<PAGE>
 
                      SECURITIES AND EXCHANGE COMMISSION

                            WASHINGTON, D.C. 20549

                                  FORM 10-QSB


(Mark One)

 X     QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
----   EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998.

_____  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
       EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO _______.

COMMISSION FILE NUMBER: 0-21145


                             COVALENT GROUP, INC.
                (Name of small business issuer in its charter)


          NEVADA                                         56-1668867

(State or other jurisdiction of             (I.R.S. Employer Identification No.)
incorporation or organization)

              ONE GLENHARDIE CORPORATE CENTER, 1275 DRUMMERS LANE
                           WAYNE, PENNSYLVANIA 19087
                   (address of principal executive offices)


Issuer's telephone number: 610-975-9533

Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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 ___
                                                              -          

State the number of shares outstanding of each of the issuer's classes of common
equity as of September 30, 1998.

Common Stock, Par Value $.001                               11,848,193
-----------------------------                               ----------
         (Class)                                            Outstanding

Transitional Small Business Disclosure Format (check one): Yes___  No  X
                                                                       -

                                       1
<PAGE>
 
FORM 10-QSB

                             COVALENT GROUP, INC.


                                     INDEX
<TABLE> 
<CAPTION> 
                                                                           Page
                                                                           ----
<S>                                                                        <C> 
PART I.    Financial Information

  Item 1.  Consolidated Financial Statements

     Balance Sheet - September 30, 1998 (Unaudited)                          3

     Statements of Operations - Nine and Three Months Ended
     September 30, 1998 and 1997 (Unaudited)                                 5

     Statements of Cash Flows - Nine Months
     Ended September 30, 1998 and 1997 (Unaudited)                           6

     Notes to Consolidated Financial Statements
     (Unaudited)                                                             7

  Item 2.  Management's Discussion and Analysis of
           Financial Condition and Results of Operations                     9

PART II.   Other Information                                                14

Signature Page                                                              15
</TABLE> 
                                       
                                       2
<PAGE>
 
PART I.  FINANCIAL INFORMATION
       ITEM 1.  CONSOLIDATED FINANCIAL STATEMENTS


                             COVALENT GROUP, INC.
                                AND SUBSIDIARY
                          CONSOLIDATED BALANCE SHEET
                              SEPTEMBER 30, 1998
                                  (Unaudited)
 
<TABLE> 
<CAPTION>  
ASSETS
<S>                                                                            <C> 
CURRENT ASSETS
  Cash and cash equivalents                                                    $     865,456                        
  Accounts receivable                                                              2,177,969                        
  Prepaid expenses and other                                                         239,461                        
  Costs and estimated earnings in excess of                                                                         
    related billings on uncompleted contracts                                      2,207,931                        
                                                                               -------------                         
                       TOTAL CURRENT ASSETS                                        5,490,817                        
                                                                               -------------                         
                                                                                                                    
                                                                                                                    
PROPERTY AND EQUIPMENT                                                                                              
  Equipment                                                                          841,521                        
  Furniture and fixtures                                                             202,316                        
  Leasehold improvements                                                              59,441                        
                                                                               ------------- 
                                                                                   1,103,278                        
              Less - Accumulated depreciation                                       (541,637)                       
                                                                               -------------                        
                     NET PROPERTY AND EQUIPMENT                                      561,641                        
                                                                               -------------                        
                                                                                                                    
                                                                                                                    
DEFERRED INCOME TAXES                                                                240,795                        
                                                                               -------------                         
OTHER ASSETS                                                                          41,765                        
                                                                               -------------                        
                                                                                                                    
TOTAL ASSETS                                                                   $   6,335,018                        
                                                                               =============                        
</TABLE> 
 
                See accompanying notes to financial statements

                                       3
<PAGE>
 
                             COVALENT GROUP, INC.
                                AND SUBSIDIARY
                          CONSOLIDATED BALANCE SHEET
                              SEPTEMBER 30, 1998
                                  (Unaudited)
 
<TABLE> 
<S>                                                                            <C>                                           
LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES
Accounts payable                                                               $ 2,152,882                        
Accrued expenses                                                                    74,393                        
Billings in excess of related costs and                                                                           
    estimated earnings on uncompleted contracts                                    623,097                        
                                                                               -----------                         
              TOTAL CURRENT LIABILITIES                                          2,850,372                        
                                                                               -----------                         
                                                                                                                  
STOCKHOLDERS' EQUITY                                                                                              
Common stock, $.001 par value,                                                                                    
    25,000,000 shares authorized,                                                                                 
    11,860,693 shares issued                                                        11,861                        
Additional paid-in-capital                                                       9,358,327                        
Accumulated deficit                                                             (5,419,015)                       
Unrealized loss on investment                                                     (416,211)                       
                                                                               -----------                        
                                                                                 3,534,962                        
LESS:                                                                                                             
    Treasury stock at cost, 12,500 shares                                          (50,316)                       
                                                                               -----------                         
              TOTAL STOCKHOLDERS' EQUITY                                         3,484,646                        
                                                                               -----------                        
                                                                                                                  
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                                     $ 6,335,018                        
                                                                               ===========                        
</TABLE> 
 
                See accompanying notes to financial statements

                                       4
<PAGE>
 
                             COVALENT GROUP, INC.
                                AND SUBSIDIARY
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                                  (Unaudited)
 
<TABLE> 
<CAPTION> 
                                                             Three Months Ended               Nine Months Ended
                                                                September 30,                   September 30,
                                                                -------------                   -------------
                                                            1998           1997            1998               1997
                                                            ----           ----            ----               ----
<S>                                                     <C>             <C>             <C>               <C> 
REVENUES                                                $ 2,708,762     $ 3,545,236     $ 7,491,582       $ 9,858,680    
                                                                                                                         
OPERATING EXPENSES                                                                                                       
  Direct                                                  1,715,548       2,605,485       5,207,675         7,888,649    
  Selling, general and administrative                     1,045,936         583,712       2,795,586         1,765,708    
                                                        -----------     -----------     -----------       -----------    
                                                                                                                         
TOTAL OPERATING EXPENSES                                  2,761,484       3,189,197       8,003,261         9,654,357    
                                                        -----------     -----------     -----------       -----------    
                                                                                                                         
INCOME (LOSS) FROM OPERATIONS                               (52,722)        356,039        (511,679)          204,323    
                                                                                                                         
INTEREST INCOME                                              20,587          32,698          78,052            82,996    
                                                        -----------     -----------     -----------       -----------    
                                                                                                                         
INCOME (LOSS) FROM CONTINUING OPERATIONS                    (32,135)        388,737        (433,627)          287,319    
 BEFORE INCOME TAXES                                                                                                     
                                                                                                                         
INCOME TAX (BENEFIT) PROVISION                              (12,333)         66,754        (147,556)          (36,754)   
                                                        -----------     -----------     -----------       -----------    
                                                                                                                         
NET INCOME (LOSS)                                       $   (19,802)    $   321,983     $  (286,071)      $   324,073    
                                                        ===========     ===========     ===========       ===========    
                                                                                                                         
NET INCOME (LOSS) PER COMMON SHARE                                                                                       
  Net Income (Loss) - Basic                             $         -     $       .03     $      (.02)      $       .03    
  Net Income (Loss) - Diluted                           $         -     $       .03     $      (.02)      $       .03    
                                                                                                                         
WEIGHTED AVERAGE COMMON AND COMMON                                                                                       
  EQUIVALENT SHARES OUTSTANDING                                                                                          
   Basic                                                 11,759,299      11,686,579      11,748,332        11,631,779    
   Diluted                                               11,759,299      12,482,710      11,748,332        12,404,523     
</TABLE> 

                See accompanying notes to financial statements.

                                       5
<PAGE>
 
                             COVALENT GROUP, INC.
                                AND SUBSIDIARY
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  (Unaudited)

<TABLE> 
<CAPTION> 
                                                                                        Nine Months Ended
                                                                                          September 30,
                                                                                          -------------
                                                                                   1998                  1997
                                                                                   ----                  ----
<S>                                                                          <C>                     <C> 
CASH FLOWS FROM OPERATING ACTIVITIES:
 
Net income (loss)                                                            $  (286,071)                324,073          
Adjustments to reconcile net income (loss) to                                                                             
   net cash (used in) provided by operating activities                                                                    
     Amortization and depreciation                                               167,196                 124,836          
     Deferred income taxes                                                      (148,855)                (59,804)         
     Changes in assets and liabilities                                                                                    
      (Increase) decrease in -                                                                                            
      Accounts receivable                                                        (42,746)              2,026,424          
      Prepaid expenses and other                                                 (68,527)               ( 98,957)         
      Costs and estimated earnings in excess                                                                              
       of related billings on uncompleted contracts                             (799,998)             (2,531,159)         
      Other assets                                                               (12,078)                 (4,042)         
      Increase (decrease) in -                                                                                            
      Accounts payable                                                           349,825               1,905,146          
      Accrued expenses                                                           (24,026)                 25,847          
      Billings in excess of related costs and                                                                             
       estimated earnings on uncompleted contracts                              (116,016)               (337,990)         
                                                                             -----------             -----------          
                                                                                                                          
NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES                             (981,296)              1,374,374          
                                                                             -----------             -----------          
                                                                                                                          
INVESTING ACTIVITIES:                                                                                                     
                                                                                                                          
Purchases of property and equipment                                              (40,702)               (300,143)         
                                                                             -----------             -----------          
                                                                                                                          
NET CASH USED IN INVESTING ACTIVITIES                                            (40,702)               (300,143)         
                                                                             -----------             -----------          
                                                                                                                          
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES:                                                                              
                                                                                                                          
Proceeds from exercise of stock options                                           92,924                  85,745          
                                                                             -----------             -----------          
                                                                                                                          
NET CASH PROVIDED BY FINANCING ACTIVITIES                                         92,924                  85,745          
                                                                             -----------             -----------          
                                                                                                                          
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS                            (929,074)              1,159,976          
                                                                                                                          
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD                                 1,794,530                 922,010          
                                                                             -----------             -----------          
                                                                                                                          
CASH AND CASH EQUIVALENTS, END OF PERIOD                                     $   865,456             $ 2,081,986          
                                                                             ===========             ===========          
</TABLE>

                See accompanying notes to financial statements

                                       6
<PAGE>
 
FORM 10-QSB

                             Covalent Group, Inc.
                                And Subsidiary
                  Notes To Consolidated Financial Statements
                                  (Unaudited)


1.   DESCRIPTION OF BUSINESS
     -----------------------

     Covalent Group, Inc. (the "Company"), is a contractual research
     organization, providing clinical research and development services to
     pharmaceutical, biotechnology, medical services and managed care
     organizations. The Company initiates, designs and monitors clinical trials,
     manages and analyzes clinical data and offers other related services and
     products.

2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
     ------------------------------------------

     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 period. Actual results could differ from those estimates.

     Principles of Consolidation
     ---------------------------

     The consolidated financial statements include the accounts of the Company
     and its wholly owned subsidiary. Intercompany transactions and balances
     have been eliminated in consolidation.

     Basis of Presentation
     ---------------------

     The financial statements for the nine and three months ended September 30,
     1998 and 1997 have been prepared without audit and, in the opinion of
     management, reflect all adjustments necessary (consisting only of normal
     recurring adjustments) to present fairly the Company's financial position
     at September 30, 1998 and the results of its operations and its cash flows
     for the interim periods presented. Such financial statements do not include
     all of the information and footnotes required by generally accepted
     accounting principles for complete financial statements. For further
     information, refer to the financial statements and footnotes thereto
     included in the Company's annual report on Form 10-KSB, as amended for the
     year ended December 31, 1997.

     Operating results for the nine months ended September 30, 1998 may not
     necessarily be indicative of the results for the year ending December 31,
     1998.

                                       7
<PAGE>
 
     Revenue Recognition
     -------------------

     Fixed price contract revenue is recognized based on the status of the work
     completed under the contract as of a given time using the percentage of
     completion method. Revenue from other contracts is recognized as services
     are provided. Revenue related to contract modifications is recognized when
     realization is assured and the amounts are reasonably determinable.
     Adjustments to contract cost estimates are made in the periods in which the
     facts which require the revisions become known. When the revised estimate
     indicates a loss, such loss is provided for currently in its entirety.
     Costs and estimated earnings in excess of related billings on uncompleted
     contracts represent revenue recognized in excess of amounts billed.
     Billings in excess of related costs and estimated earnings on uncompleted
     contracts represent amounts billed in excess of revenue recognized.

     Reclassifications
     -----------------

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

     Net Income (Loss) Per Common and Common Equivalent Share
     --------------------------------------------------------

     The Company adopted Statement of Financial Accounting Standards No. 128
     "Earnings Per Share" (SFAS No. 128) as of December 31, 1997. In accordance
     with SFAS No. 128, prior period earnings per share amount have been
     restated to conform with SFAS No. 128. SFAS No. 128 requires basic earnings
     per share which is computed by dividing reported earnings available to
     common shareholders by the weighted average shares outstanding and diluted
     earnings per share which reflects the dilutive effect of common stock
     equivalents such as stock options and warrants, unless the inclusion of
     these items would be anti dilutive.

     The weighted average common and common equivalent shares outstanding for
     purposes of calculating net income (loss) per common share are computed as
     follows:

<TABLE> 
<CAPTION> 
                                                         Three Months Ended                        Nine Months Ended
                                                            September 30,                            September 30,
                                                            -------------                            -------------
                                                       1998             1997                 1998                1997
                                                       ----             ----                 ----                ----
     <S>                                        <C>                 <C>                <C>                  <C> 
     Weighted average common shares   
       outstanding used for basic net 
       income (loss) per common share               11,759,299        11,686,579          11,748,332          11,631,779
                                      
                                      
     Dilutive effect of common stock  
       options and warrants outstanding                      -           796,131                   -             772,744
                                                --------------      ------------       -------------        ------------
                                      
     Weighted average common and      
       common equivalent shares       
       outstanding used for diluted net
       income (loss) per common share               11,759,299        12,482,710          11,748,332          12,404,523
                                                ==============      ============       =============        ============
</TABLE> 

     New Accounting Pronouncements
     -----------------------------

     In June 1997, the Financial Accounting Standards Board issued Statement of
     Financial Accounting Standards No. 130 " Reporting Comprehensive Income"
     (SFAS No. 130). SFAS No. 130 is effective for fiscal years beginning after
     December 15, 1997. SFAS No. 130 establishes standards for the reporting and
     display of comprehensive income in a set of financial statements.
     Comprehensive income is defined as the change in net assets of a 

                                       8
<PAGE>
 
     business enterprise during a period from transactions generated from non-
     owner sources. It includes all changes in equity during a period except
     those resulting from investments by owners and distributions to owners. The
     Company adopted SFAS No. 130 as of March 31, 1998 and a reconciliation of
     comprehensive income follows:

<TABLE> 
<CAPTION> 
                                                              Three Months Ended                   Nine Months Ended
                                                                 September 30,                       September 30,
                                                                 -------------                       -------------
                                                            1998               1997              1998             1997
                                                            ----               ----              ----             ----
  <S>                                                  <C>                   <C>              <C>               <C> 
  Net Income (Loss)                                    $    (19,802)         $321,983         $(286,071)        $324,073
  Unrealized Loss on Investment                             (64,993)                -          (416,211)               -
                                                       ------------          --------         ---------         --------

  Comprehensive Income (Loss)                          $    (84,795)         $321,983         $(702,282)        $324,073
                                                       ============          ========         =========         ========
</TABLE> 

ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

When used in this Report on Form 10-QSB and in other public statements, both
oral and written, by Covalent Group, Inc. (the "Company") and Company officers,
the words "estimate," "project," "intend," "believe," "anticipate" and similar
expressions are intended to identify forward-looking statements regarding events
and financial trends that may affect the Company's future operating results and
financial position. Such statements are subject to risks and uncertainties that
could cause the Company's actual results and financial position to differ
materially. Such factors include, among others: (i) the Company's success in
attracting new business; (ii) the size, duration and timing of clinical trials;
(iii) the termination, delay or cancellation of clinical trials; (iv) the
intense competition in the industry in which the Company competes; (v) the
Company's ability to obtain financing on satisfactory terms; (vi) the
sensitivity of the Company's business to general economic conditions; and (vii)
other economic, competitive, governmental and technological factors affecting
the Company's operations, markets, products, services and prices. The Company
undertakes no obligation to publicly release the result of any revision of these
forward-looking statements to reflect events or circumstances after the date
they are made or to reflect the occurrence of unanticipated events.

The information set forth and discussed below for the nine and three months
ended September 30, 1998 and 1997 is derived from the Consolidated Financial
Statements included elsewhere herein. The financial information set forth and
discussed below is unaudited but, in the opinion of management, reflects all
adjustments (consisting of normal recurring adjustments) necessary for a fair
presentation of such information. The results of operations of the Company for a
particular quarter may not be indicative of results expected during the other
quarters or for the entire year.

General
-------

The Company, through its wholly owned subsidiary, Covalent Research Alliance
Corp., is a research management organization that designs, coordinates and
monitors clinical trials in drug development for some of the world's leading
pharmaceutical firms. In addition, using advanced technologies, the Company
works extensively in managed care, medical outcomes research and health
management programs that focus on compliance and provider/patient behavior
modification. Revenue is derived principally from the identification, placement,
monitoring and management of clinical development studies in the traditional
pharmaceutical, as well as managed care environment.

                                       9
<PAGE>
 
The Company's quarterly results can fluctuate as a result of a number of
factors, including the Company's success in attracting new business, the size
and duration of the clinical trials, the timing of client decisions to conduct
new clinical trials or possible cancellation or delays of ongoing trials, and
other factors, many of which are beyond the Company's control. Clinical research
service contracts generally have terms ranging from several months to several
years. A portion of the contract fee is generally payable upon execution of the
contract, with the balance payable in installments over the life of the
contract. Revenue and related cost of revenue are recognized as specific
contract terms are fulfilled under the percentage of completion method.

Contracts generally may be terminated by clients with or without cause. Clinical
trials may be terminated or delayed for several reasons, including unexpected
results or adverse patient reactions to the drug, inadequate patient enrollment
or investigator recruitment, manufacturing problems resulting in shortages of
the drug or decisions by the client to de-emphasize or terminate a particular
trial or development efforts on a particular drug. Depending on the size of the
trial in question, a client's decision to terminate or delay a trial in which
the Company participates could have a materially adverse effect on the Company's
backlog, future revenue and profitability.

The Company's backlog, which consists of anticipated revenues from signed
contracts, is in excess of $11 million at September 30, 1998. The Company
believes that its backlog as of any date is not necessarily a meaningful
predictor of future results.

Three Months Ended September 30, 1998 Compared To Three Months Ended September
------------------------------------------------------------------------------
30, 1997
--------

Revenues for the three months ended September 30, 1998 decreased 24% to
$2,709,000 as compared to $3,545,000 for the three month period ended September
30, 1997. The decrease of $836,000 relates to the smaller value of the
individual clinical studies being conducted in the most recent quarter as
compared to the same quarter last year.

Direct expenses include compensation and other expenses directly related to
conducting clinical studies. These costs decreased by $889,000 from $2,605,000
to $1,716,000 for the three months ended September 30, 1997 and 1998,
respectively. The decrease in expenses results primarily from the decrease in
revenues and less fees being paid to investigator sites due to size of clinical
studies being conducted. Direct expenses as a percentage of total revenues were
63% for the three months ended September 30, 1998 as compared to 73% for the
same period last year. The decrease in relative percent is due to different cost
structures of the studies which are based on work requested by the Company's
clients.

Selling, general and administrative expenses include all administrative and
business development personnel, and all other support expenses not directly
related to specific contracts. Also included are expenses associated with the
development of an interactive voice recognition ("IVR") system, the platform
development of which was essentially completed in January 1998. Selling, general
and administrative expenses for the three months ended September 30, 1998
amounted to $1,046,000 as compared to $584,000 for the same period last year.
The increase in the level of expenses is due to costs associated with building
the necessary support infrastructure for the overall business, including human
resources, marketing and business development personnel, and a severance charge
of $96,000 for a former executive of the Company. As a percentage of revenues,
selling, general and administrative expenses increased from 16% to 39% for the
three months ended September 30, 

                                       10
<PAGE>
 
1997 and 1998, respectively. The increase in expenses as a percentage of
revenues results from the decrease in clinical study revenues.

Interest income decreased $12,000 from $33,000 for the three months ended
September 30, 1997 to $21,000 for the three months ended September 30, 1998.

Income tax benefit for the three months ended September 30, 1998 was $12,000
based on the $32,000 pretax loss. Management expects the tax benefit to be fully
utilized.

Nine Months Ended September 30, 1998 Compared to Nine Months Ended September 30,
--------------------------------------------------------------------------------
1997
----

Revenues for the nine months ended September 30, 1998 decreased 24% to
$7,492,000 as compared to $9,859,000 for the nine month period ended September
30, 1997. The decrease of $2,367,000 relates to the smaller value of the
individual clinical studies being conducted in the most recent period as
compared to the same period last year.

Direct expenses include compensation and other expenses directly related to
conducting clinical studies. These costs decreased by $2,681,000 from $7,889,000
to $5,208,000 for the nine months ended September 30, 1997 and 1998,
respectively. The decrease in expenses results primarily from the decrease in
revenues and less fees being paid to investigator sites due to the size of
clinical studies being conducted. Direct expenses as a percentage of total
revenues were 70% for the nine months ended September 30, 1998 as compared to
80% for the same period last year. The decrease in relative percent is due to
different cost structures of the studies which are based on work requested by
the Company's clients.

Selling, general and administrative expenses include all administrative and
business development personnel, and all other support expenses not directly
related to specific contracts. Also included are expenses associated with the
development of an IVR system the platform development of which was essentially
completed in January 1998. Selling, general and administrative expenses for the
nine months ended September 30, 1998 amounted to $2,796,000 as compared to
$1,766,000 for the same period last year. Included in selling, general and
administrative expenses for the nine months ended September 30, 1997 and 1998
are IVR development and systems maintenance expenses of $768,000 and $254,000,
respectively. The increase in the level of expenses, excluding IVR related
expenses for both periods, is due to costs associated with building the
necessary support infrastructure for the overall business, including human
resources, marketing and business development personnel, and a severance charge
of $96,000 for a former executive of the company. As a percentage of revenues,
selling, general and administrative expenses increased from 18% to 37% for the
nine months ended September 30, 1997 and 1998, respectively. The increase in
expenses as a percentage of revenues results from the decrease in clinical study
revenues.

Interest income decreased $5,000 from $83,000 for the nine months ended
September 30, 1997 to $78,000 for the nine months ended September 30, 1998.

Income tax benefit for the nine months ended September 30, 1998 amounted to
$148,000 or 34% of the pretax loss for the period. Management expects the tax
benefit to be fully utilized.

In 1996 the Company sold all of the stock of a subsidiary, Future Medical
Technologies, Inc. ("FMT"). In the six months ended June 30, 1997 the Company
reached agreement with the 

                                       11
<PAGE>
 
purchaser to treat the sale of FMT as an asset sale under Internal Revenue Code
Section 338 (h) (10). Accordingly, the loss on the sale is deductible for tax
purposes against future income, and, as a result, the Company recorded a
deferred tax asset of $94,000. Management anticipates the loss on disposal to be
fully utilized.

Liquidity and Capital Resources
-------------------------------

The Company's contracts usually require a portion of the contract amount to be
paid at the time the contract is initiated. Additional payments are generally
made upon completion of negotiated performance requirements throughout the life
of the contract. Cash receipts do not necessarily correspond to costs incurred
and revenue recognized (revenue recognition is based on the percentage of
completion accounting method). The Company typically receives a low volume of
large-dollar receipts. As a result, the number of days outstanding in accounts
receivable will fluctuate due to the timing and size of cash receipts. Compared
to December 31, 1997, accounts receivable increased $43,000 to $2,178,000 at
September 30, 1998 primarily due to the timing of progress payments for clinical
trials. Costs and estimated earnings in excess of related billings on
uncompleted contracts increased $800,000 to $2,208,000 at September 30, 1998.
This increase was attributable to eight clinical trials, for which revenues have
been recognized in excess of progress billings made to date on those contracts.
Accounts payable increased $350,000 to $2,153,000 at September 30, 1998
primarily due to an increase in payments due to investigator sites. These
contractual payments are based on completing certain milestones during the
clinical trial. Investigator fees are therefore accrued based on the work
completed and paid at a later date.

The Company's cash and cash equivalents balance at September 30, 1998 was
$865,000 as compared to $1,795,000 at December 31, 1997. The decrease in cash
was primarily due to operating results for the nine months ended September 30,
1998 including the above mentioned increase in costs and estimated earnings in
excess of related billings on uncompleted contracts.

The Company purchased $41,000 of equipment in 1998. The Company anticipates the
need for capital expenditures during the remainder of 1998 including leasehold
improvements of $60,000 and computer equipment of $100,000.

The Company has a line of credit with a commercial bank providing a maximum
credit facility of $1 million which bears interest at a rate not to exceed 1%
point above the bank's prime rate. Borrowings outstanding under the credit line
are secured by substantially all of the assets of the Company. No borrowings
were outstanding under the credit line at September 30, 1998.

The Company's principal cash needs on both a short and long-term basis are for
the funding of its operations, and capital expenditure requirements. The Company
expects to continue expanding its operations through internal growth, expansion
of its existing services, and the development of new service products for
clinical research and the healthcare industry. The Company expects such
activities to be funded from existing cash and cash equivalents and cash flow
from operations.

Management believes that the Company's operations and financial results are not
materially affected by inflation.
FORM 10-QSB

                                       12
<PAGE>
 
Year 2000 Compliance
--------------------

The Company is taking the required steps to make its existing systems Year 2000
ready at a total estimated cost of $50,000, $10,000 of which has already been
incurred in fiscal 1998 through September 30, 1998 and $40,000 of which is
expected to be incurred in fiscal 1999. The Company believes it is on schedule
to complete its remediation efforts by March 1999. If such efforts are not
completed timely, the Year 2000 issue could have a material impact on the
operations of the Company.

The Company's efforts are focused on Year 2000 compliance in the following four
principal areas:

     1.   Application software, including operating systems and applications for
          network servers, midranges and PCs;

     2.   Network and communication software, including business offices, home
          offices and field locations;

     3.   Computer equipment, including network servers, midranges and PCs; and

     4.   Telecommunications equipment, including telephone and voice mail.


These activities are intended to encompass all major categories of systems in
use by the Company, including sales, research and trial conduct and operations
and human resources.

In addition to making its own systems Year 2000 ready, the Company's Year 2000
team has and will continue to survey its key suppliers and customers to
determine the extent to which the systems of such suppliers and customers are
Year 2000 compliant and the extent to which the Company could be affected by the
failure of such third parties to be Year 2000 compliant. The Company cannot
presently estimate the impact of the failure of such third parties to be Year
2000 compliant.

The general phases of the Year 2000 Project are: (1) Year 2000 methodology
training for key IT personnel, (2) inventorying Year 2000 items, internally and
externally; (3) assigning priorities to identified items; (4) assessing the Year
2000 compliance of items determined to be material to the Company; (5)
remediating or replacing material items that are determined not to be Year 2000
compliant; (6) testing material items; and (7) designing and implementing
contingency plans to the extent deemed necessary. The Company has completes
phases (1), (2), (3), and (4) and is presently conducting phases (5), (6) and
(7). Assessment and testing is ongoing as hardware or system software is
remediated, upgraded or replaced. In anticipation of its being Year 2000
compliant by March 1999, the Company has not yet designed contingency plans in
the case that it is not Year 2000 compliant by the turn of the century. The
Company will keep a view to its Year 2000 compliance progress and adjust the
implementation of the phases and the necessity of contingency planning as it
deems appropriate.

The failure to correct a material Year 2000 problem could result in an
interruption in, or a failure of, certain normal business activities or
operations such as the Company's ability to properly conduct a particular trial
or otherwise provide necessary service to its customers. Such failures could
materially and adversely affect the Company's results of operations, liquidity
and financial condition. Due to the general uncertainty inherent in the Year
2000 problem, resulting in part from 

                                       13
<PAGE>
 
the uncertainty of the Year 2000 readiness of third-party supplies and
customers, the Company is unable to determine at this time whether the
consequences of Year 2000 failures will have a material impact on the Company's
results of operations, liquidity or financial condition. The Year 2000
assessment being conducted by the Company is expected to significantly reduce
the Company's level of uncertainty about the Year 2000 problem and, in
particular, about the Year 2000 compliance and readiness of its material
suppliers and customers.

                             COVALENT GROUP, INC.

PART II. OTHER INFORMATION

     ITEM 1.   Legal Proceedings

               None.

     ITEM 2.   Changes in Securities

               None.

     ITEM 3.   Defaults Upon Senior Securities

               None.

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

               None.

     ITEM 5.   Other Information

               Discretionary Proxy Voting Authority/Shareholder Proposals

               On May 21, 1998 the Securities and Exchange Commission adopted an
               amendment to Rule 14a-4, as promulgated under the Securities and
               Exchange Act of 1934. The amendment to Rule 14a-4(c)(1) governs
               the Company's use of its discretionary proxy voting authority
               with respect to a shareholder proposal which the shareholder has
               not sought to include in the Company's proxy statement. The new
               amendment provides that if a proponent of a proposal fails to
               notify the Company at least 45 days prior to the month and day of
               mailing of the prior year's proxy statement (or any date
               specified in an advance notice provision), then the management
               proxies will be allowed to use their discretionary voting
               authority when the proposal is raised at the shareholders
               meeting, without any discussion of the matter in the proxy
               statement.

               With respect to the Company's 1999 Annual Meeting of
               Shareholders, if the Company is not provided notice of a
               shareholder proposal, which the shareholder has not previously
               sought to include in the Company's proxy statement, by March 8,
               1999, the management proxies will be allowed to use their
               discretionary authority as outlined above.

                                       14
<PAGE>
 
     ITEM 6.   Exhibits and Reports on Form 8-K

               (a)  Exhibits

                    27 Financial Data Schedule (in electronic format only)

               (b)  Reports on Form 8-K

                    The Company filed a Current Report on Form 8-K dated August
                    19, 1998 announcing that the Company has recently entered
                    into multi-year contracts for clinical trials.

                                  SIGNATURES

     In accordance with the requirements of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.


                                             COVALENT GROUP, INC.


Dated: November 13, 1998                     By: /s/Bruce LaMont
       -----------------                         -------------------------------
                                                    Bruce LaMont, President
                                                    and Chief Executive Officer


Dated: November 13, 1998                     By: /s/William K. Robinson
       -----------------                         -------------------------------
                                                    William K. Robinson, Chief
                                                    Financial Officer

                                       15