NOVACARE INC, 10-Q, 1995-05-15

NOVACARE INC
10-Q, 1995-05-15
MISC HEALTH & ALLIED SERVICES, NEC

Previous: RIGHT MANAGEMENT CONSULTANTS INC, 10-Q, 1995-05-15

Next: SOUTHEASTERN INCOME PROPERTIES LIMITED PARTNERSHIP, 10-Q, 1995-05-15

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

U N I T E D S T A T E S
S E C U R I T I E S A N D E X C H A N G E C O M M I S S I O N
W A S H I N G T O N, D C 2 0 5 4 9

FORM 10-Q

QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1995

COMMISSION FILE NUMBER 1-10875

NOVACARE, INC.
(Exact name of registrant as specified in its charter)

<TABLE>
<S> <C>
DELAWARE 13-3247827
(State of incorporation) (I.R.S. Employer Identification No.)

1016 W. NINTH AVENUE, KING OF PRUSSIA, PA 19406
(Address of principal executive office) (Zip code)
</TABLE>

Registrant's telephone number: (610) 992-7200

(Former name, former address and former fiscal year,
if changed since last report.)

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

Yes X No
----- -----

As of May 8, 1995, NovaCare, Inc. had 65,339,061 shares of common stock, $.01
par value, outstanding.

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

<PAGE> 2
NOVACARE, INC. AND SUBSIDIARIES

FORM 10-Q - QUARTER ENDED MARCH 31, 1995

INDEX

<TABLE>
<CAPTION>
FORM 10Q FORM 10-Q FORM 10-Q
PART NO. ITEM NO. DESCRIPTION PAGE NO.
-------- -------- ----------- --------
<S> <C> <C> <C>
I FINANCIAL INFORMATION

1 Financial Statements
- Condensed Consolidated Balance Sheets as of
March 31, 1995 and 1994 1

- Condensed Consolidated Statements of Operations
for the Three Months Ended March 31, 1995 and
1994 2

- Condensed Consolidated Statements of Operations
for the Nine Months Ended March 31, 1995 and
1994 3

- Condensed Consolidated Statements of Cash Flows
for the Nine Months Ended March 31, 1995 and
1994 4

- Notes to Condensed Consolidated Financial Statements 5-9

2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 10-16

II OTHER INFORMATION

6 Exhibits and Reports on Form 8-K 17

Signatures 18
</TABLE>

<PAGE> 3
NOVACARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
As of March 31, 1995 and June 30, 1994
(In thousands, except share data)

<TABLE>
<CAPTION>
MARCH 31, JUNE 30,
1995 1994
----------- ------------
ASSETS (UNAUDITED) (See Note 1)
<S> <C> <C>
Current assets:
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . $ 30,413 $ 38,024
Marketable securities . . . . . . . . . . . . . . . . . . . . . 24,983 35,104
Accounts receivable, net . . . . . . . . . . . . . . . . . . . 235,913 215,727
Other current assets . . . . . . . . . . . . . . . . . . . . . 47,133 46,150
----------- ------------
Total current assets . . . . . . . . . . . . . . . . . . . 338,442 335,005

Marketable securities, net . . . . . . . . . . . . . . . . . . . 22,795 53,318
Property and equipment, net . . . . . . . . . . . . . . . . . . . 88,123 81,356
Excess cost of net assets acquired, net . . . . . . . . . . . . . 422,975 342,938
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . 45,965 37,924
----------- ------------

$ 918,300 $ 850,541
=========== ===========

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt and financing arrangements . $ 42,115 $ 61,518
Accounts payable and accrued expenses . . . . . . . . . . . . . 65,121 72,997
Income taxes payable . . . . . . . . . . . . . . . . . . . . . 558 6,166
----------- ------------
Total current liabilities . . . . . . . . . . . . . . . . 107,794 140,681

Long-term debt and financing arrangements, net of current portion 345,662 283,084
Deferred income . . . . . . . . . . . . . . . . . . . . . . . . . 608 993
Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . 10,486 8,638
Minority interest . . . . . . . . . . . . . . . . . . . . . . . . 1,820 1,441
----------- ------------
Total liabilities . . . . . . . . . . . . . . . . . . . . 466,370 434,837
----------- ------------

Commitments and contingencies . . . . . . . . . . . . . . . . . . --- ---

Stockholders' equity:
Common stock, $.01 par value; authorized 200,000,000 shares,
issued 65,334,328 shares at March 31, 1995 and 64,227,735
shares at June 30, 1994 . . . . . . . . . . . . . . . . . . 653 643
Additional paid-in capital . . . . . . . . . . . . . . . . . . 249,739 240,619
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . 205,113 176,225
----------- ------------
455,505 417,487
----------- ------------

Less: Common stock in treasury (at cost), 266,851 shares at
March 31, 1995 and 16,851 shares at June 30, 1994 . (2,317) (305)
Deferred compensation . . . . . . . . . . . . . . . . . (459) (662)
Valuation allowance on securities available for sale . . (799) (816)
----------- ------------
Total stockholders' equity . . . . . . . . . . . . . . . . 451,930 415,704
----------- ------------
$ 918,300 $ 850,541
=========== ============
</TABLE>

The accompanying Notes to Condensed Consolidated Financial Statements are an
integral part of these statements.

<PAGE> 4
NOVACARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)

<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
---------------------------------
1995 1994
----------- --------------
<S> <C> <C>
Net revenues . . . . . . . . . . . . . . . . . . . . . . . . . . $ 240,898 $ 204,000
Cost of services . . . . . . . . . . . . . . . . . . . . . . . . 170,939 136,219
----------- --------------

Gross profit . . . . . . . . . . . . . . . . . . . . . . . . 69,959 67,781
Selling, general and administrative expenses . . . . . . . . . . 39,783 33,621
Provision for uncollectible accounts . . . . . . . . . . . . . . 4,812 2,722
Amortization of excess cost of net assets acquired . . . . . . . 2,908 1,914
Nonrecurring expenses . . . . . . . . . . . . . . . . . . . . . . 1,000 ---
----------- --------------

Income from operations . . . . . . . . . . . . . . . . . . . 21,456 29,524

Investment income . . . . . . . . . . . . . . . . . . . . . . . . 660 979
Interest expense . . . . . . . . . . . . . . . . . . . . . . . . (6,651) (4,303)
Minority interest . . . . . . . . . . . . . . . . . . . . . . . . (109) (93)
----------- --------------

Income before income taxes . . . . . . . . . . . . . . . . . 15,356 26,107

Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . 6,403 10,151
----------- --------------

Net income . . . . . . . . . . . . . . . . . . . . . . . . . $ 8,953 $15,956
=========== ==============

Net income per share . . . . . . . . . . . . . . . . . . . . $ .14 $ .25
=========== ==============

Weighted average number of shares outstanding . . . . . . . . . . 64,953 64,991
=========== ==============
</TABLE>

The accompanying Notes to Condensed Consolidated Financial Statements are an
integral part of these statements.

<PAGE> 5
NOVACARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)

<TABLE>
<CAPTION>
NINE MONTHS ENDED
MARCH 31,
-------------------------------
1995 1994
---------- -------------
<S> <C> <C>
Net revenues . . . . . . . . . . . . . . . . . . . . . . . . . . $ 703,909 $ 576,563
Cost of services . . . . . . . . . . . . . . . . . . . . . . . . 501,276 388,778
---------- -------------

Gross profit . . . . . . . . . . . . . . . . . . . . . . . . 202,633 187,785
Selling, general and administrative expenses . . . . . . . . . . 115,663 91,460
Provision for uncollectible accounts . . . . . . . . . . . . . . 11,725 10,033
Amortization of excess cost of net assets acquired . . . . . . . 8,413 5,094
Merger and other nonrecurring expenses . . . . . . . . . . . . . 1,000 5,754
---------- -------------

Income from operations . . . . . . . . . . . . . . . . . . . 65,832 75,444

Investment income . . . . . . . . . . . . . . . . . . . . . . . . 1,969 4,125
Interest expense . . . . . . . . . . . . . . . . . . . . . . . . (18,764) (12,506)
Minority interest . . . . . . . . . . . . . . . . . . . . . . . . (379) (353)
---------- -------------

Income before income taxes . . . . . . . . . . . . . . . . . 48,658 66,710

Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . 19,770 27,722
---------- -------------

Net income . . . . . . . . . . . . . . . . . . . . . . . . . $ 28,888 $ 38,988
========== =============

Net income per share . . . . . . . . . . . . . . . . . . . . $ .44 $ .60
========== =============

Weighted average number of shares outstanding . . . . . . . . . . 65,081 64,507
========== =============
</TABLE>

The accompanying Notes to Condensed Consolidated Financial Statements are an
integral part of these statements.

<PAGE> 6
NOVACARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
MARCH 31,
---------------------------------
1995 1994
------------ ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 28,888 $ 38,988

Adjustments to reconcile net income to net cash flows provided by
operating activities:
Depreciation and amortization . . . . . . . . . . . . . . . 22,516 14,543
Minority interest . . . . . . . . . . . . . . . . . . . . . 379 353
Deferred income taxes . . . . . . . . . . . . . . . . . . . (988) 375
Provision for uncollectible accounts . . . . . . . . . . . . 11,725 10,033
Increase in assets, net of effects from acquisitions:
Accounts receivable, net . . . . . . . . . . . . . . . . (29,558) (44,003)
Other current assets . . . . . . . . . . . . . . . . . . (1,772) (1,826)
(Decrease) increase in liabilities, net of effects from
acquisitions:
Accounts payable and accrued expenses . . . . . . . . . (15,412) 1,241
Income taxes payable . . . . . . . . . . . . . . . . . . (4,355) (2,366)
Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . . (469) (751)
------------ ------------

Net cash flows provided by operating activities . . . . . 10,954 16,587
------------ ------------

CASH FLOWS FROM INVESTING ACTIVITIES:
Marketable securities:
Purchases of marketable securities . . . . . . . . . . . . . --- (147,120)
Proceeds from sales and maturities of marketable securities 40,757 167,277
------------ ------------

Net cash proceeds from marketable securities . . . . . . 40,757 20,157
------------ ------------

Acquisitions of businesses:
Payments for business acquired, net of cash acquired . . . . (59,058) (88,351)
Additional payments for businesses acquired in prior years . (8,998) (11,293)
------------ ------------

Net cash outlay for acquisitions of businesses . . . . . (68,056) (99,644)
------------ ------------

Additions to property and equipment . . . . . . . . . . . . . . . (16,118) (11,751)
Capitalized software costs . . . . . . . . . . . . . . . . . . . (5,039) (8,645)
Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,720) (4,107)
------------ ------------

Net cash flows used in investing activities . . . . . . (50,176) (103,990)
------------ ------------

CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term debt and financing arrangements . . . . 73,503 73,728
Payment of long-term debt and financing arrangements . . . . . (42,462) (61,451)
Proceeds from common stock issued . . . . . . . . . . . . . . 2,582 2,987
Cost of repurchased common stock . . . . . . . . . . . . . . . (2,012) ---
------------ ------------

Net cash flows provided by financing activities . . . . 31,611 15,264
------------ ------------

Net decrease in cash and cash equivalents . . . . . . . . . . . . (7,611) (72,139)
Cash and cash equivalents, beginning of period . . . . . . . . . 38,024 102,324
Adjustment for pooling of interests . . . . . . . . . . . . . . . --- (4,186)
------------ ------------
Cash and cash equivalents, end of period . . . . . . . . . . . . $ 30,413 $ 25,999
============ ============
</TABLE>

The accompanying Notes to Condensed Consolidated Financial Statements are an
integral part of these statements.
4

<PAGE> 7
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1995
(In thousands, except per share data)
(Unaudited)

1. BASIS OF PRESENTATION

The accompanying condensed consolidated financial statements of
NovaCare, Inc. (the "Company") are unaudited. The balance sheet as of June
30, 1994 is condensed from the audited balance sheet of NovaCare, Inc. at
that date. These statements have been prepared in accordance with the
rules and regulations of the Securities and Exchange Commission and should
be read in conjunction with the Company's consolidated financial statements
and the notes thereto for the year ended June 30, 1994. Certain
information and footnote disclosures normally in the financial statements
prepared in accordance with generally accepted accounting principles have
been condensed or omitted pursuant to such rules and regulations. In the
opinion of Company management, the condensed consolidated financial
statements for the unaudited interim periods presented include all
adjustments (consisting of only normal recurring adjustments) necessary to
present a fair statement of the results for such interim periods.

Certain amounts in the 1994 consolidated financial statements have
been reclassified to conform with the 1995 presentation.

Operating results for the three- and nine-month periods ended March
31, 1995 are not necessarily indicative of the results that may be expected
for a full year or any portion thereof.

2. BUSINESS ACQUISITIONS

During the nine months ended March 31, 1995, the Company acquired 23
businesses which provide outpatient rehabilitation services, one business
which provides orthotic and prosthetic rehabilitation services and two
businesses which provide contract therapy services. During the nine months
ended March 31, 1994, the Company acquired a business which owned five
medical rehabilitation hospitals and five outpatient facilities. In
addition, the Company acquired 15 businesses which provide outpatient
rehabilitation services, three businesses which provide orthotic and
prosthetic services and two businesses which provide contract therapy
services. All acquisitions were accounted for as purchases and,
accordingly, the aggregate purchase price was allocated to assets and
liabilities acquired based on their fair values at the date of acquisition.

The following unaudited pro forma consolidated results of operations
of the Company give effect to each of the acquisitions as if they occurred
on July 1, 1993:

<TABLE>
<CAPTION>
For the nine months ended
March 31,
---------------------------------
1995 1994
------------ ------------
<S> <C> <C>
Net revenues . . . . . . . . . . . . . . . . . . . . . . $ 709,367 $ 679,105
Net income . . . . . . . . . . . . . . . . . . . . . . . 29,282 46,529
Net income per share . . . . . . . . . . . . . . . . . . $ .45 $ .72
</TABLE>

The above pro forma information is not necessarily indicative of the
results of operations that would have occurred had the acquisitions been
made as of July 1, 1993, or of the results which may occur in the future.

<PAGE> 8
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
MARCH 31, 1995
(In thousands, except per share data)
(Unaudited)

Information with respect to businesses acquired in purchase transactions
for the nine months ended March 31, 1995 was as follows:

<TABLE>
<S> <C>
Cash paid (net of cash acquired) . . . . . . . . . . . . $ 59,058
Notes issued . . . . . . . . . . . . . . . . . . . . . . 12,100
Other consideration . . . . . . . . . . . . . . . . . . 905
----------
72,063
Liabilities assumed . . . . . . . . . . . . . . . . . . 4,164
----------
76,227
Fair value of assets acquired . . . . . . . . . . . . . 7,548
----------
Cost in excess of fair value of net assets acquired $ 68,679
==========
</TABLE>

The results of operations of businesses acquired have been included in
the consolidated results of the Company from the effective date of each
acquisition.

Certain purchase agreements require additional payments if specific
financial targets and non-financial conditions are met. Aggregate
contingent payments in connection with these acquisitions at March 31, 1995
of approximately $5,775 in cash and 1,224 shares of common stock have not
been included in the initial determination of cost of the businesses
acquired since the amount of such contingent consideration, if any, is not
presently determinable. For the nine months ended March 31, 1995, the
Company paid $8,998 in cash and issued 914 shares of common stock in
connection with businesses acquired in prior years.

3. INCOME TAXES

The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards No. 109, Accounting for Income Taxes ("SFAS
109"). SFAS 109 is an asset and liability approach that requires the
recognition of deferred tax assets and liabilities for expected future tax
consequences of events that have been recognized in the Company's financial
statements or tax returns.

Income taxes paid during the nine-month periods ended March 31, 1995
and 1994 amounted to $26,255 and $28,480 respectively.

4. INVESTMENTS IN CASH EQUIVALENTS AND MARKETABLE SECURITIES

Investments in cash equivalents and marketable securities at March 31,
1995 and June 30, 1994 consist of professionally managed portfolios
including U.S. Treasury securities, money market funds and short- and
medium-term tax-exempt municipal bonds. As of June 30, 1994, the Company
adopted Statement of Financial Accounting Standards No. 115, Accounting for
Certain Investments in Debt and Equity Securities ("SFAS 115"). The effect
of SFAS 115 is dependent upon classification of the investment and, in
certain cases, determination as to the nature of the decline in market
value below the cost basis of an investment. Investments with maturities
of greater than one year are classified as non-current. Realized gains and
losses on the sales of securities are computed using the specific
identification method.

<PAGE> 9
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
MARCH 31, 1995
(In thousands, except per share data)
(Unaudited)

For the nine months ended March 31, 1995, the cash flows from sales
and maturities of available-for-sale and held-to-maturity securities were
as follows:

<TABLE>
<CAPTION>
GROSS REALIZED
-------------------------
CARRYING
VALUE GAINS LOSSES PROCEEDS
------------ ------- ---------- -----------
<S> <C> <C> <C> <C>
Available-for-sale
Proceeds from sales $ 14,850 $ 58 $ (151) $ 14,757
Proceeds from maturities 1,000 --- --- 1,000

Held-to-maturity
Proceeds from maturity 25,000 --- --- 25,000
------------ ------- ---------- -----------
$ 40,850 $ 58 $ (151) $ 40,757
============ ======= ========== ===========
</TABLE>

No securities were considered to be trading securities at June 30,
1994 or March 31, 1995 nor were any securities classified as trading
securities during the nine months ended March 31, 1995. In addition, there
were no sales of or transfers from securities classified as
held-to-maturity during the nine months ended March 31, 1995.

Investments in U.S. Treasury securities accounted for 48% and 56% of
the total investments at March 31, 1995 and June 30, 1994, respectively.
As of March 31, 1995, the U.S. Treasury securities collateralized the
Company's reverse repurchase agreements and cannot be liquidated for
general business purposes. Securities of no other issuer exceeded 10% of
total investments at March 31, 1995 or June 30, 1994.

5. RECEIVABLES

Accounts receivable consisted of the following:

<TABLE>
<CAPTION>
MARCH 31, June 30,
1995 1994
------------- -------------
<S> <C> <C>
Accounts receivable . . . . . . . . . . . . . . . . . . . . $ 269,227 $ 246,169
Due from Medicare . . . . . . . . . . . . . . . . . . . . . 6,585 2,289
Less: Allowance for uncollectible accounts . . . . . . . . (30,695) (17,692)
Reserve for Medicare denials and other allowances . . (9,204) (15,039)
------------- -------------
$ 235,913 $ 215,727
============= =============
</TABLE>

6. PROPERTY AND EQUIPMENT

The components of property and equipment were as follows:

<TABLE>
<CAPTION>
MARCH 31, June 30,
1995 1994
-------------- ------------
<S> <C> <C>
Land and buildings . . . . . . . . . . . . . . . . . . . . . $ 33,316 $ 32,367
Property, equipment and furniture . . . . . . . . . . . . . 83,245 68,360
Leasehold improvements . . . . . . . . . . . . . . . . . . . 13,199 11,183
-------------- ------------
129,760 111,910
Less: Accumulated depreciation and amortization . . . . . . (41,637) (30,554)
-------------- ------------
$ 88,123 $ 81,356
============== ============
</TABLE>

<PAGE> 10
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
MARCH 31, 1995
(In thousands, except per share data)
(Unaudited)

7. LONG-TERM DEBT AND FINANCING ARRANGEMENTS

Long-term debt and financing arrangements consisted of the following:

<TABLE>
<CAPTION>
MARCH 31, June 30,
1995 1994
-------------- ------------
<S> <C> <C>
Convertible subordinated debentures (5.5%), due January 2000 $ 175,000 $ 175,000
Revolving credit facility (LIBOR plus 1.125%), expiring
November 28, 1997 . . . . . . . . . . . . . . . . . . . . 132,178 69,563
Reverse repurchase agreements (6%), payable through
May 15, 1995 . . . . . . . . . . . . . . . . . . . . . . . 24,743 43,281
Subordinated promissory notes (5% to 10%), payable through
2000 . . . . . . . . . . . . . . . . . . . . . . . . . . 31,205 30,580
West Virginia commercial development revenue bonds
(9.5% to 12%), payable through 2015 . . . . . . . . . . . 17,715 17,715
Notes (7% to 12%), payable through November 2000 . . . . . . 1,098 3,736
Capitalized lease obligations, payable through 2000 . . . . 5,838 4,680
Other obligations (8% to 10%), payable through September 2016 --- 47
-------------- ------------
387,777 344,602
Less: Current portion . . . . . . . . . . . . . . . . . . . 42,115 61,518
-------------- ------------
$ 345,662 $ 283,084
============== ============
</TABLE>

In November 1994, the Company amended its revolving credit facility
agreement increasing the amount available to $175,000. The funds have been
and will be used to refinance other indebtedness, as well as for general
corporate purposes, including acquisitions. At March 31, 1995, the
interest rate on amounts borrowed on the revolving credit facility was
7.625%. The amended revolving credit facility agreement requires the
maintenance of minimum working capital and net worth amounts, as well as
certain financial ratios.

During the three months ended March 31, 1995, the Company entered into
reverse repurchase agreements with primary government dealers. In the
reverse repurchase agreements, the Company sold U.S. government securities
subject to an agreement to repurchase those securities at a mutually agreed
upon date and price, which approximates market. These transactions were
accounted for as loans to the Company collateralized by the underlying
securities which are held by the primary government dealers. The
agreements required the Company to maintain investments in U.S. government
securities with market values, including accrued interest, of at least 102%
of the dollar amount of the securities sold as collateral. The repurchase
obligations outstanding on March 31, 1995 matured or will mature April 4
and May 15, 1995.

Interest paid on debt for the nine months ended March 31, 1995 and
1994 amounted to $18,821 and $13,725, respectively.

8. CONTINGENCIES

The Company is subject to legal proceedings and claims which arise in
the ordinary course of its business. In the opinion of management, the
amount of ultimate liability, if any, with respect to these actions will
not have a materially adverse affect on the financial position or results
of operations of the Company.

<PAGE> 11
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
MARCH 31, 1995
(In thousands, except per share data)
(Unaudited)

9. SALE OF REHABILITATION HOSPITALS

On February 6, 1995, the Company announced the execution of a
definitive agreement to sell its rehabilitation hospitals to HEALTHSOUTH
Corporation. Under the terms of the agreement, HEALTHSOUTH will pay the
Company total consideration of approximately $235 million, including the
payment of approximately $215 million of cash and the assumption of
approximately $20 million of debt. The transaction is expected to be
completed in the fourth quarter of fiscal 1995 and will result in a gain.
The net proceeds from the sale will be i) used to repay amounts borrowed
under the revolving credit facility agreement, ii) invested in short-term
investments, and iii) used for general corporate purposes.

<PAGE> 12
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
(In thousands)

THE COMPANY

NovaCare, Inc. (the "Company") is a leading national provider of medical
rehabilitation services. These services include providing rehabilitation
therapy and subacute services on a contract basis to health care institutions,
primarily nursing facilities; providing outpatient rehabilitation services
through contracts with healthcare institutions and a national network of
clinics; delivering orthotic and prosthetic ("O&P") rehabilitation services
through a national network of patient care centers; and operating acute medical
rehabilitation hospitals.

NovaCare provides multidisciplinary medical rehabilitation services and
management services on a contract basis to health care institutions, primarily
nursing homes, including those operated by most of the nation's largest chains.
As of March 31, 1995, NovaCare provided these services through 5,267 contracts
in 2,090 facilities located in 40 states. Orthotic and prosthetic
rehabilitation services are provided by orthotists and prosthetists, referred
to as practitioners, through 130 patient care centers in 26 states. Orthotic
rehabilitation is the fitting and fabrication of custom-made braces and support
devices for treatment of musculoskeletal conditions. Prosthetic
rehabilitation is the fitting and fabrication of custom-made artificial limbs.
NovaCare provides outpatient physical and occupational therapy services at 365
clinics in 29 states. These services are provided by licensed physical and
occupational therapists who develop individual treatment plans involving
manual, aquatic and electrical modalities and controlled exercise strengthening
programs to rehabilitate patients with musculoskeletal injuries or after
surgery. NovaCare's 11 rehabilitation hospitals provide acute rehabilitation
care on a multidisciplinary, physician-directed basis to severely disabled
patients. Five community re-entry programs treat post-acute brain injured
patients in community-based settings. NovaCare manages 48 subacute programs for
nursing facilities on a contract basis and operates subacute units in five of
its medical rehabilitation hospitals.

During February 1995, the Company announced the execution of a definitive
agreement to sell the 11 rehabilitation hospitals and five re-entry programs.
The closing of this agreement is expected during the fourth quarter of fiscal
1995.

BUSINESS STRATEGY

NovaCare is a provider of rehabilitative care and management services to
the health care industry. NovaCare's objective is to be the rehabilitation
industry leader in lower-cost, post-acute settings, establish a meaningful
presence in selected local markets and obtain regional and national contracts
with employers, managed care organizations, and other insurers. In pursuing
this strategy, NovaCare seeks to maintain flexibility in the constantly
changing health care industry by limiting its investment in fixed assets.

NovaCare's strategy is designed to capitalize upon (1) growing demand for
rehabilitation services particularly in lower-cost, post-acute settings, (2)
highly fragmented competition and (3) the lack of professional management,
information systems and access to capital, which is characteristic of much of
the industry.

During the third quarter, the Company reached an agreement with Beverly
Health and Rehabilitation ("Beverly") concerning Beverly's transition over the
next two years from contract rehabilitation services to employed therapist
teams. Beverly facilities covered under the agreement represent approximately
$65 million of the Company's annual net revenues, or seven percent of
annualized third quarter net revenues.

<PAGE> 13
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - CONTINUED
(In thousands)

There has been much discussion about nursing home customers taking therapy
services "in-house". The Company believes these concerns are exaggerated. A
recent national survey of nursing homes by LEK/Alcar, an international
strategic consulting firm, reported that 71% of nursing home beds will continue
to use contract therapy services into the foreseeable future. These are
primarily regional and local chains, independents and not-for-profit facilities
and represent a $2.9 billion market opportunity. In-house activity is
primarily among national chains (like Beverly), which operate only 16% of
nursing home beds. Because the Company derives 55% of its business from
national chains, the Company will be affected by this trend in the short term.
The Company's strategy is to target larger facilities owned by the regional and
local chains, independents and not-for-profits. This strategy has already had
impact. In March, the Company booked new contracts representing $19 million of
annualized revenues.

CONTRACT THERAPY SERVICES REIMBURSEMENT

The Health Care Financing Administration ("HCFA"), the division of the U.S.
Department of Health and Human Services which administers Medicare programs, is
in the process of reviewing existing reimbursement rates for contract therapy
services in the nursing facility setting and is expected to propose guidelines
for speech-language pathology services and occupational therapy in the near
future with implementation possible as early as 1996. Management believes
that, if speech-language pathology services and occupational therapy guidelines
are established, HCFA will increase the physical therapy salary-equivalency
rate in consideration of today's substantially higher salaries and service
standards. Because the nature and magnitude of these changes are not certain
at this time, there are no assurances with respect to the impact these changes
may have on NovaCare. Steps are being taken by management to mitigate the
economic impact of these changes.

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED
MARCH 31, 1995 AND 1994

NET REVENUES

For the three months ended March 31, 1995 compared with the year earlier
period, net revenue increased from $204,000 to $240,898, or 18%. For the same
period, exclusive of net revenue related to acquisitions, net revenue increased
from $203,862 to $213,389, or 5%. The principal reasons for the increase were
a 9% increase in net revenues per nursing home contract, and an increase in
rehabilitation hospital average occupancy rates from 67% to 72%. On a
same-store basis, net revenue relating to O&P clinics increased 15%. Net
revenue relating to rehabilitation outpatient clinics was the result of
acquisitions. Generally, rate increases for all rehabilitation services were
below that of inflation.

GROSS PROFIT

Gross profit, defined as net revenues less cost of services (primarily
salaries, benefits, and travel expenses for the Company's medical professional
staff and supervisory personnel, manufactured materials and hospital facility
costs), increased during the three months ended March 31, 1995 to $69,959 as
compared to $67,781 for the same period a year ago. Gross profit as a
percentage of revenues decreased to 29% from 33% as a result of decreased
productivity in speech language pathology and occupational therapy and higher
compensation and benefit costs, Generally, salary increases for rehabilitation
therapists increased at a rate in excess of inflation. These increases
resulted from the overall national shortage of rehabilitation therapists. This
attribute of the supply of rehabilitation therapists is likely to continue.

These factors were offset by higher average daily census, increased revenue
per patient day, decreased costs in the Company's hospitals and an increased
percentage of revenues attributable to the higher margin outpatient
rehabilitation business.

<PAGE> 14
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - CONTINUED
(In thousands)

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

Selling, general and administrative expenses as a percentage of net
revenues were 17% and 16% for the three months ended March 31, 1995 and 1994,
respectively. The absolute dollar increase of $6,162, or 18%, was due
principally to increased administrative staff in support of the Company's
revenue growth, expenses of businesses acquired, and marketing and sales
programs.

PROVISION FOR UNCOLLECTIBLE ACCOUNTS

The provision for uncollectible accounts as a percentage of net revenues
for the three months ended March 31, 1995 and 1994 was 2% and 1%, respectively.
The increase of the provision as a percentage of net revenues was due
principally to the Company's revenue growth.

AMORTIZATION OF EXCESS COST OF NET ASSETS ACQUIRED

In the third quarter of fiscal 1995, amortization of excess cost of net
assets acquired increased $994, or 52%, versus the corresponding period of the
prior year as a result of business acquired after the third quarter of fiscal
1994.

NONRECURRING EXPENSES

Nonrecurring expenses, represent expenses associated with the settlement
and legal costs, net of insurance, of a shareholder lawsuit. As of March 31,
1995, approximately $500 of this amount remains to be paid. These costs are
expected to be paid within a year.

INCOME FROM OPERATIONS

As a result of the foregoing, operating margins decreased to 9% of net
revenues in the third quarter of fiscal 1995 from 14% in the third quarter of
the prior year.

INVESTMENT INCOME

Investment income consists of interest, dividends and net gains on the
sale of the Company's portfolio of short- and medium-term investments.
Investment income decreased $319, or 33%, in the third quarter of fiscal 1995
versus the same period last year due principally to lower amounts invested, as
a result of funds expended for acquisitions in the previous quarters.

INTEREST EXPENSE

Interest expense related primarily to interest incurred on the
Company's convertible subordinated debentures, the revolving credit facility,
and business acquisition financing. Interest expense for the three months
ended March 31, 1995 increased $2,348, or 55%, compared to the same period last
year. The increase was due principally to debt incurred and assumed in
connection with business acquisitions and investments in information systems.

INCOME TAXES

The effective income tax rate of the Company was 42% for the third
quarter of fiscal 1995 compared to 39% for the same period in fiscal 1994. The
increase in the Company's effective rate was due principally to an increase in
non-deductible amortization of excess cost of net assets acquired and a
decrease in non-taxable interest income.

<PAGE> 15
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - CONTINUED
(In thousands)

The Company's third quarter fiscal 1995 and 1994 effective income tax rates
differed from the federal statutory tax rate primarily due to the
non-deductible amortization of excess cost of net assets acquired, offset
somewhat by non-taxable interest income.

NET INCOME

As a result of the foregoing, net income decreased to $8,953 in the third
quarter of fiscal 1995 from $15,956 in the third quarter of fiscal 1994.

RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED
MARCH 31, 1995 AND 1994

NET REVENUES

For the nine months ended March 31, 1995 compared with the year earlier
period, net revenue increased from $576,563 to $703,909, or 22%. For the same
period exclusive of net revenue related to acquisitions, net revenue increased
from $575,595 to $615,591, or 7%. The principal reasons for the increase were
a 8% increase in net revenues per nursing home contract, and an increase in
rehabilitation hospital average occupancy rates from 64% to 68%. On a
same-store basis, net revenue relating to O&P clinics increased by 7%. Net
revenue relating to rehabilitation outpatient clinics was the result of
acquisitions. Generally, rate increases for all rehabilitation services were
below that of inflation.

GROSS PROFIT

Gross profit, defined as net revenues less cost of services (primarily
salaries, benefits, and travel expenses for the Company's medical professional
staff and supervisory personnel, manufactured materials and hospital facility
costs), increased during the nine months ended March 31, 1995 to $202,633 as
compared to $187,785 for the same period a year ago. Gross profit as a
percentage of revenues decreased to 29% from 33% as a result of a decrease in
therapist productivity in speech language pathology and occupational therapy
and an increased use of independent contractors in the contract therapy
business, and increases in compensation and benefits. Generally, salary
increases for rehabilitation therapists increased at a rate in excess of
inflation. These increases resulted from the overall national shortage of
rehabilitation therapists. This attribute of the supply of rehabilitation
therapists is likely to continue.

These factors were offset by higher average daily census, increased revenue
per patient day, decreased costs in the Company's hospitals, and an increased
percentage of revenues attributable to the higher margin outpatient
rehabilitation business.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

Selling, general and administrative expenses as a percentage of net
revenues was 16% for the nine months ended March 31, 1995 and 1994. The
absolute dollar increase of $24,203, or 26%, was due principally to increased
administrative staff in support of the Company's revenue growth, marketing and
sales programs, expenses incurred while implementing a new service delivery
model in the contract therapy business and expenses of businesses acquired.

AMORTIZATION OF EXCESS COST OF NET ASSETS ACQUIRED

In the first nine months of fiscal 1995, amortization of excess cost of
net assets acquired increased $3,319, or 65%, versus the corresponding period
of the prior year as a result of businesses acquired after the third quarter of
fiscal 1994.

<PAGE> 16
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - CONTINUED
(In thousands)

PROVISION FOR UNCOLLECTIBLE ACCOUNTS

The provision for uncollectible accounts as a percentage of net
revenues for the nine months ended March 31, 1995 and 1994 was 2%,
respectively. The absolute dollar increase of $1,692, or 17%, was due
principally to the Company's revenue growth.

MERGER AND OTHER NONRECURRING EXPENSES

Merger and other nonrecurring expenses, which were 1% of net revenues for
the nine months ended March 31, 1994, were associated with the merger with
RehabClinics, Inc. in February 1994. Cash charges of approximately $5,084
related primarily to legal fees, investment advisory fees, and other
transaction fees. Certain non-cash charges of approximately $670 were recorded
to write off deferred financing fees incurred in connection with a debt
issuance prior to the merger. As of March 31, 1995, all funds related to the
1994 merger expense were expended.

INCOME FROM OPERATIONS

As a result of the foregoing, operating margins decreased to 9% of net
revenues for the first nine months of fiscal 1995 from 13% in the first nine
months of the prior year.

INVESTMENT INCOME

Investment income consists of interest, dividends and net gains on the
sale of the Company's portfolio of short- and medium-term investments.
Investment income decreased $2,156, or 52%, in the first nine months of fiscal
1995 versus the same period last year due principally to lower amounts
invested, as a result of funds expended for acquisitions.

INTEREST EXPENSE

Interest expense related primarily to interest incurred on the Company's
convertible subordinated debentures, the revolving credit facility and business
acquisition financing. Interest expense for the nine months ended March 31,
1995 increased $6,258, or 50%, compared to the same period last year. The
increase was due principally to debt incurred and assumed in connection with
business acquisitions and investments in information systems.

INCOME TAXES

The effective income tax rate of the Company was 41% for the nine-month
period ended March 31, 1995 compared to 42% for the same period in fiscal 1994.
The decrease in the Company's effective rate was due principally to
non-deductible merger expenses incurred in the second quarter of fiscal 1994
which were not incurred in fiscal 1995. The positive effect of this was
partially offset by an increase in non-deductible amortization of excess cost
of net assets acquired and a decrease in non-taxable interest income.

The Company's effective income tax rates for the nine months ended March
31, 1995 and 1994 differed from the federal statutory tax rate primarily due to
the amortization of excess cost of net assets acquired and nonrecurring merger
expenses in fiscal 1995 and 1994, which are not fully deductible for tax
purposes, offset somewhat by non-taxable interest income.

<PAGE> 17
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - CONTINUED
(In thousands)

NET INCOME

As a result of the foregoing, net income decreased to $28,888 in the
first nine months of fiscal 1995 from $38,988 in the first nine months of
fiscal 1994.

LIQUIDITY AND CAPITAL RESOURCES

Net cash flows provided by operating activities were $10,954 and $16,587
for the nine months ended March 31, 1995 and 1994, respectively. The principal
reasons for the decrease were the decreases in net income and accounts payable
and accrued expenses offset by an increase in depreciation and amortization,
which are non-cash charges, and a lower increase in accounts receivable as
compared with the prior year. The decreases in accounts payable were
principally due to the timing of payments. The increase in depreciation is a
result of additional property and equipment and capitalized software acquired
since the third quarter of 1994. Amortization has increased as a result of
companies acquired since the third quarter of fiscal 1994. The lower increase
in accounts receivable is due to a decreased revenue growth for the nine months
ended March 31, 1995, as compared with the nine months ended March 31, 1994.

Cash, cash equivalents and marketable securities decreased to $78,191 from
$126,446 at June 30, 1994. This decrease resulted principally from cash
expenditures for business acquisitions, additional investments in information
systems, and property and equipment additions, offset somewhat by borrowings
under the revolving credit facility. In August 1994, the Company's Board of
Directors authorized the repurchase in the open market of up to 1,000 shares of
the Company's issued and outstanding common stock. During the three months
ended March 31, 1995, the Company repurchased approximately 250 shares of
common stock in the open market. These shares have and will be used to satisfy
certain stock option and employee 401(k) obligations.

The Company's business strategy comprehends expansion of the Company's
activities through internal growth and selected acquisitions. The funds
required to support these programs are expected to be provided by existing
working capital and cash flows from operations, supplemented by financing in
the form of revolving credit facilities, private placements, leasing
arrangements or a combination thereof. In May 1994, the Company entered into a
$115,000 revolving credit facility with a syndicate of banks which was used to
refinance certain bank debt, as well as for general corporate purposes,
including acquisitions. In November 1994, the facility was amended and the
amount available under the facility was increased to $175,000. The amended
revolving credit facility agreement requires the maintenance of minimum working
capital and net worth amounts, as well as certain financial ratios.

The Company's current ratios and its working capital are set forth for the
dates indicated:

<TABLE>
<CAPTION>
MARCH 31, June 30,
1995 1994
------------- -------------
<S> <C> <C>
Current ratio.............................. 3.14:1 2.38:1
Working capital............................ $ 230,648 $ 194,324
</TABLE>

The increase in the current ratio at March 31, 1995 from June 30, 1994 is
attributable principally to a decrease in the current portion of long-term debt
resulting from the pay down of a portion of the short-term reverse repurchase
agreements held at June 30, 1994 offset by a decrease in cash and marketable
securities. The decrease in cash and marketable securities resulted from the
sale and maturity of certain marketable securities for payment of acquisitions
and reduction of debt. Working capital increased at March 31, 1995 from June
30, 1994 due principally to a decrease in the current portion of long-term debt
and accounts payable and an increase in accounts receivable, as a result of
business growth, offset somewhat by a decrease in cash and marketable
securities. The Company's investment strategy is to invest excess cash in A,
A1 or P1 rated or better fixed income governmental and corporate securities,
U.S. government securities (including guaranteed and agency issues), bankers'
acceptances and repurchase agreements.

<PAGE> 18
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - CONTINUED
(In thousands)

At March 31, 1995, debt as a percentage of total capitalization (i.e.
total debt and stockholders' equity) was 46% compared with 45% at June 30,
1994. The increase was due to higher outstanding indebtedness resulting from
funds borrowed for acquisitions, as well as indebtedness assumed in connection
with acquisitions. The Company believes that its cash and cash equivalents,
marketable securities and cash flows from operations will be sufficient to meet
its planned working capital and capital investment needs in fiscal 1995.
Additionally, the Company believes it has the capacity to obtain additional
financing sufficient to meet The Company's acquisition-related investment needs
beyond those forecasted for the near term.

As of June 30, 1994, the Company adopted Statement of Financial Accounting
Standards No. 115, Accounting for Certain Investments in Debt and Equity
Securities ("SFAS 115"), which requires investment securities to be classified
as held to maturity, available for sale, or trading. The adoption of SFAS 115
had no effect on the Company's results of operations. At March 31, 1995, a
valuation allowance in stockholders' equity of $799 was required to reflect
unrealized holding losses on municipal bonds classified as available for sale.
Unrealized holding losses on the municipal bond portfolio resulted from
increases in interest rates during calendar year 1994 and do not reflect an
impairment of the debtor's ability to repay the obligation.

SALE OF REHABILITATION HOSPITALS

On February 6, 1995, the Company announced the execution of a definitive
agreement to sell its rehabilitation hospitals to HEALTHSOUTH Corporation.
Under the terms of the agreement, HEALTHSOUTH will pay the Company total
consideration of approximately $235 million, including the payment of
approximately $215 million of cash and the assumption of approximately $20
million of debt. The transaction is expected to be completed in the fourth
quarter of fiscal 1995 and will result in a gain. The net proceeds from the
sale will be i) used to repay amounts borrowed under the revolving credit
facility agreement, ii) invested in short-term investments, and iii) used for
general corporate purposes.

<PAGE> 19
NOVACARE, INC. AND SUBSIDIARIES

PART II - OTHER INFORMATION

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

<TABLE>
<CAPTION>
(A) EXHIBIT
NUMBER EXHIBIT DESCRIPTION PAGE NUMBER
------ ------------------- -----------
<S> <C>
2 Stock Purchase Agreement dated as of February 3,
1995 by and among NovaCare, Inc., NC Resources, Inc.
and HEALTHSOUTH Corporation.

4 Rights Agreement dated as of March 9, 1995 by and
between NovaCare, Inc. and American Stock Transfer &
Trust Company, as Rights Agent (incorporated by
reference to Exhibit 99(a) to the Company's Current
Report on Form 8-K dated March 14, 1995).

10(a) Employment Agreement dated as of July 1, 1994
between the Company and John H. Foster.

10(b) Amendment dated February 2, 1995 between the Company
and John H. Foster to Employment Agreement dated as
of July 1, 1994 between the Company and John H.
Foster.

27 Financial Data Schedule
</TABLE>

(B) During the quarter ended March 31, 1995, the
Company filed a Current Report on Form 8-K
dated February 17, 1995, with respect to Item
5, "Other Events" regarding the execution of an
agreement for the sale of the Company's
rehabilitation hospitals, and a Current Report on
Form 8-K dated March 14, 1995 with respect to
Item 5, "Other Events" regarding the Company's
implementation of a stockholder share purchase
rights plan.

<PAGE> 20
NOVACARE, INC. AND SUBSIDIARIES

SIGNATURES

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THE
REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE
UNDERSIGNED THEREUNTO DULY AUTHORIZED.

NOVACARE, INC.
-----------------------------------
(REGISTRANT)

MAY 15, 1995 BY/s/ WILLIAM J. MCGINNIS
- ------------ -----------------------------------

WILLIAM J. MCGINNIS
VICE PRESIDENT
AND CHIEF ACCOUNTING OFFICER

<PAGE> 21
EXHIBIT INDEX

<TABLE>
<CAPTION>
(A) EXHIBIT
NUMBER EXHIBIT DESCRIPTION
------ -------------------
<S> <C>
2 Stock Purchase Agreement dated as of February 3,
1995 by and among NovaCare, Inc., NC Resources, Inc.
and HEALTHSOUTH Corporation.

10(a) Employment Agreement dated as of July 1, 1994
between the Company and John H. Foster.

10(b) Amendment dated February 2, 1995 between the Company
and John H. Foster to Employment Agreement dated as
of July 1, 1994 between the Company and John H.
Foster.

27 Financial Data Schedule
</TABLE>

<PAGE> 1
EXHIBIT 2

STOCK PURCHASE AGREEMENT

******

NOVACARE, INC.,

NC RESOURCES, INC.

AND

HEALTHSOUTH CORPORATION

DATED: FEBRUARY 3, 1995
<PAGE> 2
STOCK PURCHASE AGREEMENT

TABLE OF CONTENTS

<TABLE>
<S> <C> <C>
ARTICLE 1
DEFINITIONS

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Section 1.1 Certain Defined Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Section 1.2 Index of Other Defined Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

ARTICLE 2
BASIC TRANSACTIONS

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Section 2.1 Conveyance of RSC Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Section 2.2 Purchase Price; Post Closing Adjustment . . . . . . . . . . . . . . . . . . . . . . . . . 4
Section 2.3 Excluded Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Section 2.4 Employee Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Section 2.5 Use of Names and Manuals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Section 2.6 Procedure for Consents or Default . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Section 2.7 Closing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Section 2.8 Resolution of Cooperative Arrangements . . . . . . . . . . . . . . . . . . . . . . . . . 8
Section 2.9 Guaranty by NovaCare . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

ARTICLE 3
REPRESENTATIONS AND WARRANTIES OF SELLER

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Section 3.1 Organization and Corporate Power . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Section 3.2 RSC and Subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Section 3.3 Authority Relative to this Agreement . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Section 3.4 Absence of Breach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Section 3.5 Private Party Consents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Section 3.6 Governmental Consents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Section 3.7 Brokers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Section 3.8 Title to Personal Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Section 3.9 Contracts and Leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Section 3.10 Licenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Section 3.11 Employee Relations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Section 3.12 Employee Plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Section 3.13 Litigation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Section 3.14 Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Section 3.15 Hazardous Substances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Section 3.16 Financial Information and Related Matters . . . . . . . . . . . . . . . . . . . . . . . 13
Section 3.17 Changes Since Balance Sheet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Section 3.18 Compliance with Laws . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Section 3.19 Lists of Other Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
</TABLE>

(i)
<PAGE> 3
<TABLE>
<S> <C> <C>
ARTICLE 4
REPRESENTATIONS AND WARRANTIES OF BUYER

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Section 4.1 Organization and Corporate Power . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Section 4.2 Authority Relative to this Agreement . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Section 4.3 Absence of Breach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Section 4.4 Private Party Consents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Section 4.5 Governmental Consents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Section 4.6 Brokers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Section 4.7 Qualified for Licenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Section 4.8 Financial Ability to Perform . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Section 4.9 No Assurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Section 4.10 Disposal of Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

ARTICLE 5
COVENANTS OF EACH PARTY

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Section 5.1 Efforts to Consummate Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Section 5.2 Cooperation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Section 5.3 Further Assistance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
Section 5.4 Cooperation Respecting Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
Section 5.5 Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
Section 5.6 Announcements; Confidentiality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Section 5.7 Cost Reports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

ARTICLE 6
ADDITIONAL COVENANTS OF SELLER

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
Section 6.1 Conduct Pending Closing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
Section 6.2 Access and Information; Environmental Survey; Remediation or Adjustment . . . . . . . . . 23
Section 6.3 Updating . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
Section 6.4 No Solicitation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
Section 6.5 Filing of Cost Reports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

ARTICLE 7
ADDITIONAL COVENANTS OF BUYER

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
Section 7.1 Waiver of Bulk Sales Law Compliance . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
Section 7.2 Cost Reports and Audit Contests . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
Section 7.3 Letters of Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
</TABLE>

(ii)
<PAGE> 4
<TABLE>

<S> <C> <C>
ARTICLE 8
BUYER'S CONDITIONS TO CLOSING

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Section 8.1 Performance of Agreement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Section 8.2 Accuracy of Representations and Warranties . . . . . . . . . . . . . . . . . . . . . . . 25
Section 8.3 Officer's Certificate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Section 8.4 Consents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Section 8.5 Absence of Injunctions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Section 8.6 Opinion of Counsel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Section 8.7 Receipt of Other Documents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Section 8.8 Certificates of Need . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

ARTICLE 9
SELLER'S CONDITIONS TO CLOSING

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
Section 9.1 Performance of Agreement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
Section 9.2 Accuracy of Representations and Warranties . . . . . . . . . . . . . . . . . . . . . . . 27
Section 9.3 Officer's Certificate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
Section 9.4 Consents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
Section 9.5 Absence of Injunctions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
Section 9.6 Opinion of Counsel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
Section 9.7 Receipt of Other Documents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

ARTICLE 10
TERMINATION

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
Section 10.1 Termination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
Section 10.2 Effect of Termination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29

ARTICLE 11
SURVIVAL AND REMEDIES; INDEMNIFICATION

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
Section 11.1 Survival . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
Section 11.2 Exclusive Remedy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
Section 11.3 Indemnity by Seller . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
Section 11.4 Indemnity by Buyer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
Section 11.5 Further Qualifications Respecting Indemnification . . . . . . . . . . . . . . . . . . . 31
Section 11.6 Procedures Respecting Third Party Claims . . . . . . . . . . . . . . . . . . . . . . . . 32
</TABLE>

(iii)
<PAGE> 5
ARTICLE 12
GENERAL PROVISIONS

<TABLE>
<S> <C> <C>
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
Section 12.1 Notices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
Section 12.2 Attorneys' Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
Section 12.3 Successors and Assigns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
Section 12.4 Counterparts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
Section 12.5 Captions and Paragraph Headings . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
Section 12.6 Entirety of Agreement; Amendments . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
Section 12.7 Construction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
Section 12.8 Waiver . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
Section 12.9 Governing Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
Section 12.10 Severability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
Section 12.11 Consents Not Unreasonably Withheld . . . . . . . . . . . . . . . . . . . . . . . . . . 35
Section 12.12 Time Is of the Essence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
</TABLE>

(iv)
<PAGE> 6
LIST OF SCHEDULES

<TABLE>
<S> <C>
A-1 Subsidiaries and Their
Respective States of Incorporation and
Qualification

A-2 Facilities

1.1-1 Leased Real Property

1.1-2 Other Contracts

1.1-3 Owned Real Property

1.1-5 Transferred Business Names

2.3 Excluded Assets

2.4 Employee Pension Benefit Plans

3.7 Brokers

3.13 Litigation

3.16(a) EBITDA Statements

3.16(b) Balance Sheet

3.19(a) Depreciation Schedule

3.19(b) Personal Property Leases

3.19(c) Insurance

3.19(d) Employee Benefit Arrangements

3.19(f) Material Licenses

7.3 Bonds, Letters of Credit, etc.
</TABLE>

(v)
<PAGE> 7
STOCK PURCHASE AGREEMENT

STOCK PURCHASE AGREEMENT, made and entered into as of the 3d day of
February, 1995, by and among NOVACARE, INC., a Delaware corporation
("NovaCare"), NC RESOURCES, INC., a Delaware corporation ("Seller"), and
HEALTHSOUTH CORPORATION, a Delaware corporation ("Buyer").

W I T N E S S E T H :

WHEREAS, Seller owns all of the issued and outstanding capital stock
of Rehab Systems Company, a Delaware corporation ("RSC");

WHEREAS, through subsidiary corporations identified on Schedule A-1
hereto (each, a "Subsidiary", and collectively, the "Subsidiaries"), RSC
engages in the business of delivering rehabilitative health care services to
the public through 11 rehabilitation hospitals, five community re-entry
centers, five sub-acute units and two satellite outpatient facilities, all of
which are identified on Schedule A-2 (the "Facilities");

WHEREAS, Buyer desires to purchase from Seller, and Seller desires to
sell to Buyer, all of the issued and outstanding shares of capital stock of RSC
(the "RSC Shares"), such transaction being referred to herein as the
"Transaction"; and

WHEREAS, NovaCare is the ultimate parent of Seller and is willing to
guarantee the obligations of Seller hereunder.

NOW, THEREFORE, in consideration of the premises and the mutual
promises and covenants contained herein, and for other good and valuable
consideration, the receipt and sufficiency of which are hereby acknowledge, the
parties hereto to hereby agree as follows:

ARTICLE 1
DEFINITIONS

Section 1.1 Certain Defined Terms. For purposes of this Agreement,
the following terms shall have the following meanings:

"Affiliate" of a specified person shall mean any corporation,
partnership, sole proprietorship or other person or entity which directly or
indirectly through one or more intermediaries controls, is controlled by or is
under common control with the person specified. The term "control" means the
possession, direct or indirect, of the power to direct or cause the direction
of the management and policies of a person or entity.

"Code" shall mean the Internal Revenue Code of 1986, as
amended.

"Cost Report" shall mean the cost report required to be filed,
as of the end of a provider cost year or for any other required period, with
cost-based Payors with respect to cost reimbursement.
<PAGE> 8
"Cost Report Settlements" shall mean all right, title and
interest of RSC or any Subsidiary in assets resulting from the finalization
with Payors of amounts due with respect to Cost Reports.

"Equipment" means fixed machinery and equipment, other
fixtures and fittings, movable plant, machinery, equipment and furniture,
trucks, tractors, trailers, and other vehicles, tools and other similar items
of tangible personal property (i) that are not consumed, disposed of or held
for sale or as Inventory in the ordinary course of business, and (ii) that are
owned or leased by or consigned to RSC or any Subsidiary as of the closing.

"Inventory" means all of RSC's or any Subsidiary right, title
and interest in and to inventories and supplies, drugs, food, janitorial and
office supplies, maintenance and shop supplies, and other similar items of
tangible personal property intended to be consumed, disposed of or sold, in the
ordinary course of business that are owned by or consigned to RSC or any
Subsidiary as of the Closing.

"Knowledge" of a party shall mean the collective knowledge of
the persons who serve as of the date of this Agreement as the duly elected
officers of such party.

"Laws" shall mean all statutes, rules, regulations,
ordinances, orders, codes, permits, licenses and agreements with or of federal,
state, local and foreign governmental and regulatory authorities and any order,
writ, injunction or decree issued by any court, arbitrator or governmental
agency or in connection with any judicial, administrative or other non-judicial
proceeding (including, without limitation, arbitration or reference).

"Leased Real Property" shall mean the land, Facilities and
real property improvements (whether owned or leased) which are held by RSC or
any Subsidiary pursuant to the Real Property Leases and which are identified in
Schedule 1.1-1, together with all construction work-in-progress in respect
thereof and rights, privileges and easements appurtenant thereto.

"Licenses" shall mean certificates of need, accreditations,
registrations, licenses, permits and other consents or approvals of
governmental agencies or accreditation organizations.

"Other Contracts" shall mean all contracts and agreements to
which RSC or any Subsidiary is a party as of the Closing, other than Real
Property Leases, including, but not limited to the contracts identified on
Schedule 1.1-2, which contains a list of the following categories of Other
Contracts: constructions contracts relating to construction work-in-progress at
a Facility; equipment leases (whether operating or capitalized leases),
installment purchase contracts where the annualized lease or installment
payments exceed $25,000; contracts or arrangements binding on a Subsidiary or a
Facility which contain any covenant not to compete or otherwise significantly
restrict the nature of the business activities in which such Subsidiary or
Facility may engage; employment contracts, if any, between RSC, any Subsidiary
or any Facility and any person providing services for such Facility; collective
bargaining agreements, if any; Medicare and Medicaid provider numbers and
provider agreements, and provider agreements with other Payors; and any other
contracts pursuant to which RSC or any Subsidiary paid or received over $25,000
during its last fiscal year; provided, however, that Schedule 1.1-2 need not
list an Other Contract if all material obligations of RSC and/or the Subsidiary
thereunder have been, or prior to the Closing will be, completed or RSC, or RSC
or the Subsidiary is entitled, or has or by the Closing will have exercised a
right, to terminate the contract without penalty on 90 days' notice or less.

2
<PAGE> 9
"Owned Real Property" shall mean the real property owned in
fee by RSC or any Subsidiary that is identified on Schedule 1.1-3, together
with the Facilities located thereon, construction work-in-progress, and all
other buildings and improvements thereon, and all rights, privileges, permits
and easements appurtenant thereto.

"Payor" shall mean Medicare, Medicaid, CHAMPUS and Medically
Indigent Assistance programs, Blue Cross, Blue Shield or any other third party
payor (including an insurance company), or any health care provider (such as a
health maintenance organization, preferred provider organization, peer review
organization, or any other managed care program).

"Prepayments" shall mean advance payments, prepayments,
prepaid expenses, deposits and the like made by RSC or any Subsidiary in the
ordinary course of business prior to the Closing, which exist as of the Closing
and with respect to which RSC or any Subsidiary will receive the benefit after
the Closing, and other items recorded as prepaid expenses by RSC and the
Subsidiaries.

"Real Property Leases" shall mean all leases pursuant to which
RSC or any Subsidiary holds a leasehold interest in land, Facilities and/or
real property improvements, all of which are identified on Schedule 1.1-4.

"Receivables" shall mean all of RSC's or any Subsidiary's
right, title and interest as of the Closing in and to accounts receivable
recorded by RSC or such Subsidiary as an account receivable from Payors,
patients and other third parties, including, but not limited to, Cost Report
Settlements.

"Taxes" shall mean (i) all federal, state, county and local
sales, use, property, payroll, recordation and transfer taxes, (ii) all state,
county and local taxes, levies, fees, assessments or surcharges (however
designated, including privilege taxes, room or bed taxes and user fees) which
are based on the gross receipts, net operating revenues or patient days of a
Facility for a period ending on, before or including the Closing Date (as
defined in Section 2.7) or a formula taking any one of the foregoing into
account, and (iii) any interest, penalties and additions to tax attributable to
any of the foregoing.

"Transferred Business Names" means all right, title and
interest of RSC or any Subsidiary in and to the business names set forth in
Schedule 1.1-5.

Section 1.2 Index of Other Defined Terms. In addition to those terms
defined above, the following terms shall have the respective meanings given
thereto in the sections indicated below:

<TABLE>
<CAPTION>
DEFINED TERM SECTION
------------ -------
<S> <C>
Balance Sheet 3.16(b)
Buyer Preamble
Charter Documents 3.4
Claim Notice 11.6
Closing 2.7
Closing Balance Sheet 2.2(b)
Closing Date 2.7
Consultant 6.2(b)
Current Cost Reports 5.7(a)
EBITDA 3.16(a)
</TABLE>

3
<PAGE> 10
<TABLE>
<S> <C>
EBITDA Statements 3.16(a)
Employee Benefit Arrangements 3.18(d)
Environmental Regulations 3.15(a)
Environmental Survey 6.2(b)
ERISA 2.4
Excluded Assets 2.3
Facilities Recitals
Financial Schedule 3.16
Hazardous Materials 3.15
HSR Act 3.4
Indemnitee 11.5
Indemnitor 11.5(a)
Losses 11.3(a)
Manuals 2.5(b)
Material Adverse Effect 3.4
NovaCare Preamble
Panel 2.8
Pension Plans 2.14
Permitted Encumbrances 3.8
Post-Closing Adjustment Amount 2.2(b)
Prior Cost Reports 5.7(b)
Purchase Price 2.2(a)
Related Agreements 3.4
Seller Preamble
Subsidiaries Recitals
Termination Date 10.1(b)
Third Party Claims 11.5(a)
Transaction Recitals
Working Capital 2.2(b)
</TABLE>

ARTICLE 2
BASIC TRANSACTIONS

Section 2.1 Conveyance of RSC Shares. On the Closing Date, Seller
will convey, transfer and assign to Buyer all the Seller's right, title and
interest in and to the RSC Shares, free and clear of all liens, claims, charges
and encumbrances of any kind whatsoever.

Section 2.2 Purchase Price; Post-Closing Adjustment. (a) The
purchase price (the "Purchase Price") in the aggregate for all of the RSC
Shares shall be $215,000,000, as adjusted pursuant to this Section 2.2, which
price is based upon the retention by RSC and the Subsidiaries of all assets
which they own or lease immediately prior to the Closing, including, but not
limited to, working capital and Receivables, subject only to Section 2.3 below.

(b) Within 30 days after the Closing, Seller shall
deliver to Buyer a balance sheet (the "Closing Balance Sheet") of RSC as of the
Closing Date, which shall be prepared in accordance with generally accepted
accounting principles, in a manner consistent with the methods and principles
used by RSC in preparing its financial statements on the date of this
Agreement. Buyer shall provide Seller with

4
<PAGE> 11
access to the books and records of RSC and the Subsidiaries and the cooperation
of their employees in connection with such preparation. Seller shall also at
that time prepare and deliver a statement computing a "Post-Closing Adjustment
Amount" equal to the difference between $26,573,000 and the Working Capital of
RSC as reflected on the Closing Balance Sheet. For purposes of this Section
2.2, "Working Capital" shall mean the sum of the following categories on the
Closing Balance Sheet: (i) Cash, (ii) Net Patients Accounts Receivable, (iii)
Due (To) From Medicare, (iv) Other Accounts Receivable, and (v) Other Current
Assets, less (i) Accounts Payable, (ii) Accrued Expenses and (iii) Other
Current Liabilities. The following categories shall not be included in the
computation of Working Capital: (i) Current Portion of Capital Leases and (ii)
Current Portion of Long-Term Debt.

RSC and the Subsidiaries have received cash payments,
through the Subsidiary Cost Reports by interim or tentative cost report
payments and otherwise, based on Home Office Cost Statements of NovaCare for
1994 and prior years. These amounts have historically been included as a
liability in the category Due (To) From Medicare. On the Closing Balance
Sheet, these amounts will be reclassified to a liability account entitled
NovaCare, Inc. Home Office Liability.

Cash held in trust accounts or other funds to pay
indebtedness pursuant to the Trust Indentures and Loan Agreements as amended
(i) by and between Mercer County, West Virginia and American Health
Enterprises, Ltd., and (ii) by and between Wood County, West Virginia and West
Virginia Rehabilitation Services, Inc. will be included in the category Cash on
the Closing Balance Sheet.

(c) Buyer shall have a period of 15 days from the date of
delivery to it of the Closing Balance Sheet and the Post-Closing Adjustment
Amount statement to object to the determination of the Post-Closing Adjustment
Amount, computed as aforesaid. In the event of an objection from Buyer, Price
Waterhouse, LLP and a public accounting firm chosen by Buyer shall have a
period of 15 days in which to review the Closing Balance Sheet and the
statement showing Seller's computation of the Post-Closing Adjustment Amount.
If the dispute is not resolved in the said 15-day period to the satisfaction of
Buyer and Seller, such accounting firms shall have an additional period of 15
days to select a third accounting firm acceptable to both of them to review the
Closing Balance Sheet, and to make the final determination of the Post-Closing
Adjustment Amount, which determination, absent fraud, shall be conclusive and
binding. If Price Waterhouse and the second accounting firm are unable to
agree upon a third accounting firm to make the final determination, such an
accounting firm shall be appointed in accordance with the then-current rules of
the American Arbitration Association. The fees and expenses of the third
accounting firm shall be shared equally by Buyer and Seller.

(d) Upon the determination of the Post-Closing Adjustment
Amount as provided for in the preceding two paragraphs, the Purchase Price to
be paid by Buyer hereunder shall be adjusted by the amount of the Post-Closing
Adjustment Amount. Such adjustment shall be paid by the appropriate party
within ten days after final determination of the Post-Closing Adjustment
Amount.

Section 2.3 Excluded Assets. Notwithstanding any contrary provision
of this Agreement, the parties acknowledge and agree that the following
described assets of RSC and the Subsidiaries and the assets listed on Schedule
2.3 (collectively, "Excluded Assets") are not intended to be included in the
Transaction and that Seller, RSC and the Subsidiaries may take such actions as
are reasonably necessary to cause RSC and the Subsidiaries to sign all of their
respective right, title and interest in and to such Excluded Assets to Seller
(or a person or entity designated by Seller) immediately prior to the Closing:
all proprietary materials, documents, information, media, methods and processes
owned by Seller, and any and all rights to use the same, including, but not
limited to, all intangible assets of an intellectual

5
<PAGE> 12
property nature such as trademarks, service marks and trade names (whether or
not registered) other than the Transferred Business Names, proprietary computer
software, proprietary procedures and manuals, promotional and marketing
materials (including all marketing and computer hardware and software);
provided, however, that Buyer shall have the rights set forth in Section 2.5.

Section 2.4 Employee Matters. Schedule 2.4 lists all "employee
pension benefit plans" ("Pension Plans") within the meaning of Section 3(2) of
the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), in
which employees (as defined in Subsection (b) below) directly employed to work
at the Facilities participate. Neither Seller nor RSC nor any Subsidiary is a
party to, nor do any such employees participate in, any "multiemployer plans"
within the meaning of Section 3(37) of ERISA. Seller shall, or shall cause the
Subsidiaries to, (i) terminate as of the Closing Date the active participation
of all such employees in the Pension Plans, (ii) cause the Pension Plans to
make timely appropriate distributions, to the extent required, to such
employees in accordance with, and to the extent permitted by, the terms and
conditions of such Pension Plans, and (iii) in connection with the termination
of the active participation of all such employees in such Pension Plans,
comply, and cause each Pension Plan to comply, with all applicable Laws. Prior
to the Closing, Seller shall have delivered to Buyer, for information purposes
only, forms of any letters or other written communications which Seller or the
Subsidiaries shall distribute generally to such employees notifying them of
their rights in respect of their cessation of active participation in the
Pension Plans.

Section 2.5 Use of Names and Manuals.

(a) Although trade names of Seller, other than the
Transferred Business Names, are Excluded Assets, such names appear on certain
fixtures and Equipment, and on supplies, materials, stationery and similar
consumable items which will be on hand at the Facilities at the Closing.
Notwithstanding that such names are Excluded Assets, Buyer shall be entitled to
use such consumable items for a period of three months following the Closing
and shall have up to six months following the Closing to remove such names from
fixed assets, provided that Buyer shall not send correspondence or other
materials to third parties on any stationery that contains a trade name (other
than a Transferred Business Name) of Seller or any Affiliate of Seller.

(b) Seller hereby grants to Buyer, for the period from the
Closing Date through the expiration of the ninetieth day thereafter, the
non-exclusive right and license to use, solely in connection with the operation
of the Facilities, the clinical policy and procedures manuals of Seller (the
"Manuals") presently used at the Facilities. Such license shall be on the
following terms and conditions:

(i) Buyer shall accept the Manuals in their present
condition, "AS IS" and "WITH ALL FAULTS" and without any
representation or warranty of any kind whatsoever, either express or
implied, by Seller, including, but not limited to, any representation
or warranty that the Manuals are adequate for Buyer's operation of the
Facilities after the Closing or are in compliance with any Laws;

(ii) Buyer agrees that Seller shall have no
obligation whatsoever to update or otherwise revise the Manuals, even
if Seller or its Affiliates are revising similar manuals at other
healthcare facilities, and that Buyer shall have sole responsibility
for updating and revising such manuals;

6
<PAGE> 13
(iii) Buyer acknowledges and agrees that the Manuals
are confidential and proprietary information of Seller and its
Affiliates and Buyer agrees that it will not, directly or indirectly,
reproduce, distribute or disclose the contents of the Manuals except
as may be required in the operation of the Facilities (including, but
not limited to, as may be required by any Laws) and shall exercise due
care to otherwise preserve and protect the proprietary nature thereof;

(iv) Upon the termination of Buyer's use of the
Manuals pursuant to this Section, Buyer shall return to Seller all
originals and copies of the Manuals; and

(v) Buyer shall diligently implement its own policy
and procedure manuals promptly following the Closing Date, and in any
event by the date on which the license hereby granted to Buyer
terminates.

Section 2.6 Procedure for Consents or Default. The transfer of the
RSC Shares, in the absence of the consent or authorization of a third party,
could constitute a breach or default under a lease, agreement, encumbrance,
obligation or commitment or could adversely affect the rights, or increase the
obligations, of Buyer, Seller, RSC or any Subsidiary with respect thereto. If
any such consent or authorization is not obtained before Closing, and transfer
of such lease, agreement, encumbrance, obligation or commitment in the absence
of such consent or authorization would be ineffective or would adversely affect
the rights or increase the obligations of Seller, RSC, a Subsidiary or Buyer,
with respect to any such lease, agreement, encumbrance or commitment, so that
Buyer would not, in fact, receive all such rights, or assume the obligations of
Seller, RSC or such Subsidiary with respect thereto, as they exist prior to
Closing, then, in accordance with the procedures described in Section 2.8,
Seller and Buyer shall, and Seller shall cause RSC and each Subsidiary to,
enter into such reasonable cooperative arrangements as may be reasonably
acceptable to both Buyer and Seller (including, without limitation, sublease,
agency, management, indemnity or payment arrangements and/or other means to
enforce, at the cost and for the benefit of Buyer and any and all rights of RSC
and the Subsidiaries against an involved third party) to provide for Buyer the
benefits of such items or to relieve Seller from the obligations of such items.
The assignment of any contract, lease, agreement, encumbrance, obligation or
commitment, including, but not limited to, Medicare, Medicaid and similar
provider agreements, which may lawfully be made subject to customary conditions
subsequent (such as needs surveys, evaluations of Buyer or other determinations
by the counterparties to such agreements) shall be deemed not to constitute a
default under, or to in any way adversely affect the rights or increase the
obligations of Buyer with respect to, such lease, agreement, encumbrance or
commitment, whether or not the counterparty indicates prior to the Closing that
such condition or conditions subsequent are likely or not likely to be met.

Section 2.7 Closing. Subject to the terms and conditions hereof, the
consummation of the Transactions (the "Closing") shall occur at a mutually
agreeable time and place or places within five business days after the first
date on which all of the conditions set forth in Article 8 and Article 9 hereof
are capable of being satisfied, but in no event later than the Termination Date
set forth in Section 10.1(b). The date on which the Closing actually occurs is
referred to herein as the "Closing Date". The Closing shall be effective for
all purposes at 11:59 p.m. Eastern Time on the Closing Date. At the Closing,
and subject to the terms and conditions hereof, the following will occur:

(a) Deliveries by Seller. Seller shall deliver, or cause the
Subsidiaries to deliver, to Buyer:

7
<PAGE> 14
(i) A certificate or certificates representing the
RSC Shares, together with stock powers duly executed in blank:

(ii) The documents and instruments required
pursuant to Section 8.7; and

(iii) Such other instruments of transfer executed
by Seller as may be necessary or advisable to transfer to and vest in
Buyer all of Seller's right, title and interest in and to the RSC
Shares.

(b) Deliveries by Buyer. Buyer shall deliver to Seller:

(i) Immediately available funds, by way of wire
transfer to an account or accounts designated by Seller, in an amount
equal to the Purchase Price, as adjusted by the expenses due at
Closing pursuant to Section 5.5; and

(ii) The documents and instruments required to be
delivered pursuant to Section 9.7.

Section 2.8 Resolution of Cooperative Arrangements. In the event
that circumstances exist that require the parties to negotiate in good faith
cooperative arrangements under Section 2.6 or potential amendments to this
Agreement pursuant to Sections 8.5 then and in such event, such negotiations,
and the resolution of disagreements arising therefrom, shall be conducted in
accordance with the provisions of this Section 2.8. The parties shall
negotiate such cooperative arrangements in good faith prior to any scheduled
Closing Date (as may be extended by mutual agreement of the parties). If the
parties are unable to agree by the day prior to such scheduled Closing Date,
then such scheduled Closing Date (and the Termination Date, if necessary) shall
be extended for up to 15 business days to provide for the opportunity to
resolve such disagreement pursuant to the provisions of this Section 2.8. On
the day the Closing would have occurred but for the absence of agreement
between the parties, each party shall designate an individual (who may not be a
present or former officer, director, partner or employee of the party or of any
present or former investment banker, accounting firm, law firm or attorney of
or for the party) to mediate such disagreement, and advise the other party in
writing of the identity of such individual, which advice shall be accompanied
by a list of up to 10 suggested neutral individuals to serve as a third
mediator. The mediators originally designated by each party shall promptly
confer about the selection of a third mediator from such lists, and within five
business days following the originally scheduled Closing Date (or Termination
Date, as the case may be), the originally designated mediators shall agree upon
and (subject to availability) select the third mediator from the lists
submitted by the parties or otherwise, provided that if the originally
designated mediators fail to agree upon a third mediator by such date, the
third mediator shall be designated by the American Arbitration Association in
accordance with its then-current rules. The three mediators so selected are
herein referred to as the "Panel". Within two business days following the
designation of the third mediator, each party shall submit to the Panel in
writing, its proposed cooperative arrangements. Such proposals shall be
materially in accordance with the last proposals made by such party to the
other party during the course of the aforementioned good faith negotiations
between the parties. The parties shall additionally submit such memoranda,
arguments, briefs and evidence in support of their respective positions, and in
accordance with such procedures, as a majority of the Panel may determine.
Within seven business days following the designation of the third mediator, the
Panel shall, by majority vote, select the proposed cooperative arrangements
proposed by one of the parties, it being agreed that the Panel shall have no
authority to alter

8
<PAGE> 15
any such proposal in any way. Thereafter, the parties shall, subject to the
terms and conditions of this Agreement, consummate the Transactions on the
basis of such selected cooperative arrangements, amendments or adjustments at a
mutually agreeable time and place or places, in accordance with the provisions
of Section 2.7, which shall be no later than the fifteenth business day
following the originally scheduled Closing Date or such later date as the
parties may agree upon. Subject to the foregoing, the Panel may determine the
issues in dispute following such procedures, consistent with the language of
this Agreement, as it deems appropriate to the circumstances and with reference
to the amounts in issue. No particular procedures are intended to be imposed
upon the Panel, it being the desire of the parties that any such disagreement
shall be resolved as expeditiously and inexpensively as reasonably practicable.
No member of the Panel shall have any liability to the parties in connection
with service on the Panel, and the parties shall provide such indemnities to
the members of the Panel as they shall request.

Section 2.9 Guaranty by NovaCare. To induce Buyer to execute and
deliver this Agreement, NovaCare hereby absolutely and unconditionally
guarantees the full, prompt and faithful performance by Seller of all covenants
and obligations to be performed by Seller under this Agreement and any
Schedule, certificate and agreement executed and delivered in connection
herewith, including, without limitation, the payment of all sums stipulated to
be paid by Seller pursuant to this Agreement. In the event that Seller fails
to fully perform all such covenants and obligations in accordance with their
terms or pay all or any part of such sums when due, NovaCare will perform all
such covenants and obligations in accordance with their terms or immediately
pay to Buyer (or such other payee as may be provided herein or in any such
agreement) the amount due and unpaid by Seller, it being understood that each
such covenant or obligation and each obligation to pay any such amount
constitutes the direct and primary obligation of NovaCare. NovaCare hereby
waives presentment, demand of payment, protest, dishonor, notice of protest or
dishonor, and notice of acceptance of the guaranty set forth in this Section
2.9 and all rights to require Buyer to proceed against Seller, or to pursue any
other remedy it may have against Seller in the event of a breach by Seller of
any representation, warranty, obligation or covenant in this Agreement or in
any Schedule, certificate or agreement executed and delivered in connection
therewith. In the event that Seller is not liable to perform any such
obligations or covenants because the act creating such obligation or covenant
is ultra vires or unauthorized, and for such reasons such obligations or
covenants cannot be enforced against Seller, such fact shall not affect
NovaCare's liability under this Section 2.9. In the event of the merger,
acquisition, termination, liquidation or dissolution of Seller, this
unconditional guaranty shall continue in full force and effect.

ARTICLE 3
REPRESENTATIONS AND WARRANTIES OF SELLER

Seller hereby represents and warrants to Buyer, as of the date hereof,
as follows, except as disclosed in Schedule 3:

Section 3.1 Organization and Corporate Power. Seller is a
corporation duly incorporated and validly existing under the laws of, and is
authorized to exercise its corporate powers, rights and privileges and is in
good standing in, the State of Delaware and has full corporate power to carry
on its business as presently conducted and to own or lease and operate its
properties and assets now owned or leased and operated by it.

9
<PAGE> 16
Section 3.2 RSC and Subsidiaries.

(a) Each of RSC and each Subsidiary is a corporation duly
organized, validly existing and in good standing under the laws of its state of
incorporation (which in each case is indicated on Schedule A-1) and is duly
qualified and in good standing as a foreign corporation in all jurisdictions in
which such qualification is required by reason of its business, properties or
activities in or relating to such jurisdictions (which is likewise indicated on
Schedule A-1), except where the failure to be so qualified will not have a
Material Adverse Effect (as defined in Section 3.4) on RSC or the applicable
Subsidiary.

(b) (i) All of the outstanding capital stock of RSC has been
duly authorized and is validly issued, fully paid and nonassessable and is
owned beneficially and of record by Seller. There are no rights,
subscriptions, warrants, options, conversion rights or agreements of any kind
outstanding to purchase or otherwise acquire any shares of capital stock of or
securities or obligations of any kind convertible into or exchangeable for any
shares of capital stock of RSC.

(ii) All of the outstanding capital stock of each
Subsidiary has been duly authorized and is validly issued, fully paid and
nonassessable and, except as indicated on Schedule A-1, is owned beneficially
and of record by RSC. Except as provided in Schedule A-1, there are no rights,
subscriptions, warrants, options, conversion rights or agreements of any kind
outstanding to purchase or otherwise acquire any shares of capital stock of or
securities or obligations of any kind convertible into or exchangeable for any
shares of capital stock of any Subsidiary.

(c) Upon consummation of the Transaction, Buyer will acquire
valid title to the RSC Shares, free and clear of all liens, charges, pledges or
security interests (except for those created or allowed to be suffered by
Buyer) and free of any restrictions on voting and transfer.

(d) No corporate act or proceeding on the part of RSC or any
Subsidiary or their respective boards of directors or shareholders is necessary
to authorize the Transaction.

Section 3.3 Authority Relative to this Agreement. The execution,
delivery and performance of this Agreement and all other agreements
contemplated hereby and the consummation of the transactions contemplated
hereby and thereby have been duly and effectively authorized by the board of
directors of Seller; no other corporate act or proceeding on the part of
Seller, its board of directors or its stockholders is necessary to authorize
this Agreement, any such other agreement or the transactions contemplated
hereby and thereby. This Agreement has been, and each of the other agreements
contemplated hereby will as of the Closing have been, duly executed and
delivered by Seller, and this Agreement constitutes, and each such other
agreement when executed and delivered will constitute, a valid and binding
obligation of Seller, enforceable against Seller in accordance with its terms,
except as it may be limited by bankruptcy, insolvency, reorganization,
moratorium or other similar Laws now or hereafter in effect relating to
creditors' rights generally and that the remedy of specific performance and
injunctive and other forms of equitable relief may be subject to equitable
defenses and to the discretion of the court before which any proceeding may be
brought.

Section 3.4 Absence of Breach. Subject to the provisions of Sections
3.5 and 3.6 below regarding private party and governmental consents, and except
for compliance with the requirements of the Hart-Scott-Rodino Antitrust
Improvements Act of 1976, as amended (the "HSR Act"), and any regulatory or
licensing Laws applicable to the businesses and assets represented by the
Transferred

10
<PAGE> 17
Assets, the execution, delivery and performance by Seller of this Agreement and
all other agreements contemplated hereby or executed in connection herewith
(the "Related Agreements"), do not (a) conflict with or result in a breach of
any of the provisions of the Articles or Certificates of Incorporation or
Bylaws or similar charter documents (the "Charter Documents") of Seller, of RSC
or of any of the Subsidiaries, (b) contravene any Law or cause the suspension
or revocation of any License presently in effect, which affects or binds Seller
or RSC or any of the Subsidiaries, or any of their material properties, except
where such contravention, suspension or revocation will not have a Material
Adverse Effect (as defined below) on RSC and the Subsidiaries and will not
affect the validity or enforceability of this Agreement and the Related
Agreements or the validity of the Transaction contemplated hereby and thereby,
or (c) conflict with or result in a breach of or default under any indenture or
loan or credit agreement or any other agreement or instrument to which Seller
or any of the Subsidiaries is a party or by which it or they or any of their
properties may be affected or bound, the effect of which conflict, breach, or
default, either individually or in the aggregate, would be a Material Adverse
Effect on RSC and the Subsidiaries. As used herein, a "Material Adverse
Effect": (a) when used with respect to a Facility, means a material adverse
effect on a Facility and on the businesses operated therefrom, including their
condition (financial or otherwise) and results of operations, taken as a whole;
and (b) when used with respect to an entity, such as Seller, RSC, a Subsidiary
or Buyer, means a material adverse effect on the business, condition (financial
or otherwise) and results of operations of such entity taken as a whole
(including any subsidiaries of such entity).

Section 3.5 Private Party Consents. Except as set forth on Schedule
3.5, the execution, delivery and performance by Seller of this Agreement and
the Related Agreements do not require the authorization, consent or approval of
any non-governmental third party of such a nature that the failure to obtain
the same would have a Material Adverse Effect on RSC and the Subsidiaries.

Section 3.6 Governmental Consents. The execution, delivery and
performance by Seller of this Agreement and the Related Agreements do not
require the authorization, consent, approval, certification, license or order
of, or any filing with, any court or governmental agency of such a nature that
the failure to obtain the same would have a Material Adverse Effect on the
Transferred Assets, except for compliance with the HSR Act and except for such
governmental authorizations, consents, approvals, certifications, licenses and
orders that customarily accompany the transfer of health care facilities such
as the Facilities.

Section 3.7 Brokers. No broker, finder, or investment banker is
entitled to any brokerage, finder's or other fee or commission in connection
with this Agreement or the Transaction contemplated hereby based upon any
agreements or arrangements or commitments, written or oral, made by or on
behalf of Seller or any of its Affiliates. Seller shall be solely responsible
for the payment of any such fee or commission to any person or entity listed on
Schedule 3.7 as an exception to the foregoing.

Section 3.8 Title to Personal Property. Each Subsidiary has good and
defensible title, or valid and effective leasehold rights in the case of leased
property, to all tangible personal property owned by such Subsidiary or used in
the operations of the applicable Facility, free and clear of all liens,
charges, claims, pledges, security interests, equities and encumbrances of any
nature whatsoever, except for those created or allowed to be suffered by Buyer
and except for the following (individually and collectively, the "Permitted
Encumbrances"): (a) the lien of current taxes not delinquent, (b) matters that
when viewed in the aggregate, do not have a Material Adverse Effect on RSC and
the Subsidiaries, (c) such consents, authorizations, approvals and Licenses as
are referred to in Sections 3.5 and 3.6, (e) liens, charges, claims, pledges,
security interests, equities and encumbrances which will be discharged or
released either

11
<PAGE> 18
prior to, or substantially simultaneously with, the Closing, and (f) liens
created under or pursuant to the Real Property Leases.

Section 3.9 Contracts and Leases. Except for matters that, when
viewed in the aggregate, do not have a Material Adverse Effect on RSC and the
Subsidiaries, (a) there is no liability to any person by reason of the default
by Seller, RSC or a Subsidiary under any Real Property Lease or Other Contract,
(b) neither Seller nor RSC nor any Subsidiary has received written or other
notice that any person intends to cancel or terminate any Real Property Lease
or Other Contract, (c) all of the Real Property Leases and Other Contracts are
in full force and effect, (d) subject to the provisions of Sections 3.5 and
3.6, the consummation of the transactions contemplated by this Agreement will
not constitute and, to the best of Seller's current actual knowledge, no event
has occurred which, with or without the passage of time or the giving of
notice, would constitute a breach or default by Seller, RSC or a Subsidiary of
such Real Property Lease or Other Contract or would cause the acceleration of
any obligation of Seller, RSC or any Subsidiary or the creation of any lien
(except for Permitted Encumbrances) upon any asset of RSC or any Subsidiary,
and (e) neither Seller nor RSC nor any Subsidiary has waived any right under
any Real Property Lease or Other Contract.

Section 3.10 Licenses. To the best of Seller's current actual
knowledge, and except for such matters which, in the aggregate, do not have a
Material Adverse Affect on RSC and the Subsidiaries, (a) the Subsidiaries
possess all Licenses necessary for their operation of the Facilities at the
locations and in the manner presently operated, (b) if required, such
Facilities are accredited by applicable accrediting agencies as necessary for
their operations in the manner presently operated, (c) such Facilities are
certified for participation in the Medicare and applicable Medicaid programs
and have current and valid provider contracts with such programs, and (d) there
is no matter which would adversely affect the maintenance of any such Licenses,
program participations or accreditations.

Section 3.11 Employee Relations. With respect to the employees of
RSC and the Subsidiaries:

(a) Neither Seller nor RSC nor any Subsidiary nor any
Facility is a party to any agreement with any union, trade association or other
similar employee organization, no written demand has been made for recognition
by a labor organization, and to the best of Seller's current actual knowledge
no union organizing activities by or with respect to any such employees are
taking place; and

(b) There are no controversies (including, without
limitation, any unfair labor practice complaints, labor strikes, arbitrations,
disputes, work slowdowns or work stoppages) affecting a material number of such
employees pending, or to the best of Seller's current actual knowledge,
threatened.

Section 3.12 Employee Plans. Except for the Pension Plans, and
except as set forth on Schedule 3.19(d) hereto, neither RSC nor any Subsidiary
has established or maintains or is obligated to make contributions to or under
or otherwise participate in any Employee Benefit Arrangement. All such
Employee Benefit Arrangements have been operated and administered in all
material respects in accordance with, as applicable, ERISA, the Code, Title VII
of the Civil Rights Act of 1964, as amended, the Equal Pay Act of 1967, as
amended, the age discrimination in employment act of 1967, as amended, the
Americans with Disabilities Act, as amended, and the related rules and
regulations adopted by those federal agencies responsible for the
administration of such Laws. All accrued benefits under any such Employee
Benefit Arrangement will be fully funded at the Closing Date. No act or
failure to act by Seller, RSC or any Subsidiary has resulted in a "prohibited
transaction" (as defined in ERISA). With

12
<PAGE> 19
respect to any employee benefit plan, and no "reportable event" (as defined in
ERISA) has occurred with respect to any such employee benefit plan.

Section 3.13 Litigation. Except for ordinary routine claims and
litigation incidental to the businesses represented by the Facilities
(including, but not limited to, actions for negligence, professional
malpractice, workers' compensation claims, so-called "slip-and-fall" claims and
the like), and governmental inspections and reviews customarily made of
businesses such as those operated from the Facilities, there are no actions,
suits, claims or proceedings pending, or to the current actual knowledge of
Seller, threatened against or affecting RSC or the Subsidiaries or relating to
the operations of the Facilities, at law or in equity, or before or by any
federal, state, municipal or other governmental department, commission, agency
or instrumentality. Schedule 3.13 sets forth identifying information and a
brief description with respect to any pending or, to the current actual
knowledge of Seller, RSC and the Subsidiaries, threatened claims or litigation
affecting RSC, the Subsidiaries or the Facilities (i) where the amount in
controversy exceeds $100,000, (ii) which involve any alleged violation of any
Laws or (iii) which could otherwise be reasonably expected to have a Material
Adverse Effect on RSC or the applicable Subsidiary.

Section 3.14 Inventory. All Inventory of the Facilities will, at the
Closing Date, consist of a quality and quantity usable and salable in the
ordinary course of business, except for items of obsolete materials and
materials of below-standard quality, all of which in the aggregate are
immaterial to the financial condition or results of operations of the
businesses operated from the Facilities taken as a whole, or have been, or
prior to Closing will be, written down to realizable market value.

Section 3.15 Hazardous Substances. To the best of Seller's current
actual knowledge, except as may be disclosed by the Environmental Survey (as
defined in Section 6.2(b)):

(a) There are no Hazardous Materials (as defined below) upon,
about, beneath or migrating or threatening to migrate to or from the Owned Real
Property or the Leased Real Property or the existence of any violation in any
material respect of any Laws relating to industrial hygiene, Hazardous
Materials and environmental protection ("Environmental Regulations"); and

(b) There is no proceeding or action pending or threatened by
any person or governmental agency regarding the environmental condition or
occupational safety of the Facilities.

"Hazardous Materials" shall mean any substance (including, without limitation,
any asbestos, formaldehyde, radioactive substance, hydrocarbons,
polychlorinated biphenyls, industrial solvents, flammables, explosives and any
other hazardous substance or toxic material) which, in any material respect, is
known to cause, as of the date of this Agreement, a health, safety or
environmental hazard and require remediation at the behest of any governmental
agency.

Section 3.16 Financial Information and Related Matters.

(a) To be attached hereto as Schedule 3.16(a) within seven
days after the execution and delivery of this Agreement is an unaudited
statement of certain combined earnings from the operations of the Facilities
(as they were comprised on the as of date of such schedule) before interest,
income taxes, depreciation and amortization ("EBITDA") for the fiscal year
ended June 30, 1994 (the "EBITDA Statements") and for the six months ended
December 31, 1994. The EBITDA Statements present fairly the combined EBITDA of
such operations, taken as a whole, as of the dates and for the periods shown,

13
<PAGE> 20
and were derived from and are in accordance with the internal books and records
of RSC and the Subsidiaries and the regularly prepared unaudited internal
financial statements of the Facilities, which are prepared on a basis
materially in accordance with the generally accepted accounting principles
utilized in the preparation of the published financial statements of Seller.

(b) Attached hereto as Schedule 3.16(b) is a regularly
prepared internal unaudited combined balance sheet of the Facilities as of
December 31, 1994 (the "Balance Sheet"; collectively, the Balance Sheet and the
EBITDA Statement are the "Financial Schedule"). The Balance Sheet has been
prepared from, and is in accordance with, the internal books and records of RSC
and the Subsidiaries and presents fairly the financial condition of the
Facilities, taken as a whole, as of the date shown. The Balance Sheet was
prepared in accordance with Seller's practices for the preparation of internal
financial statements, consistently applied, and is materially in accordance
with the generally accepted accounting principles utilized in the preparation
of the published financial statements of Seller.

(c) Notwithstanding the foregoing, the Financial Schedule
does not (i) reflect allocations of indirect costs and overhead or the
corresponding cost reimbursement impact of claiming such costs in a Facility
cost report, (ii) reflect all intercompany eliminations, adjustments and
accruals that are reflected in financial statements of Seller, (iii) reflect
any anticipation of the divestiture of the Facilities and any adjustments to
the carrying values of the Facilities occasioned thereby, (iv) contain
footnotes or other explanatory material associated with financial statements
prepared in accordance with generally accepted accounting principles, or (v)
contain normal year-end adjustments with respect to interim periods. In
addition, the Financial Schedule is to be read in conjunction with, and is
subject to, all notes and other explanatory material set forth therein.

(d) The Balance Sheet reflects the amount of Receivables
as of the date thereof, net of allowances customarily recorded by the
Subsidiaries for uncollectible and doubtful accounts, and contractual
allowances pursuant to agreements with Payors, all in conformity with Seller's
practices for the preparation of internal financial statements and materially
in accordance with the generally accepted accounting principles utilized in the
preparation of the published financial statements of the Seller and the past
practices employed by each Subsidiary. To the current actual knowledge of
Seller, all such Receivables included in the Balance Sheet represent amounts
validly owed to the applicable Subsidiary by reason of the provision of goods,
services and other consideration by such Subsidiary, and, to the current actual
knowledge of Seller, are not valued in excess of the amounts expected to be
collected with respect thereto. Each Subsidiary maintains its accounting
records in sufficient detail to substantiate the Receivables reflected on the
Balance Sheet. Since the date of Seller's most recent audited financial
statements, neither Seller nor RSC nor any Subsidiary has changed any principle
or practice with respect to the recordation of accounts receivable or the
calculation of reserves therefor, or any material collection, discount or
write-off policy or procedure.

(e) RSC and the Subsidiaries, as applicable, have timely
filed all Cost Reports required to be filed with respect to the Facilities
prior to the date of this Agreement. All such Cost Reports are, to the
knowledge of Seller, true and complete in all material respects and comply in
all material respects with all applicable Laws respecting Cost Reports.
Neither Seller nor RSC nor any Subsidiary has received any notice with respect
to any challenge, dispute or adjustment with respect to any open Cost Reports
except challenges, disputes or adjustments (i) which, if resolved adversely to
Seller, RSC or the Applicable Subsidiary, as the case may be, would not have a
Material Adverse Effect on such entity, or (ii) which are described on Schedule
3.16(e).

14
<PAGE> 21
(f) Each of RSC and the Subsidiaries has filed all
returns required to be filed by it, and made all payments required to be made
by it, with respect to any Taxes as to which such filings or payments were due
on or before the date of this Agreement. To the best of Seller's knowledge,
neither RSC nor any Subsidiary has any liability with respect to any Taxes for
which its reserves are inadequate, except for sales, use, employment and
similar Taxes for periods as to which such Taxes have not yet become due and
payable.

Section 3.17 Changes Since Balance Sheet. Since the date of the
Balance Sheet and up to and including the date of this Agreement, other than as
contemplated or permitted by this Agreement, RSC and the Subsidiaries have
conducted their respective businesses only in the ordinary and normal course,
except for matters in anticipation of the divestiture of the Facilities, and
there has not been:

(a) Any entry into or termination by Seller or RSC or a
Subsidiary of any material commitment, contract, agreement or transaction
(including, without limitation, any borrowing or lending transaction or capital
expenditure) related to RSC, the Subsidiaries or the Facilities, except for
transactions in the ordinary course of business and renegotiation of credit
agreements to which Seller and certain of its subsidiaries are parties;

(b) Any casualty, physical damage, destruction or physical
loss respecting, or change in the physical condition of, the Facilities and the
Equipment that has had a Material Adverse Effect on RSC and the Subsidiaries;

(c) Any transfer of or rights granted under any contract
which would have been an Other Contract on the date of the Balance Sheet except
for transactions in the ordinary course of business;

(d) Other than in the ordinary course of business, any sale
or other disposition of any fixed asset included in the Balance Sheet having a
net book value in excess of $50,000 or any material mortgage, pledge or
imposition of any lien or other encumbrances on any such asset, or sales or
dispositions of, or the imposition of material encumbrances on, fixed assets
included in such Balance Sheet having a net book value that exceeds $250,000 in
the aggregate, or any sale or other disposition of Inventories included in the
Balance Sheet;

(e) Any amendment (other than general amendments which the
carrier makes for a category of policy) or termination of any insurance policy
or failure to renew any insurance policy covering the Facilities, except for
amendments, terminations or failures to renew that do not have a Material
Adverse Effect on RSC and the Subsidiaries;

(f) Any default or breach by Seller, RSC or a Subsidiary
under any contract that would have been an Other Contract on the date of the
Balance Sheet which, when viewed individually or in the aggregate of all such
breaches or defaults, has had a Material Adverse Effect on RSC and the
Facilities; or

(g) Any increase made in the compensation levels of any chief
executive officer or chief financial officer of any Facility, or any general
increase made in the compensation levels of the other employees of RSC or any
Subsidiary, except in the ordinary course of business.

Section 3.18 Compliance with Laws. Except as otherwise disclosed in
this Agreement (or in the Schedule thereto), RSC, each Subsidiary and each
Facility are, to the knowledge of NovaCare and Seller,

15
<PAGE> 22
in compliance in all material respects with all Laws applicable to a Facility
or the operations thereof, and neither Seller, RSC nor any Facility has
received any notices of violations of any such Laws.

Section 3.19 Lists of Other Data. Except for contracts and
agreements already listed in Schedules 1.1-2 and 1.1-4, Schedules 3.19(a)
through (f) contain lists, complete and correct as of the dates shown thereon,
of the following:

(a) The most recent regularly generated depreciation
schedules related to tangible personal property constituting Equipment,
together with copies of such schedules;

(b) Each lease constituting an Other Contract as of such date
(whether an operating or a capital lease) under which tangible personal
property was leased, where the annualized lease payments exceed $25,000;

(c) A brief description of insurance in force covering fixed
assets that would constitute assets of the Facilities as of such date;

(d) All compensation, bonus, incentive, deferred payments,
retirement, pension, severance, profit-sharing, stock purchase and stock option
plans, group life, automobile, medical, dental, disability, welfare or other
employee benefit plans or insurance policies, and other similar arrangements
(collectively, "Employee Benefit Arrangements") generally applicable to the
employees of the Facilities or a substantial part thereof or generally
applicable to the chief executive or chief financial officers, or a substantial
part thereof, of the Facilities as of such date;

(e) The aggregate accrued paid time off (including vacation
time) and earned or available sick pay for all employees at each Facility, as
of the date shown; and

(f) Material Licenses of Seller and the Subsidiaries in
force, as of the date shown, with respect to the Facilities.

ARTICLE 4
REPRESENTATIONS AND WARRANTIES OF BUYER

Buyer hereby represents and warrants to Seller, as of the date hereof,
as follows, except as disclosed in Schedule 4:

Section 4.1 Organization and Corporate Power. Buyer is a corporation
duly incorporated and validly existing under the laws of, and is authorized to
exercise its corporate powers, rights and privileges and is in good standing
in, the State of Delaware and has full corporate power to carry on its business
as presently conducted and to own or lease and operate its properties and
assets now owned or leased and operated by it.

Section 4.2 Authority Relative to this Agreement. The execution,
delivery and performance of this Agreement and the Related Agreements and the
consummation of the transactions contemplated hereby and thereby have been duly
and effectively authorized by the board of directors of Buyer; no other
corporate act or proceeding on the part of Buyer, its board of directors or its
stockholders is necessary to authorize this Agreement, any such Related
Agreement or the transactions contemplated hereby and

16
<PAGE> 23
thereby. This Agreement has been, and each of the Related Agreements
contemplated hereby will, as of the Closing, have been, duly executed and
delivered by Buyer and this Agreement constitutes, and each such Related
Agreement when executed and delivered will constitute, a valid and binding
obligation of Buyer, enforceable against Buyer in accordance with its terms,
except as it may be limited by bankruptcy, insolvency, reorganization,
moratorium or other similar Laws now or hereafter in effect relating to
creditors' rights generally and that the remedy of specific performance and
injunctive and other forms of equitable relief may be subject to equitable
defenses and to the discretion of the court before which any proceeding may be
brought.

Section 4.3 Absence of Breach. Subject to the provisions of Sections
4.4 and 4.5 below regarding private party and governmental consents, and except
for compliance with the requirements of the HSR Act and any regulatory or
licensing Laws applicable to the businesses and assets represented by the
Facilities, the execution, delivery and performance by Buyer of this Agreement
and the Related Agreements do not, (a) conflict with or result in a breach of
any of the provisions of Charter Documents of Buyer, (b) contravene any Law or
cause the suspension or revocation of any License presently in effect, which
affects or binds Buyer or any of its material properties, or (c) conflict with
or result in a breach of or default under any indenture or loan or credit
agreement or any other agreement or instrument to which Buyer is a party or by
which it or any of its properties may be affected or bound.

Section 4.4 Private Party Consents. The execution, delivery and
performance by Buyer of this Agreement and the Related Agreements do not
require the authorization, consent or approval of any non-governmental third
party.

Section 4.5 Governmental Consents. The execution, delivery and
performance by Buyer of this Agreement and the Related Agreements do not
require the authorization, consent, approval, certification, license or order
of, or any filing with, any court or governmental agency, except for compliance
with the HSR Act and except for such governmental authorizations, consents,
approvals, certifications, licenses and orders that customarily accompany the
transfer of health care facilities such as the Facilities.

Section 4.6 Brokers. No broker, finder, or investment banker is
entitled to any brokerage, finder's or other fee or commission in connection
with this Agreement or the transactions contemplated hereby based upon any
agreements or arrangements or commitments, written or oral, made by or on
behalf of Buyer or any of its Affiliates. Buyer shall be solely responsible
for the payment of any such fee or commission to any person or entity listed on
Schedule 4.6 as an exception to the foregoing.

Section 4.7 Qualified for Licenses. Buyer is qualified to obtain any
Licenses and program participations necessary for the operation by Buyer of the
Facilities in the same manner as the Facilities are presently operated by
Seller and the Subsidiaries. Each of Buyer and its Affiliates possesses all
Licenses and program participations necessary to permit them to operate the
healthcare facilities operated by them. If required, all such healthcare
facilities are accredited by applicable accrediting agencies as necessary for
their operations in the manner presently operated. Neither Buyer nor any of
its Affiliates has received any notice or has any knowledge of any matter which
would materially adversely affect the maintenance of any such Licenses, program
participations or accreditations.

Section 4.8 Financial Ability to Perform. Buyer has liquid capital
or committed sources therefor sufficient to permit it to perform timely its
obligations hereunder, including, but not limited to, the payment of the
Purchase Price to Seller at the Closing and the other payments to Seller
required

17
<PAGE> 24
hereunder. Promptly after its receipt of letters of commitment or other
documents related to the financing of its obligations hereunder, Buyer will
provide copies of the same to Seller.

Section 4.9 No Assurance. Buyer acknowledges and agrees that the
rates or bases used in calculating payments or reimbursements to it by any
Payor (including but not limited to Medicare) may differ from the rates and
bases used in calculating such payments or reimbursements to Seller, RSC and
the Subsidiaries.

Section 4.10 Disposal of Assets. Buyer does not intend to or
currently plan to dispose of, or cause RSC to dispose of, a significant part of
the assets of RSC or the Subsidiaries within two years after the Closing, other
than dispositions in the ordinary course of business or to eliminate duplicate
facilities or excess capacity.

ARTICLE 5
COVENANTS OF EACH PARTY

Section 5.1 Efforts to Consummate Transactions. Subject to the terms
and conditions herein provided, each of the parties hereto agrees to use its
reasonable commercial efforts to take, or to cause to be taken, all reasonable
actions and to do, or to cause to be done, all reasonable things necessary,
proper or advisable under applicable Laws to consummate and make effective, as
soon as reasonably practicable, the Transaction contemplated hereby, including
the satisfaction of all conditions thereto set forth herein. Such actions
shall include, without limitation, exerting their reasonable efforts to obtain
the consents, authorizations and approvals of all private parties and
governmental authorities whose consent is reasonably necessary to effectuate
the Transaction contemplated hereby, and effecting all other necessary
registrations and filings, including but not limited to filings under Laws
relating to the transfer or obtaining of necessary Licenses, under the HSR Act
and all other necessary filings with governmental authorities. The foregoing
notwithstanding, it shall be the responsibility of Buyer to use its reasonable
commercial efforts and to act diligently and at its expense to obtain any
authorizations, approvals and consents in connection with acquiring Licenses
and program participations that will permit it to operate the Facilities after
the Closing. Subject to Sections 2.6 and 8.8, neither party shall have any
liability to the other if, after using its reasonable commercial efforts (and,
in the case of Buyer's efforts to obtain requisite Licenses, acting
diligently), it is unable to obtain any consents, authorizations or approvals
necessary for such party to consummate the Transactions, except as may result
from cooperative arrangements determined in accordance with Section 2.8. As
used herein, the terms "reasonable commercial efforts" or "reasonable efforts"
do not include the provision of any consideration to any third party or the
suffering of any economic detriment to a party's ongoing operations for the
procurement of any such consent, authorization or approval except for the costs
of gathering and supplying data or other information or making any filings,
fees and expenses of counsel and consultants and for customary fees and charges
of governmental authorities and accreditation organizations.

Section 5.2 Cooperation. Prior to and after the Closing, upon prior
reasonable written request, each party agrees to cooperate with the other in
every reasonable commercial way to consummate the Transaction. Notwithstanding
the foregoing, all analyses, appearances, presentations, memoranda, briefs,
arguments, opinions and proposals made or submitted by or on behalf of either
party hereto in connection with proceedings under or relating to the HSR Act or
any other federal or state antitrust or fair trade law, or made or submitted by
or on behalf of Buyer in connection with proceedings to obtain the Licenses and
program participations referred to in Section 5.1 hereof, shall be subject to
the joint approval or

18
<PAGE> 25
disapproval and the joint control of Buyer and Seller, acting with the advice
of their respective counsel, it being the intent of the foregoing that the
parties hereto will consult and cooperate with one another, and consider in
good faith the views of one another, in connection with any such analysis,
presentation, memorandum, brief, argument, appearance, opinion or proposal;
provided that nothing herein shall prevent either party hereto or any of their
Affiliates or their authorized representatives from (a) making or submitting
any such analysis, appearance, presentation, memorandum, brief, argument,
opinion or proposal in response to a subpoena or other legal process or as
otherwise required by Law, or (b) submitting factual information to the United
States Department of Justice, the Federal Trade Commission, any other
governmental agency or any court or administrative law judge in response to a
request therefor or as otherwise required by Law.

Section 5.3 Further Assistance. From time to time, at the request of
either party, whether on or after the Closing, without further consideration,
either party, at its expense and within a reasonable amount of time after
request hereunder is made, shall execute and deliver such further instruments
of assignment, transfer and assumption and take such other action as may be
reasonably required to more effectively assign and transfer the RSC Shares to
Buyer, deliver or make the payment of the Purchase Price to Seller or any
amounts due from one party to the other pursuant to the terms of this Agreement
or confirm Seller's ownership of the Excluded Assets.

Section 5.4 Cooperation Respecting Proceedings. After the Closing,
upon prior reasonable written request, each party shall cooperate with the
other, at the requesting party's expense (but including only out-of-pocket
expenses to third parties and not the costs incurred by any party for the wages
or other benefits paid to its officers, directors or employees), in furnishing
information, testimony and other assistance in connection with any inquiries,
actions, tax or cost report audits, proceedings, arrangements or disputes
involving either of the parties hereto (other than in connection with disputes
between the parties hereto) and based upon contracts, arrangements or acts of
Seller, RSC or any of the Subsidiaries which were in effect or occurred on or
prior to the Closing and which relate to the Facilities, including, without
limitation, arranging discussions with (and the calling as witness of)
officers, directors, employees, agents, and representatives of Buyer.

Section 5.5 Expenses. Whether or not the Transactions contemplated
hereby are consummated, except as otherwise provided in this Agreement, all
costs and expenses incurred in connection with this Agreement and the
transactions contemplated hereby shall be paid by the party incurring such
expenses. Notwithstanding the foregoing:

(a) All costs of the Environmental Survey referred to in
Section 6.2(b) shall be borne by Buyer;

(b) All charges of any neutral independent public accountant
or mediator, and related costs, shall be borne one-half by Buyer and one-half
by Seller (it being agreed that each party shall bear the costs of its own
independent public accountant or designated mediator);

(c) All fees and charges of governmental authorities and
accreditation agencies in connection with the transfer, issuance or
authorization of any License, accreditation or program participation shall be
borne by Buyer; and

19
<PAGE> 26
(d) All fees, charges or costs, including auditing fees and
expenses, incurred as a result of Buyer's compliance with the Securities
Exchange Act of 1934, as amended, and the rules and regulations thereunder,
shall be borne by Buyer.

All such charges and expenses shall be promptly settled between the parties at
the Closing or upon termination or expiration of further proceedings under this
Agreement, or with respect to such charges and expenses not determined as of
such time, as soon thereafter as is reasonably practicable.

Section 5.6 Announcements; Confidentiality. Prior to the Closing
Date, no press or other public announcement, or public statement or comment in
response to any inquiry, relating to the transactions contemplated by this
Agreement shall be issued or made by Buyer or Seller or any Subsidiary without
the joint approval of Buyer and Seller; provided that a press release or other
public announcement, statement or comment made without such joint approval
shall not be in violation of this Section if it is made in order to comply with
applicable securities Laws or stock exchange policies and in the reasonable
judgment of the party making such release or announcement, based upon advice of
independent counsel, prior review and joint approval, despite reasonable
efforts to obtain the same, would prevent dissemination of such release or
announcement in a timely enough fashion to comply with such Laws or policies,
provided that in all instances prompt notice from one party to the other shall
be given with respect to any such release, announcement, statement or comment.
Subject to the foregoing, the parties hereto recognize and agree that all
information, instruments, documents and details concerning the businesses of
Buyer, Seller, RSC and the Subsidiaries are strictly confidential, and Seller
and Buyer expressly covenant and agree with each other that, prior to and after
the Closing, they will not, nor will they allow any of their respective
officers, directors, employees, representatives or agents (including
professional advisors) to disclose or publicly comment upon any matters
relating to the business of the other or relating to this Agreement, including,
without limitation, the terms, timing or progress of the transactions
contemplated hereby, or its negotiation, terms, provisions or conditions,
including Purchase Price, except for disclosure to their respective
professional advisors (who shall agree not to disclose the same) which is
reasonably necessary to effectuate the Transaction contemplated hereby and in a
manner consistent with the provisions of this Agreement. Each party shall keep
all information obtained from the other either before or after the date of this
Agreement confidential, and neither party shall reveal such information to, nor
produce copies of any written information for, any person outside its
management group or its professional advisors without the prior written consent
of the other party, unless such party is compelled to disclose such information
by judicial or administrative process or by any other requirements of Law. If
the Transaction contemplated by this Agreement should fail to close for any
reason, each party shall return to the other as soon as practicable all
originals and copies of written information provided to such party by or on
behalf of the other party and none of such information shall be used by either
party, or their employees, agents or representatives in the business operations
of any person. Notwithstanding the foregoing, each party's obligations under
this Section shall not apply to any information or document which is or becomes
available to the public other than as a result of a disclosure by the other
party in violation of this Agreement or other obligation of confidentiality
under which such information may be held or becomes available to the party on a
non-confidential basis from a source other than the other party or its
officers, directors, employees, representatives or agents. The parties'
obligations under this Section shall survive the termination of this Agreement.
Nothing in this Section shall, or is intended to, impair or modify any of the
rights or obligations of Buyer or its Affiliates under that certain letter
agreement dated January 14, 1995, 1995, all of which remain in effect until
termination of such letter agreement in accordance with its terms.

20
<PAGE> 27
Section 5.7 Cost Reports.

(a) Buyer shall cause the Subsidiaries to prepare and file
the Cost Reports as required under their agreements and applicable laws, rules
and regulations pertaining to Medicare and Medicaid for their current cost
report years (the "Current Cost Reports"; similar Cost Reports for prior
periods are referred to as the "Prior Cost Reports") within the time periods
required under said agreements, laws, rules and regulations. Seller shall
cooperate in the preparation of the Cost Reports.

(b) No adjustments or positions shall be taken or agreed to
by Buyer or the Subsidiaries or their successors with respect to the Current
Cost Reports, or with respect to any Cost Reports for prior or subsequent
periods, which would create any claims on the part of Buyer pursuant to Article
11 without prior written consent of Seller. With respect to rights retained by
Seller relating to Prior Cost Reports, Seller shall not agree to any adjustment
or take any position which would adversely effect Buyer or the Subsidiaries or
their successors without prior written consent of Buyer. In the event that
Seller and Buyer fail to agree on any such adjustments or positions, either of
Seller or Buyer may cause the matter to be resolved by arbitration; provided,
however, that the arbitrator chosen by the parties shall have experience with
and understanding of the rules and regulations of the Payor with which the Cost
Report in question is to be filed and in the preparation of Cost Reports. The
matter shall be resolved within the time for filing such Cost Reports, or
within the time required for taking any action with respect thereto, including
such extensions as Buyer can cause the Subsidiaries to obtain using the best
efforts of said companies.

(c) NovaCare shall prepare and file its Home Office Cost
Statement for the fiscal year beginning on July 1, 1994 and ending on June 30,
1995 within the time period required pursuant to applicable laws and
regulations. Buyer agrees to include NovaCare's home office expenses in the
applicable Subsidiaries' Cost Reports and to cause RSC and the Subsidiaries to
deliver to NovaCare within ten days after their receipt thereof any payments
made by Medicare or other cost-based payors based on such Cost Reports or based
on the Home Office Cost Statement for prior periods, or any appeals of such
reports.

(d) The Closing Balance Sheet will contain Receivables
representing amounts Seller determines are payable by Medicare to the
Subsidiaries pursuant to the Current Cost Reports and the Prior Cost Reports.
A separate schedule identifying these amounts based on the financial data in
the Closing Balance Sheet and back-up materials will be prepared and delivered
by Seller along with the Closing Balance Sheet. In addition, RSC and the
Subsidiaries may receive payments from Medicare or other cost-based payors
pursuant to appeals of items contained in the Prior Cost Reports. Buyer agrees
to cause RSC and the Subsidiaries to deliver to NovaCare, Inc. within ten days
after their receipt thereof (i) any payments based on the Current Cost Reports
in excess of the amounts reflected on such schedule; and (ii) any payments
based on the Prior Cost Reports in excess of the amounts reflected on such
schedule.

(e) Buyer, RSC or the Subsidiaries may be obligated to repay
Medicare or other cost-based payors for amounts which were reflected on Prior
Cost Reports or on the Current Cost Reports. Seller agrees to reimburse Buyer,
within ten days after such repayment is made, to the extent such repayments
exceed the amounts reflected on the schedule referred to in 5.7(d) as a
liability for such repayment. In such event, Buyer and Seller shall mutually
agree on whether to appeal the determination resulting in such repayment
obligation.

21
<PAGE> 28
ARTICLE 6
ADDITIONAL COVENANTS OF SELLER

Seller hereby additionally covenants, promises and agrees as follows:

Section 6.1 Conduct Pending Closing. Prior to consummation of the
Transaction contemplated hereby or the termination or expiration of this
Agreement pursuant to its terms, unless Buyer shall otherwise consent in
writing, which consent shall not be unreasonably withheld or delayed, and
except for actions taken pursuant to Real Property or Other Contracts, or which
arise from or are related to the anticipated transfer of the RSC Shares, or as
otherwise contemplated by this Agreement or disclosed in Schedule 6.1 or
another Schedule to this Agreement, Seller shall, and shall cause RSC and the
Subsidiaries to:

(a) Conduct the business represented by, and otherwise deal
with, the Facilities only in the usual and ordinary course, materially
consistent with practices followed prior to the execution of this Agreement;

(b) Use reasonable efforts to keep intact the Facilities and
the business they represent and to preserve relationships beneficial to such
business that physicians, patients, Payors, suppliers and others have with the
Facilities;

(c) Except as required by their terms, not amend, terminate,
renew, fail to renew or renegotiate any material contract, except in the
ordinary course of business and consistent with practices of the recent past,
or default (or take or omit to take any action that, with or without the giving
of notice or passage of time, would constitute a default) in any of its
obligations under any such contracts, that would be a Real Property Lease or
Other Contract as of the date hereof;

(d) Not sell, lease, mortgage, encumber, or otherwise dispose
of or grant any interest in, or permit or suffer to exist any lien or
encumbrance upon or the disposition of, any Facility, Inventory, or items of
Equipment having an undepreciated book value in excess of $25,000, including
without limitation any of its leasehold interests therein, whether by the
taking of action or the failure to take action, except for (i) sales of
Inventory in the ordinary course, (ii) liens constituting Permitted
Encumbrances, or (iii) sales or dispositions of Equipment in the ordinary
course of business that are consistent with practices of the recent past;

(e) Maintain in force and effect the insurance policies
identified in Section 3.19(c);

(f) Not enter into any contract that will constitute a Real
Property Lease or Other Contract as of the Closing except in the ordinary
course of business and consistent with practices of the recent past; or

(g) Not grant any general or uniform increase in the rates of
pay or benefits to employees of the Facilities (or a class thereof) or any
increase in salary or benefits of any chief executive or financial officer of
any Facility, except for compensation previously agreed to prior to the date
hereof;

provided that nothing in this Section shall (i) obligate Seller or any
Subsidiary to make expenditures other than in the ordinary course of business
and consistent with practices of the recent past or to otherwise

22
<PAGE> 29
suffer any economic detriment, or (ii) preclude Seller from paying, prepaying
or otherwise satisfying any liability of RSC or any Subsidiary.

Section 6.2 Access and Information; Environmental Survey; Remediation
or Adjustment.

(a) Subject to the restrictions set forth in Section 5.6
respecting confidentiality, Seller shall, and shall cause the Subsidiaries to,
afford Buyer, and the counsel, accountants and other representatives of Buyer,
reasonable access, throughout the period from the date hereof to the Closing,
to the Facilities and the employees, personnel and medical staff associated
therewith and all the properties, books, contracts, commitments, cost reports
and records respecting RSC, the Subsidiaries and the Facilities (regardless of
where such information may be located). Such access shall be afforded after no
less than 24 hours' prior written notice, during normal business hours whenever
reasonably possible and only in such manner so as not to disturb patient care
or to interfere with the normal operations of the Facilities. Seller's
covenants under this Section are made with the understanding that Buyer shall
use all such information in compliance with all Laws.

(b) At least ten business days prior to the Closing, Seller
shall, if so requested by Buyer, provide to Buyer copies of an environmental
survey conducted (at Buyer's expense) with respect to each of the Facilities
(the "Environmental Survey"). The Environmental Survey shall be conducted by
an environmental consulting firm or firms (the "Consultant") and in accordance
with such reasonable procedures as are jointly determined by Seller and Buyer.
The results of any such Environmental Survey shall be delivered to and owned by
Seller, and all proceedings in connection with the Environmental Survey and the
results thereof shall be subject to the confidentiality provisions of Section
5.6 and such other restrictions as Seller may impose in its reasonable
discretion. Buyer acknowledges and agrees that the Environmental Survey shall
be only an initial "Phase I" environmental site assessment. If subsequently
agreed by Seller and Buyer, after consultation with Consultant, to be necessary
or prudent and if Seller and Buyer jointly thereafter direct the Consultant to
undertake the same (at Buyer's sole cost and expense), the Environmental Survey
may include a further "Phase II" investigation respecting certain Facilities.
In any "Phase II" investigation, Seller shall give Buyer no less than 24 hours'
notice before the Consultant enters onto any Facility, and the "Phase II"
Environmental Survey shall be conducted so as not to interfere with the normal
operation of the Facilities. Buyer shall be permitted to have one of its
employees present during all inspections of, and sample gatherings (including
borings) from the soil or any floor tile, insulation or other internal
component of, a Facility.

(c) With respect to any matters disclosed by such
Environmental Survey that would constitute a breach of Seller's warranties in
Section 3.15, but for the qualifications to such warranties based on Seller's
knowledge or disclosures in the Environmental Survey, Seller will at its
election, either (i) clean up or otherwise remediate such matters in a
reasonable manner prior to the Closing Date, at its expense; or (ii) reimburse
Buyer for the costs of such reasonable clean-up or remediation incurred by
Buyer after the Closing Date, provided Seller shall have approved such costs in
advance and in writing (such approval not unreasonably to be withheld).

(d) Promptly after execution and delivery of this Agreement,
Seller shall provide, or shall cause RSC or any applicable Subsidiary to
provide, Buyer with a copy of the most recent title binder, commitment or
policy in the possession of any of the foregoing entities with respect to the
Owned Real Property and the Leased Real Property, together with any
documentation in any of such entities' possession relating to any exceptions or
encumbrances reflected on such title binders, commitments or policies.

23
<PAGE> 30
Section 6.3 Updating. Seller shall notify Buyer of any changes or
additions to any of Seller's Schedules to this Agreement by the delivery of
updates thereof, if any, not later than five business days prior to the
Closing, provided, however, that the Financial Schedule shall not be updated to
cover any period or periods subsequent to the respective dates thereof. No
such updates made pursuant to this Section shall be deemed to cure any breach
of any representation or warranty made in this Agreement, unless Buyer
specifically agrees thereto in writing, nor shall any such notification be
considered to constitute or give rise to a waiver by Buyer of any condition set
forth in this Agreement. Seller has delivered to Buyer all Other Contracts and
leases that Seller has knowledge of, if such contracts were located at the
corporate offices of Seller. Seller shall deliver all Other Contracts and
leases which it is obligated to deliver pursuant to this Agreement within seven
business days after the date hereof. Unless performance under such contracts
or leases would have a Material Adverse Effect (as defined in Section 3.4),
Buyer shall have no claim against Seller based on the delivery after the date
hereof rather than before execution of this Agreement.

Section 6.4 No Solicitation. Seller will not, and shall cause RSC
and the Subsidiaries not to, and will use its best efforts to cause its and
their officers, employees, agents and representatives (including any investment
banker) not to, directly or indirectly, solicit, encourage or initiate any
discussions with, or, subject to fiduciary duties to shareholders, negotiate or
otherwise deal with, or provide any information to, any corporation,
partnership, person or other entity or group, other than Buyer and its
officers, employees and agents, concerning any sale of or similar transactions
involving RSC, the Facilities or the stock of the Subsidiaries. None of the
foregoing shall prohibit providing information to others in a manner in keeping
with the ordinary conduct of Seller's or the Subsidiaries' businesses.

Section 6.5 Filing of Cost Reports. Seller shall cause to be
prepared and timely filed all Cost Reports which are required to be filed prior
to the Closing Date with Medicare and any other cost-based Payors with respect
to the operations of the Facilities for any and all periods ending prior to the
Closing Date.

ARTICLE 7
ADDITIONAL COVENANTS OF BUYER

Section 7.1 Waiver of Bulk Sales Law Compliance. Subject to the
indemnification provisions of Section 11.3(a)(iii) hereof, Buyer hereby waives
compliance by Seller and the Subsidiaries with the requirements, if any, of
Article 6 of the Uniform Commercial Code as in force in any state in which the
Facilities are located and all other similar laws applicable to bulk sales and
transfers.

Section 7.2 Cost Reports and Audit Contests. After the Closing and
for the period of time necessary to conclude any pending or potential audit or
contest of any Cost Reports with respect to the Facilities that include periods
ending on or before the Closing Date, Buyer shall properly keep and preserve
all financial books and records delivered to Buyer by Seller and the
Subsidiaries (if any) and utilized in preparing such Reports, including,
without limitation, accounts payable invoices, Medicare logs and billing
information in accordance with Section 5.7. Upon reasonable written notice by
Seller, Seller (or its agents) shall be entitled, at Seller's expense, during
regular business hours, to have access to, inspect and make copies of all such
books and records. Upon the reasonable request of Seller, Buyer shall assist
Seller and the Subsidiaries in obtaining information deemed by Seller to be
necessary or desirable in connection with any audit or contest of such reports.
To the extent required to meet its

24
<PAGE> 31
obligations under this Section, Buyer shall provide the reasonable support of
its employees at no cost to Seller.

Section 7.3 Letters of Credit. Subject to the terms and conditions
hereof, at the Closing, Buyer shall cause guaranties, letters of credit and
indemnity or performance bonds to be provided to substitute for those letters
of credit and bonds listed in Schedule 7.3, so that at and as of the Closing
Seller and its Affiliates shall have no further obligation to provide such
designated letters of credit or bonds. Buyer shall use its reasonable
commercial efforts to cause the release of NovaCare promptly after Closing from
any guaranties related to the business of RSC or the Subsidiaries, provided
that such guaranties have been disclosed to Buyer in writing.

ARTICLE 8
BUYER'S CONDITIONS TO CLOSING

The obligations of Buyer to consummate the Transactions at the Closing
shall be subject to the fulfillment at or prior to the Closing of the following
conditions, unless Buyer waives such fulfillment:

Section 8.1 Performance of Agreement. Seller shall have performed in
all material respects its agreements and obligations contained in this
Agreement required to be performed on or prior to the Closing.

Section 8.2 Accuracy of Representations and Warranties. The
representations and warranties of Seller set forth in Article 3 of this
Agreement shall be true in all respects as of the date of this Agreement
(unless the inaccuracy or inaccuracies which would otherwise result in a
failure of this condition have been cured by the Closing) and as of the Closing
(as updated by the revising of Schedules contemplated by Section 6.3) as if
made as of such time, except where such inaccuracy or inaccuracies would not
individually or in the aggregate result in a Material Adverse Effect on RSC and
the Subsidiaries.

Section 8.3 Officer's Certificate. Buyer shall have received from
Seller an officer's certificate, executed on Seller's behalf by its chief
executive officer, president, chief financial officer or treasurer (in his or
her capacity as such) dated the Closing Date and stating that to the actual
knowledge of such individual, after inquiry of the other officers identified in
this Section 8.3, the conditions in Sections 8.1 and 8.2 above have been met.

Section 8.4 Consents. The waiting period under the HSR Act shall
have expired or been terminated.

Section 8.5 Absence of Injunctions. There shall not be in effect a
temporary restraining order or a preliminary or permanent injunction or other
order, decree or ruling by a court of competent jurisdiction or by a
governmental agency which restrains or prohibits Buyer's acquisition or
operation of the Facilities, provided that the parties will use their
reasonable efforts to litigate against the entry of, or to obtain the lifting
of, any such order or injunction, and the existence of any such temporary
restraining order or preliminary injunction shall operate, at the option of
Seller, only to delay the Closing (and extend the Termination Date) until the
thirtieth day following the lifting of any such order or injunction, except
that such delay may not extend the original Termination Date for more than nine
months.

25
<PAGE> 32
Section 8.6 Opinion of Counsel. Buyer shall have received, on and as
of the Closing Date, an opinion of Peter D. Bewley, Esq., counsel to Seller,
substantially as to the matters set forth in Sections 3.1, 3.2, 3.3, 3.4(a),
and 3.4(c) (to the knowledge of such counsel), subject to customary conditions
and limitations.

Section 8.7 Receipt of Other Documents. Buyer shall have received
the following:

(a) Certified copies of the resolutions of Seller's board of
directors respecting this Agreement, the Related Agreements and the
Transaction, together with certified copies of any stockholder resolutions
which are necessary to approve the execution and delivery of this Agreement and
any Related Agreements and/or the performance of the obligations of Seller
hereunder and thereunder;

(b) Certified copies of Seller's, RSC's and each Subsidiary's
Charter Documents, together with a certificate of the corporate secretary of
each that none of such documents have been amended;

(c) One or more certificates as to the incumbency of each
officer of Seller or of RSC or of any Subsidiary who has signed the Agreement,
any Agreement or any certificate, document or instrument delivered pursuant to
the Agreement or any Agreement;

(d) Good standing certificates for Seller, RSC and each of
the Subsidiaries from the Secretaries of State of their respective states of
incorporation dated as of a date not earlier than 30 days prior to the Closing
Date; and

(e) Copies of all third party and governmental consents,
permits and authorizations that Seller or any Subsidiary has received in
connection with the Agreement, the Agreements and the Transactions.

Section 8.8 Certificates of Need and Consents. The consent of the
West Virginia Health Care Cost Review Authority ("HCCRA") or other applicable
authority for facilities in other states and the issuance of a Certificate of
Need is legally required for Buyer to operate certain of the Subsidiaries after
Closing. In addition, other approvals, consents, authorizations and waivers
from governmental and accreditation agencies and from other third parties are
required to consummate the transactions. If such approvals, consents,
authorizations, waivers or issuance with respect to one or more of the
Subsidiaries has not been obtained within three days before the date Closing
would otherwise have occurred pursuant to this Agreement, the following
procedure shall be followed:

(i) The shares of the affected Subsidiary or Subsidiaries
which are owned by RSC shall be transferred from RSC to Seller.

(ii) Seller shall then deposit such shares with an escrow
agent (the "Escrow Agent") chosen by the parties pursuant to the
mechanism in Section 2.8.

(iii) When the approval and issuance of a Certificate of
Need and delivery of consents, authorizations or waivers to Buyer with
respect to such Subsidiary occurs, the Escrow Agent shall deliver the
shares of such Subsidiary of Buyer.

26
<PAGE> 33
(iv) If the approval and issuance with respect to any
Subsidiary is not approved within six months after Closing, or such
longer period as Buyer may determinie, Buyer shall use commercially
reasonable efforts to resell the shares of such Subsidiary to a buyer
who is able to obtain the required Certificate of Need. Buyer shall
be entitled to retain any proceeds from such sale and shall be subject
to any liabilities or obligations in connection with such sale. Upon
closing of such sale, the Escrow Agent shall deliver the escrowed
shares of such Subsidiary to Buyer.

(v) After Closing, and until release of the shares of
each Subsidiary from escrow, Buyer shall operate the Subsidiary
pursuant to a Management Agreement. Buyer shall be entitled to any
income with respect to each Subsidiary it manages and shall be liable
for any expenses or liabilities with respect to such Subsidiary;
provided, however, that all employees providing services to the
Subsidiary shall remain employees of the Subsidiary and Buyer and the
Subsidiary shall enter into appropriate arrangements to cause Buyer to
bear all compensation expense of such employees.

(vi) Within two weeks after execution of this Agreement,
Buyer and Seller shall agree on the form of Escrow Agreement,
designation of Escrow Agent, and form of Management Agreement to
effectuate the foregoing process. If they are unable to reach
agreement by such time, the dispute shall be settled pursuant to the
mechanism in Section 2.8.

ARTICLE 9
SELLER'S CONDITIONS TO CLOSING

The obligations of Seller to consummate the Transaction at the Closing
shall be subject to the fulfillment at or prior to the Closing of the following
conditions, unless Seller waives such fulfillment:

Section 9.1 Performance of Agreement. Buyer shall have performed in
all material respects its agreements and obligations contained in this
Agreement required to be performed on or prior to the Closing.

Section 9.2 Accuracy of Representations and Warranties. The
representations and warranties of Buyer set forth in Article 4 of this
Agreement shall be true in all material respects as of the date of this
Agreement (unless the inaccuracy or inaccuracies which would otherwise result
in a failure of this condition have been cured by the Closing) and as of the
Closing as if made as of such time.

Section 9.3 Officer's Certificate. Seller shall have received from
Buyer an officers' certificate, executed on Buyer's behalf by its chief
executive officer, president, chief financial officer or treasurer (in his or
her capacity as such) dated the Closing Date and stating that to the actual
knowledge of such individual after inquiry of the other officers identified in
this Section 9.3, the conditions in Sections 9.1 and 9.2 above have been met.

Section 9.4 Consents. The waiting period under the HSR Act shall
have expired or been terminated, and, subject to the provisions of Sections
2.6, 2.7 and 2.8, all approvals, consents, authorizations and waivers from
governmental and accreditation agencies and from other third parties required
for Seller to consummate the Transaction shall have been obtained, except for
such approvals, consents,

27
<PAGE> 34
authorizations and waivers the failure to obtain which will not, individually
or in the aggregate, result in a Material Adverse Effect on Seller following
the Closing.

Section 9.5 Absence of Injunctions. There shall not be in effect a
temporary restraining order or a preliminary or permanent injunction or other
order, decree or ruling by a court of competent jurisdiction or by a
governmental agency which restrains or prohibits Seller's consummation of the
Transaction, or any threat by governmental authorities to exact any penalty or
impose any economic detriment upon Seller if it consummates the Transactions
that would have a Material Adverse Effect upon Seller following the Closing,
provided that the parties will use their reasonable efforts to litigate against
the entry of, or to obtain the lifting of, any such order, injunction or
potential penalty or imposition, and the existence of any such temporary
restraining order, preliminary injunction or potential penalty or imposition
shall operate, at the option of Seller, only to delay the Closing (and extend
the Termination Date) until the thirtieth day following the lifting of any such
order or injunction or threat, except that such delay may not extend the
original Termination Date for more than nine months.

Section 9.6 Opinion of Counsel. Seller shall have received, on and
as of the Closing Date, an opinion ofWilliam W. Horton, Esq., counsel to
Buyer, substantially as to the matters set forth in Sections 4.1, 4.2, 4.3(a),
and 4.3(c) (to the knowledge of such counsel), subject to customary conditions
and limitations.

Section 9.7 Receipt of Other Documents. Seller shall have received
the following:

(a) Certified copies of the resolutions of Buyer's board of
directors respecting this Agreement, the Related Agreements and the
Transactions;

(b) Certified copies of Buyer's Charter Documents, together
with a certificate of Buyer's corporate secretary that none of such documents
have been amended;

(c) One or more certificates as to the incumbency of each
officer of Buyer who has signed the Agreement, any Related Agreement, or any
certificate, document or instrument delivered pursuant to the Agreement or any
Related Agreement;

(d) Good standing certificates for Buyer and for each Buyer
Subsidiary from the Secretaries of State of the State of Delaware dated as of a
date not earlier than 30 days prior to the Closing Date;

(e) Copies of all third party and governmental consents,
permits and authorizations that Buyer has received in connection with the
Agreement, the Related Agreements and the Transactions; and

(f) A certificate of Buyer executed on its behalf by the
Chief Executive Officer, the Chief Financial Officer or the Treasurer of Buyer
stating that to the best of their knowledge and belief, specifying in
reasonable detail their basis for same, after giving effect to the Transaction,
neither Buyer nor any of its Subsidiaries is insolvent or will be rendered
insolvent by obligations incurred in connection therewith, or will be left with
unreasonably small capital with which to engage in their businesses, or will
have incurred obligations beyond their respective abilities to perform the same
as and when due.

28
<PAGE> 35
ARTICLE 10
TERMINATION

Section 10.1 Termination. This Agreement and the transactions
contemplated hereby may be terminated at any time prior to the Closing:

(a) By mutual consent of Seller and Buyer; or

(b) By either Buyer or Seller upon written notice to the
other party, if (i) the Closing shall not have occurred by the later of April
30, 1995, the fifth business day following the expiration of the HSR waiting
period, or such later date as may be provided for in this Agreement or agreed
upon by the parties (the "Termination Date"); or (ii)(A) in the case of
termination by Seller, the conditions set forth in Article 9 cannot reasonably
be met by the Termination Date, and (B) in the case of termination by Buyer,
the conditions set forth in Article 8 cannot reasonably be met by the
Termination Date, unless in either of the cases described in clauses (A) or
(B), the failure of the condition is the result of the material breach of this
Agreement by the party seeking to terminate.

Each party's right of termination hereunder is in addition to any other rights
it may have hereunder or otherwise.

Section 10.2 Effect of Termination. In the event this Agreement is
terminated pursuant to Section 10.1, all further obligations of the parties
hereunder shall terminate, except that the obligations set forth in Sections,
5.5 and 5.6 and in Articles 11 and 12 shall survive. In the event of
termination of this Agreement as provided above, there shall be no liability on
the part of a party to another under and by reason of this Agreement or the
transactions contemplated hereby except as set forth in Article 11 and except
for fraudulent acts by a party, the remedies for which shall not be limited by
the provisions of this Agreement. The foregoing provisions shall not, however,
limit or restrict the availability of specific performance or other injunctive
or equitable relief to the extent that specific performance or such other
relief would otherwise be available to a party hereunder.

ARTICLE 11
SURVIVAL AND REMEDIES; INDEMNIFICATION

Section 11.1 Survival. Except as may be otherwise expressly set
forth in this Agreement, the representations, warranties, covenants and
agreements of Buyer and Seller set forth in this Agreement, or in any writing
required to be delivered in connection with this Agreement, shall survive the
Closing and the consummation of the Transactions.

Section 11.2 Exclusive Remedy. Absent fraud, the sole exclusive
remedy for damages of a party hereto for any breach of the representations,
warranties, covenants and agreements of the other party contained in this
Agreement and the Agreements shall be the remedies contained in this Article
11.

29
<PAGE> 36
Section 11.3 Indemnity by Seller.

(a) Seller shall indemnify Buyer and hold Buyer harmless from
and against any and all loss, liability, damage and expense, including
reasonable attorneys' fees and costs of investigation, litigation, settlement
and judgment (collectively "Losses"), which Buyer may sustain or suffer or to
which Buyer may become subject as a result of:

(i) The inaccuracy of any representation or the
breach of any warranty made by Seller herein or in a Agreement,
provided that any such inaccuracy or breach shall be determined
without regard to any qualification of such representation or warranty
based upon the absence of a Material Adverse Effect on the Transferred
Assets; and

(ii) The nonperformance or breach of any covenant or
agreement made or undertaken by Seller in this Agreement or in any
Related Agreement.

(b) The indemnification obligations of Seller provided above
shall, in addition to the qualifications and conditions set forth in Sections
11.5 and 11.6, be subject to the following qualifications:

(i) Buyer shall not be entitled to indemnity under
Section 11.3(a)(i) above unless:

(A) Written notice to Seller of such claim
specifying the basis thereof is made, or an action at law or
in equity with respect to such claim is served, before the
second anniversary of the earlier to occur of the Closing Date
or the date on which this Agreement is terminated, as the case
may be;

(B) If the Closing occurs, the Losses
sustained or suffered by Buyer or to which it may be subject
as a result of circumstances described in such Section
11.3(a)(i) exceeds, in the aggregate, $3,000,000 (the
"Deductible Amount"), provided, however, that individual
claims of $10,000 or less shall not be aggregated for purposes
of calculating the Deductible Amount or the excess of Losses
over the Deductible Amount; and

(C) If the Closing occurs, in no event shall
Seller be liable to Buyer under Section 11.3 for (1) amounts
which, in the aggregate, exceed 100% of the Purchase Price or
(2) amounts below the Deductible Amount.

(ii) If the Closing occurs, Buyer shall not be
entitled to indemnity under Subsection (a)(ii) above except for
out-of-pocket Losses actually suffered or sustained by Buyer or to
which Buyer may become subject as a result of circumstances described
in such Subsections (a)(ii), and such indemnity shall not include
Losses in the nature of consequential damages, lost profits,
diminution in value, damage to reputation or the like.

Section 11.4 Indemnity by Buyer.

(a) Buyer shall indemnify Seller and hold Seller harmless
from and against any and all Losses which they may sustain or suffer or to
which it may become subject as a result of:

30
<PAGE> 37
(i) The inaccuracy of any representation or the
breach of any warranty made by Buyer herein or in a Agreement;

(ii) The nonperformance or breach of any covenant or
agreement made or undertaken by Buyer in this Agreement or in any
Related Agreement;

(iii) If the Closing occurs, the ongoing operations
of Buyer, RSC, the Subsidiaries and the Facilities after the Closing
Date.

(b) The indemnification obligations of Buyer provided above
shall, in addition to the qualifications and conditions set forth in Sections
11.5 and 11.6, be subject to the following qualifications:

(i) Seller shall not be entitled to indemnity under
Section 11.4(a)(i) above unless:

(A) Written notice to Buyer of such claim
specifying the basis thereof is made, or an action at law or
in equity with respect to such claim is served, before the
first anniversary of the earlier to occur of the Closing Date
or the date on which this Agreement is terminated, as the case
may be; and

(B) If the Closing occurs, the Losses
sustained or suffered by Seller or to which it may be subject
as a result of circumstances described in such Section
11.4(a)(i) exceeds, in the aggregate, the Deductible Amount,
provided, however, that individual claims of $10,000 or less
shall not be aggregated for purposes of calculating the
Deductible Amount or the excess of Losses over the Deductible
Amount; and

(C) If the Closing occurs, in no event shall
Buyer be liable to Seller under Section 11.4(a)(i) for amounts
below the Deductible Amount.

(ii) If the Closing occurs, Seller and the
Subsidiaries shall not be entitled to indemnity under Sections
11.4(a)(ii)-(iii) above except for out-of-pocket Losses actually
suffered or sustained by them or to which they may become subject as a
result of circumstances described in such Sections 11.4(a)(ii)-(iii),
and such indemnity shall not include Losses in the nature of
consequential damages, lost profits, diminution in value, damage to
reputation or the like.

Section 11.5 Further Qualifications Respecting Indemnification. The
right of a party (an "Indemnitee") to indemnity hereunder shall be subject to
the following additional qualifications:

(a) The Indemnitee shall promptly upon its discovery of facts
or circumstances giving rise to a claim for indemnification, including receipt
by it of notice of any demand, assertion, claim, action or proceeding,
judicial, governmental or otherwise, by any third party (such third party
actions being collectively referred to herein as "Third Party Claims"), give
notice thereof to the indemnifying party (the "Indemnitor"), such notice in any
event to be given within 60 days from the date the Indemnitee obtains actual
knowledge of the basis or alleged basis for the right of indemnity or such
shorter period as may be necessary to avoid material prejudice to the
Indemnitor; and

(b) In computing Losses, such amounts shall be computed net
of any related recoveries to which the Indemnitee is entitled under insurance
policies or other related payments received or

31
<PAGE> 38
receivable from third parties and net of any tax benefits actually received by
the Indemnitee or for which it is eligible, taking into account the income tax
treatment of the receipt of indemnification.

Section 11.6 Procedures Respecting Third Party Claims. In providing
notice to the Indemnitor of any Third Party Claim (the "Claim Notice"), the
Indemnitee shall provide the Indemnitor with a copy of such Third Party Claim
or other documents received and shall otherwise make available to the
Indemnitor all relevant information material to the defense of such claim and
within the Indemnitee's possession. The Indemnitor shall have the right, by
notice given to the Indemnitee within 15 days after the date of the Claim
Notice, to assume and control the defense of the Third Party Claim that is the
subject of such Claim Notice, including the employment of counsel selected by
the Indemnitor after consultation with the Indemnitee, and the Indemnitor shall
pay all expenses of, and the Indemnitee shall cooperate fully with the
Indemnitor in connection with, the conduct of such defense. The Indemnitee
shall have the right to employ separate counsel in any such proceeding and to
participate in (but not control) the defense of such Third Party Claim, but the
fees and expenses of such counsel shall be borne by the Indemnitee unless the
Indemnitor shall agree otherwise. If the Indemnitor shall have failed to
assume the defense of any Third Party Claim in accordance with the provisions
of this Section, then the Indemnitee shall have the absolute right to control
the defense of such Third Party Claim, and, if and when it is finally
determined that the Indemnitee is entitled to indemnification from the
Indemnitor hereunder, the fees and expenses of Indemnitee's counsel shall be
borne by the Indemnitor, provided that the Indemnitor shall be entitled, at its
expense, to participate in (but not control) such defense. The Indemnitor
shall have the right to settle or compromise any such Third Party Claim for
which it is providing indemnity so long as such settlement does not impose any
obligations on the Indemnitee (except with respect to providing releases of the
third party). The Indemnitor shall not be liable for any settlement effected
by the Indemnitee without the Indemnitor's consent. The Indemnitor may assume
and control, or bear the costs, of any such defense subject to its reservation
of a right to contest the Indemnitee's right to indemnification hereunder,
provided that it gives the Indemnitee notice of such reservation within 15 days
of the date of the Claim Notice.

ARTICLE 12
GENERAL PROVISIONS

Section 12.1 Notices. All notices, requests, demands, waivers,
consents and other communications hereunder shall be in writing, shall be
delivered either in person, by telegraphic, facsimile or other electronic
means, by overnight air courier or by mail, and shall be deemed to have been
duly given and to have become effective (a) upon receipt if delivered in person
or by telegraphic, facsimile or other electronic means calculated to arrive on
any business day prior to 5:30 p.m. local time at the address of the addressee,
or on the next succeeding business day if delivered on a non-business day or
after 5:30 p.m. local time, (b) one business day after having been delivered to
an air courier for overnight delivery or (c) five business days after having
been deposited in the mails as certified or registered mail, return receipt
requested, all fees prepaid, directed to the parties or their permitted
assignees at the following addresses (or at such other address as shall be
given in writing by a party hereto):

32
<PAGE> 39
If to NovaCare or Seller, addressed to:

NovaCare, Inc.
1016 West Ninth Avenue
King of Prussia, Pennsylvania 19406
Attention: Timothy E. Foster
President and Chief Operating Officer
Facsimile: (610) 992-3326

with a copy to counsel for Seller:

NovaCare, Inc.
1016 West Ninth Avenue
King of Prussia, Pennsylvania 19406
Attention: Peter D. Bewley, Esq.
Facsimile: (610) 902-3341

and

Tucci & Semes
Suite 206
Three Mill Road
Wilmington, Delaware 19806

If to Buyer, addressed to:

HEALTHSOUTH Corporation
Two Perimeter Park South
Birmingham, Alabama 35243
Attention: Richard M. Scrushy
Chairman of the Board, President and
Chief Executive Officer
Facsimile: (205) 969-4729

with a copy to counsel for Buyer:

HEALTHSOUTH Corporation
Two Perimeter Park South
Birmingham, Alabama 35243
Attention: William W. Horton, Esq.
Facsimile: (205) 969-4732

and

33
<PAGE> 40
J. Brooke Johnston, Jr., Esq.
Haskell Slaughter Young & Johnston,
Professional Association
1200 AmSouth/Harbert Plaza
1901 Sixth Avenue North
Birmingham, Alabama 35203
Facsimile: (205) 324-1133

Section 12.2 Attorneys' Fees. In any litigation or other proceeding
relating to this Agreement, including litigation with respect to any
Agreement, the prevailing party shall be entitled to recover its costs and
reasonable attorneys' fees. The term "prevailing party" shall mean the party
in whose favor final judgment after appeal (if any) is rendered with respect to
the claims asserted in such litigation or other proceeding. "Reasonable
attorneys' fees" are no greater than those attorneys' fees actually incurred in
obtaining a judgment or other determination in favor of the prevailing party.

Section 12.3 Successors and Assigns. The rights under this Agreement
shall not be assignable or transferable nor the duties delegable by either
party without the prior written consent of the other; and nothing contained in
this Agreement, express or implied, is intended to confer upon any person or
entity, other than the parties hereto and their permitted
successors-in-interest and permitted assignees, any rights or remedies under or
by reason of this Agreement unless so stated to the contrary.

Section 12.4 Counterparts. This Agreement may be executed in one or
more counterparts, each of which shall be deemed an original, but all of which
together shall constitute one and the same instrument.

Section 12.5 Captions and Paragraph Headings. Captions and paragraph
headings used herein are for convenience only and are not a part of this
Agreement and shall not be used in construing it.

Section 12.6 Entirety of Agreement; Amendments. This Agreement
(including the Schedules and Exhibits hereto) and the other documents and
instruments specifically provided for in this Agreement contain the entire
understanding between the parties concerning the subject matter of this
Agreement and such other documents and instruments and, except as expressly
provided for herein, supersede all prior understandings and agreements, whether
oral or written, between them with respect to the subject matter hereof and
thereof. There are no representations, warranties, agreements, arrangements or
understandings, oral or written, between the parties hereto relating to the
subject matter of this Agreement and such other documents and instruments which
are not fully expressed herein or therein. This Agreement may be amended or
modified only by an agreement in writing signed by each of the parties hereto.
All Exhibits and Schedules attached to or delivered in connection with this
Agreement are integral parts of this Agreement as if fully set forth herein,
and all statements appearing therein shall be deemed disclosed for all purposes
and not only in connection with the specific provision in which they are
explicitly referenced.

Section 12.7 Construction. This Agreement and any documents or
instruments delivered pursuant hereto shall be construed without regard to the
identity of the person who drafted the various provisions of the same. Each
and every provision of this Agreement and such other documents and instruments
shall be construed as though the parties participated equally in the drafting
of the same. Consequently, the parties acknowledge and agree that any rule of
construction that a document is to be

34
<PAGE> 41
construed against the drafting party shall not be applicable either to this
Agreement or such other documents and instruments.

Section 12.8 Waiver. The failure of a party to insist, in any one or
more instances, on performance of any of the terms, covenants and conditions of
this Agreement shall not be construed as a waiver or relinquishment of any
rights granted hereunder or of the future performance of any such term,
covenant or condition, but the obligations of the parties with respect thereto
shall continue in full force and effect. No waiver of any provision or
condition of this Agreement by a party shall be valid unless in writing signed
by such party or operational by the terms of this Agreement. A waiver by one
party of the performance of any covenant, condition, representation or warranty
of the other party shall not invalidate this Agreement, nor shall such waiver
be construed as a waiver of any other covenant, condition, representation or
warranty. A waiver by any party of the time for performing any act shall not
constitute a waiver of the time for performing any other act or the time for
performing an identical act required to be performed at a later time.

Section 12.9 Governing Law. This Agreement shall be governed in all
respects, including validity, interpretation and effect, by the laws of the
Commonwealth of Pennsylvania, without regard to the principles of conflicts of
law thereof.

Section 12.10 Severability. Whenever possible, each provision of
this Agreement shall be interpreted in such manner as to be valid, binding and
enforceable under applicable law, but if any provision of this Agreement is
held to be invalid, void (or voidable) or unenforceable under applicable law,
such provision shall be ineffective only to the extent held to be invalid, void
(or voidable) or unenforceable, without affecting the remainder of such
provision or the remaining provisions of this Agreement.

Section 12.11 Consents Not Unreasonably Withheld. Wherever the
consent or approval of any party is required under this Agreement, such consent
or approval shall not be unreasonably withheld, unless such consent or approval
is to be given by such party at the sole or absolute discretion of such party
or is otherwise similarly qualified.

Section 12.12 Time Is of the Essence. Time is hereby expressly made
of the essence with respect to each and every term and provision of this
Agreement. The parties acknowledge that each will be relying upon the timely
performance by the other of its obligations hereunder as a material inducement
to each party's execution of this Agreement. Consequently, the parties agree
that they are bound strictly by the provisions concerning timely performance of
their respective obligations contained in this Agreement and that if any
attempt is made by either party to perform an obligation required to be
performed or comply with a provision of this Agreement required to be complied
with in a manner other than in strict compliance with the time period
applicable thereto, even if such purported attempt is but one day late, then
such purported attempt at performance or compliance shall be deemed a violation
of this Section, shall be deemed in contravention of the intention of the
parties hereto, and shall be null and void and of no force or effect.

35
<PAGE> 42
IN WITNESS WHEREOF, the parties have duly executed this
Agreement on the date first above written.

HEALTHSOUTH CORPORATION

By
----------------------------------------

Its
-----------------------------------

NOVACARE, INC.

By
----------------------------------------

Its
-----------------------------------

NC RESOURCES, INC.

By
----------------------------------------

Its
-----------------------------------

<PAGE> 1
EXHIBIT 10(a)

EMPLOYMENT AGREEMENT

AGREEMENT dated as of the first day of July, 1994 by and
between NOVACARE, INC., a Delaware corporation (the "Company"), and JOHN H.
FOSTER (the "Executive").

W I T N E S S E T H :

WHEREAS, the Executive has served as Chairman of the Board of
Directors and Chief Executive Officer of the Company since 1984, and the
Company wishes to continue to retain the Executive in such positions, and the
Executive wishes to continue to serve the Company in such positions, upon the
terms and conditions hereinafter set forth.

NOW, THEREFORE, in consideration of the premises and the
mutual agreements hereinafter set forth, the parties hereto hereby agree as
follows:

1. EMPLOYMENT, TERM, AUTOMATIC EXTENSION.

1.1 Employment. The Company agrees to employ the
Executive, and the Executive agrees to serve in the employ of the Company, for
the term set forth in Section 1.2, in the positions and with the
responsibilities, duties and authority set forth in Section 2 and on the other
terms and conditions set forth in this Agreement.

1.2 Term. The term of the Executive's employment under
this Agreement shall commence on the date hereof and shall terminate on
December 31, 1998, unless extended or sooner terminated in accordance with this
Agreement.

1.3 Automatic Extension. As of December 31, 1997, and
December 31 on each subsequent year (each, an "Automatic Renewal Date"), unless
either party shall have given a notice of non-extension prior to such Automatic
Renewal Date, the term of this Agreement shall be extended automatically for a
period of one year to the anniversary of the expiration date of the
then-current term of this Agreement. Once a notice of non-extension shall have
been given by either party, there shall be no further automatic extension of
this Agreement.

2. POSITION, DUTIES.

The Executive shall serve in the positions of Chairman of the
Board of Directors and Chief Executive Officer of the Company. The Executive
shall perform, faithfully and diligently,
<PAGE> 2
2

such duties, and shall have such responsibilities, appropriate to said
positions, as shall be assigned to him from time to time by the Board of
Directors of the Company. The Executive shall report directly to the Board of
Directors of the Company. The Executive shall devote such time and attention
to the performance of his duties and responsibilities hereunder as shall be
necessary for the proper discharge thereof.

3. SALARY, INCENTIVE BONUS, STOCK OPTIONS.

3.1 Salary. During the term of this Agreement, in
consideration of the performance by the Executive of the services set forth in
Section 2 and his observance of the other covenants set forth herein, the
Company shall pay to the Executive, and the Executive shall accept, a base
salary at the rate of $508,000 per annum, payable in accordance with the
standard payroll practices of the Company. The Executive shall be entitled to
such increases in base salary during the term hereof as shall be determined by
the Compensation Committee of the Board of Directors of the Company in its sole
discretion, taking account of the performance of the Company and the Executive,
the size of the Company from time to time, and other factors generally
considered relevant to the salaries of chief executive officers of enterprises
comparable to the Company. In no event shall the base salary of the Executive
be decreased during the term of this Agreement.

3.2 Incentive Bonus. (a) In addition to the base salary
provided for in Section 3.1, the Company shall pay to the Executive an
incentive bonus with respect to each fiscal year of the Company ending during
the term of this Agreement in accordance with this Section 3.2. The incentive
bonus for each fiscal year shall be an amount equal to the product of the
Target Bonus (as hereinafter defined) multiplied by the Applicable Percentage
(as hereinafter defined). Any provision of this Section 3.2 notwithstanding,
the maximum incentive bonus for a fiscal year shall be one hundred fifty
percent (150%) of the Target Bonus, and no incentive bonus shall be payable
with respect to a fiscal year if less than ninety percent (90%) of Budgeted Net
Income is attained.

(b) For purposes of this Section 3.2:

audited financial statements of the Company for such fiscal year. In the event
of any change in the fiscal year of the Company, appropriate adjustments shall
be made to the provisions of this Section 3.2 in order to carry out the
essential intent and principles of this Section 3.2;

(ii) the term "Target Bonus" shall mean,
for any fiscal year of the Company, one percent (1%) of Net Income for such
fiscal year;

(iii) the term "Applicable Percentage"
shall mean, for any fiscal year of the Company, the percentage (expressed as a
decimal) of Budgeted Net Income for such fiscal year attained; provided that,
notwithstanding the foregoing, in the event that the percentage of Budgeted Net
Income attained in a fiscal year (rounded down to the nearest complete
percentage point) is between 90% and 99%, the term Applicable Percentage shall
be determined in accordance with the following table:

<TABLE>
<CAPTION>
Percentage of Budgeted
Net Income Attained Applicable Percentage
---------------------- ---------------------
<S> <C>
90% 30%
91% 37%
92% 44%
93% 51%
94% 58%
95% 65%
96% 72%
97% 79%
98% 86%
99% 93%
</TABLE>

and;

(iv) the term "Budgeted Net Income" shall
mean, for any fiscal year of the Company, net income as set forth in the annual
business plan of the Company for such fiscal year as prepared by the Company's
management and approved by the Board of Directors of the Company.

(c) In the event of the termination of employment
of the Executive pursuant to Section 6.1 (Death), 6.2 (Disability), Section 6.4
(Without Cause), 6.5 (Voluntary Termination), 6.6 (Constructive Termination) or
6.7 (Change of Control) of this Agreement, the Executive (or his estate or
other legal representative) shall be entitled to a bonus for the fiscal year in
which such termination takes place in an amount equal to
<PAGE> 4
4

the product of (i) the bonus for such fiscal year determined pursuant to
Section 3.2(a), multiplied by (ii) a fraction, the numerator of which is the
number of days from the beginning of such fiscal year to the date of
termination, and the denominator of which is 365. In the event of the
termination of employment of the Executive pursuant to Section 6.3 (Due Cause)
of this Agreement, the Executive shall not be entitled to a bonus for the
fiscal year of the Company in which such termination takes place. The
Executive shall not be entitled to a bonus for any fiscal year of the Company
subsequent to the fiscal year in which the termination of his employment
pursuant to Section 6.1 (Death), 6.2 (Disability), 6.3 (Due Cause) or 6.5
(Voluntary Termination) takes place.

(d) The bonus payable to the Executive (or his
estate or other legal representative) for any fiscal year of the Company
pursuant to this Section 3.2 shall be paid by the Company within ten (10) days
of receipt by the Company of the audited financial statements of the Company
for such fiscal year.

3.3 Stock Options. On November 3, 1993 (the "Grant
Date"), the Company granted to the Executive options (the "Options") to
purchase 2,000,000 shares of the Company's common stock, par value $.01 per
share ("Common Stock"), at an exercise price per share equal to $19.50, which
is 150% of the market value of the Common Stock on the Grant Date. The
Options:

(i) have a term of ten (10) years from the Grant
Date;

(ii) become exercisable as to 20% of the
shares covered thereby on the first anniversary of the Grant Date and as to an
additional 20% of such shares on each of the next four anniversaries of the
Grant Date;

(iii) except as provided in clause (iv) of
this Section 3.3, remain exercisable for a period of twelve (12) months
commencing on the date of termination of employment of the Executive, but only
as to those shares as to which the Options were exercisable at the date of
termination;

(iv) become exercisable in full upon a
Change in Control of the Company (as defined in Section 6.7), whether or not
the employment of the Executive shall be terminated, and upon the termination
of the employment of the Executive pursuant to Section 6.1 (Death), Section 6.2
(Disability) or Section 6.4 (Without Due Cause) and, in any such case, shall
remain exercisable for the balance of the ten year term; and
<PAGE> 5
5

(v) are transferable at any time by the
Executive to members of his immediate family or to trusts for the benefit of
the Executive or members of his immediate family.

The Options are or shall be evidenced by a Stock Option Agreement or other
appropriate documentation embodying the foregoing terms and other standard
terms and conditions not inconsistent with the foregoing terms. No additional
stock options are to be issued for the next five fiscal years.

4. EXPENSE REIMBURSEMENT.

During the term of this Agreement, the Company shall reimburse
the Executive for all reasonable and necessary out-of-pocket expenses incurred
by him in connection with the performance of his duties hereunder, upon the
presentation of proper accounts therefor in accordance with the Company's
policies.

5. BENEFITS, PERQUISITES.

5.1 Generally. During the term of this Agreement, the
Executive will be eligible to participate in all employee benefit plans and
programs offered by the Company from time to time to its employees of
comparable seniority, subject to the provisions of such plans and programs as
in effect from time to time.

5.2 Perquisites. (a) The Company agrees to lend the
Executive $700,000 to cover expenses which he has incurred, and expects to
incur, in connection with his relocation from New York, New York to Gladwyne,
Pennsylvania. Such loan shall be made not more than thirty (30) days following
the execution of this agreement, shall bear no interest, and shall be payable
in full June 30, 1999; provided that, notwithstanding the foregoing, $140,000
of the principal amount of such loan shall be forgiven on each June 30
(beginning with June 30, 1995) that the Executive is employed by the Company
until June 30, 1999 (when the full amount of the loan would be forgiven).

(b) In 1994 on July 1 (or as promptly thereafter as
possible), and in 1995, 1996, 1997, 1998 and 1999 on January 2 (or the first
business day thereafter), the Company shall pay to the Executive the Additional
Payment set forth in the second column of Schedule A hereto opposite such year,
in reimbursement of the additional federal, state and local income, health
insurance and other taxes to which it is projected he will become subject as a
result of the interest-free loan from the Company
<PAGE> 6
6

referred to in Section 5.2(a) and payments received pursuant to this Section
5.2(b).

(c) During the term of this Agreement, the
Company shall provide the Executive with first priority use of a private
corporate jet both (i) for travel in connection with the performance of his
duties hereunder and (ii) for personal travel. The obligation of the Company to
provide the Executive with the use of a private corporate jet for personal
travel shall be on the terms heretofore approved by the Compensation Committee
of the Board of Directors and shall cease during any period that the Company
does not own or lease a private corporate jet.

(d) The Company will provide the Executive and/or
members of his family with life insurance through a split dollar arrangement on
terms to be agreed upon by the Company and the Executive. The Company's
premium costs shall be applied against the Executive's incentive bonuses
hereunder.

6. TERMINATION OF EMPLOYMENT.

6.1 Death. In the event of the death of the Executive,
the Company shall (i) pay to the estate or other legal representative of the
Executive (a) the base salary provided for in Section 3.1 (at the annual rate
then in effect) accrued to the date of the Executive's death and not
theretofore paid to the Executive and (b) any incentive bonus which shall be or
become payable pursuant to Section 3.2. Rights and benefits of the estate or
other legal representative or transferee of the Executive (a) with respect to
the Options shall be determined in accordance with Section 3.3 and (b) under
the benefit plans and programs of the Company shall be determined in accordance
with the provisions of such plans and programs. Neither the estate or other
legal representative of the Executive nor the Company shall have any further
rights or obligations under this Agreement.

6.2 Disability. If the Executive shall become
incapacitated by reason of sickness, accident or other physical or mental
disability and shall be unable to perform his normal duties hereunder for a
period of six (6) consecutive months, then, at any time following the
conclusion of such six (6) month period, the employment of the Executive
hereunder may be terminated by the Company or the Executive, upon thirty (30)
days' notice to the other. In the event of such termination, the Company shall
(a) pay to the Executive the base salary provided for in Section 3.1 (at the
annual rate then in effect) accrued to the date of such termination and not
theretofore paid and (b) pay to the Executive any bonus which shall be or
become payable under
<PAGE> 7
7

Section 3.2. Rights and benefits of the Executive or his transferee (a) with
respect to the Options shall be determined in accordance with Section 3.3 and
(b) under the other benefit plans and programs of the Company shall be
determined in accordance with the terms and provisions of such plans and
programs. Neither the Executive nor the Company shall have any further rights
or obligations under this Agreement, except as provided in Sections 7, 8, 9 and
15.

6.3 Due Cause. The employment of the Executive hereunder
may be terminated by the Company at any time for Due Cause (as hereinafter
defined). In the event of such termination, the Company shall pay to the
Executive the base salary provided for in Section 3.1 (at the annual rate then
in effect) accrued to the date of such termination and not theretofore paid to
the Executive. The Company shall also pay to the Executive any bonus which
shall be or become payable to the Executive under Section 3.2 with respect to
any fiscal year of the Company ended prior to the date of such termination.
Rights and benefits of the Executive or his transferee (a) with respect to the
Options shall be determined in accordance with Section 3.3 and (b) under the
benefit plans and programs of the Company shall be determined in accordance
with the provisions of such plans and programs. For purposes hereof, "Due
Cause" shall mean (i) willful, gross neglect or willful, gross misconduct in
the Executive's discharge of his duties and responsibilities under this
Agreement, or (ii) the Executive's conviction of a felony; provided, however,
that the Executive shall be given written notice by a majority of the Board of
Directors of the Company that it intends to terminate the Executive's
employment for Due Cause, which written notice shall specify the act or acts
upon which the majority of the Board of Directors of the Company intends so to
terminate the Executive's employment, and the Executive shall then be given the
opportunity, within fifteen (15) days of his receipt of such notice, to have a
meeting with the Board of Directors of the Company to discuss such act or acts.
If the basis of such written notice is other than an act or acts described in
clause (ii), the Executive shall be given seven (7) days after such meeting
within which to cease or correct the performance (or nonperformance) giving
rise to such written notice and, upon failure of the Executive within such
seven (7) days to cease or correct such performance (or nonperformance), the
Executive's employment by the Company shall automatically be terminated
hereunder for Due Cause. Neither the Executive nor the Company shall have any
further rights or obligations under this Agreement, except as provided in
Sections 7, 8, 9 and 15.
<PAGE> 8
8

6.4 Termination by the Company Without Cause. The
Company may terminate the Executive's employment at any time for whatever
reason it deems appropriate or without reason; provided, however, that in the
event that such termination is not pursuant to Section 6.1 (Death), 6.2
(Disability), 6.3 (Due Cause) or 6.5 (Voluntary Termination):

(i) the Company shall pay to the Executive:

(A) on the date of termination, the base
salary provided for in Section 3.1 (at the annual rate then in effect) accrued
to the date of termination and not theretofore paid to the Executive;

(B) severance pay, in the form of salary
continuation for a period of two (2) years commencing on the date of
termination, at a rate equal to the base salary provided for in Section 3.1 (at
the annual rate then in effect);

(D) on a date (the "Payment Date")
within ten (10) days of receipt by the Company of the audited financial
statements of the Company for the fiscal year in which such termination shall
have occurred, an amount equal to the Final Bonus (as hereinafter defined) and,
on the first anniversary of the Payment Date, an amount equal to one-half of
the Final Bonus. As used herein, (X) if the date of termination of the
Executive's employment shall occur during the first six months of any fiscal
year of the Company, the term "Final Bonus" shall mean an amount equal to the
bonus earned by the Executive for the last completed fiscal year of the Company
preceding the date of termination of his employment and (Y) if the date of
termination of the Executive's employment shall occur during the last six
months of any fiscal year of the Company, the term "Final Bonus" shall mean an
amount equal to the greater of (i) the bonus earned by the Executive for the
last completed fiscal year of the Company preceding the date of termination of
his employment or (ii) the bonus for the fiscal year in which the termination
of employment occurs, as determined pursuant to Section 3.2(a) and before
prorating pursuant to Section 3.2(c).

The Executive shall be under no obligation to seek other employment and shall
be under no obligation to offset any amounts earned from such other employment
(whether as an employee, a consultant or otherwise) against such payments. The
Company shall continue to pay any premiums payable on any split dollar
<PAGE> 9
9

life insurance policies for a period of two (2) years commencing on the date of
termination. Rights and benefits of the Executive or his transferee (a) with
respect to the Options shall be determined in accordance with Section 3.3 and
(b) under the other benefit plans and programs of the Company shall be
determined in accordance with the provisions of such plans and programs.
Neither the Executive nor the Company shall have any further rights or
obligations under this Agreement, except as provided in Sections 7, 8, 9 and
15; and

(ii) any unpaid balance of the loan referred to in Section
5.2(a) hereof shall be forgiven.

6.5 Voluntary Termination. The Executive may terminate
his employment with the Company at any time upon thirty (30) days' prior
written notice to the Company. In the event of such termination (unless such
termination is within one year following a Change in Control of the Company, in
which case the provisions of Section 6.7 hereof shall be applicable), the
Company shall pay to the Executive the base salary provided for in Section 3.1
(at the annual rate then in effect) accrued to the date of such termination and
not theretofore paid to the Executive. The Company shall also pay to the
Executive any bonus which shall be or become payable pursuant to Section 3.2.
Rights and benefits of the Executive or his transferee (a) with respect to the
Options shall be determined in accordance with Section 3.3 and (b) under the
benefit plans and programs of the Company shall be determined in accordance
with the provisions of such plans and programs. Neither the Executive nor the
Company shall have any further rights or obligations under this Agreement,
except as provided in Sections 7, 8, 9 and 15.

6.6 Constructive Termination. Anything herein to the
contrary notwithstanding, if the Company:

(A) demotes the Executive to a lesser
position than provided in Section 2;

(B) causes a material change in the
nature or scope of the authorities, powers, functions, duties, or
responsibilities attached to the Executive's position as described in Section
2;

(C) decreases the Executive's base
salary, changes the bonus formula provided for in Section 3 or eliminates any
of the benefits or perquisites provided for in Section 5; or
<PAGE> 10
10

(D) fails to cause the election of the
Executive to the Board of Directors of the Company and as Chairman of the Board
of Directors;

then, within thirty (30) days after learning of the action (or inaction), the
Executive may advise the Company in writing that the action (or inaction)
constitutes a termination of his employment by the Company (other than for Due
Cause), in which event the Company shall have thirty (30) days (the "Correction
Period") in which to correct such action (or inaction). If the Company does
not correct such action (or inaction) during the Correction Period, such action
(or inaction) shall (unless consented to in writing by the Executive)
constitute a termination of the Executive's employment by the Company pursuant
to Section 6.4 (Without Cause) effective on the first business day following
the end of the Correction Period.

6.7 Termination of Employment Following a Change in
Control. Anything herein to the contrary notwithstanding, the Executive may
terminate his employment with the Company during the one (1) year period
following a Change in Control, and such termination shall constitute a
termination of the Executive's employment by the Company pursuant to Section
6.4 (Without Cause); provided, however, that the amounts referred to in
paragraphs (A) and (B) under clause (i) of Section 6.4 shall be paid to the
Executive in a lump sum on the date of termination and the amounts referred to
in paragraph (D) under clause (i) of Section 6.4 shall be paid to the Executive
in a lump sum on the Payment Date. For purposes of this Agreement, a Change in
Control of the Company shall be deemed to have occurred if:

(A) a "person" (meaning an individual, a
partnership, or other group or association as defined in Sections 13(d) and
14(d) of the Securities Exchange Act of 1934, other than the Executive or a
group including the Executive), either (i) acquires twenty percent (20%) or
more of the combined voting power of the outstanding securities of the Company
having a right to vote in elections of directors and such acquisition shall not
have been approved within sixty (60) days following such acquisition by a
majority of the Continuing Directors (as hereinafter defined) then in office or
(ii) acquires fifty percent (50%) or more of the combined voting power of the
outstanding securities of the Company having a right to vote in elections of
directors; or

(B) Continuing Directors shall for any
reason cease to constitute a majority of the Board of Directors of the Company;
or
<PAGE> 11
11

(C) all or substantially all of the
business and/or assets of the Company is disposed of by the Company to a party
or parties other than a subsidiary or other affiliate of the Company, in which
the Company owns less than a majority of the equity, pursuant to a partial or
complete liquidation of the Company, sale of assets (including stock of a
subsidiary of the Company) or otherwise.

For purposes of this Agreement, the term "Continuing Director"
shall mean a member of the Board of Directors of the Company who either was a
member of the Board of Directors on the date hereof or who subsequently became
a Director and whose election, or nomination for election, was approved by a
vote of at least two-thirds of the Continuing Directors then in office.

6.8 Acceleration of Payments. In the event that the
Company shall fail to pay to the Executive any amount payable pursuant to this
Section 6 at the time such payment is due, all amounts to be paid to the
Executive (or his estate or legal representative) pursuant to this Section 6,
Section 3 and any other provision of this Agreement shall become immediately
due and payable without any further action by the Executive (or his estate or
legal representative).

7. CONFIDENTIAL INFORMATION.

7.1 Nondisclosure. The Executive shall, during the term
of this Agreement and at all times thereafter, treat as confidential and,
except as required in the performance of his duties and responsibilities under
this Agreement, not disclose, publish or otherwise make available to the public
or to any individual, firm or corporation any confidential information (as
hereinafter defined).

7.2 Confidential Information Defined. For the purposes
hereof, the term "confidential information" shall mean all information acquired
by the Executive in the course of the Executive's employment with the Company
in any way concerning the products, projects, activities, business or affairs
of the Company or the Company's customers, including, without limitation, all
information concerning trade secrets and the products or projects of the
Company and/or any improvements therein, all sales and financial information
concerning the Company, all customer and supplier lists, all information
concerning projects in research and development or marketing plans for any such
products or projects, and all information in any way concerning the products,
projects, activities, business or affairs of customers of the Company which is
furnished to the
<PAGE> 12
12

Executive by the Company or any of its agents or customers, as such; provided,
however, that the term "confidential information" shall not include information
which (a) becomes generally available to the public other than as a result of a
disclosure by the Executive, (b) was available to the Executive on a
non-confidential basis prior to his employment with the Company or (c) becomes
available to the Executive on a non-confidential basis from a source other than
the Company or any of its agents or customers provided that such source is not
bound by a confidentiality agreement with the Company or any of such agents or
customers.

8. INTERFERENCE WITH THE COMPANY.

8.1 Restrictions. The Executive acknowledges that the
services to be rendered by him to the Company are of a special and unique
character. In order to induce the Company to enter into this Agreement, and in
consideration of his employment hereunder, the Executive agrees, for the
benefit of the Company, that he will not, during the period of his employment
with the Company and thereafter, for the Applicable Period (as hereinafter
defined) commencing on the date of termination of his employment with the
Company:

(a) engage, directly or indirectly, whether as
principal, consultant, employee, partner, stockholder, limited partner or other
investor (other than an investment of (i) not more than five percent (5%) of
the stock or equity of any corporation the capital stock of which is publicly
traded or (ii) not more than five percent (5%) of the ownership interest of any
partnership or other entity) or otherwise, within the United States of America,
with any firm or person in any activity or business venture which is in
competition with any line or lines of business being conducted by the Company
or any subsidiary of the Company at the date of termination of the Executive's
employment with the Company, accounting for ten percent (10%) or more of the
Company's consolidated gross sales, revenues or earnings before taxes for the
fiscal year ended immediately prior to the conduct in question, provided that,
the Executive shall not be prohibited from continuing to conduct the existing
lines of business of Apogee, Inc. and Hearing Health Services Inc. (the
"Competition Restriction"); or

(b) solicit or entice or endeavor to solicit or
entice away from the Company any person who was an "officer" (as such term is
used in Rule 16a-1 under Section 16 of the Securities Exchange Act of 1934) of
the Company, either for his own account or for any individual, firm or
corporation, whether
<PAGE> 13
13

or not such person would commit any breach of his contract of employment by
reason of leaving the service of the Company (the "Solicitation Restriction");
or

(c) employ, directly or indirectly, any person
who was an officer (as defined above) of the Company at any time during the one
year period ending on the date of termination of the Executive's employment
with the Company, except that this restriction shall not apply in the case of
any person whose employment shall have been terminated by the Company (the
"Hiring Restriction").

8.2 Time Periods. As used in this Section 8, the term
"Applicable Period" shall mean:

(a) twelve (12) months in the case of a
termination of employment pursuant to Section 6.3 (Due Cause);

(b) twenty-four (24) months as to the Competition
and Solicitation Restrictions and twelve (12) months as to the Hiring
Restriction in the case of a termination of employment pursuant to Section 6.4
(Without Due Cause) or Section 6.6 (Constructive Termination);

(c) twenty-four (24) months as to the Competition
Restriction and twelve (12) months as to the Solicitation and Hiring
Restrictions in the case of a termination pursuant to Section 6.7 (Change in
Control); and

(d) twenty-four (24) months as to the Competition
and Solicitation Restrictions and twelve (12) months as to the Hiring
Restriction in the case of a termination pursuant to Section 6.2 (Disability)
or Section 6.5 (Voluntary Termination), but only if the Company gives notice to
the Executive within thirty (30) days of the date of termination of employment
of its intention to enforce such restrictions against the Executive, and
subject to the Company's continued payment to the Executive during such
twenty-four (24) month period of the base salary provided for in Section 3.1
(at the annual rate in effect at the date of termination).

9. EQUITABLE RELIEF.

In the event of a breach or threatened breach by the Executive
of any of the provisions of Sections 7 or 8 of this Agreement, the Executive
hereby consents and agrees that the Company shall be entitled to an injunction
or similar equitable relief from any court of competent jurisdiction
restraining the
<PAGE> 14
14

Executive from committing or continuing any such breach or threatened breach or
granting specific performance of any act required to be performed by the
Executive under any of such provisions, without the necessity of showing any
actual damage or that money damages would not afford an adequate remedy and
without the necessity of posting any bond or other security. Nothing herein
shall be construed as prohibiting the Company from pursuing any other remedies
at law or in equity which it may have.

10. SUCCESSORS AND ASSIGNS.

10.1 Assignment by the Company. The Company shall require
any successors (whether direct or indirect, by purchase, merger, consolidation
or otherwise) to all or substantially all of the business and/or assets of the
Company to assume and agree to perform this Agreement in the same manner and to
the same extent that the Company would be required to perform if no such
succession had taken place. As used in this Section, the "Company" shall mean
the Company as hereinbefore defined and any successor to its business and/or
assets as aforesaid which otherwise becomes bound by all the terms and
provisions of this Agreement by operation of law and this Agreement shall be
binding upon, and inure to the benefit of, the Company, as so defined.

10.2 Assignment by the Executive. The Executive may not
assign this Agreement or any part thereof without the prior written consent of
a majority of the Board of Directors of the Company; provided, however, that
nothing herein shall preclude one or more beneficiaries of the Executive from
receiving any amount that may be payable following the occurrence of his legal
incompetency or his death and shall not preclude the legal representative of
his estate from receiving such amount or from assigning any right hereunder to
the person or persons entitled thereto under his will or, in the case of
intestacy, to the person or persons entitled thereto under the laws of
intestacy applicable to his estate. The term "beneficiaries", as used in this
Agreement, shall mean a beneficiary or beneficiaries so designated to receive
any such amount or, if no beneficiary has been so designated, the legal
representative of the Executive (in the event of his incompetency) or the
Executive's estate.

11. GOVERNING LAW.

This Agreement shall be deemed a contract made under, and for
all purposes shall be construed in accordance with, the laws of the
Commonwealth of Pennsylvania applicable to contracts to be performed entirely
within such state. In the event that a
<PAGE> 15
15

court of any jurisdiction shall hold any of the provisions of this Agreement to
be wholly or partially unenforceable for any reason, such determination shall
not bar or in any way affect the Company's right to relief as provided for
herein in the courts of any other jurisdiction. Such provisions, as they
relate to each jurisdiction, are, for this purpose, severable into diverse and
independent covenants. Service of process on the parties hereto at the
addresses set forth herein shall be deemed adequate service of such process.

12. ENTIRE AGREEMENT.

This Agreement contains all the understandings and
representations between the parties hereto pertaining to the subject matter
hereof and supersedes all undertakings and agreements, whether oral or in
writing, if any there be, previously entered into by them with respect thereto.

13. AMENDMENT, MODIFICATION, WAIVER.

No provision of this Agreement may be amended or modified
unless such amendment or modification is agreed to in writing and signed by the
Executive and by a duly authorized representative of the Company other than the
Executive. Except as otherwise specifically provided in this Agreement, no
waiver by either party hereto of any breach by the other party hereto of any
condition or provision of this Agreement to be performed by such other party
shall be deemed a waiver of a similar or dissimilar provision or condition at
the same or any prior or subsequent time, nor shall the failure of or delay by
either party hereto in exercising any right, power or privilege hereunder
operate as a waiver thereof to preclude any other or further exercise thereof
or the exercise of any other such right, power or privilege.

14. ARBITRATION.

Any controversy or claim arising out of or relating to this
Agreement, or any breach thereof, shall, except as provided in Section 9, be
settled by arbitration in accordance with the rules of the American Arbitration
Association then in effect and judgment upon such award rendered by the
arbitrator may be entered in any court having jurisdiction thereof. The
arbitration shall be held in the area where the Company then has its principal
place of business. The arbitration award shall include attorneys' fees and
costs to the prevailing party.
<PAGE> 16
16

15. ADVANCE OF DEFENSE EXPENSES.

In the event of any action, proceeding or claim against the
Executive arising out of his serving or having served in his capacity as an
officer and/or director of the Company, which in the Executive's sole judgment
requires him to retain counsel (such choice of counsel to be made in his sole
and absolute discretion) or otherwise expend his personal funds for his defense
in connection therewith, the Company shall be obligated to advance to the
Executive (or pay directly to his counsel) counsel fees and other costs
associated with the Executive's defense of such action, proceeding or claim;
provided, however, that in such event the Executive shall first agree in
writing, without posting bond or collateral, to repay all sums paid or advanced
to him pursuant to this Section 15 in the event that the final disposition of
such action, proceeding or claim is one for which the Executive would not be
entitled to indemnification pursuant to the provisions of the laws of the State
of Delaware or the Certificate of Incorporation or By-laws of the Company.

16. NOTICES.

Any notice to be given hereunder shall be in writing and
delivered personally or sent by certified mail, postage prepaid, return receipt
requested, addressed to the party concerned at the address indicated below or
at such other address as such party may subsequently designate by like notice:

If to the Company:

NovaCare, Inc.
1016 West Ninth Avenue
King of Prussia, Pennsylvania 19406
Attention: Chief Operating Officer

If to the Executive:

John H. Foster
c/o Foster Management Company
1016 West Ninth Avenue
King of Prussia, Pennsylvania 19406

17. SEVERABILITY.

Should any provision of this Agreement be held by a court or
arbitration panel of competent jurisdiction to be enforceable only if modified,
such holding shall not affect the validity of the remainder of this Agreement,
the balance of which
<PAGE> 17
17

shall continue to be binding upon the parties hereto with any such modification
to become a part hereof and treated as though originally set forth in this
Agreement. The parties further agree that any such court or arbitration panel
is expressly authorized to modify any such unenforceable provision of this
Agreement in lieu of severing such unenforceable provision from this Agreement
in its entirety, whether by rewriting the offending provision, deleting any or
all of the offending provision, adding additional language to this Agreement,
or by making such other modifications as it deems warranted to carry out the
intent and agreement of the parties as embodied herein to the maximum extent
permitted by law. The parties expressly agree that this Agreement as so
modified by the court or arbitration panel shall be binding upon and
enforceable against each of them. In any event, should one or more of the
provisions of this Agreement be held to be invalid, illegal or unenforceable in
any respect, such invalidity, illegality or unenforceability shall not affect
any other provisions hereof, and if such provision or provisions are not
modified as provided above, this Agreement shall be construed as if such
invalid, illegal or unenforceable provisions had never been set forth herein.

18. WITHHOLDING.

Anything to the contrary notwithstanding, all payments
required to be made by the Company hereunder to the Executive or his
beneficiaries, including his estate, shall be subject to withholding of such
amounts relating to taxes as the Company may reasonably determine it should
withhold pursuant to any applicable law or regulation. In lieu of withholding
such amounts, in whole or in part, the Company, may, in its sole discretion,
accept other provision for payment of taxes as permitted by law, provided it is
satisfied in its sole discretion that all requirements of law affecting its
responsibilities to withhold such taxes have been satisfied.

19. SURVIVORSHIP.

The respective rights and obligations of the parties hereunder
shall survive any termination of this Agreement to the extent necessary to the
intended preservation of such rights and obligations.
<PAGE> 18
18

20. TITLES.

Titles of the sections and paragraphs of this Agreement are
intended solely for convenience and no provision of this Agreement is to be
construed by reference to the title of any section or paragraph.

21. COUNTERPARTS.

This Agreement may be executed in counterparts, each of which
shall be deemed an original, but all of which taken together shall constitute
one and the same instrument.

* * *
<PAGE> 19
19

IN WITNESS WHEREOF, the parties hereto have executed this
Agreement as of the date first above written.

NOVACARE, INC.

By
---------------------------------
Francis W. Cash
President

-----------------------------------
John H. Foster

The foregoing Agreement has been
Approved by the Compensation Committee
of the Board of Directors:

- ----------------------------------
Robert G. Stone
Chairman of Compensation Committee
<PAGE> 20

SCHEDULE A

<TABLE>
<CAPTION>
Year Additional Payment
---- ------------------
<S> <C>
1994 $19,244

1995 34,639

1996 26,941

1997 19,244

1998 11,546

1999 3,849
</TABLE>

<PAGE> 1
EXHIBIT 10(b)

AMENDMENT TO
EMPLOYMENT AGREEMENT
DATED AS OF JULY 1, 1994

AGREEMENT dated as of the 2nd day of February, 1995 by and
between NOVACARE, INC., a Delaware corporation (the "Company"), and JOHN H.
FOSTER (the "Executive").

W I T N E S E T H:

WHEREAS, the Company and the Executive have heretofore entered
into an Employment Agreement (the "Employment Agreement") dated as of the 1st
day of July, 1994; and

WHEREAS, the Company and the Executive wish to amend the
Employment Agreement ab initio;

NOW, THEREFORE, in consideration of the premises and the
mutual agreements hereinafter set forth, the parties hereto agree as follows:

1. Section 3.2 of the Employment Agreement, as heretofore in
effect, is hereby deleted in its entirety, and replaced by a new Section 3.2 as
follows:

3.2 Incentive Bonus. (a) In addition to the base salary
provided for in Section 3.1, the Company shall pay to the Executive an
incentive bonus with respect to each fiscal year of the Company ending during
the term of this Agreement in accordance with this Section 3.2. The incentive
bonus for each fiscal year shall be an amount equal to the product of the Net
Income (as hereinafter defined) of the Company multiplied by the Applicable
Percentage (as hereinafter defined); provided that no incentive bonus shall be
payable with respect to a fiscal year in which Net Income is less than ninety
percent (90%) of Budgeted Net Income (as hereinafter defined).

For purposes of this Section 3.2:

(i) the term "Net Income" shall mean,
for any fiscal year of the Company, the consolidated after-tax profit of the
Company and its wholly-owned subsidiaries for such year, without regard to
extraordinary non-operating profits and losses such as gain from sale of
operating units, as shown in the audited financial statements of the Company
for such fiscal year. In the event of any change in the fiscal year of the
Company, appropriate adjustments shall be made to the provisions of this
<PAGE> 2
2

Section 3.2 in order to carry out the essential intent and principles of this
Section 3.2;

(ii) the term "Applicable Percentage" shall
mean 1%; provided that in any Fiscal Year in which Net Income is between
90% and 99% of Budgeted Net Income, the Applicable Percentage shall be the
Applicable Percentage for such Fiscal Year determined without regard to this
proviso multiplied by the "Adjustment Percentage" in the table below opposite
the percentage (rounded down to the nearest complete percentage point) of
Budgeted Net Income attained as Net Income in such Fiscal Year:

<TABLE>
<CAPTION>
Percentage of Budgeted
Net Income Attained Adjustment Percentage
---------------------- ---------------------
<S> <C>
90% 45%
91% 51%
92% 56%
93% 62%
94% 67%
95% 73%
96% 78%
97% 84%
98% 89%
99% 95%
</TABLE>

and;

(iii) the term "Budgeted Net Income" shall
mean, for any fiscal year of the Company, net income as set forth in the annual
business plan of the Company for such fiscal year as prepared by the Company's
management and approved by the Board of Directors of the Company.

(b) In the event of the termination of employment
of the Executive pursuant to Section 6.1 (Death), 6.2 (Disability), Section 6.4
(Without Cause), 6.5 (Voluntary Termination), 6.6 (Constructive Termination) or
6.7 (Change of Control) of this Agreement, the Executive (or his estate or
other legal representative) shall be entitled to a bonus for the fiscal year in
which such termination takes place in an amount equal to the product of (i) the
bonus for such fiscal year determined pursuant to Section 3.2(a), multiplied by
(ii) a fraction, the numerator of which is the number of days from the
beginning of such fiscal year to the date of termination, and the denominator
of which is 365. In the event of the termination of employment
<PAGE> 3
3

of the Executive pursuant to Section 6.3 (Due Cause) of this Agreement, the
Executive shall not be entitled to a bonus for the fiscal year of the Company
in which such termination takes place. The Executive shall not be entitled to
a bonus for any fiscal year of the Company subsequent to the fiscal year in
which the termination of his employment pursuant to Section 6.1 (Death), 6.2
(Disability), 6.3 (Due Cause) or 6.5 (Voluntary Termination) takes place.

(c) The bonus payable to the Executive (or his
estate or other legal representative) for any fiscal year of the Company
pursuant to this Section 3.2 shall be paid by the Company within ten (10) days
of receipt by the Company of the audited financial statements of the Company
for such fiscal year.

2. Cross-references to Sections 3.2(c) and 3.2(d) of the
Employment Agreement, as heretofore in effect, shall be deemed to refer to
Sections 3.2(b) and 3.2(c), respectively, of the Employment Agreement, as
hereby amended.

3. The amendments set forth in Sections 1 and 2 hereof
shall take effect as of July 1, 1994.

4. This Agreement may be executed in counterparts, each
of which shall be deemed an original, but all of which taken together shall
constitute one and the same instrument.

* * *
<PAGE> 4
4

IN WITNESS WHEREOF, the parties hereto have executed this
Agreement as of the date first above written.

NOVACARE, INC.

By
---------------------------------
Timothy E. Foster
President

-----------------------------------
John H. Foster

The foregoing Amendment has been
Approved by the Compensation Committee
of the Board of Directors:

- ----------------------------------
Robert G. Stone
Chairman of Compensation Committee

<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONDENSED CONSOLIDATED BALANCE SHEET AS OF MARCH 31, 1995 AND THE CONDENSED
CONSOLIDATED STATEMENT OF OPERATIONS FOR THE NINE MONTHS ENDED MARCH 31, 1995
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH STATEMENTS IN FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1995.
</LEGEND>
<MULTIPLIER> 1,000

<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JUN-30-1995
<PERIOD-START> JUL-01-1994
<PERIOD-END> MAR-31-1995
<CASH> 30,413
<SECURITIES> 47,778
<RECEIVABLES> 275,812
<ALLOWANCES> 39,899
<INVENTORY> 9,829
<CURRENT-ASSETS> 338,442
<PP&E> 129,760
<DEPRECIATION> 41,637
<TOTAL-ASSETS> 918,300
<CURRENT-LIABILITIES> 107,794
<BONDS> 345,662
<COMMON> 653
0
0
<OTHER-SE> 451,277
<TOTAL-LIABILITY-AND-EQUITY> 918,300
<SALES> 0
<TOTAL-REVENUES> 703,909
<CGS> 501,276
<TOTAL-COSTS> 115,663
<OTHER-EXPENSES> 7,823
<LOSS-PROVISION> 11,725
<INTEREST-EXPENSE> 18,764
<INCOME-PRETAX> 48,658
<INCOME-TAX> 19,770
<INCOME-CONTINUING> 28,888
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 28,888
<EPS-PRIMARY> .44
<EPS-DILUTED> .44
<FN>
<F1>Other expenses represents amortization of excess cost of net assets acquired
merger and nonrecurring expenses and minority interest offset by investment
income.
</FN>

</TABLE>