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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

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

                                   FORM 10-KSB
                                AMENDMENT NO. 1

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

FOR THE YEAR ENDED DECEMBER 31, 1998              COMMISSION FILE NO. 001-12677

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

                       PREFERRED EMPLOYERS HOLDINGS, INC.
                 (Name of small business issuer in its charter)

           DELAWARE                                    65-0698-799
 (State or other jurisdiction of                  (I.R.S. Employer
 incorporation or organization)                   Identification No.)

          10800 BISCAYNE BOULEVARD                     33161
               MIAMI, FLORIDA                        (Zip Code)
(Address of Issuer's principal executive offices)

                                 (305) 893-4040
                           (Issuer's telephone number)


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


                          Common Stock, $.01 Par Value
                          ----------------------------
                                (Title of Class)

     Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]

     Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [X]

      The issuer's revenues for the year ended December 31, 1998 were
$54,311,000.

     The aggregate market value of the registrant's voting common equity (i.e.,
the Common Stock) held by non-affiliates as of March 26, 1999 was $32,801,431,
using the closing sale price of $9.5625 per share on such date, as reported by
the Nasdaq SmallCap Market(R).

     The number of outstanding shares of the registrant's Common Stock as of
March 26, 1999 was 5,247,085.

Transitional Small Business Disclosure Format. Yes [ ] No [X]

DOCUMENTS INCORPORATED BY REFERENCE: None.

A list of Exhibits to this Annual Report on Form 10-KSB begins on Page 31.

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                               TABLE OF CONTENTS
<TABLE>
<CAPTION>

<S>                                                                                  <C>

PART I
Item 1. Description of Business.................................................     1
Item 2. Description of Property.................................................    12
Item 3. Legal Proceedings ......................................................    12
Item 4. Submission of Matters to a Vote of Security Holders.....................    12

PART II
Item 5. Market for Common Equity and Related Stockholder Matters ...............    13
Item 6. Management's Discussion and Analysis of Financial Condition and
         Results of Operations .................................................    14
Item 7. Financial Statements ...................................................    19
Item 8. Changes In and Disagreements With Accountants on
         Accounting and Financial Disclosure...................................     19

PART III
Item 9.  Directors, Executive Officers, Promoters and Control Persons; Compliance
          with Section 16(a) of the Exchange Act................................    20
Item 10. Executive Compensation ................................................    23
Item 11. Security Ownership of Certain Beneficial Owners and Management ........    27
Item 12. Certain Relationships and Related Transactions.........................    29
Item 13. Exhibits and Reports on Form 8-K.......................................    31
</TABLE>

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         The Company's principal executive offices are located at 10800 Biscayne
Boulevard, Miami, Florida 33161, and our telephone number is (305) 893-4040.

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


FORWARD-LOOKING STATEMENTS

         This Annual Report on Form 10-KSB includes forward-looking statements,
including statements regarding, among other things, the Company's:

         o anticipated growth strategies, and

         o its intention to introduce new products.

         The Company has based these forward-looking statements largely on its
expectations. Forward-looking statements are subject to a number of risks and
uncertainties, certain of which are beyond its control. Actual results could
differ materially from those anticipated as a result of numerous factors,
including among other things: (1) economic, business and competitive conditions
in the employee staffing and insurance industry and the economy in general and
innovations of new insurance products; (2) the enactment of new laws and
regulations, and the amendment of existing laws and regulations which could
affect the Company's business; (3) changes in the Company's business strategy or
development plan; (4) the Company's ability to obtain financing on acceptable
terms when needed; (5) the Company's ability to continue to attract and retain
personnel qualified to meet the staffing requirements of clients; and (6) the
Company's ability to identify appropriate acquisition candidates, complete such
acquisitions and successfully integrate acquired businesses.

         The Company does not undertake any obligation to publicly update or
revise any forward-looking statements, whether as a result of new information,
future events or otherwise. Because of risks and uncertainties, the
forward-looking events and circumstances discussed in this Annual Report on Form
10-KSB might not occur.

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                                     PART I

ITEM 1. DESCRIPTION OF BUSINESS

INTRODUCTION

We engage in the following activities:

         o we provide temporary registered nurses and other professional medical
           personnel primarily to client hospitals;

         o we sell, on behalf of others, business insurance, including workers'
           compensation, property, liability, casualty, and other types of
           coverage, and provide risk management services, including cost
           containment, safety management and claims management services,
           designed for segments of the franchise industry (particularly fast
           food restaurants, family-style restaurants and convenience stores);
           and

         o we provide reinsurance for certain workers' compensation and
           employer's liability insurance policies we sell.

         EMPLOYEE STAFFING. In March and August of 1998, we acquired businesses
providing temporary registered nurses and other professional medical personnel
(often referred to as "Travelers") mainly to client hospitals. Travelers serve
clients for periods ranging from 8 to 52 weeks and function essentially as
permanent hospital staff rather than short-term, supplemental staff. We believe
that the ability of Travelers to function as permanent staff improves the
continuity and consistency of patient care and reduces our clients' overall
administration, orientation and supervisory requirements relating to permanent
staff, as well as reducing turnover of their temporary staff.

         INSURANCE. Since 1988, we have been engaged in the sale of insurance
products designed to provide clients with cost savings and reduce the time
otherwise spent in managing insurance needs and related costs. We offer clients
competitive rates and provide risk management services, including cost
containment, safety management and claims management programs. We believe that
our innovative approach to cost containment helps clients achieve lower claims
costs.

         REINSURANCE. In 1997, we began operating as a reinsurer for certain
workers' compensation and employer's liability insurance policies sold by us.
Although we assume risks associated with being a reinsurer, our reinsurance
agreement (i) limits our liability for losses and certain expenses to the first
$300,000 per occurrence and (ii) limits our total liability for all coverage to
a maximum of 70% of the total premiums written for each underwriting year.

         For the year ended December 31, 1998, the Company's total revenues were
$54,311,000 as compared to $27,593,000 for the year ended December 31, 1997,
representing a net increase of $26,718,000 and for the year ended December 31,
1997, the Company's total revenues were $27,593,000 as compared to total
revenues of $5,955,000 for the year ended December 31, 1996, representing a net
increase of $21,638,000. Approximately 63%, 33% and 4%, respectively, of the
Company's total revenues for the year ended December 31, 1998 were derived from
our staffing, reinsurance captive and general agency businesses and
approximately 42%, 49% and 9%, respectively, of the Company's total revenues for
the year ended December 31, 1997 were derived from our staffing, reinsurance
captive and general agency businesses, respectively.

      UNLESS OTHERWISE INDICATED OR THE CONTEXT OTHERWISE REQUIRES, (I) THE
FINANCIAL STATEMENTS OF THE COMPANY GIVE RETROACTIVE EFFECT TO THE CONSUMMATION
OF THE MERGER OF NATIONAL EXPLORERS AND TRAVELERS HEALTHCARE, INC. ("NET
HEALTHCARE") WITH AND INTO PREFERRED HEALTHCARE STAFFING, INC., WHICH OCCURRED
IN AUGUST 1998 AND WAS ACCOUNTED FOR AS A "POOLING OF INTERESTS" AND (II) THE
TERMS THE "COMPANY," OUR "COMPANY" OR WORDS OF SIMILAR IMPORT MEAN PREFERRED
EMPLOYERS HOLDINGS, INC., TOGETHER WITH ITS WHOLLY-OWNED SUBSIDIARIES AS
FOLLOWS: PREFERRED EMPLOYERS GROUP, INC., P.E.G. REINSURANCE COMPANY, LTD. AND
PREFERRED HEALTHCARE STAFFING, INC.

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INDUSTRY OVERVIEW

         EMPLOYEE STAFFING. One of our subsidiaries, Preferred Healthcare
Staffing, Inc. ("Preferred Staffing"), is engaged in the employee staffing
business. Employee staffing generally is a contractual arrangement through which
a business obtains human resources from a firm specializing in these functions.
The staffing firm typically provides health, unemployment, and workers'
compensation insurance, and other benefits, while the work site employer retains
full operational control over the employee's activities. In March and August of
1998, we acquired businesses providing temporary registered nurses and other
professional medical personnel, primarily to client hospitals. These Travelers
serve clients for periods ranging from 8 to 52 weeks and function essentially as
permanent hospital staff rather than short-term, supplemental staff.

         The staffing industry has experienced rapid growth in recent years.
Initially thought of as a short-term solution for peak production periods and as
a temporary replacement for full-time personnel, the staffing industry is now
considered as an effective tool for helping companies manage their investment in
human resources. Contract personnel allows companies to expand and contract
employee levels based on current needs, thus converting fixed labor costs into
controllable variable costs while still maintaining a high degree of employee
skill level. Temporary staffing may also reduce costs associated with recruiting
and terminating employees. In addition, changing government regulations
concerning such matters as employee benefits, health insurance and retirement
plans have significantly increased employment costs related to permanent
employees. In response, an increasing number of companies are turning to
temporary staffing as a method of maintaining high employee skill levels while
controlling labor costs.

         The staffing industry is highly competitive and fragmented. The
industry is currently experiencing a trend toward consolidation as large
companies seek to reduce the number of vendors and look to staffing companies
that offer a wider range of services over a broader geographic area. As
employers find it more difficult to locate full-time candidates with special
skills, they increasingly turn to temporary staffing companies to fill these
needs.

         INSURANCE. One of our subsidiaries, Preferred Employers Group, Inc.
("Preferred Group"), sells, on behalf of others, business insurance, including
workers' compensation, property, liability, casualty, and other types of
business coverage, and provides risk management services, including cost
containment, safety management and claims management services, designed for
segments of the franchise industry (particularly fast food restaurants,
family-style restaurants and convenience stores). All fifty States and the
District of Columbia have promulgated statutes, rules and regulations that
require employers to provide wage replacement and medical benefits to work
accident victims regardless of fault. As a result of these mandates, virtually
all employers must either (i) purchase workers' compensation insurance from a
private insurance carrier, (ii) obtain coverage from a state managed fund, or
(iii) be self-insured, if permitted, by the state in which the business is
conducted.

         We believe that franchises often are the safest segment of a particular
industry. Most franchises use standardized operations based upon models with
demonstrated success. These businesses typically have standard operating
procedures and standard plant and equipment with standardized safety programs.
The design and construction of most franchises take into account safety
engineering of the workplace. For example, in a fast food restaurant, chairs and
tables are set a certain distance apart to allow for adequate walking space, and
the cooking equipment used must conform to certain safety standards. The
franchisor and the franchisee have a shared interest to maintain safe, clean and
uniform environments for their customers and employees. Consequently, we believe
that, in general, workers' compensation cost of claims for franchise businesses
are lower than non-franchise operations.

         Franchises are often subject to the same workers' compensation premium
rating system that the insurance industry uses for any comparable business. As a
result, fast food franchise restaurants may pay the same rates as bars and
taverns which generally are open until later in the evening, as fine dining
restaurants where staff often carry heavy trays, or as "mom and pop" restaurants
without safety-engineered



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facilities or formal safety programs. Although these businesses may be charged
the same workers' compensation rates, their claims experience is typically
significantly higher. Consequently, we believe most franchise companies in many
industries generally suffer premium "redundancy" or an "overcharge" in their
insurance premiums. In effect, we believe franchise businesses subsidize the
higher workers' compensation claims costs of non-franchise operations. We seek
to offer our clients the opportunity to effectively lower their cost of claims.

         REINSURANCE. One of our subsidiaries, P.E.G. Reinsurance Company, Ltd.
("Preferred Reinsurance"), acts as a reinsurer with respect to certain workers'
compensation and employer's liability insurance policies sold by us. Reinsurance
is an arrangement in which an insurance company, the reinsurer, agrees to
indemnify another insurance company, the ceding company, against all or a
portion of the insurance risks underwritten by the ceding company under one or
more insurance policies. The two basic types of reinsurance arrangements are
treaty and facultative reinsurance. In treaty reinsurance, the ceding company is
obligated to cede, and the reinsurer is obligated to assume, a specified portion
of a type or category of risk insured by the ceding company. In facultative
reinsurance, the ceding company cedes and the reinsurer generally assumes all or
part of the risk under a single insurance policy.

         Both treaty and facultative reinsurance can be written on either a
pro-rata (also known as quota share or proportional) basis or an excess of loss
basis. For reinsurance written on a pro-rata basis, the reinsurer, in return for
a predetermined portion or share of the insurance premium charged by the ceding
company, indemnifies the ceding company against a predetermined portion of the
losses and the allocated portion of loss adjustment expenses ("ALAE") of the
ceding company under the covered insurance policy or policies. For reinsurance
written on an excess of loss basis, the reinsurer generally indemnifies the
ceding company against all or a specified portion of losses and ALAE on
underlying insurance policies in excess of a specified dollar amount, known as
the ceding company's retention or attachment point, subject to a negotiated
limit. Preferred Reinsurance is a facultative reinsurance company.

BUSINESS STRATEGY

         We believe that we have substantial opportunities for growth which
include leveraging our capabilities and expertise in workers' compensation and
risk management in employee staffing and related businesses. In particular, we
believe that by combining our existing expertise in insurance matters with
strategic acquisitions of employee staffing businesses we can reduce the
operating expenses typically associated with these operations and increase the
products we offer to our existing clients and staffing employees.

         Our current strategy for growth includes:

         o seeking to enter additional segments of the staffing industry through
           selective acquisitions of employee staffing operations;

         o utilizing our core competencies to improve the efficiency and
           profitability of staffing companies we acquire;

         o focusing our employee staffing operations on industry specific
           segments without regard to geographic boundaries;

         o continuing to capitalize on our business of selling business
           insurance and providing risk management services to franchise and
           related companies; and

         o growing our existing insurance business by offering workers'
           compensation and other business insurance products, along with risk
           management services, to select industries.

         With regard to our employee staffing business, we are not seeking to
become staffing generalists. We are seeking to provide highly compensated
professionals to target industries which are not sensitive to significant
changes in economic conditions, where professionals serving the industry are
more highly compensated, where there is a shortage of technical professionals to
fill high demand, where the industry


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imbalance of supply and demand is expected to continue into the future and where
we can manage workers' compensation and healthcare risks at a profitable rate.

PRODUCTS AND SERVICES

         EMPLOYEE STAFFING. In March 1998, we purchased substantially all of the
assets of HSSI Travel Nurse Operations, Inc. ("Travel Nurse") for an aggregate
purchase price of $5.0 million in cash. In August 1998, we acquired through a
"pooling of interests" all of the outstanding capital stock of Net Healthcare
for an aggregate of 517,085 shares of our common stock. In October 1998, we
merged the two healthcare staffing companies and now the operations of Travel
Nurse and Net Healthcare are conducted through Preferred Staffing.

         For the years ended December 31, 1998 and 1997, approximately 63% and
42%, respectively, of our total revenues were derived from our employee staffing
operations. Our employee staffing operations provide registered nurses and other
professional medical personnel, often referred to as "Travelers," primarily to
client hospitals on a contractual basis for periods generally ranging from 8 to
52 weeks, with the average being approximately 17 weeks (standard assignments
are usually for durations of thirteen or twenty-six weeks). Generally, clients
utilize our Travelers to provide cost effective interim staff to meet
predictable fluctuations in staffing requirements. In addition, unlike daily or
other very short-term supplemental staff, Travelers generally serve for a long
enough period to function essentially as permanent hospital staff. We believe
that the ability of Travelers to function essentially as permanent staff
improves the continuity and consistency of patient care and reduces the overall
administration, orientation and supervisory requirements of the clients'
permanent staff. Travelers are typically employed on a full-time basis for the
period of each assignment. Each Traveler is generally provided with housing and
utilities (or a housing subsidy) while on assignment, travel allowance, and
other employee benefits, including malpractice, group health and dental
insurance.

         Preferred Staffing currently recruits personnel through its in-house
recruiting department. Recruiting methods historically have included national
and local advertising, attendance at national and regional conventions, personal
and professional referrals and the sponsoring of local seminars in selected
cities throughout the United States and Canada.

         As of March 26, 1999, Preferred Staffing had more than 750 nurses,
surgical technologists and therapists under contract, providing services to over
300 client hospitals. As of March 26, 1999, Preferred Staffing had approximately
3,000 unfilled requests for Travelers, of which 100 were recently received from
the United Kingdom.

         INSURANCE. We provide workers' compensation and business insurance
programs and risk management services to segments of the American franchise
industry. Our insurance programs are designed specifically to reduce the impact
of premium redundancy on franchise businesses while also emphasizing loss
control and cost containment. By taking advantage of this business segment's
good safety records and by providing risk management services, including loss
control, safety management and claims management, we seek to offer our clients
the opportunity to effectively lower their cost of claims. We have developed
proprietary information and claims analyses systems and custom-designed loss
reports which explain the claims procedure and assist client management in
seeking to promote safety and control claims expense. For the years ended
December 31, 1998 and 1997, respectively, approximately 4% and 9%, respectively,
of our total revenues were derived from our insurance business.

         Our insurance programs are custom designed to be offered only through
nationally recognized carriers with the highest industry ratings. We work with
these carriers to establish competitive rates, while being mindful of the
carrier's need to maintain profitability and remain viable in the marketplace.
Additionally, we offer services designed to enable our clients to realize
savings in their workers' compensation costs while reducing the time required to
manage this element of their business. Specifically, we


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provide clients with potential savings by offering competitive rates and cost
containment programs which assist our clients in managing their workers'
compensation and other business insurance costs.

         Using early intervention techniques, we seek to limit the number of
disputes with injured employees. Through a third-party administrator, we provide
our clients with access to national "toll-free" telephone numbers so that their
claims can be reported quickly, 24 hours-per-day, seven days-per-week. The
third-party administrator has trained medical staff available for four party
contact among the claimant, the employer, the adjuster and the treating
physician. This process helps to provide prompt and competent medical care for
the employee and management of the claim. We believe in the prompt settlement of
meritorious claims, but we aggressively advise to defend against non-meritorious
claims. We attempt to resolve cases prior to litigation and, if litigation
ensues, seek to settle reasonable claims.

         In addition to these cost containing activities, our client services
staff seeks to maintain communication with our clients. Our loss control
department provides advice to clients on how to control the frequency and
severity of claims. We seek to persuade clients that safety is not just an issue
of good management, rather it can have a significant impact on the financial
success of their businesses.

         We believe we have created a new, innovative, comprehensive and
aggressive approach to safety/loss control, blending old and new prevention
techniques to develop safety programs specific to each industry we serve. While
the primary thrust of our programs is safety for employees and customers,
emphasis is also placed on motivating client management to implement safety
programs as a means of improving profitability. We conduct workshops to
demonstrate the benefits of using our loss control safety programs at no
additional cost to our clients. Proprietary, custom-designed loss management
information is communicated by mail and telephoned to our clients at no
additional cost.

         We believe our safety programs help reduce workers' compensation claims
costs. The basic elements of our safety programs, as recommended to our clients,
include:

         o a written safety policy with safety rules;

         o regularly scheduled safety meetings;

         o new employee hiring practices and training of new and transferred
           employees;

         o supervisor responsibility and accountability;

         o a regular self-inspection program administered by identified
           supervisors;

         o an incentive program that rewards safety awareness;

         o a team safety committee program;

         o a timely accident reporting and investigation program;

         o a monitored record-keeping system for accidents;

         o a policy to implement corrective action for unsafe conditions and
           acts; and

         o a monthly review of programs and their implementation.

         Many states have allowed a reduction in workers' compensation insurance
premiums when an employer implements an approved safety program. Our safety
programs meet the requirements of most states that have approved safety
programs. Such workers' compensation safety program discounts are authorized on
a state-by-state basis and, therefore, guidelines are state specific. We deal
only with those able to the voluntary market, not the assigned risk market.
Certain states make safety program discounts available to all insureds while
others make them available only to those insureds with high experience
modification factors or based on the size of their premium. Some states require
state certification of the safety program on a risk-by-risk basis. We evaluate
requirements in the states where




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such discounts are available and provide employers with manuals, record keeping
tools and recommendations which assist the employer in obtaining certification.

         REINSURANCE. In December 1996, we formed Preferred Reinsurance under
the laws of Bermuda. Preferred Reinsurance acts as the reinsurer with respect to
certain workers' compensation and employer's liability insurance policies sold
by us. Although Preferred Reinsurance assumes the risks associated with being a
reinsurer, its liabilities are limited for losses and certain defined expenses
to the first $300,000 per occurrence and its aggregate liability is limited for
all coverage to an amount not to exceed 70% of the gross written premiums for
each individual underwriting year. The reinsurance arrangements are governed by
the terms of a reinsurance agreement between Preferred Reinsurance and insurance
companies affiliated with the American International Group of Companies ("AIG").
The reinsurance agreement with Preferred Reinsurance is terminable by either
party upon the occurrence of certain events. For the years ended December 31,
1998 and 1997, approximately 33% and 49%, respectively, of our total revenues
were derived from our reinsurance business.

         The purchase of excess and aggregate reinsurance from affiliates of AIG
and the stated aggregate limit of liability in the reinsurance agreement limits
the liability of Preferred Reinsurance for losses and loss adjustment expenses
and permits it to quantify its aggregate maximum loss exposure. By contrast,
maximum liability under pro-rata or quota share reinsurance contracts can be
more difficult to quantify. Quantification of loss exposure is fundamental to
the ability of Preferred Reinsurance to manage its losses.

         Pursuant to the terms of the reinsurance agreement, affiliates of AIG
are obligated to cede to Preferred Reinsurance 100% of the net written premium
less certain expenses and commissions associated with the policies covered
thereby. The affiliates retain a commission allowance, which was 27.09% in 1998
and 28.83% in 1997, based on the net written premiums, and Preferred Reinsurance
retains the premiums ceded by the AIG affiliates to Preferred Reinsurance
together with the risks and potential for underwriting profits associated
therewith. Accordingly, we believe that the operations of Preferred Reinsurance
provide us with the opportunity to retain the underwriting profitability that
was previously retained by affiliates of AIG, while creating a relatively
limited risk exposure under the reinsurance agreement.

         Preferred Reinsurance is required to provide affiliates of AIG, as
security for the payment of losses, a combination of cash, United States
government securities and/or an irrevocable letter of credit in an aggregate
amount equal to 51.5% of the net written premiums ceded to Preferred Reinsurance
pursuant to the reinsurance agreement less the amount of losses paid. Our
results of operations depend, in part, on the income derived from the investment
of premiums by Preferred Reinsurance. Increases in interest rates or events or
conditions which negatively affect the financial markets or the general economy
may result in losses, both realized and unrealized, on our investments.

CUSTOMERS

         EMPLOYEE STAFFING. As of March 26, 1999, active clients of Preferred
Staffing consisted of over 300 hospitals and other clients located in
approximately 40 states and the U.S. Virgin Islands. Travelers serve both
for-profit and not-for-profit entities which range from small rural hospitals to
major teaching and research institutions. A typical client is a hospital with
approximately 250 beds which is located in or near a major metropolitan area.

         INSURANCE. We market our insurance programs primarily to the franchise
industry both directly and through a network of broker/agents. Our customers
typically are owners of multiple unit franchises who understand the importance
of cost containment and safety features. While we focus our efforts on large,
national franchisees operating multiple outlets, we also serve smaller, regional
franchise operators.



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SALES AND MARKETING

         EMPLOYEE STAFFING. Our subsidiary, Preferred Staffing, currently
markets its Travelers program principally through in-house sales personnel.
Historically, marketing activities have been conducted primarily by telephone
contact, direct mail, attendance at national and regional conventions, seminars,
and direct contact with providers of healthcare services. Additionally, we
advertise in a variety of local and national media, including the Yellow Pages,
local and national newspapers and trade publications. We also have a Web Page on
the Internet in order to provide both prospective clients and prospective
Travelers with information about our company and our services as well as
employment opportunities.

         Preferred Staffing has developed an extensive computer database of
available, qualified personnel, which we believe should enhance our ability to
match personnel with client needs. To attract qualified personnel, we use
sophisticated direct mail techniques followed by calls from our telemarketing
teams. Interested prospective Travelers are turned over to professional
recruiters to assist them in finding the right assignment to suit their specific
goals. Our marketing plan includes a continual review of our clients'
anticipated future staffing needs to enable us to respond to changes in their
demands. We seek to develop and maintain strong interactive relationships by
anticipating and focusing on our clients' needs.

         INSURANCE. Our insurance sales and marketing programs are varied. We
engage in multiple targeted direct mail programs each year. These direct mail
programs, designed to introduce our products and services to franchise owners
and insurance agents, are complimented by extensive telemarketing efforts. We
utilize multiple databases of franchises and insurance agents in our direct mail
and telemarketing efforts. Our marketing programs identify prospective clients,
clients' agents and new agents to represent us.

         Our marketing programs are designed to generate new prospects for both
high revenue broker/agents (those whose client bases produce workers'
compensation annual premiums in excess of $2 million) as well as smaller
broker/agents who operate in small towns. Generally, we target agents that have
the ability to produce $300,000 in annualized workers' compensation premiums to
receive a contract to represent us.

         Our programs relieve the broker/agent of administrative and claims
tasks as we and/or the insurance carrier bills and collects premiums directly
from the insured, remits the commission earned to the broker/ agent, deals
directly with the insured in connection with any problems experienced by the
insured and serves as a clearinghouse, together with the third-party
administrator, with respect to reporting, processing, reviewing and evaluating
claims. As a result of the foregoing, we believe the broker/agent can earn more
revenue by focusing its efforts on selling products. Other benefits provided to
the broker/agent include the following:

         o increasing the geographic area in which the broker/agent can generate
           business;

         o reducing the likelihood of the broker/agent losing larger multiple
           store and multiple state franchisees because the broker/agent will
           have many more states in which it is able to write business;

         o providing the broker/agent with the option of offering other property
           and casualty products to its clients; and

         o providing the broker/agent's clients with the benefit of our loss
           control and cost containment programs to reduce its clients' losses.

         Client franchisees are provided with a personal client service
representative who is knowledgeable and available throughout the work day. A
1-800 "hot line" is also available to reach the manager of client services
should any issue need immediate attention. We believe that these client support
services distinguish us from our competition.



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POLICY RENEWALS

         Client policy renewals are critical to our insurance operations. We
seek to maintain favorable renewal rates by (i) providing our clients with
quality service, (ii) ensuring that all insurance policy, endorsement and audit
documents are distributed to each client on a timely basis, and (iii) ensuring
that all documents distributed to clients are complete and accurate. We seek to
communicate with each client several times each year in order to maintain a
close relationship and learn of any real or perceived problems and concerns on a
timely basis. We believe that our quality service is a major factor in our
client retention rate, which as of December 31, 1998 was approximately 62%, and
as of December 31, 1997 was approximately 70%.

         Our underwriting department reviews prospects to identify risks that
appear undesirable from a historical viewpoint and to recognize those prospects
dedicated to significant improvement in their loss history, which thereby makes
them a valuable addition to our customer base and to a carrier's portfolio. Our
underwriting department also evaluates each client for renewal purposes. This
evaluation determines whether the particular client is eligible to receive a
decrease or other form of modification to its renewal premium. If the client has
responded to loss control recommendations and its loss history reflects
improvement, a reduction in its renewal premium rate may be implemented. The
department also identifies clients whose experience has deteriorated and who
have not responded to loss control guidance and recommendations. If the
deterioration is significant enough and the client has not demonstrated a
sincere commitment to improvement in loss experience, our underwriting
department may make a recommendation not to renew the policy.

DATA MANAGEMENT

         EMPLOYEE STAFFING. Our success in the employee staffing business is
dependent, in part, upon our ability to effectively and efficiently match
skilled personnel with specific customer assignments. As a result of continuous
recruiting efforts, we have established an extensive national resume database of
prospective Travelers.

         Preferred Staffing's current database contains information on
pre-screened personnel classified by skill, experience, and choice and
availability for assignments. The database is updated on a regular basis. When
called upon to fill an assignment, our recruiters can access this database to
match a client's staffing needs with available personnel. Nurses and other
medical personnel listed in the database generally do not work exclusively for
any one employer. We continuously update our proprietary database to reflect
changes in personnel skill levels and availability. Upon receipt of assignment
specifications, we search our database to identify suitable personnel. Once a
prospective Traveler's skills are matched to the specifications, we consider
other selection criteria such as availability and geographic preferences to
ensure there is a proper fit between a prospective Traveler and the assignment
being staffed. The system also allows for the addition of new information as
acquired companies and databases are integrated. Our database is protected by a
multilevel security system.

         INSURANCE. Our insurance management information systems include, among
other things, a central database to keep us abreast of market trends, current
premium rates, rate filings, renewal dates and information on our competition.
These systems constitute an integral part of our business operations. We utilize
the systems to process insurance applications, control the issuance of policies
and endorsements, audit medical fees, pay broker/agent commissions, manage
claims, provide reports to our clients, provide accounting statements and
financial reports, and analyze claims data. We believe these systems give us the
ability to write more effective and competitive policies and result in a higher
rate of policy renewals.

COMPETITION

         EMPLOYEE STAFFING. The staffing industry is highly competitive and
fragmented. There are limited barriers to entry and new competitors frequently
enter the market. We face substantial competition from



                                       8


<PAGE>   11
local and national staffing companies, and certain of our competitors have more
established and significantly larger operations and greater financial,
marketing, human and other resources. We compete with other staffing companies
as well as our clients and other employers for qualified personnel, and we
compete with other staffing companies for suitable acquisition candidates. In
addition, during any given year a number of our staffing employees may terminate
employment with us in order to accept employment with our clients. In the
future, we may encounter difficulty in recruiting a sufficient number of
staffing employees of the caliber that we are committed to provide to our
customers.

         During periods of higher employment, we may incur increased expenses
associated with recruiting qualified staffing employees. We believe there is a
shortage of, and significant competition for, professional medical personnel who
possess the technical skills and expertise necessary to deliver services and
that such professionals are likely to remain a limited resource for the
foreseeable future. We believe that the availability and quality of candidates,
the level of service, the effective monitoring of job performance, and the price
of service are the principal elements of competition in the staffing industry.
In order to attract staffing candidates, we place emphasis upon our ability to
provide long-term placement opportunities, competitive compensation, quality and
varied assignments, and scheduling flexibility. In order to meet the challenge
of retaining qualified personnel, we provide what we believe to be a competitive
benefits package. Our years of expertise in risk management has permitted us to
earn a commission in workers' compensation and healthcare benefits, and we are
able to reinvest a portion of such commissions into better benefit packages for
our staffing employees.

         INSURANCE. The business insurance industry is highly competitive. We
compete with other general agents, numerous large insurance companies, managed
health care companies, state sponsored insurance pools, risk management
consultants and affiliated broker/agents, many of which have significantly
larger operations and greater financial, marketing, human and other resources
than us. Competitors may have material advantages over us such as with respect
to the forms of insurance and services they offer in addition to workers'
compensation products and services. Competitive factors include product lines,
premium rates, personalized service and effective cost containment measures.

         Consumers of insurance products have traditionally focused on price
rather than cost containment. They have come to expect little or no customer
service. We believe we can favorably compete by tailoring our products for each
niche market, providing quality customer service and, most importantly,
providing loss control and cost containment services.

REGULATIONS

         EMPLOYEE STAFFING. We currently conduct our employee staffing business
in 42 states, and are subject to regulation by various state agencies pertaining
to a wide variety of employment-related laws. Many of these regulations were
enacted prior to the emergence of the employee staffing industry and do not
specifically address non-traditional employers. While many states do not
explicitly regulate staffing providers, a number of states have passed laws that
have licensing, registration or compliance requirements for staffing providers,
and other states consider enacting similar regulations from time to time.

         Laws regulating the staffing industry vary from state to state. While
we believe we are currently qualified to conduct our staffing business in
substantially all of the states, there can be no assurance that we will be able
to satisfy any new licensing requirements or other applicable regulations of any
particular state. In addition, there can be no assurance that we will be able to
renew our licenses in the states in which we currently operate upon the
expiration of our licenses.

         Numerous Federal and state laws and regulations involving employment
matters, benefit plans and taxes affect our operations. Many of these laws (such
as the Employee Retirement Income Security Act and Federal and state employment
tax laws) do not specifically address the obligations and responsibilities of
non-traditional employers such as staffing providers, and do not have a uniform
definition of "employer." Many Of the states in which we operate have not
addressed the staffing relationship for


                                       9



<PAGE>   12




purposes of complying with applicable state laws governing the employer/employee
relationship. In addition, from time to time, states have considered, and may in
the future consider, imposing certain taxes on gross revenues or service fees of
staffing companies. If these Federal or state laws are adopted or applied in a
manner unfavorable to us, such adoption or application could have a material
adverse effect on our results of operations and financial condition.

         In providing staffing services to our clients, we have the obligation
to pay the salaries, wages and related benefit costs and payroll taxes of our
staffing employees. We pay the (i) salaries and wages for work performed by
staffing employees and (ii) payroll withholding taxes, Federal and state
unemployment taxes, and taxes due under the Federal Insurance Contributions Act
(FICA). We are obligated to make these payments whether or not our clients make
timely payment, or if our clients default in their payment to us of staffing
revenue owed to us. In the event of substantial client default, there can be no
assurance that our ultimate liability for staffing employee payroll and related
tax costs will not have a material adverse effect on our results of operations
or financial condition.

         INSURANCE. As a general agent, we are subject to the regulations of the
various states in which we sell insurance. These regulations vary from state to
state, and may include such matters as licensing requirements, bonding
requirements, requirements regarding our agreements with insurance carriers for
which we act as a general agent, and certain other requirements. Penalties may
be imposed for violations of such regulations.

         Under the workers' compensation system, employer insurance or
self-funded coverage is governed by individual laws in each of the fifty states
and by certain federal laws. Changes in the federal law or state regulations
concerning workers' compensation or managed healthcare may create a greater or
lesser demand for some or all of our services, or require us to develop new or
modified services in order to meet the needs of the marketplace and compete
effectively in that marketplace.

         REINSURANCE. Preferred Reinsurance is registered as a Class 3 insurer
in Bermuda and, accordingly, is subject to the provisions of the Bermuda
Insurance Act of 1978, as amended, and the regulations promulgated thereunder.
The Bermuda Insurance Act provides that no person shall carry on insurance
business in or from within Bermuda unless registered as an insurer under the
Bermuda Insurance Act by Bermuda's Minister of Finance. The Minister of Finance
has broad discretion to act in the public's interest. The Minister of Finance is
required by the Bermuda Insurance Act to ascertain whether the applicant is a
fit and proper body to be engaged in the insurance business and, in particular,
whether it has, or has available to it, adequate knowledge and expertise. In
connection with registration, the Minister of Finance may impose conditions
relating to the writing of certain types of insurance business.

         The Bermuda Insurance Act imposes on Bermuda insurance companies, such
as our subsidiary Preferred Reinsurance, solvency and liquidity standards and
auditing and reporting requirements and grants to the Minister of Finance powers
to supervise, investigate and intervene in the affairs of insurance companies.
Significant aspects of the Bermuda insurance regulatory framework include those
set forth below:

         o Preferred Reinsurance is required to maintain a principal office in
           Bermuda and appoint and maintain a principal representative in
           Bermuda. The Bermuda Insurance Act places a duty on the principal
           representative to report to the Minister of Finance the occurrence of
           certain events, including but not limited to, the failure by the
           insurer for which he or she acts to comply with a condition imposed
           by the Minister of Finance relating to a solvency margin or a
           liquidity or other ratio with respect to any other such condition.
           Without a reason acceptable to the Minister of Finance, Preferred
           Reinsurance may not terminate the appointment of its principal
           representative, and the principal representative may not cease to act
           as such, unless 30 days' advance notice in writing to the Minister of
           Finance is given of the intention to do so.




                                       10


<PAGE>   13




         o Preferred Reinsurance is required to appoint an independent auditor
           to conduct an annual audit of its statutory-based financial
           statements.

         o Preferred Reinsurance is required to maintain share capital (the
           aggregate par value of issued shares) of at least $120,000.

         o Preferred Reinsurance must maintain statutory capital and surplus
           exceeding the greater of the following three criteria: (a)
           $1,000,000; (b) 20% of the net premiums where the net premiums in the
           current financial year do not exceed $6,000,000, or where the net
           premiums exceed $6,000,000, $1,200,000 plus 15% of the net premiums
           which exceed $6,000,000 (The net premium is the gross premium after
           deduction for any premium ceded for reinsurance.); and (c) 15% of
           reserves for losses and loss expenses.

         o Preferred Reinsurance is required to maintain liquid assets at a
           level equal to or greater than 75% of its net relevant (insurance)
           liabilities. For this purpose, liquid assets include cash and time
           deposits, quoted (publicly traded) investments, unquoted bonds and
           debentures, mortgage loans backed by first liens on real estate,
           accrued investment income, accounts and premiums receivable,
           reinsurance balances receivable and funds held by ceding companies.

         o Preferred Reinsurance is required to obtain the approval of the
           Minister of Finance before reducing by 15% or more its total
           statutory capital (comprised of share capital, contributed surplus
           and any other fixed capital) as set out in its previous year's
           financial statements.

         o Preferred Reinsurance may declare and pay dividends or make
           distributions out of contributed surplus or other assets legally
           available for distribution provided that after the payment of any
           such dividend or distribution it will continue to maintain the
           required statutory capital and surplus and liquid assets as
           summarized above.

         o Preferred Reinsurance is required to have a copy of its statutory
           financial statements available at its principal office for production
           to the Registrar of Companies and to file the statutory financial
           statements and a statutory financial return within four months after
           the end of each financial year (or such longer period, not exceeding
           seven months, as the Registrar of Companies, on application, may
           allow).

         o Preferred Reinsurance is required to include in its annual statutory
           financial statements the opinion of a loss reserve specialist in
           respect of its loss and loss adjustment expense reserves.

         o The Minister of Finance may appoint an inspector with extensive
           powers to investigate the affairs of an insurer or reinsurer if the
           Minister of Finance believes that an investigation is required in the
           interest of the insurer's or reinsurer's policyholders or persons who
           may become policyholders. To verify or supplement information
           otherwise provided to him, the Minister of Finance may direct an
           insurer or reinsurer to produce documents or information relating to
           matters connected with the insurer's or reinsurer's business.

         Under current Bermuda law, there is no Bermuda income, corporation or
profits tax, withholding tax, capital gains tax, capital transfer tax, estate
duty or inheritance tax payable by our company with respect to Preferred
Reinsurance. Preferred Reinsurance is not subject to stamp or other similar duty
on the issue, transfer or redemption of its shares of common stock.

         We have obtained an assurance from the Minister of Finance under the
Exempted Undertakings Tax Protection Act of 1966 that if any legislation is
enacted in Bermuda imposing tax on profits or income, or on any capital assets,
gain or appreciation or any tax in the nature of estate duty or inheritance tax,
such tax shall not, until March 28, 2016, be applicable to us or to our
operations, or to our shares, debentures or other obligations except insofar as
such tax applies to persons ordinarily resident in Bermuda and holding such
shares, debentures or other obligations or any real property or leasehold
interests in Bermuda owned by us. As an exempted company, we are liable to pay a
registration fee in Bermuda based upon our



                                       11

<PAGE>   14




authorized capital and the premium on our issued shares of common stock at a
rate not exceeding $25,000 per annum.

         PREMIUM RATE RESTRICTIONS. State regulations governing the workers'
compensation system impose restrictions and limitations that affect the business
operations of Preferred Reinsurance. State laws regulate what workers'
compensation benefits must be paid to injured workers. Additionally, most states
must approve the workers' compensation premium rates that may be charged. As a
consequence, the ability of Preferred Reinsurance to pay insured workers'
compensation claims out of the premium revenue generated from Preferred
Reinsurance's assumption of such insurance is dependent on the level of benefits
and premium rates approved by the various states. In this regard, it is
significant that the state regulatory agency that regulates workers'
compensation benefits is often not the same agency that regulates workers'
compensation insurance premium rates.

         POSSIBLE FUTURE REGULATIONS. The federal government and several state
legislatures have considered and are considering a number of cost containment
and health care reform proposals. No assurance can be given that the federal
government or any state will not adopt future regulations that could have a
material adverse effect on us.

EMPLOYEES

         As of March 26, 1999, we had approximately 856 full-time employees, of
whom 6 were executive officers, 20 were managers, 59 were sales personnel and 58
were accounting, clerical, loss control or underwriting staff and approximately
713 were Travelers. Our Travelers do not necessarily work full-time shifts. As
the employer of the Travelers, we are responsible for the general payroll
expenses and employer's share of social security taxes (FICA), federal and state
unemployment taxes, workers' compensation insurance and other direct labor costs
relating to employees. We offer a package of benefits for our Travelers which we
believe to be competitive, including housing and utilities (or a housing
subsidy), travel allowance, 401(k) retirement plan and malpractice, health and
dental insurance. None of our employees are subject to a collective bargaining
agreement. We believe that our relationships with our employees are good.

ITEM 2. DESCRIPTION OF PROPERTY

         We lease approximately 16,500 square feet of office space in Miami,
Florida for use as our corporate headquarters. Our initial lease term expires in
2002, but we have two five-year renewal options. Preferred Staffing leases
premises in Fort Lauderdale, Florida, consisting of approximately 20,000 square
feet. The lease will expire in 2005, subject to one five-year renewal option. We
anticipate that our existing leases will be renegotiated as they expire or that
alternative properties can be leased on acceptable terms. We believe that our
present facilities are in good condition and are suitable for our needs for the
foreseeable future.

ITEM 3. LEGAL PROCEEDINGS

         We are involved in various legal proceedings arising in the ordinary
course of business. As of March 26, 1999, we are not a party to any legal
proceeding which, if adversely determined, would have a material adverse effect
on our results of operations or financial condition.

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

         During the fourth quarter of the year ended December 31, 1998, no
matters were submitted by the Company to a vote of its stockholders.



                                       12



<PAGE>   15




                                    PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

         MARKET INFORMATION. The Company's common stock is currently listed on
the Nasdaq SmallCap Market under the trading symbol "PEGI." The Company first
listed its common stock on the Nasdaq SmallCap Market in February 1997. During
the period from February 1997 to August 1997, the Company's common stock was
also listed on the Boston Stock Exchange. The following table sets forth the
high and low closing sale prices of its common stock as reported on the Nasdaq
SmallCap Market and the Boston Stock Exchange for each calendar quarter
commencing in February 1997 through December 31, 1999 (through August 1997 in
the case of the Boston Stock Exchange).

<TABLE>
<CAPTION>
                                                                                     NASDAQ SMALLCAP
                                                                                          MARKET
                                                                                   -------------------
                                                                                   CLOSING SALE PRICES
                                                                                   -------------------
YEAR                                    PERIOD                                      HIGH           LOW
----                                    ------                                      ----           ---
<S>                                        <C>                                    <C>             <C>
1997    First Quarter (Commencing February 6, 1997) ............................  $ 8.875         $7.625
        Second Quarter .........................................................    7.703           6.00
        Third Quarter...........................................................    11.00           7.00
        Fourth Quarter..........................................................    10.75           7.00
1998    First Quarter ..........................................................     8.50           7.00
        Second Quarter .........................................................     9.75           7.62
        Third Quarter...........................................................     9.25           6.25
        Fourth Quarter..........................................................   10.375           5.00
1999    First Quarter (through March 25, 1999)..................................    11.75           8.50

</TABLE>
<TABLE>
<CAPTION>
                                                                                       BOSTON STOCK
                                                                                         EXCHANGE
                                                                                   -------------------
                                                                                   CLOSING SALE PRICES
                                                                                   -------------------
YEAR                                    PERIOD                                      HIGH           LOW
----                                    ------                                      ----           ---
<S>                                        <C>                                    <C>             <C>
1997    First Quarter (Commencing February 6, 1997)............................. $  8.38         $  7.13
        Second Quarter..........................................................    7.14            6.00
        Third Quarter (Ending August 9, 1997)...................................    7.75            6.50
</TABLE>

         As of March 26, 1999, the closing sale price of the Company's common
stock on the Nasdaq SmallCap Market was $9.5625 per share. As of March 26, 1999,
there were approximately 410 holders of record for our common stock. A high
percentage of the Company's common stock held of record is registered in the
names of brokerage firms and depositaries.

         DIVIDEND POLICY. The Company has never declared nor paid any cash
dividends on its common stock and does not anticipate paying cash dividends in
respect of its common stock in the foreseeable future. Any payment of cash
dividends in the future will be at the discretion of the Company's Board of
Directors and will depend upon, among other things, its earnings (if any),
financial condition, cash flows, capital requirements and other relevant
considerations, including applicable contractual restrictions and governmental
regulations with respect to the payment of dividends. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."



                                       13


<PAGE>   16

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

         The following discussion and analysis should be read in conjunction
with the Company's audited consolidated financial statements and notes related
thereto contained elsewhere in this Annual Report on Form 10-KSB. In August
1998, the Company consummated the merger of Net Healthcare with and into one of
the Company's wholly-owned subsidiaries, and in connection therewith issued
517,085 shares of common stock in exchange for all the outstanding common stock
of Net Healthcare. The business combination was accounted for as a
"pooling-of-interests" and, accordingly, our consolidated financial statements
for applicable periods prior to the combination have been restated to include
the accounts and results of operations of NET Healthcare.

GENERAL

         The Company engages in the following activities:

         o it provides temporary registered nurses and other professional
           medical personnel primarily to client hospitals;

         o it sells, on behalf of others, business insurance, including workers'
           compensation, property, liability, casualty, and other types of
           coverage, and provides risk management services, including cost
           containment, safety management and claims management services,
           designed for segments of the franchise industry (particularly fast
           food restaurants, family-style restaurants and convenience stores);
           and

         o it provides reinsurance for certain workers' compensation and
           employer's liability insurance policies it sells.

         EMPLOYEE STAFFING. In March and August of 1998, the Company acquired
businesses providing temporary registered nurses and other professional medical
personnel (often referred to as "Travelers") mainly to client hospitals.
Travelers serve clients for periods ranging from 8 to 52 weeks and function
essentially as permanent hospital staff rather than short-term, supplemental
staff. The Company believes that the ability of Travelers to function as
permanent staff improves the continuity and consistency of patient care and
reduces its clients' overall administration, orientation and supervisory
requirements relating to permanent staff, as well as reducing turnover of their
temporary staff.

         Staffing income is recognized at the time the staffing services are
provided. In most instances, the staffing company's temporary healthcare
professionals are considered employees of the staffing company while under
assignment and costs of employment are the responsibility of the staffing
company and are included in the accompanying statements of operations.

         INSURANCE. The Company is engaged in the property and casualty
insurance business and has conducted business as a general agent on behalf of
AIG, General Accident Insurance Company ("General Accident") and the Kemper
Insurance Companies ("Kemper") and as a reinsurer for certain workers'
compensation insurance policies written by the Company on behalf of affiliates
of AIG. Pursuant to our general agency agreements, the Company is authorized to
solicit and bind insurance contracts on behalf of the insurers, collect and
account for premiums on business it writes, and request cancellation or
nonrenewal of any policy it places. The Company receives, as compensation
pursuant to the terms of these general agency agreements, gross commissions on
its business at rates which range from approximately 5% to 20%. The Company has
written workers' compensation insurance since its inception in 1988 and in late
1995 began writing other forms of property and casualty insurance (such other
forms of insurance being hereinafter referred to as "Package") for family style
and fast food restaurants as a general agent for General Accident. In June 1996,
General Accident advised the Company that it would no longer accept Package
insurance risks for fast food restaurants. As a result, the Company became a
general agent for Kemper during March 1997, through which it wrote Package as
well as other forms of property and



                                       14


<PAGE>   17

casualty insurance and workers' compensation insurance. In September 1998,
Kemper advised the Company that it would no longer accept Package insurance
risks for fast food restaurants but retained its contract with the Company to
serve as a program administrator for certain risks.

         REINSURANCE. In December 1996, the Company formed Preferred Reinsurance
and entered into a reinsurance agreement with affiliates of AIG pursuant to
which Preferred Reinsurance acts as a reinsurer with respect to certain workers'
compensation and employer's liability insurance policies in force with policy
inception dates as of January 1, 1996 and subsequent which are written by the
Company on behalf of affiliates of AIG. Preferred Reinsurance is required to
provide affiliates of AIG, as security for the payment of losses, a combination
of cash, United States government securities and/or an irrevocable letter of
credit in an aggregate amount equal to 51.5% of the net written premiums ceded
to Preferred Reinsurance pursuant to the insurance agreement less the amount of
losses paid. Preferred Reinsurance receives, as compensation pursuant to the
terms of the reinsurance agreement, the related net written premiums less
certain program expenses and commissions and the losses paid associated with the
business. Although Preferred Reinsurance assumes the risks associated with being
a reinsurer, the reinsurance agreement limits the liability of Preferred
Reinsurance for losses and certain defined expenses to the first $300,000 per
occurrence. In addition, the reinsurance agreement limits the aggregate
liability of Preferred Reinsurance for all coverage to an amount not to exceed
70% of the gross written premiums for each individual underwriting year. Because
the reinsurance agreement is effective for all business written on or after
January 1, 1996, the policies written prior to the execution of the contract and
formation of Preferred Reinsurance were accounted for as retroactive
reinsurance. The reinsurance agreement with Preferred Reinsurance is terminable
by either party upon the occurrence of certain events. In the event the
Company's reinsurance agreement is terminated, the Company, in all likelihood,
would be materially and adversely affected.

         The Company utilizes a Third Party Administrator ("TPA") for its claims
processing. In this regard, the TPA is responsible for: (i) establishing initial
individual claim reserve amounts for all reported claims; (ii) periodic review
of all open claims making the necessary upward or downward reserve adjustment
based on the most current and up-to-date information; (iii) authorizing payments
to claimants from previously established reserve amounts; (iv) closing claims as
a result of payment thereof or closing claims without payment due to
insufficient proof of loss coverage by the claimant or any combination thereof.

         As per the reinsurance agreement, the "fronting" company has the
contractual responsibility for the initial funding of all claims payments made
by the TPA and is subsequently entitled to seek reimbursement from the Company
for claims it funded in accordance with the terms of the reinsurance agreement.
To date, the fronting company has not sought reimbursement under the terms of
the reinsurance agreement. Although timely payments have been made to claimants
by the TPA, the Company's financial statements do not reflect such payments
since it has not yet reimbursed the fronting company for such payments. Instead,
the unreimbursed claim payments are included in the Company's balance sheet as
Unpaid Losses and Loss Adjustment Expenses.

         The Company collects workers' compensation premiums from the insureds
and remits the ceding commission (net of its commission) and reinsurance charge
to affiliates of AIG and remits the net premium to Preferred Reinsurance.
Commission income on workers' compensation business is recognized as income when
premiums are collected. Package insurance premiums are principally collected by
the insurance carrier. The package insurance carrier remits commissions to us
monthly on package premiums it collects. Commission income on package business
is recognized as income when premiums are due. Reinsurance premiums received by
Preferred Group are earned on a pro-rata basis over the term of the related
coverage.

         For the year ended December 31, 1998, the Company's total revenues were
$54,311,000 as compared to $27,593,000 for the year ended December 31, 1997,
representing a net increase of $26,718,000. For the year ended December 31,
1997, the Company's total revenues were $27,593,000 as compared to total
revenues of $5,955,000 for the year ended December 31, 1996, representing a net
increase of $21,638,000. For the year ended December 31, 1998, approximately,
63%, 33% and 4% of the Company's total revenues were derived from its staffing,
reinsurance captive and general agency businesses, respectively. For the year
ended December 31, 1997, approximately 42%, 49% and 9% of the Company's total
revenues were derived from its staffing, reinsurance captive and general agency
businesses, respectively.

         Historically, our employee staffing business has been seasonal, with
the demand for Travelers being the highest in the first and fourth quarters of
the calendar year (September through March), due largely to increased demand
particularly during the peak tourist and winter home period in Florida.

RESULTS OF OPERATIONS

YEARS ENDED DECEMBER 31, 1998 AND DECEMBER 31, 1997

         TOTAL REVENUES. Total revenues for the year ended December 31,1998 were
$54,311,000 compared to $27,593,000 for the year ended December 31, 1997,
representing a net increase of $26,718,000 or 96.8%.



                                       15
<PAGE>   18

         The following table provides a comparison of revenues for the years
ended December 31, 1998 and 1997 by category:

<TABLE>
<CAPTION>

                                                                                             NET      PERCENTAGE
                                                                 1998         1997         CHANGE       CHANGE
                                                             -----------   ----------    ----------   ----------
<S>                                                          <C>           <C>           <C>            <C>
 Staffing income ..........................................  $34,462,000   11,594,000    22,868,000     197.2 %
 Premiums earned ..........................................   15,594,000   11,675,000     3,919,000      33.6 %
 Net commission income:
   Workers' compensation ..................................    1,399,000    1,529,000      (130,000)     (8.5)%
   Package ................................................      416,000      483,000       (67,000)    (13.9)%
   Other, net .............................................      148,000      347,000      (199,000)    (57.4)%
                                                             -----------   ----------    ----------   ----------
     Total net commission income ..........................    1,963,000    2,359,000      (396,000)    (16.8)%
 Net investment income ....................................    1,821,000    1,395,000       426,000      30.5 %
 Other income .............................................      471,000      570,000       (99,000)    (17.4)%
                                                             -----------   ----------    ----------   ----------
   Total revenues .........................................  $54,311,000   27,593,000    26,718,000      96.8 %
                                                             ===========   ==========    ==========   ==========
 Workers' compensation:
   Premiums collected .....................................  $14,431,000   14,929,000
   Ratio of net commission income/premiums
       collected ..........................................          9.7%       10.2%
                                                             ===========   =========
</TABLE>

         Staffing income increased $22,868,000 as a result of the acquisition of
certain of the assets of Travel Nurse (acquired in March 1998) and the increase
in business related to the acquisition of Net Healthcare. Premiums earned
increased $3,919,000 or 33.6% for the year ended December 31, 1998 as compared
to the prior year as a result of new business and renewals of the prior year
business and increased retention. Workers' compensation commission income
decreased $130,000 or 8.5% for the year ended December 31, 1998 as compared to
the prior year as a result of the decrease in premiums collected of $498,000,
which is attributable to the decrease in the workers' compensation book of
business. Package commission income decreased $67,000 or 13.9% for the year
ended December 31, 1998 as compared to the prior year as a result of a reduction
in the business written for fast food restaurants. Other net commission income
decreased $199,000 or 57.4% for the year ended December 31, 1998 as compared to
the prior year as a result of the reduction in volume of audit and small
business plan premiums collected. Net investment income increased $426,000 or
30.5% for the year ended December 31, 1998 as compared to the prior year as a
result of premiums received and invested by Preferred Reinsurance and the income
earned on the net proceeds received from the sale of the Company's convertible
subordinated notes in May 1998. Other income decreased $99,000 or 17.4% as a
result of the effects of the retroactive insurance accounting treatment of
Preferred Reinsurance as discussed more fully in Note 1(c) to the Company's
consolidated financial statements included in this Annual Report.

         TOTAL OPERATING EXPENSES. Total operating expenses for the year ended
December 31, 1998 were $50,006,000 compared to $26,111,000 for the 1997
comparable period, representing an increase of $23,895,000 or 91.5%. The
following table provides a comparison of total expenses for the years ended
December 31, 1998 and 1997 by category:

<TABLE>
<CAPTION>

                                                                                             NET      PERCENTAGE
                                                                 1998          1997         CHANGE       CHANGE
                                                             -----------    ----------    ----------   ----------
<S>                                                          <C>           <C>           <C>            <C>
  Staffing costs ...........................................  $27,140,000    9,611,000    17,529,000     182.4%
  Losses and loss adjustment expenses incurred .............    8,052,000    6,257,000     1,795,000      28.7%
  Amortization of deferred acquisition costs ...............    5,000,000    4,162,000       838,000      20.1%
  Other operating expenses .................................    9,814,000    6,081,000     3,733,000      61.4%
                                                              -----------   ----------    ----------   ----------
  Total operating expenses .................................  $50,006,000   26,111,000    23,895,000      91.5%
                                                              ===========   ==========    ==========   ==========

</TABLE>


                                       16

<PAGE>   19



     Staffing costs increased $17,529,000 consistent with the increase in
staffing revenues for 1998 as discussed above.

         The major risk associated with the Company's entry into the reinsurance
business is that the Company may experience an adverse loss ratio. In an effort
to minimize such risk, the Company has obtained aggregate liability reinsurance
coverage which limits its exposure to a maximum 70% loss ratio as more fully
discussed in Note 1(c) to the Company's consolidated financial statements. The
underwriting gains recognized by the Company is the most significant benefit
realized by the Company as a result of its entry into the reinsurance business.
Losses and loss adjustment expenses incurred (i) increased $1,795,000 or 28.7%
which is consistent with the increase in premiums earned in 1998 as discussed
above and (ii) were 51.6% and 53.6% of premiums earned for the years ended
December 31, 1998 and 1997, respectively. Amortization of deferred acquisition
costs (i) increased $838,000 or 20.1% which is also consistent with the increase
in premiums earned in 1998 as discussed above and (ii) were 32.1% and 35.7% of
premiums earned for the years ended December 31, 1998 and 1997, respectively. As
a result, the underwriting gain, expressed as a percentage of earned premium,
was 16.3% and 10.7% for the years ended December 31,1998 and 1997, respectively.

         Other operating expenses increased $3,733,000 or 61.4%. The following
table provides a comparison of other operating expenses for the years ended
December 31, 1998 and 1997 by category:
<TABLE>
<CAPTION>

                                                                                             NET      PERCENTAGE
                                                                 1998         1997         CHANGE       CHANGE
                                                             -----------   ----------    ----------   ----------
<S>                                                          <C>           <C>           <C>            <C>
 Personnel costs ...........................................  $5,827,000    3,546,000     2,281,000      64.3%
 Occupancy costs ...........................................     609,000      457,000       152,000      33.3%
 Professional fees .........................................     926,000      372,000       554,000     148.9%
 Other operating expenses ..................................   2,452,000    1,706,000       746,000      43.7%
                                                              ----------    ---------     ---------   ----------
   Total other operating expenses ..........................  $9,814,000    6,081,000     3,733,000      61.4%
                                                              ==========    =========     =========   ==========
</TABLE>

         Personnel expenses increased $2,281,000 or 64.3% as a result of the
hiring of four marketing employees, one marketing executive, and three corporate
executives with aggregate annual compensation of $537,000 together with the
increased staff related to the acquisition of the assets of Travel Nurse and the
growth in the business of Net Healthcare. Occupancy expenses increased $152,000
or 33.3% principally as a result of the acquisition of Travel Nurse.
Professional fees increased $554,000 principally as a result of increased legal
and accounting fees associated with various corporate and acquisition matters.
Other operating expenses increased $746,000 or 43.7% primarily related to the
following: (i) increased insurance expense of $102,000, (ii) increased corporate
fees and services of $225,000, (iii) increased investment and service fees of
$120,000, and (iv) increased travel expenses of $124,000. Insurance expense
increased as a result of the purchase of additional coverages (i.e., directors
and officers liability insurance) and increased premiums due to increased
limits. Corporate fees and services, travel expenses, and investment and service
fees increased as a result of the expansion of the business of Net Healthcare
and the acquisition of the assets of Travel Nurse.

         TOTAL NON-OPERATING EXPENSES. Total non-operating expenses for the year
ended December 31, 1998 were $1,726,000 compared to $664,000 for the 1997
comparable period. Interest expense increased $413,000 as a result of the
Company's private placement in May 1998 of 7% convertible subordinated notes in
the aggregate principal amount of $10,580,000 and borrowings under a revolving
line of credit. Amortization of intangible assets and other non-operating
expenses increased $649,000 consistent with the acquisitions as discussed above.

LIQUIDITY AND CAPITAL RESOURCES

         GENERAL. Our principal source of cash is the collection of staffing
revenues from client hospitals and workers' compensation insurance premiums from
our insureds. In February 1997, we consummated an initial public offering of
1,725,000 shares of Common Stock (including the underwriters' over-allotment
option) and received gross cash proceeds of approximately $12,506,000. In May
1998, we consummated a $10,580,000 private placement of 7% convertible
subordinated notes due May 2003.

         At December 31, 1998, net cash and investments were $32,755,000 (net of
premiums payable of $1,703,000). Net cash provided by operating activities
decreased to $3,258,000 in 1998 from $10,506,000 in 1997, a decrease of
$7,248,000. This decrease resulted primarily from increases in accounts
receivable, unpaid losses and loss adjustment and unearned premiums of
$10,779,000, $1,863,000 and $2,009,000, respectively. The increase in accounts
receivable is primarily associated with the acquisition of certain of the assets
of Travel Nurse and the increase in billings by the merged staffing companies
during 1998 of $3,350,000, and an increase of $7,399,000 related to reinsurance
premiums receivable. The increase in unpaid losses and loss adjustment expenses
is consistent with the increase in premiums earned during the



                                       17
<PAGE>   20
year. The increase in unearned premiums is consistent with the increase in
reinsurance premiums receivable as discussed above.

         Cash flows used in investing activities decreased to $13,180,000 for
the year ended December 31, 1998 from $23,252,000 for the year ended December
31, 1997, a decrease of $10,072,000. This decrease resulted primarily from the
reduction of security purchases of $15,223,000 and the acquisition of certain of
the assets of Travel Nurse for $5,000,000 in cash as discussed in the Note 1(b)
to our consolidated financial statements included in this Annual Report.

         Cash flows from financing activities for the year ended December 31,
1998 reflects the net proceeds received from the Company's private placement of
7% convertible subordinated notes of $9,622,000, borrowings under a revolving
line of credit of $2,000,000 and repayment of lines of credit related to Net
Healthcare of $2,440,000, compared to the net proceeds received from the
Company's initial public offering of $10,384,000 and borrowings under a
revolving line of credit of $1,115,000 related to Net Healthcare for the
comparable period in 1997.

         FINANCINGS. In May 1998, Preferred Staffing entered into a $3,000,000
unsecured revolving line of credit with a bank (the "Credit Facility").
Outstanding borrowings under the Credit Facility bear interest at the bank's
base rate of interest. Interest under the Credit Facility is due and payable
monthly and all unpaid principal and interest is due on May 2, 1999. The Company
expects to renew the Credit Facility for an additional one year term.
Outstanding borrowings under the Credit Facility are secured by our guarantee.
As of December 31, 1998, there was approximately $1,850,000 in outstanding
borrowings under the Credit Facility, which borrowings bore interest at the rate
of 7 3/4% per annum. As of March 29, 1999, outstanding borrowings under the
Credit Facility were approximately $1,150,000 and bore interest at the rate of
7 3/4% per annum.

         In May 1998, we also consummated a $10,580,000 private placement of 7%
convertible subordinated notes due May 2003. The principal amount of the notes
is convertible at the option of the holder into shares of our common stock, at a
conversion price of $9.00 per share, at any time prior to the earlier of May 12,
2003 or ten business days after the receipt of a termination notice (as defined
in the notes). The notes generally prohibit or restrict, among other things, our
ability to incur liens and indebtedness, make certain fundamental corporate
changes and specified investments and conduct certain transactions with
affiliates.

         We believe that our existing cash balances and cash flows from
activities will be adequate to meet our current operations, including expected
capital expenditures, for at least the next twelve months. In connection with
our current business strategy of making strategic acquisitions, we may seek
additional funds through equity and/or debt financings. There can be no
assurance that any such additional debt or equity financings will be available
to us, or if available, will be on favorable terms to us.

YEAR 2000

         The Year 2000 presents potential concerns for businesses. The
consequences of this issue may include system failures and business process
interruption. In addition to the well-known calculation problems with the use of
2-digit date formats as the year changes from 1999 to 2000, the Year 2000 is a
special case leap year which may cause similar problems in many systems unless
remediated.

         We have developed a plan with respect to evaluating and upgrading our
core information technology systems so that they are Year 2000 compliant. Two
vendors primarily supply software to us for use in our operations. One vendor
supplies the software used by our insurance operations and one vendor supplies
the software used by our staffing operations. The vendors have each advised us
that the latest upgrades of the software used in our operations are Year 2000
compliant. We intend to implement these software upgrades, and test the upgraded
software for Year 2000 compliancy during the first half of 1999. The



                                       18
<PAGE>   21
historical and currently projected costs relating to these upgrades and Year
2000 compliance are not material.

         We are in the process of developing a plan with respect to evaluating
and upgrading our non-core information technology systems and other systems
using embedded technology so that they will be Year 2000 compliant. We expect to
complete and implement that plan during the second quarter of 1999.

         We also intend to make inquiries of other third parties supplying us
with products and services to receive assurances that they are Year 2000
compliant. We believe that we will complete that review by the end of the second
quarter of 1999.

         We have not developed a "worst case" scenario with respect to Year
2000 issues. Although we have not done a cost analysis, we believe that no
material adverse effect on our business will occur if our non-core technology
systems are not Year 2000 compliant. We anticipate that the costs related to
such non-compliance, if any, will not be material.

         Although we do not have a Year 2000 contingency plan, we are developing
such a plan, which we expect to complete by the end of the second quarter of
1999.

         If we or third parties with which we have relationships were to cease
or not successfully complete Year 2000 remediation efforts, we could encounter
disruptions to our business. However, we could be materially and adversely
impacted by widespread economic or financial market disruption, or by Year 2000
computer system failures of third parties, that may generally occur as a result
of the Year 2000 issues.

         Certain statements relating to the Year 2000 issues are forward-looking
statements and have been made pursuant to the safe harbor provision of the
Private Securities Litigation Reform Act of 1995. Forward-looking statements
involve known and unknown risks and uncertainties which may cause the actual
results in the future periods or plans for future periods to differ materially
from those described herein as anticipated, believed or estimated.

ITEM 7. FINANCIAL STATEMENTS

         The Company's audited consolidated financial statements for the years
ended December 31, 1998 and 1997, respectively, are set forth at the end of this
Annual Report on Form 10-KSB and begin on page F-1.

ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE

         None.



                                       19


<PAGE>   22




                                    PART III

ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS

DIRECTORS AND EXECUTIVE OFFICERS

         The following table sets forth certain information, as of March 26,
1999, concerning our directors and executive officers:

<TABLE>
<CAPTION>
Name                                                  Age             Positions With Our Company
----                                                  ---             --------------------------
<S>                                                  <C>    <C>
 Mel Harris ........................................  58    Chairman of the Board of Directors and Chief
                                                            Executive Officer
 Peter E. Kilissanly ...............................  51    President, Chief Operating Officer and
                                                            Director
 D. Mark Olson .....................................  50    Executive Vice President
 William R. Dresback ...............................  51    Senior Vice President and Chief Financial
                                                            Officer
 Jose Menendez .....................................  37    Vice President, General Counsel and Assistant
                                                            Secretary
 Nancy Ryan ........................................  43    Vice President and Secretary
 Jack D. Burstein ..................................  53    Director
 Stuart J. Gordon ..................................  68    Director
 Alexander M. Haig, Jr .............................  74    Director
 Maxwell M. Rabb ...................................  88    Director

</TABLE>

         The business experience of each of the persons listed above for at
least the last five years is as follows:

         MEL HARRIS has been a director of our company since its inception in
1988 and has been our Chairman of the Board of Directors and Chief Executive
Officer since April 1993. From May 1998 to January 1999, Mr. Harris served as
our President. Mr. Harris served as Vice Chairman of Jardine Insurance Brokers
New York, Inc. from February 1992 until January 1994. From 1988 until February
1992, Mr. Harris served as Vice Chairman of Alexander & Alexander of New York,
Inc. (a wholly-owned subsidiary of A&A Services, Inc.), a global insurance
brokerage organization. Mr. Harris currently serves as President of
International Insurance Group, Inc., an insurance brokerage company located in
Miami, Florida and New York, New York. Mr. Harris is also a director and
shareholder of Strategica Capital Corp., a merchant banking firm ("Strategica
Capital"). Mr. Jack D. Burstein, a director of our company, is the President of
Strategica Capital. Mr. Harris has agreed to devote such time as is necessary,
and in any event no less than 80% of his business time, to the affairs of our
company.

         PETER E. KILISSANLY has been President, Chief Operating Officer and a
director of our company since January 1999 and has been the President, Chief
Executive Officer and a director of Preferred Healthcare Staffing, Inc., a
wholly-owned subsidiary of our company, since March 1998. Prior to his
employment with Preferred Staffing, from December 1986 to September 1997, Mr.
Kilissanly served as President and Chief Operating Officer of Physician
Corporation of America. In 1986, he served as Senior Vice President of Corporate
Marketing and Communications of Equicor Health Plans. From 1984 to 1986, Mr.
Kilissanly served as Senior Vice President of Corporate Marketing and
Communications of HCA Health Plans.

         D. MARK OLSON has been an Executive Vice President of our company since
January 1999 and has been the President and Chief Executive Officer of Preferred
Employers Group, Inc., a wholly-owned subsidiary


                                       20
<PAGE>   23
of our company, since June 1998. Mr. Olson was the Chief Operating Officer of
our company from July 1997 to June 1998. Prior to his employment with Preferred
Group, from March 1996 to July 1997, Mr. Olson served as President, Chief
Executive Officer and a director of PCA Solutions, Inc., a workers' compensation
third party administration company. From 1987 to 1993, Mr. Olson served as
national director of sales for Kemper Financial Services and later as Chairman,
President and Chief Executive Officer of Invest Financial Corporation, a Kemper
Financial Services subsidiary. From November 1993 to March 1996, he served as a
consultant to several of the nation's largest insurance and asset management
companies.

         WILLIAM R. DRESBACK has been our Chief Financial Officer since May 1993
and a Senior Vice President since February 1997. From May 1993 to January 1999,
Mr. Dresback was the Secretary of our company. From 1986 to 1992, Mr. Dresback
served as Chief Financial Officer of Cobb Partners Financial, Inc. (previously a
wholly-owned subsidiary of The Walt Disney Company), a national financial
services company primarily involved in the mortgage banking, construction and
real estate development businesses. From 1981 to 1986, Mr. Dresback served as
Senior Vice President and Chief Financial Officer of International Financial
Services, Inc. (a subsidiary of The Torchmark Corporation), an international
financial services company primarily involved in the financial planning, life
insurance and securities brokerage businesses. From 1969 to 1981, Mr. Dresback
was employed by KPMG, LLP where he was responsible for managing the firm's South
Florida Insurance Practice.

         JOSE MENENDEZ has been Vice President and General Counsel of our
company since joining our company in April 1998. Mr. Menendez was appointed as
Assistant Secretary in January 1999. From 1997 to April 1998, Mr. Menendez was
Senior Vice President, General Counsel and Secretary of Physician Corporation of
America ("PCA") and was responsible for all legal matters of PCA and its
subsidiaries. From 1991 to 1997, Mr. Menendez was Vice President of Legal
Affairs for PCA.

         NANCY RYAN has been a Vice President of our company since July 1992 and
in January 1999 Ms. Ryan was appointed as Secretary. From July 1992 to January
1999, Ms. Ryan was an Assistant Secretary of our company. Ms. Ryan has over 12
years of experience in the commercial insurance industry. Ms. Ryan served as a
Vice President of Jardine Insurance Brokers New York, Inc. from February 1992
until January 1994. From 1988 until February 1992, she served as a Vice
President of Alexander & Alexander of New York, Inc. (a wholly-owned subsidiary
of A&A Services, Inc.), a global insurance brokerage organization. Since 1984,
Ms. Ryan has also served as a Vice President of International Insurance Group,
Inc. Ms. Ryan has agreed to devote at least 80% of her business time to the
affairs of our company.

         JACK D. BURSTEIN has been a director of our company since January 1997.
Mr. Burstein has been the Chairman and President of each of Strategica Group,
Inc., a merchant bank ("Strategica Group"), and Strategica Capital, an affiliate
of Strategica Group and a merchant bank, since 1992. Mr. Harris, the Company's
Chairman of the Board and Chief Executive Officer, is a director and shareholder
of Strategica Capital. From 1984 to present, Mr. Burstein has served as Chief
Executive Officer and President of American Capital Corp., a savings and loan
holding corporation, and as Chief Executive Officer of TransCapital Financial
Corporation, a savings and loan holding corporation. Prior to such time, Mr.
Burstein was a senior partner and employee, respectively, in the accounting
firms of Schecter Beame Burstein Price & Co. and Seidman & Seidman.

         STUART J. GORDON has been a director of our company since 1995. Mr.
Gordon has been of counsel to the law firm of Duane, Morris and Heckscher since
March 1997. From 1989 until March 1997, Mr. Gordon was a partner at the law firm
of Metzger, Hollis, Gordon & Alprin. Previously, Mr. Gordon served as the
Special Assistant to the Comptroller of the Currency, Deputy Chairman and
Treasurer of the United States Senate campaign of Daniel Patrick Moynihan, the
First Administrative Assistant and Chief of Staff to Senator Moynihan (in
Washington, D.C.) and Deputy Finance Chairman of the presidential campaign of
Senator John Glenn. Mr. Gordon was appointed by the Governor of the State of
Maryland to the Foster



                                       21
<PAGE>   24
Care Review Board and served as a member of the Board of Governors of Daytop
Village. Mr. Gordon serves as a member of the Board of Advisors of the
Independent College Fund of New York.

         ALEXANDER M. HAIG, A has been a director of our company since January
1999. Since August 1982, General Haig has been Chairman and President of
Worldwide Associates, Inc., a business adviser to both U.S. and foreign
companies in connection with international marketing and venture capital
activities. From January 1981 until July 1982, General Haig served as Secretary
of State of the United States. From December 1979 until January 1981, General
Haig was President and Chief Operating Officer of United Technologies Corp. and
is currently a senior consultant to such corporation. From 1974 through 1979,
General Haig was the Supreme Allied Commander of NATO. Prior to that, he was
White House Chief of Staff under the Nixon and Ford Administrations. General
Haig currently serves on the Board of Directors of America Online, Inc.,
Interneuron Pharmaceuticals, Inc., MGM Grand, Inc. and Metro Goldwyn Mayer Inc.

         MAXWELL M. RABB has been a director of our company since January 1997.
Mr. Rabb has been of counsel to the law firm of Kramer, Levin, Naftalis &
Frankel since 1991 and was a partner in the law firm of Stroock, Stroock & Lavan
from 1958 to 1981 and from 1989 to 1991. Mr. Rabb served as the United States
Ambassador to Italy from 1981 to 1989. In addition, Mr. Rabb serves as a
director of the Sterling National Bank, MIC Industries, Inc., Liberty Cable
Company, Inc., Black Hole Technologies, Inc., Data Software and Systems, Inc.
and CompuTower.

         All of our directors serve until the next annual meeting of
stockholders or until their successors are duly elected and qualified. All of
our officers serve at the discretion of the Board of Directors, subject to
rights, if any, under contracts of employment with us. See "Executive
Compensation--Employment Agreements." There are no family relationships among
our directors and executive officers.

SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

         Section 16(a) of the Securities Exchange Act of 1934, as amended,
requires the Company's executive officers, directors and persons who own more
than ten percent of a registered class of the Company's equity securities to
file certain reports regarding ownership of, and transactions in, the Company's
securities with the Securities and Exchange Commission (the "SEC"). These
officers, directors and stockholders are also required by SEC rules to furnish
the Company with copies of all Section 16(a) reports that are filed with the
SEC. Based solely on a review of copies of such forms received by the Company,
and written representations received by the Company from certain reporting
persons, the Company believes that for the year ended December 31, 1998 all
Section 16(a) reports required to be filed by the Company's executive officers,
directors and 10% stockholders were filed on a timely basis.



                                       22

<PAGE>   25
ITEM 10. EXECUTIVE COMPENSATION

         The following summary compensation table sets forth the aggregate
compensation paid to, or earned by, our Chief Executive Officer and each of our
four other most highly compensated executive officers for the three years ended
December 31, 1998 whose total annual salary and bonus exceeded $100,000 for 1998
(collectively the "Named Executive Officers").


                           SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>

                                                                                           Long-term
                                                                                           Compensation
                                                 Annual Compensation                     ----------------
                                     -----------------------------------------------        Securities
                                                                      Other Annual          Underlying          All Other
Name and Principal Position          Year     Salary($)    Bonus($)  Compensation($)     Options/SARs(#)      Compensation
---------------------------          ----     ---------    -------   --------------      ---------------      ------------
<S>                                  <C>      <C>            <C>         <C>                  <C>                <C>
 Mel Harris(1)(2) .................  1998     $ 50,000        --          --                        --            2,470(6)
   Chairman of the Board and         1997     $116,729        --          --                   275,000              775(6)
   Chief Executive Officer           1996     $ 50,000        --          --                        --               --

 Peter E. Kilissanly(l)(3) ........  1998     $100,000        --          --                   150,000               --
   President and Chief
   Operating Officer

 D. Mark Olson(l)(4) ..............  1998     $250,000    50,000          --                        --               --
   Executive Vice President          1997     $120,000        --          --                   150,000               --

 William R. Dresback(1) ...........  1998     $150,000        --          --                    25,000            3,361(7)
   Senior Vice President and         1997     $150,000        --          --                    50,000            1,666(7)
   Chief Financial Officer           1996     $125,000        --          --                        --              891(7)

 Jose Menendez(1)(5) ..............  1998     $ 85,385        --          --                    45,000               --
   Vice President and General Counsel

</TABLE>
----------------
(1)  In January 1999, Messrs. Harris, Kilissanly, Olson, Dresback and Menendez
     entered into employment agreements with our company. See "--Employment
     Agreements."
(2)  In July 1997, Mr. Harris voluntarily reduced his salary from $150,000 per
     annum to $52,000 per annum.
(3)  Mr. Kilissanly was appointed as President and Chief Operating Officer of
     the Company in January 1999 and has been President and Chief Executive
     Officer of Preferred Staffing since March 1998.
(4)  Mr. Olson was appointed Executive Vice President of the Company in January
     1999 and has been President and Chief Executive Officer of Preferred Group
     since June 1998.
(5)  Mr. Menendez has been Vice President and General Counsel of the Company
     since April 1998.
(6)  Represents contributions by the Company to its 401(K) plan on behalf of Mr.
     Harris.
(7)  Represents (i) insurance premiums paid by the Company in the amount of $891
     for each of 1996, 1997 and 1998 for a term life insurance policy for the
     benefit of Mr. Dresback and (ii) contributions by the Company to its 401(K)
     plan on behalf of Mr. Dresback for 1997 and 1998.



                                       23


<PAGE>   26
                              OPTION GRANTS IN 1998

         The following table sets forth certain information concerning the grant
of stock options in 1998 to each of the Named Executive Officers.

<TABLE>
<CAPTION>

                                                                  Percentage to Total
                                               Number of           Options Granted
                                         Securities Underlying       to Employees         Exercise Price
 Name                                       Options Granted             in 1998              ($/Share)          Expiration Date
 ----                                    ---------------------    -------------------     --------------        ---------------
<S>                                             <C>                    <C>                     <C>                  <C>
 Mel Harris ...............................         --                     --                     --                      --
 Peter E. Kilissanly(l) ...................     75,000                   23.4%                 $8.13                 3/30/08
 Peter E. Kilissanly(2) ...................     75,000                   23.4%                 $8.50                 7/22/08
 D. Mark Olson ............................         --                     --                     --                      --
 William R. Dresback(3)....................     25,000                    7.8%                 $8.50                 7/22/08
 Jose Menendez(4) .........................     45,000                   14.1%                 $8.50                 7/22/08
</TABLE>
---------------------
(1)  One-third of such options vest each year beginning on March 30, 1999. The
     vesting of one-half of such options each year is also subject to the
     Company meeting certain performance objectives.
(2)  One-fifth of such options vest each year beginning on July 22, 1999. The
     vesting of one-half of such options each year is also subject to the
     Company meeting certain performance objectives.
(3)  One-fifth of such options vest each year beginning on July 22, 1999.
(4)  One-fifth of such options vest each year beginning on July 22, 1999.

       AGGREGATE OPTION EXERCISES IN 1998 AND 1998 YEAR-END OPTION VALUES

         The following table sets forth certain information concerning the Named
Executive Officers with respect to the number of shares covered by exercisable
and unexercisable stock options at December 31, 1998 and the aggregate value of
exercisable and unexercisable "in-the-money" options at December 31, 1998. No
options were exercised by the Named Executive Officers in 1998.

<TABLE>
<CAPTION>

                                                       NUMBER OF SECURITIES        VALUE OF UNEXERCISED
                                                      UNDERLYING UNEXERCISED       IN-THE-MONEY OPTIONS
                                                    OPTIONS AT FISCAL YEAR-END     AT FISCAL YEAR-END(1)
           NAME                                      EXERCISABLE/UNEXERCISABLE   EXERCISABLE/UNEXERCISABLE
           ----                                     --------------------------   -------------------------
<S>                                                       <C>                       <C>
           Mel Harris ..................................  55,000/220,000            $103,125/$412,500
           Peter E. Kilissanly .........................      --/150,000                  --/$196,500
           D. Mark Olson ...............................  15,000/120,000            $ 39,375/$315,000
           William R. Dresback .........................   30,000/45,000            $ 71,250/$ 75,625
           Jose Menendez ...............................       --/45,000                  --/$ 50,625
</TABLE>
------------------
(1)  The value of unexercised "in-the-money" options is equal to the difference
     between the closing sale price of the common stock on the Nasdaq SmallCap
     Market as of December 31, 1998 ($9.625) and the option exercise price per
     share, multiplied by the number of shares subject to options.

DIRECTOR COMPENSATION

         Our directors do not receive compensation for their services as
directors, but are reimbursed for all reasonable out-of-pocket expenses incurred
in connection with each Board of Directors meeting attended. In addition, all of
our directors are eligible for grants of stock options pursuant to the 1996
Stock Option Plan and the Share Escrow Agreement dated February 5, 1997 by and
among the Company, Mr. Howard Odzer and the escrow agent named therein (the
"Share Escrow Agreement"). See "--Share Escrow Agreement." In 1998, no director
other than Mr. Peter Kilissanly, the Company's President and Chief Operating
Officer, received options. See "Executive Compensation." However, Mr. Jack
Burstein, one of


                                       24


<PAGE>   27
the Company's directors, did receive a warrant to purchase 25,000 shares of
common stock in connection with consulting services. See "Certain Relationships
and Related Transactions."

         In January 1999, we entered into a three-year consulting agreement with
General Alexander M. Haig, Jr. The agreement is subject to automatic one-year
extensions upon notice from the Company. Pursuant to the agreement, General Haig
is to render consulting services to the Company, including introducing the
Company to third parties in connection with potential business relationships. As
full compensation for his services, General Haig received options to purchase
100,000 shares of the Company's common stock at an exercise price of $9.25,
which options will vest equally over a three-year period beginning January 22,
2000. In addition, in January 1999, the Company granted to General Haig options
to purchase 25,000 shares of common stock at an exercise price of $9.25 per
share in connection with his services as a director of the Company. One-fifth of
such options vest each year beginning on January 22, 2000.

EMPLOYMENT AGREEMENTS

         In January 1999, we entered into a five-year employment agreement with
Mr. Harris pursuant to which he agreed to serve as Chairman of our Board of
Directors and Chief Executive Officer. The agreement is subject to automatic
one-year extensions, unless it is otherwise terminated by either party. Pursuant
to the agreement, Mr. Harris is entitled to receive an annual salary of
$300,000, reimbursement for all related business expenses and benefits and
perquisites similar to those made available to other senior executives. If Mr.
Harris' employment with the Company is terminated (i) by the Company without
cause (as defined in the agreement) or (ii) by the Company without cause or by
Mr. Harris for good reason (as defined in the agreement) within 6 months
following a change of control (as defined in the agreement), then the Company
shall pay to Mr. Harris (x) in a lump sum his base salary at the rate then in
effect for the remainder of the term (or for 90 days whichever is greater) plus
(y) on an annual basis for the remainder of the term the amount of bonus he
would have been entitled to receive under the Company's Executive Bonus
Compensation Plan (the "Bonus Plan") as if he were still employed by the Company
on the date of determination. In addition, all options granted to Mr. Harris by
the Company automatically vest upon a change of control, whether or not Mr.
Harris is terminated. Mr. Harris has agreed to devote such time as is necessary,
and in any event no less than 80% of his business time, to the affairs of our
company. The agreement contains, among other things, customary non-compete and
non-solicitation provisions.

         In January 1999, we entered into one-year employment agreements with
Mr. Kilissanly, Mr. Olson, Mr. Dresback, Mr. Menendez and Ms. Ryan. Pursuant to
the agreements, Mr. Kilissanly agreed to serve as our President and Chief
Operating Officer (and President and Chief Executive Officer of Preferred
Staffing) for a salary of $275,000 per annum, Mr. Olson agreed to serve as our
Executive Vice President (and President and Chief Executive Officer of Preferred
Group) for a salary of $250,000 per annum, Mr. Dresback agreed to serve as our
Senior Vice President and Chief Financial Officer for a salary of $175,000 per
annum, Mr. Menendez agreed to serve as our Vice President, General Counsel and
Assistant Secretary for a salary of $135,000 per annum, and Ms. Ryan agreed to
serve as our Vice President and Secretary for a salary of $90,000 per annum.

         The agreements are subject to automatic one-year extensions, unless
they are otherwise terminated by either party. All of the executives are
entitled to receive benefits similar to benefits made available to our other
senior executives and reimbursement for all related business expenses. If their
employment with the Company is terminated (i) by the Company without cause (as
defined in the agreement) or (ii) by the Company without cause or by the officer
for good reason (as defined in the agreement) within 6 months following a change
of control (as defined in the agreement), then the Company shall pay to the
officer (x) in a lump sum his or her base salary at the rate then in effect for
the remainder of the term (or for 90 days whichever is greater) plus (y) the
amount of bonus he or she would have been entitled to under the Bonus Plan as if
he or she were still employed by the Company on the date of determination on a
pro-rata basis. In addition, all options granted to the officer by the Company
automatically vest upon a change of



                                       25
<PAGE>   28
control, whether or not the officer is terminated. The agreement contains, among
other things, customary non-compete and non-solicitation provisions.

EXECUTIVE BONUS COMPENSATION PLAN

         In January 1999, the Company adopted an Executive Bonus Compensation
Plan (the "Bonus Plan") pursuant to which key management employees of the
Company, who are recommended by the Company's Chief Executive Officer and
approved by the Compensation Committee of the Board of Directors (the
"Committee"), are eligible to receive a bonus based upon the Company's operating
results. The Bonus Plan will be in effect each fiscal year beginning with the
fiscal year ending December 31, 1999, and will continue until it is otherwise
terminated by the Board of Directors. Pursuant to the Bonus Plan, the Chief
Executive Officer of the Company will recommend to the Committee on an annual
basis those employees of the Company who should be entitled to participate in
the Bonus Plan and each participant's percentage allocation of the "bonus pool."
Individuals who are then approved by the Committee will receive an award based
on an amount of the percentage of the "bonus pool" approved by the Committee for
each participant. No individual award to any participant may exceed two times
the individual's base compensation. Pursuant to the Bonus Plan, the "bonus pool"
will be an amount equal to 25% of the amount by which the Company's consolidated
pre-tax profits in a fiscal year exceeds the Company's budgeted consolidated
pre-tax profits for such fiscal year; provided, however, that $200,000 will be
contributed to the "bonus pool" in each fiscal year in which the Bonus Plan is
maintained if the Company's consolidated pre-tax profits in such fiscal year
equals 80% or more of the Company's budgeted consolidated pre-tax profits for
such fiscal year. Pursuant to the Bonus Plan, for the fiscal year ending
December 31, 1999, Messrs. Harris, Kilissanly, Olson, Dresback and Menendez will
receive 25%, 22.5%, 20%, 17.5% and 15%, respectively, of the "bonus pool."

1996 EMPLOYEE STOCK OPTION PLAN

         In 1997, the Company adopted the 1996 Stock Option Plan (the "Plan").
The Plan provides for the grant to participants (including our officers and
directors) of options to purchase shares of our common stock. In September 1998,
we increased the total number of shares of common stock reserved for issuance
under the Plan, upon the exercise of stock options granted or which may be
granted, from 300,000 to 1,000,000 shares.

         The Plan may be administered by the Board of Directors or the
Compensation Committee (the "Committee"). The Committee has the discretion to
select optionees and to establish the terms and conditions of each option,
subject to the provisions of the Plan. Options granted under the Plan may or may
not be "incentive stock options" as defined in Section 422 of the Internal
Revenue Code of 1986, as amended, depending upon the terms established by the
Committee at the time of grant, but the exercise price of options granted as
incentive stock options may not be less than 100% of the fair market value of
the common stock as of the date of grant (or 110% of the fair market value if
the grant is an incentive stock option to an employee who owns more than 10% of
the outstanding voting power of our company). Incentive stock options may not be
exercised after 10 years from the grant date (five years if the grant is an
incentive stock option to an employee who owns more than 10% of the outstanding
voting power of our company). Options granted under the Plan are not
transferable and may be exercised only by the respective grantees during their
lifetimes or by their heirs, executors, or administrators in the event of death.
Under the Plan, shares subject to cancelled or terminated options may be
available for subsequently granted options. The number of options outstanding
and the exercise price thereof are subject to adjustment under the Plan in the
case of certain transactions such as mergers, recapitalizations, stock splits or
stock dividends. As of March 26, 1999, options to purchase an aggregate of
978,000 shares of common stock were outstanding under the Plan.



                                       26


<PAGE>   29
SHARE ESCROW AGREEMENT

         Pursuant to the Share Escrow Agreement by and among Mr. Howard Odzer,
the escrow agent, and our company, Mr. Odzer placed 300,000 shares of common
stock beneficially owned by him in escrow for issuance upon the exercise of
stock options granted to certain executives, officers and directors of the
Company as designated by the Compensation Committee, in its sole discretion (the
"Escrow Options"). Mr. Odzer will receive all proceeds from any exercise of the
Escrow Options. The Escrow Options expire in February 2002. After such date, the
balance of the shares of common stock held in escrow pursuant to the Share
Escrow Agreement, if any, shall revert to Mr. Odzer. As of March 26, 1999,
options to purchase an aggregate of 300,000 shares of common stock were
outstanding under the Share Escrow Agreement. See "Certain Relationships and
Related Transactions."

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The following table sets forth information as of March 26, 1999 with
respect to the beneficial ownership of (i) any person known to us to be the
beneficial owner of more than 5% of any class of our voting securities, (ii)
each of our directors, (iii) each of the Named Executive Officers (i.e., those
officers named in the Summary Compensation Table of this Annual Report under the
heading "Executive Compensation") and (iv) all of our directors and executive
officers as a group (10 persons).

<TABLE>
<CAPTION>

           Name and Address of Beneficial Owner                  Number of Shares(2)  Percent of Class(2)
           ------------------------------------                  -------------------  -------------------
           <S>                                                      <C>                    <C>
           Mel Harris(1)(3) .....................................    1,871,470              35.3%
           Howard Odzer(4) ......................................      711,765              13.6%
           Peter E. Kilissanly(1)(5) ............................      103,177               2.0%
           D. Mark Olson(6) .....................................       15,000                 *
           William R. Dresback(1)(7) ............................       40,000                 *
           Jose Menendez(1) .....................................           --                --
           Jack D. Burstein(8) ..................................       35,000                 *
           Stuart J. Gordon(9) ..................................       10,000                 *
           Alexander M. Haig, Jr.(10) ...........................           --                 *
           Maxwell M. Rabb(11) ..................................       10,000                 *
           All directors and executive officers as a group
             (10 persons)(12)....................................    2,125,647              39.0%
</TABLE>
--------------------
 *   Less than 1%.

(1)  The business address of each such person is Preferred Employers Holdings,
     Inc., 10800 Biscayne Boulevard, Miami, Florida 33161.

(2)  Unless otherwise noted, we believe that all persons named in the table have
     sole voting and investment power with respect to the shares of common stock
     beneficially owned by them. In accordance with Rule 13d-3 under the
     Exchange Act, a person is deemed to be the beneficial owner of securities
     that can be acquired by such person within sixty days from the date of
     determination upon the exercise of warrants or options. Each beneficial
     owner's number of shares and percentage ownership as set forth above is
     determined by assuming that options or warrants that are held by such
     person (but not those held by any other person) which are exercisable
     within sixty days from the date listed above have been exercised. See
     "Certain Relationships and Related Transactions."

(3)  Includes (i) 1,340,000 shares held of record by Mr. Harris, (ii) 300,000
     shares over which Mr. Harris has shared investment and voting power subject
     to the Share Escrow Agreement by and among the Company, Mr. Odzer and the
     escrow agent, (iii) 88,235 shares held of record by Francine Harris, the
     wife of Mr. Harris, (iv) 88,235 shares held of record by Ms. Harris, as
     custodian for Jamie Jo Harris, the daughter of Mr. and Ms. Harris, and (v)
     options to purchase 55,000 shares of common stock issued



                                       27


<PAGE>   30
     pursuant to the 1996 Stock Option Plan which are exercisable within 60 days
     of March 26, 1999. Mr. Harris may be deemed to have voting control over
     such shares and may be deemed to be the beneficial owner thereof. Mr.
     Harris disclaims beneficial ownership of (a) 88,235 shares held of record
     by Ms. Harris, and (b) 88,235 shares held of record by Ms. Harris, as
     custodian for Jamie Jo Harris. Does not include options to purchase 220,000
     shares of common stock which vest over a three year period ending August
     2002 pursuant to our 1996 Stock Option Plan. The Compensation Committee of
     our Board of Directors has investment and voting power over the 300,000
     shares placed in escrow under the Share Escrow Agreement. Mr. Harris is a
     member of the Compensation Committee. See "Certain Relationships and
     Related Transactions."

(4)  Of the 711,765 shares held of record by Mr. Odzer, 300,000 shares have been
     placed in escrow pursuant to the terms of the Share Escrow Agreement. The
     Compensation Committee of our Board of Directors has investment and voting
     power over the 300,000 shares placed in escrow under the Share Escrow
     Agreement. Mr. Harris is a member of the Compensation Committee. See
     "Certain Relationships and Related Transactions." Effective May 30, 1998,
     Mr. Odzer resigned from his positions as President of Preferred Group and a
     director of our company. Mr. Odzer's address is 1399 N.E. 103rd Street,
     Miami Shores, Florida 33138.

(5)  Assumes conversion of the outstanding principal balance of $700,000
     pursuant to the Company's 7% Convertible Subordinated Note due May 2003
     issued to Mr. Kilissanly in May 1998. Includes (i) 100 shares held of
     record by Ms. Odalys Kilissanly, the wife of Mr. Kilissanly, (ii) 100
     shares held of record by Ms. Kilissanly, as custodian for Anthony
     Kilissanly, the minor son of Mr. and Ms. Kilissanly, (iii) 100 shares held
     of record by Ms. Kilissanly, as custodian for Megan Kilissanly, the minor
     daughter of Mr. and Ms. Kilissanly, (iv) 100 shares held of record by Ms.
     Kilissanly, as custodian for Lauren Ibarria, the minor daughter of Mr.
     Kilissanly and (iv) options to purchase 25,000 shares of common stock. Does
     not include (i) options to purchase an additional 50,000 shares of the
     Company's common stock, pursuant to the Company's 1996 Stock Option Plan,
     at an exercise price of $8.13 per share, vesting equally over a period of
     two years beginning on March 30, 2000 and (ii) options to purchase 75,000
     shares of the Company's common stock, pursuant to the Company's 1996 Stock
     Option Plan, at an exercise price of $8.50 per share, vesting equally over
     a period of five years beginning on July 22, 1999. Pursuant to each option
     agreement, options to purchase one-half of the number of shares in each
     year are subject to the Company meeting 80% of its budgeted pre-tax profits
     in each year.

(6)  Includes options to purchase 15,000 shares of common stock which vested on
     July 7, 1998. Does not include: (i) options to purchase 34,875 shares of
     the Company's common stock pursuant to the Company's 1996 Stock Option
     Plan, at an exercise price of $7.00 per share, of which options to purchase
     2,625, 2,250, 15,000 and 15,000 shares of common stock will vest on July 7,
     1999, 2000, 2001 and 2002, respectively (one-half of the number of shares
     covered by such option in each year are also subject to the Company meeting
     80% of its budgeted pre-tax profits in such year); (ii) options to purchase
     34,875 shares of the Company's common stock pursuant to the Company's 1996
     Stock Option Plan, at an exercise price of $7.00 per share, of which
     options to purchase 2,625, 2,250, 15,000 and 15,000 shares, respectively,
     will vest on each of July 7, 1999, 2000, 2001 and 2002, respectively; (iii)
     options to purchase 25,125 shares of common stock, pursuant to the Share
     Escrow Agreement, at an exercise price of $7.00 per share, of which options
     to purchase 12,375 and 12,750 shares of the Company's common stock will
     vest on July 7, 1999 and July 7, 2000, respectively (one-half of the number
     of shares covered by such year are also subject to the Company's meeting
     80% of its budgeted pre-tax profits in each year); (iv) options to purchase
     25,000 shares of common stock pursuant to the Share Escrow Agreement, at an
     exercise price of $7.00 per share, of which options to purchase 12,375
     shares of common stock will vest on July 1, 1999 and options to purchase
     12,750 shares of common stock will vest on July 7, 2000 and (v) options to
     purchase 15,000 shares of the Company's common stock pursuant to the
     Company's 1996 Stock Option Plan at an exercise price of $7.00 per share,
     of



                                       28
<PAGE>   31
     which options to purchase 7,500 will vest on January 22, 2000 and on
     January 21, 2001, respectively, subject to the Company meeting 80% of its
     budgeted pre-tax profits in each year.

(7)  Represents (a) options to purchase 20,000 shares of common stock issued
     pursuant to our 1996 Stock Option Plan and (b) options to purchase 20,000
     shares of common stock issued pursuant to the Share Escrow Agreement, all
     exercisable within 60 days of March 26, 1999. Does not include (a) options
     to purchase 5,000 shares of common stock pursuant to the Company's 1996
     Stock Option Plan which vest in February 2000, (b) options to purchase
     5,000 shares of common stock pursuant to the Share Escrow Agreement which
     vest in February 2000 and (c) options to purchase 25,000 shares of common
     stock which were granted in July 1998 and vest over a five year period
     commencing July 1999 and ending July 2003 pursuant to the Company's 1996
     Stock Option Plan.

(8)  Represents (a) options to purchase 5,000 shares of common stock issued
     pursuant to our 1996 Stock Option Plan, (b) options to purchase 5,000
     shares of common stock issued pursuant to the Share Escrow Agreement and
     (c) warrants to purchase an aggregate of 25,000 shares of common stock
     issued to Strategica Group, all exercisable within 60 days of March 26,
     1999. Mr. Burstein's business address is c/o Strategica Capital Corp., 1221
     Brickell Avenue, Suite 2600, Miami, Florida 33131. See "Certain
     Relationships and Related Transactions."

(9)  Represents (a) options to purchase 5,000 shares of common stock issued
     pursuant to our 1996 Stock Option Plan and (b) options to purchase 5,000
     shares of common stock issued pursuant to the Share Escrow Agreement, all
     exercisable within 60 days of March 26, 1999. Mr. Gordon's business address
     is c/o Duane Morris and Heckscher, 1667 K Street, Suite 700, Washington,
     D.C. 20006.

(10) Does not include (i) options to purchase 100,000 shares of the Company's
     common stock, pursuant to the Company's 1996 Stock Option Plan, at an
     exercise price of $9.25 per share, vesting equally over a period of three
     years beginning on January 22, 2000, and (ii) options to purchase 25,000
     shares of Common Stock, pursuant to the Company's 1996 Stock Option Plan,
     at an exercise price of $9.25 per share, vesting equally over a period of
     five years beginning on January 22, 2000. The options to purchase 100,000
     shares of common stock were granted to General Haig in connection with his
     consulting services to the Company. The options to purchase 25,000 shares
     of common stock were granted to General Haig in connection with his
     services as a director of the Company. See "Executive Compensation."
     General Haig's business address is World Wide Associates, Inc., 1155 15th
     Street, N.W., Suite 800, Washington, D.C. 20005.

(11) Represents (a) options to purchase 5,000 shares of common stock issued
     pursuant to our 1996 Stock Option Plan and (b) options to purchase 5,000
     shares of common stock issued pursuant to the Share Escrow Agreement, all
     exercisable within 60 days of March 26, 1999. Mr. Rabb's business address
     is c/o Kramer, Levin, Naftalis & Frankel, 919 3rd Avenue, 40th Floor, New
     York, New York 10022.

(12) Includes the beneficial ownership of shares of common stock by all
     directors and executive officers named in this table, including shares
     subject to options and warrants as specified above. Also includes 25,000
     shares owned by Ms. Nancy Ryan, and options to purchase 16,000 shares
     issued to Ms. Ryan pursuant to the 1996 Stock Option Plan and the Share
     Escrow Agreement.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         STRATEGICA. Mr. Burstein, a director of our company, is the Chairman
and President of Strategica Group and Strategica Capital. Mr. Harris, the
Chairman of the Board and Chief Executive Officer of our company, is a director
and shareholder of Strategica Capital, an affiliate of Strategica Group. In
March 1997, we paid Strategica Group a fee of $50,000 as compensation for its
financial advisory and planning services provided in connection with our initial
public offering of 1,725,000 shares of common stock (which was consummated in
February 1997). In April 1998, we paid Strategica Group a fee of $150,000 as
compensation for its financial advisory and planning services provided in
connection with the



                                       29


<PAGE>   32
acquisition of substantially all of the assets used or pertaining to the
business of Travel Nurse. In August 1998, we paid Strategica Group a fee of
$148,000 in connection with services provided to us relating to the acquisition
of the outstanding capital stock of Net Healthcare. In July 1998, we issued
Strategica Group a warrant to purchase an aggregate of 25,000 shares of common
stock at an exercise price of $7.88 per share for consulting services. The
warrant expires on June 30, 2003. The warrant has standard anti-dilution and
adjustment provisions.

         EXCHANGE. In February 1997, the then existing stockholders (the
"Exchanging Stockholders") of Preferred Group, a corporation which conducted
certain of our insurance operations, effected a recapitalization whereby we
exchanged 17,647.06 shares of common stock for each share of common stock of
Preferred Group held by the Exchanging Stockholders (the "Exchange"). As a
result of the Exchange, Preferred Group became a wholly-owned subsidiary of our
company. Pursuant to the Exchange, Mr. Harris, Mr. Odzer (the former President
of Preferred Group) and Ms. Ryan, a Vice President and Secretary of our company,
received 1,450,000, 1,111,765 and 25,000 shares of common stock, respectively.

         SHAREHOLDERS' AGREEMENT. In February 1997, our company, Mr. Harris and
Mr. Odzer entered into a Shareholders Agreement which provided for certain
arrangements regarding restrictions on the transferability of shares owned by
them (or by members of their respective families) and other matters. Under the
Shareholders Agreement, the parties agreed to rights of first refusal under
certain circumstances with respect to the disposition of shares of common stock
held by Messrs. Harris and Odzer and certain registration and indemnification
rights. The Shareholders Agreement also reaffirmed the irrevocable proxy granted
to Mr. Harris to vote all of the shares held of record by Mr. Odzer which was
granted by Mr. Odzer to Mr. Harris in May 1995. Under the Shareholders
Agreement, the proxy would expire when Mr. Odzer owned less than fifteen percent
of the outstanding common stock of our company. As of March 26,1999, Mr. Odzer
owned approximately 13.6% of the outstanding common stock of our company, and
accordingly, the proxy and certain sections of the Shareholders Agreement have
been terminated, and other provisions of the Shareholders Agreement will expire
on May 30, 2004.

         SHARE ESCROW AGREEMENT. Pursuant to a Share Escrow Agreement dated
February 5, 1997, Mr. Odzer placed 300,000 shares of our common stock
beneficially owned by him in escrow for issuance upon the exercise of stock
options granted to certain directors, executives and other officers of our
company, as designated by the Compensation Committee. As of March 26, 1999,
options to purchase an aggregate of 300,000 shares of common stock were
outstanding under the Share Escrow Agreement. See "Executive Compensation."

         IIG. In January 1996, we entered into a Cost Sharing Agreement with
International Insurance Group, Inc. ("IIG"), pursuant to which we provide office
space, equipment and other administrative services to IIG. IIG is an insurance
brokerage company which is wholly-owned by Mr. Harris, the Chairman of the Board
and Chief Executive Officer of our company. Under the Cost Sharing Agreement, we
are entitled to receive from IIG approximately $9,300 per month for rendering
such services. Prior to January 1996, we provided these services without
reimbursement.

         CONVERTIBLE NOTES. In May 1998, Mr. Kilissanly, the Company's President
and Chief Operating Officer, purchased a 7% Convertible Subordinated Note due
May 2003 in the aggregate principal amount of $700,000.

         We are also a party to certain employment, stock option and other
arrangements with our directors and executive officers. See "Executive
Compensation."



                                       30

<PAGE>   33
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K

     Unless otherwise indicated, the following is a list of Exhibits filed as a
part of this Annual Report on Form 10-KSB:

<TABLE>
<CAPTION>

Exhibits                    Description of Document                                      Page
--------                    -----------------------                                      ----
  <S>     <C>                                                                            <C>
  3.1     Certificate of Incorporation of Preferred (Incorporated herein by
          reference to Exhibit 3.1 to Preferred's Registration Statement on Form
          SB-2, No. 333-14103).

  3.2     By-Laws of Preferred (Incorporated herein by reference to Exhibit 3.2
          to Preferred's Registration Statement on Form SB-2, No. 333-14103).

  4.1     Form of Representative Warrants (Incorporated herein by reference to
          Exhibit 4.1 to Preferred's Registration Statement on Form SB-2, No.
          333-14103).

  4.2     Specimen Common Stock Certificate (Incorporated herein by reference to
          Exhibit 4.2 to Preferred's Registration Statement on Form SB-2, No.
          333-14103).

  4.3     Form of 7% Convertible Subordinated Note (Incorporated herein by
          reference to Exhibit 4.1 to Preferred's Current Report on Form 8-K,
          dated May 4, 1998 (filed on June 2, 1998)).

  4.4     Form of Agent's Warrant (Incorporated herein by reference to Exhibit
          4.2 to Preferred's Current Report on Form 8-K, dated May 4, 1998
          (filed on June 2, 1998)).

  10.1    Form of Preferred's 1996 Employee Stock Option Agreement (Incorporated
          herein by reference to Exhibit 10.1 to Preferred's Registration
          Statement on Form SB-2, No. 333-14103).

  10.2    Form of Share Escrow Agreement among Preferred, Baer Marks & Upham LLP
          and Howard Odzer together with the Letter Agreement Regarding
          Additional Terms (Incorporated herein by reference to Exhibit 10.2 to
          Preferred's Registration Statement on Form SB-2, No. 333-14103).

  10.3    Employment Agreement, dated May 15, 1995, between Preferred and Howard
          Odzer (Incorporated herein by reference to Exhibit 10.3 to Preferred's
          Registration Statement on Form SB-2, No. 333-14103).

  10.4    Form of Employment Agreement between Preferred and Mel Harris
          (Incorporated herein by reference to Exhibit 10.4 to Preferred's
          Registration Statement on Form SB-2, No. 333-14103).

  10.5    Letter dated October 21, 1996, from Preferred to New Hampshire
          Insurance Company regarding the Reinsurance Agreement among P.E.G.
          Reinsurance Company, Ltd., The Insurance Company of the State of
          Pennsylvania and other AIG Affiliates and Form of Reinsurance
          Agreement (Incorporated herein by reference to Exhibit 10.5 to
          Preferred's Registration Statement on Form SB-2, No. 333-14103).

  10.6    Office Space Lease Agreement, dated August 1, 1994, between Preferred
          and K/B Opportunity Fund I, LP and PEGI (Incorporated herein by
          reference to Exhibit 10.6 to Preferred's Registration Statement on
          Form SB-2, No. 333-14103).

  10.7    Form of Advisory Services Letter Agreement between Preferred and the
          Representative (Incorporated herein by reference to Exhibit 10.7 to
          Preferred's Registration Statement on Form SB-2, No. 333-14103).
</TABLE>




                                       31


<PAGE>   34
<TABLE>
<CAPTION>

Exhibits                    Description of Document                                      Page
--------                    -----------------------                                      ----
  <S>     <C>                                                                            <C>
  10.8    Stock Repurchase Agreement dated as of May 15, 1995, among Preferred,
          Howard Odzer and Ronald Rothstein (Incorporated herein by reference to
          Exhibit 10.8 to Preferred's Registration Statement on Form SB-2, No.
          333-14103).

  10.9    Cost Sharing Agreement dated January 3, 1996, between Preferred and
          International Insurance Group, Inc. (Incorporated herein by reference
          to Exhibit 10.9 to Preferred's Registration Statement on Form SB-2,
          No. 333-14103).

  10.10   Form of Share Exchange Agreement among Preferred and certain
          stockholders of PEGI listed therein (Incorporated herein by reference
          to Exhibit 10.10 to Preferred's Registration Statement on Form SB-2,
          No. 333-14103).

  10.11   Amended and Restated Shareholders Agreement dated as of May 15, 1995,
          among Preferred, Howard Odzer and Mel Harris (Incorporated herein by
          reference to Exhibit 10.11 to Preferred's Registration Statement on
          Form SB-2, No. 333-14103).

  10.12   Form of Employment Agreement between Preferred and Howard Odzer
          (Incorporated herein by reference to Exhibit 10.12 to Preferred's
          Registration Statement on Form SB-2, No. 333-14103).

  10.13   Agency Agreement dated September 1, 1994, among Preferred, General
          Accident Insurance Company of America ("GAIC") and certain affiliates
          of GAIC (Incorporated herein by reference to Exhibit 10.13 to
          Preferred's Registration Statement on Form SB-2, No. 333-14103).

  10.14   General Agency Agreement dated January 1, 1993, among Preferred, The
          Insurance Company of the State of Pennsylvania and certain affiliates
          of AIG (Incorporated herein by reference to Exhibit 10.14 to
          Preferred's Registration Statement on Form SB-2, No. 333-14103).

  10.15   Preferred's 1996 Stock Option Plan (Incorporated by reference to
          Preferred's Annual Report on Form 10-KSB for the year ended December
          31, 1997).

  10.16   Employment Agreement dated July 7, 1997, between Preferred and D. Mark
          Olson (Incorporated herein by reference to Preferred's Current Report
          on Form 8-& dated July 7, 1997 (filed on July 9, 1997)).

  10.17   Asset Purchase Agreement dated as of January 21, 1998, among HSSI
          Travel Nurse Operations, Inc., Hospital Staffing Services, Inc. and
          Preferred Employers Acquisition Corp. (Incorporated herein by
          reference to Preferred's Current Report on Form 8-K dated March 6,
          1998 (filed on March 16, 1998)).

  10.18   Shareholders Agreement dated as of February 11, 1997, among Preferred,
          Howard Odzer and Mel Harris (Incorporated hereby by reference to the
          Company's Annual Report on Form 10-KSB/A No. 1 for the year ended
          December 31, 1997).

  10.19   Loan Agreement, dated May 4, 1998, between Preferred Healthcare
          Staffing, Inc. and City National Bank of Florida (Incorporated herein
          by reference to Exhibit 10.1 to Preferred's Current Report on Form 8-K
          dated May 4, 1998 (filed on June 2, 1998)).

  10.20   Promissory Note and Security Agreement dated April 27, 1998, by
          Preferred Healthcare Staffing, Inc. to City National Bank of Florida
          (Incorporated herein by reference to Exhibit 10.2 to Preferred's
          Current Report on Form 8-K dated May 4, 1998 (filed on June 2, 1998)).
</TABLE>



                                       32
<PAGE>   35
<TABLE>
<CAPTION>

Exhibits                    Description of Document                                      Page
--------                    -----------------------                                      ----
  <S>     <C>                                                                            <C>
  10.21   Continuous Guaranty, dated May 5, 1998, by Preferred to City National
          Bank of Florida (Incorporated herein by reference to Exhibit 10.3 to
          Preferred's Current Report on Form 8-K, dated May 4, 1998 (filed on
          June 2, 1998)).

  10.22   Stock Purchase Agreement, dated July 10, 1998, by and among Preferred
          Healthcare Staffing, Inc., Debbie Bender-Balazich, Steven Barth,
          Steven Jones and Stephen M. McLaughlin (Incorporated herein by
          reference to Exhibit 10.1 to Preferred's Current Report on Form 8-K,
          dated July 10, 1998 (filed on July 28, 1998)).

  10.23   Employment Agreement, made as of August 10, 1998, between Preferred
          Healthcare Staffing, Inc. and Debbie Bender-Balazich. (Incorporated
          herein by reference to Exhibit 10.1 to Preferred's Current Report on
          Form 8-K, dated August 19, 1998 (filed on August 20, 1998)).

  10.24   Stock Option Agreement, dated as of August 10, 1998, between Preferred
          and Debbie Bender-Balazich. (Incorporated herein by reference to
          Exhibit 10.2 to Preferred's Current Report on Form 8-K, dated August
          19, 1998 (filed on August 20, 1998)).

  10.25   Employment Agreement, dated as of August 10, 1998, between Preferred
          Healthcare Staffing, Inc. and Stephen M. McLaughlin. (Incorporated
          herein by reference to Exhibit 10.3 to Preferred's Current Report on
          Form 8-K, dated August 19, 1998 (filed on August 20, 1998)).

  10.26   Stock Option Agreement, dated as of August 10, 1998, between Preferred
          and Stephen M. McLaughlin. (Incorporated herein by reference to
          Exhibit 10.4 to Preferred's Current Report on Form 8-K dated August
          19, 1998 (filed on August 20, 1998)).

  10.27   Registration Rights Agreement, dated as of August 10, 1998, by and
          among Preferred and Debbie Bender-Balazich, Steven Barth, Steven Jones
          and Stephen M. McLaughlin. (Incorporated herein by reference to
          Exhibit 10.5 to Preferred's Current Report on Form 8-K, dated August
          19, 1998 (filed on August 20, 1998)).

  *10.28  Executive Compensation Bonus Plan.

  *10.29  Employment Agreement between Preferred and Mel Harris.

  *10.30  Employment Agreement between Preferred and Peter E. Kilissanly.

  *10.31  Employment Agreement between Preferred and D. Mark Olson.

   10.32  Employment Agreement between Preferred and William R. Dresback.

  *10.33  Employment Agreement between Preferred and Jose Menendez.

  *10.34  Employment Agreement between Preferred and Nancy Ryan.

  *10.35  Consulting Agreement between Preferred and Alexander M. Haig, Jr.

   10.36  Amendment to Preferred's 1996 Stock Option Plan.

    21.1  Subsidiaries of the Company (Incorporated herein by reference to
          Exhibit 21.1 to Preferred's Annual Report on Form 10-KSB for the year
          ended December 31, 1997).

   *27.1  Financial Data Schedule.
</TABLE>
------------------------
*    Filed herewith.


                                       33
<PAGE>   36
                                    SIGNATURE

         In accordance with Section 13 or 15(d) of the Exchange Act of 1934, the
Registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized, on October 25, 1999.


                                       PREFERRED EMPLOYERS HOLDINGS, INC.



                                       By:           /s/ MEL HARRIS
                                           ------------------------------------
                                                         Mel Harris
                                           Chairman and Chief Executive Officer

         In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the Registrant and in the capacities and
on the dates indicated.

<TABLE>
<CAPTION>

           Signature                                  Title                            Date
           ----------                                 -----                            ----
<S>                                          <C>                                  <C>

       /s/ MEL HARRIS                        Chairman of the Board and            October 25, 1999
---------------------------------------        Chief Executive Officer
           Mel Harris                          (Principal Executive
                                               Officer)


    /s/ PETER E. KILISSANLY                  President, Chief Operating           October 25, 1999
---------------------------------------        Officer and Director
        Peter E. Kilissanly



   /s/ WILLIAM R. DRESBACK                   Senior Vice President and            October 25, 1999
---------------------------------------        Chief Financial Officer
       William R. Dresback                     (Principal Financial and
                                               Accounting Officer)



     /s/ JACK D. BURSTEIN                    Director                             October 25, 1999
---------------------------------------
         Jack D. Burstein



    /s/ STUART J. GORDON                     Director                             October 25, 1999
---------------------------------------
        Stuart J. Gordon



  /s/ ALEXANDER M. HAIG, JR.                 Director                             October 25, 1999
---------------------------------------
      Alexander M. Haig, Jr.



     /s/ MAXWELL M. RABB                     Director                             October 25, 1999
---------------------------------------
         Maxwell M. Rabb

</TABLE>


                                       34
<PAGE>   37

                        INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



Independent Auditors' Report ..............................................  F-2

Report of Independent Accountants .........................................  F-3

Consolidated Balance Sheets as of December 31, 1998 and 1997 ..............  F-4

Consolidated Statements of Operations for the years ended
   December 31, 1998 and 1997 .............................................  F-5

Consolidated Statements of Shareholders' Equity for the years ended
   December 31, 1998 and 1997 .............................................. F-6

Consolidated Statements of Cash Flows for the years ended
   December 31, 1998 and 1997 .............................................. F-7

Notes to Consolidated Financial Statements ................................. F-8






                                      F-1




<PAGE>   38
                          INDEPENDENT AUDITORS' REPORT


The Board of Directors
Preferred Employers Holdings, Inc.:

     We have audited the accompanying consolidated balance sheets of Preferred
Employers Holdings, Inc. and subsidiaries as of December 31, 1998 and 1997 and
the related consolidated statements of operations, shareholders' equity, and
cash flows for the two years then ended. The consolidated financial statements
give retroactive effect to the merger of Preferred Employers Holdings, Inc. and
subsidiaries and National Explorers and Travelers Healthcare, Inc. on August
10, 1998, which has been accounted for using the pooling of interests method as
described in the notes to the consolidated financial statements. Our
responsibility is to express an opinion on these financial statements based on
our audits. We did not audit the financial statements of National Explorers and
Travelers Healthcare, Inc. as of December 31, 1997, which statements reflect
total assets constituting approximately 8% of the restated consolidated balance
sheet totals as of December 31, 1997, and which reflect net losses constituting
approximately 98% of the restated consolidated statements of operations totals
for the year ended December 31, 1997. Those statements were audited by other
auditors whose report has been furnished to us, and our opinion, insofar as it
relates to data included for National Explorers and Travelers Healthcare, Inc.
is based solely on the report of other auditors.

     We conducted our audits in accordance with generally accepted auditing
standards. These 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, based on our audits and the report of other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Preferred Employers Holdings, Inc.
and subsidiaries as of December 31, 1998 and 1997 and the results of their
operations and cash flows for the years then ended.



                                         /s/ KPMG LLP


Miami, Florida
March 25, 1999

                                      F-2


<PAGE>   39
                       REPORT OF INDEPENDENT ACCOUNTANTS


To the Board of Directors of
National Explorers and Travelers Health Care, Inc.
(d/b/a NET Healthcare, Inc.)
Fort Lauderdale, Florida

     In our opinion, the accompanying balance sheet and the related statements
of operations, shareholders' deficiency and of cash flows present fairly, in
all material respects, the financial position of National Explorers and
Travelers Health Care, Inc. (d/b/a NET Healthcare, Inc.) (the "Company") at
December 31, 1997, and the results of their operations and their cash flows for
the year ended December 31, 1997, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audit. We conducted our audit of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for the opinion expressed above.

     Since the date of completion of our audit of the above referenced
financial statements and the initial issuance of our report dated June 22,
1998, which contained an explanatory paragraph regarding the Company's ability
to continue as a going concern and an emphasis of a matter paragraph regarding
the pending sale of the Company, the shareholders of the Company, as discussed
in Note 1 (d), have sold their shares of the common stock of the Company to
Preferred Healthcare Staffing, Inc., a subsidiary of Preferred Employers
Holdings, Inc. Therefore, the conditions that raised substantial doubt about
whether the Company will continue as a going concern no longer exist.

/s/ PricewaterhouseCoopers LLP

Fort Lauderdale, Florida
June 22, 1998, except for the information in
Note 1(d), for which the date is August 10, 1998





                                      F-3



<PAGE>   40
              PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES

                    CONSOLIDATED BALANCE SHEETS DECEMBER 31,
                            1998 AND 1997 (RESTATED)

<TABLE>
<CAPTION>
                                                                                              1998          1997
                                                                                           -----------   ----------
                                                                                                         (restated)
<S>                                                                                       <C>             <C>
                                                ASSETS
Investments:
  Held-to-maturity securities, at amortized cost (fair value of $15,692,019
    in 1998 and $8,237,669 in 1997) ....................................................  $15,454,481     8,015,105
  Held-to-maturity securities, at amortized cost-restricted (fair value of
    $8,388,009 in 1998 and $7,947,981 in 1997) .........................................    8,257,053     7,877,444
  Short-term investments ...............................................................    7,032,027     7,090,550
                                                                                          -----------    ----------
     Total investments .................................................................   30,743,561    22,983,099
Cash ...................................................................................    3,714,883     4,125,271
Accrued investment and interest income .................................................      408,538       311,934
Accounts, commissions and premiums receivable, net .....................................   11,200,923     2,699,657
Deferred acquisition costs .............................................................    1,807,841       903,880
Property and equipment, net ............................................................      897,625       709,800
Deferred tax assets ....................................................................      447,878       252,837
Deposits ...............................................................................      344,165       154,787
Goodwill and other intangible assets, net ..............................................    4,805,560            --
Other assets ...........................................................................    2,036,453       102,556
                                                                                          -----------    ----------
     Total assets ......................................................................  $56,407,427    32,243,821
                                                                                          ===========    ==========

                                   LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
  Notes payable ........................................................................  $12,430,000     2,440,000
  Unpaid losses and loss adjustment expenses ...........................................   13,878,892     6,107,613
  Premiums, commissions and other insurance balances payable ...........................    7,175,659     8,189,169
  Unearned premiums ....................................................................    5,463,405     2,671,831
  Accounts payable and accrued expenses ................................................    1,588,326     1,360,613
  Other liabilities ....................................................................    2,894,283       700,356
                                                                                          -----------    ----------
     Total liabilities .................................................................   43,430,565    21,469,582
                                                                                          -----------    ----------
Shareholders' equity:
  Common stock, $0.01 par value; authorized 20,000,000 shares; issued
    5,771,497 shares ...................................................................       57,715        57,715
  Additional paid-in capital ...........................................................    9,891,562     9,147,730
  Retained earnings ....................................................................    3,533,142     2,074,351
                                                                                          -----------    ----------
     Total shareholders' equity ........................................................   13,482,419    11,279,796
  Treasury stock, at cost, 529,412 shares ..............................................     (505,557)     (505,557)
                                                                                          -----------    ----------
     Net shareholders' equity ..........................................................   12,976,862    10,774,239
                                                                                          -----------    ----------
     Total liabilities and shareholders' equity ........................................  $56,407,427    32,243,821
                                                                                          ===========    ==========

</TABLE>

          See accompanying notes to consolidated financial statements.



                                      F-4


<PAGE>   41
              PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF OPERATIONS
               Years Ended December 31, 1998 and 1997 (restated)

<TABLE>
<CAPTION>
                                                                                              1998          1997
                                                                                          ------------   ----------
                                                                                                         (restated)
<S>                                                                                       <C>             <C>
Revenues:
  Staffing income ......................................................................   $34,461,735    11,594,300
  Premiums earned ......................................................................    15,594,070    11,674,659
  Net commission income ................................................................     1,963,005     2,359,445
  Net investment income ................................................................     1,820,843     1,394,544
  Other income .........................................................................       471,327       570,464
                                                                                           -----------    ----------
  Total revenues .......................................................................    54,310,980    27,593,412
                                                                                           -----------    ----------
Expenses:
  Staffing costs .......................................................................    27,140,355     9,610,778
  Losses and loss adjustment expenses incurred .........................................     8,051,866     6,257,095
  Amortization of deferred acquisition costs ...........................................     4,999,956     4,161,884
  Other operating expenses .............................................................     9,814,401     6,080,808
                                                                                           -----------    ----------
Total operating expenses ...............................................................    50,006,578    26,110,565
                                                                                           -----------    ----------
Operating income before income taxes ...................................................     4,304,402     1,482,487
                                                                                           -----------    ----------
Interest expense .......................................................................     1,076,947       663,909
Amortization of intangible assets and other non-operating expenses .....................       649,265            --
                                                                                           -----------    ----------
Total non-operating expenses ...........................................................     1,726,212       663,909
                                                                                           -----------    ----------
Income before income taxes .............................................................     2,578,190       818,938
Income taxes ...........................................................................       375,565       208,980
                                                                                           -----------    ----------
Net income .............................................................................   $ 2,202,625       609,958
                                                                                           ===========    ==========
Net income -- basic ....................................................................   $ 2,202,625       609,958
Impact of potential common shares -- convertible notes .................................       407,496            --
                                                                                           -----------    ----------
Net income -- diluted ..................................................................   $ 2,610,121       609,958
                                                                                           ===========    ==========
Weighted average outstanding shares -- basic ...........................................     5,242,085     5,030,647
Impact of potential common shares -- convertible notes .................................       737,192            --
                                                                                           -----------    ----------
Common shares and common share equivalents used in computing net earnings per
  share -- diluted .....................................................................     5,979,277     5,030,647
                                                                                           ===========    ==========
Net basic earnings per share ...........................................................   $       .42           .12
                                                                                           ===========    ==========
Net diluted earnings per share .........................................................   $       .42           .12
                                                                                           ===========    ==========
Pro forma information (Unaudited) (Note 5):
Historical income before income taxes ..................................................   $ 2,578,190       818,938
Pro forma income tax provision (benefit) ...............................................       843,485      (250,336)
                                                                                           -----------    ----------
Pro forma net income ...................................................................   $ 1,734,705     1,069,274
                                                                                           ===========    ==========
Pro forma net income -- basic ..........................................................   $ 1,734,705     1,069,274
Impact of potential common shares -- convertible notes .................................       407,496            --
                                                                                           -----------    ----------
Pro forma net income -- diluted ........................................................   $ 2,142,201     1,069,274
                                                                                           ===========    ==========
Weighted average shares outstanding -- basic ...........................................     5,242,085     5,030,647
Impact of potential common shares -- convertible notes .................................       737,192            --
                                                                                           -----------    ----------
Weighted average shares outstanding -- diluted .........................................     5,979,277     5,030,647
                                                                                           ===========    ==========
Pro forma net basic earnings per share .................................................   $       .33           .21
                                                                                           ===========    ==========
Pro forma net diluted earnings per share ...............................................   $       .33           .21
                                                                                           ===========    ==========
</TABLE>



          See accompanying notes to consolidated financial statements.




                                      F-5




<PAGE>   42
              PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES

                CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
               YEARS ENDED DECEMBER 31, 1998 AND 1997 (RESTATED)

<TABLE>
<CAPTION>
                                                                                              1998          1997
                                                                                           -----------   ----------
                                                                                                         (restated)
<S>                                                                                       <C>             <C>
COMMON STOCK -- NUMBER OF SHARES:
Balance at beginning of period .........................................................     5,771,497     3,529,412
Exchange of common shares ..............................................................            --       517,085
Issuance of common shares ..............................................................            --     1,725,000
                                                                                           -----------    ----------
Balance at end of period ...............................................................     5,771,497     5,771,497
                                                                                           ===========    ==========
COMMON STOCK:
Balance at beginning of period .........................................................   $    57,715        35,294
Exchange of common shares ..............................................................            --         5,171
Issuance of common shares ..............................................................            --        17,250
                                                                                           -----------    ----------
Balance at end of period ...............................................................   $    57,715        57,715
                                                                                           ===========    ==========
ADDITIONAL PAID-IN CAPITAL:
Balance at beginning of period .........................................................   $ 9,147,730            --
Exchange of common shares ..............................................................            --    (1,224,173)
Issuance of common shares ..............................................................            --    10,371,903
S Corporation undistributed income .....................................................       743,832            --
                                                                                           -----------    ----------
Balance at end of period ...............................................................   $ 9,891,562     9,147,730
                                                                                           ===========    ==========
RETAINED EARNINGS:
Balance at beginning of period .........................................................   $ 2,074,351       864,933
Net income .............................................................................     2,202,625     1,209,418
S Corporation undistributed income .....................................................      (743,834)           --
                                                                                           -----------    ----------
Balance at end of period ...............................................................   $ 3,533,142     2,074,351
                                                                                           ===========    ==========
TREASURY STOCK:
Balance at end of period................................................................      (505,557)     (505,557)
                                                                                           -----------    ----------
TOTAL SHAREHOLDERS' EQUITY .............................................................   $12,976,862    10,774,239
                                                                                           ===========    ==========

</TABLE>

          See accompanying notes to consolidated financial statements.



                                      F-6




<PAGE>   43
              PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
               YEARS ENDED DECEMBER 31, 1998 AND 1997 (RESTATED)

<TABLE>
<CAPTION>
                                                                                              1998          1997
                                                                                           -----------   ----------
                                                                                                         (restated)
<S>                                                                                       <C>             <C>
Cash flow from operating activities:
  Net income ...........................................................................  $  2,202,625       609,958
  Adjustments to reconcile net income to net cash provided by operating
   activities:
   Depreciation and amortization .......................................................     1,032,627       202,312
   Amortization of deferred acquisition costs ..........................................     4,999,956     4,161,884
   Deferred income taxes ...............................................................      (195,041)     (252,837)
   Provision for uncollectible accounts ................................................       (29,313)      106,367

Change in:
   Accrued investment and interest income ..............................................       (96,604)     (311,934)
   Accounts, commissions and premiums receivable .......................................    (8,471,953)    2,307,487
   Deferred acquisition costs ..........................................................    (5,903,917)   (4,161,884)
   Unpaid losses and loss adjustment expenses ..........................................     7,771,279     5,908,223
   Unearned premiums ...................................................................     2,791,574       782,854
   Premiums, commissions and other insurance balances payable ..........................    (1,013,510)    2,759,821
   Accounts payable and accrued expenses ...............................................       227,713       696,852
   Other, net ..........................................................................       (57,305)   (2,303,141)
                                                                                          ------------   -----------
      Net cash provided by operating activities ........................................     3,258,131    10,505,962
                                                                                          ------------   -----------
Cash flow from investing activities:
   Purchases of securities .............................................................    (8,346,495)  (15,892,549)
   Purchase of subsidiary ..............................................................    (5,000,000)           --
   Sale (purchase) of short-term investments, net ......................................       586,033    (7,090,550)
   Purchase of property and equipment ..................................................      (419,690)     (268,470)
                                                                                          ------------   -----------
      Net cash used in investing activities ............................................   (13,180,152)  (23,251,569)
                                                                                          ------------   -----------
Cash flow from financing activities:
   Proceeds from sale of common stock ..................................................            --    10,384,324
   Repayment of shareholder loan .......................................................            --      (300,000)
   Proceeds from subordinated convertible notes payable ................................     9,621,914            --
   Borrowings from revolving line of credit, net .......................................     2,000,000     1,114,779
   Repayment of lines of credit ........................................................    (2,590,000)           --
   Other, net ..........................................................................       479,719        27,008
                                                                                          ------------   -----------
      Net cash provided by financing activities ........................................     9,511,633    11,226,111
                                                                                          ------------   -----------
Net decrease in cash ...................................................................      (410,388)   (1,519,496)
Cash at beginning of period ............................................................     4,125,271     5,644,767
                                                                                          ------------   -----------
Cash at end of period ..................................................................  $  3,714,883     4,125,271
                                                                                          ============   ===========
Supplemental disclosure of cash flow information:
   Income taxes paid ...................................................................  $    953,500       202,300
                                                                                          ============   ===========
   Interest paid .......................................................................  $    788,217        38,235
                                                                                          ============   ===========
</TABLE>

          See accompanying notes to consolidated financial statements.



                                      F-7


<PAGE>   44
                  PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                     DECEMBER 31, 1998 AND 1997 (RESTATED)

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     (a) Basis of Presentation

     The accompanying consolidated financial statements of Preferred Employers
Holdings, Inc. (the "Company") and its subsidiaries, as described below, are
prepared in accordance with generally accepted accounting principles. These
principles vary in certain respects from statutory accounting practices
prescribed or permitted by regulatory authorities. The preparation of financial
statements in conformity with generally accepted accounting principles requires
management to make estimates, based on the best information available, in
recording transactions resulting from business operations. The balance sheet
amounts that involve a greater extent of accounting estimates and actuarial
determinations subject to future changes are the Company's liabilities for
unpaid losses and loss adjustment expenses. As additional information becomes
available (or actual amounts are determinable), the recorded estimates may be
revised and reflected in operating results. While management believes that the
liability for unpaid losses and loss adjustment expenses is adequate to cover
the ultimate liability, such estimates may be more or less than the amounts
actually paid when claims are settled.

      (b) Organization

     Preferred Employers Holdings, Inc. (the "Company") is the successor
company to Preferred Employers Group, Inc. ("PEGI"). In February, 1997, the
Company completed an initial public offering of 1,725,000 shares of common
stock (including the underwriter's over-allotment option) at a price of $7.25
per share. Immediately prior to the Company's initial public offering, the
Company and the stockholders of PEGI (the "Exchanging Stockholders") effected a
recapitalization whereby the Company exchanged 17,647.06 shares of common stock
for each share of common stock of PEGI held by the Exchanging Stockholders (the
"Exchange"). As a result of the Exchange, PEGI became a wholly-owned subsidiary
of the Company. Except as otherwise specified or when the context otherwise
requires, references to the Company herein include Preferred Employers
Holdings, Inc. and PEGI, through which the Company conducts certain of its
business.

     In March 1998, the Company, through a wholly-owned subsidiary, consummated
the purchase of substantially all the assets of HSSI Travel Nurse Operations,
Inc. ("Travel Nurse"), a wholly owned subsidiary of Hospital Staffing Services,
Inc., for $5.0 million in cash. Based in Fort Lauderdale, Florida since 1981,
Travel Nurse has provided registered nurses and other professional medical
personnel, often referred to as "Travelers," primarily to client hospitals in
the United States and the Caribbean on a contractual basis for periods
generally ranging from 8 to 52 weeks. During 1997, Travel Nurse placed in
excess of 700 nurses.

      In August 1998, the Company issued 517,085 shares of its common stock in
 exchange for all the outstanding common stock of National Explorers and
 Travelers Healthcare, Inc. ("NET Healthcare"), an employee staffing company
 and provider of temporary registered nurses and other professional medical
 personnel, primarily to client hospitals. This business combination was
 accounted for as a pooling-of-interests combination and, accordingly, the
 Company's consolidated financial statements for applicable periods prior to
 the combination have been restated to include the accounts and results of
 operations of NET Healthcare.

     The Company was appointed as a general agent ("GA") by the American
International Group of Companies ("AIG"), a major group of international
insurance carriers, on January 1, 1993. In this regard,



                                      F-8

<PAGE>   45
              PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                     DECEMBER 31, 1998 AND 1997 (RESTATED)

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

the Company is authorized to write workers' compensation as well as other forms
of "property and casualty" business (such other forms of insurance being
hereinafter referred to as "Package") on behalf of AIG. In addition, the
Company was appointed as a GA by General Accident Insurance Company of America
("GAIC") on September 1, 1994, with the authority to write all forms of
commercial property and casualty business for family style and fast-food
restaurants. On June 11, 1996, GAIC advised the Company that it would no longer
write Package insurance for fast-food restaurants; however, on March 20, 1997,
the Company was appointed as a GA by the Kemper Group of Insurance Companies
with the authority to write workers' compensation and other forms of commercial
property and casualty business for family style and fast-food restaurants and
convenience stores. In September 1998, Kemper advised the Company that they
would no longer accept Package insurance risks for fast food restaurants, but
retained its contract with the Company to serve as a program administrator for
certain risks.

      (c) Insurance Operations

     In 1996, the Company formed a Bermuda licensed reinsurance subsidiary (the
"Reinsurer") and entered into a reinsurance agreement (the "Agreement") with
AIG affiliates during the fourth quarter of 1996. The Agreement provides that
the Reinsurer assumes certain workers' compensation and employer's liability
insurance policies from AIG with policy inception dates as of January 1, 1996
and subsequent. Although the Reinsurer assumes the risks associated with being
a reinsurer, the Agreement limits the liability of the Reinsurer for losses and
certain defined expenses to the first $300,000 per occurrence. In addition, the
Agreement limits the aggregate liability of the Reinsurer for all coverage to
an amount not to exceed 70 percent of the gross written premium for each
individual underwriting year.

     Because the Agreement is effective for all business written on or after
January 1, 1996, the policies written prior to the execution of the Agreement
and formation of the Reinsurer are accounted for as retroactive reinsurance.
The principal difference between the accounting for retroactive and prospective
reinsurance is that revenue and costs of retroactive reinsurance are deferred
and accreted into income over the claim-settlement period, rather than over the
period for which contractual coverage is provided, as would be the case under
prospective reinsurance. Retroactive insurance accounting does not change the
amount of income to be recognized, but rather extends the period of recognition
from one year--the period of coverage, to six years--the period over which
claims liabilities from the business are expected to be settled. Cash flows from
the reinsurance transactions are not affected by the accounting treatment.

     The accompanying financial statements reflect a composite
retroactive/prospective accounting treatment with business written prior to
October 1, 1996 being accounted for as retroactive and business written
subsequent thereto accounted for as prospective.

     The effects of prospective and retroactive reinsurance accounting
treatment are illustrated below. The prospective method assumed that the
Agreement incepted on January 1, 1996, and provides for a loss ratio of 51.5%,
acquisition costs of 33.83%, aggregate net premiums written of approximately
$15 million ($12,600,000 relating to the period January 1 through September 30,
1996) and an investment yield of 6.5% on net cash flows. The retroactive
(deposit) method uses the same assumptions except that since the Agreement was
not executed until October 1996, any investment income on net cash flows earned
for the period from January through September 1996 are deferred and recognized
as "other income" over the payment period of the remaining claim liabilities.



                                      F-9


<PAGE>   46
              PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                     DECEMBER 31, 1998 AND 1997 (RESTATED)

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

     Income before income taxes recognized, and estimated to be recognized in
the calendar year indicated below is as follows:

                                                                  Composite
                                                    Prospective  Retroactive/
                                                      Method     Prospective
                                                    (pro forma)   (actual)
                                                    -----------  ------------
      1996 ........................................ $1,658,000      324,000
      1997 ........................................  1,288,000    1,372,000
      1998-2001 ...................................  1,314,000    2,564,000
                                                    ---------     ---------
                                                    $4,260,000    4,260,000
                                                    ==========    =========

     It should be noted that the table presented above is for illustrative
purposes only to highlight that the basis of accounting used only impacts the
timing of the net revenue recognition and not the aggregate economic results.
Further, it should be noted that the above table is based on estimates as to
the amount and timing of aggregate loss and loss expense payments, available
investment yields and acquisition and other costs associated with the provision
of insurance protection. Actual results may vary, perhaps materially, from
those illustrated above. No assurance is given or may be taken that subsequent
revisions of estimates will not have a material impact on the illustration
above.

     Prospective reinsurance premiums are earned on a pro-rata basis over the
term of the related coverage. The reserve for unearned premiums represents the
portion of the net premiums written relating to the unexpired term of coverage.

     Acquisition costs are deferred and amortized over the period in which the
related prospective reinsurance premiums are earned.

     Losses and loss adjustment expenses are charged to income as incurred. The
reserve for unpaid claims represents the accumulation of estimates for reported
losses and includes provisions for losses incurred but not reported. The
methods of determining such estimates and establishing resulting reserves are
continually reviewed and updated. Adjustments, if any, resulting therefrom are
reflected in income, currently. The Company does not discount its loss
reserves.

      (d) Staffing Operations

     In March 1998, the Company purchased substantially all of the assets of
Travel Nurse for $5.0 million in cash. Based in Fort Lauderdale, Florida since
1981, Travel Nurse has provided registered nurses and other professional
medical personnel, often referred to as "Travelers," primarily to client
hospitals in the United States and Caribbean on a contractual basis for periods
generally ranging from 8 to 52 weeks. During 1997, Travel Nurse placed in
excess of 700 nurses.

     In August 1998, the Company issued 517,085 shares of its common stock in
exchange for all the outstanding common stock of NET Healthcare, an employee
staffing company and provider of temporary registered nurses and other
professional medical personnel, primarily to client hospitals. This business
combination was accounted for as a pooling-of-interests combination.



                                      F-10
<PAGE>   47
              PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                     DECEMBER 31, 1998 AND 1997 (RESTATED)

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

     Staffing income is recognized at the time the staffing services are
provided. In most instances, the staffing company's temporary healthcare
professionals are considered employees of the staffing company while under
assignment and costs of employment are the responsibility of the staffing
company and are included in the accompanying statements of operations.

     Receivables include amounts due from healthcare organizations for services
provided by the staffing company through the placement of healthcare
professionals. These receivables are presented net of an estimated allowance
for uncollectible accounts based on an evaluation of expected collections
resulting from an analysis of current and past due accounts, past collection
experience in relation to amounts billed and other relevant information.
Concentration of credit risk relating to accounts receivable is limited by
number, diversity and geographic dispersion of the healthcare organizations
serviced by the staffing company.

     During 1995, NET Healthcare entered into a line of credit with a
shareholder to provide a total of $190,000 to fund the working capital
requirements of NET Healthcare. The line of credit bore interest at the rate of
5% per annum. In March 1996, NET Healthcare entered into an additional line of
credit with a shareholder collateralized by outstanding accounts receivable.
Interest was payable at the rate of 2% per month on average outstanding
balances. In May 1996, the agreement was amended to allow for additional
funding. In May 1997, the agreement was further amended to increase the
interest rate by .5% per month on approximately $600,000 of the balance of the
line of credit. The amended line of credit, effective April 1, 1998,
established a rate of interest of 10% per annum and eliminated restrictive
covenants included in the original agreement. The line of credit described
above had an aggregate outstanding balance of $2,440,000 at December 31, 1997.
Interest expense related to the line of credit amounted to $240,884 and
$608,300 for the years ended December 31, 1998 and 1997, respectively. The
aggregate outstanding balance together with its related accrued interest
expense was paid in full subsequent to the merger of NET Healthcare and the
Company.

     The goodwill associated with the Company's acquisition of substantially
all of the assets of Travel Nurse is amortized over 21 years.

     The former shareholders of NET Healthcare previously elected to have the
company treated as an "S Corporation" under the Internal Revenue Code and,
therefore, net income or loss was attributable directly to the former
shareholders. Accordingly, no pre-merger benefit for federal or state income
taxes has been reflected in the accompanying financial statements. In addition,
an adjustment has been made to the restated stockholders' equity of the Company
as of December 31, 1998 and 1997 to eliminate the untaxed effects of including
NET Healthcare's results of operations in the financial statements of the
Company.

      (e) Investments

     Fixed maturity securities which the Company has the positive intent and
ability to hold to maturity are classified as "held to maturity" and are
reported at amortized cost. Fixed maturity and equity securities that are
bought and held principally for the purpose of selling them in the near term
are classified as "trading" and are reported at fair value, with unrealized
gains and losses included in income. Fixed maturity and equity securities not
classified as either held to maturity or trading are classified as "available



                                      F-11


<PAGE>   48
              PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                     DECEMBER 31, 1998 AND 1997 (RESTATED)

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

for sale" and are reported at fair value, with unrealized gains and losses (net
of deferred taxes) charged or credited as a separate component of shareholders'
equity.

     Investment income is recorded as earned on the accrual basis and includes
amortization of premiums and accretion of discounts relating to investments
acquired at other than par value. Realized gains or losses on disposal of
investments are determined on a specific identification basis and are included
in revenues.

     The Company does not own any on-balance sheet or off-balance sheet
derivative instruments.

     (f) Property and Equipment, Net

     Property and equipment is stated at cost less accumulated depreciation.
Depreciation is computed using an accelerated method of depreciation over the
estimated useful lives of the related assets, which ranges from five to seven
years. Leasehold improvements are carried at cost less accumulated amortization
provided on the straight-line basis over the shorter of the lease term or the
estimated useful lives of the improvements.

     (g) Premiums Payable

     Premiums which are collected from insureds are reported as assets of the
Company and as corresponding liabilities to the insurance carriers. Premiums
received from insureds but not yet remitted to the carriers are held as
invested cash in a fiduciary capacity.

     (h) Commission Income

     Commission income is recognized when premiums are received. Any subsequent
commission adjustments, including policy cancellations, are recognized upon
notification from the insurance carrier or broker.

     (i) Income Taxes

     Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.

     (j) Earnings Per Share

     Earnings per common share is based upon the weighted average number of
common shares outstanding during each period. On December 31, 1998, the Company
adopted SFAS No. 128, Earnings per Share ("SFAS No. 128"). SFAS No. 128
requires specific computations, presentations and disclosures for earnings per
share (EPS) amounts in order to make EPS amounts more compatible with
international accounting standards. Stock options outstanding at December 31,
1998 and 1997 of 831,500 and 250,000, respectively, had no effect on diluted
earnings per share amounts.



                                      F-12



<PAGE>   49
              PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                     DECEMBER 31, 1998 and 1997 (RESTATED)

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

     In May 1998, the Company concluded a private placement of 7% convertible
subordinated notes due May 12, 2003 in the aggregate principal amount of
$10,580,000. The effect on diluted earnings per share amounts is illustrated in
the accompanying consolidated statements of operations.

     (k) Accounting Pronouncements

     On January 1, 1998, the Company adopted SFAS No. 130, Reporting
Comprehensive Income ("SFAS No. 130"). SFAS No. 130 establishes standards for
reporting and presentation of comprehensive income and its components in a full
set of financial statements. Comprehensive income consists of net income and
net unrealized gains (losses) on securities and is presented in the
consolidated statements of shareholders' equity and comprehensive income. SFAS
No. 130 requires only additional disclosures in the consolidated financial
statements; it does not affect the Company's financial position or results of
operations. The Company did not have any items for the years ended December 31,
1998 and 1997 that would require the presentation of comprehensive income in
the accompanying financial statements.

     On January 1, 1998, the Company adopted SFAS No. 131, Disclosures About
Segments of an Enterprise and Related Information ("SFAS No. 131"). SFAS No.
131 establishes standards for disclosing information about an enterprise's
operating segments. Operating segments are components of an enterprise (1) that
engage in business activities from which revenues may be earned and in which
expenses are incurred; (2) whose operating results are reviewed by the
enterprise's chief operating decision maker for purposes of making decisions
with regard to resource allocation and performance evaluation; and (3) for
which discrete financial information is available. In accordance with SFAS No.
131, the Company has disclosed such information in the accompanying financial
statements.

     (l) Reclassifications

     Certain items in the Company's 1997 financial statements have been
reclassified to conform with the 1998 presentation.

(2) INVESTMENTS

      Net investment income for the years ended December 31, 1998 and 1997 is
summarized as follows:

                                                            1998        1997
                                                         ----------   ---------
        Fixed maturities ............................... $1,341,339     973,839
        Short-term investments and cash ................    479,504     420,705
                                                         ----------   ---------
        Net investment income .......................... $1,820,843   1,394,544
                                                         ==========   =========

     At December 31, 1998 and 1997, the Company did not hold fixed-maturity
securities which individually exceeded 10% of shareholders' equity except U.S.
government and government agency securities.

     Bonds with an amortized cost of $8,257,053 and $7,877,444 were held in a
restricted account for the benefit of the ceding company (AIG) as unauthorized
reinsurance at December 31, 1998 and 1997, respectively, in accordance with
statutory requirements.



                                      F-13





<PAGE>   50
              PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                     DECEMBER 31, 1998 AND 1997 (RESTATED)

(2) INVESTMENTS (CONTINUED)

     The amortized cost and estimated fair values of the Company's investments
at December 31, 1998 and 1997 are as follows:

<TABLE>
<CAPTION>

                                                                                                       Amount At
                                                                           Gross        Gross         Which Shown
                                               Amortized    Unrealized   Unrealized   Estimated         On the
December 31, 1998                                Cost         Gains        Losses     Fair Value     Balance Sheet
-----------------                             -----------   -----------  ----------   ----------     -------------
<S>                                           <C>            <C>          <C>         <C>              <C>
Securities held to maturity:
  Fixed maturities:
    Obligations of states and political
      subdivisions .......................... $15,454,481    241,667      (4,129)     15,692,019       15,454,481
    Obligations of states and political
      subdivisions -- restricted ............   8,257,053    130,956                   8,388,009        8,257,053
                                              -----------    -------      ------      ----------       ----------
    Total fixed maturities .................. $23,711,534    372,623      (4,129)     24,080,028       23,711,534
                                              ===========    =======      ======      ==========       ==========
</TABLE>

<TABLE>
<CAPTION>

                                                                                                       Amount At
                                                                           Gross        Gross         Which Shown
                                               Amortized    Unrealized   Unrealized   Estimated         On the
December 31, 1997                                Cost         Gains        Losses     Fair Value     Balance Sheet
-----------------                             -----------   -----------  ----------   ----------     -------------
<S>                                           <C>            <C>          <C>         <C>              <C>
Securities held to maturity:
  Fixed maturities:
    Obligations of states and political
      subdivisions .........................  $ 8,015,105    222,564          --       8,237,669        8,015,105
    Obligations of states and political
      subdivisions -- restricted ...........    7,877,444     70,537          --       7,947,981        7,877,444
                                              -----------    -------      ------      ----------       ----------
    Total fixed maturities .................  $15,892,549    293,101          --      16,185,650       15,892,549
                                              ===========    =======      ======      ==========       ==========
</TABLE>



                                      F-14




<PAGE>   51
              PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                     DECEMBER 31, 1998 AND 1997 (RESTATED)

(2) INVESTMENTS (CONTINUED)

     The amortized cost and fair value of securities at December 31, 1998 and
1997, by contractual maturity date, are presented below:

<TABLE>
<CAPTION>

                                                     December 31, 1998           December 31, 1997
                                                 -------------------------    -------------------------
                                                  Amortized                   Amortized
                                                    Cost        Fair Value      Cost        Fair Value
                                                 -----------   -----------    ----------    -----------
           <S>                                   <C>           <C>            <C>          <C>
          Fixed maturities
             held-to-maturity:
          Due in one year or less .............  $        --            --            --            --
          Due after one year through
             five years ........................   14,394,846   14,600,179     6,941,072     7,139,209
          Due after one year through
             five years -- restricted ..........    7,197,418    7,296,169     6,803,411     6,849,521
          Due after five years through
             ten years .........................          --            --            --            --
          Due after ten years .................    1,059,635     1,091,840     1,074,033     1,098,460

          Due after ten years -- restricted....    1,059,635     1,091,840     1,074,033     1,098,460
                                                 -----------    ----------    ----------    ----------
                                                  23,711,534    24,080,028    15,892,549    16,185,650

         Short-term investments ................   1,515,347     1,515,347     4,903,714     4,903,714
         Short-term investments -- restricted ..   5,516,681     5,516,681     2,186,836     2,186,836
                                                 -----------    ----------    ----------    ----------
         Total ................................. $30,743,562    31,112,056    22,983,099    23,276,200
                                                 ===========    ==========    ==========    ==========
</TABLE>

(3) FINANCIAL INSTRUMENTS

     The carrying amounts for short-term investments, cash, accounts,
commissions and premiums receivable, accrued investment and interest income,
notes payable, premiums, commissions and other insurance balances payable and
accounts payable and accrued expenses approximate their fair values due to the
short-term nature of these instruments.

     Estimated fair values for fixed maturities were provided by outside
consultants using market quotations, prices provided by market makers or
estimates of fair values obtained from yield data relating to investment
securities with similar characteristics. The carrying amount for the Company's
7% convertible subordinated notes is $10,580,000 and the related estimated fair
value is $10,280,955 which was determined by management based on available
market information and appropriate valuation methodologies.



                                      F-15



<PAGE>   52
              PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
                     December 31, 1998 and 1997 (restated)

(4) ACCOUNTS, COMMISSIONS AND PREMIUMS RECEIVABLE

     Accounts, commissions and premiums receivable consists of the following at
December 31, 1998 and 1997:

<TABLE>
<CAPTION>

                                                                                 1998           1997
                                                                              -----------     ---------
           <S>                                                                <C>             <C>
           Staffing accounts receivable -- billed ..........................  $ 5,626,113     1,922,857
           Staffing accounts receivable -- unbilled ........................    1,000,370       317,095
                                                                              -----------     ---------
                                                                                6,626,483     2,239,952
           Less allowance for uncollectible accounts ......................       (96,054)     (125,367)
                                                                              -----------     ---------
           Staffing accounts receivable, net ..............................     6,530,429     2,114,585
           Premiums receivable ............................................     3,652,463
           Commissions receivable .........................................     1,018,031       585,072
                                                                              -----------     ---------
           Total ..........................................................   $11,200,923     2,699,657
                                                                              ===========     =========

</TABLE>

      The allowance for uncollectible accounts as of December 31, 1998 and 1997
consists of the following:

<TABLE>
<CAPTION>
                                                                                   1998         1997
                                                                                 ---------    --------
            <S>                                                                  <C>           <C>
            Beginning balance ................................................   $ 125,367     23,212
            Provision for uncollectible accounts .............................      96,624    106,367
            Write-offs .......................................................    (125,937)    (4,212)
                                                                                 ---------    -------
            Ending balance ...................................................   $  96,054    125,367
                                                                                 =========    =======
</TABLE>

(5) STOCKHOLDER LOAN

     In May 1995, the Company entered into a repurchase agreement with
stockholders (the "Agreement") whereby the Company agreed to repurchase from
them an aggregate of 30 shares of common stock (529,412 shares as adjusted to
give effect to the Exchange) (the "Shares") of the Company. The aggregate
purchase price for the Shares was $600,000 (including interest) to be paid in
24 installments of $25,000. The closing of the Agreement was subject to the
Company's completion of a $600,000 distribution to the stockholders of the
Company, pro rata based on the number of shares of common stock of the Company
outstanding and paid to the stockholders of record on the Agreement date,
without giving effect to the repurchase. The $600,000 distribution was made by
the Company on May 26, 1995.

     Pursuant to a subsequent agreement made with the stockholders, the
outstanding loan balance at December 31, 1995 was to be repaid in 23 monthly
installments of $25,000 (including interest) commencing in February 1996. The
outstanding balance of the above-referenced stockholder loan was paid in full
during 1997.


                                      F-16




<PAGE>   53









                                 [MISSING COPY]

















                                      F-17
<PAGE>   54
               PREFERRED EMPLOYER HOLDINGS, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                     DECEMBER 31, 1998 AND 1997 (RESTATED)

(6) INCOME TAXES (CONTINUED)

     Deferred income taxes are based upon temporary differences between the
Company's financial statements and tax bases of assets and liabilities. The
following deferred taxes are recorded for December 31, 1998 and 1997:

<TABLE>
<CAPTION>
                                                                               1998          1997
                                                                             ----------    --------
           <S>                                                               <C>          <C>
           Deferred tax assets:
             Unearned premiums ............................................. $  411,176          --
             Reserve for unpaid claims .....................................    971,252     427,414
             Other, net ....................................................     59,105      44,348
                                                                             ----------    --------
                Gross deferred tax assets ..................................  1,441,533     471,762
                                                                             ----------    --------
           Deferred tax liabilities:
             Cash to accrual change ........................................   (284,575)   (218,925)
             Deferred acquisition costs ....................................   (680,291)         --
             Other, net ....................................................    (28,789)         --
                                                                             ----------    --------
                Gross deferred tax liabilities .............................   (993,655)   (218,925)
                                                                             ----------    --------
                   Net deferred tax asset .................................. $  447,878     252,837
                                                                             ==========    ========

</TABLE>

     A valuation allowance has not been established as the Company believes it
is more likely than not that the deferred tax asset will be realized.

     The Company's reinsurance subsidiary is a Bermuda domiciled corporation.
The reinsurance subsidiary is a "controlled foreign corporation" ("CFC") for
United States federal income tax purposes. As a result, the Company includes in
its gross income for United States federal income tax purposes its pro-rata
share of the CFC's "subpart F income" even if such subpart F income is not
distributed. Substantially all of the income of the Company's reinsurance
subsidiary is subpart F income.

     The Company has elected under section 953(d) of the Internal Revenue Code
to tax its reinsurance subsidiary as a domestic corporation for U.S. income tax
purposes. The Company does not believe this election has had a material effect
on its income tax expense.

(7) STATUTORY SOLVENCY REQUIREMENTS

     The Bermuda Insurance Act of 1978 and related regulations (the "Act")
requires the Company to meet a minimum solvency margin. Statutory capital and
surplus as of December 31, 1998 and 1997 was $10,533,517 and $7,285,144
respectively, and the amounts required to be maintained by the Company were
$3,163,000 for 1998 and $3,300,000 for 1997. In addition, a minimum liquidity
ratio must be maintained whereby relevant assets, as defined by the Act, must
exceed 75% of relevant liabilities. Once these requirements have been met,
there is no restriction on the retained earnings available for distribution. At
December 31, 1998 and 1997, the Company was in compliance with this
requirement.


                                      F-18


<PAGE>   55
               PREFERRED EMPLOYER HOLDINGS, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                     DECEMBER 31, 1998 AND 1997 (RESTATED)


(8) LIABILITY FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES

     Activity with respect to the Company's liability for unpaid losses and
loss adjustment expenses is summarized as follows for the years ended December
31, 1998 and 1997:

<TABLE>
<CAPTION>

                                                                                   1998          1997
                                                                                -----------   ---------
         <S>                                                                   <C>             <C>
         Net unpaid losses and loss adjustment expenses at beginning of
           year ..............................................................  $ 6,107,613     199,390
                                                                                -----------   ---------
         Incurred related to:
           Current year ......................................................    7,614,086   6,257,095
           Prior year ........................................................      437,780          --
                                                                                -----------   ---------
              Total incurred .................................................    8,051,866   6,257,095
                                                                                -----------   ---------
         Paid related to:
           Current year ......................................................      280,587     348,872
           Prior year ........................................................           --          --
              Total paid .....................................................      280,587     348,872
                                                                                -----------   ---------

         Net unpaid losses and loss adjustment expenses at end of year......... $13,878,892   6,107,613
                                                                                ===========   =========

</TABLE>

(9) STOCK OPTIONS

     During 1997, the Company adopted the 1996 Stock Option Plan (the "Plan")
to provide directors, officers and employees of the Company with the
opportunity to receive grants of incentive stock options. The Board of
Directors or a committee established by the Board has the sole authority to
determine who receives such grants, the type, size and timing of such grants,
and specify the terms of any agreements relating to the grants. The aggregate
number of shares that may be issued under the Plan is 1,000,000 shares.

     The purchase price of the stock issuable upon the exercise of an option is
determined by the Board of Directors or its committee at the time of grant of
the option. The exercise price can not be less than 100% of the fair market
value of such stock at the time of the grant in the case of incentive stock
options, or less than 110% of the fair market value in the case of incentive
stock options granted to individuals possessing more than 10% of the total
combined voting power of all classes of stock of the Company.

      The following table summarizes stock option activity under the Plan for
1998 and 1997:

<TABLE>
<CAPTION>

                                                                1998                               1997
                                                   --------------------------------   ---------------------------------
                                                                   Weighted Average                    Weighted Average
                                                   Option Shares    Exercise Price    Option Shares     Exercise Price
                                                   -------------   ----------------   -------------    ----------------
<S>                                                   <C>               <C>              <C>                 <C>
  Beginning Balance .............................     511,500           $7.48                 --                --
  Granted .......................................     320,000           $8.44            511,500             $7.48
  Exercised .....................................          --              --                 --                --
  Expired .......................................          --              --                 --                --
                                                      -------           -----            -------             -----
  Ending Balance ................................     831,500           $7.85            511,500             $7.48
                                                      =======           =====            =======             =====
</TABLE>


                                      F-19

<PAGE>   56
               PREFERRED EMPLOYER HOLDINGS, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                     DECEMBER 31, 1998 AND 1997 (RESTATED)

(9) STOCK OPTIONS (CONTINUED)

     The following table summarizes information about stock options outstanding
at December 31, 1998:

<TABLE>
<CAPTION>

                                                  Options Outstanding            Options Exercisable
                                               -------------------------      --------------------------
                                                Weighted
                                                 Average        Weighted                        Weighted
                                                Remaining        Average                         Average
        Range of               Number          Contractual      Exercise        Number          Exercise
      Exercise Prices        Outstanding          Life            Price       Exercisable         Price
      ---------------        -----------       -----------      --------      -----------       ---------
         <S>                  <C>               <C>            <C>             <C>             <C>
         $7.00                  75,000            8.52           $ 7.00          22,274          $ 7.00
          7.25                 160,000            8.12             7.25          95,152            7.25
          7.75                 276,500            8.65             7.75          75,446            7.75
          8.50                 175,000            9.56             8.50          15,535            8.50
          8.13                  75,000            9.24             8.13          11,342            8.13
          8.625                 70,000            9.61             8.625          5,485            8.625
                               -------            ----           -------        -------          -------
         $7.00-8.625           831,500            8.86           $ 7.85         225,234          $ 7.85
                               =======            ====           =======        =======          =======

</TABLE>

     The Company has elected to follow Accounting Principles Board Opinion No.
25, Accounting for Stock Issued to Employees (APB 25) and related
Interpretations in accounting for its employee stock options as allowed
pursuant to FASB Statement No. 123, Accounting for Stock Based Compensation
(FASB Statement 123). FASB Statement 123 requires use of option valuation
models which include the input of highly subjective assumptions, including
expected stock price volatility. Because the Company's employee stock options
have characteristics significantly different from traded options and because
changes in the subjective input assumptions can materially affect the fair
value estimate, in management's opinion, the existing models do not necessarily
provide a reliable measure of the fair value of its employee stock options.

     Had compensation cost for the Company's stock option plans been determined
based on the fair value at the grant date for awards under those plans,
consistent with FASB Statement No. 123, the reduction in the Company's 1998 and
1997 net income and net income per share would have been insignificant. The
effect of applying the fair method of accounting for stock options on reported
net income and net income per share for 1998 and 1997 may not be representative
of the effects for future years because outstanding options vest over a period
of several years and additional awards are generally made each year.

     The fair value of options granted was estimated at the date of grant using
the Black-Scholes option pricing model with the following weighted average
assumptions for 1998 and 1997:

                                                            1998        1997
                                                          ---------   --------
       Risk-free interest rate .........................      5.58%      6.46%
       Expected Life ...................................  6.5 years    7 years
       Expected volatility .............................        40%        25%
       Expected dividend yield .........................          0          0

(10) LEASES

     In August 1994, the Company entered into an office lease agreement which
became effective on April 1, 1995. The agreement provides for an initial
seven-year term with two five-year renewal options. In



                                      F-20



<PAGE>   57
               PREFERRED EMPLOYER HOLDINGS, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                     DECEMBER 31, 1998 AND 1997 (RESTATED)

(10) LEASES (CONTINUED)

October 1998, the staffing company entered into an office lease agreement which
became effective on October 1, 1998. The agreement provides for an initial
seven-year term with one five-year renewal option. The following is a schedule
of the approximate future minimum lease payments for office space and equipment
for the Company and its subsidiaries as of December 31, 1998:

         Year Ending December 31,                                     Total
         ------------------------                                   ---------
         1999 ..................................................    $ 800,000
         2000 ..................................................      836,000
         2001 ..................................................      859,000
         2002 ..................................................      637,000
         Thereafter ............................................    1,453,000
                                                                   ----------
                                                                   $4,585,000
                                                                   ==========

     Rent expense for the years ended December 31, 1998 and 1997 was
approximately $433,000 and $249,000, respectively.

(11) UNSECURED REVOLVING LINE OF CREDIT

     In May 1998, the Company obtained a $3 million unsecured revolving line of
credit from a bank. The terms of the loan provide for monthly interest payments
at the bank's prime lending rate (currently 7 3/4% per annum). The loan is
renewable on an annual basis. As of December 31, 1998, the aggregate amount
outstanding under the line of credit was $1,850,000.

 (12) SUBORDINATED CONVERTIBLE NOTES

     In May 1998, the Company concluded a private placement of $10,580,000 of
7% convertible subordinated notes (the "Notes") due May 2003. The principal
amount of the Notes is convertible at the option of the holders into shares of
the Company's common stock at a conversion price of $9.00 (the "Conversion
Price") at any time prior to the earlier of the maturity date (May 12, 2003) or
10 business days after receipt of a termination notice. In the event (i) the
closing bid price of the Company's common stock equals or exceeds $13.50 per
share for twenty consecutive trading days during any period commencing upon
satisfaction of one of the conditions contained in clause (ii) described herein
and (ii) either a registration statement covering the shares of common stock
issuable upon conversion of the Notes has been declared effective by the
Securities and Exchange Commission and remains effective or at least two years
has elapsed since the issuance date of the Notes and the shares of common stock
issuable upon conversion of the Notes are saleable, without restriction, under
Rule 144(k) promulgated under the Securities Act of 1933, as amended, then the
holders' rights to convert the outstanding principal amount of the Notes shall
be terminated by the Company by delivering to the holders a notice of
termination (the "Termination Notice"), in which event (a) the holders will
have the right at any time during 10 business days after receipt of the
Termination Notice, in their sole discretion, to convert the outstanding
principal amount of the Notes into shares of common stock of the Company at the
Conversion Price, and (b) thereafter, the holders' option to convert shall
terminate and the Notes may be prepaid by the Company, at any time prior to the
Maturity Date, in whole or in part for the face amount thereof, together with
all accrued and unpaid interest through the date of prepayment.



                                      F-21


<PAGE>   58
               PREFERRED EMPLOYER HOLDINGS, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                     DECEMBER 31, 1998 and 1997 (RESTATED)

(13) SEGMENT REPORTING

     The Company's reportable business segments are strategic business units
that offer distinctive products and services that are marketed through
different channels. They are managed separately because of their unique
marketing and distribution requirements.

     There are two reportable segments: Insurance and Employee Staffing. The
insurance segment sells, on behalf of others, business insurance principally to
the franchise industry and provides reinsurance for certain workers'
compensation and employers' liability insurance policies sold by the Company.
The employee staffing segment provides temporary registered nurses and
professional medical personnel primarily to client hospitals.

     The accounting policies of the segments are the same as those described in
the summary of significant accounting policies. Management evaluates segment
performance based on profit or loss from operations before income taxes not
including non-recurring gains and losses and intersegment transactions. Sales
and services between segments are accounted for as if the sale or services were
provided to third parties, that is at current market prices.

     Certain information concerning the Company's reporting segments for the
years ended December 31, 1998 and 1997 is as follows:

<TABLE>
<CAPTION>

                                                                                  Employee
                                 1998                              Insurance      Staffing       Totals
                                 ----                             -----------    ----------    ----------
          <S>                                                     <C>            <C>           <C>
          Revenues from external customers ....................   $18,028,102    34,462,035    52,490,137
          Intersegment revenues ...............................        36,237            --        36,237
          Interest revenue ....................................     1,679,481           745     1,680,226
          Interest expense ....................................            --       494,935       494,935
          Depreciation and amortization .......................       140,657       380,018       520,675
          Segment profit ......................................     2,843,101     1,962,923     4,806,024
          Segment assets ......................................    40,434,696    12,545,917    52,980,613
          Expenditures for segment assets .....................        39,250       317,740       356,990

</TABLE>

<TABLE>
<CAPTION>

                                                                                  Employee
                                 1997                              Insurance      Staffing       Totals
                                 ----                             -----------    ----------    ----------
          <S>                                                     <C>            <C>           <C>
          Revenues from external customers ....................   $14,604,568     11,594,300   26,198,868
          Interest revenue ....................................     1,152,846             --    1,152,846
          Interest expense ....................................        16,534        647,375      663,909
          Depreciation and amortization .......................       150,341         51,971      202,312
          Segment profit (loss) ...............................     1,410,149      (599,460)      810,689
          Segment assets ......................................    24,985,368      2,543,618   27,528,986
          Expenditures for segment assets .....................        82,677        185,793      268,470
</TABLE>



                                      F-22


<PAGE>   59














                                 [MISSING COPY]










                                      F-23
<PAGE>   60
               PREFERRED EMPLOYER HOLDINGS, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
                     December 31, 1998 and 1997 (restated)

 (13) SEGMENT REPORTING (CONTINUED)

     Other Items:
<TABLE>
<CAPTION>

                                                                  Reportable   Unallocated
                                                                    Segment     Corporate   Consolidated
         1998                                                        Total        Total         Total
         ----                                                     ----------   -----------  ------------
         <S>                                                      <C>           <C>          <C>
         Depreciation and amortization .........................  $  520,675     511,952      1,032,627
         Expenditures for assets ...............................     356,990      62,700        419,690
         Amortization of deferred acquisition costs ............   4,999,956          --      4,999,956
</TABLE>

<TABLE>
<CAPTION>
                                                                  Reportable   Unallocated
                                                                    Segment     Corporate   Consolidated
         1997                                                        Total        Total         Total
         ----                                                     ----------   -----------  ------------
         <S>                                                      <C>           <C>          <C>
         Depreciation and amortization .........................  $  202,312          --        202,312
         Expenditures for assets ...............................     268,470          --        268,470
         Amortization of deferred acquisition costs ............   4,161,884          --      4,161,884

</TABLE>

     The Company does not attribute revenues or long-lived assets by geographic
areas. The Company does not have any single customer that can be identified as
major when considering the Company's consolidated revenues.

(14) LITIGATION

     The Company is a defendant in various litigation matters considered to be
in the normal course of business. While the outcome of these matters cannot be
estimated with certainty, it is the opinion of management (after consultation
with legal counsel) that the resolution of such litigation will not have a
material adverse effect on the Company's financial statements.

(15) UNAUDITED PRO FORMA INFORMATION

     Pro forma adjustments for income taxes represent the difference between
historical income taxes and income taxes that would have been reported had NET
Healthcare filed income tax returns as a taxable "C corporation" for 1998 and
1997.

(16) YEAR 2000

     Year 2000 issues are the result of computer programs being written using
two digits rather than four to define the applicable year. The Company has
developed a plan to address Year 2000 issues. The plan is based on the
Company's primary software vendors having advised the Company that the
necessary programming changes related to Year 2000 issues have been made and
tested and that the software used by the Company can be upgraded to be Year
2000 compliant. During 1998, the Company began to implement this upgrade and
expects to be fully compliant with Year 2000 issues by the end of the first
quarter of 1999. As an integral component of such plan, the Company will
determine if they are Year 2000 compliant. It is management's belief that for
any suppliers who may not be Year 2000 compliant, such non-compliance will not
have a material adverse effect on the Company's business. However, each major
supplier's compliance will be assessed in light of their response. The costs
associated with the implementation of the above project are not expected to be
material.



                                      F-24