL          COMPENSATION              EARNINGS
                                                             -------------       -------------           -----------
Balance at October 1, 1996
<S>                                                            <C>                 <C>                     <C>
  (inception)............................................      $       --          $       --              $       --
Issued to related party...............................                 --                  --                      --
Issued to employees...................................                870                  --                      --
Common stock split....................................               (120)                 --                      --
Repurchase of common stock............................                780                  --                      --
Accretion of mandatorily
  redeemable common stock.............................               (341)                 --                    (692)
Comprehensive income:
  Net income..........................................                 --                  --                     692
                                                             ------------        ------------              ----------
Balance at June 30,1997...............................         $    1,189        $         --              $       --
Issued through initial public
  offering, net of offering costs  of $6,041..........             45,652                  --                      --
Issued in connection with
  acquisitions........................................              6,470                  --                      --
Accretion of mandatorily
  redeemable common stock.............................                 --                  --                  (1,185)
Conversion of mandatorily
  redeemable common stock.............................              3,907                  --                      --
Issued in connection with stock
  option plan.........................................                124               (124)                      --
Issued upon exercise of stock
  options.............................................                 23                  --                      --
Amortization of deferred
  compensation........................................                 --                  21                      --
Comprehensive income:
  Net income..........................................                 --                  --                   5,456
                                                             ------------        ------------              ----------
Balance at June 30, 1998..............................         $   57,365          $     (103)             $    4,271
ISSUED IN CONNECTION WITH
  ACQUISITIONS........................................              9,012                  --                      --

ISSUED UPON EXERCISE OF STOCK
  OPTIONS.............................................                  5                  --                      --
REPURCHASE OF COMMON STOCK............................                 --                  --                      --
AMORTIZATION OF DEFERRED
  COMPENSATION........................................                 --                  25                      --
COMPREHENSIVE INCOME:
  NET INCOME..........................................                 --                  --                   8,996
                                                             ------------          ----------             ------------
BALANCE AT JUNE 30, 1999..............................         $   66,382          $     (78)              $   13,267
                                                               ==========          ==========             ===========

</TABLE>







The accompanying Notes to Consolidated Financial Statements are an integral part
                              of these statements.


                                       37
<PAGE>   40


                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                                                               FOR THE PERIOD
                                                                             FOR THE YEARS ENDED JUNE 30,      OCTOBER 1, 1996
                                                                             ----------------------------      (INCEPTION) TO
                                                                                1999            1998           JUNE 30, 1997
                                                                             -------------------------         -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S>                                                                          <C>             <C>                 <C>
Net income ...........................................................       $  8,996        $  5,456            $    692
Adjustments to reconcile net income to net cash flows
  provided by (used in) operating activities:
  Depreciation and amortization ......................................          5,252           3,828               1,285
  Deferred income taxes ..............................................           (107)           (817)                135
  Provision for uncollectible accounts ...............................            733             292                  26
  Provision for restructure ..........................................            910               _                   _
  Changes in assets and liabilities, net of effects from acquisitions:
     Accounts receivable -- related party ............................         32,157         (19,343)            (27,607)
     Accounts receivable -- third parties ............................         (9,585)         (4,092)             (2,293)
     Other current assets ............................................           (421)         (1,072)                230
     Accounts payable and accrued expenses ...........................         (1,925)         (5,904)             (1,309)
     Accrued salaries, wages, and payroll taxes ......................        (18,585)         26,262              22,865
     Accrued interest -- related party ...............................             --              --                 693
     Accrued workers' compensation and health claims .................        (12,638)         13,417               4,113
     Income taxes payable ............................................            235           1,533                 902
     Other, net ......................................................           (519)            428                 164
                                                                             --------        --------            --------
       Net cash flows provided by (used in) operating
          activities .................................................          4,503          19,988                (104)
                                                                             --------        --------            --------

CASH FLOWS FROM INVESTING ACTIVITIES:
Payments for businesses acquired, net of cash acquired ...............         (3,583)        (11,489)            (24,250)
Payment of deferred purchase price obligations .......................             --         (17,172)                 --
Additions to property and equipment ..................................         (3,067)         (2,784)               (329)
Other, net ...........................................................             --            (515)               (387)
                                                                             --------        --------            --------
       Net cash flows used in investing activities ...................         (6,650)        (31,960)            (24,966)
                                                                             --------        --------            --------

CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from initial public offering of common stock ............             --          45,709                  --
Proceeds from note payable to related party ..........................             --              --              27,689
Payment of note payable to related party .............................             --         (28,382)                 --
Proceeds from financing arrangements .................................         13,500           9,250                  --
Payment of financing arrangements ....................................        (11,890)        (10,484)                (94)
Payment for purchase of treasury stock ...............................             --              --              (1,080)
Proceeds from common stock issued ....................................              5              23                 914
Other, net ...........................................................             --              --                (577)
                                                                             --------        --------            --------
       Net cash flows provided by financing activities ...............          1,615          16,116              26,852
                                                                             --------        --------            --------

Net (decrease) increase in cash and cash equivalents .................           (532)          4,144               1,782
Cash and cash equivalents, beginning of period .......................          5,926           1,782                  --
                                                                             --------        --------            --------
Cash and cash equivalents, end of period .............................       $  5,394        $  5,926            $  1,782
                                                                             ========        ========            ========
</TABLE>






The accompanying Notes to Consolidated Financial Statements are an integral part
                              of these statements.


                                       38
<PAGE>   41



                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                  JUNE 30, 1999
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)

1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     Nature of Operations: NovaCare Employee Services, Inc. (the "Company") is a
national professional employer organization ("PEO") providing small and
medium-sized businesses with comprehensive, fully integrated outsourcing
solutions to human resource needs, including payroll management, workers'
compensation risk management, health care and other employee benefits
management, unemployment services, temporary staffing and human resource
consulting services. The Company provides these services to companies in a
variety of industries located primarily in the states of Florida, Arizona, New
York, Maryland, Utah, New Mexico, Pennsylvania and California.

     PEO services are typically provided under a standard client service
agreement which provides for an initial one year term, and is renewed
periodically. The agreement is subject to termination without cause by the
Company or the client at any time upon 30 days' prior written notice. The
service agreement establishes a "co-employment" relationship whereby the Company
contractually assumes certain administrative, regulatory and financial employer
responsibilities with respect to worksite employees.

     The Company was established by NovaCare, Inc. (the "Parent") in September
1996 as a subsidiary and commenced operations in October 1996, concurrent with
the acquisition of Resource One, Inc. ("Resource One"), a PEO based in Florida.
In February 1997, the Company acquired three additional PEOs -- Employee
Services of America, Inc. ("ESA"), Prostaff Human Resources, Inc. ("Prostaff")
and The TPI Group, Ltd. ("TPI") and entered into a contract with the Parent to
co-employ substantially all of the Parent's workforce (the "NovaCare Contract")
(see Note 5). The Company completed three acquisitions during the year ended
June 30, 1998, including NovaPro, a temporary staffing business, acquired from
the Parent on July 1, 1997 (see Note 5), AmeriCare Employers Group, Inc.,
(AmeriCare) a PEO based in Phoenix, Arizona, acquired December 1, 1997 and Staff
Leasing Systems, Inc. (SLS), a PEO based in Bowie, Maryland, acquired on May 1,
1998 (see Note 6). The Company acquired Pay America Inc. ("Pay America"), a PEO
based in Utah, on August 1, 1998 and Payday Professional Employer ("Payday"), a
PEO based in New Mexico, on October 1, 1998 (see Note 6).

     Operating Segments: The Company has adopted the provisions of Statement of
Financial Accounting Standards ("SFAS") No. 131, "Disclosures about Segments of
an Enterprise and Related Information." SFAS 131 establishes standards for
reporting financial and descriptive information about operating segments and
related disclosures regarding products and services, geographic areas and major
customers. The adoption of SFAS 131 did not affect the Company's results of
operations or financial position. The Company operates in the United States as
one business segment under SFAS 131, providing professional employer services.
Accordingly, there were no changes to, or additional disclosures required as a
result of adopting this new standard.

     Principles of Consolidation: The Consolidated Financial Statements include
the operations of the Company and its wholly owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated in consolidation.

     Reclassifications: Certain amounts in the fiscal 1998 and 1997 consolidated
financial statements have been reclassified to conform with the fiscal 1999
presentation.

     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.


                                       39
<PAGE>   42


                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                                  JUNE 30, 1999
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)



     Revenue Recognition: Revenues and the related costs of wages, salaries, and
employment taxes pertaining to worksite employees are recognized in the period
in which the employee performs the service. Because the Company is at risk for
all of its direct costs, independently of whether payment is received from its
clients, all amounts billed to clients for gross salaries and wages, related
employment taxes, and health care and workers' compensation coverage are
recognized as revenue by the Company. Revenues relating to worksite employees
with earned but unpaid wages at the end of each period are recognized as
unbilled accounts receivable and the corresponding direct cost as an accrued
liability. The Company establishes an allowance for doubtful accounts for
accounts receivable based on management judgement and prior experience.

     Cash and Cash Equivalents: The Company considers its holdings of highly
liquid debt and money-market instruments to be cash equivalents if the
securities mature within 90 days from the date of acquisition. These investments
are carried at cost, which approximates fair value.

     Property and Equipment: Property and equipment are stated at cost.
Depreciation is provided on a straight-line basis over the estimated useful
lives of the assets, which principally range from three to ten years. Assets
under capital leases and leasehold improvements are amortized over the lesser of
the lease term or the asset's estimated useful life.

     Excess Cost of Net Assets Acquired: Assets and liabilities acquired in
connection with business combinations accounted for under the purchase method
are recorded at their respective fair values. Deferred taxes have been recorded
to the extent of the difference between the fair value and the tax basis of the
assets acquired and liabilities assumed. The excess of the purchase price over
the fair value of net assets acquired, including the recognition of applicable
deferred taxes, consists of non-compete agreements, customer lists, assembled
workforce, and goodwill and is amortized on a straight-line basis over the
estimated useful lives of the assets, which range from five to 40 years.

     In accordance with the provisions of Statement of Financial Accounting
Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of" ("SFAS 121"), the Company reviews the
realizability of long-lived assets, certain intangible assets and goodwill
whenever events or circumstances occur which indicate recorded cost may not be
recoverable. The Company also reviews the overall recoverability of goodwill
based primarily on estimated future undiscounted cash flows.

     If the expected future cash flows (undiscounted) are less than the carrying
amount of such assets, the Company recognizes an impairment loss for the
difference between the carrying amount of the assets and their estimated fair
value. In estimating future cash flows for determining whether an asset is
impaired, and in measuring assets that are impaired, assets are grouped by
geographic market.

     Workers' Compensation: The Company is contractually obligated to provide
workers' compensation coverage for its employees and co-employees. The Company
accomplishes this through a combination of various commercial insurance policies
and self insurance programs. The self insurance programs relate to
pre-acquisition workers' compensation arrangements. The Company records
estimated accruals for workers' compensation claims, including estimates for
incurred but not reported claims, based upon a review of claims activity and
past experience. Management believes any differences which may arise between
actual settlement of claims and reserves at June 30, 1999 would not have a
material effect on the Company's financial position.

     On July 1, 1997, the Company entered into a three-year contract with a
commercial insurance company for workers' compensation coverage. Under this
program, the Parent's worksite employees and third party worksite employees are
covered under a fixed cost insurance program, which is subject to certain per
incident and aggregate deductibles.



                                       40
<PAGE>   43


                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                                  JUNE 30, 1999
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)



     Income Taxes: The Company records deferred tax assets and liabilities for
the expected future tax consequences of events that have been recognized in the
Company's financial statements or tax returns.

     Net Income Per Share: The Company computes earnings per share in accordance
with the provisions of Statement of Financial Accounting Standards No. 128,
"Earnings Per Share" ("SFAS 128"). Under this statement, earnings per
share-basic represents net income divided by the weighted average number of
shares outstanding during the period. Earnings per share-assuming dilution
represents the basic weighted average shares outstanding adjusted for the
effects of dilutive stock options and contingently issuable shares under certain
acquisition agreements.


     The following table sets forth the computation and reconciliation of net
income per share-basic and net income per share-assuming dilution:

<TABLE>
<CAPTION>



                                                                                                         FOR THE PERIOD
                                                                                                              FROM
                                                            FOR THE YEARS ENDED JUNE 30,                OCTOBER 1, 1996
                                                      ---------------------------------------           (INCEPTION) TO
                                                         1999                 1998                       JUNE 30, 1997
                                                      ---------      ------------------------       -------------------------
                                                                     Historical     Pro forma       Historical      Pro forma
                                                                     ----------     ---------       ----------      ---------
<S>                                                   <C>            <C>             <C>            <C>             <C>
NET INCOME ....................................       $  8,996       $  5,456        $  5,456       $    692        $    692
ADJUSTMENT TO NET INCOME:
Deduct -- accretion of mandatorily redeemable
  common stock ................................             --         (1,185)             --         (1,033)             --
                                                      --------       --------        --------       --------        --------
Net income (loss) attributable to common stock        $  8,996       $  4,271        $  5,456       $   (341)       $    692
                                                      ========       ========        ========       ========        ========

WEIGHTED AVERAGE SHARES OUTSTANDING:
Weighted average shares outstanding -- basic ..         29,106         24,942          24,942         18,078          18,078
  Stock options ...............................             91            135             135             --              --
  Contingently issuable shares ................            878             58              58             --              --
                                                      --------       --------        --------       --------        --------
Weighted average shares outstanding -- assuming
  dilution ....................................         30,075         25,135          25,135         18,078          18,078
                                                      ========       ========        ========       ========        ========

NET INCOME (LOSS) PER SHARE:
  Basic .......................................       $    .31       $    .17        $    .22       $   (.02)       $    .04
                                                      ========       ========        ========       ========        ========
  Assuming dilution ...........................       $    .30       $    .17        $    .22       $   (.02)       $    .04
                                                      ========       ========        ========       ========        ========
</TABLE>


     Historical net income per share is computed by dividing net income, net of
the accretion of mandatorily redeemable common stock (see Note 13), by the
weighted average number of shares outstanding.

     Pro forma net income per share is computed by dividing net income, without
consideration to the accretion of mandatorily redeemable common stock, by the
weighted average number of shares outstanding.



                                       41
<PAGE>   44


                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                                  JUNE 30, 1999
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)

     Options to purchase 1,464 shares of common stock for the year ended June
30, 1999 were not included as common stock equivalents in the computation of net
income per share-assuming dilution because the effect would be antidilutive. As
part of certain purchase agreements, the former stockholders are eligible to
receive additional shares of the Company's common stock contingent upon
achieving certain financial and operating criteria over multiple reporting
periods. Approximately 4,600 contingently issuable shares were not included in
the computation of net income per share-assuming dilution because all specified
financial and operating conditions have not been satisfied. There were no
transactions occurring subsequent to June 30, 1999 that would have materially
changed the number of shares used in computing net income per share-basic or net
income per share-assuming dilution.

     Comprehensive Income: The Company has adopted the provisions of SFAS No.
130, "Reporting Comprehensive Income." SFAS 130 establishes standards for
reporting and display of comprehensive income and its components in a full set
of general-purpose financial statements. Comprehensive income is defined as the
total of net income and all other non-owner changes in equity. There have not
been any non-owner changes in equity other than net income. Comprehensive income
is reported in the Consolidated Statements of Shareholders' Equity.

Recently Issued Accounting Standards: The Company has adopted SFAS No. 132,
"Employers' Disclosures about Pensions and Other Postretirement Benefits." This
pronouncement revises employers' disclosures about pension and other
postretirement benefit plans. SFAS 132 does not change the measurement or
recognition of those plans, however, it does require additional information on
changes in the benefit obligations and fair values of plan assets in order to
facilitate financial analysis. The Company does not have any defined benefit
pension plans or postretirement benefit plans; therefore, the adoption of SFAS
132 did not have a material impact on the Company's disclosures.

     In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position ("SOP")
98-1 "Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use". The SOP is effective for the year ending June 30, 2000.
Management does not believe the adoption of SOP 98-1 will have a material effect
on the Company's financial position or results of operations.

     In June 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued SOP 98-5 "Reporting on the Cost
of Start-Up Activities" which the Company is required to adopt no later than
June 30, 2000. SOP 98-5 provides the reporting standards for the costs of
start-up activities, including organizational costs, which should be expensed as
incurred. Management does not believe the adoption of SOP 98-5 will have a
material effect on the Company's financial position or results of operations.

2. STRATEGIC ALTERNATIVES REVIEW AND SALE OF COMPANY

     On August 13, 1999, the Parent sent a proxy statement ("Proxy Statement")
to its stockholders asking them to consider and vote upon proposals to approve:
(i) the sale of the Parent's outpatient physical rehabilitation and occupational
health business (the "PROH Sale"), (ii) the sale of the Parent's interest in the
Company (the "NCES Sale") and (iii) the adoption of the Plan of Restructuring of
the Parent ("the Restructuring Proposal"). On September 21, 1999 the Parent's
stockholders approved the three proposals noted above.

     On September 8, 1999 the Company signed a definitive agreement to sell the
Company to an investment group comprised of Patricof & Co. Ventures
Incorporated, Fidelity Ventures Limited and AFLAC Incorporated (the
"Investors"). Under the terms of the agreement, a new private company
established by the Investors will acquire all of the outstanding common stock of
the Company at a price of $2.50 per share. The purchase will be effected through
a cash tender offer to the Company's stockholders and subsequent merger of the
Company into a new private company managed by the Investors. The Parent also
executed a definitive agreement, subject to certain conditions, to tender its
shares in the tender offer at the price of $2.50 per share. The tender offer is
subject to the satisfaction of customary closing conditions. The tender offer
will commence on or about September 15, 1999 and is expected to close during
October 1999.


                                       42
<PAGE>   45



                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                                  JUNE 30, 1999
                      (IN THOUSANDS, EXCEPT PER SHARE DATA



     The Parent is in the process of seeking a buyer for its PROH business. The
Parent anticipates that the PROH Sale will be structured as a stock sale. While,
to date, no definitive agreement has been entered into with respect to the PROH
Sale, the Parent is seeking stockholder approval to proceed with the sale when a
suitable buyer is identified and a definitive agreement is negotiated with such
buyer. The consummation of the sale would be subject to the receipt by the
Parent of the minimum sales price set forth in the Proxy Statement, obtaining
the opinion of financial advisors in connection with the sale and approval by
the Board of Directors of the Parent of the terms of any definitive sale
agreement. Except as requested in the Proxy Statement, no further stockholder
vote will be solicited by the Parent for the PROH Sale or the NCES Sale.
Accordingly, the Parent's stockholders will not have the opportunity to vote on
the definitive sale agreements.

     With the approved Plan of Restructuring, the Parent intends to seek to
reinvest the net proceeds to the Parent from the PROH Sale and the NCES Sale,
after the payment of liabilities, in a new business or businesses. Any such
reinvestment would be subject to the further vote and approval of the
stockholders of the Parent. If the Parent is unable, or chooses not, to reinvest
any proceeds in a new business or businesses, the Parent will liquidate.


3. PROVISION FOR RESTRUCTURE

     On March 31, 1999, the Parent announced that, due primarily to lower
reimbursement rates and to declines in caseloads at long-term care services
customer facilities, resulting from the new reimbursement structure for therapy
under the Medicare program, it would be forced to exit selected long-term care
markets and facilities, and would continue to lower expenses by reducing labor
costs. On June 1, 1999, the Parent sold its remaining long-term care services
business. In addition, on July 1, 1999, the Parent sold its orthotics and
prosthetics division. Based on these events, the Company and the Parent
negotiated new contract terms to reflect changes in the Parent's ongoing service
needs. The new contract terms, which became effective July 1, 1999, reduce the
scope of services provided to the Parent's remaining business.

     In response to the above, the Company commenced a restructuring of its
NovaCare Contract and temporary staffing operations and recorded a pretax
provision for restructuring of $910 in the fourth quarter of fiscal 1999. The
provision consists principally of employee severance costs for the termination
of approximately 50 employees, which represent the accumulation of termination
benefits set forth in the Company's severance policy, and lease termination
costs to reduce three facilities to levels more appropriate to current business
requirements.

     The following table sets forth the components of the Company's provision
for restructure:

        <TABLE>
        <CAPTION>
                                                                             FOR THE YEAR ENDED
                                                                               JUNE 30, 1999
                                                                               -------------
        COST REDUCTION PROGRAMS:
<S>                                                                               <C>
             Employee termination benefits.........................               $  502
             Facility lease terminations...........................                  408
                                                                                  ------
        Total provision............................................               $  910
                                                                                  ======
</TABLE>


     Through June 30, 1999, $181 of the restructuring accrual has been utilized.




                                       43
<PAGE>   46


               NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                                  JUNE 30, 1999
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)

4. INITIAL PUBLIC OFFERING

     On November 14, 1997, the Company completed an initial public offering of
5,000 shares of its common stock (the "Offering"). Subsequent to the Offering,
the Company issued an additional 750 shares pursuant to the exercise of an
over-allotment provision, for a total issuance of 5,750 shares. The net proceeds
from the Offering, (including the exercise of the over-allotment provision),
after deducting offering costs of $6,041, amounted to $45,709 and were used by
the Company to pay the Company's outstanding revolving credit loan of $28,382
from the Parent and pay $17,172 to retire deferred purchase obligations. The
remaining proceeds have been allocated for general corporate purposes.

5. RELATED PARTY TRANSACTIONS

     In return for its efforts as the founder, its initial investment of $40 and
the use of the Parent's trademark, the Company issued 18,200 shares (as adjusted
for the common stock split -- see Note 12) of common stock to the Parent. Given
that the transactions were between companies under common control, the issuance
of shares was recorded at the cost basis of the Parent. The excess of the
consideration given to the Parent over the Parent's cost basis in the assets
transferred was recorded as a reduction of additional paid-in capital, the same
account credited upon issuance of the shares. Therefore, the transaction had no
net effect on shareholders' equity.

     Effective October 1996, the Company entered into a line of credit agreement
with the Parent which provided for an unspecified availability. Interest was
charged to the Company at the Parent's borrowing rate, which was the EuroDollar
rate plus a range of 0.5% to 1.125%. The weighted average borrowing rate for
fiscal 1998 and 1997 was 6.8% and 6.6%, respectively. The line of credit
agreement terminated upon completion of the Company's initial public offering,
at which time all outstanding amounts were paid to the Parent (see Note 4).

     In February 1997, the Parent and the Company entered into the NovaCare
Contract, whereby substantially all of the Parent's employees became co-employed
by the Company. Under the NovaCare Contract, the Company provided traditional
PEO services such as payroll and benefits administration, worksite safety
evaluation, employment-related risk management and compensation and benefits
consultation. The Parent paid the Company a fee for its services equal to the
salary and Federal payroll costs plus an average base fee of 9.7% of gross
earnings of employees, or approximately 117% of the gross payroll covered by the
NovaCare Contract. Effective July 1, 1998, the NovaCare Contract was amended,
whereby the Company agreed to provide the existing PEO services and a broader
array of services, including recruiting, employee training and orientation,
outplacement and human resource consulting. The amended contract was principally
a fee-for-service contract, replacing the previous payment arrangement, which
was priced as a percentage of payroll, as described above. During the fourth
quarter of fiscal 1999, the Company and the Parent negotiated new contract terms
to reflect changes in the Parent's ongoing service needs (see Note 3). The new
contract became effective July 1, 1999, for a period of four years relative to
the PROH business and for six-months relative to the Parent's corporate support
services personnel, and provides for PEO services such as payroll and benefits
administration, worksite safety evaluation, employment related risk management
and compensation and benefits consultation. The new contract is principally a
fee-for-service contract.

     The Parent may not terminate the NovaCare Contract except in the event of:
(i) the breach of any of the Company's agreements, duties, or performance
standards under the NovaCare Contract; (ii) the Company making false or
misleading representations, warranties, or statements of material fact in
documents submitted by or on behalf of the Parent; or (iii) the insolvency,
bankruptcy, or receivership of the Company.



                                       44
<PAGE>   47


                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                                  JUNE 30, 1999
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)

     The Parent is the Company's only customer with revenue concentrations in
excess of ten percent. Related party revenues totaled $685,487, $772,168 and
$255,289 of consolidated revenues for fiscal 1999, fiscal 1998 and for the
period October 1, 1996 (inception) to June 30, 1997, respectively.

     During fiscal 1998 and 1997, the Parent subleased office space to the
Company. The sublease was a month-to-month arrangement, terminable on 30 days'
notice by either party, under which the Company paid the Parent approximately $9
per month which equaled the Parent's cost. The agreement was terminated in
October 1997, concurrent with the Company's relocation to the new corporate
headquarters.

     The Parent also provides general administrative and financial services to
the Company on an as-needed basis at the Parent's cost. During fiscal 1999, 1998
and 1997, the Company reimbursed the Parent for such expenses, in the amount of
$80, $220 and $160, respectively, based upon estimates of time incurred by the
Parent's personnel on behalf of the Company.

     Effective July 1, 1997, the Company issued 1,200 shares of its common
stock, valued at $5,400, to acquire the assets and liabilities of NovaPro,
formerly a business of the Parent, in a transaction accounted for as a purchase.
Given that the transaction was between companies under common control, the
transfer of assets and liabilities was recorded at the historical cost basis of
the Parent. The excess paid over the historical cost has been treated as a
reduction of additional paid-in capital, the same account credited upon issuance
of the shares. Therefore the transaction had no effect on shareholders' equity.

     The terms of the aforementioned related party transactions are equivalent
to those that would result from transactions among unrelated parties.

6.  ACQUISITIONS

     During the year ended June 30, 1999, the Company acquired two PEO
businesses. On August 1, 1998, the Company acquired Pay America, a PEO based in
Salt Lake City, Utah. On October 1, 1998, the Company acquired Payday, a PEO
based in Albuquerque, New Mexico. The purchase price of both acquisitions was
comprised of cash, shares of the Company's common stock and future contingent
payments. The cash portion of the purchase price was partially funded through
borrowings from the Company's revolving credit facility with the remainder
generated from operations.

     During the year ended June 30, 1998, the Company acquired two PEO
businesses (see Note 1) and one temporary staffing business from the Parent (see
Note 5). During the period ended June 30, 1997, the Company acquired four PEO
businesses, which included the initial platform acquisition (see Note 1).

     The following unaudited pro forma consolidated results of the Company give
effect to each of the acquisitions as if they occurred as of July 1, 1997:

<TABLE>
<CAPTION>
                                                   FOR THE YEARS ENDED JUNE 30,
                                                ---------------------------------
                                                     1999                 1998
                                                --------------     ---------------
<S>                                             <C>                <C>
Net revenues .................................. $   1,553,916      $    1,394,206
Net income ....................................         9,113               5,720
Net income per share -- basic .................           .31                 .22
Net income per share -- assuming dilution .....           .30                 .22
</TABLE>

     The above pro forma information is not necessarily indicative of the
results of operations that would have occurred had the acquisitions been made as
of July 1, 1997, or the results that may occur in the future.



                                       45
<PAGE>   48




                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                                  JUNE 30, 1999
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)


     Information with respect to businesses acquired in purchase transactions
was as follows:

<TABLE>
<CAPTION>
                                                               AS OF JUNE 30,
                                                               --------------
                                                            1999          1998
                                                            ----          ----
<S>                                                       <C>           <C>
Goodwill ..............................................   $77,553       $68,033
Customer lists ........................................     7,764         7,552
Other .................................................     4,060         3,820
                                                          -------       -------
Cost in excess of fair value of net assets acquired....    89,377        79,405
Less: accumulated amortization ........................     7,406         3,835
                                                          -------       -------
                                                          $81,971       $75,570
                                                          =======       =======
</TABLE>



<TABLE>
<CAPTION>
                                                           FOR THE YEARS ENDED
                                                                  JUNE 30,
                                                           --------------------
                                                            1999          1998
                                                            ----          ----
<S>                                                       <C>           <C>
Cash paid (net of cash acquired) ......................   $ 2,833       $10,959
Common stock issued ...................................     4,200         7,590
Deferred purchase price obligations ...................       600         4,600
Closing costs and other ...............................       600           975
                                                          -------       -------
                                                            8,233        24,124
Liabilities assumed ...................................     2,786         9,709
                                                          -------       -------
                                                           11,019        33,833
Fair value of assets acquired .........................     1,047         9,153
                                                          -------       -------
Cost in excess of fair value of net assets acquired....   $ 9,972       $24,680
                                                          =======       =======
</TABLE>



     The acquisitions were accounted for using the purchase method of
accounting. Accordingly, a portion of the purchase price was allocated to net
assets acquired based on their estimated fair values. Net assets acquired
consisted primarily of accounts receivable and property and equipment.

     Certain purchase agreements require additional payments if specific
financial targets and/or operating conditions are met. Aggregate contingent
payments in connection with these acquisitions at June 30, 1999 of approximately
6,500 shares of common stock have not been included in the initial determination
of cost of the businesses acquired since the amount of such contingent
consideration, if any, is not presently determinable. At June 30, 1998, 484
shares of common stock valued at $4,600 were accrued. The Company issued 830
shares of common stock in fiscal 1999 and in fiscal 1998 paid $1,555 in cash and
issued 93 shares of common stock in connection with these agreements.

     Deferred current and long-term guaranteed purchase price obligations were
$1,200 at June 30, 1999. Obligations at June 30, 1998 totaled $6,206, consisting
of $1,606 in guaranteed payments and $4,600 accrued for contingent
consideration. During fiscal 1999, the Company paid $750 in cash in connection
with guaranteed payment obligations.



                                       46
<PAGE>   49


                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                                  JUNE 30, 1999
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)

7.  PROPERTY AND EQUIPMENT

     The components of property and equipment were as follows:

<TABLE>
<CAPTION>
                                                           AS OF JUNE 30,
                                                        -------------------
                                                        1999           1998
                                                        ----           ----
<S>                                                   <C>            <C>
Land and buildings ............................       $    70        $    70
Property, equipment and furniture .............         2,863          2,580
Leasehold improvements ........................           622            563
Computer equipment and capitalized software ...         5,022          2,201
                                                      -------        -------
                                                        8,577          5,414
Less: accumulated depreciation and amortization        (2,354)          (924)
                                                      -------        -------
                                                      $ 6,223        $ 4,490
                                                      =======        =======
</TABLE>

     Depreciation expense for fiscal 1999, 1998 and the period from October 1,
1996 (inception) to June 30, 1997 was $1,430, $759 and $165, respectively.

8.  FINANCING ARRANGEMENTS

     Financing arrangements consisted of the following:

<TABLE>
<CAPTION>
                                                                   AS OF JUNE 30,
                                                               --------------------
                                                                1999          1998
                                                               -------      -------
<S>                                                            <C>         <C>
$25,000 revolving credit facility, due November 17, 2000       $2,000      $    --
Subordinated promissory notes (6% to 10%), payable
    through  2002 ......................................          501          678
Capitalized lease obligations, payable through 2001 ....          150          278
                                                               ------       ------
                                                                2,651          956
Less: current portion ..................................        2,226          217
                                                               ------       ------
                                                               $  425       $  739
                                                               ======       ======
</TABLE>

     In November 1997, the Company entered into a three year revolving credit
facility with a syndicate of lenders. The credit facility provides for interest
at a variable rate, depending on certain financial ratios, equal to (a) the
EuroDollar rate plus a range of 1.375% to 2.50% or (b) the lead lender's prime
rate plus a range of 0.125% to 1.25%. The weighted average borrowing rate for
fiscal 1999 was 7.7%. In addition, the Company has agreed to pay a commitment
fee ranging from 0.30% to 0.50% per annum on the unused portion of the
commitment. Loans made under the credit facility are collateralized by a pledge
of all of the (i) Company's interest in the common stock of its subsidiaries,
(ii) assets of the Company and its subsidiaries, and (iii) Parent's interest in
the common stock of the Company. The revolving credit facility requires the
maintenance of minimum capitalization and net worth amounts, capital expenditure
thresholds as well as certain financial ratios. At June 30, 1999, the Company
was in compliance with these requirements. The unused portion of the credit
facility at June 30, 1999 was $23,000.

     At June 30, 1999, aggregate annual maturities of financing arrangements
were as follows for the next five fiscal years and thereafter:

                   <TABLE>
                   <CAPTION>
                   FISCAL YEAR
                   ---------------
<S>                <C>                            <C>
                   2000..................         $ 2,226
                   2001..................             355
                   2002..................              70
                   2003..................              --
                   2004..................              --
                   Thereafter ...........              --
                                                 --------
                                                 $  2,651
                                                 ========
                   </TABLE>

     Interest paid on debt during fiscal 1999 and 1998 and the period October 1,
1996 (inception) through June 30, 1997, amounted to $412, $804 and $49,
respectively.



                                       47
<PAGE>   50


                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                                  JUNE 30, 1999
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)


9.  ACCRUED WORKERS' COMPENSATION AND HEALTH CLAIMS

     The Company's accruals for claims are summarized as follows:

 <TABLE>
 <CAPTION>
                                                                       AS OF JUNE 30,
                                                                   ----------------------
                                                                     1999           1998
                                                                   --------      --------
<S>                                                                <C>           <C>
          Accrued health benefit premiums payable and claims
            reserves .......................................       $ 6,802       $16,638
          Accrued workers' compensation premiums payable and
            claims reserves ................................         4,848         5,776
                                                                   -------       -------
                                                                    11,650        22,414
          Less: workers' compensation claims and health
            benefits claims expected to be settled in less
            than one year ..................................         8,741        17,948
                                                                   -------       -------
                                                                   $ 2,909       $ 4,466
                                                                   =======       =======
</TABLE>

     Under the NovaCare Contract, as described in Note 5, the Company is
self-insured for certain health benefits up to $150 per individual per year. The
Company expensed amounts for estimated costs occurring from incurred losses,
both reported and unreported. The estimate of the liability for unasserted
claims arising from unreported incidents is based on an analysis of historical
claims rates.

10.  INCOME TAXES

     The components of income tax expense were as follows:

<TABLE>
<CAPTION>
                                                   FOR THE
                                                  PERIOD FROM
               FOR THE YEARS ENDED JUNE 30,      OCTOBER 1, 1996
               ----------------------------      (INCEPTION) TO
                  1999           1998            JUNE 30, 1997
                -------        --------          -------------
Current:
<S>             <C>            <C>                  <C>
  Federal       $ 6,206        $ 4,460              $   937
  State .         1,564          1,100                  470
                -------        -------              -------
                  7,770          5,560                1,407
                -------        -------              -------
Deferred:
  Federal           (81)          (744)                 122
  State .           (26)           (73)                  13
                -------        -------              -------
                   (107)          (817)                 135
                -------        -------              -------
                $ 7,663        $ 4,743              $ 1,542
                =======        =======              =======
</TABLE>


                                       48
<PAGE>   51


                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                                  JUNE 30, 1999
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)

     The components of net deferred tax assets as of June 30, 1999 and 1998 were
as follows:



<TABLE>
<CAPTION>
                                                                           AS OF JUNE 30,
                                                                       ----------------------
                                                                         1999          1998
                                                                       -------        -------
<S>                                                                    <C>            <C>
Net operating loss carryforward ................................       $ 1,669        $ 2,058
Accruals and reserves not currently deductible for tax purposes:
  Current ......................................................         2,393          1,688

  Non-current ..................................................            --             61
                                                                       -------        -------
Gross deferred tax assets ......................................         4,062          3,807
Valuation reserve ..............................................            --         (2,058)
                                                                       -------        -------
Total deferred tax assets ......................................         4,062          1,749
Expenses capitalized for financial statement
  purposes .....................................................          (344)          (195)
                                                                       -------        -------
Net deferred tax asset .........................................       $ 3,718        $ 1,554
                                                                       =======        =======
</TABLE>

     In fiscal 1997, the Company acquired net operating loss carryforwards of
approximately $6,000, of which $4,000 is remaining at June 30, 1999, expiring
through 2010. The Internal Revenue Code of 1986, (the "Code"), placed certain
restrictions on the use of net operating loss carryforwards acquired through
purchase transactions. Accordingly, a full valuation allowance was in place,
against these amounts, at June 30, 1998. During 1999, the Code was modified,
regarding the use of net operating loss carryforwards acquired in purchase
transactions, allowing the Company to reverse the valuation allowance placed
against these amounts. Because the valuation allowance was recorded as a
component of purchase accounting at the acquisition date, the reversal of the
valuation allowance resulted in a corresponding reduction in goodwill.

     The reconciliation of the expected tax expense (computed by applying the
Federal statutory tax rate to income before income taxes) to actual tax expense
was as follows:

<TABLE>
<CAPTION>

                                                                                FOR THE
                                                                               PERIOD FROM
                                           FOR THE YEARS ENDED JUNE 30,      OCTOBER 1, 1996
                                           ----------------------------       INCEPTION) TO
                                              1999           1998             JUNE 30, 1997
                                           ---------      ---------          --------------
<S>                                         <C>            <C>                    <C>
Expected Federal income tax expense .       $ 5,831        $ 3,468                $   782
State income taxes, less Federal
  benefit ...........................         1,028            603                    470
Non-deductible amortization of excess
  cost of net assets acquired .......         1,150            914                    349
Tax credits .........................          (213)          (200)                   (10)
Other, net ..........................          (133)           (42)                   (49)
                                            -------        -------                -------
                                            $ 7,663        $ 4,743                $ 1,542
                                            =======        =======                =======
</TABLE>

     Income taxes paid during fiscal 1999, 1998 and the period October 1, 1996
(inception) through June 30, 1997 amounted to $7,726, $3,960 and $178,
respectively.


                                       49
<PAGE>   52


                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                                  JUNE 30, 1999
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)


11.  OPERATING LEASES

     The Company rents office space and equipment under non-cancelable operating
leases. Total rent expense charged to operations was $1,548, $1,027 and $394 for
fiscal 1999, 1998 and the period October 1, 1996 (inception) to June 30, 1997,
respectively.

     Future minimum lease commitments for all non-cancelable leases as of June
30, 1999 are as follows:

                   <TABLE>
                   <CAPTION>
                                                                               OPERATING
                   FISCAL YEAR                                                   LEASES
                   -----------                                                   ------
<S>                <C>                                                         <C>
                   2000............................................            $   1,954
                   2001............................................                1,370
                   2002............................................                1,220
                   2003............................................                1,064
                   2004............................................                  263
                   Thereafter......................................                  134
                                                                               ---------
                   Total minimum lease payments....................            $   6,005
                                                                               =========
                   </TABLE>

12.  SHAREHOLDERS' EQUITY

Preferred Stock

     On inception, the Board of Directors authorized 1,000 shares of preferred
stock with a par value of $.01 per share. There were no shares issued or
outstanding at any time during the period from inception to June 30, 1999.

Common Stock

     During the period from October 1, 1996 (inception) through June 30, 1997,
five employees purchased 430 shares of the Company's common stock. The Chief
Executive Officer of the Company purchased 375 shares of the Company's common
stock on January 10, 1997 at the fair market value of $1.92 per share. The other
shares were purchased on various dates from February 28, 1997 through June 10,
1997 at the fair market value of $2.80 per share.

     On January 2, 1997, the Board of Directors declared a four-for-one stock
split of the Company's common stock to shareholders of record on January 2,
1997. All references in the financial statements to per share amounts have been
retroactively restated to reflect the change in the number of common shares
outstanding as a result of the stock split. Accordingly, $126 was transferred
from additional paid-in capital to common stock, representing the par value of
additional shares issued.

     On November 14, 1997, the Company completed the Offering of 5,000 shares of
its common stock. Subsequent to the Offering an additional 750 shares were
issued pursuant to the exercise of an over-allotment provision, for a total
issuance of 5,750 shares (see Note 4). Simultaneously with the completion of the
Offering, all 813 shares of mandatorily redeemable common stock were converted
into common stock (see Note 13).

     During the year ended June 30, 1999, the Company issued 1,758 shares of
common stock, in connection with fiscal 1999, 1998 and 1997 acquisitions (see
Note 6).



                                       50
<PAGE>   53


                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                                  JUNE 30, 1999
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)


Treasury Stock

     On January 2, 1997, the Company repurchased 563 shares of mandatorily
redeemable common stock from a former owner of an acquired business. Upon
repurchase, the mandatorily redeemable common stock became a component of
permanent equity. Accordingly, the 563 shares and the related par value and
additional paid-in capital associated with these shares were reflected in the
accompanying consolidated statement of shareholders' equity as treasury stock,
stated at cost. On December 1, 1997, 563 shares were reissued from the treasury
as part of the acquisition purchase price of AmeriCare. At June 30, 1998, there
were no shares held in the treasury. During the year ended June 30, 1999, the
Company repurchased 24 shares of common stock from a former owner of an acquired
business.

Deferred Compensation

     On August 8 and September 5, 1997, the Company granted options to certain
executives, in conjunction with compensation agreements, to purchase shares of
common stock at an exercise price of $4.50 per share. There was no trading
market for the common stock as of each respective date. For financial statement
purposes, a fair market value for the common stock was determined by the Board
of Directors to be $7.12 on August 8, 1997 and $9.00 on September 5, 1997.
Accordingly, the Company has recorded deferred compensation expense based on the
difference between the exercise price and the fair market value of the common
stock on the date of grant, in the aggregate amount of $124. This amount is
recognized as compensation expense over the vesting period of five years, on a
straight-line basis. The unamortized portion of deferred compensation is
recorded as a reduction to shareholders' equity. At June 30, 1999 and 1998, the
remaining unamortized portion of deferred compensation amounted to $78 and $103,
respectively.

13.  MANDATORILY REDEEMABLE COMMON STOCK

     In connection with the acquisitions described in Note 1, 1,376 shares (as
adjusted for the stock split -- see Note 12) of common stock were issued subject
to an agreement which provides certain registration rights with respect to the
common stock, as well as the right, two years from the date of acquisition, to
put the shares to the Company at a price of $16.00 per share. The put option was
rendered inoperative due to the Company's completion of the Offering prior to
December 31, 1998.

     Of the 1,376 shares, 750 (as adjusted for the stock split), 375 and 155
were issued, as of the date of acquisition, to the selling shareholders of
Resource One, ESA and TPI, respectively, at the fair market value of $1.20 per
share (as adjusted for the stock split) for Resource One and $2.48 for ESA and
TPI. Subsequent to the date of acquisition, contingent and non-contingent
payments of 41, 44, and 11 shares were issued with respect to the Resource One,
ESA and Prostaff acquisitions, respectively, at the fair market value of $2.80
per share.

     The mandatorily redeemable common stock was recorded at the fair value at
the date of issuance. The excess of the put price over the carrying value was
accreted by periodic charges to retained earnings or additional paid-in capital,
as applicable, over a two year period. As of June 30, 1997, 813 shares of
mandatorily redeemable common stock were outstanding. During fiscal 1998 and the
period from October 1, 1996 (inception) to June 30, 1997, the Company recorded
$1,185 and $1,033, respectively, of accretion to retained earnings and
additional paid-in capital. On November 11, 1997, in conjunction with the
Offering, all 813 shares were converted into common stock.


                                       51
<PAGE>   54


                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                                  JUNE 30, 1999
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)


14.  BENEFIT PLANS

Stock Option Plan:

     On February 28, 1997, the Company's Board of Directors adopted and its
shareholders approved the Company's 1997 Stock Option Plan (the "Plan") under
which 625 shares of common stock were reserved for issuance upon the exercise of
stock options. On November 24, 1997, the Plan was amended to increase the number
of shares reserved for issuance to 1,625, and limit the maximum number of
options which may be granted to any person under the Plan during any fiscal year
to 200 shares. On December 8, 1998, the Plan was amended to increase the number
of shares reserved for issuance to 3,125. As of the same date, the Company
repriced all outstanding options with prices in excess of $6.00 to $5.81 per
share. The new option price was determined based upon the fair market value per
share at December 8, 1998. Accordingly, no compensation expense was recognized
since the exercise price was equal to the market value per share. Under the
Plan, substantially all options are granted for a term of up to 10 years at
prices equal to the fair value at the date of grant. Options granted generally
are exercisable over a five year period, although vesting can be accelerated if
the Company's stock price achieves stated levels.

     The following summarizes the activity of the Plan:

<TABLE>
<CAPTION>




                                                                                                                FOR THE PERIOD
                                                                     FOR THE YEARS ENDED JUNE 30,              OCTOBER 1, 1996
                                                                ------------------------------------------      (INCEPTION) TO
                                                                     1999                       1998           JUNE 30, 1997
                                                                ------------------        ----------------    ------------------
<S>                                                             <C>                       <C>                          <C>
Options:
Outstanding at the beginning of the year....................                1,314                       371                  --
  Granted...................................................                1,156                     1,091                 375
  Exercised.................................................                   (2)                       (8)                 --
  Canceled..................................................                 (145)                     (140)                 (4)
                                                                -----------------         ------------------            --------
  Outstanding at the end of the year........................                2,323                     1,314                 371
                                                                =================         ==================            ========

Option price per share ranges:
  Granted...................................................    $     4.50 - 6.50         $    2.80 -- 9.13            $   2.80
  Exercised.................................................    $            2.80         $            2.80            $     --
  Outstanding at the end of the year........................    $     2.80 - 9.13         $    2.80 -- 9.13            $   2.80
  Options exercisable at end of year........................                  179                        83                  --
  Exercisable option price ranges...........................    $    2.80 -  9.13         $            2.80            $     --
  Options available for grant at end of year under
     the 1997 stock option plan.............................                  792                       303                 254
</TABLE>


                                       52
<PAGE>   55


                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                                  JUNE 30, 1999
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)

The Company has adopted the disclosure-only provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123"), and applies Accounting Principles Board Opinion No. 25 and related
interpretations in accounting for the Plan. The table below sets forth the pro
forma information as if the Company had adopted the compensation recognition
provisions of SFAS 123:

<TABLE>
<CAPTION>

                                                                                   FOR THE PERIOD
                                                  FOR THE YEARS ENDED JUNE 30,     OCTOBER 1, 1996
                                                  ----------------------------     (INCEPTION) TO
                                                      1999            1998          JUNE 30, 1997
                                                 -------------    -------------    ----------------
<S>                                                <C>             <C>             <C>
Increase (decrease) to:
  Net income ...............................       $     (982)     $     (342)     $          13
  Net income per share -- basic and assuming
     dilution ..............................       $     (.03)     $     (.01)                --
Assumptions:
  Expected life (years) ....................       2.2 - 6.3       3.2 -- 7.5         4.6 -- 6.6
  Risk-free interest rate ..................             4.4%             5.8%       6.1% -- 6.5%
  Volatility ...............................            93.0%            57.7%                 0%
  Dividend yield ...........................             N/A              N/A               N/A
</TABLE>

     The compensation recognition for the period ended June 30, 1997 was
calculated assuming a fair market value for the Company's common stock equal to
the assumed share value as of the date of the initial public offering. Certain
options were grouped together for purposes of valuation based upon vesting
periods and the date of grant. The weighted average fair value of the stock
options, calculated using the Black-Scholes option pricing model, granted during
the fiscal year ended June 30 1999, 1998 and 1997 was $4.47, $5.63 and $0.82,
respectively. The weighted average remaining contractual life of all options
granted as of June 30, 1999 is 9.2 years.

Retirement Plans:

     The Company and the Parent co-sponsor a defined contribution 401(k) plan
covering substantially all of the worksite employees of the Parent and certain
employees of the Company. The contributions for fiscal 1999, 1998 and for the
period October 1, 1996 (inception) to June 30, 1997 made on behalf of the Parent
and the Company were $5,193, $4,508 and $1,612, respectively. The Company and
the Parent also co-sponsored a non-qualified supplemental benefit plan covering
certain key employees. This plan was terminated in March 1999. The matching
contributions made on behalf of the Parent and the Company were $845, $859 and
$166 for fiscal 1999, 1998 and the period October 1, 1996 (inception) to June
30, 1997, respectively.

     The Company's subsidiaries maintain defined contribution 401(k) plans
covering certain of their employees and third party worksite employees. The
Company contributes, on behalf of each participating client, varying amounts
based on client elections. The Company's contributions for fiscal 1999, 1998 and
the period from October 1, 1996 (inception) to June 30, 1997 were $850, $456 and
$85, respectively.

15.  COMMITMENTS AND CONTINGENCIES

Commitments:

     In July 1999, the Company entered into agreements with a nationally
recognized software and technology provider and a leading information management
consulting firm to develop and implement an enterprise wide information system
for operating and financial applications. The cost of this commitment, including
computer hardware, software and other related costs, approximates $2,700 and is
projected to be expended during fiscal 2000.



                                       53
<PAGE>   56


                NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                                  JUNE 30, 1999
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)

Contingencies:

     The Company is subject to legal proceedings and claims which arise in the
ordinary course of its business. In the opinion of management, the amount of
ultimate liability, if any, with respect to these actions will not have a
materially adverse effect on the financial position or results of operations of
the Company.

     The Company's operations are subject to numerous Federal, state and local
laws related to employment, taxes and benefit plan matters. Generally, these
regulations affect all companies in the United States. However, the regulatory
environment for PEOs is an evolving area due to uncertainties resulting from the
non-traditional employment relationship created by PEOs. Many Federal and state
laws relating to tax and employment matters were enacted prior to the
development of PEO companies and do not specifically address the obligations and
responsibilities of these co-employer relationships. The Internal Revenue
Service ("IRS") has conducted a market segment study of the PEO industry (the
"Market Segment Study") focusing on selected PEOs (not including the Company)
for the purpose of examining the relationship among PEOs, their clients,
worksite employees, and the worksite owners. IRS officials indicate that the
Market Segment Study is near completion and suggest that an announcement of the
IRS' position with respect to PEOs has been delayed pending the outcome of
legislation that has been proposed by the PEO industry. If the IRS concludes
that PEOs are not "employers" of certain worksite employees for purposes of the
Internal Revenue Code, the Company's benefit plans (including cafeteria, health
and welfare, and retirement plans) may lose their favorable tax status, and the
Company may no longer be able to assume its clients' Federal employment tax
withholding obligations. The Company believes that, although unfavorable to the
Company, a prospective application by the IRS of an adverse conclusion would not
have a material effect on its financial position and results of operations. A
retrospective application by the IRS could have a material adverse effect on the
Company's business, financial position, results of operations and liquidity.
While the Company believes that a retrospective disqualification is unlikely,
there can be no assurance as to the ultimate resolution of these issues.

15.  QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

<TABLE>
<CAPTION>
                                                          FOURTH          THIRD         SECOND          FIRST
                                                          QUARTER        QUARTER        QUARTER        QUARTER
                                                          -------        -------        -------        -------
YEAR ENDED JUNE 30, 1999
<S>                                                       <C>            <C>            <C>            <C>
Net revenues ......................................       $374,394       $384,029       $397,037       $389,162
Gross profit ......................................         16,622         16,717         15,902         14,760
Income from operations ............................          3,913          4,872          4,446          3,810
Net income ........................................          2,052          2,573          2,344          2,027
Net income per share - basic ......................       $    .07       $    .09       $    .08       $    .07
Net income per share - assuming dilution ..........       $    .07       $    .09       $    .08       $    .07
Weighted average shares outstanding:
  Basic ...........................................         29,185         29,185         28,254         27,967
  Assuming dilution ...............................         30,766         29,886         29,296         28,935
YEAR ENDED JUNE 30, 1998
Net revenues ......................................       $363,882       $338,367       $302,751       $266,757
Gross profit ......................................         12,505         11,302          9,412          8,328
Income from operations ............................          3,645          2,840          2,287          2,126
Net income ........................................          1,921          1,479          1,119            937
Historical net income per share, after accretion
  adjustment -- basic and assuming dilution .......       $    .07       $    .05       $    .03           $ --

Pro forma net income per share, excluding accretion
  adjustment -- basic and assuming  dilution ......       $    .07       $    .05       $    .05       $    .04
Weighted average shares outstanding:
  Basic ...........................................         27,635         27,544         23,869         21,009
  Assuming dilution ...............................         28,018         27,674         24,031         21,009
</TABLE>

     Results for the fourth quarter of fiscal 1999 include a $910 pretax
provision for restructure (see Note 3). Historical net income per share is
computed by dividing net income, net of the accretion of mandatorily redeemable
common stock, by the weighted average number of shares outstanding. Pro forma
net income per share excludes the accretion of mandatorily redeemable common
stock (see Note 1).



                                       54
<PAGE>   57

                        REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Shareholders of NovaCare Employee Services, Inc.

     In our opinion, the consolidated financial statements listed in the
accompanying index appearing under Item 14(a)(1) on page 57 present fairly, in
all material respects, the financial position of NovaCare Employee Services,
Inc. and its subsidiaries at June 30, 1999 and 1998, and the results of their
operations and their cash flows for the years ended June 30, 1999 and 1998 and
the period from October 1, 1996 (date of inception) to June 30, 1997, in
conformity with generally accepted accounting principles. 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 of these statements in accordance with
generally accepted auditing standards which 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,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.

PricewaterhouseCoopers LLP
/s/ PricewaterhouseCoopers LLP

Philadelphia, PA
July 30, 1999, except for paragraphs two and three of Note 2, as to which the
date is September 8, 1999


<PAGE>   58



ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURES

     The Registrant has had no changes in or disagreements with accountants on
accounting and financial disclosure of the type referred to in Item 304 of
Regulation S-K.

                                    PART III


ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     For information concerning this item, see "Item 1 -- Business -- Executive
Officers of the Registrant" and the table and text under the caption "Name of
Nominee and Biographical Information" and "Section 16(a) Reporting Requirements"
of the Proxy Statement to be filed with respect to the 1999 annual meeting of
shareholders to be held on December 14, 1999 (the "Proxy Statement"), which
information is incorporated herein by reference.

ITEM 11.  EXECUTIVE COMPENSATION

     For information concerning this item, see the table and text under the
captions "Compensation of Executive Officers of the Company", "Compensation of
Directors of the Company", "Compensation Committee Interlocks and Insider
Participation" and "Employment Agreements" of the Proxy Statement, which
information is incorporated herein by reference.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     For information concerning this item, see the table and text under the
captions "Shares of Common Stock Owned Beneficially as of August 31, 1999" and
"Information Concerning Certain Stockholders" of the Proxy Statement, which
information is incorporated herein by reference.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     For information concerning this item, see the text under the caption
"Certain Transactions" of the Proxy Statement, which information is incorporated
herein by reference.



                                       56
<PAGE>   59


                                     PART IV

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

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

<TABLE>
<CAPTION>
                                                                                                   PAGE
                                                                                                  NUMBER
                                                                                                  ------
<S>                                                                                            <C>
(1) FINANCIAL STATEMENTS:
          NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES (THE
          "COMPANY")
          Consolidated Balance Sheets at June 30, 1999 and 1998                                     35
          Consolidated Statements of Operations for the years ended
          June 30, 1999 and 1998 and the period October 1, 1996 (inception)
          to June 30, 1997                                                                          36
          Consolidated Statements of Shareholders' Equity for the
          period October 1, 1996 (inception) to June 30, 1999                                       37
          Consolidated Statements of Cash Flows for the years ended
          June 30, 1999 and 1998 and the period October 1, 1996 (inception)
          to June 30, 1997                                                                          38
          Notes to Consolidated Financial Statements                                                39
          Report of Independent Accountants                                                         55
(2)       EXHIBITS (NUMBERED IN ACCORDANCE WITH ITEM 601 OF REGULATION
          S-K):
          The exhibits required to be filed are listed in the index to
          exhibits                                                                                  59
</TABLE>

     (b) Current Reports on Form 8-K:

     The Company filed no current reports on Form 8-K during the fourth quarter
ended June 30, 1999


                                       57
<PAGE>   60



                                POWER OF ATTORNEY

     The Registrant and each person whose signature appears below hereby appoint
E. Martin Gibson and Loren J. Hulber as attorneys-in-fact with full power of
substitution, severally, to execute in the name and on behalf of the Registrant
and each such person, individually and in each capacity stated below, one or
more amendments to the annual report which amendments may make such changes in
the report as the attorney-in-fact acting in the premises deems appropriate and
to file any such amendment to the report with the Securities and Exchange
Commission.

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

                                   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.

                         NOVACARE EMPLOYEE SERVICES, INC.

                         By:/s/ THOMAS D. SCHUBERT
                            ---------------------------------
                         THOMAS D. SCHUBERT
                         (SENIOR VICE PRESIDENT AND CHIEF FINANCIAL OFFICER)

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

<TABLE>
<CAPTION>
      SIGNATURE                                        TITLE                           DATE
      ---------                                        -----                           ----

<S>                                   <C>                                    <C>
       /S/ E. MARTIN GIBSON           Chairman of the Board and              September 27, 1999
------------------------------        Director
 (E. MARTIN GIBSON)

        /S/ LOREN J. HULBER           President, Chief Executive             September 27, 1999
------------------------------        Officer and Director
  (LOREN J. HULBER)

      /S/ THOMAS D. SCHUBERT          Senior Vice President and              September 27, 1999
------------------------------        Chief Financial Officer
(THOMAS D. SCHUBERT)

       /S/ EDWIN A. NEUMANN           Vice President of Finance and          September 27, 1999
------------------------------        Chief Accounting Officer
 (EDWIN A. NEUMANN))

 /S/ HARVEY V. FINEBERG, M.D.         Director                               September 27, 1999
------------------------------
  (HARVEY V. FINEBERG, M.D.)

         /S/ JOHN H. FOSTER           Director                               September 27, 1999
------------------------------
  (JOHN H. FOSTER)

       /S/ TIMOTHY E. FOSTER          Director                               September 27, 1999
------------------------------
 (TIMOTHY E. FOSTER)

       /S/ STEPHEN E. O'NEIL          Director                               September 27, 1999
------------------------------
 (STEPHEN E. O'NEIL)

    /S/ WILLIAM F. WELD, ESQ.         Director                               September 27, 1999
------------------------------
(WILLIAM F. WELD, ESQ.)
</TABLE>


                                       58
<PAGE>   61



                                INDEX TO EXHIBITS

<TABLE>
<CAPTION>
   EXHIBIT                                                                                   PAGE
   NUMBER                                   EXHIBIT DESCRIPTION                             NUMBER
   ------     ------------------------------------------------------------------------      ------
<S>           <C>                                                                          <C>
       2(a)   Stock Purchase Agreement dated September 16, 1996 by and among
              Resource One, Inc., Professional Insurance Planners of Florida,
              Inc., Human Resources One, Inc., Rx One, Inc., William Mayville,
              Bernard Clinton Byrd, Jr. and Nova Resource, Inc. (incorporated by
              reference to Exhibit 2(a) to the Company's Registration Statement
              on Form S-1 (No. 333-35071))                                                     --

       2(b)   Amendment dated April 8, 1997 to the stock purchase agreement
              dated as of September 16, 1996 by and among Resource One, Inc.,
              Professional Insurance Planners of Florida, Inc., Human Resource
              One, Inc., Rx One, Inc., William E. Mayville, Bernard Clinton
              Byrd, Jr. and NovaSource, Inc (incorporated by reference to
              Exhibit 2(b) to the Company's Registration Statement on Form S-1
              (No. 333-35071))                                                                 --

       2(c)   Stock Purchase Agreement dated January 24, 1997 by and among
              Employee Services of America, Inc., Employee Services of Florida,
              Inc., Employers Risk Management, Inc., Employee Benefits
              Management, Inc., Employers Diversified Services, Inc., and Nova
              Resource, Inc. (incorporated by reference to Exhibit 2(c) to the
              Company's Registration Statement on Form S-1 (No. 333-35071))                    --

       2(d)   Stock Purchase Agreement dated January 31, 1997 by and among the
              TPI Group, LTD., Deborah M. Skinner, John Skinner III, Malvern
              Tippett, Carolyn Tippett, Terry DeLong, Quansoo-TPI L.L.C. and
              NovaSource, Inc. (incorporated by reference to Exhibit 2(d) to the
              Company's Registration Statement on Form S-1 (No. 333-35071))                    --

       2(e)   Stock Purchase Agreement dated December 1, 1997 by and among
              AmeriCare Employers Group, Inc., Paralign Staffing Technologies,
              Inc., Ronald N. Shostack, Kerran L. Shostack, Ian Ackerman,
              Theresa Conroy, Zanza Personnel, Inc. and NovaCare Employee
              Services, Inc. (incorporated by reference to Exhibit 2 to the
              Company's current report on Form 8-K dated February 2, 1998)                     --

       3(a)   Certificate of Incorporation of the Company (incorporated by
              reference to Exhibit 3(a) to the Company's Registration Statement
              on Form S-1 (No. 333-35071))                                                     --

       3(b)   By-laws of the Company, as amended to date (incorporated by
              reference to Exhibit 3(b) to the Company's Registration Statement
              on Form S-1 (No. 333-35071))                                                     --

       4(a)   1997 Stock Option Plan (incorporated by reference to Exhibit 4(a)
              to the Company's Registration Statement on Form S-1 (No.
              333-35071))                                                                      --

       4(b)   Amendment No. 1 to the 1997 Stock Option Plan, dated as of
              November 24, 1997 (incorporated by reference to Exhibit 4(a) to
              the Company's Quarterly Report on Form 10-Q for the quarter ended
              December 31, 1997) --

       4(c)   Amended and Restated 1997 Stock Option Plan (incorporated by
              reference to Exhibit 4 to the Company's Registration Statement on
              Form S-8 (No. 4 (c) 333-70995))                                                  --

       10(a)  Employment Agreement dated as of January 10, 1997 between the
              Company and Loren J. Hulber (incorporated by reference to Exhibit
              10(a) to the Company's Registration Statement on Form S-1 (No.
              333-35071))                                                                      --

       10(b)  Amendment dated as of July 1, 1998 to the Employment Agreement
              dated January 10, 1997 between the Company and Loren J. Hulber
              (incorporated by reference to Exhibit 10 to the Company's
              Quarterly Report on Form 10-Q for the quarter ended September 30,
              1998)                                                                            --

       10(c)  Amendment dated as of January 27, 1999 to the Employment Agreement
              dated January 10, 1997 between the Company and Loren J. Hulber
              (incorporated by reference to Exhibit 10(a) to the Company's
              Quarterly Report on Form 10-Q for the quarter ended December 31,
              1998)                                                                            --

       10(d)  Stock Purchase Agreement dated as of February 10, 1997 between the
              Company and Loren J. Hulber (incorporated by reference to Exhibit
              10(b) to the Company's Registration Statement on Form S-1
              (No.333-35071))                                                                  --

       10(e)  Stock Purchase Agreement dated as of April 23, 1997 between the
              Company and Andrew Stith (incorporated by reference to Exhibit
              10(i) to the Company's Registration Statement on Form S-1 (No.
              333-35071))                                                                      --

</TABLE>


                                       59
<PAGE>   62



<TABLE>
<CAPTION>
<S>    <C>                                                                            <C>
       10(f)  Stock Purchase Agreement dated as of June 10, 1997 between the
              Company and Thomas D. Schubert (incorporated by reference to
              Exhibit 10(k) to the Company's Registration Statement on Form S-1
              (No. 333-35071))                                                            --

       10(g)  Employment Agreement dated as of December 8, 1998 between the
              Company and Christina D. Harris (incorporated by reference to
              Exhibit 10(d) to the Company's Quarterly Report on Form 10-Q for
              the quarter ended December 31, 1998.)                                       --

       10(h)  Employment Agreement dated as of December 8, 1998 between the
              Company and Kenneth J. Jankowski (incorporated by reference to
              Exhibit 10(e) to the Company's Quarterly Report on Form 10-Q for
              the quarter ended December 31, 1998.)                                       --

       10(i)  Employment Agreement dated as of December 8, 1998 between the
              Company and Aven A. Kerr (incorporated by reference to Exhibit
              10(b) to the Company's Quarterly Report on Form 10-Q for the
              quarter ended December 31, 1998)                                            --

       10(j)  Employment Agreement dated as of December 8, 1998 between the
              Company and Thomas D. Schubert (incorporated by reference to
              Exhibit 10(c) to the Company's Quarterly Report on Form 10-Q for
              the quarter ended December 31, 1998.)                                       --

       10(k)  Employment Agreement dated as of December 8, 1998 between the
              Company and Andrew W. Stith (incorporated by reference to Exhibit
              10 to the Company's Quarterly Report on Form 10-Q for the quarter
              ended March 31, 1999)                                                       --

       10(l)  Agreement dated as of January 25, 1997 between NovaCare, Inc. and
              NovaCare Employee Services, Inc. (incorporated by reference to
              Exhibit 10(m) to the Company's Registration Statement on Form S-1
              (No. 333-35071))                                                            --

       10(m)  Agreement dated as of January 25, 1997 between NovaCare, Inc. and
              NovaCare Employee Services, Inc. (incorporated by reference to
              Exhibit 10(n) to the Company's Registration Statement on Form S-1
              (No. 333-35071))                                                            --

       10(n)  Amended and Restated Agreement dated as of July 1, 1998 between
              NovaCare, Inc. and NovaCare Employee Services, Inc. (incorporated
              by reference to Exhibit 10(n) to the Company's Annual Report on
              Form 10-K for the year ended June 30, 1998.)                                --

       10(o)  Agreement dated as of July 1, 1999 between NovaCare, Inc. and
              NovaCare Employee Services, Inc.

       10(p)  Agreement dated as of July 1, 1999 between NovaCare, Inc. and
              NovaCare Employee Services, Inc.

       10(q)  Client Service Agreement dated as of July 1, 1999 between Hanger
              Orthopedic Group, Inc. and NovaCare Employee Services, Inc.

       10(r)  Trademark Agreement dated as of February 28, 1997 between the
              Company and NovaMark, Inc. (incorporated by reference to Exhibit
              10(o) to the Company's Registration Statement on Form S-1 (No.
              333-35071))                                                                 --

       10(s)  (i) $25,000,000 Revolving Credit Facility Credit Agreement by and
              among NovaCare Employee Services, Inc., and certain of its
              subsidiaries and the banks party thereto and PNC Bank, National
              Association, as agent, dated as of November 17, 1997 (incorporated
              by reference to Exhibit 10(a) to the Company's Quarterly Report on
              Form 10-Q for the Quarter ended September 30, 1997)                         --

              (ii) Revolving Credit Agreement First Amendment dated as of March
              30, 1998 by and among NovaCare Employee Services, Inc. and certain
              of its subsidiaries and PNC Bank, N.A., SunTrust Bank of Central
              Florida, N.A., Bank One of Kentucky, N.A. and AMSouth Bank
              incorporated by reference to Exhibit 10(a) to the Company's
              Quarterly Report on Form 10-Q for the quarter ended March 31,
              1998)                                                                       --

              (iii) Revolving Credit Agreement Second Amendment dated as of July
              7, 1998 by and among NovaCare Employee Services, Inc. and certain
              of its subsidiaries and PNC Bank, N.A., SunTrust Bank of Central
              Florida, N.A., Bank One of Kentucky, N.A., and AMSouth Bank
              (incorporated by reference to Exhibit 10(p) (iii) to the Company's
              Annual Report on Form 10-K for the year ended June 30, 1998.)               --

       10(t)  Agreement and Plan of Merger dated as of September 8, 1999 between
              Plato Holdings, Inc., New Plato Acquisition, Inc. and NovaCare
              Employee Services, Inc. (incorporated by reference to Exhibit 2(a)
              to the Company's current report on Form 8-K dated September 8,
              1999)                                                                       --

       10(u)  Short Form Merger Option Agreement dated as of September 8, 1999
              between Plato Holdings, Inc., New Plato Acquisition, Inc. and
              NovaCare Employee Services, Inc. (incorporated by reference to
              Exhibit 2(b) to the Company's current report on Form 8-K dated
              September 8, 1999.)

       21     Subsidiaries of the Company

       23     Consent of Independent Accountants

       24     Power of Attorney (See "Power of Attorney" in Form 10-K)                    --

       27     Financial Data Schedules
</TABLE>

     Copies of the exhibits filed with this Annual Report on Form 10-K or
incorporated by reference herein do not accompany copies hereof for distribution
to shareholders of the Company. The Company will furnish a copy of any such
exhibits to any shareholder requesting the same.


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