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

                                    FORM 10-K
(Mark One)

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

                     For the fiscal year ended June 30, 1997

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

             For the transition period from __________ to __________

                             Commission File Number
                                     0-19726

                     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 25, 1997,  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 $2,876,545.  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 25,
1997 was 1,157,244.  The number of shares of Class B Common Stock outstanding on
September 25, 1997 was 773,000.

     Part III of this Form 10-K  incorporates by reference  information from the
Registrant's  proxy  statement  with  respect  to the  1997  Annual  Meeting  of
Stockholders.



<PAGE>


                                TABLE OF CONTENTS
                                                                            Page

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

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

         ITEM 2.       PROPERTIES...........................................  13

         ITEM 3.       LEGAL PROCEEDINGS....................................  15

         ITEM 4.       SUBMISSION OF MATTERS TO A VOTE OF SECURITY
                       HOLDERS..............................................  15

PART II.          ..........................................................  16

         ITEM 5        MARKET FOR REGISTRANT'S COMMON EQUITY AND
                       RELATED STOCKHOLDER MATTERS..........................  16

         ITEM 6.       SELECTED FINANCIAL DATA..............................  17

         ITEM 7.  .....MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                       FINANCIAL CONDITION AND RESULTS OF OPERATIONS........  18

         ITEM 7A.      QUANTITATIVE AND QUALITATIVE DISCLOSURES
                       ABOUT MARKET RISK....................................  27

         ITEM 8.       FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA..........  27

         ITEM 9.       CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
                       ACCOUNTING AND FINANCIAL DISCLOSURE..................  27

PART III.          .........................................................  28

         ITEM 10       DIRECTORS AND EXECUTIVE OFFICERS OF THE
                       REGISTRANT...........................................  28

         ITEM 11.      EXECUTIVE COMPENSATION...............................  28

         ITEM 12.      SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
                       AND MANAGEMENT.......................................  28

         ITEM 13.      CERTAIN RELATIONSHIPS AND RELATED
                       TRANSACTIONS.........................................  28

PART IV.           .........................................................  29

         ITEM 14.      EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND
                       REPORTS ON FORM 8-K..................................  29

SIGNATURES                 .................................................  32



<PAGE>


                                     PART I

ITEM 1    BUSINESS

     Meadowbrook Rehabilitation Group, Inc. (together with its subsidiaries, the
"Company" or  "Meadowbrook"),  sold all of its traditional  acute,  subacute and
post-acute  operations  during fiscal 1997 and subsequent to fiscal year end. In
addition,  subsequent  to fiscal  year end,  the  Company  sold  certain  of its
outpatient   rehabilitation  clinics  in  Florida  and  Georgia.  The  Board  of
Directors'  decision to sell its acute,  subacute and  post-acute  operations as
well as certain of the Company's Florida and Georgia  outpatient  rehabilitation
clinic  operations were due to the poor operating  results from these businesses
as well as poor prospects for growth in their respective markets.  The growth of
these  business  lines was also  limited  by the  Company's  lack of  capital to
execute  internal growth or strategic  acquisitions,  which might have given the
Company the critical mass to compete effectively in these business lines.

     In  October   1996,   the  Company  sold  the  assets  of  its   post-acute
rehabilitation  facility located in Park Ridge,  Illinois.  On January 13, 1997,
the Company sold its three outpatient rehabilitation clinics in Alaska. On March
31,  1997,   the  Company  sold  its  Georgia   operations,   consisting   of  a
neurobehavioral   program,  a  subacute  program  operated  under  a  management
agreement,  a post-acute  program and related real estate.  Subsequent to fiscal
year end, the Company sold the assets of its Kansas  operations.  The  Company's
Kansas operations included an acute program, a subacute program and a post-acute
program.  The Kansas sale  transaction  closed on July 31,  1997.  On August 31,
1997, the Company sold five outpatient  rehabilitation clinics and certain other
assets in Florida and Georgia.  In addition,  the Company  closed six outpatient
rehabilitation clinics in Colorado and Florida during fiscal 1997.

     Following  such closures and  dispositions,  the  operations of the Company
include its home health  agencies with  operations  in Colorado and Kansas,  its
four  outpatient   rehabilitation  clinics  in  Colorado  and  three  outpatient
rehabilitation  clinics (two of which are operated under a management agreement)
in Florida. The Company's recent focus on home health reflects its view that the
home health industry has strong prospects for long-term growth.  Currently,  the
Company  has no plans to  divest  its home  health  business  and is  evaluating
possible opportunities to expand such business. In addition, the Company's Board
of Directors is continuing to evaluate 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.  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  in
non-healthcare  businesses.  As a result,  the nature of the Company's  business
could change significantly.

     The  Company's   outpatient   rehabilitation  and  home  health  businesses
comprised 52% of the  Company's  fiscal 1997 net  operating  revenues  while the
Company's acute, subacute and post-acute business lines, which where sold during
fiscal 1997 and  subsequent  to year end,  comprised  48%.  Descriptions  of the
Company's home health and outpatient  rehabilitation business lines are 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.

Home Health Services

     General.  The Company  operates  home health  agencies  with  operations in
Colorado and Kansas under the name Total Home  Health.  The Company  entered the
home health business because of its experience in acute, subacute and post-acute
healthcare  where there is a growing  trend toward early  discharges of patients
from acute and subacute  treatment  programs.  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 an increasing need
for home health services.

     Industry.  The  importance of home  healthcare is increasing as a result of
significant   economic   pressures   within  the  healthcare   industry.   Total
expenditures  within the healthcare industry have increased at twice the rate of
inflation in recent years.  The ongoing  pressure to contain  healthcare  costs,
while  maintaining  high quality care, is  accelerating  the growth of alternate
site care that reduces hospital  admissions and lengths of hospital stays,  such
as home  healthcare.  Home healthcare is one of the fastest growing  segments of
the healthcare industry.

     The  growth  in home  healthcare  is also due to  increased  acceptance  by
payors, patients and the medical community, including physicians,  hospitals and
other  providers.  Home  healthcare  often  results  in  lower  costs,  which is
increasingly  important  under managed care. In addition,  home  healthcare  has
grown  rapidly  as a result  of  advances  in  medical  technology,  which  have
facilitated  the delivery of services in alternate  sites;  demographic  trends,
such as an aging  population;  and a strong preference among patients to receive
healthcare in their homes.

     Historically,  the home healthcare  industry has been highly fragmented and
characterized  by local  providers that  typically do not offer a  comprehensive
range of  cost-effective  services.  These local providers often do not have the
capital  necessary to expand their operations or the range of services  offered,
which  limits  their  ability to compete for managed  care  contracts  and other
referrals and to realize  efficiencies in their operations.  As managed care has
become more prevalent, payors increasingly are seeking home healthcare providers
that offer a  cost-effective,  comprehensive  range of  services  in each market
served,  which  further  inhibits  the  ability  of local  providers  to compete
effectively.  As a result of these economic and competitive pressures,  the home
healthcare  industry  is  undergoing  rapid  consolidation,  a trend the Company
expects will continue.

     Strategy.  Building on its established presence in Colorado and Kansas, the
Company  seeks to further  enhance its position in these  markets by providing a
full range of cost-effective home healthcare services. To achieve this goal, the
Company intends to more closely  coordinate and monitor patient care through its
own nursing staff and in training its employees, identifying patients' needs and
cross-selling the Company's services.

     The Company  will  consider  opportunities  to expand its  existing  branch
locations,  expand the range of services  offered and  increase  referrals  from
managed  care  organizations.  In  addition,  the Company  will review  selected
acquisition  opportunities  in  the  geographic  region  in  which  the  Company
operates.  Management  believes that by developing a substantial market presence
in its  geographic  region,  the Company will be able to increase its  referrals
from managed care organizations.

     The Company is also targeting  managed care  organizations by stressing its
disease  management  programs for the treatment of HIV/AIDS,  cancer,  and other
chronic illnesses,  and by providing customized outcome and utilization reports.
The Company  expects that managed care  contracts  will  generate an  increasing
number of referrals as the penetration of managed care continues to accelerate.

     Products and Services.  The Company  delivers its services through branches
whose functions include (i) receiving referrals from physicians,  (ii) assessing
a  patient's  needs,  (iii)  determining  the  extent of a  patient's  insurance
coverage and  coordinating  reimbursement  for services,  (iv)  coordinating the
delivery of care to the patient and (v)  supervising the quality of the care the
patient receives.

     Each branch is managed by an administrator  who is responsible for ensuring
the quality of the services  provided by the Company.  Coordinators at each site
work with all of the  professionals  servicing  the patient to ensure the proper
management  of the  patient's  care.  Offering a full  range of home  healthcare
services and  coordinating  that care through its own nursing and therapy  staff
allows the Company to offer cost-effective, high quality services.

     Nursing and Related Patient  Services.  Working closely with each patient's
physician, who develops that patient's plan of treatment, the team of clinicians
at the branch closely monitor the patient's  course of treatment and provide the
physician with regular reports on the patient's status. Prior to the delivery of
home healthcare, a nurse from the local branch assesses the home environment and
helps  determine  the  suitability  of home care and what  services  are needed.
Nurses  continue to visit their  patients as needed to carefully  monitor  their
course of  treatment.  The  Company  offers a broad range of nursing and related
patient services, including:

          Registered nurses who provide a broad range of nursing care, including
          pain management,  infusion therapy, skilled observation and assessment
          and teaching procedures.

          Licensed  practical nurses who perform technical  nursing  procedures,
          such as injections and dressing changes.

          Physical  therapists  who provide  needed  therapies to help  patients
          improve activities of daily living, as well as structured therapies to
          improve mobility and specialized exercise programs.

          Occupational therapists who provide structured therapies for increased
          independence in the patient's daily living.

          Speech  therapists  who  provide  therapies  to  increase a  patient's
          communication  skills and improve  swallowing  techniques  following a
          trauma.

          Social  workers who help  patients  and their  families  deal with the
          concerns that arise from health problems.

          Home health aides who provide assistance,  hourly or around-the-clock,
          with personal care, such as bathing and walking.

          Homemakers/companions   who   assist   with   meal   preparation   and
          housekeeping.


<PAGE>



     Infusion  Therapy  Services.  Infusion  therapies  involve the  intravenous
administration of anti-infective,  chemotherapy, pain management,  nutrition and
other  therapies.  Before accepting a patient for home infusion  treatment,  the
nursing staff at the local branch works closely with the patient's  physician to
assess the patient's suitability for home care. Once it has been determined that
the patient should receive home infusion  therapy,  the nursing staff trains the
patient  and/or  patient's  family  members in the  proper use of home  infusion
therapy  equipment.  The Company  provides the following  home infusion  therapy
services:

          Enteral nutrition which is the infusion of nutrients through a feeding
          tube  inserted  directly into the  functioning  portion of a patient's
          digestive  tract.  This  long-term  therapy  is often  prescribed  for
          patients who are unable to eat or drink normally.

          Antibiotic  therapy  which is the infusion of  antibiotic  medications
          into a patient's  bloodstream  typically to treat a variety of serious
          infections and diseases.

          Total  parenteral  nutrition  which  is  the  long-term  provision  of
          nutrients  through  surgically  implanted  central  vein  catheters or
          through  peripherally  inserted  central  catheters,  for patients who
          cannot   absorb   adequate   nutrients   enterally   due  to   chronic
          gastrointestinal conditions.

          Pain management  which involves the infusion of certain drugs into the
          bloodstream of patients suffering from acute or chronic pain.

          Chemotherapy   which  is  the  infusion  of  drugs  into  a  patient's
          bloodstream to treat various forms of cancer.

          Other therapies including new delivery technologies and medications to
          address a broad range of patient conditions,  such as the side effects
          associated with transplants, HIV/AIDS and cancer.

     Marketing.  The Company  generates  referrals from  physicians,  hospitals,
discharge  planners and other healthcare  professionals.  Recently,  more people
have  enrolled in managed care  organizations  and, as a result,  the  Company's
traditional  referral  base has  changed.  In order to  compete,  the Company is
continuing its program of marketing its services to managed care  organizations.
The Company  competes for  referrals by offering a full range of  cost-effective
home healthcare  services,  a focus on disease  management and a strong regional
presence. The Company believes that its reputation as a cost-conscious  provider
of services positions it favorably among managed care organizations.

     Each  branch  manager  spends  time  marketing  the  Company's  services to
referral and payment sources.  The marketing  techniques employed by the Company
include  direct   solicitation,   direct  mail,   exhibitions  at   professional
conferences and seminars,  submission of proposals for contractual  arrangement,
active  participation  in community  events and ongoing  commitment  to customer
service.

     Corporate  personnel  work  closely  with  each  branch  to  develop  their
abilities to cross-sell the Company's services. The nursing staff assists in the
marketing  effort by helping to educate  referral sources about the services the
Company offers to its specialized patient populations.

     Competition.  The home  healthcare  market  is  highly  competitive  and is
undergoing  both  horizontal  and  vertical  integration.  As a  result  of such
consolidation,  the Company's  competitors include nationwide operators who have
hundreds  of  branches.  Some of the  competitors  include  hospital  chains and
providers of multiple products and services for the home healthcare  market. The
established referral networks of certain of these healthcare providers, combined
with their size and purchasing  power,  make them formidable  competitors to the
Company.  Managed care  organizations,  a referral base crucial to the Company's
success,  may show a preference to deal with these larger,  regional or national
providers, who may offer more services and areas of expertise.

     In addition, there are few barriers to entry in the home healthcare market.
New  competitors  have entered the areas served by the Company and others may do
so in the future. There can be no assurance that such increased competition will
not have a material  adverse  effect on the Company's  operations  and financial
condition.

     The Company  competes on the basis of a number of  factors,  including  the
cost-effectiveness  of its  services,  the  quality  of its  services,  and  its
reputation and regional  focus.  The Company's  focus on disease  management and
emphasis on treating  certain  patient  populations  allows it to  differentiate
itself from its  competitors.  By increasing its regional focus and reducing its
overhead to become a low-cost provider, the Company believes that it can compete
against larger alternate healthcare providers.

Outpatient Rehabilitation Services

     General.  Currently,  the Company  operates four outpatient  rehabilitation
clinics in Colorado and three  outpatient  rehabilitation  clinics (two of which
are operated under a management  agreement) in Florida.  During fiscal 1997, the
Company  closed six outpatient  rehabilitation  clinics in Colorado and Florida.
Subsequent to fiscal year end, the Company sold five  outpatient  rehabilitation
clinics in Florida and Georgia.  See  "Management's  Discussion  and Analysis of
Financial  Condition  and  Results of  Operations".  The  Company  is  currently
considering   possible   opportunities   to   sell   its   Colorado   outpatient
rehabilitation clinics and its remaining Florida operations.

     Products  and  Services.  The Company  delivers  its  services  through its
outpatient  rehabilitation  clinics.  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 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  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.

     Marketing.  The Company's  marketing strategy is to develop a broad base of
referral  sources for its  outpatient  rehabilitation  services on regional  and
local levels. In marketing its services, the Company focuses on the high quality
of its  services  and its  geographic  presence in  Colorado.  The Company  also
emphasizes its outcome oriented approach to rehabilitation.

     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.
The  Company  has secured  contracts  with  numerous  insurance  companies,  and
continues to pursue  contractual  relationships  with payors at the regional and
local level.

     Competition.  The outpatient  rehabilitation industry is 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.

     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 therapists and other skilled
professionals.  Many of the Company's competitors have far greater financial and
personnel resources than the Company.

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

     The Company's outpatient  rehabilitation  business has been affected 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  affected  by the  competitive  pressure  to reduce
healthcare  costs.  An  increase  in the number of  providers  offering  similar
services  resulted  in a  shift  of  patients  to  other  providers,  and  lower
reimbursement rates. These factors contributed to the Company's decision to sell
or close a number of its  outpatient  rehabilitation  clinics during fiscal 1997
and subsequent to fiscal year end. See "Management's  Discussion and Analysis of
Financial Condition and Results of Operations".


<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 business line:

                                                                 Year Ended
                                                                June 30, 1997
                                                             ------------------
                                                               (000's)      %
              Acute, Subacute and Post-Acute Rehabilitation
                 Services...................................   $9,990     48%
              Outpatient Rehabilitation Services ...........    4,541     22%
              Home Health Services..........................    6,303     30%
                                                              -------  -------
              Net Operating Revenues .......................  $20,834    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,
                   ------                  ------------------------------------
                                                    1995   1996  1997
                                                    ----   ----  ----

       Private payors and commercial insurance ....  67%    59%   51%
       Medicare ...................................  16%    34%   41%
       Medicaid ...................................  17%     7%    8%
                                                    ----   ----  ----
             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  negotiated  fixed-rate  contractual   arrangements  with  numerous
individual  patients and third party payors,  including  insurance companies and
managed care providers.  The increase in the percentage of net operating revenue
received  from  Medicare  during  fiscal 1996 and 1997  reflects  the  increased
proportion  of  Medicare  patients  at the  Company's  home  health  agencies in
Colorado and Kansas.

     During  fiscal 1997 and  subsequent to year end the Company sold all of its
acute,   subacute  and   post-acute   facilities  as  well  as  its   outpatient
rehabilitation clinics in Alaska and five outpatient  rehabilitation clinics and
certain other assets in Florida and Georgia. In addition, the Company closed six
outpatient  rehabilitation  clinics in Colorado and Florida  during fiscal 1997.
The Company currently  operates home health agencies with operations in Colorado
and  Kansas,  four  outpatient  rehabilitation  clinics  in  Colorado  and three
outpatient  rehabilitation clinics (two of which are operated under a management
agreement) in Florida.  See  "Management's  Discussion and Analysis of Financial
Condition and Results of Operations".


<PAGE>



     The  following  table  sets  forth  the  percentage  of the  Company's  net
operating  revenues for fiscal 1997 assuming that the  dispositions  referred to
above had taken place at the beginning of fiscal 1997:


                                                           Year Ended
                                                            June 30,
                               Source                         1997
                               ------                      ----------

              Private payors and commercial insurance ....     21%
              Medicare ...................................     67%
              Medicaid....................................     12%
                                                           ----------
                         Total............................    100%
                                                           ==========


     During fiscal 1997, the Company provided inpatient and outpatient  services
to  Medicare  patients  at  several  of its  facilities  and in its home  health
business.  The Medicare program  generally  utilizes a cost-based  reimbursement
system for rehabilitation  services under which home health agencies,  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.

     The Company has applied for an exception from such cost ceilings for fiscal
years 1992 through 1995 for its former Gardner, Kansas facility. The Company did
not  transfer  accounts  receivable  in  connection  with the sale of its Kansas
operations. Accordingly the Company intends to file such requests for the Kansas
facility for fiscal years 1996 and 1997.  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".

     Cost-based  reimbursement is generally  subject to retrospective  audit and
adjustment. In conducting annual reviews of a facility's or home health agency'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.

Regulation

     The healthcare industry is subject to substantial federal,  state and local
government  regulation.  These  regulations  affect  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 and programs  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.

     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 affect
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.

     The  Company's  Colorado  and Kansas home health  agencies and its Colorado
outpatient  rehabilitation  clinics are certified to participate in Medicare. 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  is also  subject to  federal  and state  fraud and abuse laws
prohibiting  direct or  indirect  payments  for patient  referrals,  prohibiting
referrals to an entity in which the referring provider has a financial interest,
and regulating reimbursement  procedures and practices under Medicare,  Medicaid
and state programs as well as in relation to private  payors.  While the Company
believes  that it is in material  compliance  with such laws,  it  continues  to
monitor its compliance.

     The  anti-kickback  provisions of the federal Medicare and Medicaid Patient
and Program  Protection Act of 1987 (the  "Anti-kickback  Statute") prohibit the
offer,  payment,  solicitation or receipt of any  remuneration in return for the
referral of items or services paid for in whole or in part under the Medicare or
Medicaid programs (or certain other state healthcare programs).  To date, courts
and government agencies have interpreted the Anti-kickback Statute to apply to a
broad range of financial  relationships  between providers and referral sources,
such as physicians  and other  practitioners.  The United  States  Department of
Health and Human  Services has adopted  regulations  creating "safe harbors" for
federal  criminal  and  civil  penalties  under  the  Anti-kickback  Statute  by
exempting certain types of ownership interests and other financial  arrangements
that do not appear to pose a threat of Medicare and Medicaid program abuse.

     Transactions  covered by the Anti-kickback Statue that do not conform to an
applicable  safe harbor are not  necessarily  in violation of the  Anti-kickback
Statute,  but the  practice  may be subject to  increased  scrutiny and possible
prosecution. The criminal penalty for conviction under the Anti-kickback Statute
is a fine of up to  $25,000  and/or  up to 5 years  imprisonment.  In  addition,
conviction  mandates  exclusion from  participation in the Medicare and Medicaid
programs.  Such exclusion can also result in conviction under other federal laws
which impose civil and criminal  penalties for submitting false claims,  such as
claims for services not provided as alleged. Several healthcare reform proposals
have included an expansion of the Anti-kickback Statute to apply to referrals of
any patients regardless of payor source.

     The federal government has increased  significantly the financial and human
resources  allocated to enforcing  the fraud and abuse laws. It is the Company's
policy to monitor its compliance with such laws and to take appropriate  actions
to ensure such  compliance.  While the Company  believes  that it is in material
compliance  with such laws,  there can be no assurance that the practices of the
Company, if reviewed, would be found to be in full compliance with such laws, as
such laws ultimately may be interpreted.

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, 1996 and 1997, the Company had the following employees:

                                                 June 30,
                                               -----------
                                               1996   1997
                                               ----   ----
              Full-Time Employees               412    274
              Part-Time Employees                73     38
              On-Call Per Diem Employees        128    113
                                               ----   ----
              Total Employees                   613    425
                                               ====   ====

     Of the  full-time  employees at June 30, 1996 and 1997,  15 and 11 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 35 employees  at the  Company's  former  Florida
outpatient  clinics were employed under a staff leasing  arrangement at June 30,
1997.  The  employees  were 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 sale of the Company's  Georgia and Illinois  operations in fiscal 1997,
resulted in a total reduction of 191 employees.  These employees are included in
the June 30, 1996  totals set forth  above.  See  "Management's  Discussion  and
Analysis of Financial Condition and Results of Operations".


<PAGE>



     The following table reflects the  approximate  number of people employed by
the  Company,  as of the  date  of  this  report,  at the  Company's  outpatient
rehabilitation  clinics in Colorado and Florida,  the home health  agencies with
operations  in Colorado and Kansas,  and the Company's  headquarters.


              Full-Time Employees         184
              Part-Time Employees          26
              On-Call Per Diem Employees   87
                                         ----
                   Total Employees        297
                                         ====

     Although  the Company has a sufficient  pool of skilled  employees to staff
its programs 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.

ITEM  2   PROPERTIES

Operating Facilities

Outpatient Rehabilitation Clinics and Home Health Agencies

     As of the  date  of this  report,  the  Company  operates  four  outpatient
rehabilitation clinics in Colorado, three outpatient rehabilitation clinics (two
of which are operated under a management  agreement) in Florida and fifteen home
health agencies and satellite locations.

     Colorado Outpatient Rehabilitation Clinics              Location
     ------------------------------------------              --------
     Medbrook Rehab Center of Colorado                       Colorado City, CO
     Medbrook Rehab Center of Colorado                       Monte Vista, CO
     Medbrook Rehab Center of Colorado                       Pueblo, CO
     Medbrook Rehab Center of Colorado                       Trinidad, CO

     Florida Outpatient Rehabilitation Clinics
     -----------------------------------------
     Medbrook Rehab Center                                   Jacksonville, FL
     Medbrook Rehab Center                                   Jacksonville, FL
     Medbrook Rehab Center                                   St. Augustine, FL

     Home Health
     -----------
     Total Home Health, Inc.                                 Colorado Springs,CO
     Total Home Health, Inc.                                 Cortez, CO
     Total Home Health, Inc.                                 Delta, CO
     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.                                 Dodge City, KS
     Total Home Health, Inc.                                 Garden City, KS
     Total Home Health, Inc.                                 Leoti, KS


<PAGE>



Sold or Closed Locations

During  fiscal 1997 and  subsequent  to year end the Company  sold or closed the
following locations:

    Colorado and Alaska  Outpatient Facilities          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 Springs, CO
    Medbrook Rehab Center of Colorado                   Florence, CO
    Medbrook Rehab Center of Colorado                   Las Animas, CO
    Medbrook Rehab Center of Colorado                   Rifle, CO
    Medbrook Rehab Center of Colorado                   Walsenburg, CO
    Medbrook Rehab Center of Colorado                   Woodland Park, CO

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

<TABLE>
<CAPTION>

    <S>                                                <C>                 <C>          <C>
    Acute Rehabilitation Facility                      Location            Capacity     Date Opened
    -----------------------------                      --------            --------     -----------
    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

</TABLE>

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

     The  Company  leases  all of its  properties.  The  Company  maintains  its
corporate  office in  Emeryville,  California  under a lease  which  expires  in
October 1997.



<PAGE>


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 only other executive  officer
of the Company is James F. Murphy.  Mr. 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 35 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  25,  1997,  the closing  sales price of the Class A Common  Stock was
$2.50 per share.

     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, 1995  through  June 30,
1997 (giving effect to the one-for-three  reverse stock split reflected on April
22, 1996 as if it had occurred on July 1, 1995):

                          Fiscal 1996                 Fiscal 1997
                          -----------                 -----------
        Quarter         High        Low             High        Low
        -------         ----        ---             ----        ---
          1st          $7 1/2      $6            $2 3/4       $1
          2nd          $6          $1 1/2        $2 3/4       $1 3/8
          3rd          $4 1/2      $2 1/4        $1 13/16     $1 5/8
          4th          $4 1/4      $1 1/2        $2 1/2       $1 7/8


     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 25, 1997,  there were 74 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>

<TABLE>
<CAPTION>

ITEM  6. SELECTED FINANCIAL DATA

                                                            Year Ended June 30,
                                              -------------------------------------------------------------

                                               1993          1994         1995         1996         1997
                                               ----          ----         ----         ----         ----
                                                          (In thousands, except per share data)
<S>                                           <C>           <C>          <C>          <C>          <C> 
Statements of Operations Data:
Net operating revenues                        $28,650       $18,052      $19,974      $23,623      $20,834
Non-capital operating expenses:
     Salaries and employee benefits            15,905        11,107       12,036       15,189       14,877
     Provision for doubtful accounts            3,681         1,099        1,371          584          454
     Other non-capital operating expenses       8,639         6,353        5,821        5,986        5,650
     Write-down of intangible assets               --            --        1,030          --         1,440
     Net loss on disposal and provision
        for subsequent disposal of assets          --            --           --          --            82
                                              --------      --------     --------     --------     --------
        Total non-capital operating expenses   28,225        18,559       20,258       21,759       22,503
                                              --------      --------     --------     --------     --------
Capital expenses:
     Depreciation and amortization                497           479          543          586          572
     Rent                                       3,085         2,223        2,351        1,953        1,635
     Interest expense (income)                   (201)         (193)          26         (114)         (55)
                                              --------      --------     --------     --------     --------
        Total capital expenses                  3,381         2,509        2,920        2,425        2,152
                                              --------      --------     --------     --------     --------

Restructuring charges                           1,041           675          310           --           --
Settlement of litigation                           --         1,438           --           --           --
                                              --------      --------     --------     --------     --------
        Total expenses                         32,647        23,181       23,488       24,184       24,655
                                              --------      --------     --------     --------     --------
Net loss before income taxes and minority
     interest                                  (3,997)       (5,129)      (3,514)        (561)      (3,821)
Income tax provision (benefit)                 (1,244)         (787)         (93)          --           --
                                              --------      --------     --------     --------     --------
Net loss before minority interest             ($2,753)      ($4,342)     ($3,421)       ($561)     ($3,821)
Minority interest                                  --            30          108           29           30
                                              --------      --------     --------     --------     --------
Net loss                                      ($2,753)      ($4,372)     ($3,529)       ($590)     ($3,851)
                                              ========      ========     ========     ========     ========
Net loss per common share                      ($1.42)       ($2.26)      ($1.82)      ($0.31)      ($1.99)
Weighted average common shares used in per
     common share calculation                   1,943         1,939        1,937        1,930        1,930


</TABLE>
<TABLE>
<CAPTION>

                                                                       At June 30,
                                              -------------------------------------------------------------
                                               1993          1994         1995         1996         1997
                                               ----          ----         ----         ----         ----
                                                                     (In thousands)
<S>                                           <C>           <C>          <C>          <C>          <C>
                                                                                                         
Balance Sheet Data:
Working capital                               $16,451       $11,889      $7,711       $6,519       $4,815
Total assets                                   23,058        18,587      16,304       14,840        9,548
Long-term liabilities and capital lease
   obligations                                    129           550       1,074          658           49
Stockholders' equity                           18,721        14,249      10,677       10,086        6,236
</TABLE>

     During  fiscal 1997 and  subsequent to year end the Company sold all of its
acute,   subacute  and   post-acute   facilities  as  well  as  its   outpatient
rehabilitation clinics in Alaska, and certain outpatient  rehabilitation clinics
in  Florida  and  Georgia.  In  addition,  the  Company  closed  six  outpatient
rehabilitation  clinics in Colorado and Florida  during fiscal 1997. The Company
currently  operates home health agencies with operations in Colorado and Kansas,
four  outpatient   rehabilitation  clinics  in  Colorado  and  three  outpatient
rehabilitation  clinics (two of which are operated under a management agreement)
in Florida.


<PAGE>



     The following table sets forth unaudited pro forma selected  financial data
for the twelve months ended June 30, 1997 as if the asset dispositions that have
occurred since July 1, 1996 had taken place on July 1, 1996.  Such unaudited pro
forma financial information reflects all adjustments for the twelve months ended
June 30, 1997,  consisting only of normal  recurring  adjustments  which, in the
opinion of  management,  are necessary to fairly state the Company's  results of
its  operations  for the period  presented.  The unaudited  pro forma  financial
information does not purport to present the consolidated  financial position and
consolidated results of operations of the Company had the dispositions  actually
occurred on July 1, 1996;  nor does it purport to be  indicative of results that
will be attained in the future.  The pro forma financial  information  should be
read in  conjunction  with the  Company's  Form 8-K dated  March 31,  1997,  the
Company's  Form 8-K dated July 31, 1997, and the Company's Form 8-K dated August
31, 1997.

                                                  Year Ended
                                                   June 30,
                                                     1997
                                            ---------------------
                                            (In thousands, except
                                                per share data)  
Pro Forma Statements of Operations Data:
Net operating revenues                             $9,186
Non-capital operating expenses:
     Salaries and employee benefits                 6,216
     Provision for doubtful accounts                   82
     Other non-capital operating expenses           2,675
     Loss on disposal of assets                         7
                                                   -------
          Total non-capital operating expenses      8,980
Capital expenses:
     Depreciation and amortization                    249
     Rent                                             508
     Interest expense (income)                       (270)
                                                   -------
          Total capital expenses                      487
                                                   -------
Net loss before income taxes                         (281)
Income tax provision (benefit)                         --
                                                   -------
Net loss                                            ($281)
                                                   =======
Net loss per common share                          ($0.15)
Weighted average common shares used in per
     common share calculation                       1,930



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

                            TRENDS AND RECENT EVENTS

Potential Ineligibility for Continued Listing on the NASDAQ National Market

     The  NASDAQ   Stock  Market  has  adopted  new   quantitative   maintenance
requirements  for  continued  listing on the  NASDAQ  National  Market.  The new
criteria  become  effective on February 23,  1998.  The Company  currently is in
compliance  with all of the new criteria for continued  NASDAQ  National  Market
listing except for the requirement  that the market value of its public float be
at least $5 million.  The Company  estimates that the market value of its public
float  as of  September  25,  1997  is  $2,877,000.  If  the  Company  is not in
compliance with the new maintenance  criteria on the effective date, the Company
understands that it would be moved to the NASDAQ SmallCap Market. Delisting from
the NASDAQ  National Market could have an adverse effect on the liquidity of the
Company's Class A Common Stock.


<PAGE>



Consideration of Strategic Alternatives

     Since  the   beginning  of  fiscal  1997,   the  Company  has  disposed  of
substantially  all of its operating assets. On August 31, 1997, the Company sold
five of its outpatient rehabilitation clinics in Florida and Georgia and certain
other assets. On July 31, 1997, the Company sold its Kansas operations. On March
31,  1997,  the Company  sold all of its  Georgia  operations,  consisting  of a
neurobehavioral   program,  a  subacute  program  operated  under  a  management
agreement,  and a post-acute  program.  Earlier in fiscal 1997, the Company sold
its post-acute program in Illinois and its outpatient  rehabilitation clinics in
Alaska. In addition, the Company closed six outpatient rehabilitation clinics in
Colorado and Florida  during fiscal 1997.  The Board of Directors of the Company
is continuing to evaluate 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/or additional 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 the
proceeds from its 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  regardless of how other
stockholders might vote.

Recent Asset Dispositions

     Sale of Florida  Operations.  On August 31,  1997,  the  Company  sold five
outpatient  rehabilitation  clinics and certain other assets  located in Florida
and  Georgia.  The  outpatient   rehabilitation  clinics  were  located  in  St.
Augustine,  Palatka,  Palm Coast,  and Ormond  Beach,  Florida and in  Moultrie,
Georgia.  The  Company  sold  the  clinics  in two  separate  transactions.  The
aggregate sale price for the outpatient  rehabilitation clinics and other assets
was $550,000.  The Company received promissory notes from the purchasers for the
aggregate  purchase  price.  The  promissory  notes are secured by the  acquired
assets and the Company also received  personal  guarantees from the stockholders
of the  purchasers.  The  purchasers  acquired  all  assets  including  accounts
receivable  and are  responsible  for all accounts  payable and certain  payroll
liabilities.  As part of the  transaction,  the Company retained all liabilities
for amounts due to the former owners of the clinics. At closing, this amount was
$197,000.  This  transaction  resulted in a loss of  $2,046,000,  primarily as a
result of the write-down of goodwill  associated with the Company's  acquisition
of  certain of the  clinics in 1994.  The loss is  recorded  as other  operating
expense in the Company's June 30, 1997 financial statements.

     Sale of Kansas  Operations.  On July 31, 1997,  the Company sold its Kansas
operations,   consisting  of  acute,  subacute  and  post-acute   rehabilitation
programs.  The sale price for the Kansas  operations was $1,500,000 in cash. The
Company's  agreement  with  the  purchaser  provides  that  the  Company  retain
outstanding  accounts  receivable and be responsible for the accounts payable at
the closing  date.  The increase in the  Company's  cash position as a result of
this  transaction,  assuming  collection  of the  accounts  receivable,  will be
approximately   $2,500,000.   This   transaction   will  result  in  a  gain  of
approximately  $1,178,000.  This gain will be reflected in the  Company's  first
quarter fiscal 1998 results.

     Sale of Georgia Operations. On March 31, 1997, the Company sold its Georgia
operations, consisting of a neurobehavioral program, a subacute program operated
under a management agreement,  and a post-acute program and related real estate.
The sale price for the Georgia  operations was $1,300,000 in cash. The Company's
agreement  with the  purchaser  provided  that the  Company  retain  outstanding
accounts  receivable and be responsible for the accounts  payable at the closing
date.  This  transaction  resulted in a gain of $517,000,  which was recorded as
other operating income in fiscal 1997.

     Sale of Alaska Operations.  On January 13, 1997, the Company sold its three
outpatient  rehabilitation clinics in Alaska. The sale price was $200,000.  This
transaction resulted in a loss of $29,000, which was recorded as other operating
expense during fiscal 1997.

     Sale of  Illinois  Operations.  On October 7, 1996,  the  Company  sold the
assets  of its  post-acute  rehabilitation  operations  located  in Park  Ridge,
Illinois  for  $100,000 in cash.  The  Company's  agreement  with the  purchaser
provided  that  the  Company  retain  outstanding  accounts  receivable  and  be
responsible  for the  accounts  payable at the closing  date.  This  transaction
resulted in a gain of $63,000,  which was  recorded  as other  operating  income
during fiscal 1997.

     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 the
results for the twelve  month  periods  ending June 30, 1996 through  1999.  The
Company was not  required to make any cash  payment  based on results as of June
30, 1996 or 1997. If the  operations  collectively  achieve the target  earnings
thresholds  for the twelve months  ending June 30, 1998 and 1999,  the Company's
maximum  liability would be $550,000.  During fiscal 1997 the Company closed its
home health agency in New Mexico.

     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.
However,  accounts receivable  collections have not been sufficient to repay the
loan,  and the loan balance on June 30, 1997 was $249,000.  This loan balance is
collateralized by personal assets of the debtor.

     In October  1995,  the Company was  notified by its  intermediary  that its
Medicare  payments for the 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.  While the  intermediary
resumed making  payments for current  charges in January 1996, the  intermediary
had withheld $728,000 related to these settlements. During the second quarter of
fiscal 1997, the Company received $425,000 in payment of amounts  withheld.  The
Company has submitted appeals on behalf of the previous owner requesting payment
of the remaining balance.  In the event that such appeals are unsuccessful,  the
Company  intends to pursue  collection  from the  previous  owner and offset the
amounts withheld against any additional  amounts due to the previous owner under
the acquisition agreements.  Amounts owed to the Company as of June 30, 1997, by
Medicare and the previous  owner of the Colorado  operations  exceed the minimum
amounts owed to the previous owner by $237,000.

     On January 1, 1996, the Company acquired the assets of two physical therapy
clinics  in  Pueblo  and  Colorado  City,  Colorado.   In  connection  with  the
acquisitions, the Company paid $45,000 and became obligated to pay an additional
$20,000. Additionally, the Company assumed liabilities of $75,000.

     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.

Healthcare Regulation and Reform

     Continuing  political  debate is  subjecting  the  healthcare  industry  to
significant  reform.  Healthcare  reform  proposals have been  formulated by the
current   administration,   members  of  Congress,   and,  periodically,   state
legislators.  These proposals include the current administration's  announcement
of a "crack down on fraud in the home  healthcare  industry" and the related six
month moratorium on the admission of new home health providers into the Medicare
program.  Government  officials can be expected to continue to review and assess
alternative  healthcare delivery systems and payment  methodologies.  Changes in
the law or new  interpretations  of existing laws may have a dramatic  effect on
the definition of permissible or impermissible activities,  the relative cost of
doing business, and the methods and amounts of payments for medical care by both
governmental and other payors.  Legislative  changes to "balance the budget" and
slow the annual rate of growth of  Medicare  and  Medicaid  are  expected.  Such
changes may adversely impact reimbursement for the Company's services.

Forward-looking Statements

     In addition to the historical  information contained herein, this Form 10-K
contains  forward-looking  statements  within the  meaning of the "safe  harbor"
provisions  of the  Private  Securities  Litigation  Reform  Act of 1995.  These
forward-looking  statements  are subject to risks and  uncertainties,  including
risks  and  uncertainties  set forth in this Form  10-K,  that may cause  actual
results to differ materially.  These forward-looking statements speak only as of
the date hereof.  The Company disclaims any intent or obligation to update these
forward-looking statements.


<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,
                                                                --------------------------------
                <S>                                             <C>          <C>         <C>
                Statements of Operations Data:                    1995        1996         1997
                                                                  ----        ----         ----

                Net operating revenues                           100.0%      100.0%       100.0%
                                                                 -------     -------     -------
                Non-capital operating expenses:
                     Salaries and employee benefits               60.3        64.3         71.4
                     Provision for doubtful accounts               6.9         2.5          2.2
                     Other non-capital operating expenses         29.1        25.3         27.1
                     Write-down of intangible assets               5.2          --          6.9
                     Net loss on disposal and provision for
                        subsequent disposal of assets               --          --          0.4
                                                                 -------     -------     -------
                          Total non-capital operating expenses   101.5        92.1        108.0
                                                                 -------     -------     -------

                Capital expenses:
                     Depreciation and amortization                 2.7         2.5          2.8
                     Rent                                         11.8         8.3          7.9
                     Interest (income) expense                     0.1        (0.5)        (0.3)
                                                                 -------     -------     -------
                          Total capital expenses                  14.6        10.3         10.4
                                                                 -------     -------     -------

                Restructuring charges                              1.6          --           --
                                                                 -------     -------     -------
                          Total expenses                         117.7       102.4        118.4
                                                                 -------     -------     -------
                Net loss before income taxes and minority
                        interest                                 (17.7)       (2.4)       (18.4)
                Income tax provision (benefit)                    (0.5)         --           --
                                                                 -------     -------     -------
                Net (loss) before minority interest              (17.2)       (2.4)       (18.4)
                Minority interest                                  0.5         0.1          0.1
                                                                 -------     -------     -------
                Net (loss)                                       (17.7%)      (2.5%)     (18.5%)
                                                                 =======     =======     =======

</TABLE>

Year ended June 30, 1997 Compared to the Year ended June 30, 1996

     The Company's net operating  revenues  decreased 12% to $20,834,000 for the
year ended June 30, 1997, as compared to  $23,623,000  in the prior fiscal year.
The  decrease  was due to  decreased  patient  volume  at the  Company's  Kansas
facility,  as well as the sale of the Company's  Illinois  operations in October
1996, the sale of the Company's Alaska operations in December 1996, and the sale
of the  Company's  Georgia  operations  in March  1997.  See  "Trends and Recent
Events".  The number of  patient  days in the  Company's  former  core  business
decreased  23% to 20,846  patient  days for the year ended June 30,  1997,  from
27,014 in the prior fiscal year.  The decrease was primarily due to lower census
levels at the Company's  Kansas facility and the sale  transactions  referred to
above.

     Below is a summary of net  operating  revenues  and patient days for fiscal
1996 and 1997 with respect to the  operations  sold by the Company during fiscal
1997:

                        Net Operating Revenues             Patient Days
                              Fiscal year                  Fiscal year
                       ------------------------         ----------------
                          1996          1997             1996      1997
                       ----------    ----------         ------    ------
         Alaska          $696,000      $372,000            N/A       N/A
         Georgia        6,068,000     4,856,000         13,767    10,672
         Illinois       1,803,000       307,000          3,142       614
                       ----------    ----------         ------    ------
           Total       $8,567,000    $5,535,000         16,909    11,286
                       ==========    ==========         ======    ======

     The  decrease  in net  operating  revenues  in the  Company's  former  core
business  was  partially  offset by  increased  net  operating  revenues  in the
Company's  home health  business.  The number of patient visits in the Company's
home health business  increased 46% to 126,510 patient visits for the year ended
June 30, 1997, from 86,868 patient visits in the prior fiscal year.

     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  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 increased 3% for the year ended June
30, 1997, to $22,503,000,  as compared to $21,759,000 for the same period in the
prior  fiscal  year.  The  increase  relates  primarily  to  the  write-down  of
intangible  assets and provision for the loss on the  subsequent  disposition of
the Company's Florida operations  totaling  $2,046,000.  Such loss was partially
offset by the net gain of $524,000 recorded on the sale of the Company's Alaska,
Georgia and Illinois operations,  as well as losses on the sale of certain other
assets.  Salaries and employee  benefits continue to be the primary component of
the Company's  non-capital  operating  expenses.  Salaries and employee benefits
decreased 2% to  $14,877,000  for the year ended June 30,  1997,  as compared to
$15,189,000 for the same period in the prior fiscal year.

     The Company's other  non-capital  operating  expenses  primarily consist of
professional fees, purchased services and other operating expenses. For the year
ended  June  30,  1997,  the  Company's  other  non-capital  operating  expenses
decreased 6% to $5,650,000, as compared to $5,986,000 for the same period in the
prior fiscal year. The decrease is primarily due to lower purchased services and
professional fees as a result of the sale of the Company's  Alaska,  Georgia and
Illinois  operations  during fiscal 1997.  The  provision for doubtful  accounts
decreased to $454,000 for the year ended June 30,  1997,  from  $584,000 for the
same period in the prior fiscal year.  The provision for doubtful  accounts as a
percentage of revenues was 2% for fiscal 1996 and 1997.

     Total capital  expenses  decreased 11% for the year ended June 30, 1997, to
$2,152,000  as compared to  $2,425,000  for the same period in the prior  fiscal
year. Rent expense  decreased 16% to $1,635,000 for the year ended June 30, 1997
as compared to  $1,953,000  for the same period in 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 operating  revenue and patient volume at
certain  facilities,  as well as the sale of the Company's  Alaska,  Georgia and
Illinois operations during fiscal 1997.

     Net interest income for the year ended June 30, 1997,  decreased to $55,000
as compared  to $114,000  for the same  period in the prior  fiscal  year.  This
decrease is due to lower cash balances  available for  investment  during fiscal
1997.

     The Company  reported a net loss of $3,851,000  for the year ended June 30,
1997,  as compared  to a net loss of  $590,000  for the same period in the prior
fiscal year.  The fiscal 1997 loss included the  $1,522,000 net loss incurred in
connection with the sale of certain  operations  during and subsequent to fiscal
1997.  The Company  did not record a tax benefit for fiscal  years 1996 and 1997
because  carrybacks of current losses against  previous  taxable earnings are no
longer available.


<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 operating revenue of $7,127,000  generated
by the Colorado  outpatient clinics and Colorado and Kansas home health business
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., its acute,  subacute and post-acute  rehabilitation  units in
Georgia,  Illinois  and  Kansas).   Excluding  the  Company's  Arlington,  Texas
post-acute  facility which was closed in fiscal 1995, the number of patient days
in the  Company's  core  business  decreased  7% to 27,014  patient days 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  was  operated  by the  Company  under  a  management
agreement beginning on June 5, 1995. The decrease in fiscal 1996 was largely due
to an increase in the  percentage of Medicare  patients  served at the Company's
Gardner, Kansas facility.

     Total  non-capital  operating  expenses  for the year ended  June 30,  1996
increased 7% to $21,759,000 from $20,258,000  during the prior fiscal year. This
increase  primarily  resulted from the  acquisition  of the Colorado  outpatient
clinics and  Colorado  and Kansas home health  agencies.  Salaries  and employee
benefits  were 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 was 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 consist of
professional fees, purchased services and other operating expenses. For the year
ended  June 30,  1996  other  non-capital  operating  expenses  increased  3% to
$5,986,000,  as compared to  $5,821,000  for the same period in the prior fiscal
year.  The  increase is  primarily  due to the  inclusion  of other  non-capital
operating  expenses for the Colorado  outpatient clinics and Colorado and Kansas
home health  agencies.  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% for the year ended June 30,  1996,  as  compared  to 7% 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
operating  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 Colorado and Kansas 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, 01996 because carrybacks of
current losses against previous taxable earnings are no longer available.

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 1996                               Fiscal 1997
                                ------------------------------------           ---------------------------------
                                  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           $5,579   $6,095   $6,321    $5,628        $5,977    $5,528    $5,508    $3,821
Income (loss) before income
taxes and minority interest        (563)     105       51      (154)         (598)     (513)       98    (2,809)
Net Income (loss)                  (585)      88       34      (127)         (611)     (517)       88    (2,811)
Earnings (loss) per share        ($0.30)   $0.05    $0.02    ($0.07)       ($0.32)   ($0.27)    $0.05    ($1.46)
Average shares outstanding        1,931    1,930    1,930     1,930         1,930     1,930     1,930     1,930

</TABLE>

LIQUIDITY AND CAPITAL RESOURCES

     At June 30, 1997, the Company had working  capital of $4,815,000,  compared
to working capital of $6,519,000 at June 30, 1996. The Company had cash and cash
equivalents  of  $2,929,000  at June 30, 1997, as compared to $3,439,000 at June
30, 1996. 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,  1997,  $279,000 of the amount  deposited is
classified as restricted cash securing the loan balance of $249,000,  as well as
security  for the  Company's  outstanding  balance  on its  line-of-credit.  See
"Trends and Recent Events".

     During  the  fiscal  year  ended June 30,  1997,  the  Company's  operating
activities used $637,000 of available cash  resources,  as compared to cash used
for  operating  activities  of  $2,001,000  during the same  period in the prior
fiscal year. The cash used for operating  activities  during the year ended June
30,  1997  primarily  reflects  amounts  necessary  to fund  the  Company's  net
operating losses.  The cash used for operating  activities during the year ended
June 30, 1996 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. Cash provided from investment  activities during
the year  ended  June 30,  1997  was  $923,000,  as  compared  to cash  used for
investment  activities  of  $1,013,000  during the prior fiscal  year.  The cash
provided from  investment  activities for the year ended June 30, 1997 primarily
relates to proceeds from the sales of the Company's Alaska, Georgia and Illinois
operations. See "Trends and Recent Events".

     Net  patient   accounts   receivable,   which  excludes  amounts  due  from
intermediaries,  was  $4,279,000  at June 30, 1997, as compared to $4,739,000 at
June 30,  1996.  At June 30,  1997,  the Company had an  allowance  for doubtful
accounts of  $1,195,000,  as compared to $1,445,000 at June 30, 1996. The number
of average days of revenue  outstanding,  excluding the revenues and receivables
related to litigation patients,  was 67 days at June 30, 1997, as compared to 65
days at June 30, 1996.

     It was the  Company's  practice  in its core  business  to  admit  selected
patients who were 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 were generally  placed against  pending  insurance  settlements.  Prior to
admitting such patients, the Company and its counsel evaluated 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 was  admitted,  the Company and its counsel  monitored the status of
the litigation.  The Company  retained the accounts  receivable  related to such
patients in connection with the sale of its Kansas  operations.  There can be no
assurance,  however,  that the Company will ultimately be reimbursed for all the
services it provided to such  patients.  At June 30, 1997,  accounts  receivable
related to these litigation  patients totaled $520,000,  as compared to $444,000
at  June  30,  1996.  These  litigation  patient  receivables  accounted  for an
additional 13 and 19 average days revenue  outstanding at June 30, 1997 and June
30, 1996, respectively.

     The Company's amount due to Medicare intermediaries of $101,000 at June 30,
1997 includes amounts the Company  anticipates to pay on cost report settlements
for its  Colorado  home  health  agencies  and its  final  cost  report  for the
Company's former Gardner, Kansas facility. 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 former  Gardner,
Kansas  facility.  Medicare  reimbursement  is generally  based upon  reasonable
direct and  indirect  allowable  costs  incurred in providing  services.  At the
Company's  former Gardner,  Kansas facility these costs were subject to the RCL.
Requests for an exception from the RCL have been submitted for fiscal years 1992
through 1995 for the Company's former Gardner,  Kansas  facility.  In connection
with the  sale of its  Kansas  operation,  the  Company  retained  the  accounts
receivable and it accordingly intends to file such a request for fiscal 1996 and
1997. The requests are based upon atypical costs incurred at the Kansas facility
in the treatment of patients who received  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.

     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  may use a portion of its cash  balance  to  finance  internal
development of its home health  business line. 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, 1997, 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.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     Not Applicable.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     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  1997  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 "Section 16(a) Beneficial  Ownership Reporting  Compliance" in
the  Company's  definitive  proxy  statement  for its  1997  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 1997 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 1997 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 1997 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, 1996 and 1997............  3

          Consolidated Statements of Operations for the Years
                  Ended June 30, 1995, 1996 and 1997.......................  4

          Consolidated Statements of Stockholders' Equity for the Years
                  Ended June 30, 1995, 1996 and 1997.......................  5

          Consolidated Statements of Cash Flows for the Years
                  Ended June 30, 1995, 1996 and 1997.......................  6

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

     2.    Financial statement schedules for the Years
                    Ended June 30, 1995, 1996 and 1997

          II      -   Valuation and Qualifying Accounts....................  17

     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  filed  as  Exhibit  3.2 to  the  Company's
                       Annual Report on Form 10-K for the fiscal year ended 1996
                       and incorporated herein by reference.

               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 on Form 10-K for the
                       fiscal  year  ended June 30,  1995 (the "1995  10-K") and
                       incorporated herein by reference.



<PAGE>


               10.2    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.

               10.3    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.

               10.4    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.

               10.5    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.

               10.6    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.

               10.7    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.

               10.8    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.

               10.9    Lease Agreement dated December 31, 1994, by and among Dr.
                       Harvey  Wm.  Glasser,   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 33 of this Form
                       10-K).

               24.1    Power of Attorney (see Page 32 of this Form 10-K).

               27.1    Financial Data Schedule.


<PAGE>



       (b)        Reports on Form 8-K:

                  On March 31, 1997,  the Company filed a current report on Form
                  8-K with the  Securities  and  Exchange  Commission  reporting
                  under items 2 and 7 thereof and including pro forma  financial
                  statements for the year ended June 30, 1996 and the six months
                  ended December 31, 1996.

                  On July 31, 1997,  the Company filed a current  report on Form
                  8-K with the  Securities  and  Exchange  Commission  reporting
                  under items 2 and 7 thereof and including pro forma  financial
                  statements  for the  year  ended  June  30,  1996 and the nine
                  months ended March 31, 1997.

                  On August 31, 1997, the Company filed a current report on Form
                  8-K with the  Securities  and  Exchange  Commission  reporting
                  under items 2 and 7 thereof and including pro forma  financial
                  statements  for the  year  ended  June  30,  1996 and the nine
                  months ended March 31, 1997.



<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:    September 26, 1997           MEADOWBROOK REHABILITATION GROUP,
                                      INC.

                                      By   /s/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,           September 26, 1997
-----------------------
Harvey Wm. Glasser, M.D.   President and Treasurer
                          (Principal Executive Officer)

JAMES F. MURPHY            Vice President and                 September 26, 1997
-----------------------
James F. Murphy            Chief Financial Officer
                          (Principal Accounting Officer
                           and Principal Financial Officer)

JOHN MCCRACKEN             Director                           September 26, 1997
-----------------------
John McCracken

ROBERT RUSH                Director                           September 26, 1997
-----------------------
Robert Rush



<PAGE>


                    CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS

     As independent public  accountants,  we hereby consent to the incorporation
of our reports  included in this Form 10-K into the Company's  previously  filed
Registration Statement File No. 33-50772.



San Francisco, California                                    ARTHUR ANDERSEN LLP
September 26, 1997



<PAGE>
 
                         MEADOWBROOK REHABILITATION GROUP, INC.
                         AND SUBSIDIARIES

                         CONSOLIDATED FINANCIAL STATEMENTS
                         AS OF JUNE 30, 1996 AND 1997
                         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,  1996 and 1997,  and the  related  consolidated  statements  of  operations,
stockholders'  equity and cash  flows for each of the three  years in the period
ended  June  30,  1997.  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, 1996 and 1997, and
the results of their operations and their cash flows for each of the three years
in the  period  ended June 30,  1997,  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 5, 1997

<PAGE>

             MEADOWBROOK REHABILITATION GROUP, INC. AND SUBSIDIARIES

              CONSOLIDATED BALANCE SHEETS - JUNE 30, 1996 AND 1997

                                     ASSETS

                                                         1996          1997
                                                    ------------  -----------
 CURRENT ASSETS:
    Cash and cash equivalents                         $3,439,440   $2,928,781
    Restricted cash                                      311,000      278,649
    Patient accounts receivable, less
       allowance for doubtful accounts of
       $1,445,000 and $1,195,000 respectively          4,738,957    4,278,756
    Other receivables                                  1,264,444      293,165
    Due from intermediaries                              331,918           --
    Income tax refund receivable                         140,362           --
    Prepaid expenses and other assets                    376,898      298,970
                                                    ------------  ------------
                Total current assets                  10,603,019    8,078,321
                                                    ------------  ------------

 PROPERTY AND EQUIPMENT, at cost:
    Land and buildings                                  683,770            --
    Furniture and equipment                           2,993,965     2,154,947
    Leasehold improvements                              783,614       686,116
                                                    ------------  -----------
                                                      4,461,349     2,841,063
    Less - accumulated depreciation                  (2,095,193)   (1,708,734)
                                                    ------------  ------------
                Net property and equipment            2,366,156     1,132,329
                                                    ------------  ------------

 OTHER ASSETS:
    Goodwill and intangible assets                    1,870,555       337,734
                                                    ------------  ------------

                Total assets                        $14,839,730    $9,548,384
                                                    ============  ============

                      LIABILITIES AND STOCKHOLDERS' EQUITY

 CURRENT LIABILITIES:
    Short-term borrowings and current maturities of    $657,724      $291,037
       notes payable
    Current maturities of capital lease obligations      32,803        24,821
    Accounts payable                                  1,226,053       968,027
    Accrued payroll and employee benefits             1,101,168       755,748
    Due to intermediaries                                    --       100,780
    Other accrued liabilities                         1,065,820     1,123,124
                                                    ------------  ------------
                Total current liabilities             4,083,568     3,263,537
                                                    ------------  ------------

 LONG-TERM LIABILITIES:
    Note payable and other long-term liabilities        636,255        48,989
    Capital lease obligations                            21,815            --
                                                    ------------   -----------
                Total long-term liabilities             658,070        48,989
                                                    ------------   -----------

                Total liabilities                     4,741,638     3,312,526
                                                    ------------   -----------

 MINORITY INTEREST IN EQUITY OF
    CONSOLIDATED SUBSIDIARIES                            11,665            --
                                                    ------------   -----------

 STOCKHOLDERS' EQUITY:
    Common stock, $.01 par value -
       Class A; 15,000,000 shares authorized;
          1,157,244 shares issued and outstanding
          at June 30, 1996 and 1997                      11,572        11,572
       Class B; 5,000,000 shares authorized;
          773,000 shares issued and outstanding
          at June 30, 1996 and 1997                       7,730         7,730
    Paid-in capital                                  17,908,122    17,908,122
    Retained deficit                                 (7,840,997)  (11,691,566)
                                                    ------------   -----------
                Total stockholders' equity           10,086,427     6,235,858
                                                    ------------   -----------
                Total liabilities and stockholders'         
                   equity                           $14,839,730    $9,548,384
                                                    ============   ===========

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

<PAGE>
<TABLE>
<CAPTION>

                                       MEADOWBROOK REHABILITATION GROUP, INC. AND SUBSIDIARIES

                                                CONSOLIDATED STATEMENTS OF OPERATIONS

                                          FOR THE YEARS ENDED JUNE 30, 1995, 1996 AND 1997
<S>                                                                 <C>              <C>               <C>   
                                                                         1995             1996            1997
                                                                     ------------    -------------     ------------

        NET OPERATING REVENUES                                       $19,973,613      $23,622,560      $20,834,438

        OPERATING EXPENSES:
               Salaries and employee benefits                         12,036,473       15,189,173       14,877,168
               Professional fees and purchased services                3,023,225        2,509,166        2,239,179
               Provision for doubtful accounts                         1,371,151          583,661          454,255
               Other operating expenses                                2,797,809        3,476,400        3,411,087
               Depreciation and amortization                             542,890          586,180          572,249
         
        Rent -
                  To unrelated parties                                 1,764,617        1,540,634        1,252,802
                  To related parties                                     586,518          412,468          382,456
               Write-down of intangible assets                         1,029,767               --        1,439,520
               Net loss on disposal and provision
        for subsequent
                   disposal of assets                                         --               --           82,130
               Restructuring charges                                     310,000               --               --
                                                                     ------------    -------------     ------------


                   Total operating expenses                           23,462,450       24,297,682       24,710,846
                                                                     ------------    -------------     ------------

                   Loss from operations                               (3,488,837)        (675,122)      (3,876,408)
                                                                     ------------    -------------     ------------

        OTHER (INCOME) EXPENSE:
               Interest (income) expense, net                             25,536         (113,834)         (55,313)
                                                                     ------------    -------------     ------------

                   Total other (income) expense                           25,536         (113,834)         (55,313)
                                                                     ------------    -------------     ------------

                   Loss before income taxes and minority interest     (3,514,373)        (561,288)      (3,821,095)

        INCOME TAX  BENEFIT                                              (92,890)              --               --
                                                                     ------------    -------------     ------------

                   Loss before minority interest                     ($3,421,483)       ($561,288)     ($3,821,095)

        MINORITY INTEREST IN EARNINGS OF
          CONSOLIDATED SUBSIDIARIES                                      107,642           29,016           29,474
                                                                     ------------    -------------     ------------

                   Net loss                                          ($3,529,125)       ($590,304)     ($3,850,569)
                                                                     ============    =============     ============

        NET LOSS PER COMMON SHARE                                         ($1.82)          ($0.31)          ($1.99)
                                                                     ============    =============     ============


        WEIGHTED AVERAGE COMMON AND COMMON
          EQUIVALENT SHARES OUTSTANDING                                1,936,703        1,930,349        1,930,244
                                                                     ============    =============   ==============

<FN>


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

<PAGE>
<TABLE>
<CAPTION>
                                       MEADOWBROOK REHABILITATION GROUP, INC. AND SUBSIDIARIES

                                           CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

                                          FOR THE YEARS ENDED JUNE 30, 1995, 1996 AND 1997



                                    
                                    Class A                Class B
                               ---------------------  --------------------
                                                                                                                    Total
                                 Shares     Amount     Shares     Amount       Paid-in         Retained         Stockholders'
                                                                               Capital          Deficit            Equity
                               --------------------  --------------------    ------------    -------------      -------------
<S>                            <C>         <C>         <C>        <C>        <C>             <C>                 <C>
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

     Net loss                         --        --          --        --              --       (3,850,569)        (3,850,569)
                               ----------  --------    -------    ------     ------------    -------------      -------------

BALANCE, JUNE 30, 1997         1,157,244   $11,572     773,000    $7,730     $17,908,122     ($11,691,566)        $6,235,858
                               ==========  ========    =======    ======     ============    =============      =============





<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, 1995, 1996 AND 1997

                                                                                            1995           1996            1997
                                                                                       -------------    -----------    ------------
<S>                                                                                    <C>              <C>            <C>

CASH FLOWS FROM OPERATING ACTIVITIES:
       Net loss                                                                         ($3,529,125)     ($590,304)    ($3,850,569)
       Adjustments to reconcile net loss to cash provided by
       (used for) operating activities -
            Depreciation and amortization                                                   542,890        586,180         572,249
            Net loss on disposal and provision for
            subsequent
                     disposal of assets                                                      33,592          8,122          82,130
            Write-down of intangible assets                                               1,029,767             --       1,439,520
            Minority interest expense                                                            --         29,016          29,474
            Changes in assets and liabilities -
                Decrease (increase) in  patient accounts receivable, net                  2,345,398       (675,012)        460,201
                Decrease in due from/to intermediaries                                    1,579,372        282,085         432,698
                Decrease in income tax refund receivable                                  1,908,244         29,638         140,362
                Decrease (increase) in other receivables                                   (161,555)      (999,962)        971,279
                Decrease (increase) in prepaid expenses and other current assets            108,892        (91,435)         77,928
                Increase (decrease) in accounts payable and accrued liabilities             217,834       (357,817)       (991,931)
                Decrease in other long-term liabilities                                          --       (221,897)             --
                                                                                        ------------    -----------    ------------
                Cash provided by (used for) operating activities                          4,075,309     (2,001,386)       (636,659)
                                                                                        ------------    -----------    ------------

       CASH FLOWS FROM INVESTMENT ACTIVITIES:
            Additions to property and equipment                                            (359,129)      (556,705)       (231,046)
            Payments on prior purchase of                                                        --       (357,543)       (330,724)
            outpatient clinics
            Proceeds from sale of assets                                                      1,950         23,431       1,485,009
            Purchase of outpatient                                                       (1,056,604)       (82,500)             --
            clinics
            Costs resulting from purchase of outpatient facilities                         (167,447)       (40,000)             --
                                                                                        ------------    -----------    ------------
                Cash provided by (used for) investment activities                        (1,581,230)    (1,013,317)        923,239
                                                                                        ------------    -----------    ------------

       CASH FLOWS FROM FINANCING ACTIVITIES:
            Short-term borrowings                                                           325,840        791,942         517,239
            Payments of short-term borrowings                                              (207,345)      (813,180)     (1,263,909)
            Long-term borrowings                                                                 --         95,198              --
            Payments of capital lease obligations                                           (70,360)       (40,003)        (29,797)
            Decrease (increase) in cash deposited  to secure a loan                        (500,000)       189,000          32,351
            Payments to minority                                                            (90,000)       (76,121)        (53,123)
            shareholders
            Issuance of common stock for options exercised                                    1,249             --              --
                                                                                        ------------    -----------     -----------

                Cash provided by (used for) financing activities                          (540,616)        146,836        (797,239)

                Net increase (decrease) in cash                                           1,953,463     (2,867,867)       (510,659)

       CASH AND CASH EQUIVALENTS, beginning of period                                     4,353,844      6,307,307       3,439,440
                                                                                       -------------    -----------     -----------

       CASH AND CASH EQUIVALENTS, end of period                                          $6,307,307     $3,439,440      $2,928,781
                                                                                       =============    ===========    ============

       SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
            Noncash activities -
                Property additions financed with capital leases                                 $--        $76,020             $--
                Property additions financed with notes payable                                   --        114,098              --
                Liability resulting from purchase of outpatient facilities                1,743,319        186,692              --
                Stock received as repayment of receivable from related party                 44,000             --              --
            Payments -
                Interest paid                                                               179,567         44,881          59,152
                Income taxes paid                                                                --         32,492          20,900

<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, 1997

1.  ORGANIZATION AND OPERATIONS:

     Meadowbrook  Rehabilitation Group, Inc.  (Meadowbrook) and its subsidiaries
(collectively,  the Company) have undergone significant operating changes during
and subsequent to fiscal year 1997. As of September  1997, the Company  operates
home health  agencies in Colorado  and Kansas,  four  outpatient  rehabilitation
clinics in Colorado and three  outpatient  rehabilitation  clinics (two of which
are operated under a management  agreement) in Florida. The Company has sold all
of its traditional acute,  subacute and post-acute operations during fiscal 1997
and subsequent to year end. In addition, the Company sold five of its outpatient
rehabilitation  clinics  located in Florida and Georgia  subsequent to year end.
The Company also closed six  outpatient  rehabilitation  clinics  during  fiscal
1997. These transactions are more fully described in Note 2.

     The Company  experienced  significant  operating losses during fiscal years
1995, 1996 and 1997.  Factors  contributing to fiscal year 1997 losses include a
net loss of $1,522,000 (including a write-down of intangible assets) recorded in
connection  with  the  Company's  sale  of  its  Alaska,  Georgia  and  Illinois
operations  during  fiscal 1997 and the sale of five  outpatient  rehabilitation
clinics and certain other assets in Florida and Georgia  subsequent to year end.
The fiscal 1997 results also include  operating losses incurred by the Company's
Florida and Kansas operations.

     Factors  contributing  to fiscal 1996 results  include  among other things,
losses  incurred at the  Company's  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
Companys acute,  subacute and post-acute  facilities and a charge of $1,030,000
to write-off  intangible  assets recorded as part of the fiscal 1994 acquisition
of its  Florida  operations.  The  write-off  was the  result  of the  Company's
management  contracts at five  facilities  being  terminated.  In addition,  the
Company  recorded a charge of  $700,000 to  write-off  two  litigation  accounts
receivable  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 in Indianapolis.  The program was closed on September 22, 1995 (see Note
2).

     The Company's future profitability is dependent on the successful operation
of the Company's  home health  agencies and outpatient  rehabilitation  clinics.
There can be no assurance as to the Company's future profitability.  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.

     The  Company's  Board of Directors is  continuing to evaluate 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  and/or  additional  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  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 regardless of how other stockholders might vote.

<PAGE>

2. OPERATING CHANGES AND SALE OF OPERATIONS: 

     Florida In May,  1997,  the  Company's  board of directors  and  management
initiated the sale of its Florida  operations.  On August 31, 1997,  the Company
sold the assets of five  outpatient  rehabilitation  clinics and  certain  other
assets  located in Florida and Georgia.  The outpatient  rehabilitation  clinics
were located in St. Augustine,  Palatka,  Palm Coast, and Ormond Beach,  Florida
and in  Moultrie,  Georgia.  The  Company  sold  the  clinics  in  two  separate
transactions. The aggregate sale price for the outpatient rehabilitation clinics
and other assets was $550,000.  The Company  received  promissory notes from the
purchasers for the aggregate purchase price. The promissory notes are secured by
the  acquired  assets and the Company also  received  personal  guarantees  from
shareholders of the  purchasers.  The purchasers  acquired all assets  including
accounts  receivable and are  responsible  for all accounts  payable and certain
payroll  liabilities.  As part of the  transaction,  the  Company  retained  all
liabilities  for amounts due to the former  owners of the  clinics.  At closing,
this  amount  was  $197,000.  The assets  sold  consisted  of current  assets of
$384,000, property and equipment of $275,000, and liabilities of $117,000. As of
June 30, 1997 a provision has been recorded to reduce the carrying  value of the
assets  related  to these  operations  to  realizable  value.  This  transaction
resulted in a loss of  $2,046,000,  primarily as a result of the  write-down  of
goodwill associated with the Company's  acquisition of certain of the clinics in
1994. The loss is recorded as other operating  expense in the Company's June 30,
1997 financial statements.

     Kansas On July 31, 1997, the Company sold the majority of the assets of its
Kansas operations,  consisting of acute, subacute and post-acute  rehabilitation
programs.  The sale price for the Kansas  operations was $1,500,000 in cash. The
Company's  agreement  with the  purchaser  provides that the Company will retain
outstanding  accounts  receivable and be responsible for the accounts payable at
the closing  date.  The assets sold  consisted  of current  assets of $2,000 and
property  and  equipment  of  $179,000.  The hospital was leased from Harvey Wm.
Glasser,  M.D., the Company's Chief Executive Officer and majority  shareholder.
Concurrently with the sale of the assets of the subsidiary, Dr. Glasser sold the
hospital leased by the subsidiary to the same  purchaser.  The Company's sale of
the Kansas  operations  will result in a gain of  $1,178,000.  This gain will be
recorded in the Company's first quarter fiscal 1998 results.

     Georgia On March 31,  1997,  the Company sold the majority of the assets of
its Georgia  operations,  consisting of a  neurobehavioral  program,  a subacute
program  operated  under a management  agreement,  and a post-acute  program and
related real estate. The sale price for the Georgia operations was $1,300,000 in
cash.  The  Company's  agreement  with the  purchaser  provides that the Company
retain  outstanding  accounts  receivable  and be  responsible  for the accounts
payable at the closing date.  This  transaction  resulted in a gain of $517,000,
which was recorded as other operating income in fiscal 1997.

     Alaska On January 13, 1997, the Company sold its three  outpatient  clinics
in Alaska.  The sale price was $200,000 in cash. This transaction  resulted in a
loss of $29,000,  which was recorded as other  operating  expense  during fiscal
1997.

     Illinois On October 7, 1996, the Company sold the majority of the assets of
its post-acute  rehabilitation  facility  located in Park Ridge,  Illinois.  The
Company's  agreement  with  the  purchaser  provided  that  the  Company  retain
outstanding  accounts  receivable and be responsible for the accounts payable at
the closing  date.  This  transaction  resulted in a gain of $63,000,  which was
recorded as other operating income during fiscal 1997.

     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.

<PAGE>

     The  operations  sold  during  fiscal year 1997 or  subsequent  to year end
comprised  the  majority  of  the  Company's  operations.  The  following  table
segregates  net operating  revenues and  operating  results  between  operations
retained  and  operation  disposed  of.  Loss from  operations  amounts  include
allocations of common corporate overhead cost.

<TABLE>
<CAPTION>

                                    1995                            1996                             1997
                                 (unaudited)                     (unaudited)                     (unaudited)
                         ----------------------------    ----------------------------    ----------------------------
                             Net                             Net                             Net
                          operating       Loss from       operating       Loss from       operating       Loss from
                          revenues        operations      revenues        operations      revenues        operations
                         -----------     ------------    -----------      ----------     -----------     ------------
<S>                      <C>             <C>             <C>              <C>            <C>             <C>
Operations retained         $870,217       ($108,895)    $10,265,871      ($182,545)      $9,186,447       ($550,850)

Operations disposed of
   during and subsequent
   to year end            19,103,396      (3,379,942)     13,356,689       (492,577)      11,647,991      (3,325,558)

      
                         -----------     ------------    -----------      ----------     -----------     ------------
                         $19,973,613     ($3,488,837)    $23,622,560      ($675,122)     $20,834,438     ($3,876,408)
                         ===========     ============    ===========      ==========     ===========     ============

</TABLE>

     The above information does not purport to present the consolidated  results
of operations of the Company had the dispositions  actually  occurred on July 1,
1994;  nor does it purport to be  indicative of results that will be attained in
the future.

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 loan balance on June 30,
1997 was $249,000. The Company has not recorded as a liability, but reflects the
restricted  cash on its  balance  sheet.  As the loan is  repaid,  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, 1997, $279,000 of the amount deposited
is classified  as restricted  cash securing the loan balance of $249,000 as well
as the Company's outstanding line-of-credit 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 had 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, 1997, the Company  wrote-off net balances of
$704,000 of accounts  receivable  compared to  $1,052,000  during the year ended
June 30, 1996.  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,  1996 and 1997,  $1,328,000  and  $1,141,000,
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.  However the nature of the reimbursement  process,
as well as the sale of certain of the Company's facilities during and subsequent
to year end, makes these judgments difficult and actual reimbursement could vary
significantly from these estimates.

<PAGE>

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
provided  care to  Medicaid  beneficiaries  under  short-term  contracts  at the
Company's Gardner, Kansas facility.

     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).

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

                                                      Year Ended June 30,
                                                --------------------------------
        Source                                  1995         1996         1997
                                               -------      -------      -------

    Private payors and commercial insurance..     67%          59%          51%
    Medicare ................................     16%          34%          41%
    Medicaid ................................     17%           7%           8%
                                               -------      -------      -------
    Total ...................................    100%         100%         100%
                                               -------      -------      -------

     The operations retained by the Company after the sale activity described in
Note 2 receive  approximately  80% of their  revenue  through the  Medicare  and
Medicaid programs.

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.

<PAGE>

     The adoption of Statement of Financial Accounting Standards (SFAS) No. 128,
"Earnings  Per Share" is not  expected  to  significantly  impact the  Company's
earnings per share calculation.
 
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, 1996 and 1997 the Company had notes payable of  $1,196,330  and
$340,026,  respectively.  These notes are payable in varying  installments at an
average  interest  rate of 8.6%.  The notes  payable  at June 30,  1997  include
$136,425 arising from prior year  acquisitions  (see Notes 2 and 10) and $60,000
related to borrowings from a bank under a line-of-credit arrangement.

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

                        1998             $291,037
                        1999               36,833
                        2000               12,156
                        2001                   --
                        2002                   --
                                         --------
                                         $340,026
                                         ========

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 $165,494 at June 30,  1996,  and $88,570 at June 30,
1997, with accumulated  depreciation of $70,632 and $32,463 as of June 30,  1996
and 1997, respectively.

     The minimum future lease payments  required under the Company's capital and
operating leases  (excluding  facilities sold subsequent to year end) during the
five years beginning July 1, 1997, are as follows:

                                                 Capital           Operating
                                                 Leases              Leases
                                               ------------     ---------------
   Year 1                                          $28,031          $  398,323
   Year 2                                               --             248,976
   Year 3                                               --             147,566
   Year 4                                               --              63,568
   Year 5                                               --              13,467
   Thereafter                                           --                  --
                                               ------------     ---------------
   Total minimum payments                           28,031            $871,900
                                                                ===============
   Interest on capital lease obligations            (3,210)
                                               ------------
   Net minimum payments                             24,821
   Current maturities of capital obligations        24,821
                                               ------------
   Long-term capital lease obligations              $   --
                                               ============


<PAGE>

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.

Potential Ineligibility for Continued Listing on the NASDAQ Stock Market

     The  NASDAQ   Stock  Market  has  adopted  new   quantitative   maintenance
requirements  for  continued  listing on the  NASDAQ  National  Market.  The new
criteria  become  effective on February 23,  1998.  The Company  currently is in
compliance  with all of the new criteria for continued  NASDAQ  National  Market
listing except for the requirement  that the market value of its public float be
at least $5 million.  The Company  estimates that the market value of its public
float  as of  September  25,  1997  is  $2,877,000.  If  the  Company  is not in
compliance with the new maintenance  criteria on the effective date, the Company
understands that it would be moved to the NASDAQ SmallCap Market. Delisting from
the NASDAQ  National Market could have an adverse effect on the liquidity of the
Company's Class A Common Stock.

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, 1997, a total of 681,667  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.

<PAGE>

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

                                              Shares             Exercise Price
                                           Under Option            Per Share
                                         -----------------     ----------------
   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
        Granted April 1996                      5,000                 4.13
                                         ------------
   Outstanding at June 30, 1996               153,333         $0.56-$39.00
                                         --------------
        Cancelled October 1996                 (5,000)                6.00
        Cancelled October 1996                 (5,000)                3.38
        Cancelled November 1996                (1,667)                6.00
        Cancelled November 1996                (1,667)                3.00
        Cancelled January 1997                 (5,000)                6.00
        Granted January 1997                    3,333                 1.75
        Cancelled March 1997                  (16,667)               18.00
        Cancelled March 1997                   (4,167)                6.18
        Cancelled March 1997                   (5,833)                3.38
        Cancelled March 1997                   (3,333)                6.00
        Granted April 1997                      3,333                 2.00
        Cancelled April 1997                   (8,333)                5.25
        Cancelled April 1997                   (1,666)                6.00
        Cancelled April 1997                   (1,666)                3.00
        Cancelled April 1997                   (1,667)                1.75
        Cancelled June 1997                    (5,000)                4.13
                                         --------------
   Outstanding at June 30, 1997                93,333         $1.75-$18.00
                                         ==============

     As of June 30, 1997, 60,000 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.
 
     The Company has not applied the provisions of SFAS No. 123, "Accounting for
Stock Based Compensation"  because options granted in fiscal years 1996 and 1997
are immaterial.

7. INCOME TAXES:

     The  Company  provides  for  income  taxes  under the  liability  method in
accordance  with 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 year ended June 30, 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 1995
primarily  because of limits on  available  federal tax  payments  made in prior
years which could be refunded.  For fiscal  years 1996 and 1997,  no benefit was
recorded because  carrybacks of current losses against previous taxable earnings
are no longer available.

<PAGE>

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

                                                Year Ended June 30
                              --------------------------------------------------
                                   1995              1996              1997
                              -------------      --------------    -------------
    Current -
         Federal              $    (92,890)      $      --          $      --
         State                       --                 --                 --
                              -------------      --------------    -------------
                                   (92,980)
    Deferred (prepaid) -
         Federal                     --                 --                 --
         State                       --                 --                 --
                              -------------      -------------     -------------
    Benefit                   $    (92,890)      $      --          $      --
                              =============      =============     =============

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

                                                      Year Ended June 30
                                      ------------------------------------------
                                          1995            1996           1997
                                      ------------   -------------  ------------

  Allowance for doubtful accounts     $   (52,910)   $   205,720    $    92,500
  Accrued payables                         82,276         74,000       (142,450)
  Depreciation                            (10,360)       (37,000)        54,390
  Tax loss carry forwards                (695,600)      (117,157)      (933,053)
  Other                                       --             --            --
  Valuation allowance                     676,594       (125,563)       928,613
                                      ------------   -------------  ------------
                                      $       --     $       --      $     --
                                      ============   =============  ============

<TABLE>
<CAPTION>

     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:

                                                                   Year Ended June 30
                                   ------------------------------------------------------------------------------
                                         1995                          1996                      1997
                                   ---------------                -------------            ---------------
                                        Amount           %            Amount        %           Amount        %
                                   ---------------     -----      -------------   -----    ---------------  -----
<S>                                <C>                 <C>        <C>             <C>      <C>               <C>
Federal statutory rate             $   (1,194,887)     (34%)      $   (200,703)   (34%)    $  (1,309,340)   (34%)
State taxes, net of federal
     effects                             (105,431)       (3)           (17,709)     (3)                       (3)
                                                                                                (115,530)
Permanent differences                     437,185        12             53,280       9           610,500      16
Net operating losses
     not currently benefited              676,594        19            165,132      28           933,053      24
Other                                      93,649         3                --       --          (118,683)     (3)
                                   ----------------    -----      -------------   -----    --------------   -----
Benefit                            $      (92,890)      (3%)      $        --       --     $         --       --
                                   ================    =====      =============   =====    ==============   =====
</TABLE>

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

                                                     1996              1997
                                               ---------------    --------------
    Allowance for doubtful accounts            $     534,650      $     442,150
    Accrued payables                                 170,940            313,390
    Depreciation                                     165,390            111,000
    Tax loss carry forwards                          995,757          1,928,810
                                               ---------------    --------------
    Net deferred income tax assets                 1,866,737          2,795,350
    Less valuation allowance                      (1,866,737)        (2,795,350)
                                               ---------------    --------------
    Deferred income tax asset                  $        --        $        --
                                               ===============    ==============

<PAGE>

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 net patient  revenue
        less a provision for bad debts above a defined threshold. Rental expense
        on these  leases for the years ended June 30, 1995,  1996 and 1997,  was
        $586,518,  $412,468  and  $382,456,  respectively,  of which  $7,577 and
        $1,158 was unpaid at June 30, 1996 and 1997, respectively. Subsequent to
        year end the majority  stockholder sold the final facility leased to the
        Company in conjunction with the Company's sale of its Kansas  operations
        (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 year  ended  June 30,  1995,  the  Company  recorded  expense of
        $27,761 related to these shares.

9.  COMMITMENTS AND CONTINGENCIES:

     Medicare Reimbursement The Company's amount due to Medicare  intermediaries
of $101,000 at June 30, 1997 includes amounts the Company  anticipates to pay on
cost report  settlements  for its  Colorado  home health  agencies  and Colorado
outpatient  rehabilitation  clinics acquired on June 30, 1995 and its final cost
report for the Company's  Gardner,  Kansas  facility.  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 Gardner, Kansas facility these costs were subject to the RCL. Requests
for an exception  from the RCL have been submitted for fiscal years 1992 through
1995 for the Company's Gardner,  Kansas facility. In connection with the sale of
its Kansas  operation,  the Company  retained  the  accounts  receivable  and it
accordingly  intends  to file  such a request  for  fiscal  1996 and  1997.  The
requests are based upon atypical  costs  incurred at the Kansas  facility in the
treatment of patients who received  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.

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 the results for the twelve month periods  ending June
30, 1996,  through  1999.  The Company was not required to make any cash payment
based on results as of June 30, 1996 and 1997.  If the  operations  collectively
achieve the target  earnings  thresholds  for the twelve  months ending June 30,
1998 through 1999, the Company's maximum liability would be $550,000.

     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.
However,  accounts receivable  collections have not been sufficient to repay the
loan and the loan  balance on June 30, 1997 was  $249,000.  This loan balance is
collateralized by personal assets of the debtor.

<PAGE>

     In October  1995,  the Company was  notified by its  intermediary  that its
Medicare  payments for the 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.  While the  intermediary
resumed making  payments for current  charges in January 1996, the  intermediary
had withheld $728,000 related to these settlements. During the second quarter of
fiscal 1997, the Company received $425,000 in payment of amounts  withheld.  The
Company has submitted appeals on behalf of the previous owner requesting payment
of the remaining balance.  In the event that such appeals are unsuccessful,  the
Company  intends to pursue  collection  from the  previous  owner and offset the
amounts withheld against any additional  amounts due to the previous owner under
the acquisition agreements.  Amounts owed to the Company as of June 30, 1997, by
Medicare and the previous  owner of the Colorado  operations  exceed the minimum
amounts owed to the previous owner by $237,000. This amount is included in other
receivables on the Company's balance sheet.

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             MEADOWBROOK REHABILITATION GROUP, INC. AND SUBSIDIARIES

                        VALUATION AND QUALIFYING ACCOUNTS

                FOR THE YEARS ENDED JUNE 30, 1995, 1996, AND 1997


                                            1995          1996           1997
                                         -----------  -----------    -----------
ALLOWANCE FOR DOUBTFUL ACCOUNTS:

     Balance at beginning of period      $2,025,000   $2,001,000     $1,445,000
     Provision charged to expense         1,371,151      583,661        454,255
     Write-offs, net of recoveries       (1,395,151)  (1,051,890)      (704,255)
     
     Other                                     --        (87,771)          --
                                         -----------  -----------    -----------

     Balance at end of period            $2,001,000   $1,445,000     $1,195,000
                                         ===========  ===========    ===========