UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                              --------------------

                                   FORM 10-K/A
      (Mark One)

            [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]

                     For the fiscal year ended June 30, 1996

            [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

             For the transition period from __________ to __________

                             Commission File Number
                                     0-19726

                     MEADOWBROOK REHABILITATION GROUP, INC.
             (Exact name of registrant as specified in its charter)

         DELAWARE                                   94-3022377    
         (State or other jurisdiction of           (I.R.S. Employer 
          incorporation or organization             Identification No.)

           2200 Powell Street, Suite 800, Emeryville, California 94608
               (Address of principal executive offices) (Zip Code)

       Registrant's telephone number, including area code: (510) 420-0900
                              ---------------------
           Securities registered pursuant to Section 12(b)of the Act:
                                      None

           Securities registered pursuant to Section 12(g) of the Act:
                 Class A Common Stock, par value $0.01 per share
                                (Title of Class)

         Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the  Securities  Exchange  Act of
1934  during  the  preceding  12 months  (or for such  shorter  period  that the
Registrant was required to file such reports),  and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No _____.

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

         As  of  September  26,  1996,   the  aggregate   market  value  of  the
Registrant's voting stock held by nonaffiliates of the Registrant,  based on the
closing  price for the  Registrant's  Class A Common  Stock in The NASDAQ  Stock
Market  on such  date,  was  $2,544,712.  This  calculation  does not  reflect a
determination  that certain  persons are  affiliates of the  Registrant  for any
other purposes.

         The number of shares of Class A Common Stock  outstanding  on September
26, 1996 was 1,157,244. The number of shares of Class B Common Stock outstanding
on September 26, 1996, was 773,000.

         Part III of this Form 10-K  incorporates by reference  information from
the  Registrant's  proxy  statement  with respect to the 1996 Annual  Meeting of
Stockholders.

<PAGE>

                                TABLE OF CONTENTS
                                                                            Page

PART I.           ..........................................................   3

         ITEM 1.    BUSINESS................................................   3

         ITEM 2.    PROPERTIES..............................................  12

         ITEM 3.    LEGAL PROCEEDINGS.......................................  14

         ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY
                    HOLDERS.................................................  14

PART II.          ..........................................................  15

         ITEM 5     MARKET FOR REGISTRANT'S COMMON EQUITY AND
                    RELATED STOCKHOLDER MATTERS.............................  15

         ITEM 6.    SELECTED FINANCIAL DATA.................................  16

         ITEM 7.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                    FINANCIAL CONDITION AND RESULTS OF OPERATIONS...........  17

         ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.............  26

         ITEM 9.    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
                    ACCOUNTING AND FINANCIAL DISCLOSURE.....................  26

PART III.          .........................................................  27

         ITEM 10    DIRECTORS AND EXECUTIVE OFFICERS OF THE
                    REGISTRANT..............................................  27

         ITEM 11.   EXECUTIVE COMPENSATION..................................  27

         ITEM 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
                    AND MANAGEMENT..........................................  27

         ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED
                    TRANSACTIONS............................................  27

PART IV.           .........................................................  28

         ITEM 14.   EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND
                    REPORTS ON FORM 8-K.....................................  28

SIGNATURES                 .................................................  31



<PAGE>


                                     PART I

ITEM 1 BUSINESS

     Meadowbrook Rehabilitation Group, Inc. (together with its subsidiaries, the
"Company" or "Meadowbrook"),  has expanded its business lines in recent years in
an effort to diversify  and expand its range of  rehabilitation  services.  This
expansion has primarily  been in outpatient  rehabilitation  services  including
most  recently,  the  Company's  fiscal 1996  acquisitions  of three  outpatient
rehabilitation  clinics in Colorado and one outpatient  rehabilitation clinic in
Florida. In addition, in 1996 the Company acquired a therapy staffing company in
Colorado. These acquisitions complement the Company's 1995 acquisition of eleven
outpatient  rehabilitation clinics in Colorado, three outpatient  rehabilitation
clinics in Alaska and home health  agencies  with  operations  in Colorado,  New
Mexico  and  Kansas,  as well  as the  fiscal  1994  acquisition  of  outpatient
rehabilitation   clinics   in   Florida.   All  of  the   Company's   outpatient
rehabilitation   clinics   specialize   in  sports,   industrial   and   general
rehabilitation.

     The Company's recent focus on development of its outpatient  rehabilitation
business  reflects  its view that the  outpatient  rehabilitation  business  has
stronger  prospects for long-term growth than the Company's  traditional  acute,
subacute  and  post-acute  business.  Over the past few years,  the  Company has
closed several  facilities in its traditional  line of business and is currently
considering  divestiture  of  additional  such  facilities.   In  addition,  the
Company's  Board of  Directors  is in the process of  evaluating  the  Company's
overall   strategic   direction  and   alternatives.   The  alternatives   under
consideration  by the  Board  include,  among  other  things,  a merger or other
business  combination  transaction or sales of assets. There can be no assurance
that any such alternatives will be available on favorable terms, if at all.

     The Company  segregates its business into two product lines: (i) outpatient
rehabilitation  and  home  health  services;  and (ii)  its  traditional  acute,
subacute and post-acute  comprehensive  rehabilitation  services.  The Company's
outpatient  rehabilitation  business  comprised 40% of the Company's fiscal 1996
net  operating  revenues  while the  traditional  business  represented  60%.  A
description of each of the Company's business lines is provided below.

     See Item 7.,  Management's  Discussion and Analysis of Financial  Condition
and Results of Operations,  for further discussion of certain trends, events and
risks affecting the Company's business.

Industry Background

     Medical  rehabilitation is the process of restoring individuals disabled by
disease  or injury to their  optimal  level of  physical,  cognitive  and social
functioning.  Rehabilitation  services  can be  segmented  into  four  types  of
programs: acute, subacute,  post-acute and outpatient. Acute rehabilitation care
is usually provided in  rehabilitation  units of  medical/surgical  hospitals or
acute  rehabilitation  hospitals.  In general,  patients in acute rehabilitation
programs  are persons  who require at least three hours of therapy  each day and
continue to show progress as a result of this therapy.  Subacute  rehabilitation
care is generally  provided in  dedicated  units of skilled  nursing  facilities
("SNFs") or  medical/surgical  hospitals  to patients who may not meet the acute
industry  standard or whose  course of recovery  is slower.  In many cases,  the
therapy and nursing  care  provided in the  subacute  setting are  substantially
equivalent to that provided in an acute care setting.  Patients who  demonstrate
moderate  independence  in  activities  of  daily  living  may be  treated  in a
post-acute  program,  such  as a  transitional  living  center  ("TLC")  or  day
treatment clinic.  Outpatient  rehabilitation  services include nursing care and
physical,  occupational and speech/language therapy and social services provided
in a clinic environment or in the patient's home.

<PAGE>

 Outpatient  Rehabilitation and Home Health Services

     General. At June 30, 1996, the Company owned or had management contracts to
operate eight outpatient rehabilitation clinics in Jacksonville,  St. Augustine,
Palm Coast and Palatka, Florida and in Moultrie, Georgia. During fiscal 1996 the
Company  acquired an  outpatient  clinic in Ormond Beach,  Florida.  The Company
opened two outpatient rehabilitation clinics in Daytona Beach and St. Augustine,
Florida. On June 30, 1995, the Company acquired eleven outpatient rehabilitation
clinics in Colorado, three outpatient  rehabilitation clinics in Alaska and home
health agencies with operations in Colorado,  New Mexico and Kansas. The Company
also acquired the assets of two outpatient  rehabilitation clinics in Pueblo and
Colorado  City,   Colorado  and  a  therapy   staffing  company  and  outpatient
rehabilitation clinic in Colorado Springs, Colorado.

     The  Company  entered  the  outpatient   rehabilitation   and  home  health
businesses  based  on its  experience  in the  acute,  subacute  and  post-acute
industry  where it  experienced  a growing  trend  toward  early  discharges  of
patients  from acute and subacute  facilities.  Many of these  patients have not
received the  intensity of services  that may be necessary for them to achieve a
full  recovery  from their  diseases,  disorders,  injuries  or other  traumatic
conditions.  As a result,  the Company  believes that there is a continuing need
for outpatient rehabilitation services.

     The Company believes the outpatient  rehabilitation market will continue to
grow primarily as the result of (i) the recognition of the cost-effectiveness of
rehabilitation;   (ii)  the  increased   acceptance  of  rehabilitation  by  the
healthcare  industry;  (iii)  increasing  emphasis on  physical  fitness and the
treatment and prevention of sports  injuries;  (iv) the aging of the population;
and (v) earlier  discharge  from acute care  hospitals to alternate  sites.  The
Company also  believes the  outpatient  rehabilitation  market will  continue to
consolidate  due  to  the  highly  fragmented  nature  of  the  market,  growing
legislative  and payor pressure to prohibit or limit  referrals by physicians to
entities in which they have a financial interest,  and the preference of managed
care  organizations  and other third party  payors to  contract  with  providers
offering comprehensive,  cost-effective  outpatient rehabilitation programs on a
regional or national basis.

     The Company  believes  that there are  opportunities  for  expansion of its
outpatient  rehabilitation and home health businesses through internal growth in
areas surrounding its current outpatient rehabilitation clinics.

     The  Company's  outpatient  operations  generally  experience a decrease in
revenues in some markets in the summer and holiday  periods.  In  addition,  the
Company's  outpatient  business  line has grown and  expects to continue to grow
through  a  limited  number  of  acquisitions,   as  well  as  through  internal
development.   These  seasonal  trends,  as  well  as  the  timing,  number  and
integration  of the  Company's  acquisitions,  may cause  financial  results  of
operations to vary on a quarterly basis.

     Outpatient  Rehabilitation  Services. The goals of the Company's outpatient
rehabilitation  services are to improve a patient's  physical strength and range
of motion,  reduce  pain,  help  prevent  re-injury  and  restore the ability to
perform basic activities. The primary services provided collectively are:

     Therapy  Modalities and  Therapeutic  Exercises.  Each patient  receives an
initial  evaluation  by a licensed  therapist and based on that  evaluation,  an
individualized rehabilitation program is developed for the patient. Patients may
be  treated in the  Company's  outpatient  rehabilitation  clinics or in nursing
homes  where the  Company  has  contracts  to provide  such  services.  At these
locations,  the  Company  provides a full range of therapy  services,  including
physical  therapy,  occupational  therapy,  speech/language  therapy  and social
<PAGE>
services.  Patients  undergo  varying  courses of therapy  dependent  upon their
needs.  Some patients may only require a few hours of therapy per week for a few
weeks, while others may remain in therapy up to six months or more, depending on
the nature, severity and complexity of their injuries.

     Functional  Capacity  Assessment.  The  Company  also  provides  functional
capacity  assessments  to evaluate the  physical  condition  and  endurance of a
current or prospective  employee to meet the  requirements  of  employment.  The
assessment  may be used by employers,  insurers and other payors to estimate the
extent  of  rehabilitation  treatment  needed  or  as  an  objective  method  of
evaluating specific work capacity.

     Preventative  Services.  The Company  also  provides  services  designed to
prevent or avoid injuries in the work place. These preventative services,  which
may be performed at an employer's work site, include programs to teach employees
proper  body  mechanics,  techniques  and  detailed  analysis  of  specific  job
activities, such as lifting, with the goal of changing how a job is performed to
prevent injuries to employees.

     Home Health  Services.  The  Company's  home health  agencies in  Colorado,
Kansas  and New  Mexico  provide  nursing  care and  rehabilitative  therapy  to
patients in their homes. This care includes medication supervision,  cardiac and
respiratory  monitoring,  oxygen therapy, skin care,  injections,  colostomy and
catheter care,  diet  instruction,  as well as instruction in home management of
health problems. The home health agencies work in conjunction with the Company's
recently   acquired  therapy  staffing  company  to  provide  physical  therapy,
occupational  therapy,  speech/language  therapy  and  social  services  in  the
patient's home. Home health care reduces the length and cost of  hospitalization
by making earlier discharge possible and in certain cases prevents admissions to
nursing homes or other institutions.  In addition,  home health care enables the
patient's  family to  participate  in the care and allows the  patient to return
more quickly to the familiar surroundings of the home.

Acute, Subacute and Post-Acute Rehabilitation Services

     The Company's  traditional business provides  comprehensive  rehabilitation
services to patients  with a wide range of  diagnoses,  including  patients with
neurologic diagnoses resulting from head injury and patients with non-neurologic
diagnoses,  including  orthopedic,  cardiac and pulmonary care, skin/wound care,
post-surgical stabilization and intravenous therapy.

     At June 30, 1996,  Meadowbrook operated seven such rehabilitation  programs
in three  metropolitan  areas in Kansas,  Georgia,  and  Illinois.  The  Company
operates one acute,  one  neurobehavioral,  two  subacute  and three  post-acute
programs.  The  Company's  acute  program  is  located  at its  Gardner,  Kansas
facility. The Company's  neurobehavioral program is located in Atlanta, Georgia,
in leased space within a 294 bed acute care  hospital.  The  Company's  subacute
rehabilitation  programs  are  located  in  dedicated  hospital-based  units  in
Gardner, Kansas and Lithia Springs, Georgia. Its post-acute programs are offered
in community settings providing  residential,  day and outpatient services.  The
post-acute programs are located in Decatur,  Georgia,  Gardner,  Kansas and Park
Ridge, Illinois.

     In its Kansas and Georgia facilities, the Company integrates treatments for
different  stages of the  rehabilitation  process  within the same  facility  or
metropolitan  area to provide a  continuum  of care as  patients  progress.  The
rehabilitation  treatment  plan for each patient is  developed  and managed by a
team of professionals, including physiatrists,  psychologists,  occupational and
physical    therapists,    speech/language    pathologists,    social   workers,
rehabilitation  nurses  and  case  managers.  The  Company's  professionals  are
specially  trained to treat  neurologic  and related  diagnoses as well as other
medical and  rehabilitation  diagnoses and are thus able to provide high quality
rehabilitation services to their patient population.

<PAGE>

     Operating  Strategy.  The  Company's  objective is to provide high quality,
comprehensive  rehabilitation  services  to patients  who can  benefit  from and
afford  such  care.  The  Company's  goal  is to  provide  these  services  on a
cost-effective  basis.  The  Company's  operating  strategy  in its  traditional
business is based on the following:

     Patient  Profile and  Pre-admission  Screening.  The Company  continues  to
derive a large amount of its volume in its traditional  rehabilitation  business
from patients with neurologic  diagnoses,  particularly  those who have suffered
traumatic  brain injury.  In general,  these  patients are younger and otherwise
healthier  with  longer  life  expectancies  than  others  in need of  intensive
rehabilitation  services.  Because of the extended survival period,  the Company
works with both the patient's  family and payor to plan a treatment  program for
the patient which is designed to restore the patient to his or her optimal level
of functioning.

     During the past four fiscal  years,  the Company has  expanded the range of
subacute  medical services  provided in its facilities.  While these patients do
not require an acute medical  setting,  they do require more  treatment  than is
available in a traditional nursing home,  outpatient or home health program. The
Company  is  providing  subacute  medical  care to  patients  with a variety  of
diagnoses,  including  orthopedic,  cardiac and pulmonary care, skin/wound care,
post-surgical stabilization and intravenous therapy.

     For  each  type of  patient,  the  planning  process  begins  prior  to the
patient's  admission.  The clinical  staff at the facility  reviews the clinical
appropriateness  of each potential  patient and assists the Company's  corporate
office in evaluating financial appropriateness.

     Specialized Team Approach.  The Company's  professionals are highly trained
in the  rehabilitation of patients with either neurologic  diagnoses or subacute
medical  needs.  By  specializing  in the treatment of these  patients,  Company
professionals  are able to recognize  and respond to their  complex  needs.  The
Company  forms  interdisciplinary  teams  comprised  of  medical  professionals,
including  attending  physicians,   physiatrists,   rehabilitation  nurses,  and
professionals  in  the  disciplines  of  physical  and   occupational   therapy,
speech/language  pathology and  psychology.  The Company  believes that its team
approach allows  continual  communication  between the various  professionals to
maximize patients' treatments,  in contrast to medical/surgical  hospitals where
the various therapy  departments often operate  independently.  Not all patients
require  the  services  of  the  entire   interdisciplinary  team,  the  Company
incorporates   the  services  of  individual  team  members  as  clinically  and
financially appropriate.

     Continuum of Service.  The Company makes  available a continuum of services
to patients in its traditional  rehabilitation business beginning with discharge
from a medical/surgical or acute  rehabilitation  hospital through the patient's
re-entry  into the  community.  This  approach  allows the  Company to match the
patient's  needs as  recovery  progresses  with the  most  effective  use of the
payor's funds. At the Company's  Georgia and Kansas facilities this continuum of
services is provided  entirely by the  Company.  In other  markets,  the Company
makes or receives referrals to or from other healthcare providers to ensure that
this continuum is provided.

     Case Management. The Company's case management system is a key component of
its traditional businesses operating strategy. The goal of case management is to
maximize the patient's  progress by providing  services  appropriate to both the
patient's  special needs and financial  resources.  Case management offers daily
monitoring of the patient's  individualized  treatment  plan. In addition,  case
management  provides  flexibility  to  tailor  services  to  individual  benefit
packages and promotes ongoing communication so that services,  costs and lengths
of stay are understood and  anticipated  by the payor.  This process  encourages
moving  patients to more  appropriate,  less expensive  programs as the patients
progress.

<PAGE>

     Each of the  Company's  inpatient  facilities  has staff case  managers  to
oversee a limited  number of patients.  Case managers  continuously  monitor the
types of services delivered to the patients,  as well as the patients' progress.
The case manager  also works with the payor to establish a common  understanding
of the  progress  that  might be  achieved,  the  anticipated  length of time to
achieve the desired  outcome and the estimated cost of providing such treatment.
This information is communicated routinely to the payor through written reports,
frequent telephone contact and regularly scheduled case management  conferences.
The case manager and the payor work together to determine  the most  appropriate
level of care for the patient, thus avoiding  inappropriate services which could
otherwise  arise  if the  medical  or  rehabilitation  process  is  not  managed
properly.

Psychiatric Partial Hospitalization Program

     During  fiscal 1995 the Company  internally  developed,  through its wholly
owned subsidiary,  Medbrook of Indiana,  a psychiatric  partial  hospitalization
program which provided  psychiatric  services in long term care  facilities.  In
June 1995, the Company decided to close the psychiatric partial  hospitalization
program. The program was closed on September 22, 1995. The Company's decision to
close the psychiatric partial hospitalization program stems from difficulties in
growing the business and potential Medicare reimbursement issues. As of June 30,
1995, the Company  recorded a  restructuring  charge of $310,000  related to the
closure of the program.  At June 30, 1996, the remaining  liability for expected
future costs related to the closure was $104,000.

Marketing

     The  Company's  overall  marketing  strategy  is to develop a broad base of
referral sources for all of its services on national, regional and local levels.
In  marketing  its  services,  the  Company  focuses on the high  quality of its
services and its geographic  presence.  The Company also  emphasizes its outcome
oriented approach to rehabilitation,  the goal of which is to return the patient
to the community.

     On a national  level,  the Company  targets  major payors such as insurance
companies,   large  preferred   provider   organizations   ("PPOs")  and  health
maintenance  organizations  ("HMOs") for referrals  and managed care  contracts.
Insurance  case  managers who have had  successful  experience  with the Company
constitute a major  referral  source and often control the placement of patients
as well as reimbursement  for services.  The Company has secured  contracts with
numerous insurance companies, and continues to pursue contractual  relationships
with payors at the national, regional and local level.

     On a regional  and local  level,  the Company  targets  hospital  discharge
planners,  regional  HMOs,  PPOs and other managed care providers and physicians
for referrals. Families are also a source of referrals, often due to information
provided by family support organizations or past experience with the Company.

<PAGE>

Sources of Revenues and Reimbursement

     The  following  table sets forth the dollar  volume and  percentage  of the
Company's net operating revenues derived from each product line.

                                                             Year Ended
                                                            June 30, 1996
                                                      -----------------------
                                                        (000's)          %
 Acute, Subacute and Post-Acute Rehabilitation
          Services                                      $14,243        60%
 Outpatient Rehabilitation and Home Health Services       9,380        40%
                                                       ---------     -----
 Net Operating Revenues ............................   $ 23,623       100%
                                                       =========     =====

     The  following  table  sets  forth  the  percentage  of the  Company's  net
operating  revenues from private  payors,  Medicare and Medicaid for the periods
indicated:

         Source                                Year Ended June 30,
         ------                        ---------     --------     ------
                                         1994         1995         1996
                                       ---------     --------     ------

       Private payors ............        81%          67%          59%
       Medicare ..................         6%          16%          34%
       Medicaid...................        13%          17%           7%
                                       ---------     --------     ------
       Total .....................       100%         100%         100%
                                       ---------     --------     ------

     Private  payors  include  indemnity  insurance  carriers,   HMOs,  workers'
compensation  programs and self paying patients.  The Company's charges for such
patients are established by the Company,  although in the Company's  traditional
business  it  negotiates  fixed-rate  contractual   arrangements  with  numerous
individual  patients and third party payors,  including  insurance companies and
managed  care  providers.  The  Company's  Georgia  and Kansas  facilities  have
negotiated  fixed-rates based on charges for its Medicaid patients who come from
a number  of  in-state  and  out-of-state  Medicaid  programs  under  short-term
contracts. The increase in the percentage of net operating revenue received from
Medicare  during fiscal 1995 and 1996 reflects the increased  number of subacute
and acute Medicare patients at the Company's Gardner,  Kansas facility,  as well
as effects of the Company's June 30, 1995 Colorado acquisition.

     The Company provides inpatient and outpatient services to Medicare patients
at  several  of its  facilities.  The  Medicare  program  generally  utilizes  a
cost-based   reimbursement  system  for  rehabilitation   services  under  which
certified SNFs, rehabilitation agencies, and certified outpatient rehabilitation
facilities  ("CORFs")  are  reimbursed  for the  reasonable  direct and indirect
allowable  costs  incurred in providing  routine care,  plus a return on equity,
subject to certain cost ceilings.  These costs normally  include  allowances for
administrative  and  general  costs  and the  cost  of  property  and  equipment
(depreciation  and  interest or rent  expense).  The Company  files  annual cost
reports for each cost-reimbursed facility. These cost reports serve as the basis
for determining  the prior year's cost  settlements and interim per diem payment
rates for the next year.

     An exception from such cost ceilings has been sought and granted for fiscal
years  1990  through  1994  for  its  former  subacute  facility  in  San  Jose,
California. The Company has applied for an exception from such cost ceilings for
fiscal years 1992 through 1995 for its  Gardner,  Kansas  facility.  The Company
intends to file such  requests for its Kansas  facility  for fiscal 1996.  These
exceptions  are based on atypical  costs  incurred in providing  more  intensive
services  to  its  patients  than  those  typically   rendered  in  a  SNF.  See
"Regulation" and  "Management's  Discussion and Analysis of Financial  Condition
and Results of Operations - Liquidity and Capital Resources".

<PAGE>

     Cost-based  reimbursement is generally  subject to retrospective  audit and
adjustment.  In conducting annual reviews of a facility's  reimbursement  rates,
Medicare may determine that payments previously made to a facility on an interim
basis were in excess of allowable costs and may recover any such overpayments by
reducing future payments to the affected  facility or other facilities  operated
by the same owner. Management believes that it has properly applied the Medicare
payment formula and that any future adjustments  arising from such retrospective
audits should have no material adverse effect on the Company.

Competition

     The healthcare  industry generally,  and the outpatient  rehabilitation and
subacute  medical  services  sectors in particular,  are highly  competitive and
subject to continual changes in the manner in which services are provided and in
which providers are selected.  Depending upon the geographic market, the Company
may compete with national, regional or local providers.

     In the  Company's  traditional  business,  it may compete with  specialized
rehabilitation   service   companies,    medical/surgical    hospitals,    acute
rehabilitation hospitals which provide subacute care and other SNFs. The Company
competes  with  regional and national  outpatient  rehabilitation  providers for
Medicare,  Medicaid and private payor  patients.  The Company also competes with
these entities in the recruitment of rehabilitation nurses, therapists and other
skilled  professionals.  In each of the  Company's  business  lines  many of the
Company's  competitors have greater  financial and personnel  resources than the
Company.

     The primary  competitive factors in the rehabilitation and subacute medical
industries  remain quality of care,  responsiveness to the patients' and payors'
needs, durable outcomes and cost-effectiveness.

     The  Company's  business  has been  effected by the  healthcare  industry's
emphasis  on  cost   containment  and  managed  care,   coupled  with  increased
competition  for national  contracts.  During the past several years the Company
was adversely effected by the competitive pressure to reduce healthcare costs in
its  traditional  business.  An  increase  in the number of  providers  offering
similar  services  resulted in a shift of patients to other  providers,  shorter
lengths of stay and lower per diem rates,  contributing  to the  decrease in the
Company's revenues in its traditional business.

Regulation

     The healthcare industry is subject to substantial federal,  state and local
government  regulation.  These  regulations  effect  the  Company  primarily  by
requiring   licensing  or   certification  of  its  facilities  and  controlling
reimbursement for services.

     Licensing is  regulated  by the states,  while  Medicare  certification  is
federally administered.  Generally,  licensing and Medicare certification follow
specific standards and requirements. Compliance is monitored by periodic on-site
inspections by representatives of applicable government agencies.

     The Company  believes that all the  facilities  operated by the Company are
duly licensed in accordance with the  requirements  of federal,  state and local
agencies  having  jurisdiction  over its  operations.  However,  there can be no
assurance that changes in present laws or  interpretations of current laws would
not have a material adverse effect on the Company.  The Company's  facilities in
Kansas,  Georgia and Illinois are accredited by the Commission on  Accreditation
of Rehabilitation Facilities.

     Some states have enacted  regulations  controlling the growth of healthcare
facilities or the operation of new facilities under a health planning  statutory
scheme  referred to as a Certificate of Need ("CON")  program.  Whether a CON is
granted depends upon a finding of need by the state health planning agency and a
determination  that the  applicant is the  appropriate  provider for the type of
services. Georgia has enacted a statute requiring a CON for facilities providing
transitional  living center  rehabilitative  services to traumatic brain injured
patients.  Prior to this  legislation,  there  was no state  regulation  of such
facilities in Georgia. The Company has received its CON certification to operate
its existing TLC program as a Traumatic  Brain Injury Facility under the Georgia
statute.  Expansion in Georgia and other  states could be adversely  effected by
state CON requirements.

     Certain state laws prohibit general business  corporations  from practicing
or holding  themselves out as a practitioner  of medicine.  The Company  neither
employs  physicians  to  practice  medicine  nor holds  itself  out as a medical
practitioner.  Generally,  the corporate  practice of medicine  doctrine has not
been  construed  by the  courts  to apply to the  type of  health  professionals
employed by the Company.  The Company  believes it is in  compliance  with state
laws prohibiting the corporate  practice of medicine.  However,  there can be no
assurance that changes in interpretations of the laws would not adversely effect
the Company's  operations.  In any event,  the Company  believes that it will be
able to adjust its operations to bring the Company in compliance with the law if
so required.

     Fifty-five beds in the Company's  inpatient facility in Kansas are Medicare
certified as acute  rehabilitation  beds. The Company's  outpatient  facility in
Moultrie,  Georgia and all of the Company's Colorado  outpatient  rehabilitation
clinics are  certified by Medicare as  rehabilitation  agencies.  The  Company's
post-acute facilities in Georgia and Illinois are CORF certified. As part of its
June 30, 1995  acquisition,  the Company  acquired  home  health  agencies  with
several sites which are all certified to participate in Medicare as providers of
home health  services.  In order to receive Medicare  reimbursement,  all of the
Company's certified facilities must meet the applicable  conditions  promulgated
by the  United  States  Department  of Health  and Human  Services  relating  to
standards of patient care, type of facility,  equipment and personnel,  and must
comply with all state and local laws,  rules and  regulations.  These facilities
undergo routine Medicare  certification surveys. To date, the Company's Medicare
certified  facilities  have  been  found  to  be  in  compliance  with  Medicare
requirements.  The Company files annual cost reports for its Medicare  certified
facilities to determine  cost  settlements  for the most recent fiscal year, and
interim payment rates for the following year.

     The Company's amount due from Medicare  intermediaries  of $332,000 at June
30, 1996,  includes  amounts the Company  anticipates  to receive on cost report
settlements  for its Colorado  home health  agencies  acquired on June 30, 1995.
Such amount also includes amounts the Company expects to receive upon regulatory
approval of the Company's  annual  application for an exception from the routine
cost limitation ("RCL") under the Medicare program for fiscal years 1992 through
1996 for its Gardner, Kansas facility. Medicare reimbursement is generally based
upon  reasonable  direct and  indirect  allowable  costs  incurred in  providing
services.  At the Company's inpatient  facilities these costs are subject to the
RCL. An exception from the RCL has been sought and granted for fiscal years 1990
through 1994 for the Company's former San Jose,  California  facility.  Requests
have been  submitted for fiscal years 1992 through 1995 for the Gardner,  Kansas
facility.  The Company  intends to file such request for its Kansas facility for
fiscal 1996. The requests are based upon atypical costs incurred at the Gardner,
Kansas  facility,  in the treatment of patients who receive  substantially  more
intensive  services  than  those  generally  received  in SNFs.  There can be no
assurance  that the Company will collect in full the amounts it has requested or
intends to request,  nor can there be an  assurance as to the timing of any such
collection. An initial three year "exemption" from the RCL expired in June 1989,
at the San Jose,  California  facility and in June 1990, at the Gardner,  Kansas
facility. 

Insurance

     The Company maintains professional  malpractice liability coverage for each
of its facilities in addition to a claims made policy for its  professional  and
general liability coverage.  The policy covers only claims that are filed within
the policy  period.  The Company  intends to  continue to carry such  insurance,
although  there can be no assurance  that coverage will continue to be available
in adequate amounts or at a reasonable cost.

Employees

     At June 30, 1995 and 1996, the Company had the following employees:

                                                       June 30,
                                                  1995        1996
                                                 -----       -----
                 Full-Time Employees               375         412
                 Part-Time Employees                86          73
                 On-Call Per Diem Employees         94         128
                                                 ======      ======
                 Total Employees                   555         613
                                                 ======      ======

     Of the  full-time  employees at June 30, 1995 and 1996,  16 and 15 persons,
respectively,  were  employed  at  the  Company's  headquarters  in  Emeryville,
California.  None of the Company's  employees are  represented by a labor union,
and  the  Company  is not  aware  of any  current  activities  to  unionize  its
employees.  Management  considers the  relationship  between the Company and its
employees to be positive. The 42 employees at the Florida outpatient clinics are
employed  under a staff leasing  arrangement.  The employees are under  contract
with a staff  leasing  agency which  provides  payroll  processing  services and
comprehensive health and workers' compensation  benefits.  All other liabilities
related  to the  employees  are  assumed by the  Company.  These  employees  are
included in the table above.

     The closure of the Company's psychiatric partial hospitalization program in
September 1995,  resulted in a total reduction of 16 employees.  These employees
are  included in the June 30, 1995  balances  provided  above.  Severance  costs
associated  with these  reductions  were expensed by the Company in fiscal 1995.
See "Management's  Discussion and Analysis of Financial Condition and Results of
Operations".

     Although  the Company has a sufficient  pool of skilled  employees to staff
its facilities at current  levels,  there is no assurance that in the event that
the  Company  grows  it  would  be able to  meet  its  needs  for  such  medical
professionals due to a general shortage of qualified therapists.

<PAGE>

ITEM  2. PROPERTIES

Operating Facilities

Outpatient Rehabilitation Clinics and Home Health Agencies

     As of June 30, 1996, the Company operated eight  outpatient  clinics in the
greater Jacksonville,  Florida area. Four of these clinics were acquired as part
of the Company's fiscal 1994 Florida  outpatient  clinic  acquisition  effective
April  30,  1994.   During  fiscal  1996,  the  Company  opened  two  outpatient
rehabilitation  clinics in St.  Augustine  and  Daytona  Beach and  acquired  an
outpatient  rehabilitation  clinic in Ormond Beach, Florida. All the clinics are
under lease agreements.  See "Management's  Discussion and Analysis of Financial
Condition and Results of Operations".

    Florida Facilities                                     Location
    ------------------                                     --------
    Beaches Physical Therapy                               St. Augustine, FL
    Body Anew                                              Ormond Beach, FL
    Bodymax Physical Therapy of Palatka                    Palatka, FL
    Medbrook Rehab Center                                  Daytona Beach, FL
    Medbrook Rehab Center                                  Palm Coast, FL
    Medbrook Rehab Center                                  St. Augustine, FL
    Medbrook Rehab Center                                  Jacksonville, FL
    Moultrie Physical Therapy                              Moultrie, GA

     On  June  30,  1995,  the  Company  announced  the  acquisition  of  eleven
outpatient  rehabilitation clinics in Colorado, three outpatient  rehabilitation
clinics in Alaska and a home  health  agency  with ten  locations  operating  in
Colorado,  New Mexico and Kansas. During fiscal 1996 the Company closed three of
these  outpatient  rehabilitation  clinics.  On  January 1,  1996,  the  Company
acquired  the  assets of two  outpatient  rehabilitation  clinics  in Pueblo and
Colorado City, Colorado.  On April 1, 1996, the Company acquired the assets of a
contract  therapy  business  with  operations  in Pueblo and  Colorado  Springs,
Colorado and a outpatient  rehabilitation clinic in Colorado Springs,  Colorado.
All the facilities are under lease agreements.

     Colorado & Alaska Clinics                             Location
     -------------------------                             --------
     Medbrook Rehab Center of Alaska                       Kenai, AK
     Medbrook Rehab Center of Alaska                       North Pole, AK
     Medbrook Rehab Center of Alaska                       Soldotna, AK
     Medbrook Rehab Center of Colorado                     Colorado City, CO
     Medbrook Rehab Center of Colorado                     Colorado Springs, CO
     Medbrook Rehab Center of Colorado                     Florence, CO
     Medbrook Rehab Center of Colorado                     Las Animas, CO
     Medbrook Rehab Center of Colorado                     Monte Vista, CO
     Medbrook Rehab Center of Colorado                     Pueblo, CO
     Medbrook Rehab Center of Colorado                     Rifle, CO
     Medbrook Rehab Center of Colorado                     Trinidad, CO
     Medbrook Rehab Center of Colorado                     Walsenburg, CO
     Medbrook Rehab Center of Colorado                     Woodland Park, CO

     Home Health
     -----------
     Total Home Health, Inc.                               Florence, CO
     Total Home Health, Inc.                               Holly, CO
     Total Home Health, Inc.                               La Junta, CO
     Total Home Health, Inc.                               Lamar, CO
     Total Home Health, Inc.                               Montrose, CO
     Total Home Health, Inc.                               Pueblo, CO
     Total Home Health, Inc.                               Rocky Ford, CO
     Total Home Health, Inc.                               Trinidad, CO
     Total Home Health, Inc.                               Walsenburg, CO
     Total Home Health, Inc.                               Leoti, KS
     Total Home Health, Inc.                               Raton, NM

     The Company  cannot  calculate  a patient  utilization  percentage  for the
Company's  outpatient  rehabilitation  facilities because there is no measurable
capacity for the potential  number of  outpatient  visits.

<PAGE>

Acute,  Subacute and Post-Acute Programs

     As of June 30, 1996,  the Company's  traditional  business  operated  seven
programs in five cities in Kansas, Georgia, and Illinois.

     Set forth below is certain information  concerning the Company's facilities
at June 30,  1996.  In fiscal 1995 the  Company  moved its  subacute  program in
Atlanta,  Georgia from the 30 bed unit which the Company leased within a 146 bed
SNF to a 48 bed hospital  based SNF unit in Lithia  Springs,  Georgia  which the
Company operates under a management contract.

<TABLE>
<CAPTION>
                                                                              
Acute, Subacute and Post-Acute Facilities              Location             Capacity (1)       Date Opened
-----------------------------------------             -------------         ------------       -----------
Acute Rehabilitation:

<S>                                                    <C>                  <C>                <C>  
  Meadowbrook Rehabilitation Hospital of Kansas        Gardner, KS          63 Beds            December 1986

Subacute Rehabilitation Facilities:
  Meadowbrook Rehabilitation Hospital of Kansas        Gardner, KS          21 Beds            December 1986
  Meadowbrook of Atlanta                               Lithia Springs, GA   48 Beds            June 1995
  Meadowbrook of Atlanta (The Neurobehavioral Ctr.)    Atlanta, GA          22 Beds            July 1991

Post-Acute, TLCs and Day Treatment Clinics:
  Meadowbrook Rehabilitation Hospital of Kansas        Gardner, KS           4 Patients        July 1987
  Meadowbrook of Atlanta                               Decatur, GA          12 Patients        December 1988
  Meadowbrook of Chicago                               Park Ridge, IL       12 Patients        May 1990



<FN>
(1) The number of beds shown in the table  reflects the number of available beds
(i.e.,  beds utilized by the facility),  which is generally less than the number
of licensed  beds.  The  Company's  residential  TLC  patients,  at its Illinois
facility,  are housed in  apartments  and can be expanded  through the rental or
acquisition of additional residential units.

(2) The Company moved its Neurobehavioral unit in February 1996, from a 120 bed
medical/surgical  hospital  in  Decatur,  Georgia to a 294 bed  medical/surgical
hospital in Atlanta, Georgia.
</FN>

</TABLE>
<PAGE>

     The   Company's   acute  and  subacute   facilities   achieved  an  overall
utilization, based on patient days, of 43% and 46% of available beds (i.e., beds
utilized by the  facility) for fiscal 1996 and 1995,  respectively.  The Company
cannot calculate a patient utilization  percentage for the Company's  post-acute
facilities  because  there  is no  measurable  capacity  for the  number  of day
treatment patients which can be served.

     The  Company  leases  all of its  properties  except  for the  Georgia  TLC
facility which the Company owns and the Georgia  subacute unit which is operated
under a management  agreement.  In fiscal 1993, the Company purchased a building
which  houses a portion of its Georgia TLC  operations.  The Company has a lease
for an  adjoining  facility  which  houses  the  remaining  portion  of its  TLC
operations.  Such lease  expires in  February  1997,  with an option to renew or
purchase.  The  Company  moved  its  neurobehavioral  facility  from  a 120  bed
medical/surgical  hospital  in  Decatur,  Georgia to a 294 bed  medical/surgical
hospital in Atlanta, Georgia. This lease expires in February 1998. The Company's
facility in Gardner,  Kansas is leased from the  Company's  President  and Chief
Executive  Officer,  Harvey  Wm.  Glasser,  M.D.  The  lease  for the  Company's
post-acute  treatment  clinic in Illinois  expired in December 1995. The Company
currently  occupies  this space under a  month-to-month  rental  agreement.  The
Company maintains its corporate offices in Emeryville,  California under a lease
which expires in October 1996, with a one year renewal option.


ITEM 3.  LEGAL PROCEEDINGS

         None.

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

         Not applicable.


Executive Officers of the Registrant

     In addition to Harvey Wm.  Glasser,  M.D.,  the  executive  officers of the
Company are as follows:

     James F. Murphy  joined the Company in March 1994,  as Vice  President  and
Chief  Financial  Officer.  From July 1993 to March 1994, Mr. Murphy served as a
consultant to the Company. From December 1991 to March 1994, Mr. Murphy operated
a financial  consulting firm specializing in corporate  restructuring.  Prior to
that, Mr. Murphy worked in finance for a large real estate developer. Mr. Murphy
worked for Arthur  Andersen  LLP from 1986 to 1990 and  received  his C.P.A.  in
1989. Mr. Murphy is 34 years old.

     Anita M. Macke  joined the Company in April  1986,  as Vice  President  and
Director of Program  Reimbursement.  During  fiscal 1996,  Ms. Macke assumed the
role of Vice  President  and  Administrator  of the  Company's  Gardner,  Kansas
hospital.  From June 1983 through April 1986,  Ms. Macke was Director of Billing
for New Medico Associates. Ms. Macke is 36 years old.

     All  officers  of the  Company  serve  at the  pleasure  of  the  Board  of
Directors.


<PAGE>

                                     PART II

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

     The Company's Class A Common Stock is traded on The NASDAQ Stock Market. On
September  26,  1996,  the closing  sales price of the Class A Common  Stock was
$2.25 per share.

     On April 22, 1996, the Restated Certificate of Incorporation of the Company
was amended to effect a one-for-three reverse stock split of the Company's Class
A and Class B Common Stock. The purpose of the reverse stock split was to permit
the Company to remain  listed on The NASDAQ  Stock  Market.  In  February  1996,
NASDAQ notified the Company that it was reviewing the Company's  eligibility for
continued  listing.  The Company was out of compliance at various times prior to
the reverse stock split with NASDAQ's requirement that it maintain a minimum bid
price of $1.00 per share. The Company believes that it is now in compliance with
all of the requirements for continued inclusion on NASDAQ.

     The table below sets forth the quarterly  high and low closing sales prices
for the Class A Common  Stock in the period from July 1, 1994  through  June 30,
1996  (giving  effect  to the  one-for-three  reverse  stock  split as if it had
occurred on July 1, 1994):

                      Fiscal 1995                 Fiscal 1996
    Quarter         High        Low             High        Low
    -------        ------      ------          ------      ------
      1st          $6          $4 7/8          $7 1/2      $6
      2nd          $6          $3 3/8          $6          $1 1/2
      3rd          $7 1/2      $5 1/4          $4 1/2      $2 1/4
      4th          $7 1/2      $5 5/8          $4 1/4      $1 1/2


     The Company has not paid cash dividends in the past and does not anticipate
paying cash dividends on its Common Stock in the foreseeable future.

     As of September 26, 1996,  there were 72 holders of record of the Company's
Class A Common  Stock and one holder of record of the  Company's  Class B Common
Stock. There is no public trading market for the Class B Common Stock.



<PAGE>


ITEM  6. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
         The  following  amends  and  restates  in  its  entirety  Item 6 of the
Registrant's Form 10-K for the fiscal year ended June 30, 1996.

                                                                     Year Ended June 30,
                                             --------------------------------------------------------------
                                               1992         1993        1994          1995          1996
                                               ----         ----        ----          ----          ----
                                                      (In thousands, except per share data)
<S>                                           <C>           <C>          <C>          <C>          <C>    
Statements of Operations Data:(1)
Net operating revenues                        $33,805       $28,650      $18,052      $19,974      $23,623
Non-capital operating expenses:(2)
  Salaries and employee benefits               16,550        15,905       11,107       12,036       15,189
  Provision for doubtful accounts                 974         3,681        1,099        1,371          584
  Other non-capital operating expenses          7,638         8,639        6,353        5,821        5,986
  Write-off of intangible assets                   --            --           --        1,030           --
                                             ---------    ----------    ---------   ----------    ---------
    Total non-capital operating expenses       25,162        28,225       18,559       20,258       21,759
                                             ---------    ----------    ---------   ----------    ---------
Capital expenses:(2)
  Depreciation and amortization                   508           497          479          543          586
  Rent                                          3,096         3,085        2,223        2,351        1,953
  Interest expense (income)                       227         (201)        (193)           26         (114)
                                             ---------    ----------    ---------   ----------    ---------
    Total capital expenses                      3,831         3,381        2,509        2,920        2,425
                                             ---------    ----------    ---------   ----------    ---------
Restructuring charges                              --         1,041          675          310           --
Settlement of litigation                           --            --        1,438           --           --
                                             ---------    ----------    ---------   ----------    ---------
          Total expenses                       28,993        32,647       23,181       23,488       24,184
                                             ---------    ----------    ---------   ----------    ---------
Income (loss) before income taxes               4,812       (3,997)      (5,129)      (3,514)         (561)
Income tax provision (benefit) before           
     minority interest                          1,925       (1,244)        (787)         (93)           --
                                             ---------    ----------    ---------   ----------    ---------
Net income (loss) before minority interest     $2,887      ($2,753)     ($4,342)     ($3,421)        ($561)
Minority interest                                 ---           ---           30          108           29
                                             ---------    ----------    ---------   ----------    ---------
Net income (loss)                              $2,887      ($2,753)     ($4,372)     ($3,529)        ($590)
                                             =========    ==========    =========   ==========    =========
Net income (loss) per common share              $1.70       ($1.42)      ($2.26)      ($1.82)       ($0.31)
Weighted average common shares used in per
     common share calculation                   1,700         1,943        1,939        1,937        1,930

</TABLE>

<TABLE>
<CAPTION>

                                                                        At June 30,
                                             --------------------------------------------------------------
                                               1992         1993          1994         1995         1996
                                               ----         ----          ----         ----         ----
                                                                     (In thousands)
<S>                                          <C>           <C>          <C>           <C>          <C>   
Balance Sheet Data: (1)
Working capital                              $19,825       $16,451      $11,889       $7,711       $6,519
Total assets                                  24,561        23,058       18,587       16,304       14,840
Long-term liabilities and capital lease   
     obligations                                  96           129          550        1,074          658
Stockholders' equity                          21,444        18,721       14,249       10,677       10,086

<FN>
    (1) See  "Management's  Discussion  and Analysis of Financial  Condition and
Results of Operations - Trends and Recent  Events" for a description  of certain
acquisitions and dispositions which affect the period-to-period comparability of
the financial information shown in the table.

    (2) See  "Management's  Discussion  and Analysis of Financial  Condition and
Results of Operations" for an explanation of  management's  evaluation of trends
in capital  and  non-capital  operating  expenses  depicted  in the  table.  The
significance of breaking out "non-capital  operating expenses" is to distinguish
for the  reader  those  costs  that  are  controllable  and  those  that are not
controllable in the short term.  Capital operating  expenses are generally fixed
in the short term.  Non-capital operating expenses are generally variable in the
short term,  and are  therefore  subject to faster  management  intervention  as
business conditions change.
</FN>
</TABLE>
<PAGE>

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

     The  following   amends  and  restates  in  its  entirety  Item  7  of  the
Registrant's Form 10-K for the fiscal year ended June 30, 1996.

                            TRENDS AND RECENT EVENTS

Loss History; Liquidity Risks

     The Company has incurred significant losses in each of the last four fiscal
years. The Company's future  profitability is dependent on a variety of factors,
including without limitation,  increased patient census, a reduction in expenses
as a percentage of total operating  revenues and the successful  integration and
management of the outpatient  rehabilitation  clinics and home health  agencies.
There can be no assurance as to the Company's future profitability.

     The Company's  recent  operating  losses and the funding of initial working
capital for its recently  acquired Colorado  outpatient  clinics and home health
agencies have substantially reduced its available working capital. The Company's
working  capital has fallen from  $7,711,000  at June 30, 1995 to  $6,519,000 on
June 30, 1996. In fiscal 1996, the Company's  operating  activities used cash of
$2,001,000.  This amount  includes  $728,000  withheld at June 30, 1996,  by the
Company's  intermediary on the basis of amounts due by the previous owner of the
Colorado home health agencies for final  settlement of the home health agencies'
cost  reports  for 1992  through  1995.  In  addition,  cash used for  operating
activities  includes  $1,447,000  of working  capital  funding for its  recently
acquired  Colorado  operations.  While the  Company  believes  that its  working
capital will be sufficient  to sustain the  Company's  needs for the next twelve
months,  the Company's ability to continue to fund its operations  thereafter is
dependent on the Company  achieving  profitability  and positive cash flows from
operating  activities.  The Company has a $1,000,000 bank  line-of-credit  which
would require a $500,000 bank deposit if drawn. Otherwise, the Company currently
does not have access to additional  capital.  There can be no assurance  that in
the  future  the  Company  will not  experience  a shortage  of  available  cash
necessary to operate its business.

Consideration of Strategic Alternatives

     As a result of the Company's continued losses, the Board of Directors is in
the process of evaluating the Company's  strategic  direction and  alternatives.
The alternatives under consideration by the Board include, among other things, a
merger or other business  combination  transaction or sales of assets. There can
be no assurance that any such alternatives will be available on favorable terms,
if at all.

     Harvey Wm. Glasser, M.D., the Company's majority stockholder, has indicated
his view that the  Company's  business  should  not  necessarily  be  limited to
medical  rehabilitation or the healthcare field generally and that, if presented
with an appropriate opportunity,  the Company should consider investing proceeds
from any asset sales in non-healthcare  businesses.  As a result,  the nature of
the Company's business could change significantly.  Dr. Glasser holds a majority
of the combined  voting power of the  Company's  two classes of common stock and
accordingly  has the  ability  to effect a change in  management  or to cause or
prevent a significant corporate transaction.

Colorado Outpatient Clinics and Home Health Agency Acquisition

     On June 30, 1995, the Company  acquired  eleven  outpatient  rehabilitation
clinics in Colorado, three outpatient  rehabilitation clinics in Alaska and home
health agencies with operations in Colorado,  New Mexico and Kansas. The Company
paid  $133,000  and  incurred  liabilities  of $572,000 in  connection  with the
purchase.  The Company  also  agreed to make  additional  payments  based on the
earnings  performance  of the  outpatient  rehabilitation  clinics  and the home
health  agencies.  Based on results  for the year ended June 30,  1996,  no cash
payment is required for the twelve months ending June 30, 1996.  The  additional
cash payments would total $825,000 if the  operations  collectively  achieve the
target  earnings  thresholds  for the twelve months ending June 30, 1997 through
1999.

     In addition,  in connection  with the  acquisition,  the Company  agreed to
deposit  $500,000 to secure a $900,000  bank loan to the  previous  owner of the
acquired  businesses.  The  Company  is over  seeing the  repayment  of the loan
through the  collection  of accounts  receivable  which are being  collected  on
behalf  of the  previous  owner.  At the time of the  acquisition,  the  Company
anticipated  that the loan  would be  repaid  based on the  accounts  receivable
balance then  outstanding.  The loan balance on June 30, 1996 was $251,000.  The
Company did not acquire  accounts  receivable in connection with the acquisition
and has funded  approximately  $1,447,000  of working  capital for the  acquired
operations since the date of acquisition.

     In October  1995,  the Company was  notified by its  intermediary  that its
Medicare  payments for the recently  acquired  home health  agencies  were being
withheld to offset amounts due by the previous owner for final settlement of the
home health  agencies' cost reports for the years 1992 through 1995.  During the
twelve months ending June 30, 1996, the intermediary  withheld  $728,000 related
to these  settlements.  This  amount is  included  in other  receivables  on the
Company's  balance  sheet.  The Company and the  previous  owner have  submitted
appeals to these  settlements  and are  currently  awaiting a response  from the
intermediary.  In the event that the  appeals of the prior owner and the Company
are unsuccessful, the Company intends to offset the amounts withheld against any
additional  amounts due to the previous owner under the acquisition  agreements.
The  intermediary  resumed making payments to the Company for current charges in
January 1996.

     On January 1,  1996,  the  Company  acquired  the assets of two  outpatient
rehabilitation clinics in Pueblo and Colorado City, Colorado. In connection with
the  acquisition,  the  Company  paid  $32,500  and became  obligated  to pay an
additional  $32,500.  Additionally,  the Company assumed liabilities of $75,000.
The net  revenues for the acquired  operations  for the six month period  ending
June 30, 1996 were $180,000.

     On April 1, 1996,  the Company  acquired  the assets of a contract  therapy
business with operations in Pueblo and Colorado Springs,  Colorado. The business
provides therapy staffing to hospitals,  nursing homes and home health agencies.
In  connection  with the  acquisition,  the  Company  paid  $10,000  and assumed
liabilities for leasehold improvements of $62,000.

Florida Outpatient Clinics Acquisition

     During fiscal 1994, the Company acquired a majority interest in or obtained
management contracts to operate nine outpatient  rehabilitation  clinics located
in Jacksonville,  Jacksonville Beach, Orange Park, St. Augustine,  St. Augustine
Beach, Palm Coast and Palatka, Florida and in Moultrie, Georgia. At closing, the
Company paid $608,000,  agreed to reimburse  certain  selling  shareholders  for
accounts  receivable of the acquired  clinics  collected after the closing,  and
agreed to make additional payments based on the earnings  performance of certain
clinics in each year during the three year period ending March 31, 1997.

     Subsequent  to June  30,  1996,  the  Company  paid  $123,000  based on the
earnings  performance  of certain  clinics  and  $20,000 in interest on deferred
acquisition  payments.  At June 30,  1996,  the  Company's  remaining  liability
resulting from the purchase was $510,000,  plus additional payments based on the
earnings  performance of certain clinics.  Such payments would total $135,000 if
the  earnings of such  clinics for the twelve  months  ending March 31, 1997 are
equal to the earnings of such clinics for the base year, the twelve months ended
December 31, 1993.

     On October 1, 1994,  the Company  acquired the minority  interest in two of
the outpatient  clinics referred to above. In connection with such  acquisition,
the Company paid  $600,000 and is  obligated  to pay an  additional  $150,000 by
September 30, 1996.

     On February  1, 1995,  the Company  acquired an  outpatient  clinic in Palm
Coast,  Florida. At June 30, 1996, the Company had paid $138,000 of the purchase
price  and  was  obligated  to pay  an  additional  $122,000  in  equal  monthly
installments of $3,300 through February 2000.

     On May 12, 1995,  the new owner of five of the Florida  outpatient  clinics
managed by the Company  advised the Company that its  management  contracts were
terminated.  As a result,  during the fourth  quarter of fiscal 1995 the Company
recorded a charge of $1,030,000 to write-off  intangible assets recorded as part
of the fiscal  1994  acquisition.  The  intangible  assets  written-off  include
goodwill and a non-compete  agreement with a physician with whom the Company had
entered into  management  contracts.  The charge is  classified  as an operating
expense.  The Company does not agree that such  contracts may be terminated  and
has filed suit to protect its legal rights.

     The Company opened two outpatient  rehabilitation clinics during the second
quarter of fiscal  1996.  The clinics are located in St.  Augustine  and Daytona
Beach,   Florida.  The  Company  also  acquired  the  assets  of  an  outpatient
rehabilitation clinic in Ormond Beach, Florida in June 1996.

<PAGE>

Closure of Facilities

     Closure of Psychiatric Partial Hospitalization Program

     During  fiscal year 1995,  the Company  internally  developed,  through its
wholly  owned   subsidiary,   Medbrook  of  Indiana,   a   psychiatric   partial
hospitalization  program which provided  psychiatric  services in long-term care
facilities.  In June 1995, the Company decided to close the psychiatric  partial
hospitalization  program and the program was closed on September  22, 1995.  The
Company's decision to close the program was based on difficulties in growing the
business and potential Medicare  reimbursement  issues. As of June 30, 1995, the
Company  recorded a restructuring  charge of $310,000  related to the closure of
the program. At June 30, 1996, the remaining liability for expected future costs
related to the closure was $104,000.

     Closure of Arlington, Texas Post-Acute Facility

     In June 1994,  the  Company  decided to close its  post-acute  facility  in
Arlington,  Texas,  and the  facility  was closed on  September  30,  1994.  The
Arlington  facility  had  experienced   increased  competition  and  significant
operating  losses  and  the  Company  was not  optimistic  about  its  long-term
prospects for  profitability.  The Company  recorded a charge of $350,000 during
fiscal 1994 related to the closure of the facility.

     Closure of San Jose, California Subacute Facility

     During  the first  quarter  of fiscal  year 1994,  the  Company  closed its
subacute program in San Jose, California. On December 27, 1994, the Company sold
its lease for the San Jose facility to an investment partnership. The investment
partnership's  rent obligation  commenced on February 15, 1995. This partnership
in turn subleases the facility to a third party.  The Company remains  obligated
to make lease payments in the event that the investment  partnership defaults on
its  obligations  under the lease.  Because the investment  partnership has made
substantial improvements to the facility, the Company does not anticipate such a
default.

Healthcare Reform

     President  Clinton and others have expressed an intention to continue their
efforts to reform the nation's  healthcare system. The principal goal of many of
the  proposals  are to  reduce  the  rate of  increase  in  national  healthcare
expenditures, particularly by cutting the rate of increase in Medicare spending.
The ability of healthcare  providers such as the Company to compete successfully
in such an  environment  may  depend on its  ability  to obtain  contracts  with
managed  care plans.  In addition to the  national  reform  proposals,  there is
proposed  legislation  in numerous  states.  There can be no assurance as to the
ultimate content, timing or effect of any healthcare reform legislation,  nor is
it possible,  at this time, to estimate the impact of potential  legislation  on
the Company, which may be material.



<PAGE>


                              RESULTS OF OPERATIONS

     The  following  table sets forth the  relationship,  as a percentage of net
operating  revenues,  of certain items  included in the  Company's  consolidated
statements of operations for the periods indicated:

<TABLE>
<CAPTION>

                                                      Year ended June 30,
                                               ---------------------------------
   Statements of Operations Data:              1994           1995          1996
                                               ----           ----          ----

<S>                                            <C>           <C>         <C>   
   Net operating revenues                      100.0%        100.0%      100.0%

   Non-capital operating expenses:
      Salaries and employee benefits            61.5          60.3        64.3
      Provision for doubtful accounts            6.1           6.9         2.5
      Other non-capital operating expenses      35.2          29.1        25.3
      Write-off of intangible assets              --           5.2          --
                                              -------       -------      ------
        Total non-capital operating expenses   102.8         101.5        92.1
                                              -------       -------      ------

   Capital expenses:
      Depreciation and amortization              2.7           2.7         2.5
      Rent                                      12.3          11.8         8.3
      Interest (income) expense                 (1.1)          0.1        (0.5)
                                              -------       -------      ------
         Total capital expenses                 13.9          14.6        10.3
                                              -------       -------      ------
   
   Restructuring charges                         3.7           1.6          --
   Settlement of litigation                      8.0            --          --
                                              -------       -------      ------
         Total expenses                        128.4         117.7       102.4
                                              -------       -------      ------
   Income (loss) before income taxes           (28.4)        (17.7)       (2.4)
   Income tax provision (benefit) before        
   minority interest                            (4.4)        ( 0.5)         --
                                              -------       -------      ------
   Net (loss) before minority interest         (24.0)        (17.2)       (2.4)
   Minority interest                             0.2           0.5         0.1
                                              -------       -------      ------
   Net (loss)                                  (24.2)%       (17.7)%      (2.5)%
                                              =======       =======      ======

</TABLE>
<PAGE>

Year ended June 30, 1996 Compared to the Year ended June 30, 1995

     The Company's net operating  revenues  increased 18% to $23,623,000 for the
year ended June 30, 1996, as compared to  $19,974,000  in the prior fiscal year.
The increase was due  primarily  to net revenue of  $7,127,000  generated by the
Colorado  outpatient  clinics and home health agency during fiscal 1996,  and to
favorable prior year cost report  settlements of $603,000 recorded in the second
quarter of fiscal 1996, related to its former San Jose,  California facility and
its Gardner,  Kansas  facility.  The  comparability  of fiscal 1996 and 1995 net
operating  revenues  was  affected by the closure of the  Company's  psychiatric
partial  hospitalization program during the first quarter of fiscal 1996 and the
conversion  in June 1995,  of the  Company's  Georgia  subacute  facility from a
leased  unit to a  management  arrangement,  under which the  Company's  revenue
consists  primarily of management fees. Fiscal 1996 net operating  revenues also
reflect  decreased  utilization of the Company's core  facilities  (i.e.  acute,
subacute and post-acute  rehabilitation  units in Georgia,  Illinois and Kansas)
during fiscal 1996. Excluding the Company's Arlington, Texas post-acute facility
which was  closed in 1995,  the  number of patient  days in the  Company's  core
business  decreased 7% to 27,014 for the fiscal year ended June 30,  1996,  from
28,944 for fiscal 1995.

     In the  Company's  core  business,  revenue per patient day decreased 7% to
$526 for the year ended June 30, 1996,  as compared to $567 for the prior fiscal
year.  Fiscal 1996 amounts do not include revenue per patient day at the Georgia
subacute  facility,  which has been  operated by the Company  under a management
agreement since June 5, 1995. This decrease is largely due to an increase in the
percentage  of  Medicare  patients  served  at  the  Company's  Gardner,  Kansas
facility.

     In  the  table  above  and  in  the  following   discussion,   the  Company
distinguishes   between  capital  and  non-capital   operating  expenses.   This
distinction  is made to clarify  those  costs that are  controllable  from those
costs that are not controllable in the short term.  Capital  operating  expenses
such as rent  are  generally  fixed in the  short  term.  Non-capital  operating
expenses such as employee costs are generally variable in the short term and are
therefore  subject to faster  management  intervention  as  business  conditions
change.

     Total  non-capital  operating  expenses  for the year ended  June 30,  1996
increased 7% to $21,758,000 from $20,258,000  during the prior fiscal year. This
increase  primarily  resulted from the  acquisition  of the Colorado  outpatient
clinics and home health agencies.  Salaries and employee benefits continue to be
the primary component of the Company's non-capital operating expenses.  Salaries
and employee  benefits  increased 26% to $15,189,000 for the year ended June 30,
1996, as compared to  $12,036,000  for the same period in the prior fiscal year.
This increase is largely due to the inclusion of salaries and employee  benefits
for the  Colorado  outpatient  clinics and home health  agencies.  Salaries  and
employee benefits as a percentage of net operating revenues increased to 64% for
the year ended June 30, 1996, as compared to 60% in the prior fiscal year.

     The Company's other non-capital  operating  expenses  primarily consists of
professional fees, purchased services and other operating expenses. For the year
ended June 30, 1996 other non-capital  expenses decreased 13% to $5,986,000,  as
compared  to  $6,851,000  for the same  period in the  prior  fiscal  year.  The
decrease is primarily due to the inclusion in non-capital  operating expenses of
a $1,030,000  write-off of  intangible  assets  during fiscal 1995 in connection
with the  termination  of  contracts  acquired in 1994,  which  provided for the
Company to manage outpatient  rehabilitation  clinics in Florida.  The provision
for  doubtful  accounts  decreased  57% to $584,000  for the year ended June 30,
1996,  from  $1,371,000  for the prior fiscal year.  The  provision for doubtful
accounts as a percentage of net  operating  revenues was 2.5% for the year ended
June 30, 1996,  as compared to 6.9% for the prior fiscal year.  The reduction in
the  provision  is due to lower  provision  rates for the  Company's  outpatient
clinics and home health business lines. In addition,  the provision for doubtful
accounts for the year ended June 30, 1995  includes a charge of $700,000 for the
write-off of two litigation  receivables in which the patients were unsuccessful
in their third party litigation.

     Total  capital  expenses  decreased 17% for the year ended June 30, 1996 to
$2,425,000,  as compared to $2,920,000  for the prior fiscal year.  Rent expense
decreased  17% to  $1,953,000  for the year ended June 30, 1996,  as compared to
$2,351,000  for the prior fiscal year. The decrease in rent expense is primarily
due to lower  rents paid under  leases  requiring  payments  on the basis of net
revenue and patient volume at certain  facilities,  as well as the conversion of
the  Company's  subacute  facility in Georgia to a  management  contract in June
1995.  The Company pays no rent under this  management  contract.  The decreases
were  partially  offset  by rents  paid  during  fiscal  1996  for its  Colorado
outpatient clinics and home health agencies.

     Net  interest  income  for the year  ended June 30,  1996 was  $114,000  as
compared to net  interest  expense of $26,000 for the prior  fiscal  year.  This
increase is due to higher interest  earnings  during the fiscal 1996 period,  as
well as less interest expense on acquisition payments during fiscal 1996.

     The  Company  reported  a net  loss  for the year  ended  June 30,  1996 of
$590,000 as compared to a net loss of $3,529,000  for the prior fiscal year. The
Company's  effective  tax rate for fiscal  1995 was a benefit of 3%. The Company
did not record a benefit for the year ended June 30, 1996 because  carrybacks of
current losses against previous taxable earnings are no longer available.

Year ended June 30, 1995 Compared to the Year ended June 30, 1994

     The Company's net operating  revenues  increased 11% to $19,974,000 for the
fiscal year ended June 30,  1995,  as compared to  $18,052,000  in fiscal  1994.
Fiscal 1995 net operating  revenues  benefited from a full year of operations at
the  Florida  outpatient  clinics  acquired  in  April  1994,  and the  revenues
generated by the Company's psychiatric partial  hospitalization  program,  which
opened in May 1994.  The nine  outpatient  clinics and the  partial  psychiatric
hospitalization  program  contributed  net operating  revenue of $2,161,000  and
$1,068,000,  respectively,  for the fiscal year ended June 30, 1995. Fiscal 1995
net operating  revenues were adversely effected by the closure of the Arlington,
Texas  facility  in the first  quarter  of fiscal  1995.  The  facility  had net
operating  revenues of  $1,091,000  in fiscal  1994,  as compared to $306,000 in
fiscal 1995.

     Revenue per patient day in the Company's  traditional business decreased 2%
to $567 for the fiscal  year ended June 30,  1995,  as  compared  to $577 in the
prior fiscal year.  Revenue per patient day was adversely effected by changes in
service mix and competitive pressures to reduce healthcare costs, which resulted
in lower per diem rates.  Total  patient days in the Company's  core  facilities
(excluding closed facilities)  increased 2% from 28,267 in fiscal 1994 to 28,944
in fiscal 1995.

     Total  non-capital  operating  expenses  for the fiscal year ended June 30,
1995 increased to $20,258,000 from $18,559,000 in the prior year,  reflecting an
increase of  approximately  9%. Salaries and employee  benefits were the primary
component of the Company's non-capital operating expenses. Salaries and employee
benefits  increased 8% to $12,036,000  for the fiscal year ending June 30, 1995,
as  compared to  $11,107,000  for fiscal  1994.  The  increase  in salaries  and
employee benefits  resulted from expenses incurred at the outpatient  clinics in
Florida and the partial psychiatric  hospitalization  program. This increase was
partially  offset by the closure of the  Arlington,  Texas facility in the first
quarter of fiscal 1995.

     The  Company's  other  non-capital  operating  expenses for the fiscal year
ended June 30, 1995,  increased 8% from  $6,353,000 in fiscal 1994 to $6,851,000
in fiscal 1995. The Company's  provision for doubtful accounts  increased 25% to
$1,371,000  for the year ended June 30, 1995,  from  $1,099,000 for fiscal 1994.
The  increase  was due to a $700,000  write-off  of two  litigation  receivables
during the fourth quarter in which the patients were unsuccessful in their third
party  litigation.  The  provision  for  doubtful  accounts as a  percentage  of
revenues was 7% for the fiscal year ended June 30,  1995,  as compared to 6% for
fiscal  1994.  In  addition,  the  Company  recorded a charge of  $1,030,000  to
write-off  intangible  assets  recorded  as  part  of its  fiscal  1994  Florida
outpatient clinic acquisition.  See "Trends and Recent Events".  These increases
were partially offset by a 19% decrease in purchased services from $3,724,000 in
fiscal 1994 to $3,023,000 in fiscal 1995. This decrease  reflects a reduction in
registry and temporary labor in the Company's core facilities.

     Total capital expenses  increased 16% during the fiscal year ended June 30,
1995, to  $2,920,000,  as compared to  $2,509,000  during the prior fiscal year.
Rent expense increased 6% to $2,351,000 for the fiscal year ended June 30, 1995,
as  compared to  $2,223,000  for the prior  fiscal  year.  The  increase in rent
expense  resulted  from rents paid at the  Florida  outpatient  clinics  and the
partial  psychiatric  hospitalization  program.  These  increases were partially
offset by lower rents paid for certain  facilities where the payment is variable
based on net revenue and patient volume.

     During fiscal 1995, the Company recorded a restructuring charge of $310,000
related to the closure of its psychiatric partial  hospitalization  program. See
"Trends and Recent Events".

     During fiscal 1994, the Company recorded a charge of $1,438,000  classified
as  non-operating  expenses  for the  settlement  of the  Company's  shareholder
litigation.

     During fiscal 1994, the Company recorded additional  restructuring  charges
of $325,000 related to the closure of its San Jose,  California  facility.  Such
charges include additional rent during the subtenant's  construction  period and
the  write-off  of  idle  equipment.   In  addition,   the  Company  recorded  a
restructuring charge of $350,000 related to the closure of its Arlington,  Texas
facility. See "Trends and Recent Events".

     For fiscal 1995, the Company incurred net interest  expense of $26,000,  as
compared to net interest income of $193,000 for fiscal 1994. Included in the net
interest expense amount is $132,000 of interest on unpaid  principal  related to
its fiscal 1994 Florida acquisition. See "Trends and Recent Events".


     The Company  sustained an after-tax loss for the fiscal year ended June 30,
1995 of  $3,529,000,  as  compared to a loss of  $4,372,000  for the fiscal year
ended June 30, 1994.  The Company's  effective tax rate decreased from a benefit
of 15% for the fiscal year ended June 30, 1994 to a benefit of 3% for the fiscal
year ended June 30,  1995.  The tax  benefits in fiscal years 1994 and 1995 were
limited by the lack of  availability  of loss carrybacks in certain states where
the Company files tax returns,  as well as limited taxable  earnings in the past
to which losses may be applied.

Unaudited Quarterly Results

     Set  forth  below  is  certain  summary  information  with  respect  to the
Company's operations for the last eight fiscal quarters

<TABLE>
<CAPTION>

                                            Fiscal 1995                               Fiscal 1996
                                -------------------------------------    -------------------------------------
                                  1st      2nd        3rd       4th           1st       2nd      3rd      4th
                                Quarter  Quarter    Quarter   Quarter       Quarter   Quarter  Quarter  Quarter
Statements of Operations Data:                      (In thousands, except per share data)
<S>                              <C>      <C>       <C>       <C>           <C>       <C>      <C>     <C>   
Net operating revenues           $5,405   $5,405    $5,155    $4,009        $5,579    $6,095   $6,321  $5,628
Income (loss) before income
taxes and minority interest         130       43      (319)   (3,368)         (563)      105       51    (154)
Net income (loss)                    29       17      (235)   (3,340)         (585)       88       34    (127)
Earnings (loss) per share         $0.01    $0.01    ($0.12)   ($1.72)       ($0.30)    $0.05    $0.02  ($0.07)
Average shares outstanding        1,936    1,936     1,937     1,937         1,931     1,930    1,930   1,930
</TABLE>


LIQUIDITY AND CAPITAL RESOURCES

     At June 30, 1996, the Company had working  capital of $6,519,000,  compared
to working capital of $7,711,000 at June 30, 1995. The Company had cash and cash
equivalents  of  $3,439,000  at June 30, 1996, as compared to $6,307,000 at June
30, 1995. At June 30, 1995, the Company had deposited  $500,000 to secure a bank
loan of  $900,000  as part of its  Colorado  outpatient  clinic and home  health
agencies  acquisition.  At June 30,  1996,  $311,000 of the amount  deposited is
classified as restricted cash securing the loan balance of $251,000,  as well as
security  for the  Company's  outstanding  balance  on its  line-of-credit.  See
"Trends and Recent Events".  The Company is  administering  the repayment of the
loan through the collection of receivables  which are being  collected on behalf
of the previous owner.

     During  the  fiscal  year  ended June 30,  1996,  the  Company's  operating
activities  used  $2,001,000 of available  cash  resources,  as compared to cash
provided for operating  activities  of $4,075,000  during the same period in the
prior fiscal year. The cash used for operating  activities during the year ended
June 30, 1996 primarily  reflects  funding of working  capital for the Company's
Colorado  outpatient  clinics and home health agencies and amounts  necessary to
fund the Company's  net  operating  losses.  In addition,  this amount  includes
amounts  withheld by the Company's  intermediary  on the basis of amounts due by
the previous  owner of the Colorado home health  agency for final  settlement of
the 1992 through 1995 home health  agencies'  cost  reports.  Cash provided from
operating  activities  for the year ended June 30,  1995  included a federal tax
refund of $1,908,000.  Cash used for investment activities during the year ended
June 30, 1996 was $1,013,000, as compared to cash used for investment activities
of $1,581,000 during the prior fiscal year.

     Net  patient   accounts   receivable,   which  excludes  amounts  due  from
intermediaries,  was  $4,739,000  at June 30, 1996, as compared to $4,064,000 at
June 30,  1995.  At June 30,  1996,  the Company had an  allowance  for doubtful
accounts of  $1,445,000,  as compared to $2,001,000 at June 30, 1995. The number
of average days of revenue  outstanding,  excluding the revenues and receivables
related to litigation patients,  was 65 days at June 30, 1996, as compared to 63
days at June 30,  1995.  

     It has been the  Company's  practice  to admit  selected  patients  who are
seeking  monetary  recovery  in pending  litigation  with third  parties.  These
patients  are  directly  obligated  to pay the  Company for  services  rendered,
although the timing of  collection  is  determined  by the  settlement  of their
litigation and is beyond the control of the Company.  For this reason, liens are
generally placed against pending insurance settlements.  Prior to admitting such
patients, the Company and its counsel evaluate the merits of the patient's case,
the  anticipated  cost of  services  to be provided  and the  likelihood  of the
patient's  successful  recovery  of damages in  litigation.  Once the patient is
admitted,  the  Company and its  counsel  monitor the status of the  litigation.
There  can be no  assurance,  however,  that  the  Company  will  ultimately  be
reimbursed for all the services it provides to such patients.  At June 30, 1996,
accounts  receivable related to these litigation  patients totaled $444,000,  as
compared to $642,000 at June 30,  1995.  These  litigation  patient  receivables
accounted for an additional 19 and 30 average days revenue  outstanding  at June
30, 1996 and June 30, 1995, respectively.

     The Company's amount due from Medicare  intermediaries  of $332,000 at June
30, 1996  includes  amounts the  Company  anticipates  to receive on cost report
settlements  for its Colorado  home health  agencies  acquired on June 30, 1995.
Such amount also includes amounts the Company expects to receive upon regulatory
approval of the Company's  annual  application for an exception from the routine
cost limitation ("RCL") under the Medicare program for fiscal years 1992 through
1996 for its Gardner, Kansas facility. Medicare reimbursement is generally based
upon  reasonable  direct and  indirect  allowable  costs  incurred in  providing
services.  At the Company's inpatient  facilities these costs are subject to the
RCL. An exception from the RCL has been sought and granted for fiscal years 1990
through 1994 for the Company's former San Jose,  California  facility.  Requests
have been  submitted for fiscal years 1992 through 1995 for the Gardner,  Kansas
facility.  The Company  intends to file such request for its Kansas facility for
fiscal 1996.  The requests are based upon atypical  costs incurred at the Kansas
facility in the treatment of patients who receive  substantially  more intensive
services than those generally  received in SNFs.  There can be no assurance that
the  Company  will  collect in full the amounts it has  requested  or intends to
request, nor can there be any assurance as to the timing of any such collection.
An initial three year  "exemption" from the RCL expired in June 1989, at the San
Jose, California facility and in June, 1990, at the Gardner, Kansas facility.

     The Company has no current material  commitments for capital  expenditures,
except for those in  connection  with the  Company's  acquisitions  as described
under "Trends and Recent Events" above. The Company also expects to make routine
capital improvements to its facilities in the normal course of business.

     The  Company  intends  to use a  portion  of its cash  balance  to  finance
internal  development of its outpatient  rehabilitation and home health business
lines.  The Company will also expand its existing  facilities  and programs when
such  expansion  meets the  Company's  investment  criteria.  The  Company has a
line-of-credit of $1,000,000 from a bank. Any draws on the line-of-credit  would
be  secured  by a cash  deposit.  At June 30,  1996,  the  Company  had  $60,000
outstanding under the line-of-credit.  The Company will need to obtain access to
additional  capital,  through  bank  loans  or  otherwise,  in order to fund any
significant  acquisition  opportunities.  The Company believes that its existing
cash, credit line and cash flows from operations,  will be sufficient to satisfy
the Company's  estimated operating cash requirements for its existing facilities
for the next twelve months.

     Inflation in recent years has not had a significant effect on the Company's
business  and is not  expected  to  adversely  effect the  Company in the future
unless the current rate of inflation increases significantly.



<PAGE>

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     The  following   amends  and  restates  in  its  entirety  Item  8  of  the
Registrant's Form 10-K for the fiscal year ended June 30, 1996.

     Reference  is  made  to  the  Consolidated  Balance  Sheets,   Consolidated
Statements of Operations,  Consolidated  Statements of Stockholders'  Equity and
Consolidated   Statements  of  Cash  Flows,  Notes  to  Consolidated   Financial
Statements,  Financial  Statement  Schedules  and Report of  Independent  Public
Accountants attached to this Form 10-K.

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

          None.


<PAGE>


                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     Information  with respect to directors of the Registrant is incorporated by
reference from the information  under the caption "Election of Directors" in the
Company's   definitive   proxy   statement  for  its  1996  Annual   Meeting  of
Stockholders.  Information  with  respect to certain  executive  officers of the
Registrant is included in Part I of this Form 10-K under the caption  "Executive
Officers of the  Registrant".  Information  concerning  compliance  with Section
16(a) of the Exchange Act is  incorporated  by  reference  from the  information
under the caption  "Compliance  with Section  16(a) of the Exchange  Act" in the
Company's   definitive   proxy   statement  for  its  1996  Annual   Meeting  of
Stockholders.

ITEM 11. EXECUTIVE COMPENSATION

     Incorporated  by reference from  information  under the caption  "Executive
Compensation"  in the Company's  definitive  proxy statement for its 1996 Annual
Meeting of Stockholders.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     Incorporated  by reference  from the  information  under the caption "Stock
Ownership of Directors and Executive Officers" in the Company's definitive proxy
statement for its 1996 Annual Meeting of Stockholders.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     Incorporated by reference from the information  under the caption  "Certain
Transactions"  in the Company's  definitive  proxy statement for its 1996 Annual
Meeting of Stockholders.



<PAGE>

                                     PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
                                                                  Reference Page
                                                           Attached Consolidated
                                                            Financial Statements

(a)   1.   Consolidated financial statements:

           Report of Independent Public Accountants........................  2

           Consolidated Balance Sheets at June 30, 1995 and 1996..........   3

           Consolidated Statements of Operations for the Years
                   Ended June 30, 1994, 1995 and 1996.....................   4

           Consolidated Statements of Stockholders' Equity for the
                   Years Ended June 30, 1994, 1995 and 1996...............   5

           Consolidated Statements of Cash Flows for the Years
                   Ended June 30, 1994, 1995 and 1996.....................   6

           Notes to Consolidated Financial Statements.....................   7

      2.   Financial statement schedules for the years ended June 30,
                   1994, 1995 and 1996:

           II      -   Valuation and Qualifying Accounts..................   19

      3.   Exhibits:
              
               3.1    Amended and Restated  Certificate of  Incorporation of the
                      Company,   filed   as   Exhibit   3.1  To  the   Company's
                      registration  statement on form S-1  (commission  file no.
                      33-44197) (The "registration  statement") and incorporated
                      herein by reference.

               3.2    Certificate  of  Amendment  of  Restated   Certificate  of
                      Incorporation.

               3.3    Amended  and  Restated  By-Laws of the  Company,  filed as
                      Exhibit 3.2 to the Registration Statement and incorporated
                      herein by reference.

               10.1   1994 Stock  Incentive Plan of the Company filed as Exhibit
                      10.1 to the  Company's  Annual Report or Form 10-K for the
                      fiscal  year  ended June 30,  1995 (the  "1995  10-K") and
                      incorporated herein by reference.

               10.2   Lease, dated September 1, 1987, between Harvey Wm. Glasser
                      and Meadowbrook Neurocare-Kansas City, Inc., addenda dated
                      May 1, 1988 and April 1, 1989 and  amendment  (with  lease
                      guaranty  by the  Company)  dated July 1,  1991,  filed as
                      Exhibit   10.1   to   the   Registration   Statement   and
                      incorporated herein by reference.


<PAGE>


               10.3   Lease,  dated July 1, 1989, between Harvey Wm. Glasser and
                      Meadowbrook  Neurocare-Kansas  City,  Inc.  and  amendment
                      (with lease  guaranty by the Company)  dated July 1, 1991,
                      filed as Exhibit 10.5 to the  Registration  Statement  and
                      incorporated herein by reference.

               10.4   Amendment To Lease,  dated January 1, 1992, between Harvey
                      Wm. Glasser and Meadowbrook  Neurocare-Kansas  City, Inc.,
                      filed as Exhibit 10.15 to the  Registration  Statement and
                      incorporated herein by reference.

               10.5   Fourth Amendment To Lease,  dated January 1, 1992, between
                      Harvey Wm. Glasser and Meadowbrook  Neurocare-Kansas City,
                      Inc., filed as Exhibit 10.11 to the Registration Statement
                      and incorporated herein by reference.

               10.6   Stock Purchase Agreements,  dated as of April 30, 1994, by
                      and among  Medbrook Corp.  and the named  shareholders  of
                      each of Southpark Rehabilitation,  Inc., Megsis, Inc., The
                      Last Stand, Inc., Soleil,  Inc., Menage A Trois, Inc., 1st
                      Coast  Physical  Therapy,  Inc.,  and  Southpark  Physical
                      Therapy,  Inc.,  filed  as  Exhibit  2.1 to the  Company's
                      current  report  on  Form  8-K  dated  May  11,  1994  and
                      incorporated herein by reference.

               10.7   Earnout  Agreement,  dated as of April  30,  1994,  by and
                      among  MedBrook   Corp,   Lynne  W.  Powell  and  Mark  W.
                      Adukiewicz,  filed as Exhibit 2.2 to the Company's current
                      report  on Form 8-K dated  May 11,  1994 and  incorporated
                      herein by reference.

               10.8   Earnout  Agreement,  dated as of April  30,  1994,  by and
                      among  MedBrook  Corp.,  Lynne W. Powell and  Elizabeth A.
                      Norton,  filed as  Exhibit  2.3 to the  Company's  current
                      report  on Form 8-K dated  May 11,  1994 and  incorporated
                      herein by reference.

               10.9   Amended and  Restated  Earnout  Agreement,  dated June 26,
                      1995, by and among  Medbrook  Corp.,  Lynne  Powell,  Mark
                      Adukiewicz, James Powell and Beth Norton, filed as Exhibit
                      10.10  to  the  1995  10-K  and  incorporated   herein  by
                      reference.

               10.10  Lease  Agreement,  dated  December 28, 1994,  by and among
                      Meadowbrook  Hospital,  Inc. and Dr.  Harvey Wm.  Glasser,
                      filed as Exhibit  10.11 to the 1995 10-K and  incorporated
                      herein by reference.

               10.11  Management  Agreement  dated  June 1,  1995,  by and among
                      Meadowbrook  Rehabilitation  Group of  Georgia,  Inc.  and
                      Parkway Medical Center, filed as Exhibit 10.12 to the 1995
                      10-K and incorporated herein by reference.

               10.12  Amendment to lease,  dated December 28, 1994, by and among
                      Meadowbrook Hospital,  Inc., North Lake Investors, LLC and
                      Dr. Harvey Wm. Glasser, filed as Exhibit 10.13 to the 1995
                      10-K and incorporated herein by reference.
<PAGE>

               10.13  Agreement for Sale of Lease,  dated  December 28, 1994, by
                      and  among  Meadowbrook  Hospital,  Inc.  and  North  Lake
                      Investors,  LLC,  filed as Exhibit  10.14 to the 1995 10-K
                      and incorporated herein by reference.

               10.14  Lease  Agreement dated December 31, 1994, by and among Dr.
                      Harvey Wm.  Glasser and  Meadowbrook  Hospital,  Inc.  and
                      Meadowbrook  Rehabilitation  Group, Inc., filed as Exhibit
                      10.16  to  the  1995  10-K  and  incorporated   herein  by
                      reference.

               21.1   Subsidiaries of the Company.

               23.1   Consent of Arthur  Andersen  LLP (see Page 31 of this Form
                      10-K).

               24.1   Power of Attorney (see Page 30 of this Form 10-K).

               27.1   Financial Data Schedule.

    (b)        Reports on Form 8-K:

               None.

<PAGE>


                                   SIGNATURES

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


DATE:    May 6, 1997               MEADOWBROOK REHABILITATION GROUP,
                                   INC.

                                   By  HARVEY WM. GLASSER, M.D.
                                       ---------------------------
                                       Harvey Wm. Glasser, M.D.
                                       Chief Executive Officer and
                                       President

                                POWER OF ATTORNEY

     KNOW ALL  PERSONS  BY THESE  PRESENTS,  that each  person  whose  signature
appears  below   constitutes  and  appoints   HARVEY  WM.   GLASSER,   M.D.  his
attorney-in-fact,  with  full  power  of  substitution,  for  him in any and all
capacities,  to sign any  amendments to this Report on Form 10-K and to file the
same, with exhibits  thereto and other documents in connection  therewith,  with
the Securities and Exchange Commission, hereby ratifying and confirming all that
said attorney-in-fact,  or his substitute or substitutes,  may do or cause to be
done by virtue hereof.

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

         Signature                    Title                         Date
         ---------                    -----                         ----
HARVEY WM. GLASSER, M.D.      Chief Executive Officer,               May 6, 1997
------------------------      President   and  Treasurer
Harvey Wm. Glasser, M.D.      (Principal Executive Officer)
                                

JAMES F. MURPHY               Vice President and                     May 6, 1997
------------------------      Chief Financial Officer
James F. Murphy               (Principal Accounting Officer
                              and Principal Financial Officer)
                     
KENNETH BARBER                Director                               May 6, 1997
------------------------
Kenneth Barber

ROBERT RUSH                   Director                               May 6, 1997
------------------------
Robert Rush

EDWARD STOLMAN                Director                               May 6, 1997
------------------------
Edward Stolman



<PAGE>


                     MEADOWBROOK REHABILITATION GROUP, INC.
                                AND SUBSIDIARIES

                        CONSOLIDATED FINANCIAL STATEMENTS
                          AS OF JUNE 30, 1995 AND 1996
                         TOGETHER WITH AUDITORS' REPORT



<PAGE>



                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS



To the Stockholders of
Meadowbrook Rehabilitation Group, Inc.:

We have audited the  accompanying  consolidated  balance  sheets of  Meadowbrook
Rehabilitation  Group, Inc. (a Delaware corporation) and subsidiaries as of June
30,  1995 and 1996,  and the  related  consolidated  statements  of  operations,
stockholders'  equity and cash  flows for each of the three  years in the period
ended  June  30,  1996.  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 the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated  financial statements referred to above present
fairly,  in  all  material  respects,  the  financial  position  of  Meadowbrook
Rehabilitation  Group,  Inc. and  subsidiaries as of June 30, 1995 and 1996, and
the results of their operations and their cash flows for each of the three years
in the  period  ended June 30,  1996,  in  conformity  with  generally  accepted
accounting principles.

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





                                                             ARTHUR ANDERSEN LLP
San Francisco, California
September 10, 1996
(except with respect to
the matters discussed in
Note 12, as to which the
date is May 6, 1997.)


<PAGE>
<TABLE>
<CAPTION>

                     MEADOWBROOK REHABILITATION GROUP, INC. AND SUBSIDIARIES

                      CONSOLIDATED BALANCE SHEETS - JUNE 30, 1995 AND 1996


                                              ASSETS

                                                                         1995            1996
                                                                    -------------    -----------
<S>                                                                   <C>             <C>       
   CURRENT ASSETS
      Cash and cash equivalents                                       $6,307,307      $3,439,440
      Restricted cash                                                    500,000         311,000
      Patient accounts receivable, less
          allowance for doubtful accounts of
          $2,001,000 and $1,445,000 respectively                       4,063,945       4,738,957
      Due from intermediaries                                            614,003         331,918
      Income tax refund receivable                                       170,000         140,362
      Other receivables                                                  264,482       1,264,444
      Prepaid expenses and other assets                                  285,463         376,898
                                                                     ------------    ------------ 
                      Total current assets                            12,205,200      10,603,019
                                                                     ------------    ------------ 
   PROPERTY AND EQUIPMENT, at cost:
      Land and building                                                  683,770         683,770
      Furniture and equipment                                          2,683,870       2,993,965
      Leasehold improvements                                             587,213         783,614
                                                                     ------------    ------------ 
                                                                       3,954,853       4,461,349
      Less accumulated depreciation                                   (1,636,309)     (2,095,193)
                                                                     ------------    ------------ 
           Net property and equipment                                  2,318,544       2,366,156
                                                                     ------------    ------------ 
   OTHER ASSETS
      Goodwill and intangible assets                                   1,780,679       1,870,555
                                                                     ------------    ------------ 
                      Total assets                                   $16,304,423     $14,839,730
                                                                     ============    ============ 

                      LIABILITIES AND STOCKHOLDERS' EQUITY

   CURRENT LIABILITIES
      Short-term borrowings and current maturities of notes payable     $725,229        $657,724
      Current maturities of capital lease obligations                     18,601          32,803
      Accounts payable                                                 1,213,083       1,226,053
      Accrued payroll and employee benefits                              905,196       1,101,168
      Other accrued liabilities                                        1,632,579       1,065,820
                                                                     ------------    ------------ 
                     Total current liabilities                         4,494,688       4,083,568
                                                                     ------------    ------------ 
   LONG-TERM LIABILITIES
      Capital lease obligations                                           --              21,815
      Notes payable and other long-term liabilities                    1,074,230         636,255
                                                                     ------------    ------------ 
                    Total long-term liabilities                        1,074,230         658,070
                                                                     ------------    ------------ 
                    Total liabilities                                  5,568,918       4,741,638
                                                                     ------------    ------------ 
   MINORITY INTEREST IN EQUITY OF
      CONSOLIDATED SUBSIDIARIES                                           58,774          11,665
                                                                     ------------    ------------ 

   STOCKHOLDERS' EQUITY
     Common stock, $.01 par value -
         Class A; 15,000,000 shares authorized;
             1,157,662 and 1,157,244 shares issued and
            outstanding at June 30, 1995 and 1996 respectively            11,577          11,572
         Class B; 5,000,000 shares authorized;
             773,000 shares issued and outstanding
             at June 30, 1995 and 1996                                     7,730           7,730
     Paid-in-capital                                                  17,908,117      17,908,122
     Retained deficit                                                 (7,250,693)     (7,840,997)
                                                                     ------------    ------------ 
                    Total stockholders' equity                        10,676,731      10,086,427
                                                                     ------------    ------------ 
                    Total liabilities and stockholders' equity        16,304,423     $14,839,730
                                                                     ============    ============ 


<FN>

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

</FN>
</TABLE>

<PAGE>

<TABLE>
<CAPTION>


                        MEADOWBROOK REHABILITATION GROUP, INC. AND SUBSIDIARIES

                                  CONSOLIDATED STATEMENTS OF OPERATIONS

                           FOR THE YEARS ENDED JUNE 30, 1994, 1995 AND 1996

                                                              1994             1995               1996
                                                          ------------     ------------      ------------
<S>                                                       <C>              <C>               <C>           
     NET OPERATING REVENUES                               $18,051,614      $19,973,613       $23,622,560   

     OPERATING EXPENSES:
           Salaries and employee benefits                  11,106,803       12,036,473        15,189,173   
           Professional fees and purchased services         3,724,439        3,023,225         2,509,166   
           Provision for doubtful accounts                  1,098,744        1,371,151           583,661   
           Other operating expenses                         2,628,991        2,797,809         3,476,400   
           Depreciation and amortization                      478,745          542,890           586,180   
           Rent -
             To unrelated parties                           1,538,738        1,764,617         1,540,634   
             To related parties                               683,915          586,518           412,468
           Restructuring charges                              675,000          310,000               -     
           Write-off of intangible assets                         -          1,029,767               -

                                                          ------------     ------------      ------------
                Total operating expenses                   21,935,375       23,462,450        24,297,682   
                                                          ------------     ------------      ------------
                Loss from operations                       (3,883,761)      (3,488,837)         (675,122)  
                                                          ------------     ------------      ------------
     OTHER (INCOME) EXPENSE:
           Interest (income) expense, net                    (192,700)          25,536          (113,834)  
            Settlement of litigation                         1,437,500              -                -
                                                          ------------     ------------      ------------
                Total other (income) expense                1,244,800           25,536          (113,834)
                                                          ------------     ------------      ------------
                Loss before income taxes                   (5,128,561)      (3,514,373)         (561,288)  
     INCOME TAX BENEFIT                                      (787,313)         (92,890)              -     
                                                          ------------     ------------      ------------
                Loss before minority interest              (4,341,248)      (3,421,483)         (561,288)

     MINORITY INTEREST IN EARNINGS OF
      CONSOLIDATED SUBSIDIARIES                                30,267          107,642            29,016
                                                          ------------     ------------      ------------
                Net loss                                  ($4,371,515)     ($3,529,125)        ($590,304)
                                                          ============     ============      ============
     NET LOSS PER COMMON SHARE                                 ($2.26)          ($1.82)           ($0.31)
                                                          ============     ============      ============
     WEIGHTED AVERAGE COMMON AND COMMON
       EQUIVALENT SHARES OUTSTANDING                        1,938,551        1,936,703         1,930,349 
                                                          ============     ============      ============



<FN>
     The  accompanying   notes  are  an  integral  part  of  these  consolidated
statements.
</FN>
</TABLE>

<PAGE>

<TABLE>
<CAPTION>

                                       MEADOWBROOK REHABILITATION GROUP, INC. AND SUBSIDIARIES

                                              CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

                                             FOR THE YEARS ENDED JUNE 30, 1994, 1995 AND 1996




                                            Class A                  Class B
                                   ----------------------     -------------------
                                                                                                        Retained          Total
                                      Shares       Amount       Shares    Amount        Paid-in         Earnings      Stockholders'
                                                                                        Capital        (Deficit)         Equity
                                   ----------------------     -------------------    ------------     ------------    ------------
<S>                                <C>           <C>           <C>        <C>        <C>                <C>           <C>        
   BALANCE, JUNE 30, 1993          1,025,078     $10,250       925,000    $9,250     $18,051,306        $649,947      $18,720,753

    Common stock issuance upon
        option exercise                3,375          34          -          -             1,839            -               1,873
    Repurchase of shares             (17,708)       (177)         -          -          (102,327)           -            (102,504)
    Conversion of Class B to 
        Class A                      152,000       1,520      (152,000)   (1,520)           -               -                -
    Net loss                             -           -            -          -              -         (4,371,515)      (4,371,515)
                                 ------------------------     -------------------    ------------     ------------    ------------
   BALANCE, JUNE 30, 1994          1,162,745      11,627       773,000     7,730      17,950,818      (3,721,568)      14,248,607

    Common stock issuance upon
        option exercise                2,250          23          -          -             1,226            -               1,249
    Repurchase of shares              (7,333)        (73)         -          -           (43,927)           -             (44,000)
    Net loss                             -            -           -          -              -         (3,529,125)      (3,529,125)
                                 ------------------------      ------------------    ------------     ------------    ------------
   BALANCE, JUNE 30, 1995          1,157,662      11,577        773,000    7,730      17,908,117      (7,250,693)      10,676,731

         Cancellation of shares         (418)         (5)          -         -                 5            -                -
         Net loss                        -            -            -         -              -           (590,304)        (590,304)
                                  -----------------------      ------------------    ------------     ------------    ------------
   BALANCE, JUNE 30, 1996          1,157,244     $11,572        773,000   $7,730     $17,908,122     ($7,840,997)     $10,086,427
                                  =======================      ==================    ============    ============     ============

<FN>

The accompanying notes are an integral part of these consolidated statements.
</FN>

</TABLE>
<PAGE>

<TABLE>
<CAPTION>

                                   MEADOWBROOK REHABILITATION GROUP, INC. AND SUBSIDIARIES

                                            CONSOLIDATED STATEMENTS OF CASH FLOWS

                                      FOR THE YEARS ENDED JUNE 30, 1994, 1995 AND 1996

                                                                                       1994            1995              1996
                                                                                  ------------     ------------       ----------
<S>                                                                               <C>              <C>                <C>       
CASH FLOWS FROM OPERATING ACTIVITIES:
    Net loss                                                                      ($4,371,515)     ($3,529,125)       ($590,304)
    Adjustments to reconcile net loss to cash provided by
     (used for) operating activities -
         Depreciation and amortization                                                478,745          542,890          586,180
         Loss on disposal of assets                                                   176,976           33,592            8,122
         Minority interest expense                                                        -                -             29,016
         Write-off of intangible assets                                                   -          1,029,767              -
         Changes in assets and liabilities -
            Decrease (increase) in patient accounts receivable, net                 1,184,995        2,345,398         (675,012)
            Decrease (increase) in due from intermediaries                           (115,209)       1,579,372          282,085
            Decrease (increase) in income tax refund receivable                      (646,276)       1,908,244           29,638
            Decrease in notes receivable from related parties                          97,629              -                -
            (Increase) in other receivables                                           (54,100)        (161,555)        (999,962)
            Decrease (increase) in prepaid expenses and other current assets          211,973          108,892          (91,435)
            Decrease in deferred income taxes                                       1,358,779              -                -
            Decrease in other long-term assets                                        184,773              -                -
            Increase (decrease) in accounts payable and accrued liabilities          (696,067)         217,834         (357,817)
            (Decrease) in other long-term liabilities                                  (8,282)             -           (221,897)
                                                                                  ------------     ------------      -----------

            Cash provided by (used for) operating activities                       (2,197,579)       4,075,309       (2,001,386)
                                                                                  ------------     ------------      -----------

CASH FLOWS FROM INVESTMENT ACTIVITIES:
         Additions to property and equipment                                         (204,816)        (359,129)        (556,705)
         Purchase of outpatient clinics                                              (608,000)      (1,056,604)         (82,500)
         Payments on prior purchase of outpatient clinics                                 -                -           (357,543)
         Costs resulting from purchase of outpatient facilities                      (202,088)        (167,447)         (40,000)
         Proceeds from sale of assets                                                  49,636            1,950           23,431
                                                                                   -----------     ------------     ------------

            Cash used for investment activities                                      (965,268)      (1,581,230)      (1,013,317)
                                                                                   -----------     ------------     ------------

CASH FLOWS FROM FINANCING ACTIVITIES:
      Short-term borrowings                                                           142,646          325,840          791,942
      Payments of short-term borrowings                                              (317,640)        (166,714)        (759,816)
      Long-term borrowings                                                                -                -             95,198
      Payments of long-term debt                                                          -            (40,631)         (53,364)
      Payments of capital lease obligations                                          (101,403)         (70,360)         (40,003)
      Decrease (increase) in cash deposited to secure a loan                              -           (500,000)         189,000
      Repurchase of common stock                                                     (102,504)             -                -
      Issuance of common stock for options exercised                                    1,873            1,249              -
      Payments to minority shareholders                                               (44,250)         (90,000)         (76,121)
                                                                                   -----------     ------------     ------------

         Cash provided by (used for) financing activities                            (421,278)        (540,616)         146,836
                                                                                   -----------     ------------     ------------

         Net increase (decrease) in cash                                           (3,584,125)       1,953,463       (2,867,867)

CASH AND CASH EQUIVALENTS, beginning of period                                      7,937,969        4,353,844        6,307,307
                                                                                   -----------     ------------     ------------

CASH AND CASH EQUIVALENTS, end of period                                           $4,353,844       $6,307,307       $3,439,440
                                                                                   ===========     ============     ============


SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
      Noncash activities -
         Property additions financed with capital leases                              $17,505       $     -            $76,020
         Property additions financed with notes payable                                   -               -            114,098
         Liability resulting from purchase of outpatient facilities                   670,683        1,743,319         186,692
         Stock received as repayment of receivable from related party                     -             44,000            -
      Payments -
         Interest paid                                                                 41,282          179,567          44,881
         Income taxes paid                                                                -               -             32,492



<FN>
     The  accompanying   notes  are  an  integral  part  of  these  consolidated
statements.

</FN>

</TABLE>
<PAGE>


             MEADOWBROOK REHABILITATION GROUP, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                  JUNE 30, 1996

1.  ORGANIZATION AND OPERATIONS:

     Meadowbrook  Rehabilitation Group, Inc.  (Meadowbrook) and its subsidiaries
(collectively,  the Company)  develop and operate  facilities  for patients with
varying medical diagnoses. The Company provides outpatient rehabilitation,  home
health services, acute, subacute and post-acute care to these patients.

     The Company  experienced  significant  operating losses during fiscal years
1994, 1995 and 1996.  Factors  contributing to fiscal 1996 results include among
other  things,  losses  incurred at the  Company's  recently  acquired  Colorado
facilities,  as well as decreased  patient census and revenue per patient day in
the Company's acute, subacute and post-acute facilities.

     Major factors contributing to fiscal 1995 losses included,  among others, a
continued  deterioration  in patient  census and  revenue per patient day at the
Company's acute,  subacute and post-acute  facilities and a charge of $1,029,767
to write-off  intangible  assets recorded as part of the fiscal 1994 acquisition
of its  Florida  operations.  The  write-off  is  the  result  of the  Company's
management  contracts  at five  facilities  being  terminated  (see Note 10). In
addition,  the Company recorded a charge of $700,000 to write-off two litigation
receivables  in which  the  patients  were  unsuccessful  in their  third  party
litigation (see Note 3). In addition, the Company recorded restructuring charges
of $310,000  related to the closure of its psychiatric  partial  hospitalization
program. The program was closed on September 22, 1995 (see Note 2).

     Major  factors   contributing  to  fiscal  1994  losses  were  a  continued
deterioration  in patient  census and revenue  per patient day at the  Company's
acute, subacute and post-acute facilities and a charge of $1,437,500 to settle a
lawsuit  brought  against  the  Company in February  1993.  The lawsuit  alleged
violations  of  securities  laws  arising out of an alleged  failure to disclose
information  about the  Company's  financial  results and business  prospects in
connection  with the Company's  initial  public  offering in February  1992, and
thereafter  (see Note 11).  In  addition,  the  Company  recorded  restructuring
charges of $675,000 related to the closure of its Arlington, Texas facility (see
Note 2) and additional charges for its San Jose,  California  facility which was
closed during fiscal 1994.

     The  Company's  future  profitability  is dependent on a number of factors,
including  increased  patient  census and  revenues  in its  traditional  acute,
subacute and post-acute  businesses and improved  profitability  of its Colorado
outpatient rehabilitation clinics and home health agencies, as well as a further
reduction  in the  Company's  expenses as a  percentage  of its total  operating
revenues.  There can be no assurance as to the Company's  future  profitability.
The  Company's  continued  operating  losses  have  substantially   reduced  its
available  working capital.  While the Company believes that its working capital
will be sufficient to sustain the  Company's  needs for the next twelve  months,
the Company's ability to continue to fund its operations thereafter is dependent
on the Company  achieving  profitability  and positive cash flows from operating
activities. The Company has a $1,000,000 bank line-of-credit which would require
a $500,000 bank deposit if drawn (see Note 3). Otherwise,  the Company currently
does not have access to additional  capital.  There can be no assurance  that in
the  future  the  Company  will not  experience  a shortage  of  available  cash
necessary to operate its business.

     As a result of the Company's continued losses, the Board of Directors is in
the process of evaluating the Company's  strategic  direction and  alternatives.
The alternatives under consideration by the Board include, among other things, a
merger  or other  business  combination  and  sales of  assets.  There can be no
assurance that any such alternatives will be available on favorable terms, if at
all.

     Harvey Wm. Glasser, M.D., the Company's majority stockholder, has indicated
his view that the  Company's  business  should  not  necessarily  be  limited to
medical  rehabilitation or the healthcare field generally and that, if presented
with an appropriate opportunity,  the Company should consider investing proceeds
from any asset sales in non-healthcare  businesses.  As a result,  the nature of
the Company's business could change significantly.  Dr. Glasser holds a majority
of the combined  voting power of the  Company's  two classes of common stock and
accordingly  has the  ability  to effect a change in  management  or to cause or
prevent a significant corporate transaction.

<PAGE>

2. OPERATING CHARGES AND RESTRUCTURING:

     During fiscal years 1994 and 1995 the Company's  operating results included
charges related to the Company's corporate  restructuring  involving  management
changes,  reductions in work force and the closure or sale of certain facilities
and  lines  of  business  as  described   below.   Costs   associated  with  the
restructuring  are  segregated  in the  accompanying  consolidated  statement of
operations and include the following:

<TABLE>
<CAPTION>

                                                       1994            1995  
                                                    ----------    ---------- 
<S>                                                 <C>           <C>        
Severance costs                                     $  64,000     $  21,000  
Future lease obligations for closed or sold
facilities:
     Related party                                    177,000            --  
     Other                                             77,000         9,000  
Future operating losses during shut-down period
     for closed facilities                            114,000        71,000  
Write-off of unrealizable assets                      208,000       139,000  
Other                                                  35,000        70,000  
                                                    ==========    ========== 
                                                    $ 675,000     $ 310,000  
                                                    ==========    ========== 

</TABLE>

Facility Closures

Indianapolis

     During  fiscal 1995 the Company  internally  developed,  through its wholly
owned subsidiary,  Medbrook of Indiana,  a psychiatric  partial  hospitalization
program which provided  psychiatric  services in long-term care  facilities.  In
June 1995, the Company decided to close the psychiatric partial  hospitalization
program.  The program was closed on September 22, 1995.  The Company  recorded a
restructuring charge of $310,000, as of June 30, 1995, related to the closure of
the program.

Arlington  

     In June 1994,  the  Company  decided to close its  post-acute  facility  in
Arlington, Texas and closed the facility in September 1994. The Company recorded
a  restructuring  charge during fiscal 1994 of $350,000  related to the facility
closure.

San Jose

     During the first  quarter of fiscal 1994,  the Company  closed its subacute
program in San Jose,  California.  On December  27,  1994,  the Company sold its
lease for the San Jose facility to an  investment  partnership.  The  investment
partnership's  rent obligation  commenced on February 15, 1995. This partnership
in turn subleases the facility to a third party.  The Company remains  obligated
to make lease payments in the event that the investment  partnership defaults on
its  obligations  under the lease.  Because the investment  partnership has made
substantial improvements to the facility, the Company does not anticipate such a
default.  The Company recorded a restructuring charge of $325,000 in fiscal 1994
related to the facility closure.

<PAGE>

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Consolidation

     The consolidated  financial  statements include the accounts of Meadowbrook
and its  subsidiaries.  All significant  intercompany  accounts and transactions
have been eliminated.

Cash, Cash Equivalents and Restricted Cash

     The Company  considers all highly liquid debt  instruments with an original
maturity of three months or less to be cash  equivalents.  In 1995,  the Company
deposited  $500,000  to  secure a bank  loan of  $900,000  made by a bank to the
previous owner of the acquired  Colorado  operations.  The Company is overseeing
the repayment of the loan through the  collection of accounts  receivable  which
are being  collected on behalf of the previous  owner.  The loan balance on June
30, 1996 was $251,000.  The Company has not recorded this amount as a liability,
but reflects a corresponding  amount as restricted cash on its balance sheet. As
the loan is paid off,  the  security  deposit  will be  transferred  and  become
security on the Company's  $1,000,000  line-of-credit with the bank. At June 30,
1996, $311,000 of the amount deposited is classified as restricted cash securing
the loan balance of $251,000, as well as, security for the Company's outstanding
balance of $60,000.

Accounts Receivable and Allowance for Doubtful Accounts

     The  reimbursement  process  related to many of the  Company's  patients is
complex and involves  multiple  payors.  In addition,  it has been the Company's
practice to admit selected patients who, although  obligated to pay the Company,
are seeking  monetary  recovery in pending  litigation  with third parties.  The
industry's  trend  towards cost  containment  has imposed  increasing  limits on
reimbursement  which has  resulted  in longer  collection  periods  and, in some
cases, has made ultimate  reimbursement more difficult.  These factors delay the
timing and affect the amount of payment to the Company.

     During the year ended June 30, 1996, the Company  wrote-off net balances of
$1,052,000 of accounts  receivable  compared to $1,395,000 during the year ended
June 30, 1995.  During fiscal 1995 the Company  recorded a charge of $700,000 to
write-off two receivables in which the patients were unsuccessful in their third
party  litigation.  As of June 30,  1995 and 1996,  $1,282,000  and  $1,328,000,
respectively,  of the Company's  accounts  receivable were greater than one year
past due. The Company has recorded  allowances for  uncollectible  accounts that
reflect the best  judgment of management  as to the ultimate  collectibility  of
accounts receivable balances,  but the nature of the reimbursement process makes
these judgments difficult and actual reimbursement could vary significantly from
these estimates.

Patient Revenues and Provision for Contractual Discounts

     Patient  services  are billed at  standard  rates.  Payments  for  services
rendered to private  payors and patients  covered by  commercial  insurance  are
generally negotiated at amounts lower than standard rates. Payments for services
rendered to patients  covered by Medicare and  Medicaid  are  generally at lower
than  standard  rates.  Contractual  allowances  are  recorded  to  reflect  the
difference  between standard rates and expected  reimbursement,  so that patient
accounts  receivable  are  recorded  net of  estimated  discounts.  The  Company
provides care to Medicaid beneficiaries under short-term contracts.

     Final determination of amounts receivable or payable under the Medicare and
Medicaid programs is subject to audit or review by the respective administrative
agencies. Provisions have been recorded for estimated adjustments (see Note 9).



<PAGE>


The following table reflects the estimated percentage of net patient revenues by
payor type:

                                   Year Ended June 30,
                           ----------------------------------
      Source                  1994        1995         1996
                           ---------    ---------    --------

  Private payors .......      81%          67%          59%
  Medicare .............       6%          16%          34%
  Medicaid .............      13%          17%           7%
                           ---------    ---------    --------
  Total ................     100%         100%         100%
                           ---------    ---------    --------

Property and Equipment and Depreciation

     Property and equipment are stated at cost.  Depreciation  and  amortization
are computed using the straight-line  method based on the estimated useful lives
that range as follows:

              Building                    - 20 years
              Furniture and equipment     - 3 to 15 years
              Leasehold improvements      - Life of the lease

Goodwill and Other Intangible Assets

     Goodwill  and other  intangible  assets  recorded  in  connection  with the
Company's acquisitions are amortized on a straight-line basis, over periods of 6
to 40 years.


Long-Lived Assets

     The Company  reviews the carrying value of its  long-lived  assets at least
quarterly to determine if facts and  circumstances  exist which suggest that the
long-lived  assets may be impaired or that the  amortization  period needs to be
modified.  Among the factors the Company  considers in making the evaluation are
changes  in  market   position,   reputation,   profitability   and   geographic
penetration,  as well as  technological  obsolescence.  If there are indications
that the  impairment  is probable,  the Company will prepare a projection of the
undiscounted cash flows of the related operation and determine if the long-lived
asset is  recoverable  based  on such  projected  undiscounted  cash  flows.  If
impairment is indicated,  then an adjustment will be made to reduce the carrying
value of the asset to its fair value.

Net Loss Per Common Share

     Net loss per share is  computed  based on the  weighted  average  number of
common shares outstanding during each period. Net common income per common share
is computed based on the weighted average number of common and common equivalent
shares outstanding during each period and the assumed exercise of dilutive stock
options  (less the number of treasury  shares  assumed to be purchased  from the
proceeds  using the  estimated  average  market price of Class A Common  Stock).
Common equivalent shares consist of stock options and warrants granted.

Use of Estimates

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

4.  SHORT-TERM BORROWINGS AND NOTES PAYABLE:

     At June 30, 1995 and 1996 the Company had notes payable of  $1,479,910  and
$1,196,330,  respectively. These notes are payable in varying installments at an
average  interest  rate of 8.6%.  The notes  payable at June 30,  1996  included
$877,616 arising from its Florida and Colorado outpatient acquisitions (see Note
10).

     Scheduled maturities for the notes payable and other long-term  liabilities
are as follows:

            1997          $   657,724
            1998              310,780
            1999              177,328
            2000              144,658
            2001                3,489
                         ------------
                          $ 1,293,979
                         ============
<PAGE>
5. LEASES:

     The  Company  leases  certain  property  and  equipment  under  capital and
operating  leases.  The original cost of assets under capital leases included in
property and  equipment  is $90,278 at June 30,  1995,  and $165,494 at June 30,
1996, with  accumulated  depreciation of $46,392 and $70,632 as of June 30, 1995
and 1996, respectively.

     The minimum future lease payments  required under the Company's capital and
operating leases during the five years beginning July 1, 1996, are as follows:

                                                       Capital      Operating
                                                       Leases        Leases
                                                      --------     ----------
       Year 1                                         $ 32,803     $1,175,159
       Year 2                                           21,815        885,497
       Year 3                                              --         657,401
       Year 4                                              --         595,326
       Year 5                                              --         435,909
       Thereafter                                          --             -- 
                                                      --------     ----------
       Total minimum payments                           54,618     $3,749,292
                                                                   ===========
       Interest on capital lease obligations               --
                                                      --------
       Net minimum payments                             54,618
       Current maturities of capital obligations        32,803
                                                      --------
       Long-term capital lease obligations            $ 21,815
                                                      ========


6. STOCKHOLDERS' EQUITY:

Common Stock

     The  Company  has Class A and Class B Common  Stock.  Class A Common  Stock
includes the same rights as Class B Common Stock in all respects  except for the
following:

      o  Class B Common  Stock has ten votes per share and Class A Common  Stock
         has one vote per share.

      o  Class B Common Stock is  convertible  1 for 1 into Class A Common Stock
         at any time at the option of the holder.

      o  Class B Common  Stock  automatically  converts to Class A Common  Stock
         when  Class B Common  Stock  represents  less  than  12.5% of the total
         number of votes entitled to be cast in the election of directors.

      o  No  additional  shares of Class B Common  Stock will be issued  without
         prior  approval  of the Class A Common  stockholders  except  for stock
         dividends and stock splits.

Reverse Stock Split

     On April 22, 1996, the Restated Certificate of Incorporation of the Company
was amended to effect a one-for-three reverse stock split of the Company's Class
A and Class B Common Stock.

     The  Company has  retroactively  reflected  the reverse  stock split in the
financial statements for all periods presented.



<PAGE>


Stock Plan

     The 1994 Stock  Incentive  Plan (the  "Plan") was adopted by the  Company's
Board  of  Directors  in  September  1994,  and was  approved  by the  Company's
stockholders  in November  1994. At June 30, 1996, a total of 626,667  shares of
Class A Common Stock were  reserved for issuance  under the Plan pursuant to the
direct  award or sale of shares or the  exercise  of options  granted  under the
Plan.  The Plan is  administered  by a  compensation  committee  of the Board of
Directors of the Company,  which selects the persons to whom shares will be sold
or awarded or to whom  options will be granted.  The  committee  determines  the
number of shares  subject to each sale,  award or grant,  and  prescribes  other
terms and conditions, including vesting schedules, in connection with each sale,
award or grant.

     The exercise price of nonqualified options must be at least 75% of the fair
market value of the Class A Common Stock on the date of the grant.  The exercise
price of incentive  stock  options  (ISOs) cannot be lower than 100% of the fair
market  value of the Class A Common  Stock on the date of the grant and,  in the
case of ISOs  granted to  holders  of more than 10% of the  voting  power of the
Company,  not less than 110% of such fair  market  value.  The term of an option
cannot exceed ten years,  and the term of an option  granted to a holder of more
than 10% of the voting  rights of the Company  cannot  exceed  five  years.  The
purchase  price of shares  sold  under the Plan must be at least 85% of the fair
market  value of the Class A Common  Stock and,  in the case of a holder of more
than 10% of the  voting  power of the  Company,  not less than 100% of such fair
market value.

     Class A Common Stock ISO's outstanding under the Plan are as follows:

                                         Shares           Exercise Price
                                      Under Option              Per Share
                                      ------------     ----------------------

    Outstanding at June 30, 1994         191,008              $0.56-$39.00
                                      ------------
         Granted July 1994                 3,333                      6.00
         Cancelled September 1994         (8,333)                     6.00
         Granted January 1995             33,333                      6.00
         Exercised February 1995          (2,250)                     0.57
         Cancelled February 1995         (18,017)               3.30-18.00
         Cancelled May 1995              ( 6,667)                     5.25
         Cancelled June 1995             ( 3,333)                     6.00
         Granted June 1995                10,000                      6.00
                                      ------------
    Outstanding at June 30, 1995         199,074              $0.56-$39.00
                                      ------------
         Granted September 1995           10,000                      6.19
         Cancelled October 1995          (33,333)                     5.63
         Cancelled October 1995          (33,333)                     6.00
         Granted October 1995             21,667                      3.38
         Cancelled November 1995            (833)                     0.03
         Cancelled November 1995          (1,667)                    39.00
         Cancelled November 1995          (1,667                     21.38
         Cancelled November 1995          (1,575)                     3.33
         Cancelled November 1995          (8,333)                     5.25
         Granted January 1996              6,667                      3.00
         Cancelled January 1996           (6,667)                     3.38
         Cancelled January 1996           (1,667)                     6.00
                                      ============
    Outstanding at June 30, 1996         148,333              $0.56-$39.00
                                      ============

As of June 30, 1996, 60,001 options were exercisable.

     The  exercise  price for options  granted was at least fair market value at
the date of grant.  Options issued under the Plan,  unless otherwise  specified,
vest evenly over a four-year period from the date of grant.

Warrants

     In  February  1992,  the  Company  granted  to each of two  partners  in an
investment banking firm, one of whom was a director of the Company, a warrant to
purchase 25,833 shares of Class A Common Stock at $39 per share.  These warrants
expire in February 1997.


<PAGE>

7. INCOME TAXES:

     The  Company  provides  for  income  taxes  under the  liability  method in
accordance  with  Statement of Financial  Accounting  Standards  (SFAS) No. 109,
"Accounting for Income Taxes".  Under SFAS 109 deferred taxes are provided under
the liability method using current tax rates.

     The  Company  recorded a tax  benefit for the years ended June 30, 1994 and
1995 due to the  availability  of federal and state loss carry backs for tax and
financial reporting purposes.  The tax benefit rate is reduced  significantly in
1994 and 1995 primarily because of limits on available federal tax payments made
in prior years which could be refunded. For fiscal 1996, no benefit was recorded
because  carrybacks of current losses against  previous  taxable earnings are no
longer available.

The following is a summary of the Company's benefit for income taxes:

                                               Year Ended June 30
                             ------------------------------------------------
                                  1994             1995             1996
                             -------------     -------------    -------------
     Current -
       Federal               $ (2,240,583)     $ (92,890)        $        --
       State                           --             --                  --
                             -------------     -------------    -------------
                               (2,240,583)       (92,890)                 --
     Deferred (prepaid) -
       Federal                  1,335,437             --                  --
       State                      117,833             --                  --
                             --------------     ------------    -------------
                                1,453,270             --                  --
                             ==============     =============   =============
     Benefit                 $   (787,313)      $  (92,890)      $        --
                             ==============     =============   =============

     The  deferred  provision  (benefit)  for  income  taxes  results  from  the
following temporary differences:

                                                      Year Ended June 30
                                        ---------------------------------------
                                            1994          1995           1996
                                        -----------    -----------    ---------

     Allowance for doubtful accounts    $  303,501      $ (52,910)    $205,720
     Accrued payables                       57,057         82,276       74,000
     Depreciation                          (22,087)       (10,360)     (37,000)
     Tax loss carry forwards              (183,000)      (695,600)    (117,157)
     Deferred preopening costs             (18,220)          --           --
     Other                                     313           --           --
     Valuation allowance                 1,315,706        676,594     (125,563)
                                        -----------    -----------    ----------
                                        $1,453,270      $    --       $   --
                                        ===========    ===========    ==========



<PAGE>


     The income tax provision  (benefit) is calculated  based upon effective tax
rates  which  differ  from the  federal  statutory  rate.  The  following  table
reconciles the differences between the two rates by amount and percentage:

<TABLE>
<CAPTION>

                                              Year Ended June 30
                          -----------------------------------------------------------
                             1994                 1995                 1996
                          ------------         ------------         ---------
                            Amount        %       Amount       %       Amount     %
                          -----------------------------------------------------------

<S>                       <C>           <C>    <C>           <C>    <C>         <C>  
Federal statutory rate    $(1,743,711)  (34%)  $(1,194,887)  (34%)  $(200,703)  (34%)
State taxes, net of 
  federal effects            (205,160)   (4)      (105,431)   (3)     (17,709)   (3)
Permanent differences          19,000    --        437,185    12       53,280     9
Net operating losses
  not currently benefited   1,315,706    26        676,594    19      165,132    28 
Other                        (173,148)   (3)        93,649     3        --       --
                          ===========================================================
Benefit                   $  (787,313)  (15%)  $   (92,890)   (3%)  $   --       --
                          ===========================================================

</TABLE>

     The deferred  income tax assets  liabilities are comprised of the following
at June 30:

                                                1995               1996
                                           ------------      ------------
      Allowance for doubtful accounts      $   740,370       $   534,650
      Accrued payables                         244,940           170,940
      Depreciation                             128,390           165,390
      Tax loss carry forwards                  878,600           995,757
                                           ------------      ------------
      Net deferred income tax assets         1,992,300         1,866,737
      Less valuation allowance              (1,992,300)       (1,866,737)
                                           ------------      ------------
      Deferred income tax asset            $      --         $      --
                                           ============      ============

8. RELATED PARTY TRANSACTIONS:

     The Company has entered  into  certain  transactions  with parties that are
related by common ownership or control. These transactions are summarized below:

o       The Company  leases and has leased in the past certain  facilities  from
        the  majority  stockholder  of the  Company.  The Company  entered  into
        agreements  to lease these  facilities  for  initial  terms of up to ten
        years.  The Company pays the stockholder a base rental amount per month,
        plus a  percentage  (ranging  from  2-1/2%  to 5%)  of  patient  revenue
        collections  above a defined  threshold.  Rental expense on these leases
        for the years ended June 30, 1994, 1995 and 1996, was $683,915, $586,518
        and  $412,468,  respectively,  of which  $2,012 and $7,577 was unpaid at
        June 30, 1995 and 1996, respectively. All but one of these leases relate
        to facilities that have been either closed or sold (see Note 2).

o       As part of the Company's  initial public  offering,  the Company granted
        certain  directors  an aggregate of 5,000 shares of Class A Common Stock
        in lieu of directors'  fees. The shares vested over a four year  period.
        For the  years  ended  June 30,  1994 and  1995,  the  Company  recorded
        expenses of $104,270 and $27,761, respectively, related to these shares.

o        During  fiscal 1995 the Company  entered into an  agreement  whereby it
         forgave a loan of $44,000 to a former  officer  in  exchange  for 7,333
         shares of Class A Common Stock which had been pledged as security.  The
         Company did not recognize any gain or loss on the transaction.



<PAGE>


9.  COMMITMENTS AND CONTINGENCIES:

Medicare Reimbursement

     The Company's amount due from Medicare  intermediaries  of $332,000 at June
30, 1996  includes  amounts the  Company  anticipates  to receive on cost report
settlements  for its Colorado  home health  agencies  acquired on June 30, 1995.
Such amount also includes amounts the Company expects to receive upon regulatory
approval of the Company's  annual  application for an exception from the routine
cost limitation ("RCL") under the Medicare program for fiscal years 1992 through
1996 for its Gardner, Kansas facility. Medicare reimbursement is generally based
upon  reasonable  direct and  indirect  allowable  costs  incurred in  providing
services.  At the Company's inpatient  facilities these costs are subject to the
RCL. An exception from the RCL has been sought and granted for fiscal years 1990
through 1994 for the Company's former San Jose,  California  facility.  Requests
have been  submitted for fiscal years 1992 through 1995 for the Gardner,  Kansas
facility.  The Company  intends to file such request for its Kansas facility for
fiscal 1996. The requests are based upon atypical costs incurred at the Gardner,
Kansas  facility,  in the treatment of patients who receive  substantially  more
intensive  services  than  those  generally  received  in SNFs.  There can be no
assurance  that the Company will collect in full the amounts it has requested or
intends to request,  nor can there be an  assurance as to the timing of any such
collection. An initial three year "exemption" from the RCL expired in June 1989,
at the San Jose,  California facility and in June 1990, at the Gardner,  Kansas
facility.

10.  ACQUISITIONS:

Colorado Outpatient Clinics and Home Health Agency Acquisition

     On June 30,  1995 the Company  acquired  eleven  outpatient  rehabilitation
clinics in Colorado, three outpatient  rehabilitation clinics in Alaska and home
health agencies with operations in Colorado,  New Mexico and Kansas. The Company
paid  $133,000  and  incurred  liabilities  of $572,000 in  connection  with the
purchase.  The Company  also  agreed to make  additional  payments  based on the
earnings  performance  of the  outpatient  rehabilitation  clinics  and the home
health  agencies.  Based on results  for the year ended June 30,  1996,  no cash
payment is required for the twelve months ending June 30, 1996.  The  additional
cash payments would total $825,000 if the  operations  collectively  achieve the
target  earnings  thresholds  for the twelve months ending June 30, 1997 through
1999.

     In addition,  in connection  with the  acquisition,  the Company  agreed to
deposit  $500,000 to secure a $900,000  bank loan to the  previous  owner of the
acquired businesses. The Company is overseeing the repayment of the loan through
the collection of accounts receivable which are being collected on behalf of the
previous owner. At the time of the acquisition, the Company anticipated that the
loan would be repaid based on the accounts  receivable balance then outstanding.
The loan  balance on June 30,  1996 was  $251,000.  The  Company did not acquire
accounts   receivable  in  connection   with  the  acquisition  and  has  funded
approximately  $1,447,000 of working capital for the acquired  operations  since
the date of acquisition.

     In October  1995 the Company  was  notified  by its  intermediary  that its
Medicare  payments for the recently  acquired  home health  agencies  were being
withheld to offset amounts due by the previous owner for final settlement of the
home health  agencies' cost reports for the years 1990 through 1994.  During the
twelve months ending June 30, 1996, the intermediary  withheld  $728,000 related
to these  settlements.  This  amount is  included  in other  receivables  on the
Company's  balance  sheet.  The Company and the  previous  owner have  submitted
appeals to these  settlements  and are  currently  awaiting a response  from the
intermediary.  In the event that the  appeals of the prior owner and the Company
are unsuccessful, the Company intends to offset the amounts withheld against any
additional  amounts due to the previous owner under the acquisition  agreements.
The  intermediary  resumed making payments to the Company for current charges in
January 1996.
<PAGE>

Florida Outpatient Clinics Acquisition

     During fiscal 1994, the Company acquired a majority interest in or obtained
management contracts to operate nine outpatient  rehabilitation  clinics located
in Jacksonville,  Jacksonville Beach, Orange Park, St. Augustine,  St. Augustine
Beach, Palm Coast and Palatka, Florida and in Moultrie, Georgia. At closing, the
Company paid $608,000,  agreed to reimburse  certain  selling  shareholders  for
accounts  receivable of the acquired  clinics  collected after the closing,  and
agreed to make additional payments based on the earnings  performance of certain
clinics in each year during the three year period ending March 31, 1997.

     The following summary, prepared on a proforma basis, combines the unaudited
consolidated  results  of the  Company's  operations  as if the nine  outpatient
clinics had been  acquired as of the  beginning of the period  presented,  after
including  the  impact  of  certain   adjustments,   such  as:  amortization  of
intangibles,  increased  interest expense on the acquisition  debt, the minority
interest in  earnings  of  consolidated  subsidiary  and the related  income tax
effects.

                                                           Year Ended June 30,
                                                                  1994
                                                              (unaudited)
                                                           -----------------
Net operating revenue                                         $19,856,806
Net loss before minority interest                              (3,803,326)
Minority interest in earnings of consolidated subsidiary          177,679
Net loss                                                       (3,981,005)
Net loss per share                                            $      2.05


     The proforma results are not necessarily  indicative of what actually would
have  occurred  if the  acquisition  had been in effect for the  entire  periods
presented.  In  addition,  they are not  intended to be a  projection  of future
results and do not reflect any  synergies  that might be achieved  from combined
operations.

     On October 1, 1994,  the Company  acquired the minority  interest in two of
the outpatient  clinics referred to above. In connection with such  acquisition,
the Company paid  $600,000 and is  obligated  to pay an  additional  $150,000 by
September 30, 1996.

     On February  1, 1995,  the Company  acquired an  outpatient  clinic in Palm
Coast,  Florida. At June 30, 1996, the Company had paid $138,000 of the purchase
price  and  was  obligated  to pay  an  additional  $122,000  in  equal  monthly
installments of $3,300 through February 2000.

     On May 12, 1995,  the new owner of five of the Florida  outpatient  clinics
managed by the Company  advised the Company that its  management  contracts were
terminated.  As a result,  during the fourth  quarter of fiscal 1995 the Company
recorded a charge of $1,029,767 to write-off  intangible assets recorded as part
of the fiscal  1994  acquisition.  The  intangible  assets  written-off  include
goodwill and a non-compete  agreement with a physician with whom the Company had
entered into  management  contracts.  The charge is  classified  as an operating
expense.  The Company does not agree that such  contracts may be terminated  and
has filed suit to protect its legal rights.

     Subsequent  to June  30,  1996,  the  Company  paid  $123,442  based on the
earnings  performance  of certain  clinics  and  $19,547 in interest on deferred
acquisition  payments.  At June 30,  1996,  the  Company's  remaining  liability
resulting from the purchase was $510,000,  plus additional payments based on the
earnings  performance of certain clinics.  Such payments would total $135,000 if
the  earnings of such  clinics for the twelve  months  ending March 31, 1997 are
equal to the earnings of such clinics for the base year, the twelve months ended
December 31, 1993.



<PAGE>

11.  LEGAL MATTERS:

Shareholder Litigation

     In February 1993, the Company was named as a defendant in a complaint filed
in the United States District Court for the Northern District of California. Six
current or former  officers  and  directors  of the  Company  were also named as
defendants in this action.  The complaint alleged  violations of securities laws
arising out of an alleged  failure to disclose  information  about the Company's
financial  results and  business  prospects  in  connection  with the  Company's
initial  public  offering  in February  1992,  and  thereafter.  The suit sought
unspecified damages on behalf of an alleged class of investors who purchased the
Company's  Class A Common Stock during the period from February 13, 1992 through
January 6, 1993.

     The  parties to the  shareholder  litigation  settled on May 20,  1994.  In
exchange for the  dismissal  of the  litigation  and pursuant to numerous  other
terms and provisions as set forth in the settlement  agreement,  the Company and
the insurance  carrier for its directors and officers funded a settlement in the
total amount of $2,875,000.  Meadowbrook  recorded a charge of $1,437,500 during
the second quarter of fiscal 1994 for its contribution to this  settlement.  The
Company  funded its  portion of the  settlement  in April  1994.  The  Company's
cumulative  charge  through  June 30,  1994,  relating  to the  defense  of this
litigation was $442,000. The majority of this amount was expensed in fiscal year
1993.

     The  Company's  willingness  to settle this  litigation  was based upon the
anticipated  costs of  defending  the  litigation  and the  desire  to  minimize
disruption of Company operations and management resources, among other factors.

12.  SUBSEQUENT EVENTS:

     The 1995  Statement  of  Operations  has been  reclassified  to include the
write-off of  intangible  assets within  operating  expenses and exclude it from
other expense.

Sale of Georgia Operations

     On March 31, 1997, Meadowbrook Rehabilitation Group, Inc. sold the business
and  assets  of  Meadowbrook   Rehabilitation   Group  of  Georgia,   Inc.  (the
"Subsidiary"),  a wholly owned subsidiary of the Company.  The Company also sold
all of the outstanding  stock of the Subsidiary in a separate  transaction  with
the same purchaser. As part of the transaction,  the Company received $1,250,000
in cash for the sale of the business and assets of the Subsidiary.  In addition,
the  Company  received  $50,000  in cash for the sale of all of the  outstanding
stock of the Subsidiary.  The assets and liabilities sold consisted primarily of
property and  equipment  with a net book value of  approximately  $750,000.  The
Company recognized a gain on the sale of approximately $530,000.

     The following summary, prepared on a proforma basis, combines the unaudited
consolidated  results of the Company's operations as if the sale had occurred at
the  beginning of the period  presented,  after  including the impact of certain
adjustments,  such as: the  elimination  of  operating  results  of the  Georgia
operations,  increased interest income on the proceeds,  increased reimbursement
form Medicare, a reduction in corporate office expenses,  and excluding the gain
on sale.

                                                           Year Ended June 30,
                                                                  1996
                                                              (unaudited)
                                                           -----------------
Net operating revenue                                         $17,738,489
Net loss before minority interest                                (328,076)
Minority interest in earnings of consolidated subsidiary           29,016
Net loss                                                         (357,092)
Net loss per share                                            $     (0.18)


     The proforma results are not necessarily  indicative of what actually would
have occurred if the disposition had occurred on July 1, 1995. In addition, they
are not intended to be a projection of future results.


<PAGE>

                                   SCHEDULE II


            MEADOWBROOK REHABILITATION GROUP, INC. AND SUBSIDIARIES

                       VALUATION AND QUALIFYING ACCOUNTS

                FOR THE YEARS ENDED JUNE 30, 1994, 1995 AND 1996

                                          1994           1995           1996
ALLOWANCE FOR DOUBTFUL ACCOUNTS:       -----------    -----------    ----------

     Balance at beginning of period    $2,711,000     $2,025,000    $2,001,000
     Provision charged to expense       1,098,744      1.381.151       583.661
     Write-offs, net of recoveries     (1,784,744)    (1,395,151)   (1,051,890)
     Other                                 --              --          (87,887)
                                       -----------    -----------   -----------
     Balance at end of period          $2,025,000     $2,001,000    $1,445,000
                                       ===========    ===========   ===========