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                     U.S. SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549

                                   FORM 10-KSB

(Mark One)
[ X ]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
           EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended           January 31, 1997
                         --------------------------------------------
                                       or
[   ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
           SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from              N/A            to
                               ---------------------------    ------------------
Commission file Number                          33-9396-LA
                      ----------------------------------------------------------
                    National Health Enhancement Systems, Inc.
--------------------------------------------------------------------------------
(Name of small business issuer in its charter)

Delaware                                                       86-0460312
(State or other jurisdiction of                                (I.R.S. Employer
 incorporation or organization)                                Identification
                                                               Number)
17th Floor                                     
3200 North Central Avenue
Phoenix, Arizona                                               85012
(Address of principal executive offices)                       (Zip Code)

Issuer's telephone number                                      602-230-7575

Securities registered under Section 12(b) of the Exchange Act:

                                      NONE

Securities registered under Section 12(g) of the Exchange Act:

                          COMMON STOCK $.001 PAR VALUE

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

Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB.[  ]

Issuer's revenues for its most recent fiscal year:   $25,185,005

As of April 22, 1997, the aggregate market value of Registrant's voting shares
held by non-affiliates, based upon the average between the closing bid and asked
prices of such stock as quoted on Nasdaq, was approximately $17,087,000.

The number of shares of the Registrant's common stock issued and outstanding was
5,539,067 at April 22, 1997.

The Registrant's definitive Proxy Statement to be filed pursuant to Regulation
14A with the Securities and Exchange Commission not later than May 31, 1997 is
incorporated by reference into Part III, Items 9 through 12.


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                                TABLE OF CONTENTS

                                                                            PAGE

PART I

           Item 1.   Description of Business                                 1
           Item 2.   Description of Properties                               9
           Item 3.   Legal Proceedings                                       9
           Item 4.   Submission of Matters to a Vote of Security Holders     10

PART II

           Item 5.   Market for Common Equity and Related Stockholder
                     Matters                                                 10
           Item 6.   Management's Discussion and Analysis of
                     Financial Condition and Results of Operations           11
           Item 7.   Financial Statements                                    14
           Item 8.   Changes In and Disagreements with Accountants on
                     Accounting and Financial Disclosure                     29

PART III
           Item 9.   Directors, Executive Officers, Promoters and
                     Control Persons:  Compliance with Section 16(a) of
                     the Exchange Act                                        30
           Item 10.  Executive Compensation                                  30
           Item 11.  Security Ownership of Certain Beneficial
                     Owners and Management                                   30
           Item 12.  Certain Relationships and Related Transactions          30

           Item 13.  Exhibits and Reports on Form 8-K                        30

SIGNATURES                                                                   31


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PART I

ITEM 1.  DESCRIPTION OF BUSINESS

BUSINESS DEVELOPMENT

National Health Enhancement Systems, Inc. (the "Company"), originally
incorporated in July 1983 as an Arizona corporation named AHI Limited, was
formed for the purpose of developing, licensing and marketing health evaluation
programs to healthcare providers, including hospitals, medical groups, clinics
and physicians. On October 7, 1986, the Company was reincorporated in Delaware
by merger into a Delaware corporation formed for that purpose.

In 1983, the Company commenced marketing a single proprietary,
software-supported health evaluation system designed to assist a healthcare
provider to assess an apparently "well" individual's overall fitness and risk of
incurring cardiovascular disease. This product, the Personal Fitness Profile,
helped healthcare providers to generate additional direct revenue and refer
consumers to other programs, departments or physicians for remedial or
preventive care. The Company's business strategy has since evolved, and the
Company's current business objective is to become the leading supplier of
Medical Call Center system products and services. The Company's products and
services are used by licensed registered nurses and other healthcare
professionals and providers in an effort to manage consumer demand for and
utilization of health care services, lower costs, improve consumer satisfaction
and improve the quality of care.

In April 1993, the Company acquired First Strategic Group, Ltd. ("FSG"), a
California corporation. FSG is a strategic consulting firm which specializes in
the development of healthcare marketing and advertising strategies. FSG services
include providing healthcare marketing consulting services and strategies and
development of creative marketing and/or advertising materials (such as direct
mail pieces and print ad materials) as requested by its clients. FSG services do
not include the placement of media or advertising.

In February 1997, the Company acquired all the stock of Atlanta, Georgia-based
Expert Systems, Inc. (ESI). ESI is a leading provider of tools for developers of
telephone and database technologies to create integrated voice response (IVR)
and computer telephony integration (CTI) features for computer telephony
applications. ESI's flagship EASE(R) product makes it easier for developers of
telephone and database technologies to create voice features for computer
telephony applications.

INDUSTRY BACKGROUND

The growth rate of healthcare expenditures in the United States continues to
rise, as do consumer demands for improved access to healthcare services.
Escalating costs of healthcare and public/political focus on healthcare have
caused many changes to occur in the healthcare market. One of the most
significant changes is the rapid and accelerating growth of managed care in both
the private and public sector. As the focus continues to shift from
fee-for-service to capitation, managed care programs continue to become more
prevalent. This trend creates a marketplace where healthcare providers seek to
maximize profitability by improving or reducing utilization and managing health
risk by keeping people healthy and providing the most cost-effective care should
they become sick.

According to the United States General Accounting Office, an estimated 90
million emergency department visits occurred in 1992, and approximately 40% of
those visits were unnecessary. The cost to diagnose and treat acute and chronic
conditions that are not truly emergencies, in an emergency department, are far
more expensive than the cost to treat such conditions in a physician's office or
an urgent care clinic.

The Company's strategy focuses upon the opportunity to assist healthcare
providers redirect these costly and unnecessary emergency room visits, and
similar inefficient utilization patterns, to more cost-effective settings, by
offering Medical Call Center products and services which can be implemented or
used by healthcare providers. The Company believes its Medical Call Center
products and services are part of the solution to improve service and reduce
healthcare costs. Medical Call Centers are staffed by registered nurses, who
field calls from people with health questions, 24-hours-a-day, seven days a
week. Specially trained nurses 


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provide callers, through the use of clinically tested algorithms, access to
specific medical information and referrals designed to direct them to
cost-effective and appropriate levels of care. The Medical Call Center system is
designed to allow patients to become actively involved in managing their own
health. The Company believes that the information callers receive helps them to
make better decisions and helps them avoid unnecessary or inappropriate
emergency or physician office visits. Ultimately, the Company believes this
reduces healthcare costs and increases satisfaction and loyalty within the
healthcare delivery system. A typical Medical Call Center offers the following
capabilities:

         1.       Assists people in evaluating their health symptoms.

         2.       Enables people to better understand and manage serious
                  healthcare episodes.

         3.       Provides assistance in administering at-home remedies.

         4.       Offers educational information on a wide variety of health
                  topics.

         5.       Offers assistance to find a physician, class or program to
                  meet the callers' needs.

As managed care and capitation continue to change the healthcare industry, the
focus continues to shift. The Company believes that healthcare providers, to
succeed, will seek to increase access to information and influence decisions
while concurrently managing access to quality healthcare services, and that this
shift toward managing the demand and utilization will require greater reliance
on three components of healthcare: self care, patient education and telephone
triage. Medical Call Center products can guide nurses in triaging adult and
pediatric patients to the most appropriate and cost effective levels of care.
Success for hospitals, primary care physicians, HMO's and other alliances will,
in the Company's opinion, depend upon the degree to which these organizations
are able to effectively educate patients and subscribers regarding appropriate
utilization of the healthcare system. The Company believes that Medical Call
Centers will support utilization management strategies by delivering information
to patients and subscribers to help them make intelligent, well-informed
decisions about their health.

The Company's software products and services provide the foundation to implement
Medical Call Centers and systems operated by or for healthcare providers. The
Company has over 300 Medical Call Center clients. These clients have an
estimated 10 million lives under managed care health plans and have fielded over
10 million triage-related calls and an estimated 30 million total calls with the
Company's Medical Call Center products. The Company currently distributes its
products and services through Company-employed sales representatives and through
distributors, including Pfizer Health Solutions, Inc., Beech Street Corp.,
Rural/Metro Corp. (NASDAQ: RURL) and Advance ParadigM, Inc. (NASDAQ: ADVP).
Historically, the Company's primary customers have been hospitals, but the
Company has recently expanded distribution to medical groups, clinics and
physician groups, self-insured employers and managed care organizations.

In September 1996, the Company launched a Company-operated Medical Call Center
service bureau offering call center services twenty four (24) hours a day, 7
days a week. Eligible participants are able to access, through a toll free
number, specially trained nurses or prerecorded information. The Company markets
the service bureau to managed care organizations, self-insured employers and
other organizations who do not wish to establish and operate their own medical
call centers. Clients include Blue Cross of Arizona, FHP of Utah and hospitals
and health systems with National Health's installed software and voice
technology who use the service bureau to handle after-hours and overflow calls.


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PRODUCTS AND SERVICES

The Company's products have expanded over the past few years to include certain
services and software-based products with license fees or prices ranging between
$2,500 and $250,000. The Company's base of users now includes over 700 clients.
The Company's management believes that this network of healthcare providers is a
base that will facilitate the Company's distribution of new products.

The Company's core Medical Call Center products and services are:

                           - Centramax. M(TM)
                           - Centramax. M Plus(TM)
                           - Voicemax Plus(TM)
                           - PTAS(TM)
                           - Parent Advice Line(TM)
                           - Women's Advice Line(TM)
                           - Call Center Service Division (Outsourcing)

The Company's products also include value-added products or services such as:

                           - Patient Test Results(TM)
                           - The Professionals
                           - Patient Assessment System
                           - Health Direct
                           - Healthcare Marketing Services
                           - Newcomers
                           - 55Plus

Centramax. In December 1989, the Company released Centramax(R), a DOS-based
software system that is designed to manage consumer contacts through a
centralized database. With Centramax, the healthcare provider or other end users
can capture and store information on the caller, and subsequently communicate
directly with this and other consumers based on specific information or needs
obtained from the caller; access, analyze and report on information contained in
the database; and track revenues generated from marketing campaigns. The Company
believes that Centramax enables a healthcare organization to improve its
customer service function and more effectively manage the marketing function
through the management of information. For example, the inbound telephone
functions of Centramax are initiated when an operator receives a call. The
Centramax operator then retrieves a particular script and follows the directions
given. The system enables the operator to cross-sell other programs offered by
the healthcare provider which may not have been motivating factors behind the
original call but which may be of interest to the caller. For example, a
pregnant caller may ask for a referral to an OB/GYN. The Centramax software will
remind the operator to mention the healthcare provider's prenatal classes. With
one keystroke the operator can access the schedule and then register the caller.

Centramax is offered to healthcare providers under a non-exclusive license at an
initial license fee plus an annual license and support fee. The user is entitled
to ongoing software support, maintenance and enhancements during the term of the
license.

Centramax Plus. The Centramax Plus product combines the Centramax software
product with certain medically-based health information algorithms, known as the
Health Reference Information System(TM) ("HRIS"), which are designed to enable
nurses to answer health-related questions on incoming calls. Centramax Plus
assists a nurse to respond to callers' questions, answer certain commonly
occurring medical and health related questions, and direct callers to available
medical resources. The Company believes the system enables providers to give the
caller greater access to information to make an informed decision and the
healthcare provider an opportunity to direct the caller to the most appropriate,
cost effective care.

Each Centramax Plus user is granted a non-exclusive license. The Company charges
an initial license fee and an annual support and license fee, which entitles the
Centramax Plus user to continue to license the product and 


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to ongoing software updates, support, maintenance, enhancements and updates to
the HRIS for the term of the license.

The Company initially developed the HRIS internally through research of
available current consumer health information and medical texts. In March 1990,
the Company transferred the ownership rights in the HRIS to Micromedex, Inc.
("Micromedex"), retaining the right to distribute the HRIS for a period of time.
Under the agreement, Micromedex is responsible for the accuracy, currency and
medical appropriateness of the HRIS, including additional HRIS developed
thereunder by the Company. Provided certain performance criteria are met, the
Company has the right to be the exclusive world-wide distributor of the HRIS for
the term of the agreement, which expires in 2002. Under certain circumstances,
the Company is granted the right to purchase all rights to the HRIS.

Centramax. M and Centramax. M Plus, which were released in January 1995, are a
Windows(R)-based software product that combines all the features included in
Centramax and Centramax Plus, respectively, with improved and enhanced reporting
and graphics capabilities. In addition, Centramax. M Plus includes pediatric
algorithms that are not offered in the Centramax Plus DOS product. The pediatric
algorithms are provided through an exclusive agreement with Barton Schmitt,
M.D., Professor of Pediatrics at the University of Colorado School of Medicine
and a recognized pioneer in pediatric telephone triage. In September 1994, the
Company entered into an agreement with Dr. Schmitt pursuant to which the Company
acquired certain exclusive rights to distribute the pediatric algorithms
developed by Dr. Schmitt to Medical Call Centers or for use in software used in
Medical Call Centers. The pediatric algorithms have been used for the past seven
(7) years in the "After Hours Program" established at the Denver Children's
Hospital. The Company has included the pediatric algorithms in certain of its
Medical Call Center products, and the Company is obligated to pay a royalty
based on the sales of the pediatric algorithms by the Company on a stand-alone
or bundled basis.

Centramax. M Plus is the base product for the Company's Medical Call Center
offering. Centramax. M and Centramax. M Plus are offered to healthcare providers
under a non-exclusive license at an initial license fee plus an annual license
and support fee. Users are entitled to ongoing software support, maintenance and
enhancements during the term of the license.

Interactive Voice Response System. The Company's interactive voice response
product line consists primarily of the Voicemax Plus product. Introduced in
September 1992, this product permits a licensee to provide health information
to callers via use of a touch-tone telephone, 24 hours a day, 7 days a week,
365 days a year. These products, which currently operate using The Brite Voice
Systems hardware platform, allow callers to anonymously access health
information (over 1,000 health categories), physician referrals, class
information or other information that can be programmed or customized by the
licensee. The Company offers a complementary marketing product called
HealthFone, which offers an exclusive name brand to assist the customer in
generating call volume for the Voicemax Plus product.

The Company believes that the benefits of its interactive voice response system
enable a licensee to improve utilization of existing resources, increase
visibility and improve profitability. Each user of the Voicemax Plus product is
granted a non-exclusive license. Each HealthFone user is granted a five-year
renewable license with an exclusive geographic service area in which the user is
the only healthcare provider in that service area that has been granted the
right to use the HealthFone trade name and marketing materials. The Company
charges each user of the interactive voice products an initial fee and an annual
license and support fee, which entitles the user to annual updates to the health
information, software support and enhancements to the interactive voice response
products.

The Professionals. The Professionals was originally released to include the
Centramax software, the HRIS and a marketing package. Currently, The
Professionals product only includes the marketing package, which is intended to
create awareness of targeted services, and to generate incoming consumer calls,
thereby helping to build the awareness of a healthcare provider's medical call
center operations. The Company believes that healthcare providers will continue
to purchase marketing tools in order to assist them to compete among other
providers for managed care and other opportunities.

Each user of The Professionals is granted a five-year renewable license with an
exclusive geographic service area in which it is the only healthcare provider in
that service area that has been granted the right to use The Professionals
service mark and customized marketing package. The Company charges each licensee
of The 


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Professionals an initial license fee and an annual license and support fee,
which entitles the user to have continued geographic exclusivity and annual
updates to the marketing package, during the term of the license.

The Patient Assessment System. The Patient Assessment System ("PAS") combines
nine proprietary, software-supported health screening products designed to
assess an individual's overall fitness and risk of incurring certain kinds of
disease. The nine products are: "The Heart Test(TM)", "The Health Test(TM)",
"The Cancer Test(TM)", "Double Check(TM)", "The Diabetes Test(TM)", "The Woman's
Health Test(TM)" and "The Woman's Health Check(TM)", "The Life Test(TM)" and
the "Custom Profile". The PAS also includes a follow-up referral system linked
to the PAS programs called "The Healthcare Telemarketing Program(TM)" (The PAS
components are referred to herein as the "Programs".) Healthcare providers
deliver the Programs as part of a lead generation system or risk education
assessment system that permits them to refer consumers to other programs,
physicians or departments for remedial or preventive care and thereby generate
additional revenue. The PAS is offered with territorial exclusivity and includes
proprietary software, confidential instruction manuals for implementing and
distributing the Programs as part of a marketing campaign or strategy; and
additional standard promotional and marketing materials. The software supporting
the Programs can also produce group summary reports analyzing a group's
cardiovascular risk factors, cancer risk factors, health assessment results,
diabetes risk factors and levels of interest in specific intervention programs.

The current standard PAS agreement grants each new PAS user up to a five-year
license with a geographic service area within which it has the exclusive right
among healthcare providers to use the software supporting the Programs. The
initial fee paid by a PAS user depends primarily on the population of the
service area, the number of hospitals in the service area, the number of
physicians in a service area and the economic environment of the area. The
Company evaluates increasing the initial PAS user fee as additional programs are
developed. In addition, the standard PAS license agreement requires that each
PAS licensee pay the Company a monthly support fee, and provides for a five year
renewal term upon payment of a renewal fee, and certain rights of first refusal
after the 5 year renewal term.

Due to the geographic exclusivity of the PAS, the number of available markets
has decreased as the Company increased its PAS customer base. Presently, the
Company believes markets remain available and that in the foreseeable future
initial license fee revenue will continue to be generated from the available
markets although at a decreasing rate. In addition, the revenues from PAS
renewal fees, support fees and material sales are expected continue to provide
the Company with ongoing future revenues.

Health Direct. On April 9, 1991, the Company entered into a distribution
agreement with McMurry Publishing Company (formerly Vim & Vigor, Inc.) pursuant
to which the Company distributes, on a nonexclusive basis, a specialized
publication now known as Health Direct. Health Direct is an eight-page, direct
response publication (direct response marketing system) designed primarily to
promote hospital services while providing health information. Health Direct
contains thirty to forty "quick read" health related articles that can be
customized by each licensee. The Company grants geographic exclusivity to
distribute the Health Direct product (generally within a certain zip code area).
In addition, the Company requires each Health Direct licensee to purchase a
minimum number of copies of Health Direct per quarter. The Company is obligated
to pay McMurry Publishing a portion of the revenue received from these
publications. In April 1997 the Company launched a Spanish-language publication
similar to Health Direct called Bienestar. The publication is marketed to health
care companies serving Spanish-speaking consumers.

Healthcare Marketing Services. FSG provides healthcare strategic and marketing
services to existing and prospective clients. FSG services include providing
healthcare marketing consulting services and strategies, development of creative
marketing and/or advertising materials (such as direct mail pieces, print ad
materials) as requested by the clients. FSG services do not include the
placement of media.


NEW PRODUCTS AND SERVICES

The Company launched a national Medical Call Center service bureau in September,
1996. The Company's Call Center provides services twenty four (24) hours a day,
7 days a week through managed care companies, health plans and employers.
Eligible participants, typically patients or health plan members, are able to
access 


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medical information through a toll free number by reaching nurses or prerecorded
audio libraries. The Company markets the service bureau to managed care
organizations, self-insured employers and other organizations who do not wish to
establish and operate their own Medical Call Centers. Establishment of the
national Medical Call Center involves numerous risks, including risks associated
with launching a new venture, diversion of management's attention from other
business concerns, loss of capital, risks of entering markets in which the
Company has limited or no direct prior experience, competition in a market where
there is at least one established competitor with significantly greater
resources than the Company, and operational (equipment) failures due to fires or
other disasters that would disable the Medical Call Center for a significant
period of time. Although preliminary results are very encouraging, there are no
assurances the service bureau will be successful.

The Company launched the Patient Test Results(TM) (PTR) product in early 1997.
PTR(TM) allows health plan members or patients to receive confidential results
for routine tests via touch-tone telephone. PTR can reduce the amount of time
spent by healthcare providers delivering routine information by allowing a
provider to record basic messages. Patients access the system via a private
access code. The PTR system documents that messages are accessed by patients.
PTR is marketed to physician group practices, hospitals and health systems,
managed care companies and other providers of routine medical tests, like
student health clinics. PTR sales results to date are not material.

The Company intends to develop or acquire, and to market to its current clients
and others, additional products and services which may or may not be similar to
its existing products. The Company's future growth in revenue is dependent on
the Company's ability to acquire or develop and successfully market new products
and services in the changing healthcare market. There are no assurances the
Company will be able to do so. The Company's future success also depends upon
its ability to sell its current products and services to, and acquire or develop
new products and services for, managed care and similar organizations. The
managed care market is changing rapidly, the Company's historical business has
not been in the managed care market, and there are no assurances that the
Company will be able to compete successfully in the managed care market.

Research and Development. Management estimates that during the fiscal years
ended January 31, 1997 and 1996, the Company spent approximately $1,227,371 and
$523,969 respectively, on company-sponsored research and development activities
(which includes enhancements and upgrades to the Company's products).

Liability in the Healthcare Industry. In recent years, participants in the
healthcare industry, including physicians, nurses and other healthcare
professionals, have become subject to an increasing number of lawsuits alleging
malpractice, product liability and related legal theories, many of which involve
large claims and significant defense costs. Although the Company does not
provide healthcare services directly to consumers, except for triage advice,
referral and health information through the Company's Medical Call Center,
medical malpractice, product liability or similar claims against the Company's
customers relating to delivery and use of the Company's products and services
may also be made against the Company. Due to the nature of its business, the
Company could become involved in litigation with the attendant risk of adverse
publicity, significant defense costs and substantial damage awards. To date, no
such claims had been made against the Company. However, there can be no
assurance that claims will not be brought against the Company. Even if such
claims ultimately prove to be without merit, defending against them can be time
consuming and expensive, and any adverse publicity associated with such a claim
could have an adverse effect on the Company. The Company is in no position to
determine the probability of such claims being made.

The Company has taken certain steps to minimize the risk of potential claims.
Delivery and use of the Company's products is the responsibility of the
licensee, and each licensee is required to indemnify the Company against third
party claims arising out of use of the products by the licensee. In addition,
the agreement with Micromedex for use of the HRIS provides that the Company
shall be indemnified and held harmless from third party claims arising from the
accuracy, currency or completeness of the information contained in the HRIS
reviewed by Micromedex. The Company also maintains professional errors and
omissions liability insurance for its installed products, and professional
liability coverage for the Call Center Service Division, which it believes to be
adequate. There can be no assurance, however, that claims in excess of the
Company's insurance coverage will not arise or that all claims would be covered
by such insurance. In addition, although the Company has not experienced
difficulty in obtaining insurance coverage in the past, there


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can be no assurance that the Company will be able to maintain existing insurance
coverage or obtain increased insurance coverage on acceptable terms or at all.
The Company expects to seek increased insurance coverage as its business grows.

REGULATORY MATTERS

Government Regulation. The healthcare industry is subject to extensive and
evolving government regulation at both the Federal and state level regarding the
provision, marketing and reimbursement of healthcare services and products,
including Medicare/Medicaid anti-kickback regulations and requirements governing
the provisions of healthcare information services. Specific sections of the
Social Security Act authorize the exclusion of an individual or entity from
reimbursement and/or participation in state health programs and Medicare
programs if it has violated the Social Security Act. In July 1991, regulations
outlined certain payment practices which would not be subject to criminal
prosecution. These regulations, commonly referred to as "safe harbor"
regulations, effect the manner in which hospitals make physician referrals. The
Company's Medical Call Center software products accommodate the entry of the
information required under the "safe harbor" regulations provided that the
appropriate policies and procedures are followed by the users of the Company's
products. In addition, certain statutes and regulations predate the development
of telephoned-based health care information and other interstate transmission
and communication of medical information and services. The literal language of
certain of these statutes and regulations governing the provision of health care
services, including the practice of nursing and the practice of medicine, and
health maintenance organizations could be construed by regulatory authorities to
apply to certain of the company's teleservicing activities, which use Arizona
registered nurses to provide Medical Call Center services such as triage and
information regarding appropriate sources of care and treatment time FRAMES, and
also could apply to certain activities of the Company's customers when operating
the Company's programs. The Company has not been made, nor is it aware that any
of its clients or nurse employees providing out-of-state teleservicing have ever
been made, the subject of such requirements by a regulatory authority. However,
if regulators seek to enforce any of the foregoing statutory and regulatory
requirements against the Company, its employees and/or its clients could be
required to obtain additional licensed personnel, to modify or curtail the
operation of the Company's programs, to modify the method of payment for the
Company's programs, or to pay fines or incur other penalties. Subject to the
foregoing, the Company has no reason to believe that its business violates any
Federal or state statutes or regulations.

TRADEMARKS AND PROPRIETARY RIGHTS

The Company claims proprietary rights in the software that supports its
products, as well as in confidential training and promotion manuals, the
questionnaires and report forms used with the PAS, the packaging and
presentation of the Company's products and their representative components and
related protectable materials. The Company has registered software source code
copyrights for all of its DOS-based software products and Cemtramax.M. In
addition, the Company's current agreements generally prohibit its customers from
decoding, reproducing or copying the software. Those agreements also require
customers to take reasonable and appropriate actions to protect and preserve the
Company's rights in the software and other proprietary materials. Subject to
certain conditions, the Company will indemnify and defend a customer with
respect to claims brought by third parties against the customer for infringement
of patents, copyrights and trademarks, or misappropriation of trade secrets or
other proprietary rights relating to the products of the Company licensed by its
customers. The Company is not aware of any such claims. Despite the precautions
taken by the Company it may be possible for unauthorized third parties to copy
or independently develop aspects of its product it considers proprietary. The
Company has no patents and existing copyright laws afford only limited product
protection.

The Company holds registered trademarks for the Centramax, The Professionals,
HealthFone and Referral One names with the United States Patent and Trademark
Office.

MARKET CONDITIONS, COMPETITION AND ADDITIONAL RISK FACTORS

The healthcare industry in general is extremely competitive. Many changes in the
industry that began in the 1980's will continue through this decade and will
transform the way healthcare providers function and the types 


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of healthcare services they provide. The following trends among others, are
anticipated to have a strong influence on healthcare through the remainder of
the 1990's:

         -    Integrated healthcare delivery systems.
         -    Rising national healthcare expenditures.
         -    Reduced reimbursement levels.
         -    Increasing competition among providers.
         -    Shifting healthcare delivery patterns.
         -    Aging population with an increased demand for healthcare services.
         -    Hospital mergers and realignments.

Within the healthcare industry, the Company and its clients are competing
directly and indirectly for the business of individuals and businesses
interested in healthcare services. The Company believes that hospitals, clinics,
group practices, managed care organizations and other healthcare providers are
seeking new ways to reduce healthcare costs and to market their services more
effectively. Healthcare providers are particularly interested in products which
assist in reducing healthcare costs and improve the quality and service of
healthcare delivery.

There are a number of software-based systems, health promotion programs, and
wellness services being offered to healthcare providers that are perceived by
the Company to be direct competitors because they have software systems or
services capable of providing health information, database information and
producing reports that contain health information similar to the Company's
reports or providing benefits similar to the Company's software products and
anticipated service bureau offering.

The barriers to entry into this market are relatively low, consisting primarily
of the means to develop or otherwise acquire supporting software and medical
assessment information; a product responsive to the healthcare providers'
particular needs; and a distribution or delivery system for the products and
services. In addition, development of similar programs by healthcare providers
for use in their own facilities may provide competition for the Company.

In addition the Company believes that the competition of offering Medical Call
Center products or services will begin to increase and that there may be new
entrants with substantially greater financial, marketing, technical and other
resources than the Company which may adversely impact the Company's ability to
compete in the market.

The Company believes that much of its competitive strength lies in its user
network and in its ability and experience in providing quality products and
services to its market. The Company's user network of healthcare providers
affords it a means of quickly reaching a group of healthcare providers who have
a proven interest in the types of products the Company supplies and who are
familiar with the quality of the products and services the Company supplies. The
Company believes that it has demonstrated ability and experience in providing
products that are (1) useful in decreasing overall healthcare costs and in
improving healthcare service and quality; (2) effective in improving operating
efficiency and increasing a healthcare provider's return on expenditures; (3)
well supported by the Company's technical expertise; and (4) easy for the
healthcare provider to use. The Company believes that these attributes are
likely to be attractive to healthcare providers without significant
reconfiguration of the products. To the extent the Company offers new products
or services or offers its existing products and services in new markets, it
expects to face increased competition from competitors with potentially greater
financial, marketing or technical resources than the Company. No assurance can
be given that the Company will be able to compete successfully.

The business of the Company is and will continue to be affected by general
economic conditions and is dependent upon both a continued interest to reduce
healthcare costs and a continued competitive environment for healthcare
providers. In addition, the success of the Company will depend upon its ability
to identify and develop sources of revenue in addition to the initial and
recurring maintenance and support fees payable from its customers, such as the
future development or acquisition and distribution of new products and services.



                                       8
<PAGE>   11
Key Employees and Management

The Company's success depends on a limited number of key management employees,
all of whom are subject to certain post-employment non-competition restrictions
of limited duration. If the services of such key employees were no longer
available to the Company, the Company would be materially and adversely
affected. The Company also believes its continued success will depend on its
ability to attract and retain highly-skilled management, marketing, sales and
other personnel. Furthermore, the Company's ability to manage change and growth
successfully will require the Company to continue to improve its management
expertise as well as its financial systems and internal controls.

Principal Customers

The Company has historically marketed its products primarily to hospitals.
Recently, the Company's marketing efforts are expanding to include managed care
organizations, physician groups, self-insured employers, integrated delivery
systems such as physician hospital organizations (PHOs). The Company does not
derive 5% or more of its revenues from any one customer.

Volatility of Operating Results and Stock Price

Revenues and operating results depend primarily on the volume and timing of
orders received during each fiscal quarter, which are difficult to forecast.
Historically, the Company has often recognized a substantial portion of its
license revenues in the last month of each fiscal quarter, frequently in the
last week. Because a significant portion of the Company's operating expenses are
relatively fixed with personnel levels and other expenses based upon anticipated
revenues, a substantial portion of which may not be generated until the end of
each fiscal quarter, the Company may not be able to reduce spending in response
to sales shortfalls or delays. These factors could cause variation in operating
results from quarter to quarter.

The Company believes that such variations in operating results, or factors such
as announcements of developments related to the Company's business, changes in
market analyst estimates and recommendations for the Company's Common Stock,
changes in government regulations and general conditions in the health care
industry and the economy could cause the price of the Company' Common Stock to
fluctuate, perhaps substantially. In addition, in the most recent fiscal year,
the Company's stock prices have experienced significant price fluctuations.

Employees

As of April 15, 1997 the Company employed a total of approximately 225 full-time
employees. None of the Company's employees are covered by a collective
bargaining agreement, and the Company believes its relations with its employees
are good.


ITEM 2.  DESCRIPTION OF PROPERTIES

The Company's corporate offices are located in a twenty-five story office
building located in Phoenix Arizona. The Company occupies approximately 23,000
square feet of leased space, for which the lease term for this space expires on
December 15, 2002. The Company believes that its existing office space, along
with the options to expand its space, will be sufficient to meet its needs for
the foreseeable future. The Company also leases approximately 6,500 square feet
of office space in Whittier, California which is used by FSG, and approximately
7,800 square feet of office space in Atlanta, Georgia used by Expert Systems,
Inc. and Health Enhancements International, Inc., a recently formed Company
subsidiary exploring international markets for the Company's products and
services.


ITEM 3.  LEGAL PROCEEDINGS

NONE



                                       9
<PAGE>   12
ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

NONE


PART II

ITEM 5.  MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

The Company's common stock trades on the Nasdaq SmallCap Market tier of the
Nasdaq Stock Market (Nasdaq) under the symbol: NHES.

The following table of market price information sets forth the range of high and
low sales price information for the Company's common stock during the past two
fiscal years as quoted on Nasdaq. These quotations reflect interdealer prices,
without retail markups, mark-downs or commissions, and may not reflect actual
transactions.

MARKET PRICE

YEAR ENDED:  JANUARY 31, 1997

<TABLE>
<CAPTION>
                          FIRST             SECOND               THIRD            FOURTH
                         QUARTER            QUARTER             QUARTER           QUARTER
                         -------            -------             -------           -------
<S>                      <C>                <C>                 <C>               <C>   
HIGH                      11.000             10.250              9.000             13.625
LOW                        5.250              5.000              6.250              6.250
</TABLE>

YEAR ENDED:  JANUARY 31, 1996

<TABLE>
<CAPTION>
                          FIRST             SECOND               THIRD            FOURTH
                         QUARTER            QUARTER             QUARTER           QUARTER
                         -------            -------             -------           -------
<S>                      <C>                <C>                 <C>               <C>   
HIGH                      1.625               1.625              2.750              9.000
LOW                       1.063               0.875              1.250              2.375
</TABLE>

The Company has not declared or paid any dividends on its Common Stock to date
and does not plan to do so in the foreseeable future. Pursuant to the Company's
current credit line the Company is prohibited from paying any dividends. On
April 18, 1997, there were approximately 216 shareholders of record and
approximately 1500 other beneficial owners of the Company's common stock.

RECENT SALES OF COMMON STOCK

In fiscal year 1997, the Company issued an aggregate of 167,667 shares of common
stock to two individuals for a total purchase price of $750,000 paid in cash,
and an aggregate of 370,370 shares of common stock to a corporation for a total
purchase price of $2,500,000 paid in cash. Each transaction was a private
placement effected in reliance upon section 4(2) of the Securities Act of 1933,
as amended.


                                       10
<PAGE>   13
ITEM 6.        MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 
               RESULTS OF OPERATIONS


Overview

Except as noted herein, all references to the Company include the Company and
its consolidated subsidiaries.

National Health Enhancement Systems, Inc. (NASDAQ:NHES) is a leading provider
of technology, software and services designed to help managed care
organizations, hospitals and delivery systems, physician group practices and
employer groups provide affordable quality health care. National Health's
Medical Call Center products and services are used by over 700 health care
organizations nationwide to lower costs, improve consumer access to care and
improve quality. National Health's capability to link software, technology,
health information and strategic consulting services helps health care
organizations, including employers, promote wellness behavior, educate members,
increase access to appropriate services and lower costs without compromising
care.

National Health implements installed onsite programs which are housed at the
client's location and staffed and managed by the client. NHES clients can also
outsource programs for in-bound and out-bound calls to National Health's Medical
Call Center, typically on a per-member, per-month basis. Whether run by a client
using NHES' tools or outsourced to NHES' Call Center services as a "turnkey"
program, licensed registered nurses and voice technology are used to service
patients, healthplan members or employee groups, as defined by the client.

Results of Operations

For the fiscal year ended January 31, 1997, the Company had income from
operations of $864,296 compared with $617,746 in fiscal year 1996, an
increase of approximately 40%. Net income for 1997 was $736,296 compared to
$559,746 in 1996, an increase of 32%. The percentage increase in income from
operations is greater than the percentage increase in net income because of the
difference in the effective tax rates between the two years. The effective tax
rate in 1997 and 1996, was 15% and 9%, respectively, the result of fully
utilizing the remainder of a prior year NOL carry forward, during the third
quarter of 1997. Fiscal year 1997 represents record earnings for the Company and
is indicative of continued growth in market penetration of the Company's
products and services.

The Company's operations are affected by consolidation, alliances and mergers in
the health care market. While there are no assurances, the Company's management
believes that its competitive strengths will permit it to continue to compete in
its targeted market and that the Company is positioned favorably to take
advantage of future opportunities in the health care industry. The Company's
management also believes its products help health care providers improve their
services and also help reduce health care costs by providing objective
information on health care issues to individuals, thereby enabling them to make
informed choices about when, where and how to seek health care services and
reduce health care costs while providing providers with a favorable return on
their investment in the Company's products. Nonetheless, the Company's
operations may be materially and adversely affected by consolidation, alliances
and mergers in the health care industry, health care reform in the private or
public sector, and by future economic conditions.

Revenues and operating results depend primarily on the volume and timing of
orders received during each fiscal quarter, which are difficult to forecast.
Historically, the Company has often recognized a substantial portion of its
license revenues in the last month of each fiscal quarter, frequently in the
last week. Because a significant portion of the Company's operating expenses are
relatively fixed with personnel levels and other expenses based upon anticipated
revenues, a substantial portion of which may not be generated until the end of
each fiscal quarter, the Company may not be able to reduce spending in response
to sales shortfalls or delays. These factors could cause variations in operating
results from quarter to quarter, which may result in volatility in the price of
the Company's common stock.

REVENUES. Total revenues for fiscal year 1997 increased 49% to $25,185,008 
compared to total revenues of $16,891,143 in fiscal year 1996. This record 
level of revenues is the result of increased demand for the Company's core 
products including strong demand for newer products such as pediatric triage and
interactive voice response (IVR) applications. The Company has also taken
measures to increase revenues from support, materials and services, and for the
first time, revenue from these sources exceeded initial license fee revenue for
fiscal year 1997, a trend which the Company anticipates continuing in the
future.

Initial license fee revenue is derived primarily from the sales of the Company's
core software products -- Centramax.M(TM), Centramax.M Plus(TM), Pediatric
Triage and Advice System(TM), Parent Advice Line(TM), and Voicemax Plus(TM) --
and 


                                       11
<PAGE>   14
the Company's value-added products and services -- The Professionals(TM),
Healthfone(TM), Patient Assessment System(TM), Health Direct, and health care
marketing services. Revenues generated from the initial license fees of core and
value-added products and services accounted for approximately 47% of the
Company's total revenues in fiscal year 1997, compared to 52% of total revenues
for fiscal year 1996. At the same time, the current year's results show initial
license fees increasing to $11,776,309 in fiscal year 1997, from $8,845,081 in
fiscal year 1996. This is an increase of $2,931,228 or 33%. Revenue from
support, materials and services accounted for approximately 53% of the Company's
total revenues in fiscal year 1997, compared to 48% of total revenues for fiscal
year 1996. At the same time, the current year's results show that revenues from
support, materials and services increased to $13,408,699 compared to support,
materials and services revenues of $8,046,062 in fiscal year 1996. This is an
increase of $5,362,637 or 67%. This increase can be primarily attributed to the
continued expansion of the Company's client base, and the Company's new policy
to charge for support commencing immediately upon contract execution rather than
after the first six months.

Support fees represent charges to customers, as provided for in the Company's
license agreements, for continued use of the products and for ongoing software
maintenance and enhancements to the products. As initial fee sales continue to
increase, revenues generated from the associated support fees should continue to
increase as well. Material sales represents the sale of printed questionnaires
and reports from the Company's PAS and quarterly publication of the Health
Direct product. Service revenue is generated from strategic consulting
engagements between the Company and its customers that provide value added
results.

OPERATING EXPENSE. Total operating expenses were $24,320,712 in fiscal year
1997, compared to $16,273,397 in fiscal year 1996, an increase of $8,047,315 or
49%. During fiscal year 1997, the Company invested in the Call Center Service
Division and in additional selling resources, client services, and product
development, all in an effort to better position the Company for the future. The
Company's investments in the sales and client services functions are designed to
enable the Company to improve product sales to new and existing clients, while
continued investments in the area of product development are part of
management's strategy for meeting market needs with a broader array of products
and maintaining existing products as leading edge. Although operating costs
increased as a result of such investment, all major expense categories decreased
or only slightly increased as a percentage of revenue compared to prior year.

COST OF INITIAL LICENSE FEES AND COMPUTER HARDWARE. Initial license fees and
computer hardware costs increased to $4,707,044 in fiscal year 1997 from
$2,158,517 in 1996. This is an increase of $2,548,527. These costs represent the
costs incurred to implement and install core products sold, including hardware
cost, third-party license fees and training. The increase in these costs during
the current fiscal year can be primarily attributed to the increase in initial
license fee revenue and the related product mix.

COST OF SUPPORT, MARKETING SERVICES, AND MATERIALS SALES. Cost of support,
marketing services, and materials sales increased to $5,281,273 in the fiscal
year 1997 from $3,509,171 in 1996, an increase of $1,772,102. These costs 
represent the costs associated with providing annual support fees, variable 
costs associated with services provided by FSG, printing costs associated with 
the Patient Assessment System(TM) and Health Direct products. The increase is 
a direct result of the increase in the corresponding revenue during the 
current fiscal year.

PRODUCT DEVELOPMENT COSTS. Product development costs were $1,227,371 in fiscal
year 1997 compared to $523,969 in 1996. Product development costs relate to
improvements and enhancements of the Company's call center products and costs
incurred to establish the technological feasibility of software products
currently under development.

SALES AND MARKETING COSTS. Sales and marketing expenses were $8,775,758 in
fiscal year 1997 compared to $7,064,368 in fiscal year 1996. This is an
increase of $1,711,390 or 24%. This increase reflects the Company's investment
in its selling resources.


                                       12
<PAGE>   15
GENERAL AND ADMINISTRATIVE. General and administrative expenses were $2,457,065
in fiscal year 1997, compared to $1,888,586 in fiscal year 1996. This is an
increase of $568,479 or 30%. As a percentage of revenue, however, general and
administrative expenses decreased from 11.2% to 9.8% in the current fiscal year.
This increase is due primarily to the additional costs and overhead associated
with the investment in the selling organization, client service, and product
development including additional space requirements, general price increases 
in areas such as health and liability insurance, and professional and
consulting services.

DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses were
$1,290,845 in fiscal year 1997 as compared to $862,286 in fiscal year 1996. This
is an increase of $428,559 or 50%. This additional increase in depreciation and
amortization costs is primarily due to the net addition of approximately
$1,794,000 in property, plant & equipment.

PROVISION FOR DOUBTFUL ACCOUNTS. The provision for doubtful accounts increased
to $581,356 in fiscal year 1997 from $266,500 at the end of fiscal year 1996, an
increase of $314,856. The provision for doubtful accounts is adjusted by the 
Company to reflect potentially uncollectible accounts receivable that may 
exist at period-end. The Company believes that the allowance for doubtful 
accounts is adequate, given the amount of receivables, the Company's credit 
terms and the Company's history of collecting receivables.

LIQUIDITY AND CAPITAL RESOURCES.

As of January 31, 1997, the Company had working capital of $1,545,095 compared
to a deficiency in working capital of $1,349,989 at January 31, 1996. The
improvement in working capital was a result of the Company's continued
improvement in results of operations and two private equity placements which
were closed in fiscal year 1997.

Cash provided by operating activities was $2,194,064 in fiscal year 1997,
compared to $678,640 in fiscal year 1996. On July 22, 1996 the Company secured
an equity investment in the amount of $750,000 for the launch of its new
national call center division. Two individuals made the investment in exchange
for 166,667 shares of restricted common stock in a private placement. In
addition, on January 14, 1997, the Company issued 370,370 shares of restricted
stock in a private placement for an aggregate purchase price of $2,500,000. In
connection therewith, the Company entered into a governance agreement pursuant
to which the corporation agreed to certain limitations on its accumulation of
additional shares and on its voting rights. In addition, the investor also
acquired the right to have up to two nominees serve on the Board of Directors of
the Company.

On October 23, 1996 the Company obtained a revolving line of credit providing up
to $2,500,000. The revolving line of credit bears interest at prime plus 2%, and
is secured by accounts receivable and matures on October 22, 1997. The
availability of borrowing on the revolving line of credit is subject to
available eligible accounts receivable and certain other covenants. The Company
also obtained a borrowing line of $250,000 from the same lender. The $250,000
borrowing line is secured by equipment and is structured as "interest only"
bearing interest at prime plus 2%. On April 22, 1997, the amount borrowed at
that time on the $250,000 line was converted into an amortizing loan bearing
interest at prime plus 2%.

During the year the average monthly outstanding balance on the revolving line of
credit was $170,000 bearing an average annual rate of interest of 9.25%. The
Company is primarily utilizing cash provided by operations for its daily
operational cash requirements and as of January 31, 1997, did not have an
outstanding balance on the line of credit. If necessary, the Company believes it
will be able to renew or replace the line of credit by October 22, 1997, the
date at which the current revolving line agreement expires. The Company
continues to evaluate opportunities to expand and increase existing capital.

The Company's operating results continue to be inconsistent on a month-to-month
basis and are dependent upon retention and performance of the Company's sales
staff, long product sales cycles related in part to pricing of the Company's
products and customer budget requirements, and 


                                       13
<PAGE>   16
to other factors, such as uncertainties associated with the health care market
and economic conditions, beyond the control of the Company. The Company,
however, will continue to evaluate methods to improve and increase its product
distribution channels and to enhance or expand its current product lines. The
Company has expanded, and will seek to continue to improve and enhance its
product lines in order to be more responsive to the market. The Company believes
that quarterly operating results are dependent, and will continue to be
dependent, on the initial license fee revenues in the foreseeable future. The
Company will continue to focus its efforts on improving cash from operations,
increasing support revenues, and increasing revenue in the new call center
division. The recurring monthly revenue from support fees, material sales and
services is currently not sufficient to maintain a break-even level at the
Company's current operating expense levels.

The discussion above includes statements which constitute forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995, which are statements other than historical fact, that involve risks and
uncertainties. In addition to the factors discussed elsewhere herein, important
factors may cause the Company's actual results to differ materially from these
and any future forward-looking statements by or on behalf of the Company. Those
factors include, among others, uncertainties and delays in the development and
marketing of new products and services, product and services demand and market
acceptance risks, the Company's ability or inability to obtain additional
financing, the impact of competitive products, services and pricing, continued
rapid change and consolidation in the health care market, general changes in
economic conditions not presently contemplated, and other factors detailed in
the Company's Securities and Exchange Commission filings.

SUBSEQUENT EVENTS.

On February 18, 1997 the Company completed an acquisition of Expert Systems,
Inc. (Expert), a developer and distributor of telephone and database
technologies to create voice features for computer telephone applications. Under
the terms of the acquisition, to be accounted for as a pooling of interests, the
Company issued 465,299 restricted shares, and options for the purchase of 59,701
shares, of the Company's common stock for all of Expert's outstanding shares and
options at an exchange ratio of .09537 shares of the Company's common stock for
each share of Expert's stock outstanding or subject to options. Of the Company
shares issued in the transaction, 46,529 are escrowed securing an indemnity
obligation in favor of the Company.




ITEM 7.  FINANCIAL STATEMENTS




                                       14
<PAGE>   17
AUDITED FINANCIAL STATEMENTS



REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS


To National Health Enhancement Systems, Inc.:

We have audited the accompanying consolidated balance sheet of NATIONAL HEALTH
ENHANCEMENT SYSTEMS, INC. (a Delaware corporation) and subsidiaries as of
January 31, 1997, and the related consolidated statements of operations, changes
in stockholders' equity and cash flows for the years ended January 31, 1997 and
1996. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our 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 financial statements referred to above present fairly, in
all material respects, the financial position of National Health Enhancement
Systems, Inc. and subsidiaries as of January 31, 1997, and the results of their
operations and their cash flows for the years ended January 31, 1997 and 1996,
in conformity with generally accepted accounting principles.






                                                        Arthur Andersen LLP
Phoenix, Arizona
March 28, 1997
----------------


                                       15
<PAGE>   18


NATIONAL HEALTH ENHANCEMENT SYSTEMS, INC.
CONSOLIDATED BALANCE SHEET
JANUARY 31, 1997

<TABLE>
<S>                                                          <C>
                                    ASSETS
CURRENT ASSETS:                                
  Cash and cash equivalents (Note 2)                             $  3,095,305
  Accounts receivable, net of allowance
    for doubtful accounts of $629,670  (Notes 2 and 3)             10,822,322
  Prepaid expenses, deferred costs and supplies (Note 2)            1,462,054
                                                                 ------------
Total current assets                                               15,379,681

CAPITALIZED SOFTWARE DEVELOPMENT COSTS,
  net of accumulated amortization of
  $1,606,623 (Note 2)                                                 984,441

PROPERTY AND EQUIPMENT,
  net (Notes 2 and 3)                                               2,166,587

EXCESS OF COST OVER
  FAIR VALUE OF NET ASSETS ACQUIRED
  (Notes 1 and 2)                                                     479,614

OTHER ASSETS (Note 2)                                                 339,574
                                                                 ------------
                                                                 $ 19,349,897
                                                                 ============


                      LIABILITIES AND STOCKHOLDERS' EQUITY


CURRENT LIABILITIES:
  Current installments of obligations under capital
    leases (Notes 1 and 3)                                       $    324,317
  Accounts payable                                                  2,002,327
  Accrued liabilities (Note 5)                                      4,925,944
  Deferred revenue (Note 2)                                         6,581,998
                                                                 ------------
Total current liabilities                                          13,834,586
                                                                 ------------
OBLIGATIONS UNDER CAPITAL LEASES,
  net of current installments (Note 3)                                434,263
                                                                 ------------
DEFERRED REVENUE, net of current portion (Note 2)                      12,323
                                                                 ------------
COMMITMENTS AND CONTINGENCIES (Notes 1,3,4, and 6)

STOCKHOLDERS' EQUITY (Notes 1 and 6):
  Series A convertible preferred stock, $.001 par
    value, 2,000,000 shares authorized, zero shares
    issued and outstanding                                                 --

  Common stock, $.001 par value,10,000,000
    shares authorized, 5,365,573 shares issued
    and 4,996,817 shares outstanding                                    4,998
  Capital contributed in excess of par value                        6,768,297
  Accumulated deficit                                              (1,701,005)
  Less: treasury stock, 3,565 shares, at cost                          (3,565)
                                                                 ------------
                                                                    5,068,725
                                                                 ------------
                                                                 $ 19,349,897
                                                                 ============
</TABLE>

The accompanying notes are an integral part of this consolidated balance sheet.


                                       16

<PAGE>   19
NATIONAL HEALTH ENHANCEMENT SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED JANUARY 31, 1997 AND 1996       


<TABLE>
<CAPTION>
                                              1997                 1996
                                          ------------        ------------
<S>                                       <C>                 <C>         
REVENUES (Note 2):
License fees and computer hardware        $ 11,776,309        $  8,845,081
Support fees, marketing services
  and material sales                        13,408,699           8,046,062
                                          ------------        ------------
Total revenues                              25,185,008          16,891,143
                                          ------------        ------------
OPERATING EXPENSES:
Cost of initial license fees
  and computer hardware                      4,707,044           2,158,517
Cost of support, marketing services
  and materials sales                        5,281,273           3,509,171
Product and other development                1,227,371             523,969
Sales and marketing                          8,775,758           7,064,368
General and administrative                   2,457,065           1,888,586
Depreciation and amortization                1,290,845             862,286
Provision for doubtful accounts                581,356             266,500
                                          ------------        ------------
Total operating expenses                    24,320,712          16,273,397
                                          ------------        ------------
INCOME BEFORE PROVISION
  FOR INCOME TAXES                             864,296             617,746

PROVISION FOR INCOME TAXES (Note 7)           (128,000)            (58,000)
                                          ------------        ------------
Net income                                $    736,296        $    559,746
                                          ============        ============

NET INCOME AVAILABLE
  FOR COMMON STOCKHOLDERS                 $    736,296        $    559,746
                                          ============        ============

NET INCOME PER
  COMMON SHARE (Note 2)
            Primary                       $        .13        $        .11
                                          ============        ============

            Fully diluted                 $        .13        $        .10
                                          ============        ============

WEIGHTED AVERAGE SHARES
  OUTSTANDING (Note 2)
            Primary                          5,534,860           5,028,367
                                          ============        ============
            Fully diluted                    5,639,859           5,457,947
                                          ============        ============
</TABLE>


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


                                       17
<PAGE>   20
NATIONAL HEALTH ENHANCEMENT SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED JANUARY 31, 1997 AND 1996


<TABLE>
<CAPTION>
                                                                             
                              Series A Convertible                              Capital 
                                 Preferred Stock        Common Stock          Contributed
                                -----------------    --------------------     In Excess of   Accumulated     Treasury
                                Shares     Amount    Shares        Amount      Par Value       Deficit         Stock         Total
                                ------     ------    ------        ------      ---------       -------         -----         -----
<S>                             <C>        <C>      <C>          <C>          <C>            <C>              <C>         <C>       
BALANCE AT
  JANUARY 31, 1995              125,000    $ 125    3,791,220    $    3,792   $ 3,442,241    $(2,997,047)     $ (3,565)   $  445,546
    Stock options exercised          --       --       44,160            44        18,886             --            --        18,930
    Net income                       --       --           --            --            --        559,746            --       559,746
                                -------    -----    ---------    ----------   -----------    -----------      --------    ----------
BALANCE AT
  JANUARY 31, 1996              125,000      125    3,835,380         3,836     3,461,127     (2,437,301)       (3,565)    1,024,222
     Stock options
       exercised                     --       --      122,600           123        58,084             --            --        58,207
     Conversion of
       preferred stock         (125,000)    (125)     500,000           500          (375)            --            --            --
     Common stock
       issued                        --       --      538,837           539     3,249,461             --            --     3,250,000
     Net Income                      --       --           --            --            --        736,296            --       736,296
                                -------    -----    ---------    ----------   -----------     ----------       -------    ----------


BALANCE AT
JANUARY 31, 1997                     --    $  --    4,996,817    $    4,998   $ 6,768,297    $(1,701,005)     $ (3,565)   $5,068,725
                                =======    =====    =========    ==========   ===========    ===========      ========    ==========
</TABLE>


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


                                       18
<PAGE>   21
NATIONAL HEALTH ENHANCEMENT SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
FOR THE YEARS ENDED JANUARY 31, 1997 AND 1996


<TABLE>
<CAPTION>
                                                           1997               1996
                                                       -----------        -----------
<S>                                                    <C>                <C>        
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income                                             $   736,296        $   559,746
Adjustments to reconcile net income to
  net cash provided by operating activities-
    Depreciation and amortization                        1,290,845            862,286
    Provision for doubtful accounts                        581,356            266,500
    Changes in assets and liabilities-
    Accounts receivable                                 (5,578,100)        (2,478,369)
    Prepaid expenses, deferred costs and supplies         (750,745)          (298,021)
    Accounts payable                                     1,004,485           (325,393)
    Accrued liabilities                                  1,848,594          1,099,658
    Deferred revenue                                     3,061,333            992,233
                                                       -----------        -----------
Net cash provided by operating activities                2,194,064            678,640
                                                       -----------        -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment                      (1,213,086)          (152,995)
Payments for capitalized software
  development costs                                       (564,591)          (615,779)
Increase in other assets                                  (136,093)          (124,081)
                                                       -----------        -----------
Net cash used in investing activities                   (1,913,770)          (892,855)
                                                       -----------        -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock                   3,250,000                 --
Proceeds from exercise of stock options                     58,207             18,930
Net proceeds (payments) on line of credit               (1,606,093)           606,093
Principal payments on capital leases                      (364,872)          (413,804)
                                                       -----------        -----------
Net cash provided by financing activities                1,337,242            211,219
                                                       -----------        -----------
NET INCREASE (DECREASE) IN CASH
  AND CASH EQUIVALENTS                                   1,617,536             (2,996)

CASH AND CASH EQUIVALENTS
  AT BEGINNING OF YEAR                                   1,477,769          1,480,765
                                                       -----------        -----------
CASH AND CASH EQUIVALENTS
  AT END OF YEAR                                       $ 3,095,305        $ 1,477,769
                                                       ===========        ===========
SUPPLEMENTAL DISCLOSURE OF
  CASH FLOW INFORMATION:
Cash paid for interest                                 $   117,128        $   309,000
                                                       ===========        ===========
Cash paid for income taxes                             $   105,057        $        --
                                                       ===========        ===========  

SUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING AND
  INVESTING ACTIVITIES:
Property and equipment acquired
  under capital leases                                 $   593,686        $   300,488
                                                       ===========        ===========
</TABLE>


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


                                       19

<PAGE>   22
NATIONAL HEALTH ENHANCEMENT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JANUARY 31, 1997


(1)      ORGANIZATION AND BASIS OF PRESENTATION:

National Health Enhancement Systems, Inc. (the Company) was incorporated in July
1983 as AHI Limited for the purpose of developing, licensing and marketing
health evaluation programs to hospitals, medical groups, clinics and physicians.
In October 1986, the Company changed its name to National Health Enhancement
Systems, Inc. and reincorporated in the state of Delaware. The Company presently
distributes proprietary software-supported, Medical Call Center products and
services designed to enable health care providers to reduce the costs associated
with inappropriate utilization of health care and improve service to their
customers.

PRINCIPLES OF CONSOLIDATION

The accompanying consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries, First Strategic Group, Ltd. (FSG) and
NHE Systems, Inc. All significant intercompany transactions have been eliminated
in consolidation. Certain 1996 balances have been reclassified to conform to the
1997 presentation.

USE OF ESTIMATES

The preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, disclosures of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reported periods. Actual results
could differ from those estimates.

STOCK SPLIT

Effective January 12, 1996, the Board of Directors authorized a two-for-one
stock split of the Company's common stock in the form of a 100% stock dividend
to those shareholders of record as of January 25, 1996. All share and per share
amounts have been restated for all periods to reflect this split.


                                       20
<PAGE>   23
ACQUISITION OF EXPERT SYSTEMS, INC.

On February 18, 1997 the company completed the acquisition of Expert Systems,
Inc. (Expert), a developer and distributor of telephone and database
technologies to create voice features for computer telephone applications. Under
the terms of the acquisition, to be accounted for as a pooling of interests in
accordance with Accounting Principles Board Opinion No. 16, the Company issued
465,299 restricted shares, and 59,701 options to purchase shares, of the
Company's common stock for all of Expert's outstanding shares and options at an
exchange rate of .09537 shares of the Company's common stock for each share of
Expert's stock. Of the shares issued in the transaction, 46,529 are escrowed
securing an indemnity obligation in favor of the Company.

The results of operations of the Company and Expert will be combined as of the
date of acquisition and all prior periods presented will be restated to give
effect to the acquisition, as if it occurred at the beginning of each period
presented. Presented below are the unaudited proforma results of operations for
the years ended January 31, 1997 and 1996 assuming the acquisition occurred on
February 1, 1995. Amounts relating to Expert have been restated to be in
conformity with the Company's fiscal year and accounting policies.

<TABLE>
<CAPTION>
                                   1997              1996
                               ------------      ------------
<S>                            <C>               <C>         
Total Revenues                 $ 28,409,678      $ 20,221,290
Net Income                          196,476           660,178
Net Income Per Common Share    $        .03      $        .12
</TABLE>

(2)      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

CASH EQUIVALENTS

Cash equivalents consist primarily of investments in bank money market funds.
The Company considers investments with initial maturities of three months or
less from purchase date to be cash equivalents.

DEFERRED COSTS

The costs incurred by the Company to provide post-contract customer support,
primarily royalties required to maintain the medical technical data included in
the Company's software products, are deferred and recognized over the period
benefited. Deferred costs totaled $659,524 at January 31, 1997. Amortization of
such deferred costs totaled $1,124,679 and $493,881 in 1997 and 1996,
respectively. 


                                       21

<PAGE>   24
CAPITALIZED SOFTWARE DEVELOPMENT COSTS

Under the criteria set forth in Statement of Financial Accounting Standards
(SFAS) No. 86, Accounting for the Costs of Computer Software to be Sold, Leased
or Otherwise Marketed, capitalization of software development costs begins upon
the establishment of technological feasibility of the product. Development costs
incurred before the product is demonstrated to be technologically feasible are
expensed. The establishment of technological feasibility and the ongoing
assessment of the recoverability of these costs require considerable judgement
by management with respect to certain external factors, including, but not
limited to, anticipated future gross product revenues, estimated economic
product lives and changes in software and hardware technology. The capitalized
development costs, which include primarily salaries, are amortized using either
the revenue-ratio method or the straight-line method over the product's
remaining estimated useful life of three years, whichever yields the greatest
amount of amortization. Software development costs capitalized during 1997 and
1996 totalled $686,000 and $633,000, respectively. Amortization of capitalized
software totalled $625,000 and $458,000 in 1997 and 1996 respectively. Total
development costs expensed during the years ended January 31, 1997 and 1996
were approximately $1,227,371 and $523,969, respectively.

PROPERTY AND EQUIPMENT

Property and equipment are stated at cost. Depreciation on property and
equipment is provided using the straight-line method over the estimated useful
lives of the assets of three to five years. Property and equipment held under
capital leases and leasehold improvements are amortized using the straight-line
method over the shorter of the lease term or estimated useful lives of the
assets.

At January 31, 1997, property and equipment consisted of the following:

<TABLE>
<S>                                     <C>        
Computer equipment                      $ 1,268,579
Office furniture and equipment              582,751
Assets held under capital leases,
primarily computer equipment              1,687,955
Leasehold improvements                      201,829
                                        -----------
                                          3,741,114
Accumulated depreciation                 (1,574,527)
                                        -----------
                                        $ 2,166,587
                                        ===========
</TABLE>

EXCESS OF COST OVER FAIR VALUE OF NET ASSETS ACQUIRED

The excess of the cost over the fair value of net assets acquired resulted from
the acquisition of FSG, and is being amortized over ten years using the
straight-line method. Amortization expense was approximately $77,000 for each of
the years ended January 31, 1997 and 1996.


                                       22
<PAGE>   25
OTHER ASSETS

Other assets include approximately $70,700 of accounts receivable from
customers with terms in excess of one year. These accounts are generally due
over periods ranging from 18 to 36 months. Interest has been imputed on these
amounts at 10%.

REVENUE RECOGNITION

Revenue is recognized in accordance with Statement of Position 91-1, Software
Revenue Recognition. Accordingly, revenue from software licensing is recognized
when delivery of the software has occurred, a signed noncancellable license
agreement has been received from the customer and any remaining obligations
under the license agreement are insignificant. Revenue related to insignificant
obligations is deferred and recognized as the obligations are fulfilled.
Revenue from software license fees related to the Company's obligation to
provide certain post-contract customer support without charge for the first year
of the license is unbundled from the license fee at its fair value and is
deferred and recognized straight-line over the contract support period. Revenue
from annual or other renewals of maintenance contracts (including long-term
contracts) is deferred and recognized straight-line over the term of the
contracts. Revenue from professional services is generally billed on a time
and materials basis. Professional services do not involve significant
customization, modification or production of the licensed software. Such
professional services fees are recognized as the related services are provided.

CONCENTRATIONS OF CREDIT RISK

Financial instruments which potentially expose the Company to concentrations of
credit risk, as defined by SFAS No. 105, Disclosure of Information About
Financial Instruments With Off-Balance Sheet Risk and Financial Investments With
Concentrations of Credit Risk, consist primarily of cash and cash equivalents
and accounts receivable. The Company places its cash and cash equivalents with
high quality financial institutions and limits the amount of credit exposure to
any one financial institution.

The Company sells its products and services to customers in the health care
industry throughout the United States. Concentrations of credit risk with
respect to accounts receivable are limited due to the geographic diversity and
large number of customers comprising the Company's customer base. The Company
performs credit evaluations of its customers, but does not require collateral to
support receivable balances. An allowance for doubtful accounts has been
established based on factors surrounding the credit risk of specific borrowers,
historical trends and other information.


                                       23

<PAGE>   26
FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company's financial instruments as defined by SFAS No. 107, Disclosures
About Fair Value of Financial Instruments, include cash and cash equivalents,
accounts receivable, accounts payable and notes payable. The carrying value of
cash and cash equivalents, accounts receivable and accounts payable approximate
fair value due to the short maturity of these instruments. The Company's notes
payable bear interest at rates indexed to the prime rate; therefore, the
carrying amounts approximate fair value.

NET INCOME PER COMMON SHARE

Net income per common share and common share equivalent is computed by dividing
the net income by the weighted average number of common shares and common share
equivalents assumed outstanding during the period. For purposes of these
calculations, the Series A Convertible Preferred Stock that was converted into
shares of common stock in 1997 has been assumed to have been converted upon
original issuance (See Note 6).

RECENTLY ISSUED ACCOUNTING STANDARDS

In March 1997, the Financial Accounting Standards Board issued SFAS No. 128,
Earnings Per Share, which supersedes Accounting Principal Board Opinion No. 15,
the existing authoritative guidance. SFAS No. 128 is effective for financial
statements for both interim and annual periods ending after December 15, 1997
and requires restatement of all prior-period earnings per share data presented.
The new statement modifies the calculations of primary and fully diluted
earnings per share and replaces them with basic and diluted earnings per share.
The following table sets forth the proforma effect on net income per common
share for fiscal 1997 and 1996 assuming the Company had adopted SFAS No. 128 on
February 1, 1995: 

<TABLE>
<CAPTION>
                         1997       1996
<S>                    <C>        <C>    
         Basic         $   .17    $   .15
         Diluted       $   .13    $   .11
</TABLE>

(3)      NOTES PAYABLE AND OBLIGATIONS UNDER CAPITAL LEASES:

Notes payable and obligations under capital leases at January 31, 1997,
were as follows:
Revolving line of credit not to exceed the stated borrowing base
as defined in the borrowing agreement or $2,500,000, bearing
interest at the lender's prime rate (8.25% at January 31, 1997)
plus 2%, matures October 29, 1997, secured by substantially
all of the assets of the Company, including eligible
accounts receivables defined in the borrowing agreement.                $ - 0 -


                                       24
<PAGE>   27
<TABLE>
<S>                                                                  <C>
Borrowing line of $250,000 bearing interest at lender's prime rate
plus 2% secured by equipment that converts to amortizing loan
on April 22, 1997 bearing interest at lender's prime rate plus 2%.        - 0 -

Obligations under capital leases bearing interest at weighted
average rate of 12.67%, maturities through November 1999,
secured by computers and other equipment                                758,580
                                                                     ----------
                                                                        758,580

Less: Current installments                                             (324,317)
                                                                     ----------
                                                                     $  434,263
                                                                     ==========
</TABLE>

The lines of credit require the Company to maintain compliance with certain
covenants including certain financial ratios. At January 31, 1997, the Company
was in compliance with the financial ratios.

Future maturities of obligations under capital leases as of January 31, 1997 are
as follows:

<TABLE>
<CAPTION>
         Fiscal Year 
         -----------
         <S>                              <C>        
         1998                             $   385,533
         1999                                 267,905
         2000                                 148,509
         2001                                  68,462
                                          -----------
                                              870,409
         Less:
         Amounts representing interest       (111,829)
                                           ----------
                                           $  758,580
                                           ==========
</TABLE>

(4)      COMMITMENTS:

The Company leases its office facilities and certain equipment under
noncancellable operating leases expiring through fiscal 2001. The leases include
options to extend for additional periods at the then prevailing market rates.
Rent expense was approximately $434,012 and $229,000 for the years ended January
31, 1997 and 1996, respectively. Future minimum payments under these leases as
of January 31, 1997 are as follows:

<TABLE>
<CAPTION>
         Fiscal Year
         <S>           <C>       
         1998          $  601,310
         1999             627,575
         2000             664,363
         2001             627,125
         2002             597,730
         Thereafter       214,817
                       ----------
                       $3,332,920
                       ==========
</TABLE>


                                       25

<PAGE>   28
The Company has entered into certain exclusive agreements with product support
vendors which require the payment of royalties on products sold and also require
minimum annual purchases of products to maintain the exclusivity associated with
these agreements. Future minimum obligations under these agreements as of
January 31, 1997 are as follows:

<TABLE>
<CAPTION>
         Fiscal Year
         -----------
         <S>                      <C>
         1998                     $   1,733,821
         1999                         2,099,709
         2000                         2,293,726
         2001                         2,938,759
         2002                         2,213,987
                                  -------------
                                  $  11,280,002
                                  =============
</TABLE>                 

(5)      ACCRUED LIABILITIES:

Accrued liabilities as of January 31, 1997, are as follows:

<TABLE>
<S>                                    <C>          
Accrued product cost of sales          $   1,459,179
Accrued payroll and commissions            1,238,244
Accrued royalties                          1,631,678
Other accrued liabilities                    596,843
                                       -------------
                                       $   4,925,944
                                       =============
</TABLE>

(6)      STOCKHOLDERS' EQUITY:

1988 STOCK OPTION PLAN

During the fiscal year ended January 31, 1989, the Company adopted the 1988
Stock Option Plan (the Plan). The Plan, as amended, will terminate in May 1998
and provides for the grant of up to 700,000 incentive stock options, 700,000
nonqualified stock options and 200,000 options to be issued at the discretion of
the Board of Directors as either incentive or nonqualified stock options. The
Company has reserved 1,600,000 shares of common stock for exercise of options
under the Plan. Key employees are eligible for both incentive and nonqualified
stock options. Officers, outside directors and certain nonemployee consultants
are eligible only for nonqualified stock options. The Board of Directors, within
the limits of the provisions of the Plan, determines the period over which
granted options become exercisable. 


                                       26
<PAGE>   29
A summary of stock option activity under the Plan as of January 31, 1997 and
1996 and for each of the years then ended is set forth in the table below: 

<TABLE>
<CAPTION>
                                    1997                        1996
                           ---------------------       ---------------------
                                            Wtd.                       Wtd.
                                            Avg.                       Avg.
                             Shares        Price        Shares        Price
<S>                        <C>           <C>           <C>           <C>    
Options outstanding
  at beginning
  of period                1,362,500     $   .98       1,196,000     $   .90
Granted                      179,300        7.88         207,000        1.18
Exercised                   (122,600)        .58         (40,500)        .40
Canceled                          --          --              --          --
                           ---------     -------       ---------     -------
Options outstanding
  at end of period         1,419,200        1.85       1,362,500         .98
                           =========                  ==========
Exercisable at
  end of period            1,071,525         .90         790,250         .64
                           =========                  ==========
Weighted average
  fair value of options
  granted                  $    5.67                  $      .82
                           =========                  ==========
</TABLE>


STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 123

During 1995, the Financial Accounting Standards Board issued SFAS No. 123,
Accounting for Stock-Based Compensation, which defines a fair value based method
of accounting for an employee stock option or similar equity instrument and
encourages all entities to adopt that method of accounting for all of their
employee stock compensation plans. However, it also allows an entity to continue
to measure compensation cost related to stock options issued to employees under
these plans using the method of accounting prescribed by the Accounting
Principles Board Opinion No. 25 (APB No. 25), Accounting for Stock Issued to
Employees. Entities electing to remain with the accounting in APB No. 25 must
make pro forma disclosures of net income and earnings per share, as if the fair
value based method of accounting defined in SFAS No. 123 has been applied.

The Company has elected to account for its stock-based compensation plans under
APB No. 25; however, the Company has computed for pro forma disclosure purposes
the value of all options granted during 1997 and 1996; using the following
weighted average assumptions used for grants:

<TABLE>
<CAPTION>
                                    1997       1996
                                    ----       ----
<S>                                  <C>        <C>  
         Risk free interest rate     5.91%      6.20%
         Expected dividend yield      N/A        N/A
         Expected lives           5 years    5 years
         Expected volatility         88.9%      85.4%
</TABLE>


                                       27
                                        
<PAGE>   30
Options were assumed to be exercised over the five-year expected life for the
purpose of this valuation. Adjustments were made for options forfeited prior to
vesting. The total value of options granted was computed to be the following
approximate amounts, which would be amortized on the straight-line basis over
the vesting period of the options:

<TABLE>
<S>                                                  <C>      
         Year ended January 31, 1997                 $1,016,000
         Year ended January 31, 1996                 $  169,740
</TABLE>

If the Company had accounted for stock options issued to employees using a fair
value based method of accounting, the Company's year end net income and net
income per common share and common share equivalent would have been reported as
follows:

<TABLE>
<CAPTION>
                                                    1997              1996
                                                    ----              ----
<S>                                            <C>              <C>        
         Net income:
             As reported                       $   736,296      $   559,746
             Pro forma                             171,400          446,586
         Net income per common share                      
           and common share equivalent:
             As reported                              0.13             0.11
             Pro forma                                0.03             0.09
</TABLE>

The effects of applying SFAS No. 123 for providing pro forma disclosures for
1997 and 1996 are not likely to be representative of the effects on reported net
income and net income per common share and common share equivalent for future
years, because options vest over several years and additional awards are made
each year.

SERIES A CONVERTIBLE PREFERRED STOCK

On August 18, 1992, the Company issued 125,000 shares of Series A Convertible
Preferred Stock (the Preferred Stock) at $2.40 per share, with a quarterly
dividend equal to a certain percentage of the Company's gross quarterly revenue
as defined in the Certificate of Designation for the Preferred Stock. Effective
February 1, 1994, the terms of the Preferred Stock were amended to make each
share of the Preferred Stock, at the option of the holder, convertible into four
shares of the Company's common stock. In addition, the holder of the Preferred
Stock is entitled to four votes for each share of Preferred Stock. Upon
liquidation or dissolution of the Company, the holder of the Preferred Stock
shall have liquidating preferences equal to $2.40 per share of Preferred Stock.
The amendment eliminated all rights to receive dividends subsequent to the
effective date. The amount of accrued and unpaid dividends of $27,763 at January
31, 1994, was reclassified to retained earnings. In 1997, the holder of the
Preferred Stock exercised in full its option to convert the Preferred Stock into
500,000 shares of common stock. 


                                       28
<PAGE>   31
EQUITY INVESTMENTS

During the year, the Company secured equity investments from two separate
investor groups. The investor groups made equity investments in the amount of
$750,000 and $2,500,000 on July 22, 1996 and on January 14, 1997, respectively.
The number of shares issued were 166,667 and 370,370 shares respectively, and
the amount of stock issued in both transactions represented less than 10% of the
Company's outstanding stock.

(7)      INCOME TAXES:

The Company accounts for income taxes under the provisions of SFAS No. 109,
Accounting for Income Taxes. SFAS No. 109 requires deferred income tax assets
and liabilities to be computed based upon cumulative temporary differences
between financial reporting and taxable income.

Income tax expense differs from the amount computed by applying the statutory
U.S. federal income tax rate of 34% to income before income taxes as a result of
the following:

<TABLE>
<CAPTION>
                                                  1997           1996
<S>                                            <C>            <C>      
Expected income tax expense
  at 34%                                       $ 294,000      $ 210,000
State income taxes,
  net of federal income tax benefit               52,000         40,000
Amortization of cost over fair value
  of net assets acquired                          40,000         40,000
Net decrease in valuation allowance             (372,000)            --
Other, including effect of utilizing
  a net operating loss carryforwards             114,000       (232,000)
                                               ---------      ---------
Provision for income taxes                     $ 128,000      $  58,000
                                               =========      =========
</TABLE>

The components of net deferred taxes as of January 31, 1997, are as follows:

<TABLE>
<S>                                                      <C>      
Deferred tax assets (liabilities):
Allowance for doubtful accounts                          $ 252,000
Accrued liabilities                                        354,000
Deferred revenue                                           290,000
Capitalized software costs                                (390,000)
Tax depreciation in excess of book depreciation           (104,000)
Valuation allowance                                       (402,000)
                                                         ---------
                                                         $      --
                                                         =========
</TABLE>

A valuation allowance is provided when it is uncertain that some portion or all
of the deferred tax asset will be recognized. The valuation allowance decreased
during the year ended January 31, 1997, due to the Company's fiscal 1997
operating results.

During 1997, the Company utilized all remaining net operating loss carry
forwards for federal and state income tax purposes of approximately $69,000.


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

        NONE

                                       29
<PAGE>   32
PART III

The information required here by Items 9, 10, 11 and 12 is incorporated by
reference to the Company's definitive Proxy Statement to be filed pursuant to
Regulation 14A with the Securities and Exchange Commission no later than May 31,
1997.

ITEM 13.      EXHIBITS AND REPORTS ON FORM 8-K



A.       All other schedules have been omitted because of the absence of
conditions under which they are required or because the required material
information is included in the Financial Statements or Notes to the Financial
Statements included herein.

         (1)      Exhibits required by Item 601 of Regulation S-B are set forth
                  on the Exhibit Index to this report which is hereby
                  incorporated herein by this reference.

         (2)      Management contracts and compensatory plans required to be
                  filed as an exhibit list form.

         (a)      Employment Agreements with Dr. Larry Gettman and Jeffrey
                  Zywicki. Incorporated by Reference to Exhibit 10.9 of S-18 No.
                  33-9397-LA.

         (b)      Form of Stock Option Agreement with Key Employees and
                  Officers. Incorporated by Reference to Exhibit 10.32 to Form
                  10-K filed for the year ended January 31, 1989.

         (c)      Form of Stock Option Agreement with Outside Directors.
                  Incorporated by Reference to Exhibit 10.33 to Form 10-K for
                  the year ended January 31, 1989.

         (d)      Key Executive Employment and Severance Agreements.
                  Incorporated by Reference to Exhibit 10.44 to Form 10KSB filed
                  for the fiscal year ended January 31, 1994.

         (e)      Employment Agreement with A. Neal Westermeyer. Incorporated by
                  Reference to Exhibit 10.46 to Form-10-KSB filed for the fiscal
                  year ended January 31, 1994.

         (f)      Restricted Stock Agreement for W. Cal McGraw Incorporated by
                  Reference to Exhibit 10.57 to this Form 10-KSB filed for the
                  fiscal year ended January 31, 1997.

B.       Reports on Form 8-K for the fourth quarter of fiscal year 1997

                  NONE


                                       30
<PAGE>   33
                                   SIGNATURES


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

NATIONAL HEALTH ENHANCEMENT SYSTEMS, INC.
(Registrant)


By       /s/ Gregory J. Petras
         ----------------------------------------
         Gregory J. Petras
         Chairman and Chief Executive Officer

Date:    April 30, 1997


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

<TABLE>
<CAPTION>
Signature                                   Title                                                Date
------------------------------------        ---------------------------------                    ---------------- 

<S>                                         <C>                                                  <C>   
/s/ Gregory J. Petras                       Chairman and Chief Executive                         04-30-97
------------------------------------        Officer
Gregory J. Petras                           


/s/ John P. Delmatoff                       Director                                             04-30-97
------------------------------------
John P. Delmatoff


/s/ Gardiner S. Dutton                      Director                                             04-30-97
------------------------------------
Gardiner S. Dutton


/s/ James W. Myers                          Director                                             04-30-97
------------------------------------
James W. Myers


/s/ Steven D. Wood, Ph.D.                   Director                                             04-30-97
------------------------------------
Steven D. Wood, Ph.D.


/s/ W. Cal McGraw                           Director                                             04-30-97
------------------------------------
W. Cal McGraw


/s/ Mark E. Liebner                         Director                                             04-30-97
------------------------------------
Mark E. Liebner


/s/ Jeffrey T. Zywicki                      Senior Vice President                                04-30-97
------------------------------------        Treasurer and Secretary
Jeffrey T. Zywicki                          


/s/ Earl E. Bray                            Chief Financial Officer                              04-30-97
------------------------------------
Earl E. Bray
</TABLE>


                                       31


<PAGE>   34
                                  EXHIBIT INDEX


<TABLE>
<CAPTION>
Exhibit                                                          Page or
number                Description                                Method of Filing
-------               -----------                                ----------------
<S>                   <C>                                        <C> 
  2.1                 Plan of Reorganization and                 Incorporated by Reference
                      Agreement of Merger                        to Form 8-k filed July 13, 1994

  3.1                 Certification of Incorporation             Incorporated by Reference
                                                                 of the Company to
                                                                 Exhibit 3.1 of S-18
                                                                 No. 33-9396-LA

  3.2                 Bylaws of the Company                      Incorporated by Reference
                                                                 to Exhibit 3.2 of S-18
                                                                 No. 33-9396-LA

  4.1                 Specimen Certificate                       Incorporated by Reference
                      Representing $.001 par value               to Exhibit 4.1 of S-18
                      Common Stock                               No. 33-9397-LA

  4.2                 Form of Warrant to the                     Incorporated by Reference
                      Underwriter                                to Exhibit 4.2 of
                                                                 Amendment No. 2 to S-18
                                                                 No. 33-9397-LA

  4.3                 Form of Warrant to the                     Incorporated by Reference
                      Advisor                                    to Exhibit 4.3 of
                                                                 Amendment No. 2 to S-18
                                                                 No. 33-9397-LA

 10.1                 Confirmation of License and                Incorporated by Reference
                      Agreement Regarding Purchase               to Exhibit 10.1 of S-18
                      Option and related letter                  No. 33-9397-LA
                      agreement dated October 2, 1986

 10.2                 Franchising and Licensing                  Incorporated by Reference
                      Agreement with The Arizona                 to Exhibit 10.2 of
                      Heart Institute, Ltd.                      Amendment No. 1 to S-18
                                                                 No. 33-9397-LA

 10.3                 Assignment of Rights to The                Incorporated by Reference
                      Heart Test                                 to Exhibit 10.3 of S-18
                                                                 No. 33-9397-LA

 10.4                 Shareholders Contribution and              Incorporated by Reference
                      Conversion Agreement as                    to Exhibit 10.4 of S-18
                      Amended, and related notes held            No. 33-9397-LA
                      by Shareholders and Affiliated

 10.5                 Form of Outstanding Warrants               Incorporated by Reference
                                                                 to Exhibit 10.5 of S-18
                                                                 No. 33-9397-LA
</TABLE>


                                       32

<PAGE>   35
<TABLE>
<CAPTION>
Exhibit                                                          Page or
number                Description                                Method of Filing
------                -----------                                ----------------
<S>                   <C>                                        <C> 
10.6                  Promissory Notes in the                    Incorporated by Reference
                      Aggregate amount of $100,000               to Exhibit 10.6 of S-18
                      Principal                                  No. 33-9397-LA

10.7                  Lease for Company's Office                 Incorporated by Reference
                      Space dated August 22, 1986                to Exhibit 10.7 of S-18
                                                                 No. 33-9397-LA

10.7.1                Amendment to Lease for                     Incorporated by Reference
                      Company's Office Space dated               to Exhibit 10.7.1 to Form
                      August 22, 1986                            10-K filed for the year
                                                                 Ended January 31, 1987

10.8                  Agreement and Plan of Merger               Incorporated by Reference
                                                                 Exhibit 10.8 of S-18
                                                                 No. 33-9397-LA

10.9                  Employment Agreements with                 Incorporated by Reference
                      Dr. Larry Gettman and                      Exhibit 10.9 of S-18
                      Jeffrey Zywicki                            No. 33-9397-LA

10.10                 Line of Credit Documentation               Incorporated by Reference
                                                                 to Exhibit 10.10 of S-18
                                                                 No. 33-9397-LA

10.11                 Promissory Note in the                     Incorporated by Reference
                      Principal Amount of $25,801                to Exhibit 10.11 of S-18
                                                                 No. 33-9397-LA

10.12                 Company Indemnities                        Incorporated by Reference
                                                                 to Exhibit 10.12 of S-18
                                                                 No. 33-9397-LA

10.13.1               Forms of Franchise                         Incorporated by Reference
                      Agreement used in 1987                     to Exhibit 10.13.1 to
                                                                 Amendment No. 2 of S-18
                                                                 No. 33-9397-LA

10.13.2               Forms of Franchise                         Incorporated by Reference
                      Agreement used in 1986                     to Exhibit 10.13.2 to
                                                                 Amendment No. 1 and
                                                                 Amendment No. 2 to S-18
                                                                 No. 33-9397-LA

10.13.3               Forms of Franchise Agreement               Incorporated by Reference
                      used in 1985                               to Exhibit 10.13.3 to S-18
                                                                 No. 33-9397-LA

10.13.4               Forms of Franchise Agreement               Incorporated by Reference
                      used in 1984                               to Exhibit 10.13.4 to S-18
                                                                 No. 33-9397-LA
</TABLE>


                                       33
<PAGE>   36
<TABLE>
<CAPTION>
Exhibit                                                          Page or
number                Description                                Method of Filing
------                -----------                                ----------------
<S>                   <C>                                        <C> 
10.13.5               Franchise Agreements Executed              Incorporated by Reference
                      Agreement                                  to Exhibit 10.13.5 of S-18
                                                                 No. 33-9397-LA

10.13.6               Existing Area Franchise                    Incorporated by Reference
                      Agreement                                  to Exhibit 10.13.6 of S-18
                                                                 No. 33-9397-LA

10.13.7               Form of Franchise Agreement                Incorporated by Reference
                      used by the Company in 1987                to Form 10-K filed for
                                                                 year ended January 31,
                                                                 1988

10.13.8               Form of Franchise Agreement                Incorporated by Reference
                      used by the Company in 1988                to Form 10-K filed for the year ended January 31,
                                                                 1989

10.13.9               Form of Franchise Agreement                Incorporated by Reference
                      used by the Company in 1989                to Form 10-K filed for the year ended January 31,
                                                                 1990

10.14                 Forms of Rescission offers                 Incorporated by Reference
                                                                 to Exhibit 10.14 of S-18
                                                                 No. 33-9397-LA

10.15                 Rescission and Refund Responses            Incorporated by Reference
                      for internal use of Programs               to Exhibit 10.15 of S-18
                                                                 No. 33-9396-LA

10.16                 Agreements with Corporations               Incorporated by Reference
                      for internal use of Programs               to Exhibit 10.16 of S-18
                                                                 No. 33-9397-LA

10.17                 South Dakota and Wisconsin                 Incorporated by Reference
                      "No Action" letters and certain            to Exhibit 10.17 of
                      related documents                          Amendment No. 1 to S-18
                                                                 No. 33-9397-LA

10.18                 Revised Exhibit A to Form of               Incorporated by Reference
                      Stock Escrow Agreement required            to Exhibit 10.18 of
                      by the Arizona Corporation                 Amendment No. 1 to S-18
                      Commission and Shareholder                 No. 33-9397-LA
                      lock-up agreements

10.19                 Promissory Note in Principal               Incorporated by Reference
                      Amount of $50,000 and related              to Exhibit 10.19 of
                      materials                                  Amendment No. 1 to S-18
                                                                 No. 33-9397-LA

10.20                 Agreement with Advisor                     Incorporated by Reference
                                                                 to Exhibit 10.20 of
                                                                 Amendment No. 1 to S-18
                                                                 No. 33-9397-LA
</TABLE>


                                       34
<PAGE>   37
<TABLE>
<CAPTION>
Exhibit                                                          Page or
number                Description                                Method of Filing
------                -----------                                ----------------
<S>                   <C>                                        <C> 
10.21                 Notification of Option to                  Incorporated by Reference
                      Purchase the Personal Fitness              to Exhibit 10.21 to Form
                      Profile Software                           10-K filed for the fiscal
                                                                 year ended January 31, 1987

10.21.1               List of Subsidiaries                       Page 37

10.22                 Promissory Note in Principal               Incorporated by Reference
                      Amount of $75,000 for purchase             to Exhibit 10.22 to Form
                      of Personal Fitness Profile                10-K filed for the fiscal
                      Software and related materials             year ended January 31, 1987

10.23                 Employment Agreement with                  Incorporated by Reference
                      James Wichterman                           to Exhibit 10.23 to Form
                                                                 10-Q filed for the quarter ended April 30, 
                                                                 1987

10.24                 Term Note Payable in the                   Incorporated by Reference
                      Principal Amount of $75,000                to Exhibit 10.24 to Form
                                                                 10-Q filed for the
                                                                 quarter ended April 30, 1987

10.25                 Software Customization and                 Incorporated by Reference
                      License Agreement with                     to Exhibit 10.25 to Form
                      Resource Center Enterprises,               10-Q filed for the
                      Inc. dated May 22, 1987                    quarter ended July 31, 1987

10.26                 Med Plus Corporation Distribution          Incorporated by Reference
                      and Sales Agreement dated                  to Exhibit 10.26 to Form
                      September 19, 1987                         10-Q filed for the quarter ended October 31, 1987

10.27                 Distribution Agreements                    Incorporated by Reference
                      for Marketing Consultants                  to exhibit 10.27 to Form
                                                                 10-Q filed for the quarter ended October 31, 1987

10.28                 Consulting, Development                    Incorporated by Reference
                      and License Agreement with                 to Exhibit 10.28 to Form
                      Humana Inc., dated December                10-K filed for the year
                      31, 1987                                   ended January 31, 1988

10.29                 Agreement with Healthscan, Inc.            Incorporated by Reference
                      to discontinue use of Healthscan           to Exhibit 10.29 to Form
                                                                 10-K filed for the year
                                                                 ended January 31, 1988

10.30                 Stock Option Letter with                   Incorporated by Reference
                      Jim Wichterman                             to Exhibit 10.30 to Form
                                                                 10-K filed for the year
                                                                 ended January 31, 1988
</TABLE>


                                       35

<PAGE>   38
<TABLE>
<CAPTION>
Exhibit                                                          Page or
number                Description                                Method of Filing
------                -----------                                ----------------
<S>                   <C>                                        <C> 
10.31                 Employment Agreement with                  Incorporated by Reference
                      Dan Bergman                                to Exhibit 10.31 to Form
                                                                 10-K filed for the year
                                                                 ended January 31, 1988

10.32                 Form of Stock Option Agreement             Incorporated by Reference
                      with Key Employees and Officers            to Exhibit 10.32 to Form
                                                                 10-K filed for the year
                                                                 ended January 31, 1989

10.33                 Form of Stock Option Agreement             Incorporated by Reference
                      with Outside Directors                     to Exhibit 10.33 to form
                                                                 10-K filed for the year
                                                                 ended January 31, 1989

10.34                 Severance Agreement with                   Incorporated by Reference
                      Gregory J. Petras                          to Exhibit 10.34 to Form
                                                                 10-K filed for the year
                                                                 ended January 31, 1989

10.35                 $100,000 Installment Note                  Incorporated by Reference
                      Payable to Three Carollo                   to Exhibit 10.35 to Form
                      Partnership                                10-Q filed for the quarter ended July 31, 1989

10.36                 Purchase, Consulting and                   Incorporated by Reference
                      Distribution Agreement with                to Exhibit 10.36 to Form
                      Micromedex, Inc.                           10-K filed for the fiscal
                                                                 year ended January 31, 1991

10.37                 $125,000 Installment Note                  Incorporated by Reference
                      Payable to Gardiner S. Dutton              to Exhibit 10.37 to Form
                      as Agent                                   10-Q for the quarter ended July 31, 1990

10.38                 Asset Purchase Agreement with              Incorporated by Reference
                      Prentice Hall, Inc. to purchase            to Exhibit 10.38 to Form
                      Riskscan                                   July 31, 1990

10.39                 Lease for Company's Office Space           Incorporated by Reference
                      dated October 1990                         to Exhibit 10.39 to Form 10-K filed for the
                                                                 fiscal year ended January 31, 1991

10.40                 Exclusive Distributor Agreement            Incorporated by Reference to Exhibit
                      with Vim & Vigor, Inc.                     10.40 to Form 10-K filed for the fiscal year
                                                                 ended January 31, 1992.

10.41                 Exclusive Agency Agreement                 Incorporated by Reference to Exhibit
                      with Joseph Stevens Group, Inc.            10.41 to Form 10-K filed for the
                                                                 fiscal year ended January 31, 1992
</TABLE>


                                       36
<PAGE>   39
<TABLE>
<CAPTION>
Exhibit                                                          Page or
number                Description                                Method of Filing
------                -----------                                ----------------
<S>                   <C>                                        <C> 
10.42                 Development and Distribution               Incorporated by Reference to Exhibit
                      Agreement with Parlay                      10.42 to Form 10-KSB filed for fiscal
                      International Communication, Inc.          year ended January 31, 1993

10.43                 Amended and Restated Purchase,             Incorporated by Reference to Exhibit
                      Consulting and Distribution Agreement      10.43 to Form 10-KSB filed for fiscal
                      with Micromedex, Inc.                      year ended January 31, 1993

10.44                 Employment Agreement with Gregory J.       Incorporated by Reference to
                      Petras and From Other key Executives       the Form 10-KSB filed for the
                                                                 fiscal year ended January 31, 1993

10.45                 1988 Stock Option Plan                     Incorporated by Reference to
                                                                 1988 Proxy statement

10.46                 Employment Agreement with                  Incorporated by Reference to
                      A. Neal Westermeyer                        Exhibit 10.46 to Form 10-KSB
                                                                 filed for fiscal year ended
                                                                 January 31, 1994

10.47                 Amendment and Restated Certificate         Incorporated by Reference to
                      of Designation Agreement of Series A       the Form 10-QSB filed for the fiscal
                      Preferred Stock dated, June 14, 1994       quarter ended April 30, 1994

10.48                 Pediatric Protocol Publishing              Incorporated by Reference to Exhibit
                      Agreement with Barton D. Schmitt M.D.      10.48 to Form 10-KSB for the fiscal year
                                                                 ended January 31, 1995

10.49                 Consulting Agreement with                  Incorporated by Reference to Exhibit
                      Steven Poole, M.D.                         10.49 to Form 10-KSB for the fiscal year
                                                                 ended January 31, 1995

10.50                 First Amendment to Amended and Restated    Incorporated by Reference to Exhibit
                      Purchase, Consulting and Distribution      10.50 to Form 10-KSB for the fiscal year
                      Agreement                                  ended January 31, 1995

10.51                 Development and Distribution Agreement     Incorporated by Reference to Form 10-KSB
                      with Pfizer Health Sciences, Inc.          for the fiscal year ended January 31, 1996

10.52                 Second Amendment to Amended and            Filed Herewith
                      Restated Purchase, Consulting and
                      Distribution Agreement.

10.53                 Third Amendment to Amended and             Filed Herewith
                      Restated Purchase, Consulting and
                      Distribution Agreement

10.54                 Fourth Amendment to Amended and            Filed Herewith
                      Restated Purchase, Consulting and
                      Distribution Agreement
</TABLE>


                                       37
<PAGE>   40
<TABLE>
<CAPTION>
<S>                   <C>                                        <C> 
10.55                 Merger Agreements Between NHES and         Incorporated by Reference to Form
                      Expert Systems, Inc.                       8-k Filed March 6, 1997

10.56                 Lease for Company's Office Space           Filed Herewith
                      Dated April 3, 1995.

10.57                 Restricted Stock Agreement for W. Cal      Filed Herewith
                      McGraw


21                    List of all subsidiaries                   Filed Herewith

27                    Financial Data Schedule                    Filed Herewith
</TABLE>


                                       38