<PAGE>
 
                    U.S. SECURITIES AND EXCHANGE COMMISSION

                            Washington, D.C.  20549

                                  Form 10-KSB

[X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
     ACT OF 1934 [Fee Required]
     For the fiscal year ended    July 31, 1998
                                  -------------


[_]  TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
     ACT OF 1934 [No Fee Required]

     For the transition period from __________ to __________.

     Commission file number         1-14382
                            -------------------------


                           SUNSTAR HEALTHCARE, INC.

                (Name of small business issuer in its charter)
--------------------------------------------------------------------------------

           DELAWARE                                       59-3361076
(State or other jurisdiction of             (I.R.S. Employer Identification No.)
incorporation or organization)              


         300 International Parkway, Suite 230, Heathrow, Florida 32746
               (Address of principal executive offices/Zip Code)
                                 (407)304-1066
                          (Issuer's telephone number)
--------------------------------------------------------------------------------

         Securities registered under Section 12(b) of the Exchange Act:

     Title of each class        Name of each exchange on which registered
     -------------------        -----------------------------------------
     Common Stock               NASDAQ-Small-Cap Market and Boston
                                Stock Exchange

        Securities registered under Section 12(g) of the Exchange Act:

                                 Common Stock
                               (Title of class)

     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 90 past days.

                    YES    X                      NO  _____
                         -----                  

     Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B is not contained in this form,  and no disclosure will 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-KSB
or any amendment to this form 10-KSB.  [X]

     State issuer's revenues for its most recent fiscal year $9,079,072
                                                              ---------

     The aggregate market value of voting stock of the Registrant held by non-
affiliates of the Registrant on October 30, 1998, was $6,649,613 (based on the
                                                       ---------
average closing bid and asked prices of the Registrant's Common Stock on October
30, 1998 of $3.50 and $4.00 respectively).
                       ----               

     As of October 30, 1998, 2,919,330 shares of the Registrant's Common Stock
were issued and outstanding.


                      DOCUMENTS INCORPORATED BY REFERENCE
                                        
     Portions of the Company's Proxy Statement for its 1998 Annual Meeting  are
incorporated by reference in Part III.  The Company's Proxy Statement will be
filed within 120 days after July 31, 1998.

 Transitional Small Business Disclosure Format (check one):  YES ___  NO  X
                                                                         ---

________________________________________________________________________________
<PAGE>
 
                                    PART I
                                        
ITEM 1. BUSINESS

     Sunstar Healthcare, Inc. ("SunStar" or the "Company") was incorporated
under the laws of the State of Delaware in December 1995 by National Home Health
Care Corp. ("NHHC"), a publicly-held Delaware corporation. In January 1996,
NHHC, then the sole shareholder of the Company, contributed to SunStar all of
the outstanding capital stock of its wholly owned subsidiaries First Health,
Inc. ("First Health") and Brevard Medical Center, Inc. ("Brevard"), which
included all of the outstanding capital stock of Brevard's wholly owned
subsidiary, SunStar Health Plan, Inc. ("SHP") (formerly known as Boro Medical
Corp.). Subsequently, the Company restructured its subsidiaries such that
Brevard, First Health and SHP all became direct, wholly-owned subsidiaries of
SunStar. Except where the context otherwise indicates, the Company, First
Health, Brevard and SHP collectively are referred to herein as "SunStar" or as
the "Company".

     On May 15, 1996, the Company completed an initial public offering (the
"Offering") pursuant to the Securities Act of 1933, as amended, which resulted
in the issuance of 1,300,000 shares of Common Stock, par value $.001 (the
"Common Stock"). The Offering yielded net proceeds to the Company of $5,230,372.
On June 7, 1996, the underwriters in the Offering exercised their over-allotment
option in full to purchase additional shares of Common Stock, resulting in the
Company's sale of an additional 195,000 shares of Common Stock, par value $.001,
and realization of $853,125 in net proceeds.

     On July 16, 1998, the Company completed a Private Placement (the "Private
Placement") under Rule 506 of Regulation D pursuant to which the Company sold
474,330 shares of previously unissued Common Stock. The Private Placement
resulted in net proceeds to the Company of $1,355,251.

     The Company is a managed healthcare company whose wholly owned subsidiary,
SHP, provides comprehensive healthcare benefits to individuals, families and
small and large employer groups in its service areas through its health
maintenance organization ("HMO") contracts. As originally organized, the Company
also operated seven outpatient primary care medical centers (the "Medical
Centers") located in central Florida. On April 15, 1998, the Company sold
substantially all of the assets of the Medical Centers, pursuant to an Asset
Purchase Agreement ("Asset Purchase Agreement"), thereby completing the
Company's transformation from a "provider" of medical services through its
Medical Centers to a "payor" for medical services through its statewide HMO. The
Company's sale of the Medical Centers has permitted the Company to focus its
full attention and resources on the rapid expansion of SHP.

     On February 24, 1997, SHP was awarded an HMO Certificate of Authority by
the Department of Insurance in the State of Florida ("DOI") and began accepting
its first HMO members effective May 1, 1997. Commencing from an initial service
area of a single county in eastern central Florida, SunStar has subsequently
received eight approvals from the Florida Agency for Healthcare Administration
("AHCA") to expand its service territory to 52 counties in central, northern,
southwestern and southeastern Florida, including the metropolitan areas of
Tampa, Orlando, Jacksonville, Sarasota, Naples, Fort Meyers, Miami, Fort
Lauderdale and Palm Beach. During the next twelve months, the Company intends to
expand its HMO target markets with the intention of providing HMO products
statewide. On January 13, 1998, SunStar filed an application to become a
contracting party with the Healthcare Financing Administration ("HCFA") to
provide HMO health service benefits to Medicare beneficiaries residing in
Florida.

     The Company's HMO products provide comprehensive healthcare benefits to
enrollees, including ambulatory and inpatient physician services,
hospitalization, pharmacy, dental, optical, mental health, ancillary diagnostic
and therapeutic services. In general, a fixed monthly enrollment fee covers all
HMO services, although the benefit plans require co-payments in addition to the
basic enrollee premium. These co-payments are made directly to the provider of
services by the member. Although a primary care physician assumes overall
responsibility for the coordination of care, the Company offers its members
access to its network of physicians without the need of a referral from the
member's primary care physician.

                                       1
<PAGE>
 
     As of November 1, 1998 the Company served approximately 55,000 enrolled
plan members in 52 counties. The Company has established a growing distribution
network of more than 5,500 brokers and 100 general agencies to market its HMO
products. The Company has also established a comprehensive delivery system of
contractual providers numbering approximately 15,000 physicians and 125
hospitals. The Company outsources all billing, enrollment and claims processing
functions through a third party administrator which provides a dedicated SunStar
team with whom the Company maintains close contact for coordination and control.

     The Company's objective is to continue to establish relationships with
qualified physicians, hospitals and other healthcare providers who are willing
to provide quality medical services to members of managed care organizations at
a reasonable cost. The Company believes that these efforts will enable it to
provide a variety of low-cost managed healthcare products to attract individuals
and employer groups willing to enroll in the Company's HMO. The Company has
focused initially on enrolling medically underwritten individuals in central and
northern Florida. Currently, the Company is entering the small group and large
group markets with a suite of tailored products and is in the process of
extending and improving upon its service area throughout the State of Florida.
Upon obtaining HCFA approval, the Company will also expand its HMO product
offerings to the Medicare market.

     The Company's strategy and preliminary and future expansion plans may be
subject to change as a result of numerous factors, including the Company's
ability to raise capital, progress or delays in the Company's expansion efforts,
changes in market conditions, competitive conditions and new or different
opportunities which may become available to the Company in the future.

HCFA AGREEMENT.

     SHP also has a prepaid cost reimbursement contract with HCFA, pursuant to
which the Company provides prescribed primary healthcare services to Medicare
beneficiaries who enrolled directly with the Company prior to January 1, 1996.
Pursuant to the Asset Purchase Agreement, the Company has agreed to transfer the
existing HCFA contract held by SHP to the buyer subject to HCFA approval, thus,
related HCFA revenues and program costs have been reported in discontinued
operations.

     The Company currently provides medical services pursuant to the HCFA
agreement to approximately 2,000 Medicare enrollees through Brevard Medical
Care, Inc. ("BMC"). Medicare enrollees pay a nominal annual enrollment fee
without monthly premiums, deductibles or copayments for primary care services.

     Pursuant to the terms of the agreement with HCFA, the Company is paid a
monthly premium in advance for each Medicare beneficiary enrolled by the
Company. Payments under the agreement are based on estimated costs incurred in
connection with medical services and are subject to year-end adjustments. The
Company is subject to governmental audit to ensure the basis of medical costs
incurred. The Company's 1996 HCFA cost report was recently audited and no
material adjustments were made.

     Pursuant to recent amendments to the Social Security Act, effective January
1, 1996, the Company is prohibited from enrolling Medicare beneficiaries who are
not members of employer groups or unions under its agreement with HCFA until it
establishes Medicare HMO operations. HCFA has notified the Company that the
existing contract under Section 1833 of 42 Code of Federal Regulations will not
be renewed after December 31, 1998 as a result of the Company obtaining its HMO
license. However, the Company has applied for a cost contract under Section 1876
of 42 Code of Federal Regulations in order to continue to service the 2,000
enrollees in Brevard County. There can be no assurance that such application
will be approved.

                                       2
<PAGE>
 
PREPAID HEALTH CLINIC.

     The Company also provided medical services to subscribers pursuant to a
prepaid health clinic license issued by the DOI. This license permitted the
Company to provide certain primary healthcare coverage to individuals for a
fixed monthly premium. As a condition of the Company receiving its license to
operate as an HMO, the Company no longer offers its prepaid health clinic
product effective September 1, 1997.


COMPETITION.

     The managed healthcare industry is very competitive and has experienced
significant changes in recent years, primarily due to rising healthcare costs.
Employer groups have demanded a variety of healthcare options, such as
traditional indemnity insurance, HMOs, point of service plans and preferred
provider options, offered either through third-parties or by self-funding. The
Company's HMO competes with providers of all of these products, including United
Healthcare of Florida, Inc., Humana Medical Plan, Inc., Prudential Healthcare,
Inc., Health Options, Inc. and CIGNA Healthcare of Florida, Inc., most of which
have substantially greater financial, management, marketing, personnel and other
resources than the Company. Additional competitors may enter the Company's
markets in the future. The Company must respond to various competitive factors
affecting the healthcare industry, including trends relating to demand for
healthcare services, regulatory, economic and political factors, changes in
patient demographics and competitive pricing strategies by HMOs and other
healthcare plans. The Company will face significant competition in any new
geographic areas it may enter, with respect to any products it may offer and
with respect to any commercial and governmental healthcare programs developed.
As a result of these factors, premium pricing has been competitive, which has
contributed to instances in the State of Florida whereby HMOs have experienced
significant operating losses over the past several years. The Company may not be
able to compete successfully in any such market.


INSURANCE.

     Although the Company has sold the Medical Centers, the Company could under
certain circumstances become liable for negligent acts performed by employees of
the Medical Centers while such centers were owned and operated by the Company.
While the Company may be indemnified by the buyer of the Medical Centers, or is
otherwise insured, against liability for such acts, the Company could be subject
to potential professional liability claims to the extent that such claims exceed
the limits of any applicable insurance coverage.

     As an HMO operator, the Company could become liable for the negligent acts
of physicians and for negligence in recruiting and selecting physicians. The
Company currently maintains managed care professional liability insurance with
limits of $3,000,000 in the aggregate and $1,000,000 per occurrence and requires
physicians to maintain malpractice liability insurance in amounts which it deems
adequate for the types of medical services provided. However, such insurance may
not be sufficient to cover potential claims, and adequate levels of coverage may
not be available in the future at a reasonable cost. A partially or completely
uninsured successful claim against the Company could have a material adverse
effect on the Company's business and financial condition.

     The Company insures its malpractice risks on a claims-made basis. The
Company has secured claims-made coverage from August 1, 1997 through April 15,
1998, with retroactive coverage through July 1, 1993. The Company does not
accrue for possible losses attributable to incidents which may have occurred and
not been identified under the Company's incident reporting system because the
amount, if any, is not readily estimable.

     The Company also carries "stop-loss" reinsurance to reimburse it for costs
resulting from catastrophic injuries or illnesses to its HMO members. Premiums
for these policies are reported as HMO medical costs and insurance recoveries,
if any, are recorded as a reduction of HMO medical costs. Under the excess loss
reinsurance policies, the Company recovers for claims of each enrollee or each
covered dependent of each enrollee, on an annual basis, in excess of the
deductible established in the policy subject to certain limitations. The
deductible under the policy for commercial healthcare claims is currently
$50,000.

                                       3
<PAGE>

GOVERNMENT REGULATION.
 
     The healthcare industry is subject to extensive, stringent and frequently
changing federal and state regulation, which is interpreted by regulatory
authorities with broad discretion. The federal government and the State of
Florida have each enacted statutes extensively regulating the activities of HMOs
that are applicable to the Company's operations. Among the areas regulated are
the scope of benefits required to be made available to members, the manner in
which member rates are structured, procedures for review of quality assurance,
enrollment requirements, composition of policy making bodies to assure member
representation, the interrelationship between HMOs and their healthcare
providers, licensure and financial condition. Under federal regulations,
services to members must be provided substantially on a fixed prepaid basis,
without regard to the actual degree of utilization of services. Although
premiums established by an HMO may vary from account to account through
composite rate factors and special treatment of certain broad classes of
enrollees, traditional experience rating of accounts (i.e., setting premiums for
a group account based on that group's part use of healthcare services) is not
permitted under federal regulations.

     In Florida, HMOs must also comply with certain other provisions of state
health and insurance laws, including the licensing of salespersons and
maintenance of subscriber grievance procedures, insolvency protection and
minimum statutory financial requirements. Pursuant to Section 641 of the Florida
Insurance Code, SHP is required to maintain a minimum capital surplus in an
amount which is the greater of $500,000 or 10% of total liabilities. Effective
September 30, 1998, the capital surplus requirement increased to an amount which
is the greater of $800,000 or 10% of total liabilities or 1% of annualized
premium. Dividends are restricted to 10% of statutory surplus or the entire net
operating profits and related net capital gains derived during the immediately
preceding fiscal year unless prior approval is received from the DOI. Pursuant
to the Florida Administrative Code, the DOI may require an HMO to submit a
corrective action plan in the event that net income before taxes over the past
four quarterly reporting periods is less than 2% of total revenue. The Company
must file periodic reports with, and will be subject to periodic review by, the
federal and state licensing authorities which regulate the Company.

     The Company believes that it is in compliance with all federal, state and
local laws, rules and regulations applicable to its operations and has obtained
all licenses necessary to conduct its business. Amendments to existing statutes
and regulations, adoption of new statutes and regulations and the Company's
expansion into new operations and jurisdictions could require the Company to
obtain additional licenses, modify its arrangements with physicians or otherwise
alter methods of operations at costs that could be substantial. There can be no
assurance that the Company will be able, for financial or other reasons, to
comply with applicable laws and regulations and licensing requirements. Failure
to comply with applicable laws and regulations and licensing requirements would
subject the Company and its physicians to civil remedies, including significant
fines, penalties, injunctions and expulsion from participation in Medicare and
Medicaid programs, as well as possible criminal sanctions, which would have a
material adverse effect on the Company.

     Several proposals have recently been made by federal and state government
officials that may lead to substantial healthcare reforms, including the
implementation of a government-directed national healthcare system and stringent
healthcare cost-containment measures. Adoption of such a system or cost controls
could further limit reimbursement for medical services. Past congressional
actions have resulted in changes in Medicare and Medicaid reimbursement rates,
and the Company believes that it is likely that Congress will, over the next
several years, substantially limit the growth of Medicare and Medicaid
expenditures. Significant uncertainty exists as to the status of reimbursement
and there can be no assurance that healthcare insurers and other third-party
payors will continue to cover certain medical services or reimburse such
services at current levels. Any significant reduction of healthcare insurance
coverage for medical services could have a material adverse effect on the
Company's business and prospects.


NASDAQ LISTING REQUIREMENTS.

     The Company's shares of Common Stock which were registered in the Offering
are traded on the NASDAQ Small-Cap Market. Continued trading of the Common Stock
on the NASDAQ Small-Cap Market is conditioned upon the Company meeting certain
criteria. The National Association of Securities Dealers ("NASD"), which
administers NASDAQ, currently requires, among other things, that for the
continued listing of the Company's Common Stock on the NASDAQ Small-Cap Market,
the Company must have: (a) either $2,000,000 in net tangible assets (total
assets, excluding goodwill, minus total liabilities), $35,000,000 market
capitalization or $500,000 net income (in the last fiscal year or two of the
last three fiscal years); (b) a public float of 500,000 shares having a market
value of at least $1,000,000; (c) a minimum bid price of not less than $1 per
share; (d) two market makers; and (e) at least 300 round lot shareholders
(holders of 100 shares or more).

                                       4
<PAGE>
 
As of July 31, 1998, the Company was in compliance with these standards, but
there can be no assurances that the Company will continue to meet such
standards. If the Company fails to meet any of these criteria, the Common Stock
could be delisted from trading on the NASDAQ Small-Cap Market, which delisting
could adversely affect the trading market for the Common Stock. In such event,
trading in the Common Stock would be conducted in the over-the-counter market
known as the NASD OTC Electronic Bulletin Board, or the "pink sheets", whereupon
trading in the Company's securities would be subject to the "Penny Stock"
regulations. As a result, an investor may find it more difficult to dispose of,
or to obtain accurate quotations as to the market value of, the Company's Common
Stock.


EMPLOYEES.

     The Company currently employs 71 persons, including 3 executive officers, 1
physician and 67 other persons engaged in operations management, administrative
and clerical capacities. None of the Company's employees are represented by a
union or subject to a collective bargaining agreement. The Company believes that
its employee relations are good.


ITEM 2. PROPERTY.

     The Company is headquartered in the metropolitan area of Orlando, Florida,
where it leases an aggregate of approximately 9,500 square feet pursuant to a
three year lease. Administrative, marketing, customer support and medical
support services are located in this space. Although the Company believes that
its facilities are adequate for its existing operations, the Company regularly
evaluates the adequacy of these facilities in light of its growth and expansion
plans.

     The following table sets forth the location, approximate square footage,
approximate annual rent, use of each location and expiration date of each lease:

<TABLE>
<CAPTION>
                                 APPROX.
                    APPROX.      ANNUAL                                      LEASE      
   LOCATION        SQ. FEET       RENT             USE                  EXPIRATION DATE 
---------------   ----------   ----------   ------------------          --------------- 
<S>               <C>          <C>          <C>                         <C>              
Heathrow, FL        9,500       $181,000    Executive Office             Oct. 31, 2000
Miami, FL             375       $  7,400    Provider Relations Office    Dec. 31, 2000

</TABLE>


ITEM 3. LEGAL PROCEEDINGS.

     There are no pending material legal proceedings to which the Company is a
party or to which any of its properties is subject.


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

     No matter was submitted to the Company's shareholders for approval during
the fourth quarter of the fiscal year covered by this report.

                                       5
<PAGE>
 
                                    PART II
                                        

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

Market Information.
-------------------

     The Company's Common Stock is traded on the NASDAQ Small-Cap Market under
the symbol "SUNS". The following are the high and low closing bid prices as
provided by NASDAQ in the NASDAQ-Small Cap Market:

<TABLE>
<CAPTION>
                           1997                                    1998
                    ------------------                      -----------------
  Quarter Ended       High      Low      Quarter Ended        High     Low
--------------------------------------------------------------------------------
<S>                   <C>       <C>      <C>                  <C>      <C>
October 31, 1996      5.00      3.25     October 31, 1997     5.25     4.00
January 31, 1997      5.875     3.00     January 31, 1998     5.25     2.75
April 30, 1997        7.25      3.75     April 30, 1998       5.25     3.75
July 31, 1997         6.50      3.75     July 31, 1998        5.25     3.63
</TABLE>

     The quotations represent prices between dealers in securities; they do not
include retail mark-ups, mark-downs, or commissions, and do not necessarily
represent actual transactions.

Holders.
--------

     The approximate number of holders of record of the Company's Common Stock
at November 9, 1998 is 87. However, the Company estimates that there were
approximately 1,000 beneficial holders of the Company's Common Stock as of that
date.

Dividends.
----------

     No cash dividends have been declared by the Company. The Company currently
anticipates that all of its earnings will be retained for development of the
Company's business, and does not anticipate paying any cash dividends in the
foreseeable future. Future cash dividends, if any, will be at the discretion of
the Company's Board of Directors and will depend upon, among other things, the
Company's future operations and earnings, capital requirements and surplus,
general financial condition, contractual restrictions, and such other factors as
the Board of Directors may deem relevant.

Sale of Unregistered Securities
-------------------------------
 
     On July 16, 1998, the Company completed the Private Placement of 474,330
shares of previously unissued Common Stock, at a per share price of $3.375,
resulting in net proceeds to the Company of $1,355,251. The Common Stock issued
in the Private Placement was not registered with the Securities and Exchange
Commission under the Securities Act and was offered and sold solely to
"accredited investors" in reliance on exemptions from registration provided in
Section 4(2) and Section 4(6) of the Securities Act and Rule 506 of Regulation D
under the Securities Act. The Private Placement was not underwritten. The
Company entered into a Placement Agent Agreement with H.J. Meyers & Co., Inc.
(the "Placement Agent") pursuant to which the Placement Agent received 10% of
the aggregate value of the Common Stock issued in the Private Placement and is
being issued 150,000 warrants to purchase 150,000 shares of Common Stock at
$4.00 per share which expire in 4 years. The Placement Agent also received a 
non-accountable expense allowance of 3% of the Private Placement proceeds. Under
the terms of the Private Placement, the Company agreed to use its reasonable
best efforts to file and obtain effectiveness of a registration statement under
the Securities Act covering the resale of the shares issued in the Private
Placement no later than 90 days after the closing of the Private Placement. If
the registration statement is not declared effective by the Securities and
Exchange Commission within such 90 day period other than by reason of delay of a
selling shareholder or its counsel or the activity or inactivity of the
Securities and Exchange Commission, then the Company is obligated to pay cash
equal to 1% of the aggregate subscription price of the Private Placement for the
first month of such delay and 2% of such aggregate subscription price for each
month of delay thereafter; provided, however, that in calculating the period of
any delay, there shall be excluded any delays attributable to the failure by a
selling shareholder to review the registration statement in a reasonably prompt
manner.

                                       6
<PAGE>
 
All expenses incurred in any registration of these shares will be paid by the
Company, but the Company will not be liable for any underwriter discounts or
commissions, brokerage fees or stock transfer taxes incurred with respect to the
shares or for the fees and expenses of counsel for any selling shareholder. As
of the date of this report, the Company is awaiting certain information from its
selling shareholders, and upon the receipt of this information, the Company
intends to file a registration statement covering these shares as promptly as
practicable.

Use of Proceeds
---------------

     On May 15, 1996, the Company completed the Offering, pursuant to which the
Company sold 1,300,000 shares of previously unissued common stock, par value
$.001. The Offering resulted in net proceeds to the Company of $5,230,372. On
June 7, 1996, the underwriters in the Offering exercised their over-allotment
option, pursuant to which the Company sold 195,000 shares of Common Stock,
resulting in additional net proceeds to the Company of $853,125. The Company
filed Forms SR, "Report of Sales of Securities and Use of Proceeds Therefrom,"
on August 27, 1996, February 24, 1997 and August 23, 1997. As of July 31, 1998,
proceeds from the Offering of approximately $2,571,000 have been directly
invested in SHP and $2,207,000 has been used as working capital to finance the
HMO development effort. An additional $452,000 of the Offering proceeds has been
used to purchase furniture and equipment.


ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.

"FORWARD-LOOKING" INFORMATION

     This report on Form 10-KSB contains certain "forward-looking statements"
within the meaning of Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), which represent the Company's expectations and
beliefs, including, but not limited to statements concerning the Company's
expected growth. The words "believe," "expect," "anticipate," "estimate,"
"project," and similar expressions identify forward-looking statements, which
speak only as of the date such statement was made. These statements by their
nature involve substantial risks and uncertainties, certain of which are beyond
the Company's control, and actual results may differ materially depending on a
variety of important factors, including the Company's ability to forge
satisfactory relationships with physician groups and provider networks and
enroll sufficient numbers of HMO members; sources for sufficient additional
capital to meet the Company's growth and operations; the failure to properly
manage growth and successfully integrate additional physician groups and
providers; changes in economic conditions; demand for the Company's products;
and changes in the competitive and regulatory environment. Future events and
actual results could differ materially from those expressed in, contemplated by,
or underlying any such forward-looking statements.

THE FOLLOWING DISCUSSION AND ANALYSIS OF THE COMPANY'S FINANCIAL CONDITION AS OF
JULY 31, 1998 AND THE COMPANY'S RESULTS OF OPERATIONS FOR THE YEARS ENDED JULY
31, 1997 AND 1998 SHOULD BE READ IN CONJUNCTION WITH THE COMPANY'S FINANCIAL
STATEMENTS AND NOTES THERETO INCLUDED ELSEWHERE IN THIS REPORT.

GENERAL.

     On February 24, 1997, SHP was awarded its HMO Certificate of Authority in
the State of Florida by the DOI.  SHP accepted its first HMO members effective
May 1, 1997 in its initial service area of Brevard County, Florida.  During the
fiscal year ended July 31, 1997 ("fiscal 1997"), SHP accelerated its plans to
enter markets that the Company believed were under-served by its managed
healthcare competitors.  Thus, SHP has rapidly expanded and been approved by
AHCA to offer its HMO products in 52 counties in central, northern, southwestern
and southeastern Florida, including the metropolitan areas of Tampa, Orlando,
Jacksonville, Sarasota, Naples, Fort Meyers, Miami, Fort Lauderdale and Palm
Beach. As a result of this accelerated growth, development costs have also been
accelerated in the areas of advertising, marketing and materials, personnel and
related expenses. SHP intends to continue this rapid expansion throughout the
entire State of Florida over the next twelve months.

                                       7
<PAGE>
 
As of November 1, 1998, the Company provides coverage to approximately 55,000
members in its current service areas. The Company has established a growing
distribution network of more than 5,500 brokers and 100 general agencies to
market its HMO products. The Company has also established a comprehensive
delivery system of contractual providers numbering approximately 15,000
physicians and 125 hospitals. The net losses for fiscal 1998 and 1997 are
consistent with management's expectations with respect to the costs associated
with the attainment of SHP's HMO license and the related start-up, development
and expansion costs of an HMO.

     As originally organized, the Company also provided managed healthcare
services pursuant to contractual arrangements, as well as on a fee-for-service
basis, through its seven primary care Medical Centers in central Florida. On
April 15, 1998, the Company sold substantially all the assets of the Medical
Centers and agreed to assign the existing HCFA contract held by SHP upon
approval by HCFA pursuant to the Asset Purchase Agreement, thereby completing
the Company's transformation from a "provider" of medical services through its
Medical Centers to a "payor" for medical services through its statewide HMO. The
Company's sale of its Medical Centers has permitted it to focus its full
attention and resources on the rapid expansion of SHP.

     Since accepting its first HMO members in May, 1997, the Company's initial
focus has been on the marketing and sale of its HMO product in the medically
underwritten individual market. The majority of the Company's initial growth
came from the sale of its products in the individual market. The Company's
strategy is to establish a sufficient base of customers for its HMO product in
the individual market within a geographic area, and then to broaden its focus to
the marketing and sale of its HMO products to include the small and large group
markets. The Company has already begun to broaden its focus in several of the
geographic areas in which the Company is currently licensed.

GENERAL FINANCIAL INFORMATION.

<TABLE>
<CAPTION>
                                      FISCAL YEAR ENDED JULY 31,
                                         1997            1998
                                      ------------   ------------ 
<S>                                   <C>            <C>
Total revenues                        $   450,048    $ 9,079,072
Loss from continuing operations        (1,705,637)    (5,389,762)
Discontinued operations                    74,472        822,405
Net loss                               (1,631,165)    (4,567,357)
Net loss per common share                    (.68)         (1.85)
Total assets                            6,370,849      8,649,518
Long term obligations                     108,521         82,939
</TABLE>

Results of Operations.
----------------------

Year ended July 31, 1998 ("fiscal 1998")  compared to fiscal 1997.

     Total revenues increased by approximately $8,629,000 from approximately
$450,000 for fiscal 1997 to approximately $9,079,000 for fiscal 1998. This
increase is attributable to an $8,745,000 increase in revenues generated by the
Company's HMO, which commenced operations in the fourth quarter of fiscal 1997,
coupled with a decline in other revenues of $99,000 and lower interest income of
approximately $17,000.

     As a result of the Company obtaining an HMO Certificate of Authority on
February 24, 1997 and commencing the enrollment of its members effective May 1,
1997, the Company realized approximately $8,845,000 and $100,000 in HMO premium
revenues in fiscal 1998 and fiscal 1997, respectively. This HMO premium revenue
increase is consistent with enrolled membership growth to 22,282 at July 31,
1998 from 643 at July 31, 1997. The Company anticipates that HMO premium
revenues will continue to rapidly increase over the next twelve month period as
the Company will further implement its accelerated growth plan.

                                       8
<PAGE>
 
However, there can be no assurance that such growth will occur as rapidly as the
Company expects.

     Other revenues declined as SHP was required to phase out its prepaid health
clinic product as a result of receiving its license to operate as an HMO.
Effective September 1, 1997, SHP no longer offered its prepaid health clinic
product.

     HMO medical costs were approximately $7,076,000 for the year ended July 31,
1998, resulting in a medical loss ratio of approximately 80%. HMO medical costs
include amounts accrued for actual claims reported but not paid and estimates of
medical services incurred but not reported. Total medical payments for all dates
of service were approximately $3,463,000, including net reinsurance premiums
paid, in fiscal 1998. The Company incurred HMO medical costs of approximately
$135,000 in fiscal 1997 or a medical loss ratio of approximately 136%. This
reduction of HMO medical costs as a percentage of HMO revenues was directly
attributable to the Company establishing reserves for its small membership in
its new HMO products.

     Selling, general and administrative expenses increased by approximately
$5,298,000 from approximately $1,997,000 for fiscal 1997 to approximately
$7,295,000 for fiscal 1998, or 80% of total revenues for the current fiscal
year. The increase is primarily the result of an increase in sales and marketing
salaries, benefits and commission expense related to the HMO products of
approximately $1,442,000, increased advertising expenses of approximately
$1,047,000, an increase in professional and outsourcing fees of approximately
$1,093,000, additional administrative salaries and related benefits of
approximately $891,000, an increase in printing, postage and other selling costs
related to HMO operations of approximately $472,000, an increase in occupancy,
insurance, general office and related costs of approximately $221,000, and an
increase of approximately $132,000 in other general and administrative expenses
including costs related to HMO enrollee medical records, benefit statements and
other miscellaneous office expenses. These additional expenses were primarily
incurred in connection with the Company's accelerated expansion into additional
Florida markets, the development of marketing materials and increased
infrastructure and personnel to effect the Company's transformation into an HMO.
The Company expects selling, general and administrative expenses as a percentage
of revenues to decrease substantially as HMO membership and premium revenues
grow. However, there can be no assurance that such membership and revenue growth
or a decline in selling, general and administrative expenses as a percentage of
revenues will occur as the Company anticipates.

     As a result of the foregoing, the net loss from continuing operations
increased to approximately $5,390,000 for fiscal 1998 compared to approximately
$1,706,000 for fiscal 1997.

     Income from discontinued operations increased by $80,000 from $74,000 for
fiscal 1997 to approximately $154,000 for the current year. This increase is
primarily due to a decline in costs of patient related services from 73% of
primary care center revenues for the year ended July 31, 1997 to 72% for the
year ended July 31, 1998 and a decline in selling, general and administrative
expenses as a percentage of primary care center revenues from 25% for fiscal
1997 to 24% for fiscal 1998. Substantially all of the assets of the primary care
Medical Centers were sold on April 15, 1998 for $1,500,000 in cash resulting in
the recognition of a gain on the sale of discontinued operations of
approximately $668,000.


Financial Condition, Liquidity and Capital Resources.
-----------------------------------------------------

     At July 31, 1998, the Company had working capital of approximately
$1,831,000 as compared to working capital of approximately $4,225,000 at July
31, 1997. The decline in working capital from fiscal 1997 is attributable
primarily to the development and marketing costs incurred in order to transform
SHP into an HMO and the Company's expansion of its initial service area.

     Net cash used by operating activities was approximately $46,000 for fiscal
1998 and approximately $1,226,000 for fiscal 1997. Net cash used by operating
activities in the current year was primarily attributable to the loss from
continuing operations of approximately $5,390,000, offset by an increase in the
medical claims payable and reserves for incurred but not reported claims of
approximately $3,689,000, additional cash received related to unearned and
deferred revenues of approximately $1,578,000 and noncash compensation expenses
of approximately $65,000.

                                       9
<PAGE>
 
     Net cash provided by investing activities for fiscal 1998 was approximately
$1,540,000 as a result of proceeds from the sale of discontinued operations and
a restricted certificate of deposit of $1,500,000 and $280,000, respectively,
offset by purchases of new capital items of approximately $242,000. Net cash
used in investing activities for fiscal 1997 was approximately $180,000,
primarily as a result of purchases of furniture and equipment associated with
the development of the Company's new administrative offices and replacement of
medical office equipment.

     Net cash provided by financing activities for the year ended July 31, 1998
was approximately $1,328,000 as compared to net cash used in financing
activities of approximately $62,000 for the year ended July 31, 1997. Cash
provided by financing activities during fiscal 1998 primarily represents net
proceeds of approximately $1,355,000 from the Private Placement and $12,500 from
the exercise of common stock options, offset slightly by principal payments
under capital lease obligations of approximately $40,000. Cash used in financing
activities in fiscal 1997 related to principal payments under capital lease
obligations of approximately $32,000 and an adjustment of approximately $30,000 
to the Offering proceeds.

     The Company has reviewed the Year 2000 problem as it relates to the
Company's internal systems as well as those of its vendors and determined that
it will not have a material impact on its business, operations nor its financial
condition. Nevertheless, the Company's rapid expansion has resulted in an
increasing number of entities with which the Company does business. While the
Company believes that the Year 2000 issue will not have a material impact on the
Company's internal operations or those of its current vendors, there can be no
guarantee that the systems of other unrelated entities on which its systems and
operations rely, or on which its systems and operations may rely in the future,
will be corrected on a timely basis and will not have a material adverse impact
on the Company.

     During the next fiscal year, the Company's liquidity will be affected by
continued accelerated HMO development, marketing and operation. Effective
September 30, 1998, SHP is required to maintain a minimum capital surplus in an
amount which is the greater of $800,000 or 10% of total liabilities or 1% of
annualized premium pursuant to Section 641 of the Florida Insurance Code.
At September 30, 1998, SHP's unaudited statutory financial statements reflect an
actual surplus of $1,099,000. The Company's cash balances are currently
maintained as a cash equivalent of a Money Market Trust Fund which invests in
securities issued or guaranteed by the U.S. Treasury and repurchase agreements
relating to such securities.

     HMO development costs will continue to be incurred by SHP in fiscal 1999 to
further establish arrangements with physicians, hospitals, and other healthcare
providers as well as to develop marketing materials and strategies necessary to
operate and maintain HMO operations in accordance with statutory requirements
(which shall include the costs of key employee's salaries and expenses). In
order to support the significant growth of the Company's HMO operations,
additional marketing, development and other personnel were hired throughout
fiscal 1998 to augment the Company's efforts to support and manage this growth.
Expenditures for such employees' salaries and related benefits will continue to
be incurred in the future and may increase as additional personnel are needed to
support further HMO membership growth. In addition, the Company anticipates that
it will make additional capital expenditures associated with, among other
things, furniture and equipment necessary due to personnel increases. There can
be no assurance that the foregoing factors will not adversely affect the
Company's future operating results.

     The Company conducted the Offering in May 1996 and the Private Placement
offering in July 1998 to provide funds for its growth and expansion plans. The
net proceeds from such offerings, approximating $7,400,000, have been used to
implement such expansion. The Company anticipates, based on currently proposed
plans and assumptions relating to its operations (including the costs associated
with its accelerated expansion), that additional offering proceeds will be
needed to fund ongoing business operations and to satisfy its net tangible asset
requirements as governed by the Nasdaq Small-Cap Market and other equity
requirements as governed by certain regulatory entities including, without
limitation, the Florida Department of Insurance, AHCA and HCFA. Management's
plans include consideration of the sale of additional equity securities under
appropriate market conditions, alliances or other partnership agreements with
entities interested in and resources to support the Company's expansion plans,
or other business transactions which would generate sufficient resources to
assure continuation of the Company's operations.

                                       10
<PAGE>
 
     The Company has retained investment banking advisors and independent
consultants to counsel it on the possible sale of equity securities as well as
to introduce and assist in the evaluation of potential merger and partnering
opportunities. However, no assurance can be given that the Company will be
successful in raising additional capital or entering into a business alliance.
Further, there can be no assurance, assuming the Company successfully raises
additional funds or enters into a business alliance, that the Company will
achieve profitability. If the Company is unable to obtain adequate additional
financing or enter into such business alliance, it will not be able to meet
ongoing business operation needs. To the extent that the Company's available
cash resources are insufficient to allow the Company to engage in operations
sufficient to generate meaningful revenues or achieve profitable operations, the
inability to obtain additional financing will have a material adverse effect on
the Company. Additional equity financing may involve substantial dilution to the
interests of the Company's existing stockholders.


ITEM 7.  FINANCIAL STATEMENTS.

     Filed as part of this report are audited financial statements for the years
ended July 31, 1998 and 1997 commencing at page F-1.


ITEM 8.  CHANGES IN ACCOUNTANTS.

     Richard A. Eisner & Company, LLP, was previously the principal accountant
for the Company. On August 27, 1996, that firm's appointment as principal
accountant was terminated and KPMG Peat Marwick LLP, was engaged as the
Company's principal accountant. The decision to change accountants was approved
by the Board of Directors and ratified by the shareholders at the annual meeting
of the shareholders held on December 16, 1996.

     In connection with the audit of the fiscal year ended July 31, 1995 and the
subsequent interim period through August 27, 1996, there were no disagreements
with Richard A. Eisner & Company, LLP, on any matter of accounting principles or
practices, financial statement disclosure, or auditing scope or procedures,
which disagreements if not resolved to its satisfaction would have caused it to
make reference in connection with its opinion to the subject matter of the
disagreement.

     The audit report of Richard A. Eisner & Company, LLP, on the consolidated
financial statements of the Company and subsidiaries as of and for the year
ended July 31, 1995, did not contain any adverse opinion or disclaimer of
opinion, nor were they qualified or modified as to uncertainty, audit scope, or
accounting principles.

                                       11
<PAGE>
 
                                   PART III
                                        

ITEM 9.  DIRECTORS, EXECUTIVE OFFICERS AND SIGNIFICANT EMPLOYEES.

     Information concerning the directors, executive officers and significant
employees of the Company is contained in the Company's Proxy Statement to be
filed with the Securities and Exchange Commission pursuant to Regulation 14A
within 120 days after the close of the fiscal year ended July 31, 1998.  Such
information is hereby incorporated by reference.


ITEM 10.  EXECUTIVE COMPENSATION.

     Information concerning executive compensation is contained in the Company's
Proxy Statement to be filed with the Securities and Exchange Commission pursuant
to Regulation 14A within 120 days after the close of the fiscal year ended July
31, 1998. Such information is hereby incorporated by reference.


ITEM 11.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

     Information concerning the security ownership of certain beneficial owners
and management is contained in the Company's Proxy Statement to be filed with
the Securities and Exchange Commission pursuant to Regulation 14A within 120
days after the close of the fiscal year ended July 31, 1998. Such information is
hereby incorporated by reference.


ITEM 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

     Information concerning certain relationships and related transactions is
contained in the Company's Proxy Statement to be filed with the Securities and
Exchange Commission pursuant to Regulation 14A within 120 days after the close
of the fiscal year ended July 31, 1998. Such information is hereby incorporated
by reference.


ITEM 13.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.

     Filed as part of this 10-KSB annual report are audited financial statements
for the years ended July 31, 1998 and 1997.

     No reports on Form 8-K were filed during the last quarter of the fiscal
year ended July 31, 1998.

                                       12
<PAGE>
 
                   SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES

                       Consolidated Financial Statements

                                 July 31, 1998


                  (With Independent Auditors' Report Thereon)

                                       1
<PAGE>
 
                   SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES

                                 July 31, 1998



                               Table of Contents
                               -----------------

<TABLE>
<CAPTION>
 
 
                                                                                        Page
                                                                                      --------
<S>                                                                                   <C>
 
Independent Auditors' Report                                                            F-1
 
Consolidated Balance Sheet at July 31, 1998                                             F-2
 
Consolidated Statements of Operations for the years ended July 31, 1997 and 1998        F-3
 
Consolidated Statement of Changes in Shareholders' Equity for the years
  ended July 31, 1997 and 1998                                                          F-4
 
Consolidated Statements of Cash Flows for the years ended July 31, 1997 and 1998        F-5
 
Notes to Consolidated Financial Statements                                            F-6 - 21
</TABLE>


                                       2
<PAGE>
 
                         Independent Auditors' Report
                         ----------------------------


The Board of Directors
SunStar Healthcare, Inc.:

We have audited the accompanying consolidated balance sheet of SunStar
Healthcare, Inc. and Subsidiaries (the Company) as of July 31, 1998, and the
related consolidated statements of operations, changes in shareholders' equity,
and cash flows for each of the years in the two-year period ended July 31, 1998.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of SunStar Healthcare,
Inc. and Subsidiaries as of July 31, 1998, and the results of its operations and
its cash flows for each of the years in the two-year period ended July 31, 1998,
in conformity with generally accepted accounting principles.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in note 8(e) to the
financial statements, the Company has experienced significant operating losses
and is seeking additional financing to meet its regulatory surplus and working
capital requirements and to fund additional expansion efforts. If the additional
financing is not obtained and the Company fails to meet these regulatory and
capital requirements, there is substantial doubt about the Company's ability to
continue as a going concern. Management's plans in regard to these matters are
also described in note 8(e). The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.



                                        KPMG Peat Marwick LLP

Jacksonville, Florida
September 18, 1998

                                      F-1
<PAGE>
 
                   SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
                          Consolidated Balance Sheet
                                 July 31, 1998
<TABLE>
<CAPTION>
 
                             Assets
                             ------
<S>                                                                 <C>
Current assets:
  Cash and cash equivalents                                         $    7,347,784
  Premiums receivable                                                       16,094
  Prepaid expenses                                                         353,170
  Other current assets (note 1(a))                                         379,960
  Deferred taxes (note 6)                                                   53,000
                                                                     -------------
          Total current asset                                            8,150,008
 
Furniture and equipment, net (note 4)                                      362,483
Deposits and other assets                                                   90,027
Deferred taxes (note 6)                                                     47,000
                                                                     -------------
          Total assets                                              $    8,649,518
                                                                     =============
 
             Liabilities and Shareholders' Equity
             ------------------------------------
Current liabilities:
  Medical claims payable                                            $    3,782,716
  Unearned premium - HMO                                                 1,540,209
  Unearned premium - Medicare                                               97,452
  Accounts payable and accrued expenses                                    763,087
  Estimated Medicare settlement                                            103,175
  Capital lease obligations, current (note 5)                               32,806
                                                                     -------------
          Total current liabilities                                      6,319,445
 
Capital lease obligations, noncurrent (note 5)                              82,939
                                                                     -------------
          Total liabilities                                              6,402,384
                                                                     -------------
 
Shareholders' equity (notes 1(h) and 8):
  Preferred stock, par value $.001 per share, 1,000,000 shares
     authorized, no shares outstanding                                       - 
 Common stock, par value $.001 per share, 10,000,000 shares
     authorized, 2,445,000 shares issued and outstanding                     2,445
  Common stock subscriptions received, par value
     $.001 per share, 474,330 shares                                           474
  Additional paid-in capital                                             8,531,027
  Unearned compensation from stock options                                 (65,105)
  Accumulated deficit                                                   (6,221,707)
                                                                     -------------
          Total shareholders' equity                                     2,247,134
                                                                     -------------
 
Commitments and contingencies (note 8)
 
          Total liabilities and shareholders' equity                $    8,649,518
                                                                     =============
</TABLE>
See accompanying notes to consolidated financial statements.

                                      F-2
<PAGE>
 
                   SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
                     Consolidated Statements of Operations
                  For the years ended July 31, 1997 and 1998


<TABLE>
<CAPTION>
 
 
                                                                     1997          1998
                                                                  -----------   -----------
<S>                                                           <C>               <C>
Revenues:
  HMO premiums                                                $       99,529     8,844,775
  Investment income                                                  249,407       231,743
  Other                                                              101,112         2,554
                                                                  ----------    ----------
       Total revenues                                                450,048     9,079,072
                                                                  ----------    ----------
 
Operating expenses:
  HMO medical costs                                                  135,211     7,076,054
  Selling, general and administrative (notes 1(a) and 3)           1,997,042     7,295,065
  Option based compensation (note 8(c))                               65,104        65,104
  Amortization of intangibles                                          9,328        32,611
                                                                  ----------    ----------
       Total operating expenses                                    2,206,685    14,468,834
                                                                  ----------    ----------
 
Loss before income taxes                                          (1,756,637)   (5,389,762)
Provision for income taxes (note 6)                                  (51,000)         -
                                                                  ----------    ----------

Loss from continuing operations                                   (1,705,637)   (5,389,762)
 
Discontinued operations (note 2):
  Income from discontinued operations                                 74,472       154,472
  Gain on sale of discontinued operations                               -          667,933
                                                                  ----------    ----------
       Total discontinued operations                                  74,472       822,405
                                                                  ----------    ----------
 
          Net loss                                            $   (1,631,165)   (4,567,357)
                                                                  ==========    ==========
 
 
Earnings per share (note 1(j))
  Loss from continuing operations                             $         (.71)        (2.18)
  Discontinued operations                                     $          .03           .33
  Net loss                                                    $         (.68)        (1.85)
 
Weighted average shares outstanding                                2,395,000     2,467,959
</TABLE> 

See accompanying notes to consolidated financial statements.

                                      F-3
<PAGE>
 
                   SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
           Consolidated Statement of Changes in Shareholders' Equity
                  For the years ended July 31, 1997 and 1998

<TABLE>
<CAPTION>
                                                                 Unearned
                                                               Compensation
                                                   Additional      From
                                          Common     Paid-in       Stock      Accumulated
                                           Stock     Capital      Options       Deficit       Total
                                          --------   -------      -------       -------     --------- 
<S>                                      <C>         <C>          <C>           <C>         <C>
Balance, July 31, 1996                   $   2,395   7,193,852    (195,313)     (23,185)    6,977,749

Net loss                                         -           -           -   (1,631,165)   (1,631,165)
Stock issuance costs (note 1(h))                 -     (30,052)          -            -       (30,052)
Amortization of compensatory
  stock options (note 8 (c))                     -           -      65,104            -        65,104
                                         ---------   ---------    --------    ---------    ----------
 
Balance, July 31, 1997                       2,395   7,163,800    (130,209)  (1,654,350)    5,381,636
 
Net loss                                         -           -           -   (4,567,357)   (4,567,357)
Stock options exercised (note 1(h))             50      12,450           -            -        12,500
Amortization of compensatory
  stock options (note 8 (c))                     -           -      65,104            -        65,104
                                         ---------   ---------    --------    ---------    ----------
                                             2,445   7,176,250     (65,105)  (6,221,707)      891,883
 Common stock subscriptions
  received (note 1(h))                         474   1,354,777           -            -     1,355,251
                                         ---------   ---------    --------    ---------    ----------
 
Balance, July 31, 1998                   $   2,919   8,531,027     (65,105)  (6,221,707)    2,247,134
                                         =========   =========    ========    ==========    ==========
</TABLE>


See accompanying notes to consolidated financial statements.

                                      F-4
<PAGE>
 
                   SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
                     Consolidated Statements of Cash Flows
                   For the years ended July 31, 1997 and 1998
<TABLE>
<CAPTION>
 
                                                                                       1997         1998
                                                                                   -----------   -----------
<S>                                                                                <C>           <C>           
Cash flows from operating activities:
  Net loss                                                                         $(1,631,165)  $(4,567,357)
  Adjustments to reconcile net loss to net cash used in operating activities:
     Depreciation and amortization                                                     163,543       159,955
     Provision for doubtful accounts                                                    15,000            -
     Deferred taxes                                                                    (37,400)           -
     Noncash compensation                                                               65,104        65,104
     Gain on sale of discontinued operations                                                -       (667,933)
     Gain on the sale of furniture and equipment                                        (3,473)       (1,224)
     Changes in operating assets and liabilities:
       Decrease (increase) in premiums receivable                                        4,871       (51,999)
       Increase in prepaid expenses                                                   (131,546)     (197,504)
       Increase in other current assets                                                (82,554)     (216,388)
       Decrease in deposits and other assets                                            17,318        33,143
       Decrease in due from Medicare                                                    38,448            -
       Increase in medical claims payable                                               93,858     3,688,857
       Increase in unearned premium - HMO                                               59,213     1,480,995
       (Decrease) increase in unearned premium - Medicare                             (159,521)       97,452
       Increase in accounts payable and accrued expenses                               230,826       159,093
       Increase (decrease) in estimated settlement - Medicare                          131,035       (27,860)
                                                                                   -----------    ----------
          Net cash used in operating activities                                     (1,226,443)      (45,666)
                                                                                   -----------    ----------
 
Cash flows from investing activities:
  Proceeds from sale of discontinued operations                                             -      1,500,000
  Purchase of furniture and equipment                                                 (183,221)     (241,585)
  Proceeds from sale of furniture and equipment                                          3,473         1,345
  Proceeds from sale of restricted certificate of deposit                                   -        280,000
                                                                                   -----------    ----------
       Net cash (used in) provided by investing activities                            (179,748)    1,539,760
                                                                                   -----------    ----------
 
Cash flows from financing activities:
  Principal payments under capital lease obligations                                   (31,689)      (39,738)
  Additional initial public offering expenses                                          (30,052)           -  
  Common stock subscribed                                                                   -      1,355,251
  Exercise of common stock options                                                          -         12,500
                                                                                   -----------    ----------
       Net cash (used in) provided by financing activities                             (61,741)    1,328,013
                                                                                   -----------    ----------
 
       Net (decrease) increase in cash and cash equivalents                         (1,467,932)    2,822,107
 
Cash and cash equivalents, beginning of period                                       5,993,609     4,525,677
                                                                                   -----------    ----------
 
Cash and cash equivalents, end of period                                           $ 4,525,677     7,347,784
                                                                                   ===========    ==========
 
Supplemental disclosure of cash flow information:
  Cash paid for interest                                                           $    10,447        18,585
                                                                                   ===========    ==========
</TABLE>
Noncash investing and financing activities (notes 1(h), 5 and 8)
See accompanying notes to consolidated financial statements.

                                      F-5
<PAGE>
 
                   SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                                 July 31, 1998



(1) Summary of Significant Accounting Policies
    ------------------------------------------

   (a) Organization
       ------------

       SunStar Healthcare, Inc. (SunStar or the Company) was incorporated in
       December 1995 and issued 875,000 shares (prior to a stock split discussed
       in note 1(h)) of common stock.  In January 1996, National Home Health
       Care Corp. (NHHC), then the sole shareholder of the Company, contributed
       to SunStar 100% of the outstanding capital stock of its wholly owned
       subsidiaries, First Health, Inc. (First Health) and Brevard Medical
       Center, Inc. (Brevard), which included 100% of the outstanding capital
       stock of Brevard's wholly owned subsidiary, SunStar Health Plan, Inc.
       (SHP).  Subsequent thereto, the Company restructured its subsidiaries
       such that Brevard, First Health, and SHP all became direct, wholly-owned
       subsidiaries of SunStar.

       SunStar is engaged in providing managed healthcare services in the State
       of Florida by operating a health maintenance organization (HMO) through
       SHP. As originally organized, the Company also operated seven primary
       care medical centers through Brevard and First Health. On April 15, 1998,
       the Company sold substantially all the assets of Brevard and First
       Health, thereby completing its transformation from a "provider" of
       medical services through its primary care medical centers to a "payor"
       for medical services by establishing and operating a statewide HMO.

       Throughout fiscal 1997, SunStar's management was active in developing and
       obtaining certification for its HMO product.  On February 24, 1997, SHP
       was issued a Certificate of Authority by the Insurance Department of the
       State of Florida to operate an HMO in accordance with the provisions of
       Chapter 641, Florida Statutes.  Effective May 1, 1997, the Company began
       accepting its first HMO members.  Through October 1, 1998, the Company
       has been approved to operate its HMO in 52 counties in the State of
       Florida and has accepted members in all of those counties.  Costs
       associated with the development of SunStar's HMO, including management
       salaries and benefits, administrative and other indirect costs have been
       reflected as selling, general and administrative expense in the
       accompanying consolidated financial statements.
 
       The Company has entered into a service agreement with a third party
       administrator (TPA) for enrollment and underwriting administration,
       claims processing, payment of agent's commissions and premium billing and
       collection.  Service fees charged to operations under such contract were
       $16,078 and $904,141 for the years ended July 31, 1997 and 1998,
       respectively.  At July 31, 1998, the Company has a receivable of
       approximately $289,000 for premiums and collections due from the TPA
       which is included in other current assets.

                                      F-6
<PAGE>
 
                   SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements



(1) Summary of Significant Accounting Policies, continued
    -----------------------------------------------------

   (b) Basis of Presentation
       ---------------------

       The accompanying consolidated financial statements have been prepared in
       conformity with generally accepted accounting principles (GAAP).  These
       financial statements include the accounts of SunStar, SHP, Brevard and
       First Health.  All significant intercompany transactions and balances
       have been eliminated in consolidation.

       As discussed in note 2, effective April 15, 1998, the Company sold
       substantially all the assets of Brevard and First Health pursuant to a
       single Asset Purchase Agreement.  Accordingly, the results of operations
       for Brevard and First Health for all periods presented are reported in
       the accompanying consolidated statements of operations under discontinued
       operations.  Pursuant to the Asset Purchase Agreement, the Company has
       agreed to assign the existing Health Care Financing Administration (HCFA)
       contract held by SHP to the buyer subject to HCFA approval, thus, related
       HCFA revenues and program costs have also been included in discontinued
       operations in the accompanying consolidated statements of operations for
       all periods presented.

   (c) Cash and Cash Equivalents
       -------------------------

       Cash and cash equivalents include short-term investments with original
       maturities of 90 days or less.

   (d) Furniture and Equipment
       -----------------------

       Furniture and equipment are stated at cost and depreciated over estimated
       useful lives of three to ten years on a straight-line basis.

   (e) Medical Claims Payable
       ----------------------

       Medical claims payable consist of actual claims reported but not paid and
       estimates of medical services incurred but not reported.  The medical
       claims payable is based on historical data, current enrollment, health
       service utilization statistics, premium revenues and other related
       information.  These accruals are continually monitored and reviewed.
       Modification in assumptions for medical costs caused by variances in
       actual experience could cause these estimates to change.

                                      F-7
<PAGE>
 
                   SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements



(1) Summary of Significant Accounting Policies, continued
    -----------------------------------------------------

    (f) Revenue Recognition
        -------------------

       Premium revenue under the Company's HMO is recognized as earned on a pro
       rata basis over the contract period.  Reimbursement for the Company's
       participation under a federal third-party reimbursement contract is based
       on cost reimbursement principles and is subject to audit and
       retrospective adjustment.  The accompanying consolidated financial
       statements reflect an estimated settlement for open-year cost reports
       subject to audit.  As discussed in note 1(b), the Company has agreed to
       assign the reimbursement contract to the buyer subject to HCFA approval.
       Accordingly, related revenues and program costs have been reflected in
       discontinued operations in the accompanying consolidated financial
       statements.

   (g) Income Taxes
       ------------

       The Company accounts for income taxes in accordance with Statement of
       Financial Accounting Standards No. 109, "Accounting for Income Taxes."
       Deferred tax assets and liabilities are recognized for the future tax
       consequences attributable to differences between the financial statement
       carrying amounts of existing assets and liabilities and their respective
       tax bases and operating loss and tax credit carryforwards.  Deferred tax
       assets and liabilities are measured using enacted tax rates expected to
       apply to taxable income in the years in which those temporary differences
       are expected to be recovered or settled.  Deferred taxes result primarily
       from liabilities for medical claims payable and temporary differences
       between the tax and financial statement recognition of option based
       compensation expense.

   (h) Equity Transactions
       -------------------

       SunStar is authorized to issue 10,000,000 shares of common stock, par
       value $.001 per share, and 1,000,000 shares of preferred stock, par value
       $.001 per share. The preferred stock may be issued in one or more series,
       the terms of which may be determined at the time of issuance by the Board
       of Directors. In April 1996, the Board of Directors approved a 1.02857
       for one stock split. As a result of the stock split, NHHC holds 900,000
       shares of the Company's common stock representing a 30.8% interest. All
       share amounts have been retroactively adjusted for all periods presented.

                                      F-8
<PAGE>
 
                   SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements



(1) Summary of Significant Accounting Policies, continued
    -----------------------------------------------------

   (h) Equity Transactions, continued
       ------------------------------

       On May 15, 1996, the Company completed an initial public offering (the
       Offering), pursuant to which the Company sold 1,300,000 shares of
       previously unissued common stock, par value $.001.  The Offering resulted
       in net proceeds to the Company of $5,230,372.  On June 7, 1996, the
       underwriters in the Offering exercised their over-allotment option to
       purchase additional shares of common stock, pursuant to which the Company
       sold 195,000 shares of common stock, par value $.001, resulting in
       additional net proceeds to the Company of $853,125.  During 1997, the
       Company paid $30,052 of additional stock issuance costs related to the
       Offering which has been reflected as a reduction of paid-in capital in
       the accompanying financial statements.  In November 1997, a consultant
       exercised stock options to purchase 50,000 shares of common stock at $.25
       per share.

       On July 16, 1998, the Company completed a Regulation D, Rule 506, Private
       Placement (the Private Placement) pursuant to which the Company sold
       474,330 shares of previously unissued common stock, par value $.001,
       resulting in net proceeds to the Company of $1,355,251.  Common stock
       sold pursuant to the private placement was issued on August 31, 1998.
       Under the terms of the Private Placement, the Company has agreed to
       effect the registration and sale of the 474,330 shares issued on behalf
       of the Private Placement shareholders within 90 days of the Private
       Placement, subject to extensions for various causes.  The Company intends
       to complete the registration required under the Private Placement as soon
       as practical following the filing of its form 10-KSB for the year ended
       July 31, 1998.

   (i) Accounting for Stock-Based Compensation
       ---------------------------------------

       In October 1995, the Financial Accounting Standards Board issued
       Statement of Financial Accounting Standards No. 123, "Accounting for
       Stock-based Compensation" (SFAS 123). SFAS 123 requires the fair value of
       stock options and other stock-based compensation issued to employees to
       either be recognized as compensation expense in the income statement, or
       be disclosed as a pro forma effect on net income and earnings per share
       in the footnotes to the Company's consolidated financial statements. The
       Company has elected to adopt SFAS 123 on a disclosure basis only and will
       continue to measure stock-based compensation in accordance with
       Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued
       to Employees," using intrinsic values with appropriate disclosures under
       the fair value based method as required by SFAS 123.

                                      F-9
<PAGE>
 
                   SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements



(1) Summary of Significant Accounting Policies, continued
    -----------------------------------------------------

   (j) Per Share Data
       --------------

       The Company adopted Statement of Financial Accounting Standards No. 128,
       "Earnings Per Share," during the quarter ended January 31, 1998 and,
       accordingly, has restated all prior periods to conform with the
       applicable provisions.  Common stock options are not included in the
       computation of diluted earnings per share as their effect is antidilutive
       due to the Company's net losses attributable to common shares.

   (k) Recently Issued Accounting Pronouncements
       -----------------------------------------

       In June 1997, the Financial Accounting Standards Board issued Statement
       of Financial Accounting Standards No. 130 "Reporting Comprehensive
       Income" (SFAS 130) and Statement of Financial Accounting Standards No.
       131 "Disclosure about Segments of an Enterprise and Related Information"
       (SFAS 131). SFAS 130 requires all items that meet the definition of
       components of comprehensive income be reported in the consolidated
       financial statements for the period in which they are recognized and is
       effective for fiscal years beginning after December 15, 1997. SFAS 131
       provides for the disclosure of financial information desegregated by the
       way management organizes the segments of the enterprise for making
       operating decisions and is effective for fiscal years beginning after
       December 15, 1997. The Company intends to adopt the provisions of SFAS
       130 and SFAS 131 during fiscal year 1999 and has not determined the
       impact, if any, of the adoption of these pronouncements on the Company's
       consolidated financial statement disclosure.

   (l) 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 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.  Such estimates relate primarily to depreciable
       assets, valuation reserves for deferred tax assets and liabilities for
       incurred but not reported medical claims.

   (m) Reclassification
       ----------------

       Certain amounts presented for 1997 have been reclassified to conform with
       the presentation adopted for 1998.

                                      F-10
<PAGE>
 
                   SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements



(2) Discontinued Operations
    -----------------------

    On April 15, 1998, the Company sold substantially all the assets of its
    primary care medical centers, Brevard and First Health, pursuant to a single
    Asset Purchase Agreement, to Brevard Medical Care, Inc. for $1,500,000.
    Pursuant to the Asset Purchase Agreement, the Company has agreed to assign
    the existing HCFA contract held by SHP to the buyer subject to HCFA
    approval. The assets sold consisted primarily of accounts receivable,
    furniture, equipment and leasehold improvements and capital lease
    commitments associated with these assets as well as physician and other
    payor agreements.

    Assets excluded from the sale consist of cash and cash equivalents. The
    Company retained substantially all obligations and liabilities which arose
    from or in connection with operations prior to the sales transaction, except
    for those capital lease commitments previously discussed.

    The results of operations for Brevard and First Health and HCFA revenues
    and program costs for all periods presented are reported in the accompanying
    consolidated statements of operations under discontinued operations.

    Information with respect to discontinued operations for the years ended
    July 31, 1997 and 1998 is summarized as follows:

<TABLE>
<CAPTION>
 
                                                         1997        1998
                                                       ---------   ---------
<S>                                                <C>             <C>
 
          Revenues                                 $   4,544,852   3,069,322
 
          Expenses                                     4,470,380   2,914,850
                                                       ---------   ---------
 
          Income from discontinued operations      $      74,472     154,472
                                                       =========   =========
 
</TABLE>

    The Company will utilize previously generated net operating loss
    carryforwards to offset the tax effect of the sale and, as such, has not
    recognized any tax expense or benefits resulting from the sale.

                                      F-11
<PAGE>
 
                   SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements



(3) Related Party Transaction
    -------------------------

    SunStar is engaged in providing managed healthcare services by operating an
    HMO through SHP. The Company has entered into a management contract with SHP
    for the provision of administrative and marketing services. Management fees
    charged to SHP under such contract were $16,078 and $1,325,660 for the years
    ended July 31, 1997 and 1998, respectively. As discussed in note 1(a), costs
    associated with the development of the Company's HMO, including management
    salaries and benefits, administrative and other indirect costs have been
    reflected as selling, general and administrative expense in the accompanying
    consolidated financial statements.


(4) Furniture and Equipment
    -----------------------

    Furniture and equipment at July 31, 1998 consist of the following:

          Furniture and equipment         $   469,049
          Less accumulated depreciation      (106,566)
                                             -------- 

          Net furniture and equipment     $   362,483
                                              =======

    The net book value of furniture and equipment held under capital leases was
    approximately $122,000 at July 31, 1998.  Depreciation expense includes
    depreciation on assets held under capital leases.


(5) Capital Lease Obligations
    -------------------------

    Future minimum lease payments under capitalized lease obligations at July
    31, 1998, were as follows:
<TABLE>
<CAPTION>
            Year ended July 31                            Amount
            ------------------                            ------
<S>                                                     <C>
                                                       
            1999                                        $  43,613
            2000                                           45,986
            2001                                           34,393
            2002                                           12,245
            2003                                            2,766
                                                          -------
               Total minimum lease payments               139,003
                                                       
            Less amounts representing interest            (23,258)
            Less amounts due within one year              (32,806)
                                                          -------
            Amounts due after one year                  $  82,939
                                                          =======
</TABLE>

                                      F-12
<PAGE>
 
                   SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements



(5) Capital Lease Obligations, continued
    ------------------------------------

    During 1998, the Company acquired equipment under capital leases for $91,660
    of which $29,182 was sold pursuant to the sale of the assets of Brevard and
    First Health as discussed in note 2.

(6) Income Taxes
    ------------

    The provision for income taxes for the years ended July 31, 1997 and 1998
    consists of:

<TABLE>
<CAPTION>
 
                                                     1997       1998  
                                                  ---------   --------
<S>                                               <C>         <C>     
                                                                      
                      Current:                                        
                         Federal                  $(13,600)         - 
                         State                          -           - 
                                                   (13,600)         - 
                      Deferred tax benefit         (37,400)         - 
                                                   -------     -------
                         Total                    $(51,000)         - 
                                                   =======     ======= 
                                                 
</TABLE>

    Deferred tax assets at July 31, 1998 are as follows:

<TABLE>
<CAPTION>
 
           Deferred tax assets:                                  
      <S>                                             <C>        
              Net operating loss carryforward      $    1,968,800
              Medical claims payable                      371,300
              Stock option amortization                   128,400
              Estimated Medicare settlement                38,800
                                                       ----------
                                                        2,507,300
              Less valuation allowance                 (2,305,600)
                                                       ----------
                 Net deferred tax assets                  201,700
                                                       ----------
                                                                 
           Deferred tax liabilities:                             
              HMO startup costs                          (22,000)
              Furniture and equipment                    (10,200)
              Other assets                               (69,500)
                                                      ---------- 
                 Net deferred tax liabilities           (101,700)
                                                      ---------- 
                                                                 
                 Net deferred tax asset           $      100,000 
                                                      ==========  
</TABLE>

                                      F-13
<PAGE>
 
                   SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements



(6) Income Taxes, continued
    -----------------------

    The reconciliation of the statutory tax rate to the effective rate
    for the years ended July 31, 1997 and 1998 are as follows:
<TABLE>
<CAPTION>
                                                        1997         1998
                                                        ----         ----     
<S>                                                 <C>          <C>
 
      Federal statutory rate                        $ (571,900)  (1,552,900)
      State taxes, net of federal tax benefit          (70,200)    (164,700)
      Discontinued operations                                -       90,000
      Change in valuation allowance                    625,200    1,600,600
      Overaccrual of prior year taxes                  (13,600)          -
      Other                                            (20,500)      27,000
                                                    ----------   ----------
                                                    $  (51,000)          -
                                                    ==========   ========== 
</TABLE>


    The difference between the tax provision provided for the year ended July
    31, 1998 and that expected from applying the U.S. statutory rate to loss
    from operations before taxes is primarily attributable to the Company
    recording a valuation allowance for deferred tax assets related to net
    operating loss (NOL) carryforwards and compensation charges for stock
    options to key employees which are not currently deductible for income
    taxes. The realization of the tax benefits related to these NOL
    carryforwards and stock options is dependent on future earnings and market
    conditions and have not been recorded. Management believes that it is more
    likely than not that the results of future operations will generate
    sufficient taxable income to realize net deferred tax assets resulting from
    other temporary differences. NOL carryforwards against future taxable income
    were approximately $5,232,000 at July 31, 1998. Such NOLs are scheduled to
    expire in years through 2013.

(7) Financial Instruments
    ---------------------

    The Company's financial instruments exposed to concentrations of credit risk
    consist primarily of its cash and cash equivalents and premiums and other
    receivables. The Company's cash and cash equivalents are concentrated in
    liquid investments. Premiums and other receivables are geographically
    disbursed through out Central and South Florida.

    Financial instruments, such as cash and cash equivalents, are valued
    at cost which approximates fair market value.

                                      F-14
<PAGE>
 
                   SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements



(8) Commitments, Contingencies and Other Matters
    --------------------------------------------

   (a) Leases
       ------

       The Company rents various office facilities and equipment under terms
       of several lease agreements which include escalation clauses.

       At July 31, 1998, minimum annual rental commitments under noncancelable
       operating leases are as follows:
<TABLE>
<CAPTION>
 
<S>                           <C>
           1999               $245,680
           2000                227,067
           2001                 59,396
           2002                  6,677
           2003                  5,008
 
</TABLE>
       Rent expense amounted to approximately $389,000 and $322,000
       for the years ended July 31, 1997 and 1998, respectively.

   (b) Regulatory Requirements
       -----------------------

       As an HMO licensed in Florida, SHP is required, pursuant to Section 641
       of the Florida Insurance Code, to maintain a minimum capital surplus in
       an amount which is the greater of $500,000 or 10% of total liabilities
       which at July 31, 1998 was approximately $547,000. The Company is in
       compliance with this requirement and had an unaudited statutory surplus
       of $906,000 at July 31, 1998. Effective September 30, 1998, the capital
       surplus requirement will increase to an amount which is the greater of
       $800,000 or 10% of total liabilities or 1% of annualized premium.
       Dividends are restricted to 10% of statutory surplus or the entire net
       operating profits and related net capital gains derived during the
       immediately preceding fiscal year unless prior approval is received from
       the Insurance Department of the State of Florida.

       Pursuant to the Florida Administrative Code, the Department may require
       an HMO to submit a corrective action plan in the event that net income
       before taxes over the past four quarterly reporting periods is less than
       2% of total revenue. SHP's reported, unaudited, quarterly net income has
       met the 2% criteria.

                                      F-15
<PAGE>
 
                   SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements



(8) Commitments, Contingencies and Other Matters, continued
    -------------------------------------------------------

    (c) Stock Option and Warrant Plans
        ------------------------------

        In February 1996, the Board of Directors of SunStar adopted and
        SunStar's sole shareholder at that time, NHHC, approved the 1996 Stock
        Option Plan (the Plan) pursuant to which 200,000 shares of common stock
        were reserved for issuance upon the exercise of options designated as
        either (i) options intended to constitute incentive stock options (ISOs)
        under the Internal Revenue Code of 1986, as amended, or (ii)
        nonqualified options. ISOs may be granted under the Plan to employees
        and officers of the Company. Nonqualified options may be granted to
        consultants, directors (whether or not they are employees), employees or
        officers of the Company.

        The Plan is intended to qualify under Rule 16b-3 under the Securities
        Exchange Act of 1934, as amended (the Exchange Act) and is administered
        by a committee of the Board of Directors; provided that the full Board
        of Directors currently is administering the Plan.

        The Board of Directors or the committee, as the case may be, within the
        limitations of the Plan, determines the persons to whom options will be
        granted, the number of shares to be covered by each option, whether the
        options granted are intended to be ISOs, the duration and rate of
        exercise of each option, the exercise price per share and the manner of
        exercise and the time, manner and form of payment upon exercise of an
        option. Unless terminated, the Plan will expire on February 13, 2006.

        ISOs granted under the Plan may not be granted at a price less than the
        fair market value of the common stock on the date of grant (or 110% of
        fair market value in the case of persons holding 10% or more of the
        voting stock of the Company). The aggregate fair market value of shares
        for which ISOs granted to any employee are exercisable for the first
        time by such employee during any calendar year (under all stock option
        plans of the Company) may not exceed $100,000 and options to purchase no
        more than 50,000 shares may be granted under the Plan to any single
        optionee in any calendar year. Nonqualified options granted under the
        Plan may not be granted at a price less than 90% of the fair market
        value of the common stock on the date of grant. Options granted under
        the Plan will expire not more than ten years from the date of grant
        (five years in the case of ISOs granted to persons holding 10% or more
        of the voting stock of the Company). All options granted under the Plan
        are not transferable during an optionee's lifetime but are transferable
        at death by will or by the laws of descent and distribution. In general,
        upon termination of employment of an optionee, all options granted to
        such person which are not exercisable on the date of such termination
        immediately terminate, and any options that are exercisable terminate 90
        days following termination of employment.

                                      F-16
<PAGE>
 
                   SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements



(8) Commitments, Contingencies and Other Matters, continued
    -------------------------------------------------------

   (c) Stock Option and Warrant Plans, continued
       -----------------------------------------

       The Plan contains anti-dilution provisions authorizing appropriate
       adjustments in certain circumstances. Shares of common stock subject to
       options which expire without being exercised or which are canceled as a
       result of cessation of employment are available for further grants. No
       shares of common stock may be issued to any optionee until the full
       exercise price has been paid. The Board of Directors or the committee, as
       the case may be, may grant individual options under the Plan with more
       stringent provisions than those specified in the Plan.

       The Plan provides that each nonemployee director automatically receives,
       upon first becoming a nonemployee director, a grant of options to
       purchase 7,500 shares of the Company's common stock at an exercise price
       equal to the fair market value of the Company's common stock on the date
       of grant. The Company granted an aggregate of 37,500 of such options to
       nonemployee directors on May 15, 1996 at $5.00 per share.

       During the year ended July 31, 1998, 7,500 of such options were canceled
       due to the resignation of a director. Each nonemployee director option
       will expire five years from the date of grant.

       The Company's granting of options with exercise prices below the market
       price of the stock on the grant date resulted in charges to operations of
       approximately $65,000 in the years ended July 31, 1997 and 1998,
       respectively. Unearned compensation at July 31, 1998 amounts to
       approximately $65,000 which is presented as a reduction of equity. Such
       unearned amounts will be accounted for as an expense during the periods
       in which the related services are performed.

       The fair value for options was estimated at the date of grant using a
       Black-Scholes option pricing model with the following weighted-average
       assumptions for the years ended July 31, 1997 and 1998: risk-free
       interest rate of 6.5%; dividend yield of 0%; volatility factor of the
       expected market price of the Company's common stock of .84 and .82,
       respectively; and a weighted-average expected life of the option of 5
       years.

                                      F-17
<PAGE>
 
                   SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements



(8) Commitments, Contingencies and Other Matters, continued
    -------------------------------------------------------

   (c) Stock Option and Warrant Plans, continued
       -----------------------------------------

       The Black-Scholes option valuation model was developed for use
       in estimating the fair value of traded options which have no vesting
       restrictions and are fully transferable.  In addition, option valuation
       models require the input of highly subjective assumptions including the
       expected stock price volatility.  Because the Company's stock options
       have characteristics significantly different from those of traded
       options, and because changes in the subjective input assumptions can
       materially affect the fair value estimate, in management's opinion, the
       existing models do not necessarily provide a reliable single measure of
       the fair value of its stock options.

       For purposes of pro forma disclosures, the estimated fair value
       of the options is amortized to expense over the options' vesting period.
       The Company's pro forma information for the years ended July 31, follows:
<TABLE>
<CAPTION>
 
                                                   1997          1998
                                                -----------   -----------
<S>                                             <C>           <C>
 
               Pro forma net loss               $(1,755,373)   (4,704,324)
 
               Pro forma loss per share         $      (.73)        (1.94)
 
</TABLE>

       The weighted average fair value of options granted during the years ended
       July 31, 1997 and 1998 with exercise prices equal to the market price of
       the stock on the date of grant was $2.82 and $2.42, respectively.

                                      F-18
<PAGE>
 
                   SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements



(8) Commitments, Contingencies and Other Matters, continued
    -------------------------------------------------------

   (c) Stock Option and Warrant Plans, continued
       -----------------------------------------

       A summary of the Company's stock option activity, and related
       information for the years ended July 31 follows:
<TABLE>
<CAPTION>
 
 
                                                      1997                      1998              
                                             -----------------------     -------------------      
                                                            Weighted                Weighted      
                                                            Average                 Average       
                                                            Exercise                Exercise      
                                             Options         Price       Options     Price        
                                             -------        --------     -------    --------      
<S>                                          <C>            <C>          <C>        <C>           
                                                                                                  
         Outstanding, beginning of year      437,500        $   1.47     492,500      1.60        
                                                                                                  
         Granted                             130,000            4.00      12,500      3.50        
                                                                                                  
         Exercised                                -                -     (50,000)      .25        
                                                                                                  
         Forfeited/canceled                  (75,000)           5.00     (37,500)     4.20        
                                             -------                     -------                  
                                                                                                  
         Outstanding, end of year            492,500            1.60     417,500      1.59        
                                             =======                     =======                  
                                                                                                  
         Exercisable at end of year          280,833            1.46     313,333      1.55        
                                             =======                     =======                   
 
</TABLE>

       Exercise prices for options outstanding as of July 31, 1998 ranged from
       $0.25 to $5.00. Options exercisable at $0.25 per share totaled 275,000 of
       which 212,500 were exercisable at July 31, 1998. Options with exercise
       prices ranging from $3.50 to $5.00 totaled 142,500 of which 100,833 were
       exercisable at July 31, 1998. The weighted average remaining contractual
       life of options exercisable at $0.25 and $3.50 to $5.00 per share was
       7.53 and 7.13 years, respectively, at July 31, 1998.

       In connection with the Offering, the Company has granted warrants to the
       underwriter to purchase an aggregate of 130,000 shares of common stock at
       an exercise price equal to $6.00 per share. The warrants are exercisable
       on or after April 15, 1997 and expire on May 15, 2001.

                                      F-19
<PAGE>
 
                   SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements



(8) Commitments, Contingencies and Other Matters, continued
    -------------------------------------------------------

   (c) Stock Option and Warrant Plans, continued
       -----------------------------------------

       In connection with the Private Placement, the Company has granted
       warrants to the placement agent to purchase an aggregate of 150,000
       shares of common stock at an exercise price equal to $4.00 per share. The
       warrants are exercisable on or after July 16, 1998 and expire four years
       from that date.

       Common stock reserved for future issuance at July 31, 1998 is as follows:
<TABLE>
<CAPTION>
 
 
                                                                          Number of
                                                                           Shares
                                                                          ---------
<S>                                                                       <C>
 
          Options granted under employment and consulting agreements        275,000
          Options granted under the Plan                                    142,500
          Reserved for future grants under the Plan                          57,500
          Warrants granted to underwriters                                  280,000
                                                                            -------
                                                                            755,000
                                                                            =======
</TABLE>

   (d) Professional Liability
       ----------------------

       The Company insures its professional liability risks on a claims-made 
       basis.  The Company has secured claims-made coverage from August 1,
       1997 through April 15, 1998, with retroactive coverage through July 1,
       1993 to insure for potential professional liability claims by patients
       and others as a result of the negligence of physicians that occurred
       prior to the divestment of the primary care medical centers.  The Company
       could become liable for the negligent acts of physicians, as well as
       negligence in recruiting and selecting physicians.  The Company currently
       maintains professional liability insurance with limits of $1,000,000 in
       the aggregate and $1,000,000 per occurrence and requires physicians to
       maintain malpractice liability insurance in amounts which it deems
       adequate for the type of medical services provided.  No accrual for
       possible losses attributable to incidents which may have occurred and not
       been identified under the Company's incident reporting system has been
       made because management has not identified any such incidents.

                                      F-20
<PAGE>
 
                   SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements



(8) Commitments, Contingencies and Other Matters, continued
    -------------------------------------------------------

   (d) Professional Liability, continued
       ---------------------------------

       The Company carries "stop-loss" reinsurance to reimburse it for
       costs resulting from catastrophic injuries or illnesses to its HMO
       members.  Premiums for these policies are reported as HMO medical costs
       and insurance recoveries, if any, are recorded as a reduction of HMO
       medical costs.  Under the excess loss reinsurance policies, recoveries
       are made for claims of each enrollee or each covered dependent of each
       enrollee, on an annual basis, in excess of the deductible established in
       the policy subject to certain limitations.  The deductible under the
       policy for commercial healthcare claims is currently $50,000.

   (e) Liquidity
       ---------

       The Company's consolidated financial statements for the year ended
       July 31, 1998 have been prepared on a going concern basis which
       contemplates the realization of assets and the settlement of liabilities
       and commitments in the normal course of business.  The Company incurred a
       net loss of $1,631,165 and $4,567,357 for the years ended July 31, 1997
       and 1998, respectively, and as of July 31, 1998 had an accumulated
       deficit of $6,221,707.  The Company expects to incur substantial
       expenditures to further its HMO development and to expand its current
       commercial service area and enter into the Medicare market.  The
       Company's working capital at July 31, 1998 will not be sufficient to fund
       ongoing business operations.  Management recognizes that the Company must
       generate additional resources to enable it to continue operations.
       Management's plans include consideration of the sale of additional equity
       securities under appropriate market conditions, alliances or other
       partnership agreements with entities interested in and resources to
       support the Company's expansion plans, or other business transactions
       which would generate sufficient resources to assure continuation of the
       Company's operations.

       The Company has retained investment banking advisors and independent
       consultants to counsel it on the possible sale of equity securities as
       well as to introduce and assist in the evaluation of potential merger and
       partnering opportunities.  However, no assurance can be given that the
       Company will be successful in raising additional capital or entering into
       a business alliance.  Further, there can be no assurance, assuming the
       Company successfully raises additional funds or enters into a business
       alliance, that the Company will achieve profitability.  If the Company is
       unable to obtain adequate additional financing or enter into such
       business alliance it will not be able to meet ongoing business operation
       needs.  The consolidated financial statements do not include any
       adjustments that may result from the possible inability of the Company to
       continue as a going concern.

                                      F-21
<PAGE>
 
                                   SIGNATURES
                                        
     In accordance with Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.


                                     SUNSTAR HEALTHCARE, INC.


                                     By:  /s/ Jack W. Shields
                                        -----------------------
                                        Jack W. Shields
                                        Vice President and 
                                        Chief Financial Officer

Dated:  November 13, 1998


     In accordance with 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 indicated:

<TABLE>
<CAPTION>

SIGNATURES                                           TITLE
----------                                           -----
<S>                                                  <C>
 
/s/  Warren D. Stowell                               
--------------------------------------------------   President, Chief Executive Officer, and Chairman           
Warren D. Stowell                                    (Principal Executive Officer)                              
                                                                                                                
/s/  David A. Jesse                                                                                             
--------------------------------------------------   Executive Vice President, Chief Operating Officer, Director
David A. Jesse                                                                                                  
                                                                                                                
/s/  Jack W. Shields                                                                                            
--------------------------------------------------   Vice President, Chief Financial Officer                    
Jack W. Shields                                      (Principal Financial and Accounting Officer)               
                                                                                                                
/s/  Frederick H. Failkow                                                                                       
--------------------------------------------------   Director                                                   
Frederick H. Failkow                                                                                            
                                                                                                                
/s/  Steven Failkow                                                                                             
--------------------------------------------------   Director                                                   
Steven Failkow                                                                                                  
                                                                                                                
/s/  Bernard Levine, M.D.                                                                                       
--------------------------------------------------   Director                                                   
Bernard Levine, M.D.                                                                                            
                                                                                                                
/s/  Richard Seidelman, M.D.                                                                                    
--------------------------------------------------   Director                                                   
Richard Seidelman, M.D.                                                                                         
                                                                                                                
/s/  Howard Silverman                                                                                           
--------------------------------------------------   Director                                                    
Howard Silverman
 
</TABLE>
<PAGE>
 
     Exhibits required to be filed by Item 601 of Regulation SB are included in
Exhibits to this Report as follows:

<TABLE>
<CAPTION>

EXHIBIT  EXHIBIT DESCRIPTION
-------  -------------------
<C>      <S>
   2.1   Asset Purchase Agreement, dated April 15, 1998, between Brevard Medical Care, Inc. and SunStar
         Healthcare, Inc.****

   3.1   Certificate of Incorporation*

   3.2   By-Laws*

   4.1   Specimen Certificate of the Company's Common Stock**

   4.2   Form of Warrant Agreement (including Form of Underwriter's Common Stock Purchase Warrant)*

   4.3   1996 Stock Option Plan*

   4.4   Form of 1996 Stock Option Contract**

  10.3   Agreement for Third Party Administrator Services, dated March 7, 1997, between Healthplan Services,
         Inc. and SunStar Health Plan, Inc.***

  10.4   Lease, dated November 26, 1997 between the Company and Pizzuti*****

  10.4   Agreement for Health Care Prepayment Plan, dated September 30, 1992, between the Health Care
         Financing Administration and Boro Medical Corporation*

  10.5   Certificate from State of Florida, Agency for Health Care Administration certifying Boro Medical
         Corporation a Healthcare Provider*

   11.   Statement of Per Share Earnings (included in Consolidated Financial Statements attached to this
         report)

  16.1   Letter on Change in Certifying Accountant*****

  21.1   List of Subsidiaries*****

  23.1   Consent of KPMG Peat Marwick LLP*****

   27.   Financial Data Schedule *****

____________________

    *    Filed as same exhibit reference to Form SB-2 Registration Statement, filed on February 26, 1996, File
             No. 333-1650

   **    Filed as same exhibit reference to Amendment No. 2 to Form SB-2 Registration Statement, filed on May
             9, 1996, File No. 333-1650.

  ***    Filed as Exhibit 10.12 to Form 10-KSB for the fiscal year ended July 31, 1997.

 ****    Filed as same exhibit reference to Form 10-QSB, for the quarterly period ended April 30, 1998.

*****    Filed herewith.
</TABLE>

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