<PAGE>
 
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                      SECURITIES AND EXCHANGE COMMISSION
                             Washington, DC 20549
 
                               ----------------
 
                                   FORM 10-K
 
  [X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
       EXCHANGE ACT OF 1934
 
                  for the fiscal year ended December 27, 1998
 
                                      OR
 
  [_]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
       SECURITIES EXCHANGE ACT OF 1934
 
                        Commission file number 0-22869
 
                               ----------------
 
                        HALL, KINION & ASSOCIATES, INC.
            (Exact name of registrant as specified in its charter)
 
<TABLE>
<S>                                <C>
            Delaware                                 77-0337705
 
  (State or other jurisdiction                    (I.R.S. Employer
of incorporation or organization)               Identification No.)
</TABLE>
 
              185 Berry Street, China Basin Landing, Suite 6440,
                            San Francisco, CA 94107
                   (Address of principal executive offices)
 
                                (415) 974-1300
             (Registrant's telephone number, including area code)
 
                               ----------------
 
          Securities registered pursuant to Section 12(b) of the Act:
                                     None
 
          Securities registered pursuant to Section 12(g) of the Act:
                         Common Stock $0.001 par value
 
   Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) had been subject to
such filing requirements for the past 90 days. Yes [X] No [_]
 
   Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
 
   As of March 1, 1999, there were outstanding 9,566,606 shares of the
Registrant's Common Stock. The aggregate market value of the common stock held
by non-affiliates of the registrant, based on the closing price of the common
stock as reported on the Nasdaq Stock Market (National Market System) on March
1, 1999, was approximately $68,760,000.
 
                      DOCUMENTS INCORPORATED BY REFERENCE
 
   Portions of the Registrant's Proxy Statement to be mailed to stockholders
in connection with the registrant's annual meeting of stockholders, scheduled
to be held on May 14, 1999 are incorporated by reference in Part III of this
report. Except as expressly incorporated by reference, the registrant's Proxy
Statement shall not be deemed to be part of this report.
 
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<PAGE>
 
                                    PART I
 
Item 1. Business
 
Forward Looking Statements
 
   The discussion in this Report contains forward looking statements that
involve risks and uncertainties. The statements contained in this release that
are not purely historical are forward-looking statements within the meaning of
Section 21E of the Securities and Exchange Act of 1934, including statements
regarding the Company's "expectations," "beliefs," "hopes," "intentions" or
"strategies," or the like, regarding the future. All forward-looking
statements included in this release are based upon information available to
the Company as of the date hereof, and the Company assumes no obligation to
update any such forward-looking statement. Actual results could differ
materially from those indicated by the forward-looking statements made herein
or presented elsewhere by the Company's management from time to time. Factors
that could cause or contribute to such differences include, but are not
limited to, the rate of hiring and productivity of revenue generating
personnel; the availability of qualified IT professionals; changes in the
relative mix between contract services and permanent placement services;
changes in the pricing of the Company's services; the timing and rate of
entrance into new regional markets and the addition of Practice Groups; the
structure and timing of acquisitions; changes in demand for IT professionals;
general economic factors; and other factors discussed under the caption "Risk
Factors," elsewhere in this Report, and in the Company's Securities and
Exchange Commission Filings.
 
The Company
 
   Hall, Kinion & Associates, Inc. (the "Company" or "Hall Kinion") is a
leading provider of high-end information technology ("IT") professionals on a
contract and permanent basis, with more than 25 offices in 15 domestic markets
and London, England to serve the technology services industry. To meet the
specialized needs of its clients, the Company provides its services through
distinct technology practice groups ("Practice Groups") organized around
specific technologies (such as Windows, Unix or CAD) frequently used by its
clients. The Company is organized into two divisions: Contract Services and
Permanent Placement. The Contract Services division ("Contract Services")
provides supplemental IT professionals to research and development ("R&D")
departments of high technology companies and to information systems ("IS")
departments of corporate clients. In 1998, 1997 and 1996, Contract Services
represented 85.5%, 86.5% and 83.6% of the Company's net revenues,
respectively. The Permanent Placement division ("Permanent Placement") places
IT professionals in permanent positions with high-technology companies and
other corporate clients. In 1998, 1997 and 1996, Permanent Placement
represented 14.5%, 13.5% and 16.4% of the Company's net revenues,
respectively. The Company's customers include an extensive group of global
high technology companies, including Inprise, Cisco Systems, IBM, Microsoft,
Motorola, Oracle and numerous emerging growth companies, such as The Gap,
Magellan Communications, Inc., Net Frame Systems, Exodus Communications, Inc.,
Resumix and Remedy Corporation. No single client represented more than 5% of
the Company's net revenues in 1998, 1997 or 1996.
 
   The high-technology industry continues to experience substantial growth and
rapid rates of innovation. These trends, combined with intense competition,
have placed pressure on high technology companies to shorten product life
cycles and the time-to-market of new products. The development of next
generation products, however, often requires significant and highly
specialized technical talent, which may not be available internally.
Furthermore, as new technologies and systems are introduced, businesses, which
rely on them for mission-critical functions, must implement these systems
within their already complex computing environments. Consequently, IS
departments are faced with the challenge of finding qualified IT professionals
to design, develop, deploy and maintain their systems. To address these
demands for contract and permanent IT professionals, both the R&D departments
of high technology companies and the IS departments of large corporations are
turning to IT professional service companies to augment their existing
operations.
 
   The Company's objective is to provide efficient and high quality contract
and permanent IT professionals to R&D departments of high technology clients
and IS departments of corporate clients and to become the "agent
 
                                       1
<PAGE>
 
of choice" for IT professionals. To achieve this objective, the Company: (i)
focuses on technology-driven clients that typically require IT professionals
with more highly specialized skill sets than traditional supplemental IT
personnel; (ii) provides specialized IT services through distinct Practice
Groups that are focused on specific technologies and that operate relatively
autonomously with their own sales forces and recruiting personnel; (iii)
pursues cross-selling opportunities between permanent placement and contract
services; (iv) seeks to attract and retain qualified IT professionals; and (v)
provides strong corporate support to its 16 regional markets (including
London, England).
 
   The Company was incorporated in California in 1991. In 1994, the Stellar
Group, Inc. and Kinion Hall, affiliated companies under common ownership, were
merged with the Company and in December 1996, the Company acquired certain
assets of TeamAlliance Technology Partners, L.P. and certain of its affiliated
regional operating companies ("TeamAlliance" or the "TeamAlliance
Acquisition"). The Company was reincorporated in Delaware in July 1997 and
completed an initial public offering of shares of its Common Stock, $0.001 par
value, on August 4, 1997.
 
   The following table illustrates the Practice Groups currently located in
each of the Company's existing regional markets. Although the Company does not
expect to add every Practice Group to each regional market, the Company
believes that there are opportunities to add Practice Groups in each regional
market, particularly those that have been recently entered.
 
                      PRACTICE GROUPS BY REGIONAL MARKET
 
<TABLE>
<CAPTION>
                                                                                    Permanent
               Contract                                                 Tech.       Placement
               Services: Windows Unix QA  CAD Writers Internet Net IS  Support IPEX Services
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<S>            <C>       <C>     <C>  <C> <C> <C>     <C>      <C> <C> <C>     <C>  <C>
Silicon
Valley             *         .     .    .   .     .              .         .     .       .
---------------------------------------------------------------------------------------------
Seattle            *         .                    .              .                       .
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Portland                     .              .                    .                       .
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Phoenix                      .              .                    .                       .
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Salt Lake
City                         .                                       .                   .
---------------------------------------------------------------------------------------------
Denver                       .     .        .                    .   .                   .
---------------------------------------------------------------------------------------------
Austin             *         .              .                    .                       .
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Houston                                     .                        .                   .
---------------------------------------------------------------------------------------------
Chicago            *         .     .        .                    .   .                   .
---------------------------------------------------------------------------------------------
Boston                       .                                                           .
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San Francisco                .     .                                                     .
---------------------------------------------------------------------------------------------
Raleigh                                                              .                   .
---------------------------------------------------------------------------------------------
New York
City                         .     .                      .          .                   .
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Tampa                                                                .                   .
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Connecticut                  .     .    .                 .      .   .                   .
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London                                                                                   .
</TABLE>
 .   Practice Groups
*   Multiple Office locations
 
Strategy
 
   In late 1994, the Company implemented a growth strategy intended to create
a network of offices in regional markets; each comprised of multiple Practice
Groups. Key elements of this growth strategy are to:
 
   Hire additional revenue-generating employees for existing Practice
Groups. The Company believes that there is a potential for revenue growth from
the addition of technical recruiting agents (TRAs) and Account
 
                                       2
<PAGE>
 
Managers in existing Practice Groups. The addition of these employees
represents increased opportunities to generate revenues by servicing a greater
number of current and prospective clients and IT professionals. The Company
increased the number of revenue-generating employees from 273 employees in
1996 to 348 employees in 1997 and 397 employees in 1998. In large part, this
internal expansion has been implemented according to a growth model based on
the Company's experience expanding in regional markets with substantially
similar characteristics. By using its growth model, the decisions to make
additional investments such as increasing headcount, advertising expense and
the number and type of Practice Groups, is determined based on objective
performance criteria. The Company believes that its growth model provides its
managers an effective tool for executing and monitoring an expansion strategy
and schedule.
 
   Add Practice Groups to existing regional markets. The Company has 11
different types of Practice Groups and nine of the Company's 16 regional
markets (including London) have more than four types of Practice Groups. The
Company also has 6 markets with multiple office locations. The Company
believes that there is a substantial opportunity to increase the number of
Practice Groups within its existing regional markets and the potential to
expand into new markets. Historically, the Company has entered a new market
with the Permanent Placement Division and then added additional Practice
Groups in that market to leverage that office's reputation and relationships
and to take advantage of cross-selling opportunities. The Company intends to
implement a focused expansion of its Practice Groups in existing regional
markets in order to meet the needs of new and existing clients.
 
   Open additional locations in new regional technology markets. A key element
of the Company's growth strategy is to continue to enter new regional markets
with a concentration of high technology companies. The Company currently has
Practice Groups in 15 domestic markets, including Silicon Valley, Seattle, the
Research Triangle, certain other technology service markets and London.
 
   Acquire complementary businesses. The Company intends to explore the
potential acquisition of businesses that would provide it with: (i) new
technology practices; (ii) strategically complementary businesses; (iii) new
geographical presences; (iv) international recruiting capabilities; or (v)
executive retainer search businesses. For example, as a result of the recently
completed acquisition of certain assets of ITC and Huntington, the Company has
not only established a new geographic presence in Connecticut, but also has
taken advantage of a strategically complementary business that consists of
both of contract services and permanent placement services and has acquired
executive retainer search capabilities as well.
 
Hall Kinion Services
 
 Contract Services
 
   The Company's Contract Services Division provides supplemental IT
professionals to high technology companies and to information systems
departments of its corporate clients. In a typical R&D contract, an IT
professional is contracted to a high technology client, usually in connection
with a specific application or project. In a typical IS contract, an IT
professional is contracted to an IS department for the implementation and
maintenance of corporate computer systems. The Company's IT professionals
usually work on assignments with a maturity of approximately three to nine
months, with all work billed on an hourly basis and performed at the direction
of the client.
 
   The Company has organized its Contract Services Division into eight types
of Practice Groups focused on those technologies widely used by its high
technology clients in the development of their products (Windows, Unix, QA,
CAD, NET, IS, Internet and Writers.) In addition, through its Technology
Support Practice Group, the Company offers its high technology clients access
to IT professionals providing administrative support, data entry, help desk
and customer support. The Company expects this Practice Group to represent a
declining percentage of the Company's net revenues as the Company focuses on
more specialized, higher margin Practice Groups.
 
                                       3
<PAGE>
 
 Permanent Placement Services
 
   The Company provides IT professionals for permanent placement with its high
technology companies and other corporate clients. The Company currently
delivers such services in all of the Company's regional markets. The Company
recognizes revenue when the IT professional commences employment. The Company
typically guarantees this placement for a period of 90 days. This placement
fee is usually structured as a percentage of the IT professional's first-year
annual compensation. The Permanent Placement Division not only offers its
service to R&D departments of high technology firms, but also to the IS
departments of its corporate clients. The Permanent Placement Division plans
to expand its retainer search business as well as other segments of the
technology services industry.
 
 Group-IPEX
 
   Group-IPEX focuses on recruiting international IT research and development
professionals to work on short term R&D contracts at leading technology
vendors. In a typical R&D contract, international IT research and development
professionals are brokered to companies similar to Hall Kinion who then
contract them out to high technology clients. The majority of the work is
billed on an hourly basis and performed at the direction of the client.
 
 Interactive Acquisition Corporation
 
   Interactive Acquisition Corporation, a wholly owned subsidiary of the
Company, acquired substantially all of the assets of ITC, a provider of
specialized IT professionals on a contract basis, and continues to provide
contract professionals for leading technology customers such as Hyperion
Solutions, IBM, Pitney Bowes, and GE Capital I.T.S. as it has since 1996. The
Company's IT professionals work on an hourly basis and perform work at the
direction of the client.
 
 Huntington Acquisition Corporation
 
   Huntington Acquisition Corporation, a wholly owned subsidiary of the
Company, doing business as the Huntington Group, provides professionals for
permanent placement with its corporate clients. This company purchased
substantially all of the assets of Huntington and primarily conducts executive
searches on a retainer basis at a national level. Since its founding in 1990,
Huntington has placed more than 800 executives and professionals with leading
technology companies such as, Hyperion Solutions, the Gartner Group, and
Andersen Consulting. The retainer fee is structured such that a portion is
paid at the start of the search, then a portion when the candidate is found,
and a final payment when the candidate starts working.
 
 TKO Personnel, Inc.
 
   TKO Personnel, Inc. ("TKO") is an international permanent placement
provider for IT professionals. TKO primarily focuses on international
recruiting from Japan, but also from China and Korea. TKO places professionals
at corporate clients both in the United States as well as in foreign
countries.
 
Hall Kinion's Operating and Sales Approach
 
 Contract Services Division
 
  Technical Recruiting Agents
 
   TRAs are responsible for recruiting and assessing the Company's IT
professionals, understanding their preferences and capabilities and monitoring
their availability, progress and job satisfaction. The Company's goal is for
its TRAs to build long-term relationships with IT professionals in their
particular fields of specialization. Each experienced TRA is responsible for
up to approximately 30 IT professionals under contract at any time and
monitors the job status and availability of additional IT professionals. TRAs
operate only within a particular
 
                                       4
<PAGE>
 
division or Practice Group and are required to attend Company training
programs and to keep current on the latest technologies within their
particular specialization. As of December 27, 1998, the Company employed 95
TRAs located throughout its regional markets.
 
  Account Managers
 
   Account Managers are responsible for relationships with the Company's
clients. The Company's Account Managers form exclusive relationships with the
Company's clients, rather than operate within a particular technical
specialization. The Company believes that enabling Account Managers to develop
relationships in different departments of clients and at different levels
leads to quicker, more accurate placements as well as increased revenue for
the Company. As of December 27, 1998, the Company employed approximately 114
Account Managers throughout its regional markets.
 
  IT Professionals
 
   A major challenge facing IT services companies is the identification and
retention of highly qualified software engineers, computer programmers,
technical writers and designers. The Company believes that it has developed a
reputation among IT professionals for efficient and high quality placements
by: (i) focusing on an IT professional's particular field of technical
specialization; (ii) identifying and delivering high quality assignments
involving leading-edge technologies; and (iii) providing access for IT
professionals to cash compensation levels comparable to or higher than that of
similarly skilled, full-time employees. The Company's goal is to become the
"agent of choice" for IT professionals and is developing programs such as the
Star Campaign to increase the retention of IT professionals. The Star Campaign
is designed to enable the Company to attract and retain the highest quality IT
professionals available by providing these selected professionals with, among
other things, advance notice of state-of-the-art assignments and perquisites,
including participation in the Company's 401(k) plan, access to medical and
dental benefits and inclusion in the Company's stock options plan for IT
Professionals.
 
 Permanent Placement Division
 
  Recruiters
 
   Recruiters are primarily responsible for establishing relationships with
clients needing permanent IT professional services and matching the needs of
the Company's clients with the preferences and skills of the Company's
permanent placement job candidates. Recruiters frequently engage in other
activities to enhance their knowledge of the IT industry and issues that are
relevant to clients. Many Recruiters are members of industry trade
organizations and participate with clients in Company-sponsored seminars. In
addition, from time to time Recruiters will bring clients together to discuss
mutual technical issues or challenges. The Company believes these types of
activities strengthen client relationships and help to build alliances or
partnerships. The Company employed a total of approximately 188 Recruiters as
of December 27, 1998.
 
   Recruiters are paid primarily on a commission basis. The Company's
compensation for Recruiters encourages communication and cooperation among
Recruiters by sharing compensation among Recruiters involved in an individual
placement. The Company establishes performance standards based on revenue
generation and other factors, such as the number of sales calls completed by
Recruiters.
 
Corporate Support Services
 
   In support of its Practice Groups, the Company provides centralized
training, information systems, financial and accounting services. Managers
from the corporate office regularly visit each regional market, monitor
results of each Practice Group and oversee the addition of new employees.
Performance is measured at the service level and not at the office or regional
market level. The Company believes that this management structure fosters
synergy among divisions and Practice Groups, as well as cooperation and cross-
referrals from regional market to regional market.
 
                                       5
<PAGE>
 
   In addition to administrative support functions, the Company makes
substantial annual investments in training for its Vice Presidents, Directors,
TRAs, Account Managers and Recruiters. The Company provides management and
sales training throughout the year at its corporate headquarters in San
Francisco, California and at its training facility in Park City, Utah.
 
   The Company has developed a business growth model and related best
practices training program. Developed from in-house historical data, the model
consists of a set of detailed guidelines for use by the Company's divisions
and Practice Groups to expand within the Company's regional markets. By using
the growth model, decisions to make additional investments, such as increasing
headcount, advertising expense and the number of Practice Groups, are
determined based on objective performance criteria. The Company believes that
the growth model provides its managers with an effective tool for executing
and monitoring an expansion strategy and schedule. The growth model was also
used for all new Practice Groups added during the last three years.
 
Competition
 
   The IT staffing industry is highly competitive and fragmented and has low
barriers to entry. The Company competes for potential clients with providers
of outsourcing services, systems integrators, computer systems consultants,
other providers of IT staffing services and temporary personnel agencies. Many
of the Company's current and potential competitors have longer operating
histories, significantly greater financial and marketing resources, greater
name recognition and a larger installed base of IT professionals and clients
than the Company. In addition, many of these competitors, including numerous
smaller privately held companies, may be able to respond more quickly to
customer requirements and devote greater resources to the marketing services
than the Company. Because there are relatively low barriers to entry, the
company expects that competition will increase in the future. Increased
competition could result in price reductions, reduced margins or loss of
market share, any of which could materially and adversely affect the Company's
business, operating results and financial condition. Further, there can be no
assurance that the Company will be able to compete successfully against
current and future competitors or that competitive pressures faced by the
Company will not have a material adverse effect on its business, operating
results and financial condition. The Company believes that the principal
factors relevant to competition in the IT staffing industry services industry
are the recruitment and retention of highly qualified IT professionals, rapid
and accurate response to client requirements and, to a lesser extent, price.
The Company believes that it competes favorably with respect to these factors.
 
Employees
 
   As of December 27, 1998, approximately 1,159 IT professionals placed by the
Company were providing contract services to the Company's clients. The
Company's corporate staff at December 27, 1998, consisted of 471 full-time
employees, of whom 95 are TRAs, 114 are Account Managers, 188 are Recruiters,
and 74 serve in various administrative and accounting capabilities. The
Company is not a party to any collective bargaining agreements covering any of
its employees, has never experienced any material labor disruption and is
unaware of any current efforts or plans to organize its employees. The Company
considers its relationship with its employees to be good.
 
                                       6
<PAGE>
 
                                 RISK FACTORS
 
   The discussion of this Report contains forward looking statements that
involve risks and uncertainties. The statements contained in this release that
are not purely historical are forward looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934, including statement
regarding the Company's "expectations," "beliefs," "hopes," "intentions" or
"strategies," or the like, regarding the future. All forward looking
statements included in this released are based upon information available to
the Company as of the date hereof, and the Company assumes no obligation to
update any such forward looking statement. Actual results could differ
materially from those indicated by the forward looking statements made herein
or presented elsewhere by the Company's management from time to time. Factors
that could cause or contribute to such differences include, but are not
limited to, the rate of hiring and productivity of revenue generating
personnel; the availability of qualified IT professionals; changes in the
relative mix between contract services and permanent placement services;
changes in the pricing of the Company's services; the timing and rate of
entrance into new regional markets and the addition of Practice Groups; the
structure and timing of acquisitions; changes in the demand for IT
professionals; general economic factors; and other factors discussed under the
caption "Risk Factors," elsewhere in this Report, and in the Company's
Securities and Exchange Commission Filings.
 
Ability to Attract and Retain Qualified IT Professionals
 
   The Company's success depends on its ability to attract and retain
qualified IT professionals with the technical skills and experience necessary
to meet its clients' requirements for technical personnel. Competition for
individuals with proven technical skills particularly in the Windows, Unix,
CAD and other technology environments for which the Company provides services,
is intense, and the Company expects that competition for IT professionals will
increase in the future. Furthermore, IT professionals typically provide
services on an assignment-by-assignment basis and can terminate an assignment
with the Company at any time. The Company competes for such individuals with
other providers of technical staffing services, system integrators, providers
of outsourcing services, computer consultants and temporary personnel
agencies. Many of the IT professionals who work with the Company also work
with the Company's competitors, and there can be no assurance that IT
professionals currently working on projects for the Company will not choose to
work for competitors on future assignments. There also can be no assurance
that the Company will be able to attract and retain qualified IT professionals
in sufficient numbers in the future. The Company's net revenues in any period
are related, among other factors, to the number of IT professionals it has on
staff and engaged on assignments. If the Company were unable to hire or retain
such personnel, the Company's business, operating results and financial
condition would be materially adversely affected.
 
Risks Inherent in Addition of Practice Groups and Expansion Into New Markets
 
   The Company's growth depends on its ability to successfully expand existing
Practice Groups, add additional Practice Groups within its existing regional
markets and enter new regional markets. This expansion is dependent on a
number of factors, including the Company's ability to: attract, hire,
integrate and retain qualified revenue generating employees; develop, recruit
and maintain a base of qualified IT professionals within a regional market;
accurately assess the demand of a new market; and initiate, develop and
sustain corporate client relationships in each new regional market. There can
be no assurance that the addition of Practice Groups and entrance into new
regional markets will occur on a timely basis or achieve anticipated financial
results. For example, in 1998 the Company closed the Orlando IS Practice Group
because its revenue growth was lower than management's expectations. The
addition of new Practice Groups and entrance into new regional markets
typically results in increases in operating expenses, primarily due to
increased headcount. Expenses are incurred in advance of forecasted revenue,
and there is typically a delay before the Company's new recruiting personnel
and sales employees reach full productivity. If the Company is unable to add
Practice Groups or enter new regional markets in a cost-effective manner or if
those Practice Groups and regional markets do not achieve anticipated
financial results, the Company's business, operating results and financial
condition could be materially adversely affected.
 
                                       7
<PAGE>
 
Fluctuations in Quarterly Results, Seasonality
 
   The Company's quarterly operating results have in the past and may in the
future fluctuate significantly depending on a number or factors, including,
but not limited to: the rate of hiring and the productivity of revenue-
generating personnel; the availability of IT professionals; changes in the
relative mix between the Company's contract services and permanent placement
services; changes in the pricing of the Company's services; the timing and
rate of entrance into new regional markets and the addition of practice
groups; departures or temporary absences of key revenue-generating personnel;
the structure and timing of acquisitions; changes in the demand for IT
professionals; and general economic factors.
 
   In addition, because the Company provides services on an assignment-by-
assignment basis, which clients can terminate at any time, there can be no
assurance that existing clients will continue to use the Company's services at
historical levels. Although the impact of seasonal factors will vary, the
Company experiences a certain amount of seasonality in its first quarter due
primarily to the number of holidays and the number of internal training and
incentive programs in the first quarter, which may reduce the number of days
worked by IT professionals and revenue-generating employees during such
quarter. As a result, the Company believes that period-to-period comparisons
of its results of operations are not necessarily meaningful and should not be
relied upon as any indication of future performance. In the event the
Company's operations should fall below the expectations of public market
analysts and investors, the price of the Company's Common Stock would likely
be materially adversely affected. Although the Company has experienced
substantial revenue growth in recent years, there can be no assurance that, in
the future, the Company will sustain revenue growth or profitability on a
quarterly or annual basis at historical levels.
 
Dependence on Key Personnel
 
   The Company's future business and operating results depend in significant
part upon the continued contributions of its key employees and senior
management personnel, many of whom would be difficult to replace. The loss or
temporary absence of any of the Company's senior management, significant
revenue generating employees, other key personnel and, in particular, Brenda
C. Rhodes, its Chief Executive Officer and Paul H. Bartlett, its President, or
the inability to attract and retain key employees or management personnel in
the future, could have a material adverse effect of the Company's business,
operating results and financial condition.
 
Management of Growth
 
   The Company has recently experienced a period of rapid growth that has
placed and will continue to place significant demands upon its management and
other resources. The Company's net revenues increased 83.6% from $50.6 million
in 1996 to $92.8 million in 1997, and 33.7% to $124.1 million in 1998 while
headcount increased from 425 employees in 1997 to 471 employees in 1998. The
Company's ability to effectively manage future growth will require the Company
to expand its operational, financial and other internal systems. Implementing
a new or expanded financial and management information system can be time-
consuming and expensive and require significant management resources. There
can be no assurance that the Company's current personnel, systems, procedures
and controls will be adequate to support the Company's future operations or
that any new system can be implemented effectively. Any failure to manage its
growth effectively could have a material adverse effect on the Company's
business, operating results and financial condition.
 
Risks of Acquisition
 
   A component of the Company's growth strategy is the acquisition of
complementary businesses. The successful implementation of this strategy is
dependent upon the Company's ability to identify suitable acquisition
candidates, obtain requisite financing, acquire such companies on suitable
terms and integrate their operations successfully with those of the Company.
There can be no assurance that the Company will be able to identify suitable
acquisition candidates or that the Company will be able to acquire such
candidates on favorable
 
                                       8
<PAGE>
 
terms. Moreover, other providers of IT professional services are also
competing for acquisition candidates, which could result in an increase in the
price of acquisition targets and a diminished pool of companies available for
acquisition. Acquisitions also involve a number of other risks, including
adverse effects on the Company's reported operating results from increases in
goodwill amortization and interest expense, the diversion of management's
attention and the subsequent integration of acquired businesses.
 
   To the extent the Company seeks to acquire complementary businesses for
cash, the Company may be required to obtain additional financing and there can
be no assurance such financing will be available on favorable terms, if at
all. Due to all of the foregoing, acquisitions may have a material adverse
effect on the Company's business, operating results and financial condition.
In addition, if the Company issues stock to complete any future acquisitions,
existing stockholders will experience ownership dilution.
 
   For example, in 1998 the Company acquired four companies: Group-IPEX, TKO,
Huntington and ITC, each of which is located and conducts business in multiple
states. All of these companies are operating as independent subsidiaries. The
integration of these companies, their clients, IT professionals, and employees
has required a significant amount of management's time and attention, and has
resulted in significant integration-related expenses, including expenses
associated with training their employees and contractors.
 
Industry and Geographic Concentration
 
   The Company's business is dependent on the trends prevalent in, and the
continued growth and rate of change of, the high technology industry. In 1997
and 1998, substantially all of the Company's net revenues were derived by
providing services to clients in the high technology industry. In addition,
approximately 47% and 43% of the Company's net revenues in 1997 and 1998,
respectively, were derived from services provided to clients in Silicon
Valley. Substantial deterioration in general economic conditions in Silicon
Valley or in the high technology industry as a whole would materially and
adversely affect the Company's business, financial condition and operating
results.
 
Highly Competitive Market
 
   The IT staffing industry is highly competitive and fragmented and has low
barriers to entry. The Company competes for potential clients with providers
of outsourcing services, system integrators, and computer systems consultants,
other providers of IT services and temporary personnel agencies. Many of the
Company's current and potential competitors have longer operating histories,
significantly greater financial and marketing resources, greater name
recognition and a larger installed base of IT professionals and clients than
the Company. In addition, many of these competitors, including numerous
smaller privately held companies, may be able to respond more quickly to
customer requirements and to devote greater resources to the marketing of
services than the Company. Because there are relatively low barriers to entry,
the Company expects that competition will increase in the future. Increased
competition could result in price reductions, reduced margins or loss of
market share, any of which could materially and adversely affect the Company's
business, operating results and financial condition. Further, there can be no
assurance that the Company will be able to compete successfully against
current and future competitors or that competitive pressures faced by the
Company will not have a material adverse effect on its business, operating
results and financial condition.
 
Governmental Regulation of Immigration
 
   Certain of the Company's IT professionals are foreign nationals working in
the United States under H-1B permits. Accordingly, both the Company and these
foreign nationals must comply with the United States immigration laws. The
inability of the Company to obtain H-1B permits for certain of its employees
in sufficient quantities or at a sufficient rate could have a material adverse
effect on the Company's business, operating results and financial condition.
Furthermore, Congress and administrative agencies with jurisdiction over
immigration matters have periodically expressed concerns over the levels of
legal and illegal immigration into the U.S. These concerns have often resulted
in proposed legislation, rules and regulations aimed at reducing the number of
work
 
                                       9
<PAGE>
 
permits that may be issued. For example, in 1998 the maximum number of
permitted H-1B permits available for 1998 were issued during the third quarter
of 1998, resulting in an inability to obtain additional permits for these
applicants for the balance of the year. Any changes in such laws making it
more difficult to hire foreign nationals or limiting the ability of the
Company to obtain foreign employees could require the Company to incur
additional unexpected labor costs and expense. Further, any such restrictions
or limitations on hiring practices could have a material adverse effect on
business, operating results and financial condition.
 
Concentration of Ownership by Principal Stockholders
 
   The Company's principal stockholders, Brenda C. Rhodes and Todd J. Kinion
beneficially owned approximately 34% of the Company's outstanding shares of
Common Stock at December 27, 1998. As a result, these stockholders as a group
will be able to exercise substantial control over matters requiring
stockholder approval, including the election of directors and approval of
significant corporate transactions. This concentration of ownership could have
the effect of making it difficult for a third party to acquire control of the
Company and may discourage third parties from attempting to do so.
 
Liability Risks
 
   The Company is exposed to liability with respect to actions taken by its IT
professionals while on assignment, such as damages caused by errors of IT
professionals, misuse of client proprietary information or theft of client
property. The Company often indemnifies its clients from the foregoing.
Although the Company maintains insurance coverage, due to the nature of the
Company's assignments, and in particular the access by IT professionals to
client information systems and confidential information, and the potential
liability with respect thereto, there can be no assurance that such insurance
coverage will continue to be available on reasonable terms or that it will be
adequate to cover any such liability. The Company may be exposed to
discrimination and harassment claims or other similar claims as a result of
inappropriate actions allegedly taken against IT professionals by corporate
clients. As an employer, the Company is also exposed to possible claims of
wrongful discharge and violations of immigration laws. Employment related
claims might result in negative publicity, litigation and liability for
monetary damages and fines.
 
Effect of Certain Charter Provisions; Anti-Takeover Effects or Certificate
Incorporation, Bylaws, Delaware Law
 
   The Company's Amended and Restated Certificate of Incorporation (the
"Certificate") and Bylaws and Delaware law contain provisions that could have
the effect of delaying, deferring or preventing an unsolicited change in
control of the Company, which may adversely affect the market price of the
Common Stock or the ability of stockholders to participate in a transaction in
which they might otherwise receive a premium for their shares over the then
current market price. Such provisions also may have the effect of preventing
changes in the management of the Company. These provisions provide that all
stockholder action must be taken at an annual meeting of stockholders, that
only the Board of Directors may call special meetings of the stockholders and
that the Board of Directors be divided into three classes to serve for
staggered three-year terms. In addition, the Certificate authorizes the Board
of Directors to issue up to 10,000,000 shares of preferred stock ("Preferred
Stock") without stockholder approval and on such terms as the Board of
Directors may determine. Although no shares of Preferred Stock are outstanding
as of December 27, 1998, and the Company has no plans to issue any shares of
Preferred Stock, the holders of Common Stock will be subject to, and may be
adversely affected by, the right of any Preferred Stock that may be issued in
the future. In addition, the Company is subject to the anti-takeover
provisions of Section 203 of the Delaware General Corporation law, which could
have the effect of delaying or preventing a change of control of the Company.
 
Impact of the Year 2000 Issue
 
   The Year 2000 issue results from computer programs written using two digits
rather than four to define the applicable year. Any of the Company's computer
programs that have date-sensitive software may recognize a
 
                                      10
<PAGE>
 
date using "00" as the year 1900 rather than the year 2000. This could result
in a system failure or miscalculations causing disruptions of operations,
among other things, a temporary inability to process transactions, send
invoices, or engage in similar normal business activities.
 
   The Company is in the process of conducting assessments of its computer
information systems and is beginning to take the necessary steps to determine
the nature and extent of the work required to make its systems Year 2000
compliant, where necessary. These steps will require to Company to modify,
upgrade or replace some of its internal financial and operational systems,
equipment and operation systems. The Company continues to evaluate the
estimated cost of bringing all internal systems, equipment and operations into
Year 2000 compliance, but has not finished determining the total cost of these
compliance efforts. While these efforts may involve additional costs, the
Company believes, based upon currently available information, that these costs
will not have a material adverse effect on the business, financial condition,
or results of operations of the Company. However, if these efforts are not
completed on time, or if the cost of updating or replacing the Company's
information systems, if necessary exceeds current estimates, the Year 2000
issue could have a material adverse impact on the business, financial
condition or results of operations of the Company.
 
   The Company is in the process of implementing a new financial ERP suite
that is Year 2000 compliant. The Company expects that this new system will be
implemented in the second quarter of 1999. In addition, the Company has
identified a non-financial system used by the company for management of
contractor resumes that might not be Year 2000 compliant. The Company is
reviewing the impact, if any, that such non-compliance could have on its
business, and intends to bring such system into compliance, or implement a
new, Year 2000 compliant system as soon as possible. The Company's failure to
fix its current system, or to implement a new system, is likely to result in
implementation of a manual process of tracking resumes which could, in turn,
have an adverse effect on the Company's business, financial condition or
results of operations.
 
   The Company also intends to determine the extent to which the Company may
be vulnerable to any failure by its major partners and service providers to
remedy their own Year 2000 issues, and is in the process of initiating formal
communications with these parties. At this time the Company is unable to
estimate the nature or extent of any potential adverse impact resulting from
the failure of third parties to achieve Year 2000 compliance, however, there
can be no assurance that these third parties will not experience Year 2000
problems or that any problems would not have a material effect on the
Company's business, financial condition or result of operations. The Company
has contacted all major suppliers and obtained confirmation that they have
addressed the Year 2000 problem
 
Item 2. Properties
 
   The Company's principal executive offices are currently located in San
Francisco, California and occupy an aggregate of approximately 5,000 square
feet of office space pursuant to a lease that expires in October 2003. The
Company also leases or subleases office space for its operations in Austin and
Houston, Texas; Capitola, Foster City, Fremont, Mountain View, and Cupertino,
California; Boston, Massachusetts; Chicago and Schaumburg, Illinois; Denver,
Colorado; London, England; New York, New York; Trumbull, Connecticut; Tampa,
Florida; Phoenix, Arizona; Portland, Oregon; Raleigh, North Carolina; Salt
Lake City, Utah; and Seattle, Washington. In addition, the Company owns a
training facility located in Park City, Utah.
 
Item 3. Legal Proceedings
 
   The Company is not a party to any material pending legal proceedings other
than routine litigation incidental to its business.
 
Item 4. Submission of Matters to a Vote of Security Holders
 
   No matter was submitted to a vote of the Company's security holders during
the fourth quarter of the fiscal year covered by this report.
 
                                      11
<PAGE>
 
                                    PART II
 
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
 
   The Company's Common Stock is listed for trading on the NASDAQ under the
symbol "HAKI". On December 27, 1998, there were approximately 76 holders of
record of the Common Stock.
 
   The table below sets forth the high and low sales prices per share as
reported on the NASDAQ National Market System since the Company's initial
public offering on August 4, 1997. The Company's initial public offering price
was $15.00 per share.
 
<TABLE>
<CAPTION>
                                                                Sales Price
                                                               ------------- ---
   Fiscal year ended December 27, 1998                          High   Low
   -----------------------------------                         ------ ------
   <S>                                                         <C>    <C>    <C>
   4th quarter ended December 27, 1998........................ $ 8.88 $ 5.88
   3rd quarter ended September 30, 1998....................... $ 9.25 $ 5.94
   2nd quarter ended June 28, 1998............................ $19.25 $ 6.38
   1st quarter ended March 29, 1998........................... $21.88 $13.00
<CAPTION>
   Fiscal year ended December 28, 1997                          High   Low
   -----------------------------------                         ------ ------
   <S>                                                         <C>    <C>    <C>
   4th quarter ended December 28, 1997........................ $21.13 $15.00
   3rd quarter ended September 28, 1997(1).................... $22.50 $17.87
</TABLE>
--------
(1) Trading of the Company's Common Stock commenced on August 4, 1997.
 
   No cash dividends were paid in 1998, 1997, or 1996. The Company, as it
deems appropriate, may continue to retain all earnings for use in its business
or may consider paying a dividend in the future. The Company cannot currently
issue dividends without acquiring bank consent prior to issuance.
 
                                      12
<PAGE>
 
Item 6. Selected Financial Data
 
   The following selected financial data has been derived from the audited
Consolidated Financial Statements. The information set forth below is not
necessarily indicative of result of future operations and should be read in
conjunction with "Management's Discussion and Analysis of Financial Conditions
and Result of Operations" and the Consolidated Financial Statements and
related notes thereto included elsewhere in this Form 10-K.
 
<TABLE>
<CAPTION>
                                                Fiscal Year
                                  --------------------------------------------
                                    1998     1997     1996     1995     1994
                                  --------  -------  -------  -------  -------
                                  (in thousands, except per share amounts)
<S>                               <C>       <C>      <C>      <C>      <C>
Consolidated Statement of Income
 Data:
Net revenues....................  $124,132  $92,831  $50,571  $29,385  $15,968
Cost of contract services.......    69,066   54,769   30,342   19,209   10,728
                                  --------  -------  -------  -------  -------
Gross profit....................    55,066   38,062   20,229   10,176    5,240
Selling, general and
 administrative expenses........    47,284   33,689   18,233    8,869    4,978
                                  --------  -------  -------  -------  -------
Income from operations..........     7,782    4,373    1,996    1,307      262
Other income (expense), net            (51)    (127)     369     (156)    (203)
                                  --------  -------  -------  -------  -------
Income before income taxes......     7,731    4,246    2,365    1,151       59
Income taxes....................     3,325    1,737    1,004      469       26
                                  --------  -------  -------  -------  -------
Net income......................  $  4,406  $ 2,509  $ 1,361  $   682  $    33
                                  ========  =======  =======  =======  =======
Income per share:
  Basic.........................  $   0.47  $  0.34  $  0.22  $  0.11  $  0.01
                                  ========  =======  =======  =======  =======
  Diluted.......................  $   0.43  $  0.25  $  0.16  $  0.11  $  0.01
                                  ========  =======  =======  =======  =======
Consolidated Balance Sheet Data:
Working capital (deficit).......  $  7,808  $19,390  $   189  $  (114) $  (209)
Total assets....................    55,976   42,440   22,994    5,680    2,572
Long term debt..................     1,083    2,549    6,738       --       --
Redeemable convertible preferred
 stock..........................        --       --    9,900       --       --
Stockholders' equity (deficit)..    37,902   31,530   (2,748)     941      259
</TABLE>
 
                                      13
<PAGE>
 
Item 7. Management's Discussion and Analysis of Financial condition and
Results of Operations
 
   The discussion in this Report contains forward looking statements that
involve risks and uncertainties. The statements contained in this release that
are not purely historical are forward looking statements within the meaning of
Section 21E of the Securities Act of 1934, including statements regarding the
Company's "expectations," "beliefs," "hopes," "intentions" or "strategies," or
the like, regarding the future. All forward looking statements included in
this release are based upon information available to the Company as of the
date hereof, and the Company assumes no obligation to update any such forward
looking statement. Actual results could differ materially from those indicated
by the forward looking statements made herein or presented elsewhere by the
Company's management from time to time. Factors that could cause or contribute
to such differences include, but are not limited to, the rate of hiring and
productivity of revenue generating personnel; the availability of qualified IT
professionals; changes in the relative mix between contract services and
permanent placement services; changes in the pricing of the Company's
services; the timing and rate of entrance into new regional markets and the
addition of Practice Groups; the structure and timing of acquisitions; changes
in demand for IT professionals; general economic factors; and other factors as
discussed under the caption "Risk Factors," elsewhere in this Report, and in
the Company's Securities and Exchange Commission Filings.
 
Overview
 
   Hall Kinion is a leading provider of high-end IT professionals to corporate
clients through 25 offices located in 15 domestic markets and in London,
England. The Company is organized into two divisions: Contract Services, which
provides specialized IT professionals to R&D and IS departments of high
technology companies, and Permanent Placement, which places IT professionals
in permanent positions.
 
   In 1998, 1997 and 1996, the Contract Services Division represented 85.5%,
86.5% and 83.6% of the Company's net revenues, respectively. For the same
periods, the Permanent Placement Division represented 14.5%, 13.5% and 16.4%
of the Company's net revenues, respectively.
 
   The Company's net revenues are derived from hourly billings of IT
professionals performing contract assignments and from fees received for
permanent placements. For contract services, assignments generally last from
three to nine months and revenues are recognized as services are provided.
Because the Company only derives revenues when its consultants are working,
its operating results may be adversely affected when client facilities are
closed due to holidays or inclement weather. In particular, the Company
experiences a certain amount of seasonality in its first fiscal quarter. For
its permanent placement IT professionals, the Company receives a fee upon
placement of the candidate. The fee is typically structured as a percentage of
the placed IT professional's first-year annual compensation. Permanent
placement revenues from fees are recognized when the IT professional commences
employment.
 
   The Company has experienced growth by adding additional sales and
recruiting employees, developing new Practice Groups, acquisitions and
entering into new regional markets. As of December 1996, the Company had 327
employees in 14 regional markets. As of December 1997, the Company had 425
employees in 14 regional markets. As of December 1998, the Company had 471
employees in 16 regional markets. During this period, net revenues increased
from $92.8 million to $124.1 million or 33.7%. Overall headcount for the
comparable period increased from 327 to 471, or 44.0%. Although contributing
to the increase in net revenues, the addition of new Practice Groups,
acquisitions, and the entry into new regional markets has resulted in
substantial increases in operating expenses, primarily due to increased
headcount. These expenses are incurred in advance of any recognized revenue
and there is often a delay before the Company's new personnel and sales
employees reach full productivity.
 
                                      14
<PAGE>
 
Results of Operations
 
   The following table sets forth as a percentage of net revenues, except as
otherwise noted, the Company's results of operations for the periods shown:
 
<TABLE>
<CAPTION>
                                                               Fiscal Year
                                                            -------------------
                                                            1998   1997   1996
                                                            -----  -----  -----
<S>                                                         <C>    <C>    <C>
Net revenues:
  Contract services........................................  85.5%  86.5%  83.6%
  Permanent placement......................................  14.5   13.5   16.4
                                                            -----  -----  -----
    Total net revenues..................................... 100.0  100.0  100.0
Cost of contract services..................................  55.6   59.0   60.0
                                                            -----  -----  -----
Gross profit (1)...........................................  44.4   41.0   40.0
Selling, general administrative expenses...................  38.1   36.3   34.4
Other operating expenses...................................    --     --    1.6
                                                            -----  -----  -----
Income from operations.....................................   6.3    4.7    4.0
Other income (expenses), net...............................  (0.1)  (0.1)   0.7
                                                            -----  -----  -----
Income before taxes........................................   6.2%   4.6%   4.7%
                                                            =====  =====  =====
</TABLE>
--------
(1) Gross profit for contract services excluding permanent placement revenues
    (as a percentage of net contact service revenues) was 34.9%, 31.8% and
    28.2% for years 1998, 1997, and 1996, respectively. The Company's fiscal
    year ends on the last Sunday of December.
 
Years Ended December 27, 1998, December 28, 1997 and December 29, 1996
 
   Net revenues. Net revenues were $124.1 million, $92.8 million, and $50.6
million for the years 1998, 1997 and 1996, respectively, increasing by 33.7%
during 1998 and 83.6% during 1997. The Company's net revenues from contract
services were $106.1 million, $80.3 million and $42.3 million for the years
1998, 1997 and 1996, respectively, increasing by 32.2% during 1998 and 89.9%
during 1997. The Company's net revenues from permanent placements were $18.0
million, $12.6 million and $8.3 million for the years 1998, 1997 and 1996,
respectively, increasing by 43.2% during 1998 and 51.1% during 1997. The
increase in net revenues in 1998 was primarily due to internal growth and
acquisitions. In 1998, the Company's revenue producing headcount increased
from 348 to 397 or 14.1%, with the increases occurring evenly throughout the
year. The increase in net revenue in 1998 was partially offset by the delay
experienced by the Company before new employees reach full productivity, which
the Company experienced in the first two quarters of the year. To a lesser
extent, net revenues were offset by the closure of the IS Practice Group in
Orlando. The increase in net revenues in 1997 was primarily due to a full year
of revenue from the TeamAlliance operations, the opening of 20 new Practice
Groups within existing regional markets, as well as a full year of revenue
from the Austin, Phoenix, Raleigh and London offices. In 1997, the Company's
revenue producing headcount increased from 273 to 348, a 27.8% increase, with
much of the increase occurring in the third and fourth quarters. As a result,
the increase in net revenue in 1997 was partially offset due to the delay
experienced by the Company before new employees reached full productivity.
 
   Gross Profit. Gross profit from the Company's Contract Services represent
revenues less direct cost of services, which consists of direct payroll,
payroll taxes and insurance costs for contract employees. Gross profit dollars
from Permanent Placement services are equal to revenues, as there are no
direct costs associated with such revenues. Gross profit for the Company's
Contract Services were $37.1 million, $25.5 million, and $11.9 million for the
years 1998, 1997 and 1996, respectively, increasing by 45.4% and 114.0% in
1998 and 1997, respectively. The gross margin percentage improvement reflects
higher gross margins from (i) acquisitions of companies with higher gross
margin business, (ii) emphasis on expansion of higher margin business in
existing markets, and (iii) cross selling of higher margin services. Gross
profit for the Company's permanent placement
 
                                      15
<PAGE>
 
division were $18.0 million, $12.6 million and $8.3 million for the years
1998, 1997 and 1996, respectively, increasing by 43.2% and 51.1% in 1998 and
1997, respectively. These increases were primarily due to increases in demand
for the Company's permanent placement services.
 
   Operating Expenses. Operating expenses were $47.3 million in 1998 compared
to $33.7 million in 1997 and $18.2 million in 1996. Operating expenses as a
percentage of net revenues were 38.1% in 1998 and 36.3% in 1997 and 36.0% in
1996. Selling, general and administrative expenses consist primarily of
employee costs, amortization of intangible assets related to acquisitions, and
public company costs. The increase in 1998 was primarily due to increased
headcount and operating expenses from new Practice Groups, the integration of
acquisitions, including training costs and public company costs, most of which
generally follow revenue. Goodwill representing the cost in excess of the fair
value of net assets acquired related to acquisitions is being amortized in a
straight-line basis over 5 to 40 years. The Company evaluates the
recoverability of goodwill on a quarterly basis based upon estimated future
cash flows of the acquisition. The increase in 1997 was primarily due to the
increased headcount and operating expenses from new Practice Groups, the
integration of TeamAlliance operations, including training costs and office
relocation costs incurred in the Houston, Tampa and Chicago regional markets.
 
   Other Income (Expense). Interest income for the years 1998, 1997 and 1996
was $215,000, $485,000 and $434,000, respectively. Interest expense for the
years 1998, 1997 and 1996 was $255,000, $581,000 and $65,000 respectively. The
decrease in interest income resulted from use of cash balances for business
acquisitions and related expenses. The decrease in interest expense primarily
reflects the repayment of the TeamAlliance debt in June 1998.
 
   Income Taxes. The provision for income taxes was 43.0%, 40.9%, and 42.5%
for the years 1998, 1997 and 1996. The Company's income taxes as a percentage
of income before taxes varies somewhat from period to period due primarily to
changes in nondeductible expenses.
 
Liquidity and Capital Resources
 
   During 1998, 1997, and 1996, the Company provided cash in operations of
approximately $5.2 million, and used cash of $517,000 and $1.6 million,
respectively. In 1998 the increase was due to higher operating income, which
is attributable to the increase in revenue, operating gross margin, and
accounts receivable collections. The principal use of cash during 1997 and
1996 was to support growth in accounts receivable resulting from the Company's
growth in net revenues and to fund operating expenses associated with entering
new markets and adding Practice Groups. In 1997, the Company experienced an
increase in accounts receivable in part from generated business from the
acquisition of TeamAlliance, which was purchased in December 1996. In
connection with this acquisition, the Company did not purchase the existing
accounts receivable balances. This growth in accounts receivable was primarily
financed by the initial public offering in August 1997. Historically, the
Company has utilized various sources of financing to fund its working capital
requirements, including cash flow from internal operations, bank credit lines
and the sale of its capital stock.
 
   In August 1997, the Company completed its initial public offering of its
common stock. Of the 2,892,250 shares of common stock offered, 1,666,667
shares were sold by the Company and 1,225,583 shares were sold by selling
stockholders. The Company received approximately $21.5 million of cash, net of
underwriting discounts and commissions, and other expenses. Approximately $7.0
million of the net proceeds was used to repay all outstanding indebtedness
under the Company's credit facility and approximately $1.0 million was used to
finance the addition of new Practice Groups during the fourth quarter. An
additional $1.3 million was used to pay a note outstanding to certain
stockholders affiliated with the TeamAlliance operations. The remaining net
proceeds were invested in short term securities. In connection with the
initial public offering, all of the Company's outstanding shares of preferred
stock were automatically converted into an equal number of shares of common
stock.
 
   The Company pays its IT professionals on a weekly basis, while corporate
clients are generally billed at the end of the applicable pay period.
Corporate clients typically remit payments 30 to 40 days after invoice date.
 
                                      16
<PAGE>
 
The Company's working capital requirements are somewhat mitigated by permanent
placement revenues, as the sales commissions associated with such revenues are
not paid until fees are collected from the Company's clients.
 
   During 1998, 1997 and 1996, the Company made capital expenditures of $1.7
million, $1.9 million and $2.6 respectively. In October 1996, the Company
purchased a corporate training facility in Park City, Utah. The purchase price
consisted of $1.0 million in cash plus a note payable to the seller in the
amount of $1.1 million. The note bears interest at 8.75% per annum, matures in
the year 2026 and requires installments of principal and interest totaling
$9,023 each month. The note is fully secured by a deed of trust against the
property. In January 1999, the Company paid off the note with a cash payment
of $1.1 million.
 
   In December 1996, the Company completed the TeamAlliance Acquisition for a
cash payment of $4.3 million at the date of acquisition and the issuance of
52,000 shares of the Company's Common Stock. In addition, the Company agreed
to pay the principals an aggregate of an additional $4.2 million in three
installments in October 1997, 1998 and 1999. Pursuant to this obligation, the
Company made a payment of $1.25 million on October 31, 1998. In addition, the
Company made additional payments aggregating approximately $502,000 to certain
management companies associated with TeamAlliance and their shareholders
during 1997. The Company financed the initial cash portion of the purchase
price with available borrowings under the term loan facility. The subsequent
payments in 1997 were made from the net proceeds of the initial public
offering. In June 1998, the Company paid off the notes with a cash payment of
$2.4 million.
 
   In January 1996, entities affiliated with the Sprout Group ("Sprout")
purchased 1,600,000 shares of Series A Preferred Stock and warrants to
purchase and aggregate of up to 250,000 shares of Common Stock. In connection
with this transaction, Brenda C. Rhodes, the Company's Chief Executive Officer
and a director of the Company, and Todd J. Kinion, a former officer and a
current director of the Company, borrowed from the Company $3.0 million and
$2.0 million respectively, pursuant to secured promissory notes. Upon closing
of the initial public offering in August 1997, Ms. Hall and Mr. Kinion paid
their respective promissory notes by tendering to the Company 480,000 and
320,000 shares of Common Stock, respectively.
 
Year 2000 Issues
 
   The Company is in the process of conducting assessments of its computer
information systems and is beginning to take the necessary steps to determine
the nature and extent of the work required to make its systems Year 2000
compliant, where necessary. These steps will require the Company to modify,
upgrade or replace some of its internal financial operational systems. The
Company continues to evaluate the estimated cost of bringing all internal
systems, equipment and operations into Year 2000 compliance, but has not
finished determining the total cost of these compliance efforts. While these
efforts may involve additional costs, the Company believes, based upon
currently available information, that these costs will not have a material
adverse effect on the business, financial condition or results of operations
of the Company. However, if these efforts are not completed on time, or if the
cost of updating or replacing the Company's information systems, if necessary,
exceeds current estimates, the Year 2000 issue could have a material effect on
the Company's business financial condition or results of operations of the
Company.
 
   The Company is the process of implementing a new financial ERP suite that
is Year 2000 compliant. The Company expects this new system will be
implemented in the second quarter of 1999. In addition, the Company has
identified a non-financial system used by the company for management of
contractor resumes that might not be Year 2000 compliant. The Company is
reviewing the impact, if any, that such non-compliance could have on its
business, and intends to bring such system into compliance, or implement a
new, Year 2000 compliant system as soon as possible. The Company's failure to
fix its current system, or to implement a new system, is likely to result in
implementation of a manual process of tracking resumes which could, in turn,
have an adverse effect on the Company's business, financial condition or
results of operations.
 
   The Company also intends to determine the extent to which it may be
vulnerable to any failures by its major partners and service providers to
remedy their own Year 2000 issues, and is in the process of initiating formal
 
                                      17
<PAGE>
 
communications with these parties. At this time the Company is unable to
estimate the nature or extent of any potential adverse impact resulting from
the failure of third parties to achieve Year 2000 compliance; however, there
can be no assurance that these third parties will not experience Year 2000
problems or that any problems would not have a material effect on the
Company's business, financial conditions or results of operations. The Company
has contacted all major suppliers and obtained confirmation that they have
addressed the Year 2000 problem.
 
Subsequent Events
 
   In January 1999, the Company loaned Brenda C. Rhodes, Chief Executive
Officer, $2,000,000, which loan bears interest at the rate of the Company's
cost to borrowing plus 1/8% per annum, compounded monthly. This loan is
secured by 1,000,000 shares of the Company's Common Stock held by Brenda
Rhodes. The principal balance of this note, together with interest accrued is
due and payable January 25, 2002. The outstanding principal balance on the
loan as of March 22, 1999 is $2,000,000.
 
Item 7a. Quantitative and Qualificative Disclosures about Market Risk
 
   The following discussion about the Company's market risk disclosures
involves forward-looking statements. Actual results could differ materially
from those projected in the forward-looking statements. The Company is exposed
to market risk related to changes in interest rates and foreign currency
exchange rates. The Company does not use derivative financial instruments for
speculative purposes.
 
   Short term investments. The Company maintains a short-term investment
portfolio consisting mainly of debt securities with an average maturity of
less than one year. These available-for-sale securities are subject to
interest rate risk and will rise or fall in value if market interest rates
change. The Company has the ability to hold its fixed income investments until
maturity, and therefore the Company would not expect its operating results or
cash flows to be affected to any significant degree by the effect of a sudden
change in market interest rates on its investment portfolio.
 
   As of December 27, 1998, the Company had fixed rate long-term debt of
approximately $1.08 million and floating rate short term debt of $3.13 million
outstanding under a $15 million revolving line of credit. If short-term
interest rates were to increase 10 percent, the increased interest expense
associated with these arrangements would not have a material impact on the
Company's net income or cash flows. The Company does not hedge any interest
rate exposures.
 
   Foreign Currency Exchange Rate. The United Kingdom pound is the financial
currency in the Company's subsidiary in the United Kingdom. The Company does
not currently enter into foreign exchange forward looking contracts to hedge
certain balance sheet exposures and intercompany balances against future
movements in foreign exchange rates. However, the Company does maintain cash
balances denominated in the United Kingdom pound. If foreign exchange rates
were to weaken against the U.S. dollar immediately and uniformly by 10 percent
from the exchange rate at December 27, 1998, the fair value of these foreign
currency amounts would decline by an immaterial amount.
 
                                      18
<PAGE>
 
Item 8. Financial Statements and Supplementary Data
 
                HALL, KINION & ASSOCIATES, INC. AND SUBSIDIARIES
 
                          CONSOLIDATED BALANCE SHEETS
 
<TABLE>
<CAPTION>
                                                        December    December
                                                           27,         28,
                                                          1998        1997
                                                       ----------- -----------
<S>                                                    <C>         <C>
ASSETS
Current Assets:
  Cash and equivalents................................ $ 3,082,000 $ 4,310,000
  Investments.........................................      15,000   9,120,000
  Accounts receivable, net of allowance for doubtful
   accounts of $1,083,000 in 1998 and $344,000 in
   1997...............................................  18,158,000  12,774,000
  Prepaid expenses and other current assets...........     613,000     326,000
  Prepaid income taxes................................          --     407,000
  Deferred income taxes...............................   1,726,000     612,000
                                                       ----------- -----------
    Total current assets..............................  23,594,000  27,549,000
Property and equipment, net...........................   5,909,000   5,404,000
Goodwill, net.........................................  25,982,000   9,016,000
Other assets..........................................     491,000     471,000
                                                       ----------- -----------
Total assets.......................................... $55,976,000 $42,440,000
                                                       =========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
  Line of credit...................................... $ 1,000,000 $ 1,250,000
  Accounts payable....................................   3,547,000   1,835,000
  Accrued salaries, commissions and related payroll
   taxes..............................................   4,935,000   2,794,000
  Accrued liabilities.................................   2,662,000   1,280,000
  Income taxes payable................................     514,000          --
  Current portion of long term debt...................   3,128,000   1,000,000
                                                       ----------- -----------
    Total current liabilities.........................  15,786,000   8,159,000
Long term debt and other obligations..................   1,083,000   2,549,000
Deferred income taxes.................................   1,205,000     202,000
                                                       ----------- -----------
    Total liabilities.................................  18,074,000  10,910,000
                                                       ----------- -----------
Commitments and contingencies (see Notes 2, 6 and 10)
Stockholders' Equity:
  Common stock; $0.001 par value; 100,000,000 shares
   authorized: Shares outstanding: 1998--9,536,000;
   1997--9,025,000....................................  34,269,000  32,312,000
  Stockholder notes receivable........................          --      (6,000)
  Accumulated translation adjustment..................       5,000       2,000
  Retained earnings (deficit).........................   3,628,000    (778,000)
                                                       ----------- -----------
    Total stockholders' equity........................  37,902,000  31,530,000
                                                       ----------- -----------
Total liabilities and stockholders' equity............ $55,976,000 $42,440,000
                                                       =========== ===========
</TABLE>
 
                See notes to consolidated financial statements.
 
                                       19
<PAGE>
 
                HALL, KINION & ASSOCIATES, INC. AND SUBSIDIARIES
 
                       CONSOLIDATED STATEMENTS OF INCOME
 
<TABLE>
<CAPTION>
                                                   Years Ended
                                       --------------------------------------
                                                      December     December
                                       December 27,      28,          29,
                                           1998         1997         1996
                                       ------------  -----------  -----------
<S>                                    <C>           <C>          <C>
Net revenues:
  Contract services................... $106,127,000  $80,260,000  $42,254,000
  Permanent placement.................   18,005,000   12,571,000    8,317,000
                                       ------------  -----------  -----------
Total net revenues....................  124,132,000   92,831,000   50,571,000
Cost of contract services.............   69,066,000   54,769,000   30,342,000
                                       ------------  -----------  -----------
Gross profit..........................   55,066,000   38,062,000   20,229,000
                                       ------------  -----------  -----------
Selling, general and administrative
 expenses.............................   47,284,000   33,689,000   17,412,000
Other operating expenses..............           --           --      821,000
                                       ------------  -----------  -----------
    Total operating expenses..........   47,284,000   33,689,000   18,233,000
                                       ------------  -----------  -----------
Income from operations................    7,782,000    4,373,000    1,996,000
                                       ------------  -----------  -----------
Other income (expense):
  Interest income.....................      215,000      485,000      434,000
  Interest expense....................     (255,000)    (581,000)     (65,000)
  Other expense, net..................      (11,000)     (31,000)          --
                                       ------------  -----------  -----------
    Total other income (expense),
     net..............................      (51,000)    (127,000)     369,000
                                       ------------  -----------  -----------
Income before income taxes............    7,731,000    4,246,000    2,365,000
Income taxes..........................    3,325,000    1,737,000    1,004,000
                                       ------------  -----------  -----------
Net income............................ $  4,406,000  $ 2,509,000  $ 1,361,000
                                       ============  ===========  ===========
Net Income per share:
  Basic............................... $       0.47  $      0.34  $      0.22
  Diluted............................. $       0.43  $      0.25  $      0.16
</TABLE>
 
                CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
<TABLE>
<CAPTION>
                                                     Years Ended
                                        --------------------------------------
                                        December 27, December 28, December 29,
                                            1998         1997         1996
                                        ------------ ------------ ------------
<S>                                     <C>          <C>          <C>
Net income.............................  $4,406,000   $2,509,000   $1,361,000
Change in accumulated translation
 adjustment............................       3,000        5,000       (3,000)
                                         ----------   ----------   ----------
Net comprehensive income...............  $4,409,000   $2,514,000   $1,358,000
                                         ==========   ==========   ==========
</TABLE>
 
                 See notes to consolidated financial statements
 
                                       20
<PAGE>
 
                HALL, KINION & ASSOCIATES, INC. AND SUBSIDIARIES
 
           CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
 
<TABLE>
<CAPTION>
                             Common Stock        Stockholder  Accumulated
                         ----------------------     Notes     Translation  Retained
                          Shares      Amount     Receivable   Adjustment   Earnings       Total
                         ---------  -----------  -----------  ----------- -----------  -----------
<S>                      <C>        <C>          <C>          <C>         <C>          <C>
BALANCES, December 30,
 1995................... 6,282,000  $    81,000  $        --    $    --   $   860,000  $   941,000
 Notes to stockholders
  secured by stock......                          (5,000,000)                           (5,000,000)
 Interest on
  stockholders notes
  receivable............                            (317,000)                             (317,000)
 Issuance of common
  stock in connection
  with acquisition......    52,000      260,000
 Exercise of stock
  options...............     5,000        6,000       (6,000)                                   --
 Compensation charge for
  acceleration of the
  vesting of stock
  options...............                 10,000
 Accumulated translation
  adjustment............                                         (3,000)                    (3,000)
 Net income.............                                                    1,361,000    1,361,000
                         ---------  -----------  -----------    -------   -----------  -----------
BALANCES
 December 29, 1996...... 6,339,000      357,000   (5,323,000)    (3,000)    2,221,000   (2,748,000)
 Issuance of common
  stock, upon initial
  public offering, net
  of issuance costs of
  $1,767,000............ 1,667,000   21,458,000           --         --            --   21,458,000
 Conversion of
  redeemable convertible
  Preferred stock to
  common stock.......... 1,600,000    9,900,000           --         --            --    9,900,000
 Repayment of
  stockholder notes
  receivable............  (800,000)     (10,000)   5,518,000         --    (5,508,000)          --
 Interest on stockholder
  notes receivable......        --           --     (201,000)        --            --     (201,000)
 Exercise of stock
  options...............   204,000      457,000           --         --            --      457,000
 Issuance of common
  stock.................    15,000      150,000           --         --            --      150,000
 Accumulated translation
  adjustment............        --           --           --      5,000            --        5,000
 Net income.............        --           --           --         --     2,509,000    2,509,000
                         ---------  -----------  -----------    -------   -----------  -----------
BALANCES as of December
 28, 1997............... 9,025,000   32,312,000       (6,000)     2,000      (778,000)  31,530,000
 Net exercise of
  warrants into common
  stock.................   250,000           --           --         --            --           --
 Exercise of stock
  options...............   215,000      639,000           --         --            --      639,000
 Tax benefit related to
  stock options.........        --      404,000           --         --            --      404,000
 Issuance of common
  stock.................    46,000      914,000           --         --            --      914,000
 Repayment of
  stockholder note
  receivable............        --           --        6,000         --            --        6,000
 Accumulated translation
  adjustment............        --           --           --      3,000            --        3,000
 Net income.............        --           --           --         --     4,406,000    4,406,000
                         ---------  -----------  -----------    -------   -----------  -----------
BALANCES as of December
 27, 1998............... 9,536,000  $34,269,000  $        --    $ 5,000   $ 3,628,000  $37,902,000
                         =========  ===========  ===========    =======   ===========  ===========
</TABLE>
 
 
                See notes to consolidated financial statements.
 
                                       21
<PAGE>
 
                HALL, KINION & ASSOCIATES, INC. AND SUBSIDIARIES
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
 
<TABLE>
<CAPTION>
                                                    Years Ended
                                       ----------------------------------------
                                       December 27,  December 28,  December 29,
                                           1998          1997          1996
                                       ------------  ------------  ------------
<S>                                    <C>           <C>           <C>
Cash flows from operating activities:
 Net income........................... $  4,406,000  $  2,509,000  $ 1,361,000
 Adjustments to reconcile net income
  to net cash provided by (used for)
  operating activities:
  Depreciation and amortization.......    1,945,000     1,289,000      448,000
  Deferred income taxes...............     (666,000)      (70,000)     (61,000)
  Compensation expense on stock
   options............................           --            --       10,000
  Interest on stockholder notes
   receivable.........................           --      (201,000)    (317,000)
  Loss on sale of fixed assets........        5,000        10,000           --
  Discount on early repayment of
   debt...............................       13,000            --           --
  Changes in assets and liabilities:
   Accounts receivable................   (3,113,000)   (5,153,000)  (3,352,000)
   Prepaid expenses and other assets..     (211,000)     (124,000)    (482,000)
   Prepaid income taxes...............      407,000       379,000     (786,000)
   Accounts payable and accrued
    expenses..........................    1,863,000       844,000    1,754,000
   Income taxes payable...............      485,000            --     (145,000)
                                       ------------  ------------  -----------
    Net cash provided by (used for)
     operating activities.............    5,134,000      (517,000)  (1,570,000)
                                       ------------  ------------  -----------
Cash flows from investing activities:
 Sales (purchases) of investments.....    9,578,000    (9,120,000)          --
 Purchase of property and equipment...   (1,705,000)   (1,936,000)  (2,581,000)
 Deposits for property and equipment..           --            --      122,000
 Cash paid for business acquisitions..  (14,074,000)           --   (4,323,000)
                                       ------------  ------------  -----------
    Net cash used for investing
     activities.......................   (6,201,000)  (11,056,000)  (6,782,000)
                                       ------------  ------------  -----------
Cash flows from financing activities:
 Cash overdraft, net..................           --    (1,229,000)     891,000
 Line of credit, net..................     (810,000)      832,000   (1,316,000)
 Borrowing on debt....................    3,000,000            --    4,000,000
 Repayments of debt...................   (2,996,000)   (5,691,000)     (71,000)
 Proceeds from sale of common stock,
  net of issuance costs...............           --    21,458,000           --
 Proceeds from sale of preferred
  stock, net of issuance costs........           --            --    9,900,000
 Proceeds from exercise of options....      639,000       457,000           --
 Stockholder notes receivable.........        6,000            --   (5,000,000)
                                       ------------  ------------  -----------
    Net cash provided by (used for)
     financing activities                  (161,000)   15,827,000    8,404,000
                                       ------------  ------------  -----------
Net increase (decrease) in cash and
 equivalents..........................   (1,228,000)    4,254,000       52,000
Cash and equivalents, beginning of
 period...............................    4,310,000        56,000        4,000
                                       ------------  ------------  -----------
Cash and equivalents, end of period... $  3,082,000  $  4,310,000  $    56,000
                                       ============  ============  ===========
</TABLE>
 
                See notes to consolidated financial statements.
 
                                       22
<PAGE>
 
               HALL, KINION & ASSOCIATES, INC. AND SUBSIDIARIES
 
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
    YEARS ENDED DECEMBER 27, 1998, DECEMBER 28, 1997 AND DECEMBER 29, 1996
 
Note 1. Business and Significant Accounting Policies
 
   Business. Hall, Kinion & Associates, Inc. ("the Company") is an information
technology staffing company specializing in placing high technology personnel
on both a contract and permanent basis. During 1998 the Company acquired
certain assets from Group-IPEX, purchased all assets from TKO Personnel, Inc.
("TKO"), and certain assets from Alexander, Bohemer & Tomasco, dba, The
Huntington Group, ("Huntington") and Interactive Technology Consultants, LLC,
("ITC"). In December 1996, the Company acquired certain assets of
TeamAllianceTechnology Partners, L.P. (Note 2).
 
   Initial Public Offering. In August 1997, the Company completed its initial
public offering of its common stock. Of the 2,892,250 shares of common stock
offered, 1,666,667 shares were sold by the Company and 1,225,583 shares were
sold by selling stockholders. The Company received approximately $21.5 million
of cash, net of underwriting discounts and commissions, and other expenses.
Simultaneously, all outstanding shares of preferred stock were automatically
converted into an equal number of shares of common stock.
 
   Principles of Consolidation. The consolidated financial statements include
the accounts of the Company and its wholly-owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated.
 
   Certain Significant Risks and Uncertainties. The preparation of financial
statements in conformity with generally accepted accounting principles
requires management to make certain estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statement and the reported
amounts of revenues and expenses during the reporting period. Such management
estimates include the allowance for doubtful accounts receivable and certain
accruals. Actual results could differ from those estimates.
 
   The Company operates in a dynamic industry, and accordingly, can be
affected by a variety of factors. For example, management of the Company
believes that changes in any of the following areas could have a negative
effect on the Company in terms of its future financial position and results of
operations: ability to obtain additional financing, regulatory changes,
uncertainty relating to the performance of the U.S. economy, competition,
demand for the Company's services, litigation or other claims against the
Company, and the hiring, training and retention of key employees.
 
   The Company's financial instruments that are exposed to credit risk are
primarily cash and equivalents, investments and accounts receivable. The
Company places its cash with what it believes are high credit quality
financial institutions. In granting credit, the Company routinely evaluates
the financial strength of its customers.
 
   Cash and Equivalents. The Company considers all highly liquid investments
with an original maturity of three months or less to be cash equivalents. Cash
equivalents, consisting primarily of money market funds and bank accounts, are
stated at a cost which approximates fair value.
 
   Investments. Investments consist of high quality money market instruments
with original maturities greater than 90 days, but less than one year, and are
stated at fair value. At December 27, 1998, the Company's investments are all
classified as available for sale. Unrealized gains and losses on securities
classified as available-for-sale were not significant.
 
   Property and Equipment. Property and equipment are stated at cost and
depreciated on a straight-line basis over the estimated useful lives of the
assets, generally three to twenty-five years. Leasehold improvements are
amortized over the shorter of the estimated life of the asset or the lease
term.
 
                                      23
<PAGE>
 
               HALL, KINION & ASSOCIATES, INC. AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
   Goodwill. Goodwill representing the cost in excess of the fair value of net
assets acquired related to acquisitions is being amortized on a straight-line
basis over 5 to 40 years. For the years ended December 27, 1998, December 28,
1997, and December 29, 1996 amortization expense was $561,000, $304,000, and
$25,000 respectively. The Company evaluates the recoverability of goodwill on
a quarterly basis based upon estimated future cash flows.
 
   Revenue Recognition. Revenue from contract placements is recognized as
services are performed. Revenue from permanent placements is recognized upon
commencement of employment.
 
   Other Operating Expenses. Other operating expenses include certain non-
recurring charges including litigation settlement and related costs and
severance costs.
 
   Income Taxes. The Company accounts for income taxes in accordance with
Statement of Financial Accounting Standards No. 109, Accounting for Income
Taxes, which requires an asset and liability approach of accounting for income
taxes.
 
   Stock-Based Compensation. The Company accounts for stock-based awards to
employees using the intrinsic value method in accordance with Accounting
Principles Board Opinion No. 25 (APB 25), Accounting for Stock Issued to
Employees.
 
   Net Income Per Share. Basic net income per share excludes dilution and is
computed by dividing net income attributable to common stockholders by the
weighted average of common shares outstanding for the period. Diluted net
income per share reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or
converted into common stock.
 
   A reconciliation of basic weighted average common stock shares to diluted
weighted average common shares follows:
 
<TABLE>
<CAPTION>
                                                    Years Ended
                                       --------------------------------------
                                       December 27, December 28, December 29,
                                           1998         1997         1996
                                       ------------ ------------ ------------
     <S>                               <C>          <C>          <C>
     Basic weighted average common
      shares outstanding..............   9,439,000   7,339,000    6,282,000
     Preferred stock..................          --     958,000    1,469,000
     Warrants.........................      10,000     250,000      230,000
     Stock options....................     893,000   1,360,000      369,000
                                        ----------   ---------    ---------
     Diluted weighted average shares
      outstanding.....................  10,342,000   9,907,000    8,350,000
                                        ==========   =========    =========
</TABLE>
 
   Fiscal Year. The Company's fiscal year ends on the Sunday closest to
December 31. Fiscal years 1998, 1997, and 1996 all consisted of 52 weeks.
 
   New Accounting Pronouncement. In June 1998, the Financial Accounting
Standard Board adopted SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities, which establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts and for hedging activities. It requires that an entity
recognize all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. The Company
has not yet determined the effect, if any, that adoption of SFAS No. 133 will
have on the Company's consolidated financial position, results of operations
or cash flows. The statement is effective for fiscal quarters beginning after
June 15, 1999, and should not be applied retroactively to financial statements
of prior periods.
 
 
                                      24
<PAGE>
 
               HALL, KINION & ASSOCIATES, INC. AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
Note 2. Acquisitions
 
   In November 1998, the Company acquired the assets of Alexander, Boehmer,
Tomasco, LLC, doing business as Huntington Group (HG) and Interactive
Technologies Consultants (ITC), for an aggregate of $8.9 million consisting of
a cash payment of $8.1 million and assumed net liabilities of $800,000. The
Huntington Group is a retainer-based executive research firm while ITC is a
provider of IT professionals on a contract basis. Both companies are located
in Trumbull, Connecticut.
 
   Had the acquisitions of Huntington and ITC been completed at the beginning
of 1998, the Company's unaudited pro forma revenues, net income and basic and
diluted earnings per share for 1998 would have been approximately
$130,400,000, $4,652,000, $0.49, and $0.45. Pro forma adjustments reflect
interest on the cash paid in the acquisition and the amortization of goodwill.
 
   In August 1998, the Company acquired substantially all of the assets of TKO
Personnel, Inc. for $913,000 consisting of a cash payment of $228,000 and
assumed net liabilities of $685,000. TKO Personnel, Inc. based in San Jose,
California, is an international permanent placement recruiting organization
for IT research and development professionals focusing on recruiting primarily
for Japan, but also from China and Korea.
 
   In January 1998, the Company completed the acquisition of substantially all
of the assets of Group-IPEX an international recruiting organization for
information technology IT research and development professionals. Group IPEX
focuses on recruiting international IT professionals primarily from India but
also from Russia and China. The acquisition was accounted for as a purchase.
Total consideration for this purchase was $7,339,000 including approximately
$250,000 of costs attributable to the acquisition. Terms of the acquisition
included cash payment of $6,175,000 at the date of acquisition and the
issuance of 46,000 shares of the Company's Common stock valued at $914,000. In
addition, if certain revenue targets as defined, are achieved, the Company has
agreed to pay the sellers an aggregate of $3,375,000 in three future annual
installments as follows: May 10, 1999--$1,125,000; May 10, 2000--$1,125,000;
and May 10, 2001--$1,125,000. The 1999 targets were substantially met and the
corresponding payment will be made in the month of May.
 
   Had the acquisition of Group-IPEX been completed at the beginning of 1997,
the Company's unaudited pro forma revenues, net income and basic and diluted
earnings per share for 1997 would have been approximately $100,077,000,
$2,388,000, $0.32, and $0.24. Pro forma adjustments reflect interest on the
cash paid in the acquisition and the amortization of goodwill as well as the
dilution attributable to the shares issued.
 
   In December 1996, the Company completed the acquisition of certain assets
of TeamAlliance Technology Partners, L.P. and its related limited liability
companies ("TeamAlliance"), a provider of staffing services to information
technology companies. The acquisition was accounted for as a purchase. The
1996 consolidated financial statements of the Company include only the results
of operations of TeamAlliance for the month of December 1996. The total
consideration for this purchase was $9,424,000 including $949,000 of costs
attributable to the acquisition. Terms of the acquisition included a cash
payment of $4,168,000 at the date of acquisition and the issuance of 52,000
shares of Company common stock valued at $260,000. In 1997, the Company paid
the sellers $1,250,000 and $502,000 for the limited liability companies.
Additional payments to the sellers total $2,950,000 due in two future annual
installments as follows: October 31, 1998-$1,250,000 and October 31, 1999-
$1,700,000. In 1998 the Company paid off the note for a cash payment of $2.6
million.
 
   Had the acquisition of TeamAlliance been completed at the beginning of
1996, the Company's unaudited pro forma revenues, net income and basic and
diluted earnings per share for 1996 could have been approximately $65,091,000,
$475,000 and $0.08 and $0.06. Pro forma adjustments reflect the elimination of
TeamAlliance revenues for offices not acquired by the Company, the interest on
the cash paid in the acquisition and the amortization of goodwill as well as
the dilution attributable to the shares issued and stock options granted.
 
                                      25
<PAGE>
 
               HALL, KINION & ASSOCIATES, INC. AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
Note 3. Property and Equipment
 
   Property and equipment consists of:
 
<TABLE>
<CAPTION>
                                                     December 27,  December 28,
                                                         1998          1997
                                                     ------------  ------------
     <S>                                             <C>           <C>
     Property and equipment........................  $ 6,510,000   $ 4,564,000
     Land and building.............................    2,047,000     2,047,000
     Leasehold improvements........................      586,000       516,000
                                                     -----------   -----------
                                                       9,143,000     7,127,000
     Accumulated depreciation and amortization.....   (3,234,000)   (1,723,000)
                                                     -----------   -----------
                                                     $ 5,909,000   $ 5,404,000
                                                     ===========   ===========
</TABLE>
 
Note 4. Debt
 
   The Company has a revolving line of credit facility enabling the Company to
borrow a stated percentage of eligible accounts receivable up to a maximum of
$15,000,000. Borrowings under this facility bear interest at the bank's prime
rate (8.5% at December 28, 1997). Borrowings under this facility are
collaterized by substantially all of the assets of the Company. At December
27, 1998, the Company had $1,000,000 outstanding under the revolving line of
credit. The terms of the current portion of debt are as follows; $500,000 at a
rate of 6.5% due February 1999, $500,00 at the rate of 6.31% due May 1999, and
$2,000,000 at the rate of 5.25% due November, 1999.
 
   The facility contains certain covenants requiring the Company to maintain a
minimum level of profitability and net worth and to maintain specific ratios
of working capital and current portion of debt to operating cash flow. The
Company was in compliance with all of these covenants as of December 27, 1998.
 
   Debt consists of:
<TABLE>
<CAPTION>
                                                      December 27,  December 28,
                                                          1998          1997
                                                      ------------  ------------
     <S>                                              <C>           <C>
     Bank term loan.................................. $ 3,000,000   $        --
     Mortgage note payable...........................   1,128,000     1,137,000
     Deferred rent...................................      83,000            --
     Present value of installments due in connection
      with the acquisition of TeamAlliance
      (discounted at 8.3%) (Note 2)..................          --     2,412,000
                                                      -----------   -----------
                                                        4,211,000     3,549,000
     Current portion of debt.........................  (3,128,000)   (1,000,000)
                                                      ===========   ===========
     Long term debt and other obligations............ $ 1,083,000   $ 2,549,000
                                                      ===========   ===========
</TABLE>
 
   Future payment requirements in connection with debt are: 1999, $3,128,000;
2000, $1,000,000.
 
Note 5. Employee Benefit Plans
 
   The Company has a 401(k) profit-sharing plan covering substantially all
employees with at least 90 days of continuous service. Employees may
contribute up to 15% of their eligible compensation to a maximum amount as
provided by the Internal Revenue Code. At the discretion of the Board of
Directors, the Company may match employee contributions. In February 1998, the
Board of Directors approved a nonqualified deferred compensation plan for
officers and key employees. At the discretion of the Board of Directors, the
Company may match contributions. The Company has not contributed any matching
contributions as of December 27, 1998.
 
                                      26
<PAGE>
 
               HALL, KINION & ASSOCIATES, INC. AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
Note 6. Lease Commitments
 
   The Company leases its office facilities under various noncancellable
operating leases which expire through 2003. Rent expense include in operating
expenses for 1998, 1997 and 1996 was approximately $2,385,000, $1,797,000 and
$802,000 respectively. Future minimum payments under all operating leases are
as follows:
 
<TABLE>
<CAPTION>
     Years Ending December
     ---------------------
     <S>                                                              <C>
       1999.......................................................... $2,402,000
       2000..........................................................  1,879,000
       2001..........................................................  1,000,000
       2002..........................................................    613,000
       2003..........................................................    229,000
                                                                      ----------
         Total....................................................... $6,123,000
                                                                      ==========
</TABLE>
 
Note 7. Redeemable Convertible Preferred Stock
 
   In January 1996, the Company sold 1,600,000 shares of Series A redeemable
preferred stock for an aggregate price of $10,000,000 less costs of
approximately $100,000 associated with the issuance. In August 1997, all
Series A redeemable preferred stock was converted to 1,600,000 shares of
common stock.
 
Note 8. Stockholders' Equity
 
   Capital Stock--The Company is authorized to issue 110,000,000 shares of
capital stock consisting of 100,000,000 shares of common stock and 10,000,000
shares of preferred stock.
 
   Stockholder Notes Receivable--In January 1996, the Company loaned to its
two principal common stockholders an aggregate of $5,000,000 under promissory
notes collateralized by a total of 1,600,000 shares of the Company's common
stock. Each promissory note bore interest at 6.9% per annum. In August 1997,
in connection with the initial public offering, the two principal common
stockholders tendered an aggregate of 800,000 shares of Common Stock as full
payment of the principal and interest due on the promissory notes.
 
   Stock Options--The Company's 1997 Stock Option Plan (the Plan), as amended
authorizes the issuance of up to 2,763,000 shares of common stock for the
grant of incentive or nonqualified stock options to key employees,
nonemployees, directors and consultants who provide services to the Company.
Under the Plan, options are generally granted at fair market value at the date
of grants as determined by the Board of Directors. Such options vest over
periods ranging from two to five years and expire up to ten years from the
grant date. In 1996, the Company issued 974,000 options outside of the Plan to
an employee of which 50% were vested at year ended December 29, 1996 and 50%
will vest ratably over 24 months commencing January 1998 with acceleration
clauses.
 
   The Company's IT Professional Stock Plan (the "IT Professional Plan") was
adopted by the Board of Directors in May 1997. The Company has authorized
485,000 shares of Common Stock and has 407,000 shares of common stock
available for grant under the IT Professional Plan and an additional number of
shares equal to 1.5% of the number of shares of Common Stock outstanding on
the first day of each calendar year is automatically added to the IT
Professional Plan. Under the IT Professional Plan, independent consultants
may, at the discretion of the plan administrator, be granted options to
purchase shares of Common Stock at an exercise price no less than 85% of the
fair market value of such shares on the grant date. Options under the IT
Professional Plan are generally vested when granted and expire ten years from
grant date.
 
 
                                      27
<PAGE>
 
               HALL, KINION & ASSOCIATES, INC. AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
   Common Stock Warrants--Common stock warrants have been issued in
conjunction with the issuance of preferred stock in January 1996. At December
28, 1997, the Company had outstanding warrants to purchase 250,000 shares of
common stock at $0.01 per share. In January 1998, these warrants were
converted to 250,000 shares of common stock.
 
   Option activity under all plans is as follows:
 
<TABLE>
<CAPTION>
                                                                    Weighted
                                                       Number       Average
                                                      of Shares  Exercise Price
                                                      ---------  --------------
   <S>                                                <C>        <C>
   Balance, December 31, 1995.......................    441,000      $ 0.30
   Granted (weighted average fair value of $0.58 per
    share)..........................................  1,828,000      $ 4.07
   Canceled.........................................    (63,000)     $ 3.00
   Exercised........................................     (5,000)     $ 1.26
                                                      ---------
   Balance, December 29, 1996.......................  2,201,000      $ 3.35
   Granted (weighted average fair value of $3.49 per
    share)..........................................    596,000      $12.42
   Canceled.........................................   (238,000)     $ 4.43
   Exercised........................................   (210,000)     $ 2.28
                                                      ---------
   Balance, December 28, 1997.......................  2,349,000      $ 5.63
   Granted (weighted average fair value of $1.92 per
    share)..........................................    550,000      $10.50
   Canceled.........................................   (272,000)     $ 9.47
   Exercised........................................   (209,000)     $ 2.95
                                                      ---------
   Balance, December 27, 1998.......................  2,418,000      $ 6.54
                                                      =========
</TABLE>
 
   Additional information regarding options outstanding as of December 27,
1998 is as follows:
 
<TABLE>
<CAPTION>
                                            Options Outstanding                      Options Exercisable
                            ----------------------------------------------------- --------------------------
                                            Weighted Average          Weighted                   Weighted
                              Number            Remaining             Average       Number       Average
   Range of Exercise Prices Outstanding Contractual Life (Years)   Exercise Price Exercisable Exercise Price
   ------------------------ ----------- -----------------------    -------------- ----------- --------------
   <C>                      <C>         <S>                        <C>            <C>         <C>
   $ 0.300--$ 1.500            212,000            6.79                 $ 0.63        147,000      $ 0.77
   $ 4.000                   1,170,000            7.77                 $ 4.00      1,170,000      $ 4.00
   $ 5.100--$10.000            692,000            8.84                 $ 7.67        385,000      $ 8.62
   $10.500--$19.250            229,000            8.96                 $14.34         98,000      $11.47
   $19.375--$21.875            115,000            8.89                 $20.66         16,000      $21.54
                             ---------                                             ---------
   $ 0.300--$21.875          2,418,000            8.16                 $ 6.54      1,816,000      $ 5.28
                             =========                                             =========
</TABLE>
 
   At December 27, 1998, 1,366,000 options were available for future grant. As
of December 28, 1997 and December 29, 1996 the options exercisable were
2,092,000 and 1,923,000 at an average price of $5.00 and $3.79 per share.
 
   Additional Stock Plan Information--As discussed in Note 1, the Company
continues to account for its stock-based awards using the intrinsic value
method in accordance with APB25, Accounting for Stock Issued to Employees and
its related interpretations. Accordingly, no compensation expense has been
recognized in the financial statements for employee stock arrangements, as the
options exercise price is not less than the fair market value of the
underlying common stock at date of grant.
 
                                      28
<PAGE>
 
               HALL, KINION & ASSOCIATES, INC. AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
   Statement of Financial Accounting Standards No. 123, Accounting for Stock-
Based Compensation, (SFAS 123) requires the disclosure of pro forma net income
and earnings per share had the Company adopted the fair value method as of the
beginning of fiscal 1995. Under SFAS 123, the fair value of stock-based awards
to employees is calculated through the use of option price models, even though
models were developed to estimate the fair value of freely tradable, fully
transferable options without vesting restrictions, which significantly differ
from the Company's stock option awards. These models also require subjective
assumptions, including future stock price volatility and expected time to
exercise, which affect the calculated values.
 
   The Company's calculations were made using the Black-Scholes option pricing
model with the following average assumptions: expected life, 12 months
following vesting; volatility, 37.2% after the initial public offering on
August 4, 1997 and zero before that date; risk free interest rates, 6.5% in
1998, 6.2% in 1997 and 6.5% in 1996; and no dividends during the expected
term.
 
   The Company's calculations are based on a multiple option valuation
approach and forfeitures are recognized as they occur. If the computed fair
value of the 1998, 1997 and 1996 awards had been amortized to expense over the
vesting period of the awards, pro forma net income and pro forma diluted net
income per share would have been $3,278,000, $0.32 per share, $1,764,000,
$0.18 per share and $1,087,000, $0.12 per share, in 1998, 1997 and 1996,
respectively.
 
Note 9. Income Taxes
 
   The provision for income taxes consists of the following:
 
<TABLE>
<CAPTION>
                                                       Years Ended
                                          --------------------------------------
                                          December 27, December 28, December 29,
                                              1998         1997         1996
                                          ------------ ------------ ------------
     <S>                                  <C>          <C>          <C>
     Current:
      Federal............................  $3,124,000   $1,391,000   $  808,000
      State..............................     867,000      416,000      257,000
                                           ----------   ----------   ----------
                                            3,991,000    1,807,000    1,065,000
                                           ----------   ----------   ----------
     Deferred:
      Federal............................    (533,000)     (94,000)     (41,000)
      State..............................    (133,000)      24,000      (20,000)
                                           ----------   ----------   ----------
                                             (666,000)     (70,000)     (61,000)
                                           ----------   ----------   ----------
                                           $3,325,000   $1,737,000   $1,004,000
                                           ==========   ==========   ==========
</TABLE>
 
   The Company's effective tax rate differs from the federal statutory rate as
follows:
 
<TABLE>
<CAPTION>
                                                               1998  1997  1996
                                                               ----  ----  ----
     <S>                                                       <C>   <C>   <C>
     Income tax expense at statutory rate..................... 34.0% 34.0% 34.0%
     State income tax taxes, net of federal benefit...........  6.1   6.7   6.5
     Other items, net.........................................  2.9   0.2   2.0
                                                               ----  ----  ----
                                                               43.0% 40.9% 42.5%
                                                               ====  ====  ====
</TABLE>
 
                                      29
<PAGE>
 
               HALL, KINION & ASSOCIATES, INC. AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
   The components of deferred income taxes are as follows:
 
<TABLE>
<CAPTION>
                                                       December 27, December 28,
                                                           1998         1997
                                                       ------------ ------------
     <S>                                               <C>          <C>
     Deferred tax assets:
       Allowance for doubtful accounts................  $  469,000   $ 137,000
       Accrued expenses...............................   1,257,000     475,000
                                                        ----------   ---------
         Total deferred tax assets....................   1,726,000     612,000
                                                        ----------   ---------
     Deferred tax liabilities:
       Depreciation and amortization..................     611,000    (207,000)
       Goodwill and intangible assets.................     (14,000)    409,000
       Accrued acquisition liabilities................     608,000          --
                                                        ----------   ---------
         Total deferred tax liabilities...............   1,205,000     202,000
                                                        ----------   ---------
           Net deferred income taxes..................  $  521,000   $ 410,000
                                                        ==========   =========
</TABLE>
 
Note 10. Contingencies
 
   The Company is party to various legal actions in the course of business.
Although the ultimate outcome of these matters is not presently determinable,
management believes that the resolution of all such pending matters will not
have a material adverse effect on the Company's financial position or results
of operations.
 
Note 11. Supplemental Disclosure of Cash Flow Information
 
   The following provides additional information concerning supplemental
disclosures of cash flow activities:
 
<TABLE>
<CAPTION>
                                                     Years Ended
                                        ---------------------------------------
                                        December 27,  December 28, December 29,
                                            1998          1997         1996
                                        ------------  ------------ ------------
   <S>                                  <C>           <C>          <C>
   Cash paid during the period for:
     Income taxes.....................  $ 3,097,000    $1,531,000  $ 1,956,000
     Interest.........................      320,000       536,000       46,000
 
   Noncash investing and financing
    activities:
     Conversion of preferred stock to
      common stock....................           --     9,900,000           --
     Payment of stockholder loan by
      stock...........................           --     5,518,000           --
     Common stock issued in settlement
      agreement.......................           --       150,000           --
     Imputed interest on installment
      note............................           --       116,000           --
     Purchase of land, building and
      furniture for a note payable....           --            --    1,147,000
     Exercise of stock options for a
      note receivable from
      stockholder.....................           --            --        6,000
 
   Effect of business acquisitions:
     Current assets acquired..........  $ 2,933,000            --           --
     Intangible assets and equipment
      acquired........................   17,700,000            --    9,424,000
     Liabilities acquired.............   (5,045,000)           --           --
     Installment obligations issued...           --            --   (4,047,000)
     Common stock issued..............     (914,000)           --     (260,000)
     Accrued expenses in connection
      with acquisitions...............     (600,000)           --     (794,000)
                                        -----------    ----------  -----------
       Cash paid for business
        acquisitions..................  $14,074,000    $       --  $ 4,323,000
                                        ===========    ==========  ===========
</TABLE>
 
 
                                      30
<PAGE>
 
               HALL, KINION & ASSOCIATES, INC. AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
Note 12. Business Segment Reporting
 
   In 1998 the Company adopted SFAS 131, Disclosures about Segments of an
Enterprise and Related Information. The statement requires that an
enterprise's operating segments be determined in the manner in which
management operates the business. Specifically, financial information is to be
reported on the basis that is used internally by the chief operating decision
maker in making decisions related to resource allocation and segment
performance. The Company's reportable segments are operated and managed as
strategic business units and are organized base on types of services
performed.
 
   Under SFAS 131, the Company's operations were divided into two industry
segments, Contract Services and Permanent Placement Services. Operations in
the Contract Services segment provides supplemental IT professionals on a
contract basis. In a typical R&D contract, an IT professional is contracted to
a high technology client, usually in connection with a specific application or
project. The Permanent Placement segment provides professionals for permanent
placement with its corporate clients.
 
   Management evaluates segment performance based primarily on segment
revenues, cost of revenues, and gross profit. Continuing operations by
business segment are as follows:
 
<TABLE>
<CAPTION>
                                                                      Gross
                                     Net Revenues Cost of Revenues   Profit
                                     ------------ ---------------- -----------
     <S>                             <C>          <C>              <C>
     Year ended December 27, 1998
       Contract Services............ $106,127,000   $69,066,000    $37,061,000
       Permanent Placement..........   18,005,000            --     18,005,000
                                     ------------   -----------    -----------
         Total...................... $124,132,000   $69,066,000    $55,066,000
                                     ============   ===========    ===========
     Year ended December 28, 1997
       Contract Services............ $ 80,260,000   $54,769,000    $25,491,000
       Permanent Placement..........   12,571,000            --     12,571,000
                                     ------------   -----------    -----------
         Total...................... $ 92,831,000   $54,769,000    $38,062,000
                                     ============   ===========    ===========
     Year ended December 29, 1996
       Contract Services............ $ 42,254,000   $30,342,000    $11,912,000
       Permanent Placement..........    8,317,000            --      8,317,000
                                     ------------   -----------    -----------
         Total...................... $ 50,571,000   $30,342,000    $20,229,000
                                     ============   ===========    ===========
</TABLE>
 
   Net Revenues to unaffiliated customers by geographic area as follows:
 
<TABLE>
<CAPTION>
                                                        Years Ended
                                            ------------------------------------
                                                          December    December
                                            December 27,     28,         29,
                                                1998        1997        1996
                                            ------------ ----------- -----------
     <S>                                    <C>          <C>         <C>
     United States......................... $122,953,000 $91,910,000 $50,571,000
     Europe................................    1,179,000     921,000          --
                                            ------------ ----------- -----------
       Total............................... $124,132,000 $92,831,000 $50,571,000
                                            ============ =========== ===========
</TABLE>
 
   The Company currently does not segregate operations of business by assets.
 
Note 13. Subsequent Event
 
   In January 1999, the Company loaned to Brenda C. Rhodes, Chief Executive
Officer, $2,000,000, which loan bears interest at the rate of the Company's
cost of borrowing plus 1/8% per annum, compounded monthly. Such loan is
secured by 1,000,000 shares of the Company's common stock held by Brenda
Rhodes. The principal balance of this note, together with interest accrued is
due and payable January 25, 2002.
 
                                      31
<PAGE>
 
                HALL, KINION & ASSOCIATES, INC. AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
Note 14. Quarterly Financial Data (Unaudited)
 
   The following tabulation shows certain quarterly financial data for 1998 and
1997:
 
<TABLE>
<CAPTION>
                                                     Quarter
                                 -----------------------------------------------
   1998                               1           2           3           4
   ----                          ----------- ----------- ----------- -----------
   <S>                           <C>         <C>         <C>         <C>
   Total net revenue...........  $26,834,000 $28,549,000 $34,065,000 $34,684,000
   Gross profit................   12,091,000  12,837,000  14,722,000  15,416,000
   Income before income taxes..    1,656,000   1,637,000   2,081,000   2,357,000
   Net income..................      944,000     933,000   1,186,000   1,343,000
   Net income per share--
    Basic......................         0.10        0.10        0.13        0.14
   Net income per share--
    Diluted....................         0.09        0.09        0.12        0.13
<CAPTION>
                                                     Quarter
                                 -----------------------------------------------
   1997                               1           2           3           4
   ----                          ----------- ----------- ----------- -----------
   <S>                           <C>         <C>         <C>         <C>
   Total net revenues..........  $19,193,000 $23,498,000 $24,608,000 $25,532,000
   Gross profit................    7,173,000   9,585,000  10,121,000  11,183,000
   Income before income taxes..       73,000     892,000   1,489,000   1,792,000
   Net income..................       20,000     535,000     893,000   1,061,000
   Net income per share--
    Basic......................           --        0.09        0.11        0.12
   Net income per share--
    Diluted....................           --        0.06        0.09        0.10
</TABLE>
 
                                       32
<PAGE>
 
                         INDEPENDENT AUDITORS' REPORT
 
To the Board of Directors and Stockholders of
Hall, Kinion & Associates, Inc. and Subsidiaries:
 
   We have audited the accompanying consolidated balance sheets of Hall,
Kinion & Associates, Inc. and Subsidiaries as of December 27, 1998 and
December 28, 1997, and the related consolidated statements of income,
comprehensive income, stockholders' equity (deficit) and cash flows for each
of the three years in the period ended December 27, 1998. These financial
statements are the responsibility of Company's management. Our responsibility
is to express an opinion on these financial statements based on our audits.
 
   We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that out audits provide a reasonable basis
for our opinion.
 
   In our opinion, such financial statements present fairly, in all material
respects, the financial position of Hall, Kinion & Associates, Inc. and
Subsidiaries as of December 27, 1998 and December 28, 1997, and the results of
their operations and their cash flows for each of the three years in the
period ended December 27, 1998 in conformity with general accepted accounting
principles.
 
DELOITTE & TOUCHE LLP
 
San Jose, California
January 26, 1999
 
                                      33
<PAGE>
 
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
 
   Not applicable.
 
                                   PART III
 
   The information required by Items 10 through 13 of Part III is incorporated
by reference from the registrant's Proxy Statement, under the captions
"Nomination and Election of Directors," "Beneficial Stock Ownership,"
"Compensation of Directors," "Compensation of Executive Officers" and
"Compensation Committee Interlocks and Insider Participation of Insider
Participation and Certain Transactions," which Proxy Statement will be mailed
to stockholders in connection with the registrant's annual meeting of
stockholders which is scheduled to be held in May 14, 1999.
 
                                    PART IV
 
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
 
(a)(1) Financial Statements
 
       The following consolidated financial statements of the
    Company and its subsidiaries are included in Item 8 of this
    report:
 
<TABLE>
<CAPTION>
                                                                          Page
                                                                          ----
     <S>                                                                  <C>
     Consolidated balance sheets at December 27, 1998 and December
      28, 1997.                                                            19
     Consolidated statements of income for the years ended December 27,
      1998. December 28, 1997 and December 29, 1996.                       20
     Consolidated statements of comprehensive income for the years ended
      December 27 1998, December 28, 1997, and December 29, 1996.          20
     Consolidated statements of stockholders' equity (deficit) for the
      years ended December 27, 1998, December 28, 1997 and December 29,
      1998.                                                                21
     Consolidated statements of cash flows for the years ended December
      27,1998, December 28, 1997 and December 29, 1996.                    22
     Notes to consolidated financial statements.                           23
     Selected quarterly financial data for the years ended December 27,
      1998 and December 28, 1997 are set forth in Note 14--Quarterly
      Financial Data (Unaudited) included in Item 8 of this report.        32
     Independent Auditors Report.                                          33
</TABLE>
 
(b)(2) Financial Statement Schedules
 
     Independent Auditors Report on Financial Statement Schedule
 
     Schedule II: Valuation and Qualifying Accounts
 
(c)(3) Exhibits
 
<TABLE>
     <C> <C>   <S>
     2.1  (1)  Agreement and Plan Merger dated July 9, 1997, for the Merger of
               Hall, Kinion & Associates, Inc. a California Corporation, into
               Hall, Kinion & Associates, Inc., a Delaware corporation (the
               "Registrant").
 
     2.2  (1)  Asset Purchase Agreement dated November 26, 1996, among the
               Registrant and the other parties named therein.
 
     2.3  (1)  Stock Purchase Agreement dated December 20, 1997 by and among
               the Registrant, Group-Ipex, Inc., and Lalit M. Kapoor and
               Satindra Kapoor.
</TABLE>
 
                                      34
<PAGE>
 
<TABLE>
     <C>   <C>   <S>
      2.4   (3)  Huntington Asset Purchase Agreement between Hall, Kinion &
                 Associates, Inc., Huntington, Acquisition Corporation,
                 Alexander Bohemer and Tomasco, LLC, Raymond Tomasco and Karen
                 Vacheron Alexander, dated November 18, 1998.
 
      2.5   (3)  ITC Asset Purchase Agreement between Hall, Kinion &
                 Associates, Inc., Interactive Acquisition Corporation,
                 Interactive Technology Consultants, LLC, Raymond Tomasco,
                 Karen Vacheron Alexander, and Gary Malbin, dated November 18,
                 1998.
 
      3.4   (1)  Amended and Restated Certificate of Incorporation of the
                 Registrant filed August 8, 1998
 
      4.1        Reference is made to Exhibits 3.1, 3.3 and 3.4.
 
      4.2   (1)  Investors' Rights Agreement, dated January 26, 1996, among the
                 Registrant, certain stockholders and investors named therein.
 
      4.4   (1)  Specimen Common Stock certificate.
 
      9.2   (1)  Kinion Voting Trust Agreement, dated January 17, 1996, among
                 Todd Kinion and the stockholders of the Registrant named
                 therein.
 
      9.3   (1)  Amended and Restated Voting Trust Agreement, dated October 29,
                 1996, among the Registrant, Brenda C. Hall and Todd J. Kinion.
 
     10.1   (1)  Form of Indemnification Agreement entered into between the
                 Registrant and each of its directors and certain officers.
 
     10.2   (1)  The Registrant's 1997 Stock Option Plan.
 
     10.3   (1)  The Registrant's Employee Stock Purchase Plan.
 
     10.11  (1)  Form of Employment Agreement, dated October 18, 1996, among
                 the Registrant, Paul Bartlett and Brenda C. Hall as amended.
 
     10.12  (1)  Form of Stock Option Agreement, dated October 18, 1996,
                 between the Registrant and Paul Bartlett as amended.
 
     10.13  (1)  Settlement Agreement and General Release, dated October 29,
                 1996 among the Registrant, Brenda Hall, as Voting Trustee of
                 the Voting Trust, and Todd Kinion.
 
     10.14  (1)  Employment Agreement, dated December 2, 1996, between the
                 Registrant and Moredecai Levine.
 
     10.15  (1)  Employment Agreement, dated December 2, 1996, between the
                 Registrant and Richard Harmon.
 
     10.16  (1)  Consulting and Settlement Agreement, dated February 28, 1997,
                 between the Registrant and Keith Corbin.
 
     10.17  (1)  Loan and Security Agreement (Accounts and Inventory), dated
                 April 26, 1995, between the Registrant and Comerica Bank-
                 California (the "Loan & Security Agreement"); Addendum to Loan
                 & Security Agreement; Second Addendum to Loan & Security
                 Agreement; Modification to Loan & Security Agreement, dated
                 December 20, 1995; Second Modification to Loan & Security
                 Agreement, dated October 21, 1996; Borrower's Authorization
                 dated October 16, 1996, Borrowers Authorization dated October
                 21, 1996; and Guaranty, dated April 26, 1995.
 
     10.18  (1)  Assumption and Assignment to Sublease, dated December 2, 1996,
                 between the Registrant and TeamAlliance Technology Partners,
                 L.P.
 
     10.19  (1)  Standard Sublease, dated March 1, 1997, between the Registrant
                 and Seagate Technology, Inc.
 
     10.20  (1)  Employment Agreement, dated May 23, 1997, between the
                 Registrant and Brenda C. Hall.
</TABLE>
 
                                       35
<PAGE>
 
<TABLE>
     <C>   <C>   <S>
     10.21  (1)  Agreement to Tender Shares dated May 23, 1997 between the
                 Registrant and Brenda C. Hall.
 
     10.22  (1)  Agreement to Tender Shares, dated May 23, 1997, between the
                 Registrant and Todd J. Kinion.
 
     10.23  (1)  Promissory Note Secured by Deed of Trust, dated August 5,
                 1996, made by Rita S. Hazell and Quentin D. Hazell in favor of
                 the Registrant.
 
     10.24  (1)  Settlement Agreement with Mutual Release, dated May, 1997,
                 between Richard Swanson and the Registrant, Brenda C. Hall and
                 Todd J. Kinion.
 
     10.25  (1)  The Registrant's IT Professional Plan.
 
     10.26  (1)  Reference is made to Exhibit 2.3.
 
     21.1        Subsidiaries of Registrant.
 
     23.1        Independent Auditors Consent.
 
     27.1        Financial Data Schedule.
</TABLE>
--------
(1) Incorporated by reference to the Registrant's Registration Statement on
    Form S-1, as amended, declared Effective by the Securities and Exchange
    Commission on August 4, 1997(File No. 333-28365).
 
(2) Incorporated by Reference to the Registrant's Current Report on Form 8-K,
    filed January 13, 1998 (File No. 000-22869).
 
(3)  Incorporated by Reference to the Registrant's Current Report on Form 8-K,
     filed December 2, 1998 (File No. 000-22869).
 
(b)  Reports on Form 8-K.
 
     The Registrant filed a report on Form 8-K on December 2, 1998 concerning
  the acquisition of substantially all of the assets of Interactive
  Technology Consultants LLC ("ITC") and Alexander, Bohemer and Tomasco LLC
  ("Huntington") pursuant to those Stock Purchase Agreements each dated
  November 18, 1998.
 
(c)  Exhibits
 
     See (a)(3) above.
 
                                      36
<PAGE>
 
                                  SIGNATURES
 
   Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, therunto duly authorized.
 
                                          HALL, KINION & ASSOCIATES, INC.
 
                                          By: /s/ Martin A. Kropelnicki
                                            -----------------------------------
                                            Martin A. Kropelnicki
                                            Vice President and Chief Financial
                                            Officer and Corporate Secretary
                                            (Principal Financial Officer)
 
Date: March 22, 1999
 
   Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacity and on the dates indicated.
 
<TABLE>
<S>  <C>
</TABLE>
Date: March 22, 1999                      By: /s/ BRENDA C. RHODES
                                            -----------------------------------
                                            Chairman of the Board,
                                            Chief Executive Officer, And a
                                            Director (Principal Executive
                                            Officer)
 
Date: March 22, 1999                      By: /s/ PAUL H. BARTLETT
                                            -----------------------------------
                                            President and Director
 
Date: March 22, 1999                      By: /s/ JON H. ROWBERRY
                                            -----------------------------------
                                            Director
 
Date: March 22, 1999                      By: /s/ WILL HERMAN
                                            -----------------------------------
                                            Director
 
Date: March 22, 1999                      By: /s/ TODD J. KINION
                                            -----------------------------------
                                            Director
 
Date: March 22, 1999                      By: /s/ MARTIN A. KROPELNICKI
                                            -----------------------------------
                                            Vice President, Chief Financial
                                            Officer and Secretary
                                            (Principal Financial Officer)
 
                                      37
<PAGE>
 
                                  SCHEDULE II
 
                HALL, KINION & ASSOCIATES, INC. AND SUBSIDIARIES
 
                       VALUATION AND QUALIFYING ACCOUNTS
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                   Additions                  Deductions
                         ------------------------------ -----------------------
                         Balance at Charged to Charged  Write-off of   Balance
                         Beginning  Costs and  to Other Uncollectible  at End
                         of Period   Expenses  Accounts   Accounts    of Period
                         ---------- ---------- -------- ------------- ---------
<S>                      <C>        <C>        <C>      <C>           <C>
Allowance for Doubtful
 Accounts:
Year ended December 29,
 1996...................    $296      $  145     $31        $ (69)     $  403
Year ended December 28,
 1997...................     403         120      --         (179)        344
Year ended December 27,
 1998...................     344       1,012      --         (273)      1,083
</TABLE>
 
                                      S-1
<PAGE>
 
                   INDEPENDENT AUDITORS' REPORT ON SCHEDULE
 
To the Board of Directors and Stockholders of
Hall, Kinion & Associates, Inc:
 
   We have audited the consolidated financial statements of Hall, Kinion &
Associates, Inc. and subsidiaries as of December 27, 1998 and December 28,
1997, and for each of the three years in the period ended December 27, 1998,
and have issued our report thereon dated January 26, 1999 included elsewhere
in this Annual Report on Form 10-K. Our audits also included the financial
statement schedule of Hall, Kinion & Associates, Inc. listed in Item 14(a)(2)
of this Annual Report on Form 10-K. This financial statement schedule is the
responsibility of the Company's management. Our responsibility is to express
an opinion based on our audits. In our opinion, such financial statement
schedule, when considered in relation to the basic financial statements taken
as a whole, presents fairly, in all material respects the information set
forth therein.
 
DELOITTE & TOUCHE LLP
 
San Jose, California
January 26, 1999
 
                                      S-2