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                                    FORM 10-K

                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) of
                       the SECURITIES EXCHANGE ACT OF 1934
 
For the year ended December 31, 1997

Commission file number 0-19294

                              RehabCare Group, Inc.
             (Exact name of Registrant as specified in its charter)

    Delaware                                             51-0265872
(State or other jurisdiction of            (I.R.S. Employer Identification No.)
 incorporation or organization)

          7733 Forsyth Boulevard, 17th Floor, St. Louis, Missouri 63105
              (Address of principal executive offices and zip code)

Registrant's telephone number, including area code (314) 863-7422

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share           Preferred Stock Purchase Rights

         Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the  Securities  Exchange  Act of
1934  during  the  preceding  12 months  (or for such  shorter  period  that the
Registrant was required to file such reports),  and (2) has been subject to such
filing requirements for the past 90 days.

                          Yes   x                No

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

         The aggregate  market value of voting stock held by  non-affiliates  of
Registrant  at March  13,  1998,  was  $139,415,274.  At  March  13,  1998,  the
Registrant had 5,969,289 shares of Common Stock outstanding.

                       DOCUMENTS INCORPORATED BY REFERENCE

         Part III of this Annual Report on Form 10-K  incorporates  by reference
information contained in the Registrant's Proxy Statement for its annual meeting
of stockholders to be held May 5, 1998.






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                                     PART I

ITEM 1.      BUSINESS

General

      RehabCare Group,  Inc. (the "Company" or the  "Registrant"),  is a leading
provider  to  healthcare  facilities  of  comprehensive  medical  rehabilitation
programs, subacute (skilled nursing) programs and outpatient therapy programs on
a  multi-year  contract  basis.  The  Company  also  is a  leading  provider  of
therapists to hospitals and long-term care and rehabilitation facilities on both
an interim and permanent basis.  Therapy  professionals  employed by the Company
include  licensed  physical  and  occupational  therapists  and  their  licensed
assistants,  as well as speech language  pathologists.  The Company believes the
locus of care in the communities  where it has contracts will continue to be the
acute-care  hospital and, thus, it works primarily with acute-care  hospitals to
deliver these programs with the goal of enhancing the overall economic viability
of the client  facility.  The  Company's  strategy is to use its  expertise  and
experience to provide its clients with an efficient and cost-effective  means to
offer physical medicine and rehabilitation  services in whatever setting is most
economically  feasible  while  establishing  long-term  relationships  with  its
clients.  Each of the product  lines the Company  offers is part of a post-acute
continuum directed at restoring  functional  independence and returning patients
to a residential setting.

      On January  28,  1997,  the Company  acquired  TeamRehab,  Inc.  and Moore
Rehabilitation Services, Inc. ("Team and Moore"), a provider of contract therapy
to hospitals and nursing  homes.  On June 12, 1997,  the Company  acquired Rehab
Unlimited,  Inc., also a provider of contract  therapy that was merged with Team
and Moore.  On August 15,  1997,  the Company  acquired a 40% interest in Allied
Therapy  Services,  L.L.C.,  a joint venture with one of its hospital clients to
provide outpatient  therapy to school systems,  home health agencies and nursing
homes through the acquisition of local independent therapy providers.

      Historically,  the Company  has sought to broaden  its service  offerings,
both through  internal  growth and  acquisition.  To its basic business of acute
inpatient  units,  it has added the  services  of the  subacute  and  outpatient
product  lines for its  hospital  clients  as well as the  addition  of  therapy
staffing and contract management to hospitals and long-term care facilities. The
Company  believes that the  acquisition  of  therapy-based  contract  management
companies,  established  outpatient operators and other therapy providers within
the rehabilitation  industry is an appropriate  strategy for growth.  Additional
related acquisition opportunities are regularly reviewed by the Company.

Industry Overview

      Many healthcare  providers are  increasingly  seeking to outsource a broad
range of services  through  contracts  with product line  managers.  Outsourcing
allows  healthcare  providers to take advantage of the specialized  expertise of
contract  managers,  thereby enabling providers to concentrate on the businesses
they know best,  such as facility and nurse  management.  The trend to lower the
cost of  healthcare  by  reducing  lengths  of stay  has  left  most  healthcare
providers with empty beds. As overhead and operating cost  constraints have come
into place and manpower has been reduced,  outsourcing has become more important
in order to  increase  patient  volumes  and  provide  services  at a lower cost
without sacrificing quality.

      By outsourcing  post-acute  services,  healthcare  providers use specialty
contract managers such as the Company to:

      Utilize unused space - Post-acute  services help  hospitals  utilize empty
wings of their facilities that have resulted from the shortening of stays in the
acute-care  setting.  Use of this space also allows the  hospital to recover the
cost of capital investment and overhead associated with the space.


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      Retain patients - Patients needing less intensive treatment who would have
been  referred  to other  venues for  treatment  can now remain in the  hospital
setting, allowing hospitals to capture revenues that would otherwise be realized
by another provider.

      Sign   agreements   with  managed  care   organizations   -  Managed  care
organizations  find it more  advantageous to sign a contract covering both acute
and  post-acute  services  with one entity rather than several  separate,  often
unrelated  entities.  Contract managers may provide patient  evaluation  systems
that  collect  data on  patients  in each of their  units  showing the degree of
improvement  and the related  costs from the time the patient is admitted to the
post-acute  program through the time of discharge.  This is an important feature
to  managed  care  organizations  in  controlling  their  costs  while  assuring
appropriate  outcomes.  Contract  managers  may often  also have the  ability to
capture and analyze this information from a large number of acute rehabilitation
and subacute units,  which an individual  hospital could not otherwise do on its
own without a substantial investment in specialized systems.  Becoming part of a
managed care network helps the hospital attract  physicians,  and in turn, bring
more patients to the hospital.

      Increase  cost  control  -  Because  of  their  extensive   experience  in
post-acute  product lines,  contract managers can offer pricing  structures that
effectively  control a  healthcare  provider's  financial  risk  related  to the
service provided. Contract managers also frequently share in the financial risks
with their hospital clients of any losses the hospital incurs in connection with
starting the unit and  reimbursement  from payors.  For hospitals using contract
managers,  the result is often lower average  costs per discharge  than those of
self-managed  programs.  A hospital is able to  increase  its  revenues  without
having to increase its administrative staff or incur other fixed costs.

      Recruit  therapists - Therapists are  frequently not readily  available in
sufficient number in many communities across the nation. Contract managers often
operate tele-recruiting  departments with recruiters whose job it is to match up
candidates  with  therapist   openings.   They  will  typically  maintain  close
connections  with  therapy  schools and attend  regional  and  national  therapy
association conferences several times a year.

      Obtain  reimbursement  advice - The  contract  managers  may  also  employ
reimbursement  specialists  who are  available  to assist  client  hospitals  in
interpreting   complicated   regulations.   These  specialists  analyze  current
regulations  and assist the  hospital in complying  with them,  a highly  valued
service in the current changing healthcare environment.

Services

      Acute  Rehabilitation  Units - Since its inception in 1982,  the Company's
core business has been the staffing and management of acute rehabilitation units
within  acute-care  hospitals.  The Company  operates these units on a fee basis
that is  computed  in most  cases  based on patient  days in the unit.  The unit
typically  consists of 20 beds and utilizes formerly idle space in the hospital.
It treats patients having primarily one of the ten required diagnoses  including
stroke, head injury or hip replacement. The Company typically provides marketing
and management of the unit including a program director, a physician, as well as
the clinical staff which may include a psychologist,  physical and  occupational
therapists,  a speech  pathologist,  a social worker,  a nurse  manager,  a case
manager  and  other  appropriate  supporting  personnel.  The unit  affords  the
hospital  the  ability to offer  rehabilitation  services to its  patients  thus
retaining  those patients who might otherwise be discharged to a setting outside
the hospital.  This product line represented  approximately 53% of the Company's
revenues  in 1997.  The  Company  plans to  continue  growing  this  part of its
business both through the signing of new contracts as well as through  retention
of current clients.  Re-signings of expiring acute rehabilitation contracts have
historically  been at the 80% level,  however,  in 1997,  this rate increased to
over 90% on contracts that had terms expiring in such year.

      Subacute Units - In 1994, the Company added the subacute service line. The
subacute unit is located in the acute-care  hospital and is separately  licensed
as a skilled nursing unit,  utilizing formerly idle space in the hospital.  This
unit  treats  the  patients  who  are at the  low end of  need  for  medical  or
rehabilitative care, with

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greater need for nursing care. These patients'  diagnoses cover approximately 60
clinical  conditions  including  stroke,  post-surgical  conditions,   pulmonary
disease,  burn,  cancer,  congestive  heart  failure and wound  management.  The
subacute unit makes it possible for the patient to remain in a hospital  setting
where  emergency  needs  can be  quickly  met as  opposed  to  being  sent  to a
freestanding skilled nursing facility.  The Company provides  administrative and
nurse management.  The hospital benefits,  once again, by retaining patients who
would be discharged to another setting, thereby capturing additional revenue and
utilizing  idle space.  This service line  represented  approximately  7% of the
Company's  revenues in 1997.  The Company plans to continue to grow this line of
business by signing additional contracts.

      Outpatient  Programs  - In  October  1994,  RehabCare  acquired  RehabCare
Outpatient  Services,  Inc.  ("ROSI"),  a  contract  manager  of  hospital-based
outpatient  programs.  At its outpatient  locations,  ROSI  furnishes  primarily
therapy, program development and administrative personnel.  Pressure from payors
to move patients to lower cost settings has helped fuel the growth in outpatient
services.  Outpatient programs help bring patients into the hospital through the
referral  development  efforts of ROSI in the community.  These programs serve a
younger  population  reimbursed by commercial  and managed care payors and treat
mainly  sports  medicine and worker's  compensation  patients.  The service line
helps hospitals  compete with freestanding  clinics.  ROSI's programs are always
conducted on the client hospital's campus or in satellite  locations  controlled
by the  hospital.  The Company  signed a joint  venture with one of its hospital
clients in 1997 to purchase an outpatient facility enabling the client to expand
its business.  In 1997, this product line  represented  approximately  6% of the
Company's  revenues.  The  Company  plans to  increase  this line of business by
signing  additional  contracts  with  hospitals as well as  purchasing  existing
outpatient facilities in partnership with its hospital clients.

      Therapy Staffing - In March 1996,  RehabCare acquired  Healthcare Staffing
Solutions, Inc. ("HSSI"), located in Lowell, Massachusetts, thereby entering the
therapy staffing business.  Through its Health Tour division,  HSSI recruits and
relocates  physical,   occupational  and  speech  therapists  to  hospitals  and
long-term  care  facilities  for  typically   13-week   assignments   (traveling
therapists).  HSSI started two new divisions in 1997:  Health Star, which places
therapists  in permanent  positions,  and Quick Staff,  now operating in Boston,
Irvine, Orlando and Dallas, which provides therapists for short-term assignments
ranging  from 1 day to 13  weeks  to fill  vacancies  typically  resulting  from
turnover,  vacation,  maternity and sick leave.  HSSI is the largest provider of
traveling therapists to nursing homes, acute-care hospitals and contract therapy
companies. Business from therapy staffing accounted for approximately 29% of the
Company's  1997  revenues.  The  benefit to the client is having the  ability to
obtain a therapist on short notice. Growth of this business is planned primarily
by increasing the number of traveling therapists on assignment and the number of
Quick Staff locations in operation.

      Contract  Therapy - In January 1997,  the Company  acquired Team and Moore
which added  contract  therapy to its  product  lines.  Contract  therapy is the
management  and  delivery  of  services,   including  providing  therapists,  in
long-term care settings. A follow-on  acquisition was made in June 1997 of Rehab
Unlimited,  Inc. and Cimarron Health Care, Inc. also providing  contract therapy
services to long-term care facilities.  These entities became a part of Team and
Moore with a combined total of 44 facilities in Missouri.  Since 1989,  when the
implementation  of the Omnibus  Budget  Reconciliation  Act of 1987 mandated the
delivery of therapy services in long-term care facilities, these facilities have
found it increasingly  difficult to recruit and retain an appropriate complement
of qualified therapists to deliver mandated services.  Contract therapy revenues
in 1997  accounted  for  approximately  5% of the Company's  business.  Contract
therapy  affords the client the opportunity to fulfill their need for therapists
on a part-time basis without the need to add full-time  staff. The Company plans
to  grow  this  service  line  both  through  additional  contracts  as  well as
acquisitions.

Expansion Strategy

      The  Company's  expertise is in  delivering  quality  acute,  subacute and
outpatient  rehabilitation  and  therapy  programs,  services  and  professional
personnel.  Drawing on this expertise, the thrust of its expansion strategy will
be to  develop  and  expand  contract  relationships  with  host  facilities  to
establish  and manage  acute,  subacute  and  outpatient  physical  medicine and
rehabilitation programs as well as provide therapy staffing and contract therapy
services.  Acute-care  hospitals have traditionally been the focus of healthcare
delivery in the community

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and as such,  have  controlled  a  substantial  amount of the  expenditures  for
healthcare  services.  As healthcare  reform evolves,  the Company believes that
hospitals  will  continue to play a central role in the  delivery of  healthcare
services,  providing  that they can  achieve  cost  efficiencies  and  provide a
complete range of services required within their  communities.  To this end, the
Company  has  positioned  itself  to  assist  hospitals  in  providing  the full
continuum  of  physical  medicine  and  rehabilitation  services  within  acute,
subacute and outpatient  settings  controlled by the hospital.  The economies of
scale offered by the hospital's  existing plant and equipment,  coupled with the
Company's  expertise in delivering these services,  offers the opportunity for a
community  hospital  to be a full  service  provider  in the  area  of  physical
medicine and rehabilitation on a cost-effective basis.

Business Development

     The Company's  sales force  focuses on  generating  new accounts and making
follow-on sales. It has seven regional  development officers who are responsible
for  cultivating  relationships  with  prospective  clients.  In  addition,  the
Company's  officers play an integral role in the  Company's  marketing  efforts.
With a broad  range of  services,  the Company has  significant  opportunity  to
expand within its existing  client base.  Further,  cross-selling  more than one
product  line  strengthens  the  Company's   relationships   with  its  clients.
Competition

      The  Company  has no direct  competitors  offering  all the same  services
although other companies may offer one or more of the same services. The Company
competes with other  contract  management  and therapy  companies for agreements
with acute-care  hospitals and extended care facilities.  The Company's programs
in  acute-care  hospitals  also compete for patients  with the programs of other
acute-care hospitals and freestanding  rehabilitation and outpatient facilities.
Among the  principal  competitive  advantages  the  Company  believes it has are
reputation for quality,  cost effectiveness,  a proprietary  outcomes management
system, innovation and price. The Company also competes with hospitals,  nursing
homes,  clinics,  physicians'  offices and contract  therapy  companies  for the
services of physical, occupational and speech therapists.

Regulation

      The  healthcare  industry  is  regulated  by  Federal,   state  and  local
governmental  agencies.  These  regulations  attempt  to  control  the growth of
healthcare   facilities   through   certificate  of  need  laws,   licensure  or
certification  of healthcare  facilities  and the  reimbursement  for healthcare
services.

      In  many  states,   acute-care  hospitals  contracting  with  the  Company
generally are not required to obtain a  certificate  of need prior to opening an
inpatient unit. If a certificate of need is required, the process may take up to
12 months  depending upon the state  involved.  The application may be denied if
contested by a competitor or the state agency.  Certificates of need are usually
issued for a specified  maximum  expenditure and require  implementation  of the
proposed improvement within a specified period of time.

      Licensure is a state or local requirement, while Medicare certification is
a Federal requirement.  Generally,  licensure and Medicare  certification follow
specific  standards and requirements.  Compliance is monitored by annual on-site
inspections  by  representatives  of  relevant  government  agencies.   Loss  of
licensure or Medicare  certification  by a hospital with which the Company has a
management contract would likely result in the termination of that contract.

      Prior to 1983,  Medicare  provided for  reimbursement of reasonable direct
and  indirect  costs of the services  furnished  by hospitals to patients.  As a
result of the Social  Security  Amendments  Act of 1983,  Congress  adopted  the
Prospective  Payment System ("PPS") as a means to control costs of most Medicare
inpatient hospital services.  Under this system, the Secretary of the Department
of Health and Human  Services  established  fixed payment  amounts per discharge
based on Diagnosis-Related  Groups ("DRG"). In general, a hospital's payment for
Medicare  inpatients  is  limited to the DRG rate,  regardless  of the amount of
services  provided to the patient or the length of the patient's  hospital stay.
Under PPS, a hospital may keep any difference between its DRG

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payment and its operating costs incurred in furnishing  inpatient services,  but
is at risk for any  operating  costs that exceed its payment  rate. As a result,
hospitals  have  an  incentive  to  discharge  Medicare  patients  as soon as is
clinically appropriate.

      Inpatient   rehabilitation   and  skilled  nursing  units  and  outpatient
rehabilitation  services are exempt from PPS. Acute  rehabilitation units within
acute-care  hospitals  are eligible to obtain an exemption  from PPS,  generally
after the first  year of  operation,  upon  satisfaction  of  specified  Federal
criteria. Such criteria include the operation for a full 12 months under PPS and
the completion of an initial  exemption  survey.  The exemption  survey measures
compliance with certain criteria applicable to exempt units generally, including
approval to  participate as a Medicare  provider,  admission  standards,  record
keeping,  compliance with state licensure laws,  segregation of beds, accounting
standards and certain specific  standards  applicable to  rehabilitation  units,
including  staffing,  medical care and patient mix. Skilled nursing units may be
surveyed shortly after admitting their first patient. Upon successful completion
of the survey, Medicare payments for rehabilitation and skilled nursing services
provided in inpatient units are made under a cost-based reimbursement system.

      In 1997,  Congress enacted the Balanced Budget Act of 1997, which includes
numerous  changes  to  the  Medicare  system.   These  changes  include  various
reductions in payments under the current  cost-based  reimbursement  system, the
implementation  of a prospective  payment system for skilled nursing  facilities
and units to be phased in starting  July 1998 and a prospective  payment  system
for  acute  rehabilitation  facilities  and units to be phased in over two years
starting  in  late  2000.  Although  specifics  of  these  systems  are  not yet
available,   the  changes  will  almost  certainly  favor  low-cost,   efficient
providers.  The Company believes that its strategy of administering  programs on
the premises of host facilities positions it well for the changing reimbursement
environment.  In addition,  the aging  population  will continue to increase the
demand for therapy staffing services.

      Various Federal and state laws regulate the relationship between providers
of healthcare services and physicians.  These laws include the "fraud and abuse"
provisions of the Social Security Act, under which civil and criminal  penalties
can be  imposed  upon  persons  who pay or  receive  remuneration  in return for
referrals of patients who are eligible for  reimbursement  under the Medicare or
Medicaid programs.  The Company does not believe its business  arrangements with
physicians who admit patients to the Company's  units are out of compliance with
these  provisions.  The  provisions  are broadly  written and the full extent of
their  application  is  not  currently  known.  The  Inspector  General  of  the
Department  of Health and Human  Services has issued "safe  harbor"  regulations
specifying  certain forms of relationships that will not be deemed violations of
these provisions.  The Company believes that its business  arrangements with its
medical directors are in compliance with any definitive regulations.

      In 1987,  Congress  enacted nursing home reform  provisions in response to
widespread  concern that nursing homes were not providing patients with adequate
care.  These  provisions  were  implemented in 1990 and included the requirement
that the status of every  resident  be  evaluated  and  appropriate  services be
provided,  including  rehabilitative  services.  As a  result,  the  demand  for
physical,  occupational and speech therapy services and professionals in nursing
homes has risen sharply since 1990.

Employees

      As of December 31, 1997, the Company had  approximately  2,366  employees.
The  physicians  who are the medical  directors  of the  contract  units and the
psychologists serving on program treatment teams are independent contractors and
not employees of the Company.  None of the Company's  employees are subject to a
collective bargaining agreement.  Management considers the relationship with its
employees to be good.

ITEM 2.      PROPERTIES

      The Company  currently leases 15,000 square feet of executive office space
in Clayton,  Missouri,  with an additional  8,000 square feet commencing in July
1998 under a lease that expires in the year 2008,  assuming all options to renew
are  exercised.  In  addition to the monthly  rental  cost,  the Company is also
responsible for

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specified  increases  in  operating  costs.  HSSI leases  31,000  square feet of
executive office space in Lowell,  Massachusetts,  under a lease that expires in
the year 2005, assuming all options to renew are exercised,  plus leases various
properties throughout the country used as temporary housing for therapists. Team
and Moore  leases  3,000  square  feet of  executive  office  space in  Clayton,
Missouri under a lease that expires in 1998.

ITEM 3.      LEGAL PROCEEDINGS

      The Company has  undergone a Federal  payroll tax audit for the years 1989
through 1993. The Internal Revenue Service ("IRS") asserted that certain medical
professionals  and others  engaged as independent  contractors  should have been
treated as employees  for payroll tax purposes.  The IRS, in May 1996,  issued a
proposed  assessment  against the Company of  $1,935,455  for years 1989 through
1993. The Company  subsequently  received from the IRS separate proposed Closing
Agreements  for  these  same  independent   contractors   under  the  IRS's  new
"Classification  Settlement Program" with an alternate  aggregate  assessment of
$253,426  covering  the  1989  through  1993  audit,  including  any  additional
potential  liability  through  December  31,  1996.  The  Company  has  accepted
settlement  offers  under the program for two classes of medical  professionals,
paid $61,000 as settlements and agreed to  prospectively  treat these classes of
professionals as employees. The IRS has accepted the Company's classification of
the remaining classes as independent contractors and has closed the audit.

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

      Not applicable.

                                     PART II

ITEM 5.      MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED
             SHAREHOLDER MATTERS

      Information  concerning  the Common Stock of the Registrant is included in
Exhibit 13.1 in this Annual Report of the Registrant.

ITEM 6.      SELECTED FINANCIAL DATA

     Six-Year  Financial  Summary is  included  in Exhibit  13.1 in this  Annual
Report of the Registrant for the year ended December 31, 1997.

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

      OVERVIEW

      The  Company  changed its fiscal year end from the last day of February to
December 31,  effective as of December 31, 1996. The change  resulted in a short
period of ten months  that began March 1, 1996,  and ended  December  31,  1996.
Information  for calendar 1996 refers to the ten months ended December 31, 1996,
and fiscal 1996 refers to the twelve months ended February 29, 1996.

      The growth in the  Company's  operating  revenues and net earnings  during
1997 was the result of an  increase in the number of acute and  subacute  units,
and growth  from  acquisitions.  The 1997  results  reflect an  increase  in the
average number of acute units as a result of fewer unit closures, an increase in
the average  number of subacute  units managed by the Company from 11.5 to 22.0,
increased weeks worked at HSSI and the acquisition of Team and Moore. Outpatient
revenue  decreased  9.8% in 1997,  reflecting  a two-unit  reduction  in average
number of units. The growth for calendar 1996 was primarily  attributable to the
increase in the number of subacute  units and results from HSSI.  Calendar  1996
reflects an increase in the average number of subacute units

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from 4.1 to 11.5. Outpatient revenue decreased 8.1% in calendar 1996, reflecting
the closure of three locations.

      In the normal  course of business,  new units are opened and some existing
units are closed  each year.  During  the first year of  operation,  a new acute
rehabilitation  unit will typically be subject to  limitations in  reimbursement
from  Medicare   considerably   below  the  hospital's   operating  cost.  As  a
consequence,  during this period the Company agrees with the client  hospital to
bear certain  start-up costs on the hospital's  behalf and to waive a portion of
its fees until the unit  qualifies for an exemption  from Medicare  limitations.
The Company assists the hospital in qualifying the unit for the exemption and in
minimizing the unreimbursed  costs during this non-exempt  period. The Company's
average  operating  losses during the qualifying  period can range to as high as
$150,000 to $200,000 per unit.  If the Company does not obtain an exemption  for
the unit,  the  contract  may be  terminated  and, in the event of  termination,
start-up  losses would  generally  not be  recoverable.  Upon  completion of the
qualifying year and obtaining the exemption, the hospital is eligible to recover
all of its costs related to the  operation of the unit,  including the Company's
fees  under  the  management  contract.  Once a unit  becomes  exempt,  the unit
experiences  accelerated  growth in operating  revenues and profitability as the
patient  population is expanded in response to the more favorable  reimbursement
terms.

      Subacute  units  and  outpatient  programs  are not  subject  to the  same
limitations in reimbursement  from Medicare as acute  rehabilitation  units and,
therefore,  should result in significantly  reduced start-up losses per unit. In
1997,  Congress enacted changes to Medicare calling for the  implementation of a
prospective  payment system for skilled nursing units and facilities  commencing
in July 1998.

      In March 1996 the Company  acquired HSSI. The aggregate  purchase price of
$21,450,000 paid at closing included  $13,258,000 in cash, a $6,000,000 ten-year
convertible  subordinated  promissory  note and 185,295  shares of the Company's
common stock.  Additional  consideration  will be paid to the HSSI  stockholders
contingent  upon the attainment of certain  target  cumulative  earnings  before
interest  and  income  taxes  up  to  a  maximum  of  $8,800,000  in  additional
consideration  over  six  years  of  which  $1,000,000  was  paid in  1997,  and
$2,104,000  was paid during March 1998. The  transaction  was accounted for as a
purchase and, as such, the Company's  consolidated  financial statements reflect
the results of operations of HSSI commencing with the  consummation  date of the
acquisition.

      In January  1997,  the  Company  acquired  Team and Moore.  The  aggregate
purchase  price of  $5,600,000  paid at closing  included  $3,600,000 in cash, a
$1,500,000  subordinated  promissory  note and  38,047  shares of the  Company's
common stock. Additional consideration will be paid to the former Team and Moore
stockholders  contingent upon attainment of certain target  cumulative  earnings
before  interest and income  taxes,  up to a maximum of $2,400,000 in additional
consideration  over four years. In June 1997, the Company  purchased 100% of the
capital stock of Rehab  Unlimited,  Inc. and the assets of Cimarron Health Care,
Inc.  and  merged  them into Team and Moore.  The  aggregate  purchase  price of
$1,350,000 paid at closing  included  $675,000 in cash, a $325,000  subordinated
promissory  note  and  16,104  shares  of  the  Company's   common  stock.   The
transactions  were  accounted  for as  purchases  and,  as such,  the  Company's
consolidated financial statements reflect the financial condition and results of
operations of Team and Moore and Rehab Unlimited  commencing on the consummation
date of each acquisition.

      In  January  1997,  the  Company  made a tender  offer to  purchase  up to
1,387,500  shares of its common stock at a single purchase price,  not less than
$13.33 nor in excess of $15.00 per share,  the purchase  price to be selected by
the Company based on prices  specified by tendering  stockholders  at the lowest
single purchase price sufficient to purchase  1,387,500  shares.  As of February
28,  1997,  the closing  date,  shares  totaling  greater  than  1,387,500  were
tendered,  resulting in the Company's repurchase on March 12, 1997 of a total of
1,499,932  shares at the single per share price of $15.00 per share.  To finance
the repurchase and restructure its current debt, the Company obtained  financing
from a  syndicate  of  financial  institutions  totaling  $45  million in senior
secured debt,  comprised of a $25 million term loan and a $20 million  revolving
credit facility.

      On  August  26,  1997,  the  Company's  Board  of  Directors   approved  a
three-for-two  split  of the  Company's  common  stock  in the  form  of a stock
dividend, payable October 1, 1997, to shareholders of record as of

                                       8

<PAGE> 9



September  12,  1997.  All share and per share  amounts set forth in this Annual
Report reflect the effect of the stock split.

RESULTS OF OPERATIONS

      The  following  table sets forth for 1997,  calendar 1996 and fiscal 1996,
the  percentage  that certain items in the  consolidated  statements of earnings
bear to operating revenues:

<TABLE>

<CAPTION>
                                                              Year Ended       Ten Months Ended        Year Ended
                                                             December 31,        December 31,          February 29,
                                                                1997                 1996                 1996
------------------------------------------------- ----------------------- ------------------ ---------------------
<S>                                                             <C>                   <C>                  <C>
Operating revenues                                              100.0%                100.0%               100.0%
Costs and expenses:
    Operating expenses                                           68.9                  71.1                 73.3
    General and administrative                                   17.0                  16.1                 12.5
    Depreciation and amortization                                 2.3                   2.6                  2.7
Operating earnings                                               11.8                  10.2                 11.5
Gain on sale of marketable securities                              .9                    --                   --
Other expense, net                                               (1.6)                 (1.0)                (0.4)
Earnings before income taxes                                     11.1                   9.2                 11.1
Income taxes                                                      4.5                   3.7                  4.5
Net earnings                                                      6.6%                  5.5%                 6.6%
===========================================  ======================== =====================  =====================

</TABLE>


      Management  believes that a comparison of the twelve months ended December
31, 1997 to the ten months ended December 31, 1996 and the comparison of the ten
months ended  December 31, 1996 to the twelve months ended February 29, 1996 are
not  meaningful  because  of the  difference  in  length of  reporting  periods.
Therefore,  this  discussion and analysis of results of operations  compares the
audited   twelve-month   period  ended  December  31,  1997,  to  the  unaudited
twelve-month  period ended December 31, 1996, and the audited  ten-month  period
ended  December 31, 1996 to the unaudited  ten-month  period ended  December 31,
1995.

     Twelve  Months  Ended  December  31, 1997  Compared to Twelve  Months Ended
December 31, 1996

      Operating  revenues  in  1997  increased  by  $40,924,000,  or  34.1%,  to
$160,780,000 as compared to the same period in 1996.  Acquisitions accounted for
35.0% of the net increase.  A 20.8%  increase in the average number of inpatient
units from 91.3 to 110.3 units,  and an increase in the average  daily  billable
census per inpatient unit of 3.1% from 12.8 to 13.2,  generated a 24.6% increase
in billable  patient days to 532,195.  The increase in billable  census per unit
for inpatient  units is primarily  attributable to a 9.0% increase in admissions
per unit,  offset by a 5.4%  decline in  average  billable  length of stay.  The
decline in average  length of stay reflects both the continued  trend of reduced
rehabilitation lengths of stay and the increase in subacute units operational in
1997, which carry a shorter length of stay than acute rehabilitation  units. The
increase in billable  patient days was offset by a 3.7%  decrease in average per
diem billing rates, reflecting a greater mix of subacute units which carry lower
average per diem rates than acute units.  The $16,279,000  increase in inpatient
unit revenue was offset by a 9.8% decrease in outpatient  revenue to $9,429,000,
primarily  reflecting  the  loss  of  two  units.  Revenues  of  HSSI  increased
$11,505,000  primarily  as a result of an increase in weeks  worked plus revenue
from HSSI's new temporary staffing division.

     Operating  expenses  for the twelve  month  periods  compared  increased by
$25,305,000, or 29.6%, to $110,726,000.  Acquisitions accounted for 34.2% of the
net increase. The remaining increase was attributable

                                       9

<PAGE> 10



to the increase in patient days and increased placements at HSSI.

      The excess of operating expenses over operating  revenues  associated with
non-exempt  units  decreased  from  $912,000 to $778,000,  on an increase in the
average number of non-exempt  units from 5.4 to 7.7. The per unit average excess
of operating expenses over operating revenues declined from $169,000 to $102,000
reflecting a 2.5%  increase in billable  patients per unit to 2.9 plus a greater
percentage of units where the Company is not obligated to provide therapy staff.
Average  start-up losses for units for which the Company  provides therapy staff
during their non-exempt year can range to as high as $150,000 to $200,000.

      General and  administrative  expenses increased  $8,725,000,  or 47.0%, to
$27,294,000,   reflecting   increases   in   professional   services,   business
development,  general office,  marketing and operations compared to the previous
year,  plus the  addition of general and  administrative  expenses of  companies
acquired.

      Depreciation and amortization  increased $631,000 reflecting primarily the
amortization  of  goodwill  from  the  purchase  of Team  and  Moore  and  Rehab
Unlimited.

      Interest income decreased  $83,000 as a result of reductions in investment
balances,  as cash  was  used to make  acquisitions  and  make  payments  on the
Company's debt.

      Interest expense increased  $1,441,000  reflecting  interest on additional
debt arising from the  repurchase of shares of the Company's  common stock,  and
the  acquisitions of HSSI, Team and Moore and Rehab  Unlimited.  Gain on sale of
marketable  securities  reflects the sale of approximately  50% of the Company's
investment in Intensiva HealthCare Corporation.

      Earnings  before  income  taxes  increased  by  $6,192,000,  or 53.0%,  to
$17,882,000.  The  provision  for  income  taxes for the  twelve  month  periods
compared was $7,267,000 compared to $4,698,000,  reflecting effective income tax
rates of 40.6% and 40.2% for the respective  periods.  Net earnings increased by
$3,623,000, or 51.8%, to $10,615,000. Diluted earnings per share increased 58.1%
to  $1.47  from  $.93  on  a  4.4%  decrease  in  the  weighted-average   shares
outstanding.   The  decrease  in  shares  outstanding  is  attributable  to  the
repurchase of shares of the Company's  common stock offset by an increase in the
dilutive effect of outstanding stock options.

Ten Months  Ended  December 31, 1996  Compared to Ten Months Ended  December 31,
1995

      Operating revenues during the ten months ended December 31, 1996 increased
by  $30,476,000,  or 41.1%,  to  $104,611,000  as compared to the same period in
1995. The  acquisition  of HSSI accounted for 94.7% of the net increase.  A 9.6%
increase in the average number of inpatient units from 83.7 to 91.7, offset by a
decrease in the average daily  billable  census per inpatient  unit of 3.8% from
13.3 to 12.8, generated a 5.5% increase in billable patient days to 357,780. The
decrease  in  billable   census  per  unit  for  inpatient  units  is  primarily
attributable  to a 9.7%  decline  in average  billable  length of stay on a 6.6%
increase in admissions  per unit. The decline in average length of stay reflects
both the  continued  trend of  reduced  rehabilitation  lengths  of stay and the
increase in subacute  units  operational  for the ten months ended  December 31,
1996, which carry a shorter length of stay than acute rehabilitation  units. The
increase in billable  patient  days was offset by a .9%  decrease in average per
diem billing rates, reflecting a greater mix of subacute units which carry lower
average per diem rates than acute units.  The  $2,960,000  increase in inpatient
unit revenue was offset by an 8.1% decrease in outpatient revenue to $8,495,000,
reflecting the loss of one unit each in February, March and April 1996.

      Operating  expenses  for  the  ten-month  periods  compared  increased  by
$19,933,000,  or 36.6%,  to  $74,326,000.  The acquisition of HSSI accounted for
substantially all of this increase.

      The excess of operating expenses over operating  revenues  associated with
non-exempt  units  increased  from  $193,000 to  $749,000,  attributable  to the
increase  in the average  number of  non-exempt  units from 1.5 to 5.5.  Average
start-up  losses for units during their  non-exempt year can range to as high as
$150,000 to $200,000.

                                       10


<PAGE> 11



      General and  administrative  expenses increased  $7,369,000,  or 77.8%, to
$16,844,000,   reflecting   increases   in   professional   services,   business
development,  general  office,  outpatient  services,  and legal compared to the
previous year, plus the addition of HSSI's corporate staff.

      Depreciation   and   amortization   increased   $737,000   reflecting  the
amortization  of goodwill  from the  purchase of HSSI and  depreciation  of HSSI
fixed assets.

      Interest income decreased  $71,000 as a result of reductions in investment
balances,  as cash was used to acquire HSSI and make  payments on the  Company's
debt.  Interest  expense  increased  $560,000  reflecting new debt issued in the
acquisition of HSSI.

      Earnings  before  income  taxes  increased  by  $1,802,000,  or 23.0%,  to
$9,654,000.  The provision for income taxes for the ten-month  periods  compared
was $3,886,000 compared to $3,197,000,  reflecting effective income tax rates of
40.3%  and  40.7%  for  the  respective  periods.   Net  earnings  increased  by
$1,113,000, or 23.9%, to $5,768,000.  Diluted earnings per share increased 13.4%
to  $.76  from  $.67  on  a  13.0%  increase  in  the  weighted-average   shares
outstanding. The increase in shares outstanding is attributable primarily to the
shares issued in the  acquisition of HSSI and an increase in the dilutive effect
of outstanding stock options.

LIQUIDITY AND CAPITAL RESOURCES

      As of December 31, 1997,  the Company had  $6,639,000  in cash and current
marketable  securities  and a current  ratio of  1.6:1.  Working  capital  as of
December 31, 1997,  increased  from December 31, 1996, by $3,539,000 due to cash
flows generated by operations  offset by the cash paid and debt arising from the
acquisitions  of Team and Moore and Rehab  Unlimited,  Inc.  and the increase in
current  portion of  long-term  debt issued in the  repurchase  of shares of the
Company's common stock.

      Net accounts  receivable were $24,147,000 at December 31, 1997 compared to
$15,546,000 at December 31, 1996. The number of days average net revenues in net
receivable  was 52.0 days and 45.5 days as of December 31, 1997 and December 31,
1996, respectively.

      During the year ended  December 31,  1997,  the Company  incurred  capital
expenditures  of  $1,343,000 as compared to $864,000 for the twelve months ended
December 31, 1996. At December 31, 1997, the Company had no material commitments
for capital expenditures.

      In connection with the development and implementation of additional units,
the Company may incur capital  expenditures  for  equipment  and deferred  costs
arising from payments  made to hospitals  for a portion of capital  improvements
needed to begin a unit's  operation.  For the twelve  months ended  December 31,
1997, the Company made deferred cost payments to four client hospitals  totaling
$368,000 for capital  improvements,  while for the twelve months ended  December
31, 1996,  payments were made to five client  hospitals  totaling  $400,000.  At
December 31, 1997, the Company had ten commitments  totaling  $1,565,000 to make
additional capital improvement payments to client hospitals.

      The  Company's  operating  cash flows  constitute  its  primary  source of
liquidity and  historically  have been  sufficient  to fund its working  capital
requirements.  The Company expects to meet its future working  capital,  capital
expenditure, business expansion and debt service requirements from a combination
of internal sources and outside financing.  As of December 31, 1997, the Company
had $10,845,000 of unused available bank line of credit.

      On January 10, 1997,  the Company sold 165,000 shares of its investment in
Intensiva HealthCare Corporation in a market transaction for $1,485,000.

      On March 12, 1997, the Company repurchased  1,499,932 shares of its common
stock.  To finance the repurchase and  restructure its current debt, the Company
issued $45 million in senior secured debt.

                                       11

<PAGE> 12



INFLATION

      Although  inflation has abated during the last several years,  the rate of
inflation  in  healthcare   related  services   continues  to  exceed  the  rate
experienced  by the  economy  as a whole.  The  Company's  management  contracts
typically  provide for an annual increase in the fees paid to the Company by its
client  hospitals  based upon  increases  in various  inflation  indices.  These
increases generally offset increases in costs incurred by the Company.

ITEM 7A.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

      Not applicable.






















                                       12

<PAGE> 13



ITEM 8.      FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA











                          Independent Auditors' Report

The Board of Directors
RehabCare Group, Inc.:

We have audited the accompanying consolidated balance sheets of RehabCare Group,
Inc. and subsidiaries  (the "Company") as of December 31, 1997 and 1996, and the
related  consolidated  statements of earnings,  stockholders'  equity,  and cash
flows for the year ended  December 31, 1997,  for the ten months ended  December
31, 1996 and for the year ended February 29, 1996. These consolidated  financial
statements   are  the   responsibility   of  the   Company's   management.   Our
responsibility  is  to  express  an  opinion  on  these  consolidated  financial
statements based on our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated  financial statements referred to above present
fairly,  in all material  respects,  the financial  position of RehabCare Group,
Inc. and subsidiaries as of December 31, 1997 and 1996, and the results of their
operations  and their cash flows for the year ended  December 31, 1997,  for the
ten months ended  December 31, 1996 and for the year ended February 29, 1996, in
conformity with generally accepted accounting principles.

                                                          /s/ KPMG Peat Marwick





St. Louis, Missouri
February 6, 1998


                                       13
                                                        

<PAGE> 14

<TABLE>
                                                     REHABCARE GROUP, INC.

                                                  Consolidated Balance Sheets
                                         (dollars in thousands, except per share data)
<CAPTION>
                                                                                               December 31,     December 31,
                                                Assets                                            1997             1996
                                                ------                                            ----             ----
<S>
Current assets:                                                                            <C>                   <C>
     Cash and cash equivalents                                                             $     1,975              772
     Marketable securities, available-for-sale                                                   4,664            6,666
     Accounts receivable, net of allowance for doubtful accounts
         of $1,338 and $1,386, respectively                                                     24,147           15,546
     Deferred tax assets                                                                         1,773              921
     Prepaid expenses and other current assets                                                     720              525
                                                                                                ------           ------
                            Total current assets                                                33,279           24,430
                                                                                                ------           ------
Marketable securities, available-for-sale, noncurrent                                            1,812            1,310
                                                                                                ------           ------
Equipment and leasehold improvements, net                                                        3,342            2,935
                                                                                                ------           ------
Other assets:
     Excess of cost over net assets acquired, net                                               52,949           47,119
     Deferred contract costs, net                                                                1,138            1,302
     Pre-opening costs, net                                                                      2,908            2,295
     Deferred tax assets                                                                           181              424
     Other                                                                                       1,632              987
                                                                                                ------           ------
                            Total other assets                                                  58,808           52,127
                                                                                                ------           ------
                                                                                           $    97,241           80,802
                                                                                                ======           ======
                                 Liabilities and Stockholders' Equity
                                 ------------------------------------  
Current liabilities:
     Revolving credit facility                                                             $       --               500
     Current portion of long-term debt                                                           4,520            2,967
     Accounts payable                                                                            1,700            1,083
     Accrued salaries and wages                                                                  9,925            6,969
     Accrued expenses                                                                            3,570            2,026
     Income taxes payable                                                                          771            1,631
                                                                                                ------           ------
                            Total current liabilities                                           20,486           15,176
                                                                                                ------           ------
Deferred compensation                                                                            2,501            1,956
                                                                                                ------           ------
Long-term debt, less current portion                                                            34,494           14,000
                                                                                                ------           ------
Stockholders' equity:
     Preferred stock, $.10 par value; authorized 10,000,000 shares,
         none issued and outstanding                                                                --               --
     Common stock, $.01 par value; authorized 20,000,000 shares,
         issued 7,152,191 shares and 7,040,043 shares as of
         December 31, 1997 and 1996, respectively                                                   72               70
     Additional paid-in capital                                                                 23,972           22,793
     Retained earnings                                                                          35,192           24,577
     Less common stock held in treasury at cost,
           1,311,307 shares as of December 31, 1997                                            (20,212)              --
     Unrealized gain on marketable securities, net of tax                                          736            2,230
                                                                                                ------           ------ 
                            Total stockholders' equity                                          39,760           49,670
                                                                                                ------           ------
                                                                                          $     97,241           80,802
                                                                                                ======           ======

See accompanying notes to consolidated financial statements.
</TABLE>
                                                             14


<PAGE> 15

<TABLE>
                                                     REHABCARE GROUP, INC.

                                              Consolidated Statements of Earnings
                                         (dollars in thousands, except per share data)

<CAPTION>

                                                                      Year Ended        Ten Months Ended        Year Ended
                                                                      December 31,        December 31,          February 29,
                                                                         1997                 1996                1996
                                                                         ----                 ----                ----
<S>                                                                 <C>                    <C>                  <C>
Operating revenues                                                  $ 160,780              104,611              89,377
Costs and expenses:
    Operating expenses                                                110,726               74,326              65,487
    General and administrative                                         27,294               16,844              11,202
    Depreciation and amortization                                       3,780                2,743               2,412
                                                                      -------               ------             -------
               Total costs and expenses                               141,800               93,913              79,101
                                                                      -------               ------              ------
               Operating earnings                                      18,980               10,698              10,276
Interest income                                                           186                  152                 344
Interest expense                                                       (2,759)              (1,211)               (759)
Gain on sale of marketable securities                                   1,448                   --                  --
Other income, net                                                          27                   15                  26
                                                                      -------               ------             -------
               Earnings before income taxes                            17,882                9,654               9,887
Income taxes                                                            7,267                3,886               4,009
                                                                      -------               ------             -------
               Net earnings                                         $  10,615                5,768               5,878
                                                                      =======               ======             =======

Net earnings per common share:
    Basic                                                           $    1.77                  .82                 .87
                                                                         ====                =====               =====
    Diluted                                                         $    1.47                  .76                 .84
                                                                         ====                =====               =====


See accompanying notes to consolidated financial statements.
</TABLE>
                                                             15




















<PAGE> 16

<TABLE>
                                                     REHABCARE GROUP, INC.

                                        Consolidated Statements of Stockholders' Equity
                                                    (amounts in thousands)
<CAPTION>

                                                Common Stock                                                   
                                          ------------------------ Additional                                   Total   
                                          Issued  Treasury          paid-in   Retained  Treasury  Unrealized stockholders'
                                          Shares   Stock   Amount   capital   earnings    Stock     gain        equity
                                          ------   ------  -------  --------  --------    ----     ------     -----------

<S>                                       <C>       <C>    <C>        <C>       <C>       <C>       <C>       <C>
Balance, February 28, 1995                6,706       --   $   67     19,433    12,931        --        --    32,431

Net earnings                                 --       --       --         --     5,878        --        --     5,878
Exercise of stock options (including
          tax benefit)                       71       --       --        588        --        --        --       588
                                          -----     ----     ----     ------    ------    ------    ------    ------
Balance, February 29, 1996                6,777       --       67     20,021    18,809        --        --    38,897

Net earnings                                 --       --       --         --     5,768        --        --     5,768
Issuance of common stock
          in connection with acquisition    185       --        2      2,190        --        --        --     2,192
Exercise of stock options (including
          tax benefit)                       78       --        1        582        --        --        --       583
Unrealized gain on marketable
         securities, net of tax              --       --       --         --        --        --     2,230     2,230
                                          -----     ----     ----     ------    ------    ------     -----    ------
Balance, December 31, 1996                7,040       --       70     22,793    24,577        --     2,230    49,670

Net earnings                                 --       --       --         --    10,615        --        --    10,615
Purchase of treasury stock                   --    1,500       --         --        --   (23,131)       --   (23,131)
Issuance of common stock
          in connection with acquisitions    38      (41)       1        639        --       644        --     1,284
Exercise of stock options (including
          tax benefit)                       74     (148)       1        540        --     2,275        --     2,816
Change in unrealized gain on
          marketable securities, net of tax  --       --       --         --        --        --    (1,494)   (1,494)
                                          -----     ----     ----     ------    ------    ------     -----    ------
Balance, December 31, 1997                7,152    1,311  $    72     23,972    35,192   (20,212)      736    39,760
                                          =====    =====    =====     ======    ======    ======    ======    ======


See accompanying notes to consolidated financial statements.
</TABLE>
                                                             16


<PAGE> 17
<TABLE>

                                                     REHABCARE GROUP, INC.

                                              Consolidated Statements of Cash Flows
                                                    (dollars in thousands)
<CAPTION>
                                                                                Year Ended    Ten Months Ended    Year Ended
                                                                                December 31,    December 31,      February 29,
                                                                                  1997               1996            1996
                                                                                  ----               ----            ----
<S>                                                                           <C>                 <C>               <C>
Cash flows from operating activities:
     Net earnings                                                             $    10,615           5,768            5,878
     Adjustments to reconcile net earnings to net cash provided
         by operating activities:
              Depreciation and amortization                                         3,780           2,743            2,412
              Provision for losses on accounts receivable                             717             549              348
              Equity in earnings of affiliate                                         (20)             --               --
              Gain on sale of marketable securities                                (1,448)             --               --
              Increase in deferred compensation                                       545             586              560
              Decrease (increase) in accounts receivable, net                      (7,755)         (4,586)           1,721
              Decrease (increase) in prepaid expenses and other current assets       (155)            259               31
              Decrease in other assets                                                 15             122              236
              Increase (decrease) in accounts payable and accrued expenses          1,759          (1,915)             111
              Increase in accrued salaries and wages                                2,386           1,390              485
              Decrease in income taxes payable and deferred                          (622)           (498)             (99)
                                                                                   ------          ------           ------
                      Net cash provided by operating activities                     9,817           4,418           11,683
                                                                                   ------          ------           ------

Cash flows from investing activities:
     Additions to equipment and leasehold improvements, net                        (1,343)           (732)            (402)
     Purchase of marketable securities                                             (1,473)         (1,128)          (5,245)
     Proceeds from sale/maturities of marketable securities                         2,080           1,815              510
     Cash paid in acquisition of businesses, net of cash received                  (6,629)        (19,258)            (195)
     Investment in joint venture                                                     (630)             --               --
     Deferred contract costs, net                                                    (368)           (160)            (265)
     Pre-opening costs, net                                                        (1,483)         (1,047)            (651)
     Other, net                                                                        --            (235)              --
                                                                                   ------          ------           ------
                      Net cash used in investing activities                        (9,846)        (20,745)          (6,248)
                                                                                   ------          ------           ------

Cash flows from financing activities:
     Proceeds from (payments on) revolving credit facility                           (500)          2,000           (1,000)
     Payments on long-term debt                                                    (3,603)         (2,408)          (2,075)
     Proceeds on issuance of long-term debt                                        23,500           4,750               --
     Proceeds on issuance of notes payable                                          2,150           6,000               --
     Purchase of treasury stock                                                   (23,131)             --               --
     Exercise of stock options (including tax benefit)                              2,816             583              588
                                                                                   ------          ------          -------
                      Net cash provided by (used in) financing activities           1,232          10,925           (2,487)
                                                                                   ------          ------          -------
                      Net increase (decrease) in cash and cash
                                equivalents                                         1,203          (5,402)           2,948
Cash and cash equivalents at beginning of period                                      772           6,174            3,226
                                                                                   ------         -------          -------
Cash and cash equivalents at end of period                                    $     1,975             772            6,174
                                                                                   ======         =======          =======


See accompanying notes to consolidated financial statements.
</TABLE>
                                                             17





<PAGE> 18


                              REHABCARE GROUP, INC.

                   Notes to Consolidated Financial Statements



(1)Summary of Significant Accounting Policies

      (a)    Business and Principles of Consolidation
             RehabCare Group,  Inc. and  subsidiaries  (the "Company")  develop,
                market and manage  programs  for the  delivery of  comprehensive
                medical   rehabilitation  and  therapy  services  in  acute-care
                hospitals,  skilled nursing units and outpatient facilities. The
                Company also is a contract  provider of  therapists to hospitals
                and   long-term   care  and   rehabilitation   facilities.   The
                consolidated  financial  statements  include the accounts of the
                parent   company  and  its  wholly   owned   subsidiaries.   All
                significant  intercompany  balances and  transactions  have been
                eliminated in consolidation.

      (b)    Change in Fiscal Year
             The Company changed  its  fiscal  year  end  from  the  last day of
                February to December 31,  effective as of December 31, 1996. The
                change resulted in a short period of ten months that began March
                1, 1996,  and ended December 31, 1996.  Information  included in
                the  footnotes to the  financial  statements  for calendar  1996
                refers to the ten months ended December 31, 1996 and fiscal 1996
                refers to the twelve months ended February 29, 1996.

      (c)    Common Stock Split
             On August 26, 1997,  the  Company's  Board of Directors  approved a
                three-for-two split of the Company's common stock in the form of
                a stock  dividend,  payable  October 1, 1997, to shareholders of
                record as of September 12, 1997.  Share and per share amounts in
                the consolidated financial statements have been restated for all
                amounts presented to reflect the split.

      (d)    Cash Equivalents and Marketable Securities
             Cash in excess of daily  requirements  is  invested  in  short-term
                investments  with  original  maturities of three months or less.
                Such  investments are deemed to be cash equivalents for purposes
                of the consolidated statements of cash flows.

                The Company  classifies its debt and equity  securities into one
                of   three    categories:    held-to-maturity,    trading,    or
                available-for-sale.   Management   determines  the   appropriate
                classification  of its  investments  at the time of purchase and
                reevaluates  such  determination  at each  balance  sheet  date.
                Investments  at December 31, 1997 consist of  marketable  equity
                securities,  variable  rate  municipal  bonds and  money  market
                securities.   All   marketable   securities  are  classified  as
                available-for-sale  and as such, the difference between cost and
                market,  net of estimated taxes, is recorded as an adjustment to
                stockholders'  equity.  Gain (or loss) is not  recognized in the
                consolidated  statement  of earnings  until the  securities  are
                sold.

      (e)    Credit Risk
             The Company primarily provides services to a geographically diverse
                clientele of healthcare  providers throughout the United States.
                The Company performs ongoing credit evaluations of its clientele
                and does not  require  collateral.  An  allowance  for  doubtful
                accounts is maintained at a level which  management  believes is
                sufficient to cover potential credit losses.

      (f)    Equipment and Leasehold Improvements
             Depreciation   and   amortization   of  equipment   and   leasehold
                improvements are computed on the  straight-line  method over the
                estimated  useful  lives  of the  related  assets,  principally:
                equipment - five to seven years and leasehold  improvements life
                of lease or life of asset, whichever is less.

                                       18

<PAGE> 19


                              REHABCARE GROUP, INC.

                   Notes to Consolidated Financial Statements



      (g)    Intangible Assets
             Substantially  all the  excess  of cost  over net  assets  acquired
                (goodwill)  relates  to  acquisitions  and  is  amortized  on  a
                straight-line basis over 40 years.  Accumulated  amortization of
                goodwill was  $5,206,000  and $4,284,000 as of December 31, 1997
                and 1996, respectively.  The Company evaluates the realizability
                of goodwill based upon  expectations of undiscounted  cash flows
                and operating income.  Based upon its most recent analysis,  the
                Company  believes  that no  impairment  of  goodwill  exists  at
                December 31, 1997.

      (h)    Deferred Contract Costs and Pre-Opening Costs
             Deferred contract costs represent  payments made to hospitals for a
                portion  of  capital  improvements  needed  to  begin  a  unit's
                operation and certain pre-opening costs. The Company is entitled
                to a pro rata refund of deferred  capital  improvement  costs in
                the event that the hospital  terminates the contract  before its
                scheduled  termination date.  Pre-opening costs include payments
                made primarily for architectural,  legal and consulting services
                expended  to  begin  a  unit's   operations.   These  costs  are
                capitalized until the unit begins operations.  Deferred contract
                costs and  pre-opening  costs are  charged to  expense  over the
                initial  term  of the  contracts.  Accumulated  amortization  of
                deferred  contract  costs was  $1,138,000  and  $1,336,000 as of
                December   31,   1997  and   1996,   respectively.   Accumulated
                amortization of pre-opening  costs was $1,466,000 and $1,183,000
                as of December 31, 1997 and 1996, respectively.

      (i)    Disclosure About Fair Value of Financial  Instruments  
             The estimated  fair-market value of the revolving  credit  facility
                and  long-term  debt  (including   current  portions   thereof),
                approximates carrying value due to the variable rate features of
                the  instruments.  The Company  believes it is not  practical to
                estimate a fair value  different  from the carrying value of its
                subordinated  debt and the notes  payable to related  parties as
                the  instruments  have numerous  unique features as discussed in
                note 6.

      (j)    Revenues and Costs
             The  Company recognizes  revenues as services are  provided or when
               the revenue is earned.  The  Company  has adopted the  accounting
               and  reporting  methods  approved by the  American   Institute of
               Certified  Public  Accountants in its  healthcare  industry audit
               guide. Accordingly, the Company's provision for doubtful accounts
               is  recorded  as  an  expense  of  operations  for  all   periods
               presented.  Costs  related to  marketing  and  development of new
               contracts at the corporate level are expensed as incurred.

      (k)    Income Taxes
             Deferred tax assets and  liabilities  are  recognized for temporary
                differences  between the financial statement carrying amounts of
                existing assets and  liabilities and their  respective tax bases
                and operating  loss and tax credit  carryforwards.  Deferred tax
                assets and  liabilities  are measured using enacted tax rates in
                effect for the year in which those  differences  are expected to
                be recovered or settled.

      (l)    Treasury Stock
             The  purchase of the Company's  common  stock is  recorded at cost.
               Upon subsequent reissuance, the treasury stock account is reduced
               by the average cost basis of such stock.

                                       19

<PAGE> 20


                              REHABCARE GROUP, INC.

                   Notes to Consolidated Financial Statements



      (m)    Earnings Per Share
             The Company  adopted  the  provisions  of  Statement  of  Financial
                Accounting  Standards  ("SFAS") No. 128,  Earnings per Share, on
                December  31,  1997,  which  replaced  the  previously  reported
                primary  and fully  dilutive  earnings  per share with basic and
                diluted  earnings per share.  Unlike primary earnings per share,
                basic earnings per share excludes any dilutive effect of options
                and convertible  securities.  Diluted earnings per share is very
                similar to the previously  reported  fully diluted  earnings per
                share.  Earnings  per share  amounts for all  periods  have been
                restated to conform with the requirements of SFAS No. 128.

      (n)    Stock Option Plan
             Prior to March 1996,  the Company  accounted  for its stock  option
                plans in accordance with the provisions of Accounting Principles
                Board  ("APB")  Opinion No. 25,  Accounting  for Stock Issued to
                Employees,  and related  interpretations.  As such, compensation
                expense  was  recorded  on the date of grant only if the current
                market  price of the  underlying  stock  exceeded  the  exercise
                price.  On March 1, 1996,  the  Company  adopted  SFAS No.  123,
                Accounting for Stock-Based Compensation,  which permits entities
                to recognize  as expense over the vesting  period the fair value
                of all stock-based  awards on the date of grant.  Alternatively,
                SFAS No. 123 allows entities to continue to apply the provisions
                of APB  Opinion  No. 25 and provide pro forma net income and pro
                forma earnings per share  disclosures  for employee stock option
                grants made in 1995 and future years as if the  fair-value-based
                method defined in SFAS No. 123 had been applied. The Company has
                elected to continue to apply the  provisions  of APB Opinion No.
                25 and provide the pro forma disclosure provisions of SFAS No.
                123. See note 7.

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

      (p)    Reclassifications
             Certain prior years' amounts have been reclassified to conform with
                the current year presentation.

(2)   Acquisitions
      On August 15, 1997, the Company  acquired a 40% interest in Allied Therapy
         Services,  L.L.C.  for  $630,000 in cash and notes.  The joint  venture
         provides physical,  occupational and speech therapy services to nursing
         homes,  other long-term care  facilities,  outpatient  clinics,  school
         systems and home  health  agencies  in  southern  Georgia and  northern
         Florida.  The  Company  accounts  for its  investment  using the equity
         method.

      On January 28, 1997,  the Company  purchased  100% of the capital stock of
         TeamRehab,  Inc. and Moore  Rehabilitation  Services,  Inc.  ("Team and
         Moore").  The aggregate  purchase  price of $5,600,000  paid at closing
         included $3,600,000 in cash, a $1,500,000  subordinated promissory note
         and  38,047   shares  of  the  Company's   common   stock.   Additional
         consideration  will be paid to the former  Team and Moore  stockholders
         contingent  upon the attainment of certain target  cumulative  earnings
         before  interest and income  taxes,  up to a maximum of  $2,400,000  in
         additional consideration over four years. On June 12, 1997, the Company
         purchased  100% of the capital stock of Rehab  Unlimited,  Inc. and the
         assets of

                                       20

<PAGE> 21


                              REHABCARE GROUP, INC.

                   Notes to Consolidated Financial Statements



         Cimarron  Health Care,  Inc.  and merged them into Team and Moore.  The
         aggregate  purchase  price  of  $1,350,000  paid  at  closing  included
         $675,000 in cash, a $325,000  subordinated  promissory  note and 16,104
         shares  of  the  Company's  common  stock.   Goodwill  related  to  the
         acquisitions totaling $6,254,000 is being amortized over 40 years.

      On March 1, 1996,  the  Company  purchased  100% of the  capital  stock of
         Healthcare  Staffing Solutions,  Inc. ("HSSI").  The aggregate purchase
         price of $21,450,000  paid at closing  included  $13,258,000 in cash, a
         $6,000,000  ten-year  convertible   subordinated  promissory  note  and
         185,295  shares of the Company's  common stock.  Of the  $13,258,000 of
         cash paid,  $8,750,000  was borrowed  under the Company's term loan and
         revolving credit facility. Additional consideration will be paid to the
         former HSSI  stockholders  contingent  upon the  attainment  of certain
         target  cumulative  earnings  before  interest and income taxes up to a
         maximum of $8,800,000 in additional  consideration  over six years.  In
         1997,  $1,000,000  of contingent  consideration  was paid to the former
         owners of HSSI.

      The following  unaudited  pro  forma  financial   information  assumes the
         acquisition  of HSSI occurred at the beginning of the fiscal year ended
         February 29, 1996. This  information is not  necessarily  indicative of
         results of  operations  that would have  occurred had the purchase been
         made at the beginning of the fiscal year.

                                                                  Year Ended
                                                                  February 29,
                                                                     1996
                                                                  -----------

          Operating revenues                              $       115,401,000
          Net earnings                                              6,443,000

          Net earning per common share:
               Basic                                                      .93
               Diluted                                                    .88


     The  acquisitions of Team and Moore,  Rehab  Unlimited,  Inc. and HSSI have
          been accounted for by the purchase method of accounting, whereby their
          operating results are included in the Company's  results of operations
          commencing on the respective closing dates of acquisition.

(3)    Marketable Securities
       Current marketable  securities at December 31, 1997 consist of $3,000,000
           in variable rate municipal bonds, an equity  investment of $1,246,000
           representing  161,297 shares of common stock of Intensiva  HealthCare
           Corporation  and $418,000 in money  market funds held in escrow.  The
           Company  classified its equity  investments as  "available-for-sale,"
           and as such has  recorded  the  investment  at  market  value  with a
           corresponding  credit,  net of taxes, to  stockholders'  equity.  The
           market value of the  investment  in common stock at December 31, 1997
           of  $1,246,000  exceeded  the cost  basis by  $1,209,000.  Noncurrent
           marketable   securities   consist  of  marketable  equity  securities
           ($1,469,000   and   $1,121,000   at  December   31,  1997  and  1996,
           respectively) and money market  securities  ($343,000 and $189,000 at
           December  31,  1997 and 1996,  respectively)  held in trust under the
           Company's deferred compensation plan.

                                       21




<PAGE> 22


                              REHABCARE GROUP, INC.

                   Notes to Consolidated Financial Statements





(4)     Allowance  for  Doubtful  Accounts  
        Activity  in the  allowance  for doubtful accounts is as follows:

<TABLE>
<CAPTION>

                                                                      Year Ended     Ten Months Ended       Year Ended
                                                                      December 31,      December 31,        February 29,
                                                                          1997              1996               1996
                                                                          ----              ----               ----

               <S>                                            <C>                         <C>                <C>
               Balance at beginning of period                 $        1,386,000            822,000          1,043,000
               Provisions for doubtful accounts                          717,000            549,000            348,000
               Allowance related to acquisitions                          30,000            387,000                 --
               Accounts written off                                     (795,000)          (375,000)          (569,000)
               Recoveries                                                   --                3,000                 --
                                                                       ---------          ---------          ---------
               Balance at end of period                       $        1,338,000          1,386,000            822,000
                                                                       =========          =========          =========

</TABLE>


(5)    Equipment and Leasehold Improvements
       Equipment and leasehold improvements, at cost, consist of the following:
<TABLE>
<CAPTION>


                                                                                          December 31,       December 31,
                                                                                              1997               1996
                                                                                              ----               ----  
               <S>                                                              <C>                          <C>
               Equipment                                                        $         5,752,000          4,615,000
               Leasehold improvements                                                       132,000            126,000
                                                                                          ---------          ---------
                                                                                          5,884,000          4,741,000
               Less accumulated depreciation and amortization                             2,542,000          1,806,000
                                                                                          ---------          ---------
               Equipment and leasehold improvements, net                        $         3,342,000          2,935,000
                                                                                          =========          =========



</TABLE>


                                                             22










<PAGE> 23


                              REHABCARE GROUP, INC.

                   Notes to Consolidated Financial Statements


                                                                           
(6)    Long - Term Debt
       Long-term debt consists of the following:
<TABLE>
<CAPTION>          
                                                                                December 31,       December 31,
       Bank Debt:                                                                 1997                 1996
       ---------                                                                  ----                 ----
<S>                                                                       <C>                         <C> 
Term facility - LIBOR plus 1.25% to 2.00% or Corporate Base               $     22,750,000            8,500,000
  Rate ("CBR"), rate dependent on the ratio of indebtedness, net
  of cash and  marketable  securities,  to cash  flow,  maturing
  March 5,  2002   (weighted-average  rates of 7.2%  and  7.1% at  
  December  31,  1997 and  1996, respectively).


Revolving credit facility - LIBOR plus 1.25% to 2.00% or CBR,                    8,000,000            2,000,000
  rate dependent on the ratio of indebtedness, net of cash and
  marketable securities, to cash flow, maturing March 5, 2002
  (weighted-average rates of 7.4% and 7.1% at December 31,
  1997 and 1996, respectively).

       Subordinated Debt:
       ----------------- 

Note payable, 6.25% convertible, maturing March 1, 2006                          6,000,000            6,000,000
Note payable, 8%, maturing October 15, 1997, held in escrow as
  of December 31, 1997                                                             395,000              967,000
Note payable, 8%, payable $93,750 quarterly through February
  1, 2001                                                                        1,219,000                   --
Note payable, 8%, payable in quarterly installments of $40,625
  commencing July 1, 1999, maturing July 1, 2001                                   325,000                   --
Note payable, 8%, maturing August 15, 2001                                         325,000                   --
                                                                               -----------          -----------
                                                                                39,014,000           17,467,000
Less current portion                                                             4,520,000            3,467,000
                                                                               -----------          -----------
Total long-term debt                                                      $     34,494,000           14,000,000
                                                                                ==========           ==========

</TABLE>

       On  March 5, 1997 the Company  restructured  and increased its bank debt.
           Under  the  terms of the  restructured  loan  agreement  the  Company
           entered into a five-year,  $25,000,000 term loan and a revolving line
           of credit  which  allows  the  Company  to borrow up to the lesser of
           $20,000,000 or 85% of eligible accounts  receivable as defined by the
           agreement,  reduced by amounts  outstanding  under any bank letter of
           credit.  The  Company  pays  a fee  on  the  unused  portion  of  the
           commitment  from  .30%  to .50%  per  annum,  with  such  rate  being
           dependent on the ratio of the Company's indebtedness, net of cash and
           marketable securities,  to cash flow. Borrowings under the agreement,
           including the revolving credit facility, are secured primarily by the
           Company's accounts receivable,  equipment and leasehold improvements,
           and future  income  and  profits.  The loan  agreement  requires  the
           Company to meet certain  financial  covenants  including  maintaining
           minimum  net  worth  and  fixed  charge  coverage  ratios.  The  loan
           agreement  also  restricts the Company's  ability to pay dividends to
           its  stockholders.  The  average  outstanding  borrowings  under  the
           revolving  credit  facility for 1997,  calendar  1996 and fiscal 1996
           were  $7,507,000,  $3,000,000  and  $301,000  at  a  weighted-average
           interest rate of 7.4%, 7.5% and 7.2% per annum, respectively.

                                       23

<PAGE> 24


                              REHABCARE GROUP, INC.

                   Notes to Consolidated Financial Statements



       The $6,000,000 convertible  subordinated notes payable may be redeemed in
           whole or in part by the  Company at any time  after  March 1, 2000 at
           from 100% to 104% of the principal balance. The notes are convertible
           into the  Company's  common stock prior to March 1, 2006,  subject to
           earlier  redemption by the Company,  at the option of the former HSSI
           shareholders,  at a  conversion  price of $14.17  per  share.  Of the
           $6,000,000 balance outstanding $4,500,000 is payable to a director of
           the Company who is president of HSSI.

       The scheduled  principal  payments of long-term debt at December 31, 1997
           are  as  follows:  $4,520,000,  $5,206,000,  $6,288,000,  $7,250,000,
           $1,750,000 and $6,000,000,  in years 1998, 1999, 2000, 2001, 2002 and
           thereafter,  respectively.  Interest paid for 1997, calendar 1996 and
           fiscal 1996 was $2,598,000, $1,053,000 and $763,000, respectively.

(7)    Stockholders' Equity
       On  January 31,  1997,  the Company made a tender offer to purchase up to
           1,387,500  shares of its common stock at a single purchase price, not
           less  than  $13.33  nor in excess of $15.00  per  share.  The  actual
           purchase  price was  determined  based on the lowest single  purchase
           price at which  stockholders  tendered  shares that was sufficient to
           purchase at least  1,387,500  shares.  As of February 28,  1997,  the
           closing date,  shares totaling  greater than 1,387,500 were tendered,
           resulting in the  Company's  repurchase on March 12, 1997, of a total
           of 1,499,932 shares at the single purchase price of $15.00 per share.
           To finance the repurchase,  on March 5, 1997, the Company's bank term
           loan and revolving credit facility were restructured and increased.

       On  April 23, 1996 the Company  adopted  the 1996  Long-Term  Performance
           Plan pursuant to which stock appreciation  rights,  restricted stock,
           performance  awards,  incentive stock options or  nonqualified  stock
           options,  may be granted to employees.  Under the plan,  stock awards
           for  1,050,000  shares may be granted  within 10 years of the date of
           adoption of the plan.  The Company  also has a 1987  Incentive  Stock
           Option Plan, a 1987 Nonstatutory  Stock Option Plan, and a Directors'
           Stock Option Plan (together with the 1996 Long-Term Performance Plan,
           the "Plans") pursuant to which incentive stock options may be granted
           to  employees  and  nonstatutory  stock  options  may be  granted  to
           employees or  directors.  Under the 1987  Incentive  Stock Option and
           Nonstatutory Stock Option Plans, options to purchase 1,500,000 shares
           were  available  for grant,  of which 825,000  shares were  incentive
           stock  options.   Under  the   Directors'   Stock  Option  Plan  (the
           "Directors'  Plan"),  options to purchase 525,000 shares of stock may
           be granted.  Stock options may be granted for a term not to exceed 10
           years (five years with  respect to a person  receiving  an  incentive
           stock  option  who owns  more  than 10% of the  capital  stock of the
           Company)  and  must be  granted  within  10  years  from  the date of
           adoption of the  respective  plan.  The  exercise  price of all stock
           options must be at least equal to the fair market value (110% of fair
           market value for a person  receiving  an  incentive  stock option who
           owns more than 10% of the capital stock of the Company) of the shares
           on the date granted.  Under the  Directors'  Stock Option Plan,  each
           director who is not  otherwise an officer or employee of the Company,
           shall receive an option to acquire  15,000  shares of stock,  or such
           lesser amount as provided in the Directors' Stock Option Plan, at the
           fair market  value on the  respective  option  grant date.  All stock
           options become fully exercisable after four years from date of grant,
           except for options  granted  under the  Directors'  Stock Option Plan
           which become fully exercisable after six months.

       The per share weighted-average fair value of stock options granted during
           1997, calendar 1996 and fiscal 1996 was $7.64, $6.89 and $6.91 on the
           dates of grant using the Black Scholes  option-pricing model with the
           following  weighted-average  assumptions:  1997 -  expected  dividend
           yield 0%, volatility of

                                       24

<PAGE> 25


                              REHABCARE GROUP, INC.

                   Notes to Consolidated Financial Statements



           33%,  risk-free  interest rate of 5.6% and an expected life of 4 to 7
           years; calendar 1996 - expected dividend yield 0%, volatility of 30%,
           risk-free  interest  rate of  6.25%  and an  expected  life of 4 to 7
           years;  fiscal 1996 - expected  dividend yield 0%, volatility of 30%,
           risk-free  interest  rate of  6.25%  and an  expected  life of 5 to 7
           years.

       The Company  applies APB Opinion  No. 25 and related  Interpretations  in
           accounting for its Plans. Accordingly,  no compensation cost has been
           recognized for its long-term  performance and stock option plans. Had
           compensation cost for the Company's  stock-based  compensation  plans
           been determined based on the fair value at the grant dates for awards
           under those  plans  consistent  with the method of SFAS No. 123,  the
           Company's  net income and  earnings per share would have been reduced
           to the pro forma amounts indicated below:

<TABLE>
<CAPTION>
                                                             Year Ended          Ten Months Ended         Year Ended
                                                            December 31,            December 31,         February 29,
                                                               1997                   1996                  1996
                                                               ----                   ----                  ----

<S>                                                      <C>                      <C>                    <C>
Net Income                      As reported              $10,615,000              $5,768,000             $5,878,000
                                Pro forma                  9,589,000               5,169,000              5,679,000

Basic earnings per share        As reported                     1.77                     .82                    .87
                                Pro forma                       1.60                     .74                    .84

Diluted earnings per share      As reported                     1.47                     .76                    .84
                                Pro forma                       1.33                     .69                    .81

</TABLE>

       In  accordance  with SFAS No. 123, the pro forma net income reflects only
           options granted  subsequent to February 1995 and does not reflect the
           full  impact  of  calculating  compensation  cost for  stock  options
           granted prior to March 1995,  that vested in 1997,  calendar 1996 and
           fiscal 1996.

       A   summary  of the  status of the  Company's  stock  option  plans as of
           December 31, 1997 and 1996, and February 29, 1996, and changes during
           the periods ending on those dates is presented below:
<TABLE>
<CAPTION>

                                          Year Ended                 Ten Months Ended                   Year Ended
                                       December 31, 1997             December 31, 1996                 February 29, 1996
                                       -----------------             -----------------                 -----------------
                                              Weighted-Average             Weighted-Average                  Weighted-Average
                                     Shares    Exercise Price     Shares    Exercise Price          Shares    Exercise Price
                                     ------    --------------     ------    --------------          ------    --------------
            <S>                     <C>         <C>              <C>          <C>                 <C>           <C>
            Outstanding at
              beginning of period   1,863,671   $   9.11         1,625,738    $     8.64          1,491,750     $    8.31
            Granted                   335,375      19.43           456,399         10.78            255,000          9.99
            Exercised                (221,558)      7.78           (78,028)         6.65            (71,250)         6.86
            Forfeited                 (51,679)     11.45          (140,438)        10.43            (49,762)         8.31
                                    ---------                     ---------                       ----------
            Outstanding at
              end of period         1,925,809      11.00         1,863,671          9.11          1,625,738          8.64
                                    =========                    =========                        =========

          Options exercisable
              at end of period      1,247,265                    1,159,959                        1,047,510

</TABLE>
                                       25

<PAGE> 26


                              REHABCARE GROUP, INC.

                   Notes to Consolidated Financial Statements



       The  following   table   summarizes   information   about  stock  options
outstanding at December 31, 1997:

<TABLE>
<CAPTION>


                                        Options Outstanding                                 Options Exercisable
                      -------------------------------------------------------      ------------------------------------  
                           Number      Weighted-Average                                 Number
       Range of         Outstanding         Remaining         Weighted-Average       Exercisable        Weighted-Average
     Exercise Prices  at Dec. 31, 1997  Contractual Life       Exercise Price      at Dec. 31, 1997      Exercise Price
     ---------------  ----------------  ----------------       --------------      ----------------      --------------
   <S>                   <C>                  <C>              <C>                    <C>               <C>
   $  4.83 -  8.83         893,137            4.8 years        $   8.55                 795,638         $   8.56
      9.00 - 16.42         807,172            7.7                 10.62                 451,627            10.38
     20.08 - 26.88         225,500            9.5                 22.01                      --               --
                         ---------                                                    ---------
      4.83 - 26.88       1,925,809            6.6                 10.99               1,247,265             9.22
                         =========                                                    =========

</TABLE>

       On  September 21, 1992, the Board of Directors of the Company  declared a
           dividend  distribution  of one preferred  stock  purchase  right (the
           "Rights")  for each share of the  Company's  common stock owned as of
           October 1, 1992,  and for each share of the  Company's  common  stock
           issued  until  the  Rights  become  exercisable.   Each  Right,  when
           exercisable,  will entitle the registered holder to purchase from the
           Company one sixty-seventh of a share of the Company's Series A junior
           participating preferred stock, $.10 par value (the Series A preferred
           stock),  at a price  of $35 per one  sixty-seventh  of a  share.  The
           Rights  are  not  exercisable  and are  transferable  only  with  the
           Company's  common  stock  until the  earlier of 10 days  following  a
           public  announcement  that a person has acquired  ownership of 15% or
           more of the Company's  outstanding  common stock, or the commencement
           or announcement of a tender offer or exchange offer, the consummation
           of which would result in the  ownership by a person of 15% or more of
           the Company's  outstanding common stock. The Series A preferred stock
           will be  nonredeemable  and junior to any other  series of  preferred
           stock that the Company may issue in the future.  Each share of Series
           A preferred stock, upon issuance,  will have a preferential  dividend
           in an amount equal to the greater of $1.00 per share or 100 times the
           dividend  declared per share of the Company's  common  stock.  In the
           event of the liquidation of the Company, the Series A preferred stock
           will receive a preferred  liquidation payment equal to the greater of
           $100 or 100 times the  payment  made on each  share of the  Company's
           common stock. Each one sixty-seventh of a share of Series A preferred
           stock  outstanding will have one vote on all matters submitted to the
           stockholders  of the Company and will vote together as one class with
           the holders of the Company's common stock.

       In the event that a person acquires  beneficial  ownership of 15% or more
          of the  Company's  common  stock,  holders of Rights  (other  than the
          acquiring  person or group) may purchase,  at the Rights' then current
          purchase price, shares of the Company's common stock having a value at
          that time equal to twice such  exercise  price.  In the event that the
          Company  merges into or otherwise  transfers 50% or more of its assets
          or earnings  power to any person after the Rights become  exercisable,
          holders  of Rights  (other  than the  acquiring  person or group)  may
          purchase,  at the then  current  exercise  price,  common stock of the
          acquiring  entity  having a value  at that  time  equal to twice  such
          exercise price.

                                       26

<PAGE> 27


                              REHABCARE GROUP, INC.

                   Notes to Consolidated Financial Statements



(8)    Earnings per Share
       The  following  table sets  forth the  computation  of basic and  diluted
          earnings per share:


<TABLE>
<CAPTION>

                                                                    Year Ended       Ten Months Ended        Year Ended
                                                                   December 31,        December 31,         February 29,
                                                                       1997                1996                 1996
                                                                       ----                ----                 ----


<S>                                                            <C>                    <C>                  <C>
Numerator:
Numerator for basic earnings per share - earnings
    available to common stockholders (net earnings)             $   10,615,000         5,768,000           5,878,000
Effect of dilutive securities - after tax interest on
    convertible subordinated promissory notes                          225,000           184,000                  --
                                                                    ----------         ---------           ---------
Numerator for diluted earnings per share - earnings
    available to common stockholders after assumed
    conversions                                                 $   10,840,000         5,952,000           5,878,000
                                                                    ==========         =========           =========

Denominator:
Denominator for basic earnings per share -
    weighted-average shares outstanding                              5,999,000         7,001,000           6,725,000
Effect of dilutive securities:
    Stock options                                                      809,000           388,000             250,000
    Convertible subordinated promissory notes                          423,000           423,000                  --
    Contingently issuable shares                                       144,000              --                    --
                                                                    ----------         ---------           ---------
Denominator for diluted earnings per share -
    adjusted weighted-average shares and assumed
    conversions                                                      7,375,000         7,812,000           6,975,000
                                                                     =========         =========           =========

Basic earnings per share                                        $         1.77               .82                 .87
                                                                          ====               ===                 ===
Diluted earnings per share                                      $         1.47               .76                 .84
                                                                          ====               ===                 ===

</TABLE>

    For   additional   disclosures   regarding   stock   options,    convertible
          subordinated  promissory notes and contingently  issuable shares,  see
          notes 6 and 7.

(9)   Employee Benefits
      The  Company has an Employee Savings Plan, which is a defined contribution
           plan qualified under Section 401(k) of the Internal Revenue Code, for
           the benefit of its eligible  employees.  Employees who attain the age
           of 21 and complete  twelve  consecutive  months of employment  with a
           minimum of 1,000  hours  worked are  eligible to  participate  in the
           plan.  Each  participant  may contribute from 2% to 20% of his or her
           compensation  to the  plan  subject  to  limitations  on  the  highly
           compensated  employees  to  ensure  the  plan  is  nondiscriminatory.
           Contributions  made by the Company to the Employee  Savings Plan were
           at rates  of up to 50% of the  first  4% of  employee  contributions.
           Expense  in  connection  with the  Employee  Savings  Plan for  1997,
           calendar  1996  and  fiscal  1996  totaled  $439,000,   $329,000  and
           $313,000, respectively.

                                       27




<PAGE> 28


                              REHABCARE GROUP, INC.

                   Notes to Consolidated Financial Statements



      The  Company  maintains  a  nonqualified  deferred  compensation  plan for
           certain employees.  Under the plan, participants may defer up to 100%
           of their yearly compensation.  The amounts deferred are held in trust
           but remain the  property of the  Company.  At  December  31, 1997 and
           1996,  $1,267,000 and $778,000,  respectively,  was payable under the
           plan and  approximated  the  value of the trust  assets  owned by the
           Company. See note 3.

      In   October  1992,  the Company  entered into a  supplemental  bonus plan
           which,   as  of  December  31,  1997  included  six  key  members  of
           management. Participants began vesting in the supplemental bonus on a
           pro rata basis  beginning  March 1, 1993 and became  fully  vested on
           February 1, 1997. The total cost of the  supplemental  bonus plan was
           charged to earnings as deferred  compensation over the service period
           of the participants. Compensation expense related to the supplemental
           bonus plan for 1997,  calendar 1996 and fiscal 1996 totaled  $56,000,
           $309,000  and  $321,000,   respectively.   In  November   1996,   the
           supplemental bonus plan was amended allowing participants to defer up
           to 50% of the  balances  under  the  supplemental  bonus  plan in the
           Company's common stock as part of the Company's nonqualified deferred
           compensation  plan.  As of December  31, 1997,  50,426  shares of the
           Company's stock are held in trust under the plan.

(10)   Lease Commitments
       The Company  leases office  space  and  certain  office  equipment  under
          noncancellable  operating leases.  Future minimum lease payments under
          noncancellable  operating  leases,  as of December 31, 1997, that have
          initial  or  remaining  lease  terms  in  excess  of  one  year  total
          approximately $767,000 for 1998, $824,000 for 1999, $784,000 for 2000,
          $592,000 for 2001 and $1,020,000 for 2002 and thereafter. Rent expense
          for 1997,  calendar 1996 and fiscal 1996 was  approximately  $766,000,
          $605,000 and $393,000, respectively.

(11)   Income Taxes
       Income taxes consist of the following:

<TABLE>
<CAPTION>

                                                   Year Ended     Ten Months Ended       Year Ended
                                                   December 31,       December 31,      February 29,
                                                      1997               1996               1996
                                                      ----               ----               ----
       <S>                                         <C>                 <C>               <C>
       Federal - current                           $ 6,298,000         3,787,000         3,156,000
       Federal - deferred                             (122,000)         (539,000)          213,000
       State                                         1,091,000           638,000           640,000
                                                     ---------         ---------         ---------
                                                   $ 7,267,000         3,886,000         4,009,000
                                                     =========         =========         =========

       Deferred tax liability recorded
           in stockholders' equity                 $   520,000         1,367,000                --
                                                     =========         =========         =========
</TABLE>


                                       28





<PAGE> 29

                             REHABCARE GROUP, INC.

                   Notes to Consolidated Financial Statements


       A   reconciliation  between  expected income taxes,  computed by applying
           the  statutory  Federal  income tax rates to earnings  before  income
           taxes, and actual income tax is as follows:

<TABLE>
<CAPTION>
                                                        Year Ended          Ten Months Ended        Year Ended
                                                       December 31,            December 31,         February 29,
                                                           1997                    1996                1996
                                                           ----                    ----                ----
<S>                                             <C>                            <C>                   <C>
Statutory U.S. Federal rate                                 35%                     34%                 34%
                                                            ===                     ===                 ===

Expected income taxes                           $        6,259,000             3,282,000             3,362,000
Tax effect of interest income from
      municipal bond obligations
      exempt from Federal taxation                         (54,000)              (43,000)              (74,000)
State income taxes, net of Federal
      income tax benefit                                   709,000               421,000               422,000
Tax effect of amortization expense
      not deductible for tax purposes                      261,000               211,000               254,000
Other, net                                                  92,000                15,000                45,000
                                                         ---------             ---------             ---------
                                                $        7,267,000             3,886,000             4,009,000
                                                         =========             =========             =========

</TABLE>

       The tax effects of temporary  differences  that give rise to the deferred
tax assets and liabilities are as follows:

<TABLE>
<CAPTION>

                                                                               December 31,         December 31,
                                                                                  1997                   1996
                                                                                  ----                   ----
<S>                                                                     <C>                         <C>
Deferred tax assets:
      Net operating loss carryforwards                                  $        569,000               889,000
      Provision for doubtful accounts                                            519,000               397,000
      Accrued insurance, bonus and
          vacation expense                                                     2,442,000             2,036,000
      Other                                                                      351,000               289,000
                                                                              ----------            ----------
                                                                               3,881,000             3,611,000
                                                                               ---------             ---------
Deferred tax liabilities:
      Unrealized gain on marketable
          securities                                                             520,000             1,367,000
      Goodwill amortization                                                      765,000               253,000
      Pre-opening costs                                                          504,000               393,000
      Other                                                                      138,000               253,000
                                                                              ----------            ----------
                                                                               1,927,000             2,266,000
                                                                               ---------             ---------
      Net deferred tax asset                                            $      1,954,000             1,345,000
                                                                               =========             =========


</TABLE>
                                       29

<PAGE> 30
        
                             REHABCARE GROUP, INC.

                   Notes to Consolidated Financial Statements


       The Company is required to establish a valuation  allowance  for deferred
          tax assets if, based on the weight of available  evidence,  it is more
          likely than not that some  portion or all of the  deferred  tax assets
          will not be realized.  The ultimate realization of deferred tax assets
          is dependent  upon the  generation of future taxable income during the
          periods  in  which  those  temporary  differences  become  deductible.
          Management   considers   the   scheduled   reversal  of  deferred  tax
          liabilities,   projected   future  taxable  income  and  tax  planning
          strategies  in  making  this  assessment.  Based  upon  the  level  of
          historical taxable income and projections for future taxable income of
          the periods which the deferred tax assets are  deductible,  management
          believes  that a valuation  allowance is not  required,  as it is more
          likely than not that the results of future  operations  will  generate
          sufficient taxable income to realize the deferred tax assets.

       As a result of the acquisition of Advanced Rehabilitation Resources, Inc.
          in 1993,  the  Company,  as of December 31,  1997,  has  approximately
          $1,423,000  of  net  operating  loss   carryforwards  for  income  tax
          purposes, which will expire in years 2005 through 2008. The Tax Reform
          Act  of  1986  imposes  an  annual  limitation  on the  amount  of any
          preacquisition  loss  carryforwards that can be used to offset Company
          Federal  taxable  income   generated   after  the  acquisition   date.
          Generally, this annual limitation will approximate $1,200,000.

       Income taxes paid by the Company for 1997,  calendar 1996 and fiscal 1996
          were $6,400,000, $4,234,000 and $4,010,000, respectively.

(12)   Contingencies
       The Company has undergone a Federal  payroll tax audit for the years 1989
           through 1993.  The Internal  Revenue  Service  ("IRS")  asserted that
           certain  medical  professionals  and others  engaged  as  independent
           contractors  should have been  treated as  employees  for payroll tax
           purposes.  The IRS, in May 1996, issued a proposed assessment against
           the Company of $1,935,455  for years 1989 through  1993.  The Company
           subsequently   received  from  the  IRS  separate   proposed  Closing
           Agreements for these same independent contractors under the IRS's new
           "Classification  Settlement  Program"  with  an  alternate  aggregate
           assessment  of  $253,426   covering  the  1989  through  1993  audit,
           including any additional  potential  liability  through  December 31,
           1996.  The Company has accepted  settlement  offers under the program
           for two classes of medical professionals, paid $61,000 as settlements
           and agreed to  prospectively  treat these classes of professionals as
           employees.  The IRS has accepted the Company's  classification of the
           remaining  classes  as  independent  contractors  and has  closed the
           audit.

(13)   Quarterly Financial  Information  (Unaudited) 
       (In thousands, except per share data)
<TABLE>
<CAPTION>

                                                                  Quarter Ended
                      1997                     Dec.  31       Sep. 30       June 30      Mar. 31
                      ----                     --------       -------       -------      -------

<S>                                     <C>                   <C>           <C>           <C>
Operating revenues                      $       42,728        42,151        39,496        36,405
Operating earnings                               5,352         4,854         4,464         4,310
Earnings before income taxes                     4,659         4,139         3,741         5,343
Net earnings                                     2,744         2,439         2,165         3,267
Net earnings per common share:
      Basic                                        .47           .43           .38           .48
      Diluted                                      .38           .35           .31           .42


</TABLE>

                                       30

<PAGE> 31

                                               REHABCARE GROUP, INC.

                                    Notes to Consolidated Financial Statements
<TABLE>
<CAPTION>
                                              One Month
                                                Ended                    Quarter Ended
                   Calendar 1996               Dec. 31       Nov. 30       Aug. 31        May 31
                   -------------               -------       -------       -------        ------
<S>                                       <C>                 <C>           <C>           <C>
Operating revenues                        $     11,204        31,519        30,888        31,000
Operating earnings                               1,244         3,422         3,096         2,936
Earnings before income taxes                     1,153         3,108         2,770         2,623
Net earnings                                       689         1,864         1,653         1,562
Net earnings per common share:
      Basic                                        .10           .27           .24           .22
      Diluted                                      .09           .24           .22           .21

</TABLE>

                  The sum of the  quarterly  earnings  per common  share may not
                  equal the full year  earnings per common share due to rounding
                  and computational differences.

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

      Not applicable.

                                    PART III

ITEM 10.        DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

      Certain  information  regarding  directors and  executive  officers of the
Company is contained  under the caption  "Election of Directors" and "Compliance
with Section 16(a) of the Securities Exchange Act of 1934" included in the Proxy
Statement for the 1998 Annual  Meeting of  Stockholders,  which  information  is
incorporated herein by reference.

      The following is a list as of March 13, 1998, of the names and ages of the
executive officers of the Company and positions with the Company. The employment
history of each of the  executive  officers for the past five years  follows the
list. There is no family relationship between any of the named persons.

        Name             Age        Position
        ----             ---        --------

  James M. Usdan         48   President and Chief Executive Officer
  Richard C.  Stoddard   49   Executive Vice President, President, HSSI
  Tom E.  Davis          48   President, Inpatient Division
  Keith L. Goding        47   Executive Vice President and 
                                 Chief Development Officer
  Alan C. Henderson      52   Executive Vice President, Chief Financial Officer 
                                 and Secretary
  Alfred J.  Howard      45   President, Outpatient Division
  Hickley M. Waguespack  54   Executive Vice President, Customer Service and 
                                 Retention



     JAMES M. USDAN has been President of the Company since April 1990 and Chief
Executive Officer since June 1991.

     RICHARD C. STODDARD is a co-founder of HSSI, has been President since 1989,
and is also a Board Member at the Company.

     TOM E. DAVIS has been  President of the  Inpatient  Division  since January
1998 and joined the Company

                                       31

<PAGE> 32



in January  1997 as Senior Vice  President of  Operations.  Prior to joining the
Company,  Mr. Davis was Group Vice  President for Quorum Health  Resources  from
January 1990 to January 1997.

      KEITH L. GODING has been Executive  Vice  President and Chief  Development
Officer of the Company since  February 1995.  Prior to joining the Company,  Mr.
Goding was Vice  President for Corporate  Alliances and Vice President of Sales,
Marketing and Product Development for Spectrum Healthcare  Services,  a division
of ARAMARK, where he was employed since 1974.

     ALAN C. HENDERSON has been  Executive  Vice  President and Chief  Financial
Officer of the Company since March 1991. In June 1991, Mr. Henderson was elected
Secretary of the Company.

      ALFRED J.  HOWARD has been  President  of the  Outpatient  Division  since
August  1996.  Prior to joining  the  Company he was  President  of the  Eastern
Operations for Pacific  Rehabilitation  and Sports Medicine from October 1993 to
August 1996.

      HICKLEY M. WAGUESPACK has been Executive Vice President,  Customer Service
and Retention  since January 1998,  was Chief  Operating  Officer of the Company
from March 1995 through  December 1997, was a Senior Vice President - Operations
from June 1991 until February 1995.

ITEM 11.        EXECUTIVE COMPENSATION

      Information  regarding  executive  compensation  is  contained  under  the
caption  "Compensation of Executive  Officers,"  included in the Proxy Statement
for the 1998 Annual Meeting of  Stockholders,  which is  incorporated  herein by
reference.

ITEM 12.        SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
                MANAGEMENT

      Information  regarding security ownership of certain beneficial owners and
management  is contained  under the captions  "Voting  Securities  and Principal
Holders Thereof" and "Security  Ownership by Management,"  included in the Proxy
Statement for the 1998 Annual  Meeting of  Stockholders,  which is  incorporated
herein by reference.

ITEM 13.       CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

      Not applicable.
                                     PART IV

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

      (a) The following documents are filed as part of this report:

            (1) Financial Statements
                    Independent Auditors' Report
                    Consolidated Balance Sheets as of December 31, 1997 and 1996
                    Consolidated Statements of Earnings for the year ended
                        December 31, 1997, for the ten months ended December 31,
                        1996 and for the year ended February 29, 1996
                    Consolidated Statements of Stockholders' Equity for the year
                        ended  December  31,  1997,  for  the ten  months  ended
                        December 31, 1996 and for year ended February 29, 1996
                    Consolidated  Statements  of Cash  Flows for the year  ended
                        December 31, 1997, for the ten months ended December 31,
                        1996 and for the year February 29, 1996
                    Notes to Consolidated Financial Statements

                                       32


<PAGE> 33



            (2)  Financial Statement Schedules:
                      None

            (3) Exhibits:

                  3.1   Restated  Certificate of Incorporation (filed as Exhibit
                        3.1 to the Registrant's  Registration  Statement on Form
                        S-1, dated May 9, 1991  [Registration  No. 33-40467] and
                        incorporated herein by reference)

                  3.2   Certificate of Amendment of Certificate of Incorporation
                        (filed as Exhibit 3.1 to the Registrant's Report on Form
                        10-Q for the quarter ended May 31, 1995 and incorporated
                        herein by reference)

                  3.3   Bylaws  (filed  as  Exhibit  3.2  to  the   Registrant's
                        Registration  Statement  on Form S-1,  dated May 9, 1991
                        [Registration  No. 33-40467] and incorporated  herein by
                        reference)

                  4.1   Rights  Agreement,  dated  September  21,  1992,  by and
                        between the Company and Boatmen's  Trust Company  (filed
                        as Exhibit 1 to the Company's  Registration Statement on
                        Form 8-A  filed  September  24,  1992  and  incorporated
                        herein by reference)

                 10.1   1987 Incentive Stock Option and 1987 Nonstatutory  Stock
                        Option Plans (filed as Exhibit 10.1 to the  Registrant's
                        Registration  Statement  on Form S-1,  dated May 9, 1991
                        [Registration  No. 33-40467] and incorporated  herein by
                        reference)

                 10.2   Form of Stock Option Agreement (filed as Exhibit 10.2 to
                        the  Registrant's  Registration  Statement  on Form S-1,
                        dated  May  9,  1991  [Registration  No.  33-40467]  and
                        incorporated herein by reference)

                 10.3   Employment  Agreement with James M. Usdan,  dated May 1,
                        1991 (filed as Exhibit  10.3 to  Amendment  No. 1 to the
                        Registrant's  Registration  Statement on Form S-1, dated
                        June  19,   1991   [Registration   No.   33-40467]   and
                        incorporated herein by reference)

                 10.4   Employment  Agreement with Alan C. Henderson,  dated May
                        1, 1991 (filed as Exhibit 10.4 to Amendment No. 1 to the
                        Registrant's  Registration  Statement on Form S-1, dated
                        June  19,   1991   [Registration   No.   33-40467]   and
                        incorporated herein by reference)

                 10.5   Employment  Agreement  with Richard C.  Stoddard,  dated
                        March  1,  1996 by and  between  Registrant,  Healthcare
                        Staffing Solutions,  Inc. d/b/a Health Tour, and Richard
                        C. Stoddard  (filed as Exhibit 10.1 to the  Registrant's
                        Current  Report  on Form  8-K,  dated  March 1, 1996 and
                        incorporated herein by reference)

                 10.6   Form of Termination  Compensation Agreement for James M.
                        Usdan and Alan C.  Henderson  (filed as Exhibit  10.6 to
                        the  Registrant's  Registration  Statement  on Form S-1,
                        dated February 18, 1993  [Registration No. 33-58490] and
                        incorporated herein by reference)

                 10.7   Form of  Termination  Compensation  Agreement  for other
                        executive   officers  (filed  as  Exhibit  10.7  to  the
                        Registrant's  Registration  Statement on Form S-1, dated
                        February  18,  1993   [Registration  No.  33-58490]  and
                        incorporated herein by reference)

                                       33


<PAGE> 34



                 10.8   Supplemental  Bonus Plan  (filed as Exhibit  10.8 to the
                        Registrant's  Registration  Statement on Form S-1, dated
                        February  18,  1993   [Registration  No.  33-58490]  and
                        incorporated herein by reference)

                 10.9   Settlement Agreement and Release dated December 1996 and
                        Settlement  Agreement and Mutual Release dated September
                        17,   1996   with    Comprehensive    Care   Corporation
                        ("CompCare")  regarding the Tax Sharing  Agreement  with
                        CompCare dated May 8,  1991(filed as Exhibit 10.1 to the
                        Registrant's  Report on Form 10-Q dated January 14, 1997
                        and incorporated herein by reference)

                 10.10  Deferred  Profit Sharing Plan (filed as Exhibit 10.15 to
                        the  Registrant's  Registration  Statement  on Form S-1,
                        dated February 18, 1993  [Registration No. 33-58490] and
                        incorporated herein by reference)

                 10.11  RehabCare Executive Deferred Compensation Plan (filed as
                        Exhibit 10.12 to the  Registrant's  Report on Form 10-K,
                        dated May 27, 1994 and incorporated herein by reference)

                 10.12  RehabCare   Directors'   Stock  Option  Plan  (filed  as
                        Appendix A to Registrant's  Proxy Statement for the 1994
                        Annual Meeting of Stockholders and  incorporated  herein
                        by reference)

                 10.13  RehabCare  Group,  Inc. 1996 Long-Term  Performance Plan
                        (filed as Appendix A to the Registrant's Proxy Statement
                        for  the  1996  Annual  Meeting  of   Stockholders   and
                        incorporated herein by reference)

                 10.14  Form  of  Subordinated  Convertible  Promissory  Note of
                        Registrant issued to stockholders of Healthcare Staffing
                        Solutions,  Inc. d/b/a Health Tour (filed as Exhibit 2.4
                        to the  Registrant's  Current  Report on Form 8-K, dated
                        March 1, 1996 and incorporated herein by reference)

                 10.15  Stock Purchase Agreement,  dated January 27, 1997 by and
                        among  Registrant  and the  stockholders  of  TeamRehab,
                        Inc., Moore  Rehabilitation  Services,  Incorporated and
                        Moore  Rehabilitation  Services,  PC.  (filed as Exhibit
                        10.19 to the  Registrant's  Report on Form  10-K,  dated
                        March 12, 1997 and incorporated herein by reference)

                 10.16  Form  of  Subordinated  Promissory  Note  of  Registrant
                        issued to the  stockholders  of TeamRehab,  Inc.,  Moore
                        Rehabilitation   Services,    Incorporated   and   Moore
                        Rehabilitation  Services, PC. (filed as Exhibit 10.20 to
                        the  Registrant's  Report on Form 10-K,  dated March 12,
                        1997 and incorporated herein by reference)

                  13.1  Those  portions of the Annual  Report for the year ended
                        December 31, 1997 of the Registrant included in response
                        to Items 5 and 6 of Form 10-K

                  21.1   Subsidiaries of the Registrant

                    23  Consent of KPMG Peat Marwick LLP

                    27  Financial Data Schedule

      (b)  Reports on Form 8-K

No  reports  on Form 8-K were filed by the  Registrant  during the three  months
ended December 31, 1997.

                                       34

<PAGE> 35



SIGNATURES

      Pursuant to the requirements of Section 13 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.

Dated: March 13, 1998
                                              REHABCARE GROUP, INC.
                                                  (Registrant)


                                           By: /s/ JAMES M. USDAN
                                                  (James M. Usdan)
                                           President and Chief Executive Officer

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

Signature                         Title                               Dated


/s/  JAMES M. USDAN               President, Chief Executive     March 13, 1998
----------------------------      Officer and Director
(James M. Usdan)
Principal Executive Officer

/s/  ALAN C. HENDERSON            Executive Vice President       March 13, 1998
----------------------------      and Chief Financial Officer
(Alan C. Henderson)
Principal Financial Officer

/s/  JOHN R. FINKENKELLER         Senior Vice President          March 13, 1998
----------------------------      and Treasurer
(John R. Finkenkeller)
Principal Accounting Officer

/s/  WILLIAM G. ANDERSON          Director                       March 13, 1998
----------------------------
(William G. Anderson)

/s/  RICHARD E. RAGSDALE          Director                       March 13, 1998
----------------------------
(Richard E. Ragsdale)

/s/ JOHN H. SHORT                 Director                       March 13, 1998
----------------------------
(John H. Short)

/s/ RICHARD C. STODDARD           Director                       March 13, 1998
----------------------------
(Richard C. Stoddard)

/s/  H. EDWIN TRUSHEIM            Director                       March 13, 1998
----------------------------
(H. Edwin Trusheim)

/s/ THEODORE M. WIGHT             Director                       March 13, 1998
----------------------------
(Theodore M. Wight)

                                       35





<PAGE> 36

                                 EXHIBIT INDEX

Exhibit                                                               Page
Number                   Description                                 Number 
------                   -----------                                 ------

 3.1  Restated  Certificate of Incorporation (filed as Exhibit         
      3.1 to  the  Registrant's Registration Statement on Form 
      S-1, dated May 9, 1991  [Registration  No. 33-40467] and
      incorporated herein by reference)

 3.2  Certificate of Amendment of Certificate of Incorporation             
      (filed as Exhibit 3.1 to the Registrant's Report on Form
      10-Q for the quarter ended May 31, 1995 and incorporated
      herein by reference)

 3.3  Bylaws  (filed  as  Exhibit  3.2  to  the   Registrant's
      Registration  Statement  on Form S-1,  dated May 9, 1991
      [Registration  No. 33-40467] and incorporated  herein by
      reference)

 4.1  Rights  Agreement,  dated  September  21,  1992,  by and
      between the Company and Boatmen's  Trust Company  (filed
      as Exhibit 1 to the Company's  Registration Statement on
      Form 8-A  filed  September  24,  1992  and  incorporated
      herein by reference)

10.1  1987 Incentive Stock Option and 1987 Nonstatutory  Stock
      Option Plans (filed as Exhibit 10.1 to the  Registrant's
      Registration  Statement  on Form S-1,  dated May 9, 1991
      [Registration  No. 33-40467] and incorporated  herein by
      reference)

10.2  Form of Stock Option Agreement (filed as Exhibit 10.2 to
      the  Registrant's  Registration  Statement  on Form S-1,
      dated  May  9,  1991  [Registration  No.  33-40467]  and
      incorporated herein by reference)

10.3  Employment  Agreement with James M. Usdan,  dated May 1,
      1991 (filed as Exhibit  10.3 to  Amendment  No. 1 to the
      Registrant's  Registration  Statement on Form S-1, dated
      June  19,   1991   [Registration   No.   33-40467]   and
      incorporated herein by reference)

10.4  Employment  Agreement with Alan C. Henderson,  dated May
      1, 1991 (filed as Exhibit 10.4 to Amendment No. 1 to the
      Registrant's  Registration  Statement on Form S-1, dated
      June  19,   1991   [Registration   No.   33-40467]   and
      incorporated herein by reference)

10.5  Employment  Agreement  with Richard C.  Stoddard,  dated
      March  1,  1996 by and  between  Registrant,  Healthcare
      Staffing Solutions,  Inc. d/b/a Health Tour, and Richard
      C. Stoddard  (filed as Exhibit 10.1 to the  Registrant's
      Current  Report  on Form  8-K,  dated  March 1, 1996 and
      incorporated herein by reference)

10.6  Form of Termination  Compensation Agreement for James M.
      Usdan and Alan C.  Henderson  (filed as Exhibit  10.6 to
      the  Registrant's  Registration  Statement  on Form S-1,
      dated February 18, 1993  [Registration No. 33-58490] and
      incorporated herein by reference)

10.7  Form of  Termination  Compensation  Agreement  for other
      executive   officers  (filed  as  Exhibit  10.7  to  the
      Registrant's  Registration  Statement on Form S-1, dated
      February  18,  1993   [Registration  No.  33-58490]  and
      incorporated herein by reference)

                                       36

<PAGE> 37
                                 

Exhibit                                                               Page
Number                   Description                                 Number 
------                   -----------                                 ------

10.8  Supplemental  Bonus Plan  (filed as Exhibit  10.8 to the
      Registrant's  Registration  Statement on Form S-1, dated
      February  18,  1993   [Registration  No.  33-58490]  and
      incorporated herein by reference)

10.9  Settlement Agreement and Release dated December 1996 and
      Settlement  Agreement and Mutual Release dated September
      17,   1996   with    Comprehensive    Care   Corporation
      ("CompCare")  regarding the Tax Sharing  Agreement  with
      CompCare dated May 8,  1991(filed as Exhibit 10.1 to the
      Registrant's  Report on Form 10-Q dated January 14, 1997
      and incorporated herein by reference)

10.10 Deferred  Profit Sharing Plan (filed as Exhibit 10.15 to
      the  Registrant's  Registration  Statement  on Form S-1,
      dated February 18, 1993  [Registration No. 33-58490] and
      incorporated herein by reference)

10.11 RehabCare Executive Deferred Compensation Plan (filed as
      Exhibit 10.12 to the  Registrant's  Report on Form 10-K,
      dated May 27, 1994 and incorporated herein by reference)

10.12 RehabCare   Directors'   Stock  Option  Plan  (filed  as
      Appendix A to Registrant's  Proxy Statement for the 1994
      Annual Meeting of Stockholders and  incorporated  herein
      by reference)

10.13 RehabCare  Group,  Inc. 1996 Long-Term  Performance Plan
      (filed as Appendix A to the Registrant's Proxy Statement
      for  the  1996  Annual  Meeting  of   Stockholders   and
      incorporated herein by reference)

10.14 Form  of  Subordinated  Convertible  Promissory  Note of
      Registrant issued to stockholders of Healthcare Staffing
      Solutions,  Inc. d/b/a Health Tour (filed as Exhibit 2.4
      to the  Registrant's  Current  Report on Form 8-K, dated
      March 1, 1996 and incorporated herein by reference)

10.15 Stock Purchase Agreement,  dated January 27, 1997 by and
      among  Registrant  and the  stockholders  of  TeamRehab,
      Inc., Moore  Rehabilitation  Services,  Incorporated and
      Moore  Rehabilitation  Services,  PC.  (filed as Exhibit
      10.19 to the  Registrant's  Report on Form  10-K,  dated
      March 12, 1997 and incorporated herein by reference)

10.16 Form  of  Subordinated  Promissory  Note  of  Registrant
      issued to the  stockholders  of TeamRehab,  Inc.,  Moore
      Rehabilitation   Services,    Incorporated   and   Moore
      Rehabilitation  Services, PC. (filed as Exhibit 10.20 to
      the  Registrant's  Report on Form 10-K,  dated March 12,
      1997 and incorporated herein by reference)

13.1  Those  portions of the Annual  Report for the year ended
      December 31, 1997 of the Registrant included in response
      to Items 5 and 6 of Form 10-K                                   38

21.1  Subsidiaries of the Registrant                                  39

  23  Consent of KPMG Peat Marwick LLP                                40

  27  Financial Data Schedule                                         41 

                                       37

<PAGE> 38                                                       Exhibit 13.1
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
Six-Year Financial Summary                                             Dollars in thousands, except per share data
(Year ended December 31, unless noted)               1997          1996<F1>        1996<F2>       1995<F2>      1994<F2>    1993<F2>
------------------------------------------------------------------------------------------------------------------------------------
<S>                                              <C>            <C>             <C>            <C>           <C>            <C>
Statement of earnings data:
Operating revenues                               $   160,780    $   119,856     $   89,377     $   83,210    $   61,740     $ 48,419
Operating earnings                                    18,980         12,717         10,276          8,531         5,533        5,026
Net earnings                                          10,615          6,992          5,878          4,735         3,070        2,948
Net earnings per share (EPS): <F3>
     Basic                                       $      1.77    $      1.01     $      .87     $      .71    $      .59     $    .49
     Diluted                                     $      1.47    $       .93     $      .84     $      .70    $      .59     $    .48
Weighted average shares outstanding (000s):<F3>
     Basic                                             5,999          6,955          6,725          6,614         4,514        5,837
     Diluted                                           7,375          7,711          6,975          6,783         5,214        6,088
------------------------------------------------------------------------------------------------------------------------------------
Balance sheet data:
Working capital                                  $    12,793    $     9,254     $   11,818     $    5,460    $    6,271     $  7,798
Total assets                                          97,241         80,802         57,066         52,833        45,445       20,124
Long-term debt                                        34,494         14,000          5,032          7,122         7,500        9,500
Redeemable preferred stock                                --             --             --             --         3,568        3,499
Stockholders' equity                                  39,760         49,670         38,897         32,431        24,132        (291)
------------------------------------------------------------------------------------------------------------------------------------
Financial statistics:
Operating margin                                       11.8%          10.6%          11.5%          10.2%          9.0%        10.4%
Net margin                                              6.6%           5.8%           6.6%           5.7%          5.0%         6.1%
Current ratio                                          1.6:1          1.6:1          2.0:1          1.4:1         1.6:1        2.1:1
Diluted EPS growth rate                                58.1%          14.8%          20.0%          18.6%         22.9%        20.0%
Return on equity <F4>                                  23.7%          16.1%          16.5%          16.7%         25.8%        36.9%
------------------------------------------------------------------------------------------------------------------------------------
Operating statistics:
Inpatient (acute rehab and subacute)
     Average number of units                           110.3           91.3           84.7           84.1          64.4         49.3
     Average occupied beds per unit                     13.2           12.8           13.2           13.2          13.8         14.5
     Average admissions per unit                         321            294            279            261           264          266
     Average length of stay (billable)                  15.0           15.9           17.3           18.4          19.0         19.8
     Patient days (billable)                         532,195        426,995        408,385        403,784       323,040      260,134
Outpatient:
     Average number of locations                        17.9           19.6           21.2           13.6           7.6          5.1
     Patient visits                                  231,256        223,904        278,970        135,064           N/A          N/A
Therapy staffing - Number of weeks worked             29,652         21,908             --             --            --           --
Contract therapy - Average number of locations          35.8             --             --             --            --           --
------------------------------------------------------------------------------------------------------------------------------------
<FN>
<F1>For  comparability  purposes,  reflects the twelve months ended December 31,
    1996.  Statement of earnings data for the ten month accounting  period ended
    December 31, 1996, reflecting the change to a calendar fiscal year-end as of
    December 31, 1996 from the last day of February  previously,  is included in
    the consolidated financial statements.
<F2>Twelve month period ended last day of February.  
<F3>All share data adjusted for 3-for-2 stock split in October 1997.
<F4>Average of beginning and ending equity.
N/A - Not available
</FN>
--------------------------------------------------------------------------------
</TABLE>
Stock Data
The Company's  common stock is listed and traded on the NASDAQ  National  Market
System under the symbol "RHBC". The stock prices below are the high and low sale
prices as reported on NASDAQ.

Calendar Quarter             1st      2nd     3rd      4th
--------------------------------------------------------------------------------
1997:   High               $17.58   $24.83  $25.25   $31.13
        Low                 12.50    15.75   17.67    23.50
--------------------------------------------------------------------------------
1996:   High                13.17    12.25   13.08    13.75
        Low                 10.00     9.83    9.83    11.17

The Company  effected a 3-for-2 stock split to  shareholders on October 1, 1997.
The  Company  has not paid  dividends  on its common  stock  during the two most
recently  completed fiscal periods and has not declared any dividends during the
current fiscal year.  The Company does not  anticipate  paying cash dividends in
the foreseeable  future.  The number of holders of the Company's common stock as
of March 13, 1998 was  approximately  3,358 including 157 shareholders of record
and an estimated 3,201 persons or entities holding common stock in nominee name.

In our ongoing efforts to control costs,  we have  eliminated  production of our
quarterly  reports,  an action  taken by many  other  publicly  held  companies.
Instead,  shareholders may receive earnings news releases,  which provide timely
financial  information,  by notifying  our investor  relations  department or by
visiting our website at http://www.rehabcare.com
     
                                    38              

<PAGE> 39
                                                                    Exhibit 21.1



                              REHABCARE GROUP, INC.

                           Subsidiaries of Registrant




RehabCare Outpatient Services, Inc.        Incorporated in the State of Florida

Healthcare Staffing Solutions, Inc.        Incorporated in the Commonwealth
     d/b/a Health Tour                     of Massachusetts

Health Tour Management, Inc.               Incorporated in the Commonwealth
                                           of Massachusetts

TeamRehab, Inc.                            Incorporated in the State of Missouri

Moore Rehabilitation Services, Inc.        Incorporated in the State of Missouri

RehabCare Group East, Inc.                 Incorporated in the State of Delaware

RehabCare Group Management Services, Inc.  Incorporated in the State of Delaware

RehabCare Group of California, Inc.        Incorporated in the State of Delaware

RehabCare Group Texas Holdings, Inc.       Incorporated in the State of Delaware

                                   39            

<PAGE> 40



                                                                      Exhibit 23












                          Independent Auditors' Consent

The Board of Directors
RehabCare Group, Inc.:

We consent to the  incorporation by reference in the registration  statement No.
33-82106 on Form S-8,  registration  statement  No.  33-82048  on Form S-8,  and
registration statement No. 333-11311 on Form S-8 of RehabCare Group, Inc. of our
report dated February 6, 1998, with respect to the  consolidated  balance sheets
of RehabCare Group,  Inc. and subsidiaries as of December 31, 1997 and 1996, and
the related consolidated statements of earnings,  stockholders' equity, and cash
flows for the year ended  December 31, 1997,  for the ten months ended  December
31, 1996, and for the year ended February 29, 1996,  which report is included in
the December 31, 1997 annual report on Form 10-K of RehabCare Group, Inc.


                                           /S/ KPMG PEAT MARWICK LLP




St. Louis, Missouri
March 20, 1998

                                  40