<PAGE>   1
===============================================================================

                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION

                              WASHINGTON, DC 20549

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

                                  FORM 10-QSB
                                AMENDMENT NO. 1

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

                 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999

                        COMMISSION FILE NUMBER 1-12677

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

                      PREFERRED EMPLOYERS HOLDINGS, INC.
             (Exact name of registrant as specified in its charter)

           Delaware                                  65-0698779
(State or other jurisdiction of           (I.R.S. Employer Identification No.)
       incorporation or
        organization)


                 10800 BISCAYNE BOULEVARD, MIAMI, FLORIDA 33161
                    (Address of principal executive offices)

                                 (305) 893-4040
              (Registrant's telephone number, including area code)

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

     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 past 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]

                     APPLICABLE ONLY TO CORPORATE ISSUERS

     The number of shares outstanding of each of the issuer's classes of common
stock, as of August 12, 1999 was 5,247,085 shares of Common Stock.


===============================================================================

<PAGE>   2
                      PREFERRED EMPLOYERS HOLDINGS, INC.

                FORM 10-Q -- FOR THE QUARTER ENDED JUNE 30, 1999

                                     INDEX


                                                                           Page
                                                                           ----
PART I   --  FINANCIAL INFORMATION

Item - 1 --  Quarterly Financial Statements

             Consolidated Balance Sheets .................................  3

             Consolidated Statements of Operations .......................  4

             Consolidated Statements of Cash Flows .......................  6

             Notes to Consolidated Financial Statements ..................  8

Item - 2 --  Management's Discussion and Analysis of Financial Condition
              and Results of Operations .................................. 23

Item - 3 --  Quantitative and Qualitative Discussions About Market Risk .. 30

PART II  --  OTHER INFORMATION

Item - 1 --  Legal Proceedings ........................................... 31

Item - 2 --  Changes in Securities and Use of Proceeds ................... 31

Item - 3 --  Defaults Upon Senior Securities ............................. 31

Item - 4 --  Submission of Matters to a Vote of Security Holders ......... 31

Item - 5 --  Other Information ........................................... 31

Item - 6 --  Exhibits and Reports on Form 8-K ............................ 31

SIGNATURE ................................................................ 32





                                       2

<PAGE>   3
                         PART 1: FINANCIAL INFORMATION

ITEM I. FINANCIAL STATEMENTS

              PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES

                          CONSOLIDATED BALANCE SHEETS
                JUNE 30, 1999 (UNAUDITED) AND DECEMBER 31, 1998
<TABLE>
<CAPTION>
                                                                                    June 30, 1999     December 31, 1998
                                                                                    -------------     -----------------
<S>                                                                                  <C>                <C>
ASSETS
Investments:
  Held-to-maturity securities, at amortized cost (fair value of
    $19,438,700 in 1999 and $15,692,019 in 1998) ..................................   $19,610,103        15,454,481
  Held-to-maturity securities, at amortized cost-restricted (fair value of
    $9,191,460 in 1999 and $8,388,009 in 1998) ....................................     9,265,583         8,257,053
  Short-term investments ..........................................................     3,852,725         7,032,027
                                                                                      -----------        ----------

  Total investments ...............................................................    32,728,411        30,743,561

Cash ..............................................................................     6,785,535         3,714,883
Accrued investment and interest income ............................................       471,100           408,538
Accounts, commissions and premiums receivables, net ...............................    11,899,245        11,200,923
Deferred acquisition costs ........................................................     2,083,056         1,807,841
Property and equipment, net .......................................................       939,341           897,625
Deferred tax assets ...............................................................       827,594           447,878
Deposits ..........................................................................       436,719           344,165
Goodwill and other intangible assets, net .........................................     4,688,896         4,805,560
Prepaid expenses ..................................................................       777,414           427,502
Deferred convertible note issue costs .............................................       863,507           979,137
Other assets ......................................................................       490,269           629,814
                                                                                      -----------        ----------
  Total assets ....................................................................   $62,991,087        56,407,427
                                                                                      ===========        ==========

                              LIABILITIES AND SHAREHOLDERS' EQUITY

Liabilities:
  Notes payable ...................................................................   $11,021,417        12,430,000
  Unpaid losses and loss adjustment expenses ......................................    18,113,136        13,878,892
  Premiums, commissions and other insurance balances payable ......................     7,243,435         7,175,659
  Unearned premiums ...............................................................     6,295,120         5,463,405
  Accounts payable and accrued expenses ...........................................     2,124,095         1,588,326
  Escrow and trust funds ..........................................................     3,666,111         1,891,966
  Other liabilities ...............................................................       784,183         1,002,317
                                                                                      -----------        ----------
     Total liabilities ............................................................    49,247,497        43,430,565
                                                                                      -----------        ----------
Shareholders' equity:
  Common stock, $0.01 par value; authorized 20,000,000 shares; issued
   5,776,497 shares in 1999 and 5,771,497 shares in 1998 ..........................        57,765            57,715
  Additional paid-in capital ......................................................     9,936,512         9,891,562
  Retained earnings ...............................................................     4,254,870         3,533,142
                                                                                      -----------        ----------
     Total shareholders' equity ....................................................   14,249,147        13,482,419
  Treasury stock, at cost, 529,412 shares ..........................................     (505,557)         (505,557)
                                                                                      -----------        ----------
  Net shareholders' equity .........................................................   13,743,590        12,976,862
                                                                                      -----------        ----------
     Total liabilities and shareholders' equity ....................................  $62,991,087        56,407,427
                                                                                      ===========        ==========
</TABLE>

          See accompanying notes to consolidated financial statements.



                                       3

<PAGE>   4




              PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES

               CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
 FOR THE THREE MONTHS ENDED JUNE 30, 1999, 1998 (RESTATED) AND 1997 (RESTATED)

<TABLE>
<CAPTION>

                                                                                            (RESTATED) (RESTATED)
                                                                                1999           1998       1997
                                                                              -----------   ---------  ----------
<S>                                                                           <C>           <C>        <C>
REVENUES:
 Staffing income ...........................................................  $11,318,878   8,941,998  2,419,269
 Premiums earned ...........................................................    4,141,662   4,349,917  2,625,364
 Net commission income .....................................................      341,086     526,585    497,072
 Net investment income .....................................................      456,760     505,561    505,994
 Other income ..............................................................       75,790     125,426    142,977
                                                                               ----------  ----------  ---------
 Total revenues ............................................................   16,334,176  14,449,487  6,190,676
                                                                               ----------  ----------  ---------
Expenses:
 Staffing costs ............................................................    8,732,954   6,820,469  2,150,538
 Losses and loss adjustment expenses incurred ..............................    2,277,914   2,348,955  1,422,830
 Amortization of deferred acquisition costs ................................    1,371,322   1,464,038    952,255
 Other operating expenses ..................................................    3,339,802   2,738,872  1,382,855
                                                                               ----------  ----------  ---------
    Total expenses .........................................................   15,721,992  13,372,334  5,908,478
                                                                               ----------  ----------  ---------
Operating income before income taxes .......................................      612,184   1,077,153    282,198
                                                                               ----------  ----------  ---------
Interest expense ...........................................................      255,513     256,635    162,997
Amortization of intangible assets and other non-operating expenses .........       81,131     138,060         --
                                                                               ----------  ----------  ---------
    Total non-operating expenses ...........................................      336,644     394,695    162,997
                                                                               ----------  ----------  ---------
Income before income taxes .................................................      275,540     682,458    119,201
Income taxes ...............................................................        7,646      91,629     41,233
                                                                               ----------  ----------  ---------
  Net income ...............................................................   $  267,894     590,829     77,968
                                                                               ==========  ==========  =========
Net income -- basic ........................................................   $  267,894     590,829     77,968
Impact of potential common shares -- convertible notes .....................      152,536      79,287         --
                                                                               ----------  ----------  ---------
Net income -- diluted ......................................................   $  420,430     670,116     77,968
                                                                               ==========  ==========  =========
Weighted average outstanding shares -- basic ...............................    5,247,085   5,242,085  5,242,085
Impact of potential common shares -- convertible notes .....................    1,170,000     581,044         --
                                                                               ----------  ----------  ---------
Common shares and common shares equivalents used in computing net
 earnings per shares -- diluted ............................................    6,417,085   5,823,129  5,242,085
                                                                               ==========  ==========  =========
Net basic earnings per share ...............................................   $     0.05        0.11       0.01
                                                                               ==========  ==========  =========
Net diluted earnings per share .............................................   $     0.05        0.11       0.01
                                                                               ==========  ==========  =========
PRO FORMA INFORMATION (NOTES 6 AND 13):
Historical income before income taxes ......................................   $  275,540     682,458    119,201
Pro forma income tax provision .............................................        7,646     256,350      5,229
                                                                               ----------  ----------  ---------
Pro forma net income .......................................................   $  267,894     426,108    113,972
                                                                               ==========  ==========  =========
Pro forma net income -- basic ..............................................   $  267,894     426,108    113,972
Impact of potential common shares -- convertible notes .....................      152,536      79,287         --
                                                                               ----------  ----------  ---------
Pro forma net income -- diluted ............................................   $  420,430     505,395    113,972
                                                                               ==========  ==========  =========
Weighted average outstanding shares -- basic ...............................    5,247,085   5,242,085  5,242,085
Impact of potential common shares -- convertible notes .....................    1,170,000     581,044         --
                                                                               ----------  ----------  ---------
Weighted average outstanding shares -- diluted .............................    6,417,085   5,823,129  5,242,085
                                                                               ==========  ==========  =========
Pro forma net basic earnings per share .....................................   $     0.05        0.08       0.02
                                                                               ==========  ==========  =========
Pro forma net diluted earnings per share ...................................   $     0.05        0.08       0.02
                                                                               ==========  ==========  =========

</TABLE>

          See accompanying notes to consolidated financial statements.



                                       4


<PAGE>   5
              PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES

               CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
                  FOR THE SIX MONTHS ENDED JUNE 30, 1999, 1998
                         (RESTATED) AND 1997 (RESTATED)

<TABLE>
<CAPTION>

                                                                                            (RESTATED) (RESTATED)
                                                                                1999           1998       1997
                                                                              -----------  ----------  ----------
<S>                                                                           <C>          <C>         <C>
REVENUES:
 Staffing income ...........................................................  $22,171,854  14,863,410   4,664,203
 Premiums earned ...........................................................    7,883,505   7,416,526   4,669,794
 Net commission income .....................................................      721,824   1,069,715   1,131,386
 Net investment income .....................................................      891,924     891,546     719,646
 Other income ..............................................................      210,709     264,331     288,061
                                                                              -----------  ----------  ----------
     Total revenues ........................................................   31,879,816  24,505,528  11,473,090
                                                                              -----------  ----------  ----------
Expenses:
 Staffing costs ............................................................   17,060,963  11,596,918   4,014,249
 Losses and loss adjustment expenses incurred ..............................    4,335,927   4,004,924   2,526,147
 Amortization of deferred acquisition costs ................................    2,609,364   2,445,353   1,689,564
 Other operating expenses ..................................................    6,326,620   4,519,855   2,667,109
                                                                              -----------  ----------  ----------
     Total expenses ........................................................   30,332,874  22,567,050  10,897,069
                                                                              -----------  ----------  ----------
Operating income before income taxes ......................................     1,546,942   1,938,478     576,021
                                                                              -----------  ----------  ----------
Interest expense ..........................................................       536,691     458,585     279,960
Amortization of intangible assets and other non-operating expenses ........       139,463     238,621          --
                                                                              -----------  ----------  ----------
    Total non-operating expenses ..........................................       676,154     697,206     279,960
                                                                              -----------  ----------  ----------
Income before income taxes ................................................       870,788   1,241,272     296,061
Income taxes ..............................................................       149,060     141,968     170,823
                                                                              -----------  ----------  ----------
    Net income ............................................................   $   721,728   1,099,304     125,238
                                                                              ===========  ==========  ==========
Net income -- basic .......................................................   $   721,728   1,099,304     125,238
Impact of potential common shares -- convertible notes ....................       306,633      79,287          --
                                                                              -----------  ----------  ----------
Net income -- diluted .....................................................   $ 1,028,361   1,178,591     125,238
                                                                              ===========  ==========  ==========
Weighted average outstanding shares -- basic ..............................     5,247,085   5,242,085   4,815,704
Impact of potential common shares -- convertible notes ....................     1,170,000     292,127          --
                                                                              -----------  ----------  ----------
Common shares and common shares equivalents used in computing net
  earnings per shares -- diluted ...........................................    6,417,085   5,534,212   4,815,704
                                                                              ===========  ==========  ==========
Net basic earnings per share ..............................................   $      0.14        0.21        0.03
                                                                              ===========  ==========  ==========
Net diluted earnings per share ............................................   $      0.14        0.21        0.03
                                                                              ===========  ==========  ==========
PRO FORMA INFORMATION (NOTES 6 AND 13):
Historical income before income taxes .....................................   $   870,787   1,241,272     296,061
Pro forma income tax provision ............................................       149,060     464,578     102,122
                                                                              ===========  ==========  ==========
Pro forma net income ......................................................   $   721,728     776,694     193,939
                                                                              ===========  ==========  ==========
Pro forma net income -- basic .............................................   $   721,728     776,694     193,939
Impact of potential common shares -- convertible notes ....................       306,633      79,287          --
                                                                              -----------  ----------  ----------
Pro forma net income -- diluted ...........................................   $ 1,028,361     855,981     193,939
                                                                              ===========  ==========  ==========
Weighted average outstanding shares -- basic ..............................     5,247,085   5,242,085   4,815,704
Impact of potential common shares -- convertible notes ....................     1,170,000     292,127          --
                                                                              -----------  ----------  ----------

Weighted average outstanding shares -- diluted ............................     6,417,085   5,534,212   4,815,704
                                                                              ===========  ==========  ==========
Pro forma net basic earnings per share ....................................   $      0.14        0.15        0.04
                                                                              ===========  ==========  ==========
Pro forma net diluted earnings per share ..................................   $      0.14        0.15        0.04
                                                                              ===========  ==========  ==========
</TABLE>


          See accompanying notes to consolidated financial statements.



                                       5


<PAGE>   6
              PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES

               CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
                 FOR THE THREE MONTHS ENDED JUNE 30, 1999, 1998
                         (RESTATED) AND 1997 (RESTATED)

<TABLE>
<CAPTION>

                                                                                         (RESTATED)     (RESTATED)
                                                                            1999            1998           1997
                                                                         -----------     ----------     ----------
<S>                                                                      <C>            <C>             <C>
Cash flow from operating activities:
 Net Income .......................................................... $   267,894         590,829         77,968
 Adjustments to reconcile net income to net cash provided
  by operating activities:
  Depreciation and amortization ......................................     185,542         219,880         60,430
  Loss on sale of property and equipment .............................      22,799              --             --
  Amortization of deferred acquisition costs .........................   1,371,321       1,464,038        952,255
  Deferred income taxes ..............................................    (297,725)       (477,630)            --
  Provision for uncollectible accounts ...............................      (7,275)        (38,969)        18,107
Change in:
 Accrued investment and interest income ..............................    (148,625)        (13,453)      (173,941)
 Accounts, commissions and premiums receivable .......................     419,862      (4,380,750)       395,959
 Deferred acquisition costs ..........................................  (1,409,782)     (3,288,725)    (1,689,564)
 Unpaid losses and loss adjustment expenses ..........................   2,227,595       2,155,636      1,335,597
 Unearned premiums ...................................................     116,228       3,846,284       (348,461)
 Premiums, commissions and other insurance balances...................  (1,147,581)       (718,749)      (931,135)
 Accounts payable and accrued expenses ...............................     (64,090)        725,115        464,494
 Other, net ..........................................................     883,949         (75,013)       404,287
                                                                       -----------     -----------     ----------
    Net cash provided by operating activities ........................   2,420,112           8,493        565,996
                                                                       -----------     -----------     ----------
Cash flow from investing activities:
 Purchases of short-term investments, net ............................  (1,726,055)    (10,922,753)    (2,329,458)
 Proceeds from disposal of property and equipment ....................       6,000              --             --
 Purchases of property and equipment .................................     (55,368)        (32,529)      (111,450)
                                                                       -----------     -----------     ----------
    Net cash used in investing activities ............................  (1,775,423)    (10,955,282)    (2,440,908)
                                                                       -----------     -----------     ----------
Cash flow from financing activities:
 Proceeds from subordinated convertible notes payable ................          --       9,621,914             --
 Repayment of shareholder loan .......................................          --              --        (75,000)
 Borrowings from revolving line of credit, net .......................          --       2,000,000        699,195
 Repayment of line of credit .........................................    (663,583)             --       (289,271)
 Other, net ..........................................................          --          (2,830)       (20,635)
                                                                       -----------     -----------     ----------
    Net cash (used in) provided by financing activities...............    (663,583)     11,619,084        314,289
                                                                       -----------     -----------     ----------
Net increase (decrease) in cash ......................................     (18,894)        672,295     (1,560,623)
Cash at beginning of period ..........................................   6,804,429       3,028,300      5,576,023
                                                                       -----------     -----------     ----------
Cash at end of period ................................................ $ 6,785,535       3,700,595      4,015,400
                                                                       ===========     ===========     ==========
Supplemental disclosure of cash flow information:
 Income taxes paid ................................................... $   343,000         950,000             --
                                                                       ===========     ===========     ==========
 Interest paid ....................................................... $   195,750         135,010        180,134
                                                                       ===========     ===========     ==========
</TABLE>

          See accompanying notes to consolidated financial statements.



                                       6



<PAGE>   7

              PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES

                CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
                  FOR THE SIX MONTHS ENDED JUNE 30, 1999, 1998
                         (RESTATED) AND 1997 (RESTATED)
<TABLE>
<CAPTION>

                                                                                         (RESTATED)      (RESTATED)
                                                                            1999            1998            1997
                                                                         -----------     ----------      ----------
<S>                                                                      <C>            <C>              <C>
Cash flow from operating activities:
 Net Income ...........................................................  $   721,728      1,099,304        125,238
 Adjustments to reconcile net income to net cash provided by
  operating activities:
  Depreciation and amortization .......................................      372,432        370,644        104,972
  Loss on sale of property and equipment ..............................       22,799             --             --
  Amortization of deferred acquisition costs ..........................    2,609,364      2,445,353      1,689,564
  Deferred income taxes ...............................................     (379,716)      (829,401)            --
  Provision for uncollectible accounts ................................        6,274        (22,420)        44,428
 Change in:
  Accrued investment and interest income ..............................      (62,562)        54,521       (173,941)
  Accounts, commissions and premiums receivable .......................     (704,596)    (7,248,897)     3,085,775
  Deferred acquisition costs ..........................................   (2,884,579)    (3,940,329)    (1,689,564)
  Unpaid losses and loss adjustment expenses ..........................    4,234,244      3,811,005      2,351,679
  Unearned premiums ...................................................      831,715      4,419,082       (951,896)
  Premiums, commissions and other insurance balances ..................       67,776        (56,989)      (953,252)
  Accounts payable and accrued expenses ...............................      535,769      1,535,746      1,367,841
  Other, net ..........................................................    1,764,154       (114,348)     2,038,763
                                                                         -----------   ------------    -----------
     Net cash provided by operating activities ........................    7,134,801      1,523,871      7,039,607
                                                                         -----------   ------------    -----------
Cash flow from investing activities:
 Purchase of subsidiary ................................................          --     (5,000,000)            --
 Purchases of short-term investments, net ..............................  (1,984,850)    (8,471,577)   (19,735,394)
 Proceeds from disposal of property and equipment ......................       6,000             --             --
 Purchases of property and equipment ...................................    (203,671)       (54,897)      (172,452)
                                                                         -----------   ------------    -----------
     Net cash used in investing activities .............................  (2,182,520)   (13,526,474)   (19,907,846)
                                                                         -----------   ------------    -----------
Cash flow from financing activities:
 Proceeds from sale of common stock ....................................          --             --     10,384,324
 Proceeds from subordinated convertible notes payable ..................          --      9,621,914             --
 Repayment of shareholder loan .........................................          --             --       (150,000)
 Borrowings from revolving line of credit, net .........................          --      2,000,000      1,579,195
 Repayment of line of credit ...........................................  (1,363,583)            --       (568,987)
 Bank overdraft ........................................................    (518,046)       (38,327)            --
 Other, net ............................................................          --         (5,660)        (5,660)
                                                                         -----------   ------------    -----------
     Net cash (used in) provided by financing activities ...............  (1,881,629)    11,577,927     11,238,872
                                                                         -----------   ------------    -----------
Net increase (decrease) in cash ........................................   3,070,652       (424,676)    (1,629,367)

Cash at beginning of period ............................................   3,714,883      4,125,271      5,644,767
                                                                         -----------   ------------    -----------
Cash at end of period .................................................. $ 6,785,535      3,700,595      4,015,400
                                                                         ===========   ============    ===========
Supplemental disclosure of cash flow information:
 Income taxes paid ..................................................... $   523,000        950,000             --
                                                                         ===========   ============    ===========
 Interest paid ......................................................... $   417,844        343,983        267,876
                                                                         ===========   ============    ===========

</TABLE>

          See accompanying notes to consolidated financial statements.




                                       7

<PAGE>   8
              PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           JUNE 30, 1999 (UNAUDITED)


(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     (a) Basis of Presentation

     The accompanying unaudited consolidated financial statements of Preferred
Employers Holdings, Inc. (the "Company") and its subsidiaries have been
prepared in accordance with generally accepted accounting principles for
interim financial information. Accordingly, they do not include all of the
information and notes required by generally accepted accounting principles for
complete financial statements. In the opinion of management, all adjustments,
consisting of normal recurring accruals, considered necessary for a fair
presentation have been included. Operating results for the six months period
ended June 30, 1999 are not necessarily indicative of the results that may be
expected for the year ending December 31, 1999. These consolidated financial
statements and notes should be read in conjunction with the financial
statements and notes included in the audited consolidated financial statements
of the Company for the year ended December 31, 1998.

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

      (b) Organization

     Preferred Employers Holding, Inc. is the successor company to Preferred
Employers Group, Inc. ("PEGI"). Except as otherwise specified or when the
context otherwise requires, references to the Company herein include Preferred
Employers Holdings, Inc. and PEGI, through which the Company conducts certain
of its business operations.

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

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



                                       8



<PAGE>   9
              PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           JUNE 30, 1999 (UNAUDITED)


(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

     The Company was appointed as a general agent ("GA") by the American
International Group of Companies ("AIG"), a major group of international
insurance carriers, on January 1, 1993. In this regard, the Company is
authorized to write workers' compensation as well as other forms of "property
and casualty" business (such other forms of insurance being hereinafter referred
to as "Package") on behalf of AIG. In addition, the Company was appointed as a
GA by General Accident Insurance Company of America ("GAIC") on September 1,
1994, with the authority to write all forms of commercial property and casualty
business for family style and fast-food restaurants. On June 11, 1996, GAIC
advised the Company that it would no longer write Package insurance for
fast-food restaurants; however, on March 20, 1997, the Company was appointed as
a GA by the Kemper Group of Insurance Companies ("Kemper") with the authority to
write workers' compensation and other forms of commercial property and casualty
business for family style and fast-food restaurants and convenience stores. In
September 1998, Kemper advised the Company that they would no longer accept
Package insurance risks for fast food restaurants, but retained its contract
with the Company to serve as a program administrator for certain risks. On June
1, 1999, the Company entered into an agreement with a division of United States
Fidelity and Guaranty Company to provide Package insurance for franchise, fast
food and family style restaurants.

      (c) Insurance Operations

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

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

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

     The effects of prospective and retroactive insurance accounting treatment
are illustrated below. The prospective method assumes that the Agreement
incepted on January 1, 1996, and provides for a loss ratio of 51.5%,
acquisition costs of 33.83%, aggregate net premiums written of approximately
$15 million ($12,600,000 relating to the period from January 1 through
September 30, 1996) and an investment yield of 6.5% on net cash flows. The
retroactive (deposit) method uses the same assumptions except that since the



                                       9


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

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           JUNE 30, 1999 (UNAUDITED)


(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Agreement was not executed until October 1996, any investment income on net
cash flows earned for the period from January through September 1996 are
deferred and recognized as "other income" over the payment period of the
remaining claim liabilities.

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


<TABLE>
<CAPTION>
                                                          Prospective        Composite
                                                            Method     Retroactive/Prospective
 Years                                                    (Pro Forma)         (Actual)
 -----                                                   -----------   -----------------------
 <S>                                                       <C>             <C>
 1996 ..................................................   $1,658,000         324,000
 1997 ..................................................    1,288,000       1,372,000
 1998 ..................................................      400,000         840,000
 1999 ..................................................      332,000         658,000
 2000 ..................................................      300,000         563,000
 2001 ..................................................      282,000         503,000
                                                           ----------       ---------
                                                           $4,260,000       4,260,000
                                                           ==========       =========
</TABLE>

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

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

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

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

      (d) Staffing Operations

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



                                      10



<PAGE>   11
              PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           JUNE 30, 1999 (UNAUDITED)


(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

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

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

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

     During 1995, NET Healthcare entered into a line of credit with a
shareholder to provide a total of $190,000 to fund the working capital
requirements of NET Healthcare. The line of credit bore interest at the rate of
5% per annum. In March 1996, NET Healthcare entered into an additional line of
credit with a shareholder collateralized by outstanding accounts receivable.
Interest was payable at the rate of 2% per month on average outstanding
balances. In May 1996, the agreement was amended to allow for additional
funding. In May 1997, the agreement was further amended to increase the
interest rate by .5% per month on approximately $600,000 of the balance of the
line of credit. The amended line of credit, effective April 1, 1998,
established a rate of interest of 10% per annum and eliminated restrictive
covenants included in the original agreement. Interest expense related to the
line of credit amounted to $215,030 and $267,959 for the six months ended June
30, 1998 and 1997, respectively. The aggregate outstanding balance together
with its related accrued interest expense was paid in full subsequent to the
merger of NET Healthcare and the Company.

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

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

     (e) Investments

     Fixed maturity securities which the Company has the positive intent and
ability to hold to maturity are classified as "held to maturity" and are
reported at amortized cost. Fixed maturity and equity securities that are
bought and held principally for the purpose of selling them in the near term
are classified as "trading" and are reported at fair value, with unrealized
gains and losses included in income. Fixed



                                      11


<PAGE>   12
              PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           JUNE 30, 1999 (UNAUDITED)


(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

maturity and equity securities not classified as either held to maturity or
trading are classified as "available for sale" and are reported at fair value,
with unrealized gains and losses (net of deferred taxes) charged or credited as
a separate component of shareholders' equity.

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

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

     (f) Property and Equipment, Net

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

     (g) Premiums Payable

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

     (h) Commission Income

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

     (i) Income Taxes

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

      (j) Earnings Per Share

     Earnings per common share is based upon the weighted average number of
common shares outstanding during each period. On December 31, 1998, the Company
adopted SFAS No. 128, Earnings per Share ("SFAS No. 128"). SFAS No. 128
requires specific computations, presentations and disclosures for earnings per
share (EPS) amounts in order to make EPS amounts more compatible with
international accounting standards. Stock options outstanding at June 30, 1999,
1998 and 1997 of 1,263,000, 616,500 and 250,000, respectively, had no effect on
diluted earnings per share amounts.



                                      12

<PAGE>   13
              PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           JUNE 30, 1999 (UNAUDITED)


(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

     In May 1998, the Company consummated a private placement of 7% convertible
subordinated notes due May 12, 2003 in the aggregate principal amount of
$10,580,000. Principal balances outstanding as of June 30, 1999 and December
31, 1998 were $10,535,000 and $10,580,000, respectively. The effect on diluted
earnings per share amounts is presented in the accompanying consolidated
statements of operations.

     (k) Reclassifications

     Certain items in the Company's 1998 and 1997 financial statements have
been reclassified to conform them with the presentation of the Company's
financial statements as of and for the three months and six months ended June
30, 1999.

(2) INVESTMENTS

     At June 30, 1999 and December 31, 1998, the Company did not hold
fixed-maturity securities which individually exceeded 10% of shareholders'
equity except U.S. government and government agency securities.

     Bonds with an amortized cost of $9,265,583 and $8,257,053 were held in a
restricted account for the benefit of the ceding company (AIG) as unauthorized
reinsurance at June 30, 1999 and December 31, 1998, respectively, in accordance
with statutory requirements.

     The amortized cost and estimated fair values of the Company's investments
at June 30, 1999 and December 31, 1998 are as follows:

<TABLE>
<CAPTION>
                                                                                                             Amount at
                                                                                                               Which
                                                                                                               Shown
                                                                                                               on the
                                                    Amortized     Unrealized    Unrealized     Estimated       Balance
                                                      Cost          Gains         Losses       Fair Value      Sheet
                                                   -----------    ----------    -----------    ----------    ----------
<S>                                                <C>             <C>         <C>             <C>          <C>
June 30, 1999:
--------------
Securities held to maturity:
Fixed maturities:
  Obligations of states and political
    subdivision .................................  $19,610,103      64,587      (235,990)      19,438,700    19,610,103
  Obligations of states and political
   subdivisions -- restricted....................    9,265,583       6,740       (80,863)       9,191,460     9,265,583
                                                   -----------     -------      --------       ----------    ----------
 Total fixed maturities .........................  $28,875,686      71,327      (316,853)      28,630,160    28,875,686
                                                   ===========     =======      ========       ==========    ==========

December 31, 1998:
------------------
Securities held to maturity:
Fixed maturities:
  Obligations of states and political
    subdivision..................................  $15,454,481     241,667        (4,129)      15,692,019    15,454,481
  Obligations of state and political
    subdivisions -- restricted...................    8,257,053     130,956            --        8,388,009     8,257,053
                                                   -----------     -------      --------       ----------    ----------
Total fixed maturities...........................  $23,711,534     372,623        (4,129)      24,080,028    23,711,534
                                                   ===========     =======      ========       ==========    ==========

</TABLE>




                                      13
<PAGE>   14
              PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           JUNE 30, 1999 (UNAUDITED)


(2) INVESTMENTS (CONTINUED)

     The amortized cost and fair value of securities at June 30, 1999 and
December 31, 1998, by contractual maturity date, are presented below:

<TABLE>
<CAPTION>

                                                                 June 30, 1999             December 31, 1998
                                                           -------------------------    --------------------------
                                                             Amortized      Fair         Amortized       Fair
                                                               Cost         Value          Cost          Value
                                                           -----------    ----------    ----------    -----------
<S>                                                        <C>           <C>           <C>           <C>
Fixed maturities held-to-maturity:
 Due in one year or less ................................  $        --            --            --            --

 Due after one year through five years ..................   17,497,971    17,376,380    14,394,846    14,600,179
 Due after one year through five years --
   restricted ...........................................    9,265,583     9,191,460     7,197,418     7,296,169
 Due after five years through ten years .................    1,049,756     1,024,300            --            --
 Due after ten years ....................................    1,062,376     1,038,020     1,059,635     1,091,840
 Due after ten years -- restricted ......................           --            --     1,059,635     1,091,840
                                                           -----------    ----------    ----------    ----------
                                                            28,875,686    28,630,160    23,711,534    24,080,028
 Short-term investments .................................      162,965       162,965     1,515,347     1,515,347
 Short-term investments -- restricted ...................    3,689,760     3,689,760     5,516,680     5,516,680
                                                           -----------    ----------    ----------    ----------
 Total ..................................................  $32,728,411    32,482,885    30,743,561    31,112,055
                                                           ===========    ==========    ==========    ==========

</TABLE>

(3) FINANCIAL INSTRUMENTS

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

     Estimated fair values for fixed maturities were provided by outside
consultants using market quotations, prices provided by market makers or
estimates of fair values obtained from yield data relating to investment
securities with similar characteristics. The carrying amount for the 7%
convertible subordinated notes at June 30, 1999 and December 31, 1998 was
$10,535,000 and $10,580,000, respectively, and the related estimated fair value
at June 30, 1999 and December 31, 1998 was $10,265,465 and $10,280,955,
respectively, which was determined by management based on available market
information and appropriate valuation methodologies.




                                       14

<PAGE>   15
              PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           JUNE 30, 1999 (UNAUDITED)


(4) ACCOUNTS, COMMISSIONS AND PREMIUMS RECEIVABLE

     Accounts, commissions and premiums receivable consists of the following at
June 30, 1999 and December 31,1998:

<TABLE>
<CAPTION>

                                                                        June 30, 1999     December 31, 1998
                                                                        -------------     -----------------
           <S>                                                          <C>                  <C>
           Staffing accounts receivable -- billed ....................   $ 4,038,581          5,626,113
           Staffing accounts receivable -- unbilled ..................     1,907,833          1,000,370
                                                                         -----------          ---------
                                                                           5,946,414          6 626,483
           Less allowance for uncollectible accounts .................      (102,328)           (96,054)
                                                                         -----------          ---------
           Staffing accounts receivable, net .........................     5,844,086          6,530,429
           Premiums receivable .......................................     4,949,709          3,652,463
           Commissions receivable ....................................     1,105,450          1,018,031
                                                                         -----------         ----------
           Total .....................................................   $11,899,245         11,200,923
                                                                         ===========         ==========
</TABLE>

     The allowance for uncollectible accounts as of June 30, 1999 and December
31, 1998 consists of the following:

<TABLE>
<CAPTION>

                                                                        June 30, 1999     December 31, 1998
                                                                        -------------     -----------------
           <S>                                                          <C>                  <C>
           Beginning balance .........................................    $ 96,054             125,367
           Provision for uncollectible accounts ......................      47,116              96,624
           Write-offs ................................................     (40,842)           (125,937)
                                                                          --------            --------
           Ending Balance ............................................    $102,328              96,054
                                                                          ========            ========

</TABLE>

(5) STOCKHOLDERS LOAN

     In May 1995, the Company entered into a repurchase agreement with PEGI
stockholders (the "Agreement") whereby the Company agreed to repurchase from
them an aggregate of 30 shares of common stock (529,412 shares as adjusted to
give effect to the recapitalization of the Company in February 1997 whereby the
Company exchanged 17,647.06 shares of Common Stock for each share of PEGI
Common Stock held by the stockholders of PEGI) (the "Shares") of the Company.
The aggregate purchase price for the Shares was $600,000 (including interest)
to be paid in 24 installments of $25,000. The closing of the Agreement was
subject to the Company's completion of a $600,000 distribution to the
stockholders of the Company, pro rata based on the number of shares of common
stock of the Company outstanding and paid to the stockholders of record on the
Agreement date, without giving effect to the repurchase. The $600,000
distribution was made by the Company on May 26, 1995.

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



                                       15


<PAGE>   16
              PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           JUNE 30, 1999 (UNAUDITED)


(6)  INCOME TAXES

         U.S. Federal and state income tax expense (benefit) consists of the
following components:

<TABLE>
<CAPTION>

           For the Three Months Ended                                   Current    Deferred     Total
           --------------------------                                  --------    --------     ------
           <S>                                                         <C>         <C>           <C>
           June 30, 1999 ...........................................   $305,371    (297,725)     7,646
           June 30, 1998 ...........................................    569,259    (477,630)    91,629
           June 30, 1997 ...........................................     41,233          --     41,233

           For the Six Months Ended                                     Current    Deferred      Total
           ------------------------                                    --------    --------     -------
           June 30, 1999 ...........................................   $528,776    (379,716)    149,060
           June 30, 1998 ...........................................    971,369    (829,401)    141,968
           June 30, 1997 ...........................................    170,823          --     170,823

</TABLE>

     Income tax expense for the three months and six months ended June 30,
1999, 1998 and 1997 differed from the amount computed by applying the U.S.
Federal income tax rate of 34% to income before Federal income taxes as a
result of the following:

<TABLE>
<CAPTION>

                                                           For the Three Months            For the Six Months
                                                              Ended June 30,                 Ended June 30,
                                                        ---------------------------   ------------------------------
                                                          1999     1998       1997       1999       1998      1997
                                                        -------   -------   -------   --------   --------   --------
<S>                                                     <C>       <C>        <C>       <C>        <C>        <C>
 Expected income tax expense ........................   $93,684   232,036    40,528    296,068    422,032   100,661
 State income tax, net ..............................     9,738    16,361     4,768     31,837     29,578    11,842
 Tax-exempt investment income .......................   (93,303)  (58,694)  (67,873)  (182,678)  (124,598)  (86,934)
 Travel and entertainment expense ...................     6,646        --        --     23,584         --        --
 "S Corporation" (income) expense ...................        --   (78,785)   62,281         --   (144,989)  158,586
 Other, net .........................................    (9,119)  (19,289)    1,529    (19,751)   (40,055)  (13,332)
                                                        -------   -------   -------   --------   --------   -------
 Total income tax expense ...........................   $ 7,646    91,629    41,233    149,060    141,968   170,823
                                                        =======   =======   =======   ========   ========   =======

</TABLE>

     As a result of the August 1998 business combination of NET Healthcare, an
"S corporation," with the Company, a "C corporation," NET Healthcare's "S
Corporation" status ceased to exist. The unaudited pro forma information in the
consolidated statements of operations reflect income tax expense had NET
Healthcare been taxed as a "C corporation," of $256,350 and $5,229 for the
three months ended June 30, 1998 and 1997, respectively, and $464,578 and
$102,122 for the six months ended June 30, 1998 and 1997, respectively.



                                       16


<PAGE>   17
              PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           JUNE 30, 1999 (UNAUDITED)


(6) INCOME TAXES (CONTINUED)

     Deferred income taxes are based upon temporary differences between the
financial statement and tax bases of assets and liabilities. The following
deferred taxes are recorded for June 30, 1999, and December 31, 1998,
respectively:

<TABLE>
<CAPTION>

                                                                                     1999         1998
                                                                                 -----------    ---------
           <S>                                                                   <C>              <C>
           Deferred tax assets:
             Unearned premiums ................................................    $   473,771      411,176

             Reserve for unpaid losses and loss adjustment expenses............      1,305,205      971,252

             Other, net .......................................................         59,105       59,105
                                                                                   -----------    ---------
               Gross deferred tax assets ......................................      1,838,081    1,441,533
                                                                                   -----------    ---------
           Deferred tax liabilities:
             Cash to accrual change ...........................................       (219,704)    (284,575)
             Deferred acquisition costs .......................................       (783,854)    (680,291)
             Other, net .......................................................         (6,929)     (28,789)
                                                                                   -----------    ---------
               Gross deferred tax liabilities .................................     (1,010,487)    (993,655)
                                                                                   -----------    ---------
                 Net deferred tax asset .......................................    $   827,594      447,878
                                                                                   ===========    =========

</TABLE>


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

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

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

(7) ANNUAL STATUTORY SOLVENCY REQUIREMENTS

     The Bermuda Insurance Act of 1978 and related regulations (the "Act")
requires the Company's reinsurance subsidiary to meet a minimum solvency
margin. Statutory capital and surplus as of December 31, 1998 was $10,531,208
and the amount required to be maintained by the Company's reinsurance
subsidiary was $3,163,000. In addition, a minimum liquidity ratio must be
maintained whereby relevant assets, as defined by the Act, must exceed 75% of
relevant liabilities. Once these requirements have been met, there is no
restriction on the retained earnings available for distribution. At June 30,
1999 and December 31, 1998, the Company's reinsurance subsidiary was in
compliance with this requirement.



                                       17


<PAGE>   18
              PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           JUNE 30, 1999 (UNAUDITED)


(8) LIABILITY FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES

     Activity in the liability for unpaid losses and loss adjustment expenses
is summarized as follows for the six months ended June 30, 1999, 1998 and 1997:

<TABLE>
<CAPTION>

                                                                                1999         1998         1997
                                                                            -----------    ---------   ----------
<S>                                                                         <C>            <C>           <C>
 Net unpaid losses and loss adjustment expenses at beginning of
   period ..............................................................    $13,878,892    6,107,613     199,390
                                                                            -----------    ---------   ---------
 Incurred related to
   Current year ........................................................      3,677,961    4,004,924   2,526,147
   Prior year ..........................................................        657,966           --          --
                                                                            -----------    ---------   ---------
     Total incurred ....................................................      4,335,927    4,004,924   2,526,147
                                                                            -----------    ---------     -------
 Paid related to:
   Current year ........................................................        100,021      193,319     174,468
   Prior year ..........................................................          1,662           --          --
                                                                            -----------    ---------   ---------
     Total paid ........................................................        101,683      193,319     174,468
                                                                            -----------    ---------   ---------
Net unpaid losses and loss adjustment expenses at end of period ........    $18,113,136    9,919,218   2,551,069
                                                                            ===========    =========   =========
</TABLE>


(9) UNSECURED REVOLVING LINE OF CREDIT

     In May 1998, the Company obtained a $3 million unsecured revolving line of
credit from a bank. The terms of the loan provide for monthly interest payments
at the bank's prime lending rate (7 3/4% per annum at June 30, 1999). The loan
is renewable on an annual basis. As of June 30, 1999 and December 31, 1998,
the aggregate amount outstanding under the line of credit was $486,417 and
$1,850,000, respectively.

(10) SUBORDINATED CONVERTIBLE NOTES

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



                                       18

<PAGE>   19
              PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           JUNE 30, 1999 (UNAUDITED)


(10) SUBORDINATED CONVERTIBLE NOTES (CONTINUED)

any time prior to the Maturity Date, in whole or in part for the face amount
thereof, together with all accrued and unpaid interest through the date of
prepayment. As of June 30, 1999, the aggregate principal amount of Notes
outstanding was $10,535,000. Notes in an aggregate principal amount of $45,000
were converted into 5,000 shares of common stock of the Company during the
first quarter of 1999.

(11) SEGMENT REPORTING

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

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

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

     Certain information concerning the Company's reporting segments for the
three months and six months ended June 30, 1999, 1998 and 1997 is as follows:

For the Three Months Ended June 30,
-----------------------------------

<TABLE>
<CAPTION>


                                                                                 Employee
           1999                                                  Insurance       Staffing      Totals
           ----                                                  ---------      ----------   ----------
           <S>                                                   <C>            <C>          <C>
           Revenues from external customers ...................  $4,558,538     11,318,878   15,877,416
           Intersegment revenue ...............................       6,507             --        6,507
           Interest revenue ...................................     452,289            302      452,591
           Segment profit .....................................     529,022        949,034    1,478,056

           1998
           ----
           Revenues from external customers ...................  $5,001,928      8,941,998   13,943,926
           Interest revenue ...................................     505,561             --      505,561
           Segment profit .....................................     756,348        365,079    1,121,427

           1997
           ----
           Revenues from external customers ...................  $3,265,511      2,419,269    5,684,780
           Interest revenue ...................................     425,887             --      425,887
           Segment profit .....................................     354,967       (293,047)      61,920

</TABLE>



                                       19

<PAGE>   20
              PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           JUNE 30, 1999 (UNAUDITED)


(11) SEGMENT REPORTING (CONTINUED)


FOR THE SIX MONTHS ENDED JUNE 30,
---------------------------------

<TABLE>
<CAPTION>
                                                                                          Employee
1999                                                                       Insurance      Staffing      Totals
----                                                                       ----------    ----------   ----------
<S>                                                                       <C>            <C>          <C>
Revenues from external customers ........................................ $ 8,816,038    22,171,854   30,987,892
Intersegment revenue ....................................................      16,341            --       16,341
Interest revenue ........................................................     868,479           302      868,781
Segment profit ..........................................................   1,184,475     1,768,158    2,952,633
Segment assets ..........................................................  49,114,134    12,832,371   61,946,505

1998
----
Revenues from external customers ........................................ $ 8,750,572    14,863,410   23,613,982
Interest revenue ........................................................     891,546            --      891,546
Segment profit ..........................................................   1,310,984       555,044    1,866,028
Segment assets ..........................................................  36,802,571    12,083,921   48,886,492

1997
----
Revenues from external customers ........................................ $ 6,089,042     4,664,203   10,753,245
Interest revenue ........................................................     606,778            --      606,778
Segment profit ..........................................................     672,153      (466,431)     205,722
Segment assets ..........................................................  18,597,890     1,906,885   20,504,775

</TABLE>

     Information for the Company's reportable segments relates to the
enterprise's consolidated totals as follows:

FOR THE THREE MONTHS ENDED JUNE 30,
-----------------------------------

<TABLE>
<CAPTION>
                                                                                1999          1998        1997
                                                                             -----------   ----------   ---------
Revenues:
---------
<S>                                                                          <C>           <C>          <C>
Total revenues for reportable segments ...................................   $16,336,514   14,449,487   6,110,667
Intersegment revenue .....................................................        (6,507)          --          --
Unallocated corporate interest revenue ...................................         4,169           --      80,009
                                                                             -----------    ----------  ---------
Total consolidated revenues ..............................................   $16,334,176    14,449,487  6,190,676
                                                                             ===========    ==========  =========
Profit or Loss:
----------------
Total profit or loss for reportable segments .............................   $ 1,478,056     1,121,427     61,920
Unallocated amounts:
  General corporate expenses .............................................    (1,206,685)    (438,969)    (22,728)
  Corporate interest revenue .............................................         4,169           --      80,009
                                                                            ------------    ---------   ---------
Income before income taxes ...............................................  $    275,540       682,458    119,201
                                                                            ============    ==========  =========

</TABLE>




                                       20

<PAGE>   21
              PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           JUNE 30, 1999 (UNAUDITED)


(11) SEGMENT REPORTING (CONTINUED)

     OTHER items:

<TABLE>
<CAPTION>

                                                                           Reportable     Unallocated
                                                                            Segment        Corporate       Consolidated
                                                                             Total           Total            Total
                                                                          ----------      -----------     ------------
1999
-----
<S>                                                                       <C>                <C>            <C>
Depreciation and amortization ..........................................  $  121,765         4,674          126,439
Amortization of deferred acquisition costs .............................   1,371,322            --        1,371,322

1998
----
Depreciation and amortization ..........................................  $  191,191            --          191,191
Amortization of deferred acquisition costs .............................   1,464,038            --        1,464,038

1997
----
Depreciation and amortization ..........................................  $   43,809            --           43,809
Amortization of deferred acquisition costs .............................     952,255            --          952,255

</TABLE>

FOR THE SIX MONTHS ENDED JUNE 30,
----------------------------------

<TABLE>
<CAPTION>

                                                                            1999          1998           1997
                                                                         -----------    ----------    ----------
Revenues:
---------
<S>                                                                      <C>            <C>           <C>
Total revenues for reportable segments ................................  $31,873,014    24,505,528    11,360,023
Intersegment revenue ..................................................      (16,341)           --            --
Unallocated corporate interest revenue ................................       23,143            --       113,067
                                                                         -----------    ----------    ----------
Total consolidated revenues ...........................................  $31,879,816    24,505,528    11,473,090
                                                                         ===========    ==========    ==========
Profit or Loss:
---------------
Total profit or loss for reportable segments ..........................  $ 2,952,633     1,866,028       205,722
Unallocated amounts:
  General corporate expenses ..........................................   (2,104,989)    (624,756)      (22,728)
  Corporate interest revenue ..........................................       23,143           --        113,067
                                                                         -----------    ----------    ----------
Income before income taxes ............................................  $   870,787     1,241,272       296,061
                                                                         ===========    ==========    ==========

Assets:
-------
Total assets for reportable segments ..................................  $61,946,505    48,886,492    20,504,775
Elimination of intersegment receivables ...............................     (276,286)     (539,748)           --
Unallocated general corporate assets ..................................    2,799,477     9,349,268     6,104,104
Elimination of receivable from corporate ..............................   (1,478,609)     (576,641)     (201,641)
                                                                         -----------    ----------    ----------
Total consolidated assets .............................................  $62,991,087    57,119,371    26,407,238
                                                                         ===========    ==========    ==========
</TABLE>


                                       21


<PAGE>   22
              PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           JUNE 30, 1999 (UNAUDITED)


(11) SEGMENT REPORTING (CONTINUED)

     Other items:

<TABLE>
<CAPTION>

                                                                           Reportable     Unallocated
                                                                            Segment        Corporate       Consolidated
                                                                             Total           Total            Total
                                                                          ----------      -----------     ------------
1999
-----
<S>                                                                       <C>                <C>            <C>
Depreciation and amortization     ......................................  $  240,871         8,949            249,820

Amortization of deferred acquisition costs .............................   2,609,364            --          2,609,364

1998
----
Depreciation and amortization ..........................................  $  341,955            --            341,955
Amortization of deferred acquisition costs .............................   2,445,353            --          2,445,353

1997
----
Depreciation and amortization ..........................................  $   82,472            --             82,472
Amortization of deferred acquisition costs .............................   1,689,564            --          1,689,564

</TABLE>

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

(12) LITIGATION

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

(13) UNAUDITED PRO FORMA INFORMATION

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

(14) YEAR 2000

     Year 2000 issues are the result of computer programs being written using
two digits rather than four to define the applicable year. The Company has
developed a plan to address Year 2000 issues. The plan is based on the
Company's primary software vendors having advised the Company that the
necessary programming changes related to Year 2000 issues have been made and
tested and that the software used by the Company can be upgraded to be Year
2000 compliant. During the first quarter of 1999, the Company completed the
implementation of this upgrade. The additional costs associated with the
implementation of the above project were not material.

     It is management's belief that for any suppliers who may not be Year 2000
compliant, such non-compliance will not have a material adverse effect on the
Company's business. However, each major supplier's compliance will be assessed
in light of their response.



                                       22



<PAGE>   23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

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

GENERAL

     The Company engages in the following activities:

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

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

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

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

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

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




                                      23


<PAGE>   24
casualty insurance and workers' compensation insurance. In September 1998,
Kemper advised the Company that it would no longer accept Package insurance
risks for fast food restaurants but retained its contract with the Company to
serve as a program administrator for certain risks. On June 1, 1999, the
Company entered into an agreement with a division of United States Fidelity and
Guaranty Company to provide Package insurance for franchise, fast food and
family style restaurants.

     Reinsurance. In December 1996, the Company formed Preferred Reinsurance
and entered into a reinsurance agreement with affiliates of AIG pursuant to
which Preferred Reinsurance acts as a reinsurer with respect to certain
workers' compensation and employer's liability insurance policies in force with
policy inception dates as of January 1, 1996 and subsequent which are written
by the Company on behalf of affiliates of AIG. Preferred Reinsurance is
required to provide affiliates of AIG, as security for the payment of losses, a
combination of cash, United States government securities and/or an irrevocable
letter of credit in an aggregate amount equal to 51.5% of the net written
premiums ceded to Preferred Reinsurance pursuant to the insurance agreement
less the amount of losses paid. Preferred Reinsurance receives, as compensation
pursuant to the terms of the reinsurance agreement, the related net written
premiums less certain program expenses and commissions and the losses paid.
Preferred Reinsurance receives, as compensation pursuant to the terms of the
reinsurance agreement, the related net written premiums less certain program
expenses and commissions and the losses paid associated with the business.
Although Preferred Reinsurance assumes the risks associated with being a
reinsurer, the reinsurance agreement limits the liability of Preferred
Reinsurance for losses and certain defined expenses to the first $300,000 per
occurrence. In addition, the reinsurance agreement limits the aggregate
liability of Preferred Reinsurance for all coverage to an amount not to exceed
70% of the gross written premiums for each individual underwriting year.
Because the reinsurance agreement is effective for all business written on or
after January 1, 1996, the policies written prior to the execution of the
contract and formation of Preferred Reinsurance were accounted for as
retroactive reinsurance. The reinsurance agreement with Preferred Reinsurance
is terminable by either party upon the occurrence of certain events. In the
event the Company's reinsurance agreement is terminated, the Company, in all
likelihood, would be materially and adversely affected.
     The Company utilizes a Third Party Administrator ("TPA") for its claims
processing. In this regard, the TPA is responsible for: (i) establishing initial
individual claim reserve amounts for all reported claims; (ii) periodic review
of all open claims making the necessary upward or downward reserve adjustment
based on the most current and up-to-date information; (iii) authorizing payments
to claimants from previously established reserve amounts; (iv) closing claims as
a result of payment thereof or closing claims without payment due to
insufficient proof of loss coverage by the claimant or any combination thereof.

     As per the reinsurance agreement, the "fronting" company has the
contractual responsibility for the initial funding of all claims payments made
by the TPA and is subsequently entitled to seek reimbursement from the Company
for claims it funded in accordance with the terms of the reinsurance agreement.
To date, the fronting company has not sought reimbursement under the terms of
the reinsurance agreement. Although timely payments have been made to claimants
by the TPA, the Company's financial statements do not reflect such payments
since it has not yet reimbursed the fronting company for such payments. Instead,
the unreimbursed claim payments are included in the Company's balance sheet as
Unpaid Losses and Loss Adjustment Expenses.
     The Company collects workers' compensation premiums from the insureds and
remits the ceding commission (net of its commission) and reinsurance charges to
affiliates of AIG and remits the net premium to Preferred Reinsurance.
Commission income on workers' compensation business is recognized as income
when premiums are billed. Package insurance premiums are principally collected
by the insurance carrier. The package insurance carrier remits commissions to
the Company monthly on package premiums it collects. Commission income on
package business is recognized as income when premiums are due. Reinsurance
premiums received are earned on a pro-rata basis over the term of the related
coverage.

     For the three months ended June 30, 1999, the Company's total revenues
were $16,334,000 as compared to $14,449,000 for the 1998 comparable period,
representing a net increase of $1,885,000. For the three months ended June 30,
1998, the Company's total revenues were $14,449,000 as compared to total
revenues of $6,191,000 for the 1997 comparable period, representing a net
increase of $8,258,000. For the three months ended June 30, 1999,
approximately, 69%, 29% and 2% of the Company's total revenues were derived
from its staffing, reinsurance captive and general agency businesses,
respectively. For the three months ended June 30, 1998, approximately 62%, 34%,
and 4% of the Company's total revenues were derived from its staffing,
reinsurance captive and general agency businesses, respectively. For the three
months ended June 30, 1997, approximately 39%, 53% and 8% of the Company's
total revenues were derived from its staffing, reinsurance captive and general
agency businesses, respectively.

     For the six months ended June 30, 1999, the Company's total revenues were
$31,880,000 compared to $24,506,000 for the 1998 comparable period, representing
a net increase of $7,374,000. For the six months ended June 30, 1998, the
Company's total revenues were $24,506,000 as compared to total revenue of
$11,473,000 for the 1997 comparable period, representing a net increase of
$13,033,000. For the six months ended June 30, 1999, approximately, 70%, 28% and
2% of the Company's total revenues were derived



                                      24

<PAGE>   25
from its staffing, reinsurance captive and general agency business,
respectively. For the six months ended June 30, 1998, approximately 61%, 35%,
and 4% of Company's total revenue were derived from its staffing, reinsurance
captive and general agency business, respectively. For the six months ended
June 30, 1997, approximately 41%, 49% and 10% of the Company's total revenues
were derived from its staffing, reinsurance captive and general agency
business, respectively.

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

RESULTS OF OPERATIONS

FOR THE THREE MONTHS ENDED JUNE 30, 1999 AND 1998

     Total Revenues. Total revenues for the three months ended June 30, 1999
were $16,334,000 compared to $14,449,000 for the 1998 comparable period,
representing a net increase of $1,885,000 or 13.0%. Total revenues for the
three months ended June 30, 1998 were $14,449,000 compared to $6,191,000 for
the 1997 comparable period, representing a net increase of $8,258,000 or
133.4%.

     The following table provides a comparison of revenues for the three months
ended June 30, 1999 and 1998 by category:

<TABLE>
<CAPTION>

                                                                                           Net       Percentage
                                                             1999            1998         Change       Change
                                                          -----------     ---------     ---------    ----------
<S>                                                       <C>             <C>           <C>             <C>
Staffing Income ......................................... $11,319,000     8,942,000     2,377,000       26.6 %
Premiums earned .........................................   4,141,000     4,350,000      (209,000)      (4.8)%
Net commission income:
  Workers' compensation .................................     284,000       393,000      (109,000)     (27.7)%
  Package ...............................................      17,000        93,000       (76,000)     (81.7)%
  Other, net ............................................      40,000        41,000        (1,000)      (2.4)%
                                                          -----------    ----------     ---------       ----
     Total net commission income ........................     341,000       527,000      (186,000)     (35.3)%
Net investment income ...................................     457,000       505,000       (48,000)      (9.5)%
Other income ............................................      76,000       125,000       (49,000)     (39.2)%
                                                          -----------    ----------     ---------       -----
     Total revenues ..................................... $16,334,000    14,449,000     1,885,000       13.0 %
                                                          ===========    ==========     =========       =====
Workers' compensation:
  Premiums collected .................................... $ 3,437,000     4,276,000
                                                          ===========    ==========
  Ratio of net commission income/premiums
    collected ...........................................         8.3%         9.2%
                                                          ===========    =========
</TABLE>

     Staffing income increased $2,377,000 or 26.6% as a result of the
acquisition of certain of the assets of Travel Nurse (acquired in March 1998)
and the increase in business related to the acquisition and merger of NET
Healthcare. Premiums earned decreased $209,000 or 4.8% for the three months
ended June 30, 1999 as compared to the 1998 comparable period as a result of
the decrease in the book of business. Workers' compensation commission income
decreased $109,000 or 27.7% for the three months ended June 30, 1999 as
compared to the 1998 comparable period as a result of the decrease in premiums
collected of $839,000, which was attributable to the decrease in the workers'
compensation book of business. Package commission income decreased $76,000 or
81.7% for the three months ended June 30, 1999 as compared to the 1998
comparable period as a result of a reduction in the business written for fast
food restaurants. Other net commission income decreased $1,000 or 2.4% for the
three months ended June 30, 1999 as compared to the 1998 comparable period as a
result of the decrease in volume of small business plan premiums collected. Net
investment income decreased $48,000 or 9.5% and other income



                                       25





<PAGE>   26
decreased $49,000 or 39.2% for the three months ended June 30, 1999 as compared
to the 1998 comparable period as a result of the effects of the retroactive
insurance accounting treatment of Preferred Reinsurance as discussed more fully
in Note 1 (c) to the Company's consolidated financial statements.

     Total Operating Expenses. Total operating expenses for the three months
ended June 30, 1999 were $15,722,000 compared to $13,372,000 for the 1998
comparable period, representing an increase of $2,350,000 or 17.6%. Total
operating expenses for the three months ended June 30, 1998 were $13,372,000
compared to $5,908,000 for the 1997 comparable period, representing an increase
of $7,464,000 or 126.3%.

     The following table provides a comparison of total operating expenses for
the three months ended June 1999 and 1998 by category:

<TABLE>
<CAPTION>

                                                                                          Net       Percentage
                                                              1999            1998       Change       Change
                                                          -----------      ---------    ---------   ----------
<S>                                                       <C>              <C>          <C>            <C>
Staffing costs ........................................   $ 8,733,000      6,820,000    1,913,000      28.0 %
Losses and loss adjustment expenses incurred ..........     2,278,000      2,349,000      (71,000)     (3.0)%
Amortization of deferred acquisition costs ............     1,371,000      1,464,000      (93,000)     (6.4)%
Other operating expenses ..............................     3,340,000      2,739,000      601,000      21.9 %
                                                          -----------     ----------    ---------      ----
  Total operating expenses .............................. $15,722,000     13,372,000    2,350,000      17.6 %
                                                          ===========     ==========    =========      ====
</TABLE>

     Staffing costs increased $1,913,000 or 28.0% consistent with the increase
in staffing revenues for the three months ended June 30, 1999 as discussed
above. The major risk associated with the Company's entry into the reinsurance
business is that the Company may experience an adverse loss ratio. In an effort
to minimize such risk, the Company has obtained aggregate liability reinsurance
coverage which limits its exposure to a maximum 70% loss ratio as more fully
discussed in Note 1(c) to the Company's consolidated financial statements. The
underwriting gains recognized by the Company is the most significant benefit
realized by the Company as a result of its entry into the reinsurance business.
Losses and loss adjustment expenses incurred (i) decreased $71,000 or 3.0% which
is consistent with the decrease in premiums earned for the three months ended
June 30, 1999 as discussed above and (ii) were 55.0% and 54.0% of premiums
earned for the three month periods ended June 30, 1999 and June 30, 1998,
respectively. Amortization of deferred acquisition costs (i) decreased $93,000
or 6.4% which is also consistent with the decrease in premiums earned during the
three months ended June 30, 1999 as discussed above and (ii) were 33.1% and
33.7% of premiums earned for the three month periods ended June 30, 1999 and
1998, respectively. As a result, the underwriting gain, expressed as a
percentage of earned premium, was 11.9% and 12.3% for the three month periods
ended June 30, 1999 and 1998, respectively.

     Other operating expenses increased $601,000 or 21.9%. The following
table provides a comparison of other operating expenses for the three months
ended June 30, 1999 and 1998 by category:

<TABLE>
<CAPTION>

                                                                                          Net       Percentage
                                                              1999            1998       Change       Change
                                                          -----------      ---------    ---------   ----------
<S>                                                       <C>              <C>          <C>            <C>
Personnel costs .........................................  $1,881,000      1,592,000      289,000       18.2 %
Occupancy expenses ......................................     214,000        223,000       (9,000)      (4.0)%
Professional fees .......................................     462,000        189,000      273,000      144.4 %
Other operating expenses ................................     783,000        735,000       48,000        6.5 %
                                                           ----------      ---------      -------      -----
  Total other operating expenses ........................  $3,340,000      2,739,000      601,000       21.9 %
                                                           ==========      =========      =======      =====
</TABLE>

     Personnel costs increased $289,000 or 18.2% as a result of annual salary
increases together with the increased staff related to the acquisition of the
assets of Travel Nurse and the growth in the business of NET Healthcare.
Occupancy expenses decreased $9,000 or 4.0% principally as a result of changing
to a long distance carrier with lower rates. Professional fees increased
$273,000 or 144.4% principally as a result of increased legal, accounting and
actuarial fees associated with various corporate and acquisition matters. Other
operating expenses increased $48,000 or 6.5% primarily related to the increased
advertising and promotional expenses, which increased as a result of the
expansion of the staffing business.

     Total Non-Operating Expenses. Total non-operating expenses for the three
months ended June 30, 1999 were $337,000 compared to $395,000 for the 1998
comparable period. Amortization of intangible assets and other non-operating
expenses decreased $57,000, primarily related to the acquisition and merger of
NET Healthcare.



                                       26


<PAGE>   27




FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998

     Total Revenues Total revenues for the six months ended June 30, 1999 were
$31,880,000 compared to $24,506,000 for the 1998 comparable period,
representing a net increase of $7,374,000 or 30.1%. Total revenues for the six
months ended June 30, 1998 were $24,506,000 compared to $11,473,000 in the 1997
comparable period, representing a net increase of $13,033,000 or 113.6%.

     The following table provides a comparison of revenues for the six months
ended June 30, 1999 and 1998 by category:

<TABLE>
<CAPTION>

                                                                                          Net       Percentage
                                                              1999            1998       Change       Change
                                                          -----------      ---------    ---------   ----------
<S>                                                       <C>              <C>          <C>            <C>
Staffing Income ......................................... $22,172,000    14,863,000     7,309,000        49.2 %
Premiums earned .........................................   7,883,000     7,417,000       466,000         6.3 %
Net commission income:
  Workers' compensation .................................     570,000       809,000      (239,000)      (29.5)%
  Package ...............................................      71,000       182,000      (111,000)      (61.0)%
  Other, net ............................................      81,000        79,000         2,000         2.5 %
                                                          -----------    ----------     ---------       -----
    Total net commission income .........................     722,000     1,070,000      (348,000)      (32.5)%
    Net investment income ...............................     892,000       892,000            --          --
    Other income ........................................     211,000       264,000       (53,000)      (20.1)%
                                                          -----------    ----------     ---------      ------
    Total revenues ...................................... $31,880,000    24,506,000     7,374,000        30.1 %
                                                          ===========    ==========     =========      ======
Workers' compensation:
  Premiums collected .................................... $ 6,366,000     7,982,000
                                                          ===========    ==========
  Ratio of net commission income/premiums
    collected ...........................................         9.0%         10.1%
                                                          ===========    ==========
</TABLE>

     Staffing income increased $7,309,000 or 49.2% as a result of the
acquisition of certain of the assets of Travel Nurse (acquired in March 1998)
and the increase in business related to the acquisition and merger of NET
Healthcare. Premiums earned increased $466,000 or 6.3% for the six months ended
June 30, 1999 as compared to the prior year as a result of new business and
renewals of the prior year business. Workers' compensation commission income
decreased $239,000 or 29.5% for the six months ended June 30, 1999 as compared
to the 1998 comparable period as a result of the decrease in premiums collected
of $1,616,000, which was attributable to the decrease in the workers'
compensation book of business. Package commission income decreased $111,000 or
61.0% for the six months ended June 30, 1999 as compared to the 1998 comparable
period as a result of a reduction in the business written for fast food
restaurants. Other net commission income increased $2,000 or 2.5% for the six
months ended June 30, 1999 as compared to the 1998 comparable period as a
result of the increase in volume of small business plan premiums collected.
Other income decreased $53,000 or 20.1% as a result of the effects of the
retroactive insurance accounting treatment of Preferred Reinsurance as
discussed more fully in Note 1(c) to the Company's consolidated financial
statements.

     Total Operating Expenses. Total operating expenses for the six months
ended June 30, 1999 were $30,333,000 as compared to $22,567,000 for the 1998
comparable period, representing an increase of $7,766,000 or 34.4%. Total
operating expenses for the six months ended June 30, 1998 were $22,567,000 as
compared to $10,897,000 for the 1997 comparable period, representing an
increase of $11,670,000 or 107.1%.



                                       27



<PAGE>   28
      The following table provides a comparison of total operating expenses for
the six months ended June 30, 1999 and 1998 by category:

<TABLE>
<CAPTION>

                                                                                          Net       Percentage
                                                              1999            1998       Change       Change
                                                          -----------      ---------    ---------   ----------
<S>                                                       <C>              <C>          <C>            <C>
Staffing costs .......................................... $17,061,000       11,597,000   5,464,000      47.1%
Losses and loss adjustment expenses incurred ............   4,336,000        4,005,000     331,000       8.3%
Amortization of deferred acquisition costs ..............   2,609,000        2,445,000     164,000       6.7%
Other operating expenses ................................   6,327,000        4,520,000   1,807,000      40.0%
                                                          -----------      -----------   ---------      ----
 Total operating expenses ............................... $30,333,000       22,567,000   7,766,000      34.4%
                                                          ===========      ===========   =========      ====
</TABLE>

     Staffing costs increased $5,464,000 or 47.1% consistent with the increase
in staffing revenues for the six months ended June 30, 1999 as discussed above.
The major risk associated with the Company's entry into the reinsurance business
is that the Company may experience an adverse loss ratio. In an effort to
minimize such risk, the Company has obtained aggregate liability reinsurance
coverage which limits its exposure to a maximum 70% loss ratio as more fully
discussed in Note 1(c) to the Company's consolidated financial statements. The
underwriting gains recognized by the Company is the most significant benefit
realized by the Company as a result of its entry into the reinsurance business.
Losses and loss adjustment expenses incurred (i) increased $331,000 or 8.3%
which is consistent with the increase in premiums earned for the six months
ended June 30, 1999 as discussed above and (ii) were 55% and 54% of premiums
earned for the six month periods ended June 30, 1999 and 1998, respectively.
Amortization of deferred acquisition costs (i) increased $164,000 or 6.7% which
is also consistent with the increase in premiums earned for the six months ended
June 30, 1999 and 1998, respectively. As a result, the underwriting gain,
expressed as a percentage of earned premium, was 11.9% and 13.0% for the six
month periods ended June 30, 1999 and 1998, respectively.


      Other operating expenses increased $1,807,000 or 40.0%. The following
table provides a comparison of other operating expenses for the six months ended
June 30, 1999 and 1998 by category:

<TABLE>
<CAPTION>

                                                                                          Net       Percentage
                                                              1999            1998       Change       Change
                                                          -----------      ---------    ---------   ----------
<S>                                                       <C>              <C>          <C>            <C>
Personnel costs ........................................  $3,637,000        2,673,000     964,000       36.1%
Occupancy expenses .....................................     432,000          344,000      88,000       25.6%
Professional fees ......................................     737,000          332,000     405,000      122.0%
Other operating expenses ...............................   1,521,000        1,171,000     350,000       29.9%
                                                          ----------        ---------   ---------      -----
 Total other operating expenses ........................  $6,327,000        4,520,000   1,807,000       40.0%
                                                          ==========        =========   =========      =====
</TABLE>


      Personnel costs increased $964,000 or 36.1% as a result of annual salary
increases together with the increased staff related to the acquisition of the
assets of Travel Nurse and the growth in the business of NET Healthcare.
Occupancy expenses increased $88,000 or 25.6% principally as a result of the
lease of additional office space and relocation of our subsidiary Preferred
Healthcare Staffing, Inc. Professional fees increased $405,000 or 122.0%
principally as a result of increased legal, accounting and actuarial fees
associated with various corporate and acquisition matters. Other operating
expenses increased $350,000 or 29.9% primarily related to the following: (i)
increased insurance expense of $20,000, (ii) increased corporate fees and
services of $64,000, (iii) increased investment and service fees of $40,000,
and (iv) increased advertising and promotional expenses of $147,000. Insurance
expense increased as a result of the purchase of additional coverages (i.e.,
directors and officers liability insurance) and increased premiums due to
increased limits. Corporate fees and services, advertising and promotional, and
investment and service fees increased as a result of the expansion of the
staffing business.

      Total Non-Operating Expenses. Total non-operating expenses for the six
months ended June 30, 1999 were $676,000 compared to $697,000 for the 1998
comparable period. Interest expense increased $78,000 as a result of the
Company's private placement in May 1998 of 7% convertible subordinated notes in
the aggregate principal amount of $10,580,000 and borrowings under a revolving
line of credit.

      Amortization of intangible assets and other non-operating expenses
decreased $100,000, primarily related to the acquisition and merger of NET
Healthcare.



                                       28
<PAGE>   29
LIQUIDITY AND CAPITAL RESOURCES

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

     For the six months ended June 30, 1999, net cash and investments were
$37,679,000 (net of premiums payable of $1,835,000). Net cash provided by
operating activities for the six months ended June 30, 1999 increase to
$7,135,000 from $1,524,000 in the 1998 comparable period, an increase of
$5,611,000. This increase resulted primarily from decreases in accounts
receivable, deferred acquisition cost in unpaid losses and loss adjustment
expenses and premiums of $6,544,000, $1,056,000, and $3,587,000, respectively,
and increases in unpaid losses and loss adjustment expenses and premiums,
commissions and other insurance balances of $423,000 and $125,000, respectively.
The decrease in accounts receivable was primarily associated with increased
collection efforts of the staffing company during 1999. The increases in unpaid
losses and loss adjustment expenses and premiums, commissions and other
insurance balances are consistent with the increase in premiums earned during
1999. The decreases in unearned premiums and deferred acquisition costs are
consistent with a decrease in reinsurance premiums receivable during 1999.

     Cash flows used in investing activities decreased to $2,183,000 for the
six months ended June 30, 1999 from $13,526,000 for the six months ended June
30, 1998, a decrease of $11,343,000. This decrease resulted primarily from the
decrease of net investment purchases of $6,487,000 and the acquisition of
certain of the assets of Travel Nurse for $5,000,000 in cash during the first
quarter of 1998 as discussed in the Note 1 (b) to our consolidated financial
statements included herein.

     A decrease in cash flows from financing activities for the six months
ended June 30, 1999 reflects the repayment of a portion of the revolving line
of credit of $1,364,000 and payment of a bank overdraft of $518,000, compared
to the net proceeds received from the private placement of convertible
subordinated notes of $9,622,000 and borrowings under the revolving line of
credit of $2,000,000 and the repayment of a bank overdraft of $38,000 for the
comparable period in 1998.

     Financings. In May 1998, Preferred Staffing entered into a $3,000,000
unsecured revolving line of credit with a bank (the "Credit Facility").
Outstanding borrowings under the Credit Facility bear interest at the bank's
base rate of interest. Interest under the Credit Facility is due and payable
monthly and all unpaid principal and interest is due on May 2, 2000.
Outstanding borrowings under the Credit Facility are secured by our guarantee.
As of June 30, 1999, outstanding borrowings under the Credit Facility were
approximately $486,000 and bore interest at the rate of 7 3/4% per annum.

     In May 1998, we also consummated a $10,580,000 private placement of 7%
convertible subordinated notes due May 2003. The principal amount of the notes
is convertible at the option of the holder into shares of our common stock, at
a conversion price of $9.00 per share, at any time prior to the earlier of May
12, 2003 or ten business days after the receipt of a termination notice (as
defined in the notes). The notes generally prohibit or restrict, among other
things, our ability to incur liens and indebtedness, make certain fundamental
corporate changes and specified investments and conduct certain transactions
with affiliates. At June 30, 1999, the principal amount outstanding under the
7% convertible subordinated notes was $10,535,000.

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



                                      29

<PAGE>   30
YEAR 2000

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

     We have developed a plan with respect to evaluating and upgrading our core
information technology systems so that they are Year 2000 compliant. Two
vendors primarily supply software to us for use in our operations. One vendor
supplies the software used by our insurance operations and another vendor
supplies the software used by our staffing operations. The vendors have each
advised us that the latest upgrades of the software used in our operations are
Year 2000 compliant. We implemented these software upgrades, and we are
currently testing the upgraded software for Year 2000 compliancy. We intend to
finish the testing step during the third quarter of 1999. The historical and
currently projected costs relating to these upgrades and Year 2000 compliance
are not material.

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

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

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

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

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

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

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCUSSIONS ABOUT MARKET RISK

     Not Applicable.



                                      30

<PAGE>   31
                          PART II: OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

     Not Applicable.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.

     Not Applicable.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

     Not Applicable.

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

     Not Applicable.

ITEM 5. OTHER INFORMATION.

     Not Applicable.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.

      (a) The following exhibits are included in this Quarterly Report a Form
10-Q:

     27.1  Financial Data Schedule

      (b) Reports on Form 8-K. The Company's Current Report on Form 8-K dated
May 7, 1999 (filed on May 12, 1999).




                                      31




<PAGE>   32
                                   SIGNATURE

     Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto, duly authorized.



                                           PREFERRED EMPLOYERS HOLDINGS, INC.



                                           By: /s/ WILLIAM R. DRESBACK
                                               --------------------------------
                                               William R. Dresback
                                               Senior Vice President and Chief
                                               Financial Officer (principal and
                                               chief accounting officer and
                                               duly authorized to sign on behalf
                                               of the Registrant)



Date: October 25, 1999





                                      32