<PAGE> 1
FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 1999
Commission file number 1-10875
NOVACARE, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 13-3247827
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)
1016 WEST NINTH AVENUE, KING OF PRUSSIA, PA 19406
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE) (ZIP CODE)
Registrant's telephone number, including area code: (610) 992-7200
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on
COMMON STOCK, PAR VALUE $.01 PER SHARE which registered
NEW YORK STOCK EXCHANGE, INC.
5 1/2% CONVERTIBLE SUBORDINATED NEW YORK STOCK EXCHANGE, INC.
DEBENTURES DUE 2000
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS.
YES X NO
INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM
405 OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED, TO THE
BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION STATEMENTS
INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY AMENDMENT TO THIS
FORM 10-K. [X]
AS OF SEPTEMBER 16, 1999, 63,287,447 SHARES OF COMMON STOCK WERE
OUTSTANDING, AND THE AGGREGATE MARKET VALUE OF THE SHARES OF COMMON STOCK HELD
BY NON-AFFILIATES WAS APPROXIMATELY $72,156,280. (DETERMINATION OF STOCK
OWNERSHIP BY NON-AFFILIATES WAS MADE SOLELY FOR THE PURPOSE OF RESPONDING TO
THIS REQUIREMENT AND THE REGISTRANT IS NOT BOUND BY THIS DETERMINATION FOR ANY
OTHER PURPOSE.)
DOCUMENTS INCORPORATED BY REFERENCE
NONE.
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NOVACARE, INC. AND SUBSIDIARIES
FORM 10-K -- FISCAL YEAR ENDED JUNE 30, 1999
CONTENTS AND CROSS REFERENCE SHEET
FURNISHED PURSUANT TO GENERAL INSTRUCTION G(4) OF FORM 10-K
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FORM 10-K FORM 10-K FORM 10-K
PART NO. ITEM NO. DESCRIPTION PAGE NO.
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I 1 Business ........................................................ 3
The Company................................................... 3
Overview................................................. 3
Corporate and Capital Structure Changes..................... 3
Continuing Operations....................................... 10
Outpatient Services........................................... 10
Industry Background........................................ 10
Strategy Statement ........................................ 11
Plan for Growth and Operations............................. 12
Business Profile........................................... 13
Competition................................................ 14
Reimbursement/Government Relations......................... 14
Government Regulation ..................................... 15
Employee Services............................................. 15
Industry Background ....................................... 15
Strategy Statement......................................... 16
Plan for Growth and Operations ............................ 16
Business Profile........................................... 18
Information Technology..................................... 20
Competition................................................ 20
Government Regulation...................................... 20
Insurance..................................................... 22
Employees..................................................... 22
Executive Officers of the Registrant ......................... 23
2 Properties....................................................... 23
3 Legal Proceedings................................................ 23
4 Submission of Matters to a Vote of Security Holders.............. 23
II 5 Market for Registrant's Common Equity and Related Stockholder
Matters....................................................... 24
6 Selected Financial Data.......................................... 25
7 Management's Discussion and Analysis of Financial Condition
and Results of Operations .................................... 26
7a Quantitative and Qualitative Disclosures About Market Risk....... 36
8 Financial Statements and Supplementary Data...................... 37
9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure ..................................... 60
III 10 Directors and Executive Officers of the Registrant .............. 61
11 Executive Compensation........................................... 63
12 Security Ownership of Certain Beneficial Owners and
Management.................................................... 67
13 Certain Relationships and Related Transactions................... 68
IV 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K.. 69
Signatures...................................................................................... 70
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PART I
ITEM 1. BUSINESS
THE COMPANY
OVERVIEW
NovaCare, Inc. ("NovaCare" or the "Company") was formed in 1985 and is a
national leader in physical rehabilitation services and employee services.
Physical rehabilitation services are the processes that restore individuals
disabled by trauma, injury or disease to their optimal level of functionality
and self-sufficiency. Across the health care spectrum, more than 80% of
individuals receiving physical rehabilitation services return to the community
in productive endeavors or to active retirement. Historically, NovaCare's
physical rehabilitation services have been provided in two industry segments:
(i) outpatient services -- providing outpatient physical therapy and
occupational health rehabilitation services ("PROH") and orthotic and prosthetic
services ("O&P") through a national network of patient care centers, and (ii)
long-term care services -- providing rehabilitation therapy and health care
consulting services on a contract basis to health care institutions, primarily
long-term care facilities. As described under "Corporate and Capital Structure
Changes" below, the Company sold its long-term care services business on June 1,
1999 and its O&P business on July 1, 1999.
The Company's employee services consist of comprehensive, fully integrated
outsourcing solutions to human resource needs, including payroll management,
workers' compensation risk management, benefits administration, unemployment
management and human resource management and consulting services generally
provided to small- and medium-sized businesses through its 67% owned subsidiary,
NovaCare Employee Services, Inc. ("NCES"). The Company believes it offers better
solutions at the best value by providing a convenient integrated complement of
services. The Company creates relationships with both its clients and worksite
employees by contractually assuming certain administrative, regulatory and
financial employer responsibilities with respect to worksite employees in a
"co-employment" relationship.
CORPORATE AND CAPITAL STRUCTURE CHANGES
Long-Term Care Services--Regulatory Changes
Reimbursement for long-term care services provided by the Company was
primarily through the Medicare program. Medicare is a federally funded health
program that provides health insurance coverage for certain disabled persons and
persons age 65 or older.
Prior to April 10, 1998, Medicare reimbursed long-term care facilities,
primarily skilled nursing facilities, for contract therapy services on a cost
basis. The fee paid to contract therapy service providers, such as NovaCare, was
a reimbursable cost for the long-term care facility. Reimbursement levels were
determined based on a reasonable-cost standard. Contract occupational therapy
and speech-language pathology services were evaluated based upon the
reasonableness of costs incurred by the provider under a "prudent buyer"
standard. Specific guidelines existed for evaluating the reasonable cost of
physical therapy. The specific guideline system for physical therapy was called
"salary equivalency," a method used to determine the prudent hourly cost for
physical therapy services in long-term care facilities.
Effective April 10, 1998, the Health Care Financing Administration
("HCFA"), the Federal agency responsible for the rules governing Medicare,
implemented salary equivalency reimbursement guidelines for occupational therapy
and speech-language pathology services and revised guidelines for physical
therapy services. With its enactment in June 1997, the Balanced Budget Act of
1997 (the "BBA") revised the manner in which Medicare reimburses long-term care
facilities by entirely eliminating cost-based reimbursement. Commencing on July
1, 1998, Medicare Part A services (in-patient services) became reimbursed under
a prospective payment system ("PPS") which includes payment for therapy services
in an all-inclusive per diem payment based on the acuity level of the patient's
illness. Medicare Part B services (outpatient and all other services not covered
by Part A) became covered by a fee schedule with total charges subject to an
annual cap effective January 1, 1999.
<PAGE> 4
As a consequence of these regulatory changes, net revenues for the
Company's long-term care services segment decreased from $176.3 million in the
quarter ended March 31, 1998, the last quarter prior to the regulatory changes
discussed above, to $68.6 million in the quarter ended March 31, 1999, a 61%
decline. The decrease in net revenues was primarily due to the implementation of
the BBA (i) directly through lower reimbursement rates, and (ii) indirectly due
to decreased Medicare patient census in facilities served as a result of the
uncertainty of long-term care facilities management with respect to the
reimbursement economics of Medicare patients under the BBA. NovaCare's long-term
care services segment incurred an EBITDA (earnings before interest, taxes,
depreciation and amortization) loss (excluding provision for restructure) of
$9.6 million for the quarter ended March 31, 1999, compared with positive EBITDA
of $36.5 million for the same quarter of the prior year, a $46.1 million
decrease (approximately $184 million annualized).
In order to mitigate the effect of these trends in the long-term care
services segment, effective March 30, 1999, the Company implemented a
restructure plan involving a complete exit of selected markets with low customer
and therapist concentration. These markets, generally in the western United
States, were unprofitable (net revenues less cost of services, or gross profits,
resulted in a loss of approximately $0.2 million in March 1999, or approximately
$2 million annualized) and considered unlikely to return to a satisfactory level
of profitability in the foreseeable future.
In its remaining long-term care services markets, the Company continued
to implement a revised operating model during the third quarter ended March 31,
1999 and into the fiscal 1999 fourth quarter, however, the EBITDA loss for the
segment continued to be significant. Based on further analysis of the business
segment's remaining operations, management determined that in order for the
segment to become profitable by December 1999, the following business operating
model and cost structure changes had to take place: (i) reduce selling, general
and administrative expenses by approximately 50%, (ii) increase clinical
productivity by approximately 20%, (iii) increase revenue per customer facility
by approximately 15%, (iv) increase new contract sales levels, and (v) decrease
customer contract cancellations. Such dramatic changes were necessary due to the
size of the EBITDA loss ($7.5 million for the quarter ended March 31, 1999, or
approximately $30 million annualized). In management's opinion, the operating
model and cost structure changes that the Company would need to make to the
business were so extensive, that the remaining long-term care services segment
business would not likely be profitable in the foreseeable future. The Board of
Directors and management considered the relative economics of the only viable
alternatives available to the Company, selling or exiting the remaining
long-term care services business, culminating with the Company's divestiture of
its stock in its long-term care services subsidiary on June 1, 1999 for a
nominal amount to Chance Murphy, Inc., a newly formed and independent company.
Chance Murphy, Inc. has hired Integrated Health Services, Inc. to manage the
business under a long-term management agreement. In making this determination,
management estimated the net cash flows of selling or exiting the businesses. In
essence, management's analysis indicated that the costs of terminating the
Company's contractual obligations to long-term care services customers,
employees and vendors, in the complete market exit, would cost the Company
approximately $12 million more than the terms of the divestiture transaction.
Pursuant to the divestiture, NovaCare has provided a working capital
guarantee of $30 million and the purchaser has agreed to pay to NovaCare the
amount, if any, of working capital as of June 1, 1999 in excess of $30 million
or, as applicable, to transfer to the Company any remaining accounts receivable
relating to periods prior to June 1, 1999 once the working capital guarantee has
been satisfied. Under the terms of the transaction, the working capital
guarantee is expected to be satisfied by no later than October 29, 1999. At June
30, 1999, $28.2 million of the working capital guarantee remained outstanding.
As a result of the exit of selected markets and the divestiture, NovaCare's
long-term care services segment recognized an after-tax loss of approximately
$93.2 and $30.8 million in the third and fourth quarters of fiscal 1999,
respectively.
Capital Structure--Highly Leveraged Balance Sheet
Due to the Company's lower EBITDA, caused by the impact of regulatory
changes in the long-term care services segment, the Company's cash flow from
operations was too low to satisfy its debt obligations. This situation
characterizes a capital structure that is highly leveraged. NovaCare's total
debt at March 31, 1999 was $596.0 million, of which $540.7 was due in less than
one year. EBITDA (excluding provision for restructure) for the quarter ended
March 31, 1999 was a loss of $2.3 million ($7.3 million positive EBITDA without
the long-term care services segment). In comparison, (i) at June 30, 1998, prior
to the phase-in of the BBA, the Company's total debt was $508.4 million ($32.1
million current portion) and EBITDA for the quarter ended June 30, 1998 was
$46.2 million, (ii) at September 30, 1998, total debt was $576.8 million ($35.2
million current portion) and EBITDA for the quarter was $33.6 million, and (iii)
at December 31, 1998, total debt was $581.4 million ($30.8 million current
portion) and EBITDA for the quarter was $25.8 million, excluding a $17.8 million
provision for restructure.
<PAGE> 5
This highly leveraged condition led the Board of Directors and management
of the Company to undertake a strategic analysis of the Company's alternatives
to satisfy the indebtedness. To assist the Board of Directors and management in
assessing the Company's capital structure alternatives, the Company engaged
Warburg Dillon Read LLC ("WDR") and Wasserstein Perella & Co., Inc. ("WP").
Sale of Orthotics and Prosthetics Business
To partially reduce the Company's debt leverage, on July 1, 1999, the
Company sold its O&P business to Hanger Orthopedic Group, Inc. ("Hanger") for
$445.0 million, including $407.7 million in cash and the assumption of seller
notes of $37.3 million. Of the purchase price, $15.0 million has been placed in
escrow in conjunction with a $94.0 million working capital guarantee to Hanger
by the Company. The final working capital amount is expected to be settled no
later than October 29, 1999. The proceeds from the transaction were used to
satisfy the entire balance of the Company's revolving credit facility, with
approximately $37 million remaining after transaction-related costs. These funds
have been temporarily invested to satisfy working capital requirements and
future maturities of other debt obligations.
Capital Structure Alternatives
Subsequent to the sale of the O&P business, NovaCare remained highly
leveraged with indebtedness of approximately $221 million primarily consisting
of (i) $175 million of convertible subordinated debentures (the "Debentures")
maturing on January 15, 2000 and (ii) $42 million comprising principally
subordinated seller notes (the "Seller Notes") related to PROH acquisitions and
maturing at various dates through 2007.
The only remaining asset of the Company which would provide sufficient
funds to satisfy the Debentures is the PROH business. The capital structure
alternatives considered by the Company were either obtaining medium-term (three-
to five-year) financing secured by PROH assets, selling PROH, selling NovaCare
or, in the event all else failed, filing for reorganization under the Bankruptcy
Code. Obtaining secured financing was rejected, because even if adequate secured
financing could be obtained, the Company would be too highly leveraged (debt
would be approximately four times EBITDA) for it to realize sustainable business
growth. For example, PROH EBITDA for the latest quarter ended June 30, 1999
annualized (multiplied by four) was $38.5 million. Interest costs would be $18.5
million per year at an assumed 12% annual rate (a typical high-yield interest
rate for businesses with a risk profile similar to that of PROH) on average debt
of $154 million (four times EBITDA). Assuming a 40% effective tax rate (the
combined federal and state income tax rate which would be applicable for PROH on
a stand-alone basis), income taxes would be $2.9 million. Further assuming that
latest quarter annualized depreciation of $12.8 million is reinvested in capital
expenditures to cover the normal replacement of property and equipment, only
$4.3 million ($38.5 million EBITDA less $12.8 million capital expenditures,
$18.5 million interest and $2.9 million income taxes) would be available to
invest in the working capital and acquisitions to sustain business growth.
Presuming that all other alternatives were exhausted and bankruptcy
protection would be available, management believes that such an action would be
so disruptive to customer and employee relations that realizable stockholder
value would be substantially eroded.
The Board of Directors and management believe that a sale of PROH (the
"PROH Sale"), rather than a sale of NovaCare, will optimize the net proceeds to
the Company because (i) the tax loss expected on the PROH Sale (approximately
$282 million and $183 million at the low and high ends, respectively, of the
range of estimated values of PROH set forth below under "Restructuring
Proposal--Liquidation Analysis and Estimates") would fully offset the tax due on
the gain from the O&P sale and the sale of NCES (the "NCES Sale" - see "Proposed
NCES Sale"), a tax advantage not available to the Company if NovaCare is sold,
and (ii) the NovaCare sales price would reflect a risk adjusted discount for the
potential and perceived risks to buyers with respect to contingent liabilities
associated with the Company's exit from a portion of the long-term care services
business and the sales of the remaining long-term care services business and
O&P, a risk not borne by a buyer who only buys the PROH business.
Assuming the PROH Sale is approved by the stockholders in order to
satisfy the Company's debt obligations, the only remaining operating business of
the Company would be its 67% owned subsidiary, NCES. The Board of Directors and
management of the Company determined that the Company should sell NCES because
(i) relatively favorable market conditions exist for the sale of professional
employer organizations ("PEOs"), (ii) due to the sale of all the other operating
businesses of the Company, NCES would be better served being strategically
aligned with a business partner other than NovaCare, and (iii) at a 67%
ownership level, the tax structure between the Company and NCES is inefficient,
requiring the Company to attain 80% ownership or greater in NCES to avoid double
taxation of NCES earnings. Although the double taxation issue has been relevant
since NCES's initial public offering, prior to the sale of the other operating
businesses of NovaCare, it had been outweighed by the benefits of the strategic
alignment between NCES and the Company. With regard to strategic alignment,
NovaCare founded NCES to leverage the Company's investments in human resource
management, information
<PAGE> 6
systems, relationship selling, workers' compensation risk management,
outsourcing, and management of a dispersed work force. Access to these
capabilities in NovaCare's infrastructure on an incremental cost basis was a key
premise behind NovaCare's founding of NCES. With the sale of the Company's other
operating businesses and consequently the sale and dismantling of its
infrastructure, NCES no longer benefits from its affiliation with the Company.
Based on due consideration of these alternatives and to optimize
stockholder value, the Board of Directors and management engaged WDR to approach
a number of potential strategic and financial buyers for the Company's PROH
business and WP to approach a number of potential strategic and financial buyers
for the Company's 67% ownership interest in NCES.
In a proxy statement mailed to stockholders on August 13, 1999 (the
"Proxy Statement"), stockholders were notified of a special meeting of
stockholders of NovaCare to be held on September 21, 1999 (the "Special
Meeting") to consider and vote upon proposals to approve: (i) the PROH Sale,
(ii) the NCES sale and (iii) the adoption of the Plan of Restructuring of the
Company (the "Restructuring Proposal"). These proposals, which are described
below, were approved by the Board of Directors on August 5, 1999.
Proposed PROH Sale
The Company has engaged WDR to conduct a competitive bidding process
among buyers of the stock of the Company's subsidiaries which comprise PROH. No
affiliates of the Company or any officers or directors of the Company may
participate in the bidding process. In July 1999, at the direction of the
Company, WDR contacted 32 potential acquirers of PROH. Of the parties contacted,
certain prospective buyers requested and received a confidential information
memorandum. On July 30, 1999, letters were distributed to these potential
buyers, and preliminary, non-binding indications of interest were submitted in
early August 1999. The Company and WDR evaluated the indications of interest
based on, among other factors, the price offered and the ability of potential
buyers to consummate a transaction. Based on this evaluation, selected potential
buyers are presently involved in performing their due diligence efforts with
regard to the PROH business. Final non-binding indications of interest are
expected to be submitted in late September. The Company and WDR intend to
evaluate any final indications of interest based on, among other factors, the
price offered, the ability of potential buyers to consummate a transaction and
the material terms of acquisition agreements proposed by potential buyers.
The Company currently anticipates that the minimum sale price for PROH
will be $200 million, including approximately $43 million of debt assumed and
the balance of the purchase price in cash. The proceeds of the sale and
available cash will be utilized to satisfy the Company's remaining debt
obligations and the costs of liquidating the Company and to pay stockholders as
reflected in "Restructuring Proposal--Liquidation Analysis and Estimates" below.
In determining the anticipated sale price range for the PROH business,
the Board of Directors consulted with management of the Company. In making its
determination, the Board of Directors reviewed and analyzed the historical
financial results and future prospects of the PROH business, comparable
valuations of businesses similar to those of PROH to the extent that comparable
information was available from public and private transactions and other
relevant and appropriate information. The Board of Directors and management
determined that a transaction value (cash paid plus debt assumed) expressed as a
multiple of the latest quarter annualized ("LQA") EBITDA results was, among
other factors, an appropriate measure of comparability. The Board of Directors
believed that LQA EBITDA was an appropriate measure of comparability for a
transaction such as the PROH Sale, which involves a non-publicly traded
subsidiary, since potential strategic and financial buyers traditionally use LQA
EBITDA to determine the ability of an acquisition target to cover the capital
costs associated with financing acquisitions. Of the eight publicly disclosed
sales transactions involving comparable businesses sold since 1993 (the
acquisitions by HealthSouth Corp. of Horizon/CMS Healthcare Corp., Professional
Sports Care Management Inc., Advantage Health Corp., Caremark Orthopedic
Services Inc., the NovaCare Rehabilitation Hospital Division, ReLife Inc. and
the rehabilitation hospitals and outpatient centers of National Medical
Enterprises Inc. and the acquisition by NovaCare of RehabClinics, Inc.), the
lowest EBITDA multiple of LQA results was 6.3 times. The highest EBITDA multiple
of LQA results was 11.7 times, with the average multiple being 9.8 times. At a
minimum sales price of $200 million, the PROH transaction value would equate to
an LQA EBITDA multiple of 5.2 times. Although this LQA EBITDA multiple is below
the lowest LQA EBITDA multiple for the publicly disclosed comparable
transactions, the Board of Directors believed it was appropriate to use this
multiple as a minimum because the most recent publicly disclosed comparable
transaction was approximately two and one-half years old and, given the
Company's need to satisfy the Debentures by January 15, 2000, the Board of
Directors considered it essential to give management the flexibility to
consummate a sale of PROH in a timely manner. In connection with the execution
of a definitive purchase agreement with a buyer of the PROH business, the
Company will request an opinion from WDR as to the fairness, from a financial
point of view, to the Company of the consideration to be received by the Company
in the sale of the PROH business.
<PAGE> 7
If either the PROH Sale is not approved by the stockholders or the
conditions to the PROH Sale are not met, the Board of Directors will explore the
alternatives then available for the future of the Company. Such alternatives
include (i) to refinance the convertible subordinated debentures through a
combination of private equity and/or public or private debt, which management
believes would demand a high interest rate due to the Company's highly leveraged
position and, moreover, there is no assurance that such financing could be
obtained, and (ii) in the event the $200 million sale price condition is not
met, seeking to obtain stockholder approval of a sale at a lower price. See
"Capital Structure Alternatives" for a discussion of the financing alternative.
Proposed NCES Sale
The Company engaged WP to conduct a competitive bidding process among
potential buyers of the Company's stock interest in NCES. No affiliates of the
Company or any officers or directors of the Company participated in the bidding
process. WP received final proposals from these potential buyers and evaluated
the offers received from potential buyers with respect to, among other factors,
price per share offered for the common stock of NCES, the ability of potential
buyers to consummate a transaction, and the material terms of acquisition
agreements proposed by potential buyers. On September 8, 1999, the Company
entered into a definitive agreement, subject to certain conditions, to tender
its 64% ownership interest in the outstanding stock of NCES at the price of
$2.50 per share, or an aggregate of $48.5 million (the "NCES Sale"). (As of
August 20, 1999, the Company's 19,400,000 share ownership interest in NCES's
common stock was reduced to 64% from 67% as a result of NCES's issuance of
additional shares to third parties in accordance with certain contractual
obligations). The agreement was reached in conjunction with a definitive
agreement by NCES to sell NCES to an investment group comprising Patricof & Co.
Ventures, Fidelity Ventures Limited and AFLAC Incorporated (the "Investors").
Under the terms of the agreement by NCES, a new private company, established by
the Investors, will acquire all the stock of NCES at a price of $2.50 per share
of common stock. The Investors intend to effect the purchase through a cash
tender offer to NCES stockholders, which commenced on September 15, 1999, and a
subsequent merger of NCES into a new private company managed by the Investors.
The Company's tender offer of its ownership interest in NCES is subject to
approval of the Company's stockholders at the Special Meeting and the
satisfaction of customary closing conditions. The proceeds of the sale will be
utilized to pay stockholders as reflected in "Restructuring Proposal
- --Liquidation Analysis and Estimates" below.
The NCES tender offer is expected to close during October 1999. In the
event that the stockholders of NovaCare vote in favor of the NCES Sale, NovaCare
intends to vote all of its shares of NCES in favor of a sale of NCES. As the
owner of 64% of the outstanding stock of NCES, NovaCare has the ability to
approve such a sale under Delaware law.
WP has delivered to the Board of Directors of the Company its written
opinion (the "Fairness Opinion"), dated September 8, 1999, with respect to the
fairness, from a financial point of view, to NovaCare of the consideration to be
received by the Company pursuant to the terms of the definitive agreement for
the NCES Sale. In connection with rendering their opinion, WP reviewed the
definitive agreement for the NCES Sale, reviewed and analyzed certain publicly
available business and financial information relating to NCES for recent years
and interim period to date, as well as certain internal financial and operating
information, including financial forecasts, analyses and projections prepared by
or on behalf of NCES and provided to WP for purposes of their analysis, and met
with management of NCES to review and discuss such information and, among other
matters, NCES's business, operations, assets, financial condition, and future
prospects. WP also reviewed and discussed with NovaCare management its views as
to the short-term liquidity needs of and capital resources available to the
Company.
WP reviewed and considered certain financial and stock market data
relating to NCES and compared that data with similar data for certain other
companies, the securities of which are publicly traded, that WP believes may be
relevant or comparable in certain respects to NCES or one or more of its
businesses or assets, and reviewed and considered the financial terms of certain
recent acquisitions and business combination transactions in the PEO industry
specifically, and in other industries generally, that WP believes to be
reasonably comparable to the NCES Sale or otherwise relevant to WP's inquiry. WP
also performed such other financial studies, analyses, and investigations and
reviewed such other information as considered appropriate for purposes of the
Fairness Opinion.
In WP's review and analysis and in formulating their Fairness Opinion, WP
assumed and relied upon the accuracy and completeness of all of the financial
and other information provided to or discussed with WP or publicly available,
and WP has not assumed any responsibility for independent verification of any of
such information. WP assumed and relied upon the reasonableness and accuracy of
the financial projections, forecasts, and analyses provided to WP, and WP
assumed that such projections, forecasts and analyses were reasonably prepared
in good faith and on bases reflecting the best currently available judgments and
estimates of NCES's management. WP also considered and took into account
NovaCare management's views as to the short-term liquidity needs of and capital
resources available to the Company. WP expressed no opinion with respect to such
projections, forecasts, analyses and views or
<PAGE> 8
the assumptions upon which they were based. In addition, WP has not reviewed any
of the books and records of NCES, or assumed any responsibility for conducting a
physical inspection of the properties or facilities of NCES or for making or
obtaining an independent valuation or appraisal of the assets or liabilities of
NCES and no such independent valuation or appraisal was provided to WP. WP
expressed no opinion as to the potential tax consequences of the NCES Sale to
NovaCare. WP also has assumed that the transactions described in the definitive
agreement will be consummated without waiver or modification of any of the
material terms or conditions contained therein by any party thereto. WP's
opinion was necessarily based on economic and market conditions and other
circumstances as they existed and could be evaluated by WP as of the date of the
Fairness Opinion.
In the ordinary course of WP's business, they may actively trade the debt
and equity securities of NovaCare and NCES for their own account and for the
accounts of customers and, accordingly, may at any time hold a long or short
position in such securities.
WP acted as financial advisor to NovaCare in connection with the NCES
Sale and will receive a fee for these services, which is contingent upon the
consummation of the NCES Sale. In addition, WP has performed various investment
banking services for NovaCare from time to time in the past and has received
customary fees for rendering such services and WP expects to continue to provide
additional financial advisory services to NovaCare for which WP will receive
customary fees.
The Fairness Opinion addresses only the fairness from a financial point
of view to NovaCare of the consideration to be received by the Company pursuant
to the NCES Sale and does not express any views on any other terms of the NCES
Sale. Specifically, the Fairness Opinion does not address NCES's or NovaCare's
respective underlying business decisions to effect the transactions contemplated
by the definitive agreement for the NCES Sale.
In the event that the NCES Sale is not approved by the stockholders or
the closing conditions are not met, the Board of Directors will explore the
alternatives then available to the Company. Such alternatives include (i)
negotiate the NCES Sale with another buyer, (ii) distribute the Company's
interest in NCES to NovaCare stockholders pro rata as a dividend, and (iii) pay
existing indebtedness of the Company with shares of NCES stock (provided such
stock is valued at not less than $2.50 per share).
Restructuring Proposal
The Board of Directors has adopted a Restructuring Proposal, which would
include the sale and possible distribution of any remaining assets of the
Company after consummation of the PROH Sale and the NCES Sale and adoption of a
Plan of Restructuring of the Company (the "Plan"). The Company's interest in
PROH and NCES represents substantially all of the assets (other than cash or
cash equivalents) of the Company. After the sales of PROH and NCES, the Company
will endeavor to sell or convert into cash any remaining assets of the Company.
As described below, if the Restructuring Proposal is approved, the
Company intends to seek to reinvest the net proceeds to the Company from the
PROH Sale and the NCES Sale, after the payment of liabilities, in a new business
or businesses. Approval of the Restructuring Proposal does not constitute
approval of the reinvestment in any new business or businesses and such
reinvestment would be subject to further vote and approval of the stockholders
of the Company. If the Company is unable, or chooses not, to reinvest any
proceeds in a new business or businesses, the Company will liquidate. Approval
of the Restructuring Proposal constitutes approval of such liquidation.
Under the terms of the Plan and pursuant to Delaware law, the Board of
Directors may amend or abandon the Plan prior to the dissolution of the Company
without stockholder approval. Furthermore, under the Plan, NovaCare will not
liquidate prior to December 31, 2000 (the "Liquidation Date"), unless the Board
of Directors determines to liquidate on an earlier date. The Board of Directors
does not currently intend to distribute the proceeds of the sales of PROH and
NCES to the Company's stockholders, if at all, until after the Liquidation Date.
The uses of the proceeds from the sales of PROH and NCES, if consummated, that
may be considered by the Board include the development, acquisition and/or
investment in or merger with new or existing businesses, distributions to the
Company's stockholders, repurchases of the Company's securities and general
business purposes. Such activities could include the acquisition of an entire
company or companies, or divisions thereof, either through a merger or a
purchase of assets, as well as an investment in the securities of a company or
companies or, alternatively, a combination with another business in which the
Company would not be the surviving corporation. The Company has not entered into
any substantive negotiations concerning such acquisitions or investments.
Consummation of any investments or business combinations will be subject to vote
and approval by the stockholders. If any investments or business combinations
are approved by the stockholders of the Company, the Plan will be terminated.
<PAGE> 9
The Restructuring Proposal may eventually result in the complete
liquidation of all of the Company's assets. If the Restructuring Proposal is
approved, and if, prior to the Liquidation Date, no suitable investment or
business combination is identified, the Board of Directors will cause the
Company to file a certificate of dissolution with the Secretary of State of the
State of Delaware, wind up the Company's affairs, attempt to convert all Company
assets into cash or cash equivalents, pay or attempt to adequately provide for
the payment of all of the Company's known obligations and liabilities and
distribute pro rata in one or more liquidating distributions to or for the
benefit of the Company's stockholders, as of the applicable record date(s), all
of the Company's assets. If the Company is dissolved, pursuant to Delaware law,
the Company will continue to exist for three years (or such longer period of
time as the Court of Chancery of the State of Delaware shall direct) for the
purpose of prosecuting and defending suits against it or enabling the Company
gradually to close its business, to dispose of property, to discharge its
liabilities and to distribute the remaining assets to the stockholders of the
Company.
If assets of the Company remain undistributed to its stockholders by
December 31, 2001 (the "Final Distribution Date"), those assets would be
transferred to a liquidating trust (the "Liquidating Trust") for the pro rata
benefit of the stockholders of the Company of record on the Final Distribution
Date. Approval of the Restructuring Proposal will constitute stockholder
approval of the Plan and of the possible appointment by the Board of Directors
of one or more trustees of the Liquidating Trust (the "Liquidating Trustees")
and the execution of a liquidating trust agreement with the Liquidating Trustees
on such terms and conditions as the Board of Directors shall determine in its
absolute discretion. In addition, approval of the Restructuring Proposal will
constitute stockholder approval of any and all sales of assets of the Company
approved by the Board of Directors or, if applicable, the Liquidating Trustees.
The Restructuring Proposal, including the Plan, was approved by the Board
of Directors, subject to stockholder approval, on August 5, 1999.
If the stockholders do not approve the Restructuring Proposal, the
Company's Board of Directors will explore the alternatives then available for
the future of the Company, including (i) presenting a new investment opportunity
to stockholders or (ii) liquidating the Company.
Liquidation Analysis and Estimates
Management has estimated the potential realizable values or range of
values for its assets, estimated liabilities, the estimated operating losses
prior to the sales of PROH and NCES and the cost of liquidation after the
Company sells PROH and NCES, assuming those businesses are sold by September 30,
1999. Based on these estimates, which are detailed in the Proxy Statement, as
amended through September 10, 1999, the estimated net proceeds available for
distribution per outstanding common share upon liquidation of the Company is
between $1.76 and $3.51. In determining the range of estimates, the net proceeds
from the sales of businesses were estimated based on completed transactions with
regard to long-term care services and O&P and proposed transactions for PROH and
NCES as described in"Proposed PROH Sale" and "Proposed NCES Sale", respectively,
above. The basis for the minimum or low end of the estimated realizable values
from the sale of PROH is discussed in "Proposed PROH Sale". The maximum or high
end of the range of realizable values for the sale of PROH was determined on the
same basis, but utilizing the higher end of the range of comparable factors (LQA
EBITDA). All business dispositions were assumed to be divestitures of the
Company's ownership in the stock of those businesses. Therefore, all assets and
liabilities of those subsidiaries are realized through the net proceeds from
these sales, except for the long-term care services sale, pursuant to which,
upon satisfying a $30 million working capital guarantee, any accounts receivable
of the subsidiary sold which relate to periods prior to the date of the sale
(June 1, 1999) are transferred back to NovaCare. The remaining assets and
liabilities reflected in the estimates were those assets and liabilities of
NovaCare, the parent company, and were estimated to be fully realizable, net of
valuation allowances, as reflected in the Company's balance sheet as of March
31, 1999. The Company's results of operations and cash flows for the quarter
ended June 30, 1999 were consistent with the estimates contained in the
liquidation analysis and estimates in the Proxy Statement.
IN DETERMINING THE ESTIMATED NET PROCEEDS AVAILABLE FOR DISTRIBUTION
PER OUTSTANDING COMMON SHARE UPON THE LIQUIDATION OF THE COMPANY OF $1.76 TO
$3.51, THE METHODS USED BY THE BOARD OF DIRECTORS AND MANAGEMENT IN ESTIMATING
THE VALUES AND VALUE RANGES OF THE COMPANY'S ASSETS WERE INEXACT AND MAY NOT
APPROXIMATE VALUES ACTUALLY REALIZED. THE BOARD OF DIRECTORS' ASSESSMENT ASSUMES
THAT THE ESTIMATES OF THE COMPANY'S LIABILITIES AND OPERATING COSTS ARE
ACCURATE, BUT THOSE ESTIMATES ARE SUBJECT TO NUMEROUS UNCERTAINTIES BEYOND THE
COMPANY'S CONTROL AND ALSO DO NOT REFLECT ANY CONTINGENT LIABILITIES THAT MAY
MATERIALIZE. FOR ALL THESE REASONS, THERE CAN BE NO ASSURANCE THAT THE ACTUAL
NET PROCEEDS DISTRIBUTED TO STOCKHOLDERS IN LIQUIDATION WILL NOT BE
SIGNIFICANTLY LESS THAN THE AMOUNT ESTIMATED. MOREOVER, NO ASSURANCE CAN BE
GIVEN THAT ANY AMOUNTS TO BE RECEIVED BY
<PAGE> 10
THE COMPANY'S STOCKHOLDERS IN LIQUIDATION WILL EQUAL OR EXCEED THE PRICE OR
PRICES AT WHICH THE COMMON STOCK HAS RECENTLY TRADED OR MAY TRADE IN THE FUTURE.
CONTINUING OPERATIONS
As discussed above under "The Company - Corporate and Capital Structure
Changes -- Long-Term Care Services Regulatory Changes" and "The Company -
Corporate and Capital Structure Changes -- Sale of Orthotics and Prosthetics
Business", NovaCare had exited or sold substantially all of its businesses
previously included in the long-term care services segment as of June 1, 1999
and on July 1, 1999 sold its O&P business previously included in the outpatient
services segment. Therefore, the remainder of "Item 1. Business" describes the
Company's PROH business in the outpatient services segment and NCES in the
employee services segment.
OUTPATIENT SERVICES
INDUSTRY BACKGROUND
Outpatient Physical Therapy and Rehabilitation Services
The outpatient physical rehabilitation industry provides skilled services
to individuals to minimize physical and cognitive impairments, maximize
functional ability and restore lost functional capacity. Outpatient physical
rehabilitation services are rendered primarily in outpatient physical
rehabilitation facilities, physical rehabilitation hospitals, acute care
hospitals, physician offices, industrial settings, schools and patients' homes.
The professionals providing these services include physical and occupational
therapists, physiatrists and other qualified physical rehabilitation physicians
and nurses, speech-language pathologists, respiratory therapists, athletic
trainers, recreational therapists, physical rehabilitation counselors and
others.
According to industry sources, the outpatient physical rehabilitation
services industry is a $10 billion industry with 55% of the services provided
through approximately 9,200 free standing clinics. The two largest providers,
NovaCare and HealthSouth Corp., have a combined market share of 19.8% based on
facilities (6.4% and 13.4%, respectively), and 11.5% based on fiscal 1999
revenues (3.0% and 8.5%, respectively). Other significant competitors consist of
hospitals and nursing homes offering physical rehabilitation services and
private independent operators (physician and therapist entrepreneurs).
Industry experts assert that the outpatient physical rehabilitation
industry has been growing at a compound annual growth rate of approximately 5%
per year since 1992. This trend is expected to continue for several fundamental
reasons:
Cost Containment Opportunities. Outpatient physical rehabilitation is
recognized to be a cost-effective and high-quality substitute for more expensive
settings and has been winning market share from acute care and rehabilitation
hospitals. According to a 1995 Health Insurance Corporation of America study,
for every $1 spent on physical rehabilitation, approximately $30 in future
health care, lost productivity and other costs are saved. Outpatient clinics are
able to provide their services at lower costs than hospitals because of their
lower overhead. In addition, reimbursement changes have encouraged the rapid
discharge of patients from acute care hospitals even though they are in serious
need of physical rehabilitation services. In addition, growth of the outpatient
sector is expected to benefit from changes to the PPS for rehabilitation
hospitals, scheduled for October 2000.
Outpatient Medical and Technological Innovation. Each year more than
three million people regain all, or substantially all, of their musculoskeletal
functionality following near-fatal auto accidents, sports injuries, strokes,
heart attacks and other medical occurrences, reflecting advances in medical
technology and treatment, including more intensive use of physical
rehabilitation. In addition, improving technologies and techniques allow for an
increasing number of surgical procedures to be performed outside of hospitals.
These patients rely heavily on outpatient physical rehabilitation services for
restoring functionality.
Graying of America: Aging Population Requiring More Rehabilitation
Services. The U.S. Bureau of Census estimates that the fastest growing segment
of the nation's population is the 65-and-over group. This age group is expected
to grow 18% between 1996 and 2010, and 75% from 2010 to 2030. This group
requires more physical rehabilitation services than any other age-group, because
the incidence of ailments such as hip fractures, strokes and other
musculoskeletal conditions is the greatest within this age-group. Combined with
the increasing physical activity and the high quality of life expectations of
the elderly and the disabled, the growth in this segment of the population
promotes increasing utilization of outpatient physical rehabilitation services.
<PAGE> 11
Occupational Health Services
The occupational health services industry is estimated to be a $26
billion industry. It comprises $4 billion of primary clinical care services, $4
billion of non-injury services and $18 billion of specialty and hospital care
services. Analysts estimate that there are more than 2,000 specialized
occupational health centers in the United States with 80.2% privately held,
single-center businesses. Approximately 40% of work-related injuries require
physical rehabilitation. The medical segment of the industry is growing at
approximately 9%. Currently, NovaCare competes in the primary care market and in
the approximately $1 billion prevention segment of the non-injury services
market. The injury segment includes treatment for work-related injuries,
physical and occupational rehabilitation therapy, pre-placement physical
examinations and evaluations, diagnostic testing and other employer-requested or
government-mandated work-related health care services. Non-injury services
include case management, utilization management, bill review and processing,
on-site safety training and evaluation and vaccination programs.
This industry is highly fragmented. The four largest competitors,
including the Company, comprise 19.8% of the industry based on number of
facilities. Based on 1999 revenues, they have a combined market share of 12.2%
of the $5 billion primary care services and prevention services segment of
non-injury services.
As a result of ballooning expenditures, controlling workers' compensation
costs is a high growth, high profile business. Expenditures under the workers'
compensation program in the United States grew from $67 billion in 1991 to $93
billion in 1996, a compound annual growth rate of 7%. By 2000, workers'
compensation costs are expected to rise to approximately $120 billion. In recent
years, medical costs associated with workers' compensation claims have grown
faster than those of general healthcare costs, and the medical expenditures
portion as a share of workers' compensation expenditures has increased as well.
Occupational health companies that are able to leverage utilization
management, case management and cost-effective provider networks to return the
injured employee to work quickly and reduce the total cost of return-to-work,
including both indemnity and medical costs, are positioned to benefit
significantly by substantially reducing the costs to employers of work-related
illnesses and injuries.
Broader definitions of work-related injuries and illnesses covered by
workers' compensation laws, regulatory requirements calling for increased health
testing (i.e. substance abuse), the shifting of medical costs from group plans
to the workers' compensation system, an aging work force, the merging of
traditional workers' compensation insurance with disability insurance and, most
importantly, the absence of comprehensive cost containment programs will
continue to increase the demand for occupational health services.
Demographics and advanced technology also will contribute significantly
to the growth of this fragmented and localized industry. Increasingly, as both
volume of workers' compensation injuries and the cost per injury increase, the
industry will continue to consolidate to accommodate employers' needs to
coordinate and lower work-related injury costs.
The outpatient physical rehabilitation and occupational health industries
have been undergoing a trend of consolidation in recent years. Larger successful
companies with access to capital and resources have been driving the
consolidation as payers in both industries have demonstrated their desire to
work with fewer providers to reduce expenses and control utilization, and care
providers have needed to focus on economies of scale to minimize variable costs
and spread overhead for increasingly complex and sophisticated information
systems in a cost sensitive managed care world.
STRATEGY STATEMENT
NovaCare's outpatient services strategy is to expand its local market
presence and enhance relationships with providers, payers and employers to
achieve local market leadership. The strategy is based on management's belief
that:
- Health care is a local business. Local market growth is dependent upon
relationships with physicians, hospitals, post-acute care and managed
care delivery systems, employers and payers.
- The highest margins in a market generally accrue to the provider with
the greatest regional market share and scale.
<PAGE> 12
- Outpatient physical therapy and occupational health rehabilitation
services will continue to experience steady or growing demand because
health care payer cost-containment efforts will continue to drive
patients toward the most cost-effective, outcome-oriented health care
solution to satisfy patients' needs and customers' requirements.
- Purchasers of outpatient physical therapy and occupational health
rehabilitation services will continue to emphasize cost-effective,
clinically proven outcomes in the selection of rehabilitation providers.
- Clinical superiority through technological leadership and demonstrated,
measurable outcomes should produce a clear competitive advantage.
PLAN FOR GROWTH AND OPERATIONS
The Company's outpatient services growth and margin improvement plan has
four principal components: (i) achieve the leading position in target markets,
(ii) enhance the effectiveness of contract pricing, utilization and payer mix
disciplines, (iii) implement proprietary information systems, and (iv) reduce
labor costs.
Achieve the Leading Position in Target Markets. NovaCare has expanded its
extensive network of outpatient services sites in target geographic markets
through acquisitions, start-up centers and the development of rehabilitation
provider networks. Management believes that the size and density of NovaCare's
outpatient services network in many markets positions the Company favorably to
affiliate with health care delivery systems and to compete for referrals from
managed care organizations, physician groups, hospitals and commercial
customers. As a result of the Company's forward target market strategy, NovaCare
commands the number one or two market position, based on revenues, in 18 of its
31 target markets, and is one of the top three providers in 24 of these markets.
NovaCare intends to build and maintain leading market positions in its 31
target geographic markets by leveraging relationships with leading health care
providers and brand recognition in these target markets. The Company's goal is
to enhance referral and health care system relationships, increase brand
awareness and leverage its clinical resources and infrastructure investments in
target markets. Management believes that with its outpatient services network,
NovaCare is in a strong position to meet the needs of health care systems in a
local or regional market. NovaCare offers the attributes that health care
systems partners find attractive: (i) dispersed outpatient services
capabilities, and (ii) cost-effective, clinically proven outcomes.
NovaCare has built a well-recognized brand which is strongly identified
with customer needs. The Company's high quality and cost-effective clinical
programs with proven treatment results, easily accessible network of clinics
providing timely and attentive care and innovative customer service initiatives
cause NovaCare to be recognized in its markets as the leading service provider
to physicians, payers, employers and patients alike. Closely measured marketing
and service initiatives have solidified NovaCare's market share and brand
identity in local markets. NovaCare also enhances its brand and clinical
reputation by leveraging relationships with 66 national, professional and
collegiate sports teams and athletes.
Enhance the Effectiveness of Contract Pricing, Utilization and Payer Mix
Disciplines. During the period from fiscal 1997 to 1999, increases in patient
visits have more than offset declines in average price per visit. The declines
resulted from inadequately controlled fee-for-service and capitated pricing
awarded to managed care organizations, insufficient control of service
utilization by capitated patients, a reduction in Medicare rates and a reduced
concentration of higher-priced workers' compensation business. Management
expects to reverse this trend by (i) establishing a highly disciplined,
centrally controlled pricing and contract management function; (ii) installing
the PRONET system (discussed under "Implement Proprietary Systems" below) to
better identify and manage emerging pricing and utilization issues; and (iii)
marketing to increase the concentration of relatively more attractive payers,
especially workers' compensation and commercial insurance.
Implement Proprietary Information Systems. NovaCare's growth is supported
by a leading-edge proprietary billing, collections and management reporting
system, PRONET, which simplifies, standardizes and tightly controls the billing
process from patient registration through collections. Major functions,
including contract management, patient registration, scheduling, insurance
verification, charge entry, bill production, cash application and collections,
are all provided in one integrated system. The unique system provides a
substantial foundation for operating efficiency and service differentiation. In
addition, NovaCare can offer payers the accuracy and timeliness of electronic
data interfaces for billing and documentation. The PRONET system has been
<PAGE> 13
implemented in over 40% of the Company's outpatient physical rehabilitation
business with full implementation planned to be completed by June 30, 2000.
The flexibility of PRONET allows for the integration of additional
components necessary for complete automation of the outpatient business process,
including clinician credentialing, clinical automation, enterprise scheduling
and outcomes reporting. The system is built with scaleable technology to allow
for volume growth and currently supports 12,000 payer plans. PRONET is also a
critical management tool, providing daily clinic-by-clinic data on key operating
variables. A state-of-the-art system, STIX, with similar business functionality
as PRONET, supports the occupational health business. It enhances NovaCare's
relationship with employers and manages the injury care and return-to-work
process, as well as reimbursement for injury and non-injury services.
Reduce Labor Costs. Clinical and technological improvements and innovation,
an improved operating and staffing model and deflation in clinical compensation
due to an over supply of clinical staff as a result of the Medicare changes for
rehabilitation reimbursement in long-term care facilities and hospitals, are
expected to lower the cost of service delivery.
BUSINESS PROFILE
For the fiscal years ended June 30, 1999 and 1998, outpatient service
represented 42% and 52%, respectively, of the Company's net revenues. On July 1,
1999, the Company sold its O&P business as discussed under "The Company -
Corporate and Capital Structure Changes."
Management believes that NovaCare is the second largest provider of
freestanding outpatient physical therapy and rehabilitation services and the
fourth largest provider of occupational health services in the United States
based on revenues. The Company's national network of 623 clinics comprises
stand-alone clinics, hospital-based clinics and employer on-site clinics in 33
states. NovaCare augments its "owned" clinic network with a physical
rehabilitation provider network of 755 affiliated clinics in 15 states. Through
its owned settings, approximately 2,600 physical and occupational clinical staff
develop and deliver individual treatment plans and utilize a sports medicine
approach to rehabilitate patients and manage recovery from orthopedic surgery,
injuries and disease-related conditions.
Outpatient physical therapy and rehabilitation services include: (i) general
physical rehabilitation, which is designed to return injured and post-operative
patients to their optimal functional capacity, (ii) sports medicine, which is
designed to minimize the "downtime" of injured sports participants and safely
return them to sports activities, (iii) enhanced performance training, which is
designed to improve the muscular and cardiovascular performance of both
professional caliber athletes and "weekend warriors", as well as the "senior
citizen" population, (iv) industrial rehabilitation, which is designed to reduce
work-related injuries and rehabilitate and strengthen injured patients to allow
a rapid, safe and productive return to normal job activities, and (v)
hospital-based services, which involve providing inpatient and outpatient
rehabilitation services on a contract basis to acute care hospitals.
Patients are generally referred by physicians (most commonly orthopedists,
physiatrists, primary care physicians, internists and neurologists), managed
care insurers, workers' compensation insurers, case managers and risk managers
of industrial companies. Patients generally receive referrals or prescriptions
to receive either a set regimen of treatment or a specific number of therapy
sessions lasting various time periods. In a number of states, patients can
obtain outpatient therapy services by "direct access," without a physician's
referral.
The occupational health services business provides medical treatment for
work-related injuries and illnesses and a range of health related non-injury
services to employers. Practitioners of medical care consist of specialized
occupational health physicians, physical therapists, physiatrists and other
health care professionals. Medical care for work-related injuries is provided in
specialized occupational health clinics. The non-injury services sector includes
employment-related physical examinations, drug and alcohol testing, functional
capacity testing and other related programs designed to meet specific employer
needs. Non-injury health care services also consist of case and utilization
management, and prevention programs related to managing an employer's workers'
compensation program.
The most common work-related injuries are soft tissue injuries, lacerations,
moderate trauma injuries to the spine or extremities and exposure to hazardous
materials. Work-related injuries are costly to treat and require attention by
providers and case managers that have expertise in the field. Work-related
injuries cost 1.7 times more to treat than comparable non-work injuries. As a
result of higher medical costs, related indemnity benefits and legal and
administrative expenses, the cost of on-the-job injuries is extremely high.
<PAGE> 14
Customers for occupational health services include workers' compensation
insurance companies, commercial and government self-insured employers that
operate through third-party administrators and employees covered by various
insurance programs.
The occupational health services market is highly fragmented and many
providers of occupational health care, such as hospital emergency departments
and general practitioners, are not specialized in occupational health care. The
Company believes that, due to increasing business and regulatory complexity,
capital requirements and the development of health care systems in local and
regional markets, an increasing number of physicians specializing in
occupational health services are seeking to affiliate with larger health care
service organizations.
NovaCare is one of the four largest occupational health services providers
managing work injury rehabilitation and prevention programs for employers
through on-site programs and outpatient care through the Company's 35
freestanding occupational health centers and its 588 outpatient rehabilitation
clinics. NovaCare performs work-site analyses to assess workplace risk, provides
work-site safety programs and helps employers comply with work-related state and
federal requirements.
COMPETITION
The health care industry in general, and rehabilitation in particular, is
highly competitive and subject to continual changes in methods of service
delivery and provider selection. Rehabilitation is largely a local market
business and competition varies considerably among markets. NovaCare competes
primarily in the 31 target geographic markets where its outpatient services
patient care centers are located. The primary competitive factors in such local
markets are: (i) breadth of the providers' patient referral network, (ii)
inclusion in payer provider panels, (iii) skilled clinical personnel, and (iv)
information systems which can track contracts and patient services to ensure
maximum reimbursement.
The Company believes that its national and local sponsorship and support of
organizations for injured and disabled individuals and affiliations with
professional sports teams enhance NovaCare's visibility, brand recognition and
competitive position. NovaCare has relationships with 66 national, professional
and collegiate sports teams and athletes.
The Company competes in local markets with other national, regional and
local outpatient rehabilitation service providers, as well as hospital-based
outpatient clinics and physician-directed therapy practices. Some of these
competitors may have greater patient referral, personnel and geographic
resources in certain local markets.
In the occupational health services industry, the market is highly
fragmented and competitive. The largest competitor in the industry has less than
8% market share. Competitors include other occupational health services
companies, independent physicians, hospitals, insurance companies, HMO's,
managed care providers and networks of primary care physician specialists. The
ability to compete successfully is dependent upon: (i) returning employees to
work quickly at the highest rate of functionality and the lowest cost for the
care provided, (ii) expertise in treating work-related injuries, (iii)
relationships with employers, employees and workers' compensation payer sources,
and (iv) information systems to case manage each worker back to their job most
appropriately.
REIMBURSEMENT/GOVERNMENT RELATIONS
The principal sources of reimbursement for outpatient services are workers'
compensation insurance, managed care plans, commercial insurance, self-insured
employers, Medicare and individual patients on a self-pay basis.
Workers' Compensation. Workers' compensation is a state mandated,
comprehensive insurance program that requires employers to fund medical
expenses, lost wages and other costs resulting from work-related injuries and
illnesses. (See "Government Regulation" in the "Employee Services" section
below.) Workers' compensation represented approximately 31% of fiscal 1999 PROH
net revenues.
Managed Care. NovaCare receives revenues under managed care plans either on
a discounted fee-for-service basis or, in a growing number of cases, on the
basis of capitated fees per covered member per month. Managed care plans
represented approximately 25% of fiscal 1999 PROH net revenues.
Commercial Insurance. Traditional indemnity insurance plans constituted 17%
of fiscal 1999 PROH net revenues.
<PAGE> 15
Medicare. NovaCare receives reimbursement by Medicare for outpatient and
occupational health care services primarily through NovaCare's certified
rehabilitation agencies. See "Government Regulation," discussed later. Medicare
insurance programs represented approximately 7% of net revenues for PROH in
fiscal 1999.
Other. Self-insured employers, individual patients on a self-pay basis and
other payer sources represented approximately 20% of fiscal 1999 PROH net
revenues.
GOVERNMENT REGULATION
The health care industry, including outpatient services, is subject to
extensive Federal, state and local regulation. Various layers of regulation
affect NovaCare's business by requiring licensure or certification of its
employees and facilities and controlling reimbursement for services provided.
Government and other third-party payers' health care policies and programs have
been subject to changes in payment amounts and methodologies for a number of
years.
NovaCare operates certified rehabilitation agencies to facilitate billing
for a portion of its outpatient services. In order to receive Medicare
reimbursement directly, outpatient centers must be certified by Medicare as
rehabilitation agencies or comprehensive outpatient rehabilitation facilities.
The certification criteria relate to the type of facility and its equipment,
record keeping, staffing, and service, as well as compliance with all state and
local laws. In addition, certain states require facilities to obtain state
licensure as a health facility as a requirement for reimbursement. As of June
30, 1999, NovaCare operated 117 certified rehabilitation agencies for outpatient
services. Management believes its operations are structured to comply with all
applicable rules and regulations.
In most states, the employment of therapists by business corporations is a
permissible practice. However, several states, including states in which
NovaCare operates, have enacted legislation or regulations or have interpreted
existing licensing laws to restrict business corporations, such as NovaCare,
from practicing therapy through the direct employment of therapists. Management
believes its operations are structured to comply with applicable laws and
regulations.
Various state and Federal laws and regulations govern the relationships
between providers of health care services and physicians, including employment
or service contracts and investment relationships. These laws and regulations
include the fraud and abuse provisions of the Medicare and Medicaid statutes,
which prohibit the payment, receipt or offering of any direct or indirect
remuneration for the referral of or to induce a referral of Medicare or Medicaid
patients or for the ordering or providing of Medicare or Medicaid covered
services, items or equipment and the self-referral provisions of Federal and
state law which generally prohibit referrals by a physician to persons with whom
the physician has certain types of financial relationships. Violations of these
provisions may result in civil or criminal penalties for individuals or entities
and/or exclusion from participation in the Medicare and Medicaid programs.
Management believes it is in compliance with these laws and regulations and has
established a compliance program to ensure conformance with these rules as well
as other laws and regulations.
EMPLOYEE SERVICES
INDUSTRY BACKGROUND
According to industry analysts, the PEO industry had approximately $22
billion in annual revenues during 1997 with a historical growth rate over the
last five years of approximately 28% per year. According to the U.S. Small
Business Administration, there are nearly six million businesses in the United
States with fewer than 500 employees, employing more than 52 million persons and
with $1.2 trillion in aggregate annual payroll. The National Association of
Professional Employer Organizations ("NAPEO") estimates that the PEO industry
employs fewer than three million worksite employees. The Company believes,
therefore, that approximately 49 million of these employees are currently
unserved by the PEO industry.
The PEO industry is highly fragmented. NAPEO data suggest that there are
approximately 2,000 PEOs currently in operation. According to industry analysts,
the ten largest PEOs account for approximately 39% of existing revenues in the
industry. The Company believes that significant consolidation opportunities
exist within the PEO industry due to increasing industry regulatory complexity
and capital requirements associated with developing larger service delivery
infrastructures, more diversified services and more sophisticated management
information systems.
<PAGE> 16
Demand for Services. The PEO industry evolved in the early 1980's in
response to increasing employment and benefit costs, and the complexities of the
legal and regulatory environment for the rapidly expanding small- to
medium-sized business sector. The Company believes demand for PEO services will
continue to increase as: (i) employment-related governmental regulation grows
more complex, (ii) growth continues within the small- to medium-sized business
community, (iii) the need to provide health and retirement benefits in a
cost-effective convenient manner increases, and (iv) the business and regulatory
communities accept and recognize the PEO industry. While various service
providers, such as payroll processing firms, benefits and safety consultants and
temporary services firms, are available to assist these businesses with specific
tasks, such organizations do not typically provide the more comprehensive range
of services generally offered by PEOs. PEOs enter into agreements with numerous
small- to medium-sized employers, and can, therefore, achieve economies of scale
as professional employers and offer benefits packages and human resource
services at a level typically available only to larger companies which have
greater resources to devote to human resources management. The Company believes
PEO services will continue to experience growing demand because of the growing
trend among small- to medium-sized employers to: (i) outsource non-core
competencies, (ii) seek to reduce employee benefit costs, (iii) avoid
employee-related risks and regulatory complexities, and (iv) attract better
employees and retain them through improved benefit plans.
Effectiveness of Services. According to estimates by the U.S. Small Business
Administration, the management of a typical small- to medium-sized business
devotes from 7% to 25% of its time to employee-related matters, leaving
management with less time to focus on core competencies. Work-related injuries
cost employers over $53 billion in medical expenses and lost employee
productivity each year, according to industry estimates. Employees are typically
attracted to small and medium-sized businesses that provide them with an array
of human resources benefits and services typically characteristic of large
employers. An industry analyst's study indicated that 40% of the companies that
outsourced services to a PEO upgraded their employee benefits offerings and
one-fourth of those clients offered health care and other benefits for the first
time.
STRATEGY STATEMENT
The Company's strategy is to be the preferred human resources partner by
leveraging operational excellence, technology and strategic alliances to achieve
market leadership. The strategy is based on management's belief that:
- PEO services will continue to experience growing demand because of the
trend among small- to medium-sized employers to: (i) outsource non-core
competencies, (ii) reduce employee benefit costs, (iii) avoid
employee-related risks and regulatory complexities, and (iv) attract
better employees and retain them through improved benefit plans.
- The market for PEO services, based on analyst reports, is more than 95%
unserved and is expected to grow at the rate of 28% per year for the
next five years.
- The PEO industry is highly fragmented with significant consolidation
opportunities for companies with access to capital, larger service
delivery infrastructures, and well developed and sophisticated
management information systems.
- PEOs typically take a transaction processing approach to their services
and do not emphasize the improved workforce performance characteristic
of satisfied employees.
- In selecting PEO providers, small- to medium-sized businesses will
increase their emphasis on cost-effectiveness, service excellence and
the breadth of services provided.
- Employees are attracted to small- and medium-sized businesses that
provide employees with human resource services characteristic of large
employers.
- Strategic alliances will enable PEOs to enhance endorsement
opportunities, widen the network distribution channel and broaden the
service/product offering.
PLAN FOR GROWTH AND OPERATIONS
NovaCare's subsidiary, NCES, is one of the largest (measured by number of
worksite employees) PEOs in the United States. NCES commenced operations in
October 1996, concurrent with the acquisition of one PEO business. In February
1997, NCES acquired three additional PEOs. NCES completed its initial public
offering in November 1997 with an offering of 5,750,000 shares of
<PAGE> 17
common stock. In fiscal 1998, NCES acquired PEOs in Arizona and Maryland and in
fiscal 1999 acquired PEOs in Utah and New Mexico. As of June 30, 1999, NCES
served approximately 4,100 client organizations with approximately 54,300
employees at more than 5,000 worksites primarily in ten industries and 46
states, including approximately 8,700 employees employed by the Company,
principally in its outpatient services business.
NCES intends to grow through: (i) increasing investment in marketing and
sales, (ii) focusing on geographic expansion, (iii) targeting high potential
industries and services, (iv) acquiring PEOs and other employee service
providers, and (v) entering into strategic alliances.
Increasing Investment in Marketing and Sales. The Company's management is
experienced in building businesses utilizing focused marketing strategies and
professional sales forces. A significant part of NCES's marketing strategy is
the continued development of its brand identity. A recognized brand name is a
valuable marketing tool. NCES believes that its marketing efforts will benefit
from its brand strategy. NCES's brand promise is to provide better human
resources solutions at the best value. NCES seeks to create a more satisfying
and more productive relationship between its worksite employees and clients by
"caring for and about people." By effectively and consistently delivering
against this service commitment, NCES believes it will attain a brand name
reputation for operational excellence among existing and potential clients.
Focusing on Geographic Expansion. NCES has identified key attractive
geographic target markets and has established a plan for entering those markets
in a disciplined manner. NCES believes that its market development model will
enable it to penetrate new markets quickly. This market development model
consists of a highly structured sales management control system and efficient
selling process. The model includes market research to identify potential client
businesses and a direct mail and telemarketing campaign to reach those
businesses. In certain cases, NCES may rely on platform acquisitions to achieve
scale in a market.
Entry priority for specific markets is determined by the number and growth
of small- to medium-sized businesses, the state regulatory environment and
access to infrastructure to support operations. Once a market is selected, NCES
executes an entry plan which includes defining benefit plans and service
offerings, recruiting a management sales team, site selection, training and
orientation, and launching a specific marketing plan to begin the selling
process.
Targeting High Potential Industries and Services. Targeted industries will
vary from market to market depending on economic characteristics and business
demographics of each geographic location. NCES intends to focus on industries
with high gross profit per worksite employee and significant workers'
compensation profit opportunities. High potential industries are those, such as
health care and construction, that NCES believes could benefit most from its
risk management expertise (e.g., traditional high workers' compensation
classifications) and its offering of an extensive benefits package (e.g.,
industries facing a shortage of workers). Other high potential industries would
include those characterized by rapid growth or change. The sales force is
expected to utilize the key industry strategy and become expert in one or more
select industries in the markets in which they operate. NCES plans to target
larger accounts where it can leverage its unique capabilities and expertise
gained from servicing the Company.
Acquiring PEOs and Other Employee Service Providers. The Company believes
that the opportunities for PEO consolidation are substantial with approximately
2,000 PEOs (according to an estimate by NAPEO) operating in a highly fragmented
industry. The Company believes that industry consolidation will be driven by
increasing industry and regulatory complexity, increasing capital requirements
and the significant economies of scale available to PEOs with a concentration of
clients and employees in target markets. NCES intends to make opportunistic
acquisitions where appropriate to achieve greater density in targeted geographic
markets or expand its service offering.
Entering into Strategic Alliances. NCES is creating strategic alliances with
service providers to small- and medium-sized businesses. For example, in March
1999, NCES entered into a strategic alliance with AFLAC, Incorporated, the
nation's largest provider of supplemental insurance products with approximately
130,000 clients, whereby products and services are cross-sold among each firm's
existing and targeted client base. The Florida Home Builders Association, an
organization that has approximately 17,000 members with 450,000 worksite
employees, has endorsed the Company as the PEO of choice for its members. In
addition, the Greater Philadelphia Chamber of Commerce has endorsed NCES as the
exclusive PEO of choice for its approximately 6,000 small business client
members, under a three-year arrangement.
With the trend toward outsourcing non-core competencies, small- and
medium-sized businesses typically have service relationships with accountants,
attorneys, banks, trade associations and other business advisors. Alliances with
these service providers
<PAGE> 18
offer a cross-selling opportunity for NCES's services. Other potential alliances
being pursued include additional product or service offerings, as well as
creating additional sales distribution channels. NCES intends to develop such
alliance opportunities as an extension of its marketing and sales capability.
BUSINESS PROFILE
For the fiscal years ended June 30, 1999 and 1998, employee services
represented 58% and 48%, respectively, of the Company's net revenues.
As co-employer of worksite employees, NCES assumes responsibility for and
manages the risks associated with: (i) worksite employee payroll, (ii)
employee-related benefits, such as workers' compensation and health care
insurance coverage, and (iii) compliance with certain employment-related
governmental regulations that can be effectively managed away from the client's
business. The client retains responsibility for supervision and direction of the
worksite employees' services in its business and generally remains responsible
for compliance with other employment-related governmental regulations that are
more closely related to worksite employee supervision. The service fee charged
by NCES to its clients covers the cost of certain employment-related taxes,
workers' compensation insurance coverage and risk management services,
administrative and field services, wages of worksite employees and the client's
portion of health and retirement benefit plan costs. NCES also provides other
value-added services such as temporary staffing, recruiting, training and human
resource consulting.
NCES believes its services enable small- and medium-sized businesses to
cost-effectively manage and enhance the employment relationship by: (i)
controlling the risks and costs associated with workers' compensation, workplace
safety and employee-related litigation, (ii) providing employees with high
quality health care coverage and related benefits, (iii) managing the
increasingly complex legal and regulatory environment affecting employment, (iv)
providing payroll and human resource administrative services that are reliable,
accurate and delivered in a friendly and caring way, and (v) achieving scale
advantages typically available to larger organizations.
NCES contractually assumes certain administrative, regulatory and financial
employer responsibilities with respect to worksite employees in a
"co-employment" relationship. NCES believes its clients benefit from its
services by: (i) improving profitability through lowering or controlling costs
associated with workers' compensation, health insurance, other benefit coverage
and regulatory compliance, (ii) improving productivity through reducing the time
and effort expended by business owners and executives to deal with the
complexities of employment management, enabling them to focus on their business
core competencies and growth, and (iii) improving employee satisfaction and
performance. NCES helps its worksite employers improve job satisfaction and
performance of the worksite employees by providing improved health care and
related benefits, delivering training programs, and delivering dependable
payroll and benefits administration.
In order to implement its strategy to provide better solutions at the best
value, NCES provides six primary categories of employee services: (i) workers'
compensation and safety management, (ii) unemployment insurance management,
(iii) employee benefits procurement and administration, (iv) human resources and
compliance management, (v) payroll management, and (vi) other value-added
services. By engaging NCES to provide these services, clients can focus on their
core competencies.
These services are provided under NCES's PEO client service agreement, which
typically has an initial one-year term; thereafter, the agreement is renewed
periodically. The agreement is subject to termination by NCES or the client upon
30 days prior written notice. Service revenues, billed to clients along with
each periodic payroll, are based on a pricing model that takes into account the
gross pay of each employee and a mark-up that includes the estimated costs of
employment-related taxes, providing insurance coverage and benefit plans,
performing human resource administration, payroll, benefits and compliance
management and other services and an administration fee. The specific mark-up
varies by client based principally on the workers' compensation classification
of the worksite employees, their human resource needs and the size of the
client. Accordingly, NCES's average mark-up percentage will fluctuate based on
client mix.
Clients are required to pay NCES its total fee concurrent with the
applicable payroll date. Although NCES is ultimately liable as the employer to
pay employees for work previously performed, it retains the right to terminate
the PEO client service agreement as well as the worksite employees upon
non-payment by a client, which limits any future liability. This right and the
periodic nature of payroll, combined with client credit verifications and NCES's
client selection process, are used to control this exposure.
<PAGE> 19
Workers' Compensation and Safety Management. Workers' compensation is a
state-mandated, comprehensive insurance program that requires employers to fund
medical expenses, lost wages and other costs that result from work-related
injuries and illnesses, regardless of fault and without any co-payment by
employees. See "Government Regulation" below for a discussion of workers'
compensation. Pursuant to NCES's PEO client service agreement, NCES assumes the
obligations of its clients to pay workers' compensation claims. NCES seeks to
control its workers' compensation costs through comprehensive risk evaluation of
prospective clients, the prevention of workplace injuries, timely intervention
with employee injuries, aggressive management of the medical costs related to
such injuries and the prompt return of employees to work. NCES seeks to prevent
workplace injuries by implementing a wide variety of training and safety
programs. NCES's efforts to return employees to work quickly involve both
rehabilitation services and the placement of employees in transitional,
light-duty positions until they are able to resume their former positions.
Unemployment Insurance Management. Pursuant to NCES's PEO client service
agreement, NCES also assumes the obligation of its clients to pay unemployment
insurance costs. NCES manages its unemployment insurance costs by establishing
employee termination procedures, timely responding to unemployment claims,
attending unemployment hearings and attempting to reassign employees to other
worksites when a reduction in force occurs at any one worksite location.
Employee Benefits Procurement and Administration. Pursuant to NCES's PEO
client service agreement, NCES is required to provide mandated employee benefits
to worksite employees. Additionally, NCES offers worksite employees a voluntary
benefits package that includes several health care options, such as
point-of-service, preferred provider organizations, health maintenance
organizations ("HMOs") and indemnity plans. Supplemental benefit programs offer
dental care, prescription drugs, and life and disability insurance options. NCES
also offers 401(k) retirement savings, cafeteria style plans to its eligible
employees. NCES believes that its ability to provide and administer a wide
variety of employee benefits on behalf of its clients tends to mitigate the
competitive disadvantage small and medium-sized businesses normally face in the
areas of employee benefit cost control and employee recruiting and retention.
Human Resources and Compliance Management. Pursuant to NCES's PEO client
service agreement, NCES provides comprehensive human resources services to its
clients. These services reduce the employment-related administrative burdens
faced by its clients, and provide worksite employees with a wide array of
benefits typically offered by large employers. NCES develops and administers
human resources policies and procedures for each of its clients, relating to,
among other things, recruiting, retention programs, performance management,
discipline and terminations. NCES also provides orientation, training and
development, counseling and substance abuse awareness for worksite employees.
By contract, NCES generally assumes responsibility for complying with many
employment-related regulatory requirements. In addition, NCES assists its
clients in understanding and complying with other employment-related
requirements for which NCES does not assume responsibility. Laws and regulations
applicable to employers include state and Federal tax laws, state workers'
compensation laws, state unemployment laws, occupational safety laws,
immigration laws, and discrimination, sexual harassment and other civil rights
laws.
Payroll Management. Pursuant to the PEO client service agreement, NCES is
responsible for payroll processing, check preparation, distribution and
recordkeeping, payroll tax deposits, payroll tax reporting, employee file
maintenance, unemployment claims and monitoring and responding to changing
regulatory requirements. NCES indemnifies the client against NCES's failure to
comply with regulatory requirements. Payroll reports are prepared for clients
for financial and other recordkeeping purposes. Provision of these services by
NCES generally reduces the client's employment liabilities and allows clients to
focus on their core business.
Other Value-Added Services. NCES offers rehabilitation temporary staffing in
the healthcare industry. The rehabilitation temporary staffing service currently
can draw on a pool of approximately 6,000 rehabilitation clinicians to provide
staff to health care providers. This business is supported by technology, which
provides detailed recruitment and sales productivity information for management
purposes. It also generates billing and utilization reports for clients.
NCES also plans to offer additional value-added services to clients and
worksite employees. Such services may include employee recognition programs,
travel discount arrangements, vision care, credit union membership, smart cards,
warehouse club memberships and various financial services. Some of these
services may generate fee income or commissions for NCES.
<PAGE> 20
INFORMATION TECHNOLOGY
NCES's nationwide information systems network connects its local customer
service centers, regional processing centers, worksite employees, clients and
service providers. These technologies include, but are not limited to, a
combined Internet/Intranet access and electronic mail system, client
server-based expertise, which provides distributed processing and rapid
implementation of business changes and telecopier to data technology (which
eliminates the need for manual data entry). The regional processing centers
serve as disaster recovery backup sites, having the capability to handle NCES's
operations for a short period of time.
NCES currently uses commercially available software to manage information
related to payroll processing, benefits administration, human resource
management and employee enrollment. NCES has also developed the requirements to
create a proprietary information management system to handle the expected growth
in worksite employees.
COMPETITION
The PEO industry consists of at least 2,000 companies (according to an
estimate by NAPEO), most of which serve a single market or region. NCES believes
that it is the third largest PEO (measured by number of worksite employees) in
the United States. According to industry analysts, the ten largest PEOs account
for 39% of the existing revenues in the industry. NCES considers its primary
competition to include: (i) traditional in-house human resources departments;
(ii) other PEOs, and (iii) providers of unbundled employment-related services
such as payroll processing firms, temporary employment firms, commercial
insurance brokers, human resource consultants, workers' compensation insurers,
HMOs and other specialty managed care providers.
Competition in the highly fragmented PEO industry is generally on a local or
regional basis. Management believes that the primary elements of competition are
quality of service, choice and quality of benefits, reputation and price. NCES
believes that brand recognition, regulatory expertise, financial resources, risk
management, information technology capability, strategic alliances and economies
of scale can distinguish a large-scale PEO from the rest of the industry. The
Company believes that NCES competes favorably in these areas.
NCES believes that barriers to entry into the PEO industry are increasing
primarily due to the following factors: (i) the complexity of the PEO business
and the need for expertise in multiple disciplines; (ii) the three to five years
of experience required to establish experience ratings in key cost areas of
workers' compensation, health insurance and unemployment; and (iii) the need for
sophisticated management information systems to track all aspects of business in
a high growth environment.
GOVERNMENT REGULATION
NCES is subject to local, state and Federal regulations, which include
operating, fiscal and licensing requirements. Adding complexity to NCES's
regulatory environment are: (i) uncertainties resulting from the non-traditional
employment relationships created by PEOs, (ii) variations in state regulatory
schemes, and (iii) the ongoing evolution of regulations regarding health care
and workers' compensation.
Many of the Federal and state laws and regulations relating to tax, benefit
and employment matters applicable to employers were enacted prior to the
development of non-traditional employment relationships and, accordingly, do not
specifically address the obligations and responsibilities of PEOs or the
co-employment relationship. Moreover, NCES's PEO services are regulated
primarily at the state level. Regulatory requirements regarding NovaCare's
business therefore vary from state to state, and as NCES enters new states it
will be faced with new regulatory and licensing environments. There can be no
assurance that NCES will be able to: (i) satisfy the licensing requirements or
other applicable regulations of any particular state, (ii) provide the full
range of services currently offered, or (iii) operate profitably within the
regulatory environment of any state in which it does not obtain regulatory
approval. The absence of required licenses would require NCES to restrict the
services it offers. New legislation or new interpretations of current licensing
and regulatory requirements could impose operating or licensing requirements on
NCES which it may not be able to satisfy or which could have a material adverse
effect on NCES's business, financial condition, results of operations and
liquidity. Additionally, interpretation of such legislation or regulation by
regulatory agencies with broad discretionary powers could require NCES to modify
its existing operations materially in order to comply with applicable
regulations.
<PAGE> 21
The application of many laws to NCES's PEO services will depend on whether
NCES is considered an employer under the relevant statutes and regulations. The
Internal Revenue Service ("IRS") is currently examining this issue. See
"Employee Benefit Plans" below. In addition, from time to time there have been
proposals to enact a statutory definition of employer for certain purposes of
the Internal Revenue Code of 1986, as amended (the "Code").
PEO Licensing Requirements. A critical aspect of the growth of the PEO
industry has been increasing recognition and acceptance of PEOs by state
authorities. While many states do not explicitly regulate PEOs, approximately
one-third of the states have passed laws that have licensing or registration
requirements for PEOs and several additional states are considering such
regulation. Such laws vary from state to state but generally provide for
monitoring the fiscal responsibility of PEOs. NCES is licensed in 13 states and
expects to be licensed in several more over the next twelve months. State
regulation assists in screening insufficiently capitalized PEO operations,
imposes requirements regarding payment of wages, taxes, benefits and workers'
compensation and resolves issues concerning an employee's status for specific
purposes under applicable state law. Because existing regulations are relatively
new, there is limited interpretive or enforcement guidance available. The
development of additional regulations and interpretation of existing regulations
can be expected to evolve over time.
Federal and State Employment Taxes. NCES assumes the responsibility and
liability for the payment of Federal and state employment taxes with respect to
wages and salaries paid to its employees, including worksite employees. To date,
the IRS has relied extensively on the common law test of employment in
determining employer status and the resulting liability for failure to withhold.
However, the IRS has formed a Market Segment Study Group for the stated purpose
of examining whether PEOs, such as NCES, are the employers of the worksite
employees under the Code provisions applicable to Federal employment taxes and,
consequently, whether they are exclusively responsible for payment of employment
taxes on wages and salaries paid to such employees. Another stated purpose of
the Market Segment Study Group is to determine whether owners of client
companies can be employees of PEOs under the Federal employment tax laws.
The interpretive uncertainties raised by the Market Segment Study Group may
affect NCES's ability to report employment taxes on its own account rather than
for the accounts of its clients and would increase administrative burdens on
NCES's payroll service function.
Employee Benefit Plans. NCES offers various employee benefit plans to its
worksite employees, including 401(k) plans, cafeteria plans, group health plans,
group life insurance plans, group disability insurance plans and employee
assistance programs. Generally, employee benefit plans are subject to provisions
of both the Code and the Employee Retirement Income Security Act of 1974, as
amended ("ERISA"). In order to qualify for favorable tax treatment under the
Code, the plan must be established and maintained by an employer for the
exclusive benefit of its employees.
The Market Segment Study Group established by the IRS is examining whether
PEOs, such as NCES, are the employers of worksite employees under Code
provisions applicable to employee benefit plans and consequently able to offer
to worksite employees benefit plans that qualify for favorable tax treatment.
NCES is unable to predict the actual timing or nature of the findings of the
Market Segment Study Group or the ultimate outcome of such conclusions or
findings. If the IRS study were to conclude that a PEO is not an employer of its
worksite employees for plan purposes, worksite employees might not be able to
continue to make contributions to NCES's 401(k) plans or cafeteria plans. NCES
believes that although unfavorable to NCES, a prospective application by the IRS
of an adverse conclusion would not have a material adverse effect on its
financial position and results of operations. If such conclusion were applied
retroactively, employees' vested account balances would become taxable
immediately, NCES would lose its tax deduction to the extent the contributions
were not vested, the plans' trusts would become taxable trusts and penalties
could be assessed. In such a case, NCES would face the risk of client
dissatisfaction as well as potential litigation. A retrospective application by
the IRS could have an adverse effect on NCES's business, financial position, and
results of operations and liquidity. While NCES believes that a retroactive
disqualification is unlikely, there can be no assurance as to the ultimate
resolution of these issues.
In addition to the employer/employee relationship requirement described
above, pension and profit-sharing plans, including NCES's 401(k) plans, must
satisfy certain other requirements under the Code. These other requirements are
generally designed to prevent discrimination in favor of highly compensated
employees to the detriment of non-highly compensated employees with respect to
both the availability of, and the benefits, rights and features offered in,
qualified employee benefit plans. NCES applies the nondiscrimination
requirements of the Code at both a consolidated and client company level to
ensure that its 401(k) plans are in compliance with the requirements of the
Code.
<PAGE> 22
Workers' Compensation. Workers' compensation is a state-mandated,
comprehensive insurance program that requires employers to fund or insure
medical expenses, lost wages and other costs resulting from work-related
injuries and illnesses. In exchange for providing workers' compensation coverage
for employees, employers are not subject to litigation by employees for benefits
in excess of those provided by the relevant state statute. In most states, the
extensive benefits coverage (for both medical costs and lost wages) is provided
through the purchase of commercial insurance from private insurance companies,
participation in state-run insurance funds or employer self-insurance. Workers'
compensation benefits and arrangements vary on a state-by-state basis and are
often highly complex. These laws establish the rights of workers to receive
benefits and to appeal benefit denials. Workers' compensation laws also regulate
the methods and procedures which NCES may employ in its workers' compensation
managed care programs.
As a creation of state law, workers' compensation is subject to change by
each state's legislature and is influenced by the political processes in each
state. Several states have mandated that employers receive coverage only from
state-operated funds. Other states have adopted legislation requiring that all
workers' compensation injuries be treated through a managed care program. While
such legislation may increase the market for NCES's workers' compensation
managed care services, it may also intensify the competition faced by NCES for
such services. In addition, Federal health care reform proposals include a
proposal that may require 24-hour health coverage, in which the coverage of
traditional employer-sponsored health plans is combined with workers'
compensation coverage to provide a single insurance plan for health problems,
whether or not related to work. Incorporating workers' compensation coverage
into conventional health plans may adversely affect the market for NovaCare's
services and may intensify the competition faced by NCES from HMOs and other
health care providers. Moreover, because workers' compensation benefits are
mandated by law and are subject to extensive regulation, payers and employers do
not have the same flexibility to alter benefits as they have with other health
benefit programs. Finally, because workers' compensation programs vary from
state to state, it is difficult for payers and multi-state employers to adopt
uniform policies to administer, manage and control the costs of benefits.
Other Employer-Related Requirements. As an employer, NCES is subject to a
wide variety of Federal, state and local laws and regulations governing
employer-employee relationships, including the Immigration Reform and Control
Act, the Americans with Disabilities Act, the Family and Medical Leave Act, the
Occupational Safety and Health Act, wage and hour regulations, and comprehensive
local, state and Federal civil rights laws and regulations, including those
prohibiting discrimination and sexual harassment. The definition of employer may
be broadly interpreted under these laws.
Responsibility for complying with various state and Federal laws and
regulations is allocated by agreement between NCES and its clients, or in some
cases is the joint responsibility of both. Because NCES acts as a co-employer
with the client company, it is possible that NCES could incur liability for
violations of laws even though NCES is not contractually or otherwise
responsible for the conduct giving rise to such liability. NCES's PEO client
service agreement generally provides that the client will indemnify NCES for
liability incurred as a result of an act of negligence of a worksite employee
under the direction and control of the client or to the extent the liability is
attributable to the client's failure to comply with any law or regulation for
which it has specified contractual responsibility. However, there can be no
assurance that NCES will be able to enforce such indemnification and NCES may
therefore be ultimately responsible for satisfying the liability in question.
INSURANCE
The Company maintains professional liability insurance in amounts deemed
appropriate by management based upon historical claims and the nature and risks
of the business. The Company also maintains property and general liability
insurance for the customary risks inherent in the operation of business in
general. While NovaCare believes its insurance policies to be adequate in amount
and coverage for its current operations, there can be no assurance that any
future claims will not exceed the limits of those policies or that such
insurance will continue to be available.
EMPLOYEES
At June 30, 1999, the Company had approximately 54,800 employees. Of these,
approximately 8,700 were outpatient services personnel and 46,100 were employee
services personnel. Of the employee services personnel, approximately 500 were
"administrative" employees and 45,600 were worksite employees of client
companies. NovaCare's employees are not represented by any labor union and the
Company is not aware of any current activity to organize any of its non-worksite
employees. Management considers relations between the Company and its employees
to be good. For information with respect to the Company's worksite employees,
see "Business Profile" in the "Employee Services" section above.
<PAGE> 23
EXECUTIVE OFFICERS OF THE REGISTRANT
For the executive officers of NovaCare, see "Item 10 - Directors and
Executive Officers of the Registrant".
ITEM 2. PROPERTIES
NovaCare's principal executive offices are located at 1016 West Ninth
Avenue, King of Prussia, Pennsylvania 19406 where NovaCare leases approximately
143,000 square feet of office space. The principal lease for this office space
expires in June 2005. In connection with the Company's corporate and capital
restructure changes (see "Item 1. - Business - The Company - Corporate and
Capital Structure Changes"), the Company is presently negotiating to mitigate
its lease obligations with respect to approximately 85,000 square feet of space
at its principal executive offices. In addition, the Company leases other office
space in various cities within the United States for terms which typically are
five years or less. See Note 12 of Notes to Consolidated Financial Statements
for information concerning the Company's leases for its facilities.
The Company does not anticipate that, where applicable to PROH and NCES, it
will experience difficulty in renewing such leases upon their expiration or
obtaining different space on comparable terms if such leases are not renewed.
The Company believes that these facilities are well maintained and are of
adequate size for present and foreseeable needs.
NovaCare also has sublease agreements for approximately 16,500 square feet
of office space, expiring February 2003 with companies of which NovaCare's
Chairman of the Board is a director and/or an executive officer.
ITEM 3. LEGAL PROCEEDINGS
From time to time, NovaCare is party to certain claims, suits and complaints
which arise in the ordinary course of business. Currently, there are no such
claims, suits or complaints which, in the opinion of management, would have a
material adverse effect on the Company's business, financial condition, results
of operations and liquidity.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
<PAGE> 24
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
NovaCare's common stock is traded on the New York Stock Exchange (NYSE)
under the symbol NOV. On September 3, 1999, there were 1,614 holders of record
of common stock.
The following table sets forth the high and low sales prices per share of
common stock as reported on the NYSE Composite Tape for the relevant periods.
<TABLE>
<CAPTION>
COMMON STOCK
PRICES
----------------------
HIGH LOW
--------- ---------
<S> <C> <C>
YEAR ENDED JUNE 30, 1999:
First Quarter ............ $ 12.63 $ 2.88
Second Quarter ........... 4.31 2.19
Third Quarter ............ 3.06 1.25
Fourth Quarter ........... 2.25 1.19
YEAR ENDED JUNE 30, 1998:
First Quarter ............ $ 17.06 $ 12.50
Second Quarter ........... 17.31 11.81
Third Quarter ............ 14.87 11.87
Fourth Quarter ........... 14.81 10.62
</TABLE>
With the exception of 2-for-1 stock splits of common stock effected in the
form of stock dividends in June 1987 and July 1991, no other dividends have been
paid or declared on common stock since NovaCare's initial public offering on
November 5, 1986. NovaCare does not expect to declare any cash dividends on
common stock in the foreseeable future.
<PAGE> 25
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with
NovaCare's consolidated financial statements and the accompanying notes
presented elsewhere herein.
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
-------------------------------------------------------------------
1999 1998 1997 1996 1995(1)
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net revenues ................................ $ 1,477,917 $ 1,037,571 $ 516,925 $ 287,823 $392,039
Gross profit ................................ 210,426 180,153 111,569 66,223 111,068
(Loss) income from continuing operations .... (81,836) (3,214) (18,790) (34,133) 34,841
(Loss) income from continuing operations
per share:
Basic and assuming dilution ............. (1.30) (0.05) (0.31) (0.56) 0.53
</TABLE>
<TABLE>
<CAPTION>
AS OF JUNE 30,
-------------------------------------------------------------------
1999 1998 1997 1996 1995
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Total assets................................. $ 1,204,865 $ 1,296,705 $ 977,920 $750,134 $803,538
Total indebtedness........................... 605,557 508,382 342,678 192,215 225,015
Shareholders' equity......................... 393,259 580,673 508,006 484,394 487,635
</TABLE>
(1) Includes the results of the medical rehabilitation hospital business which
was sold in February 1995.
<PAGE> 26
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
In the fiscal year ended June 30, 1999, the Company's long-term care
services segment experienced a significant decline in net revenues and earnings
as a consequence of regulatory changes in the Medicare program, the primary
source of reimbursement for long-term care services provided by the Company. The
Company implemented a restructure plan involving the complete exit of selected
markets and the implementation of a revised operating model, however, the
operating loss for the segment continued to be significant. Subsequently,
management determined that the remaining long-term care services segment would
likely not be profitable in the foreseeable future, therefore, on June 1, 1999
the Company sold substantially all of its business previously included in its
long-term care services segment. Accordingly, the operations and the loss on the
sale of this segment have been classified as discontinued operations in the
current fiscal year's financial statements and all prior periods presented have
been reclassified to include the operations of this segment as discontinued
operations.
In the fiscal years ended June 30, 1998 and 1997, the Company experienced
significant revenue and earnings expansion resulting from acquisitions and
internal growth of its existing businesses. During fiscal 1999, the Company
curtailed its acquisition activity because of capital structure constraints.
During fiscal 1998, the Company purchased 90 outpatient services businesses,
consisting of 48 outpatient physical therapy and occupational health
rehabilitation services ("PROH") businesses, 42 orthotic and prosthetic ("O&P")
businesses; and two professional employer organization ("PEO") businesses.
During fiscal 1997, the Company acquired 55 outpatient services businesses,
consisting of 22 PROH businesses and 33 O&P businesses; and four PEO businesses.
During fiscal 1998, NovaCare Employee Services, Inc. ("NCES") sold
approximately 5.8 million shares to third parties in an initial public offering,
receiving net proceeds of $45.7 million. As of June 30, 1999, the Company
retained a 67% interest in NCES.
Segment Reporting
In fiscal 1998, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 131, "Disclosures about Segments of an Enterprise and
Related Information", which requires companies to report operating segments
based upon the way a company manages its activities. Because of the Company's
reporting, organization and management structure, segment information has been
presented for the continuing operations of outpatient services and employee
services. As discussed above, the Company's long-term care segment has been
reclassified to discontinued operations.
See Note 16 to the Condensed Consolidated Financial Statements for financial
data for each of the Company's operating segments. Management's discussion and
analysis focuses on the amounts and captions provided in Note 7 because they are
among the most significant factors used by the Company to manage its business
and operating segments. Certain data provided, such as gross profit excluding
depreciation, (loss) income from operations excluding provision for restructure
and earnings before interest, income taxes, depreciation and amortization
("EBITDA") are not intended to replace gross profit, operating income or net
income presented in the basic financial statements as measures of profitability.
Continuing Operations
Outpatient services relate to the provision of PROH and O&P services through
a national network of patient care centers. Employee services are comprehensive,
fully integrated outsourcing solutions to human resource needs. These services
include payroll management, workers' compensation risk management, benefits
administration, unemployment management and human resource management and
consulting services, and are generally provided to small and medium-sized
business. The Company entered this business on October 1, 1996 with the
acquisition of its first PEO business.
Effective January 25, 1997, employee services were also provided to the
outpatient services and long-term care services segments of the Company.
On July 1, 1999, the Company sold its O&P business for $445.0 million,
including $407.7 million in cash and the assumption of seller notes of $37.3
million. Of the purchase price, the Company has placed $15.0 million in escrow
<PAGE> 27
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (CONTINUED)
in conjunction with a working capital guarantee to the purchaser. The final
working capital amount is expected to be settled no later than October 29, 1999.
The Company expects to record a gain on the sale in the first quarter of fiscal
2000 of approximately $50-57 million. The proceeds from this sale were used
primarily to pay the entire balance of the Company's revolving credit facility.
Net revenues, gross profit and income from operations of the O&P business for
fiscal 1999 was $278.8 million, $67.5 million and $41.6 million, respectively.
See Note 16 of Notes to Consolidated Financial Statements for financial data
for each of the Company's continuing operating segments.
Discontinued Operations
The Company's long-term care services segment provided rehabilitation
therapy and health care consulting services on a contract basis to health care
institutions, primarily long-term care facilities. As discussed above, as a
result of significant regulatory changes in the Medicare reimbursement to
long-term care facilities for the Company's therapy services, the Company
implemented a restructure plan in the third quarter of fiscal 1999. The
restructure plan related to its decision to completely exit certain long-term
care services markets, principally in the Western United States, where it was
determined that low customer and therapist concentration would preclude a return
to profitability. These markets included California, Colorado, Texas and the
Northwest. The Company determined that it would be unable to recover its
investment in long-lived assets in the long-term care services operating segment
and, accordingly, wrote down all of its investment in these assets and
recognized the cost, consisting principally of employee severance costs, of
exiting the selected markets. The exit plan called for the termination of
approximately 1,300 employees, of which 1,200 were direct care providers in the
geographic regions exited and the remainder were general and administrative
personnel. Subsequent to the restructuring, the Company determined that in spite
of the business operating model and cost structure changes, that its remaining
long-term care services operations were unlikely to achieve a sufficient level
of profitability to justify continuing that segment's operations. Accordingly,
the Company sold its remaining long-term care operations as of June 1, 1999 for
a nominal amount and provided a working capital guarantee of $30.0 million to
the buyer. The working capital guarantee is expected to be settled by October
29, 1999.
In connection with this sale, the Company recognized a pretax loss of $36.7
million which included the working capital guarantee and the write down of
certain property and equipment and other assets. Results of operations for the
long-term care services operating segment consisted of the following:
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
(IN THOUSANDS)
------------------------------------------
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Net revenues ....................... $ 351,128 $ 634,534 $ 549,526
Gross profit ....................... 61,247 174,506 148,517
(Loss) income before income taxes .. (84,616) 90,027 90,993
Income tax (benefit) provision ..... (7,680) 28,898 33,293
Net (loss) income .................. $ (76,936) $ 61,129 $ 57,700
</TABLE>
Gain from Issuance of Subsidiary Stock
During fiscal 1999, the Company recorded a gain of $1.5 million related to
the issuance of stock by NCES in connection with acquisitions.
During fiscal 1998, the Company recorded a gain of $38.8 million related to
the sale of stock by NCES to third parties through an initial public offering of
its stock, issuance of stock in connection with conversion of its mandatorily
redeemable common stock and acquisitions.
<PAGE> 28
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (CONTINUED)
Provision for Restructure
During fiscal 1999, the Company decided to exit certain non-strategic
markets served by its PROH business within its outpatient services segment
resulting in a $30.2 million provision for restructure. The markets consisted of
40 clinics. This decision resulted in a write-down of the value of the related
assets to estimated net realizable value. The provision for restructure consists
principally of the write-down of excess cost of net assets acquired, net ($28.3
million). The clinics to be disposed of had annualized net revenues of
approximately $16.6 million and annualized operating profit of approximately
$0.2 million. At June 30, 1999, five of the clinics have been sold for proceeds
totaling $0.9 million. The net book value of the remaining assets to be sold is
approximately $5.0 million. The Company is reevaluating the decision to dispose
of these clinics in light of the sale of PROH described under "Liquidity and
Capital Resources - Capital Structure Alternatives".
As a result of the Company's decision to exit the long-term care services
operating segment and sell the O&P business included in its outpatient services
segment, the services the Company required of its employee services segment were
substantially reduced. The Company's employee services segment recorded a
provision for restructure of $0.9 million, consisting principally of employee
severance costs for 49 employees working at its corporate headquarters and lease
mitigation costs, to reflect the impact of this decision. The Company
anticipates annual savings of $2.6 million as a result of these work force
reductions. As of June 30, 1999, 32 employees have been terminated related to
this charge.
Also as a result of the Company's decision to exit the long-term care
services operating segment and sell the O&P business, the Company has
implemented a program to substantially reduce its unallocated selling, general
and administrative costs incurred at its corporate headquarters. This program
(with an aggregate provision of $12.3 million) involves the termination of
approximately 74 employees ($3.1 million), lease termination costs ($4.8
million) and long-term information services agreement buyouts ($4.4 million).
All of these costs are expected to be expended by June 30, 2000. The Company
anticipates that this program will result in annual savings of approximately $30
million when completely implemented.
YEAR ENDED JUNE 30, 1999 COMPARED WITH THE YEAR ENDED JUNE 30, 1998
Net revenues for the year ended June 30, 1999 were $1.5 billion, an increase
of $440.3 million over fiscal 1998. Gross profit for fiscal 1999 was $210.4
million, an increase of $30.3 million over fiscal 1998. These increases resulted
principally from acquisitions ($38.5 million increase in gross profit
year-over-year) and internal growth ($1.1 increase in gross profit
year-over-year), partially offset by increased cost of services ($6.7 million
decrease in gross profit year-over-year).
Other operating expenses, excluding the $43.4 million restructure charges
described above, were $228.1 million, an increase of $47.9 million over fiscal
1998. Other operating expenses include selling, general and administrative
expenses, depreciation (other than depreciation included in cost of services)
and amortization of excess cost of net assets acquired ("amortization") and
provision for uncollectible accounts. The increase in operating expenses
resulted principally from an increase in the provision for uncollectible
accounts ($24.2 million), the inclusion of the full year effect of acquisitions
completed in fiscal 1998 ($16.8 million), and an increase in other costs ($6.9
million). The increase in the provision for uncollectible accounts resulted from
a $15.3 million provision related to PROH receivables aged greater than one year
which had been recorded during and prior to the conversion to centralized
billing systems and subsequently contracted to independent agencies for
collection and an increase in the provision resulting from an increase in net
revenues. As a percentage of net revenues, other operating expenses decreased to
15.4% in fiscal 1999 compared to 17.4% in fiscal 1998. This decrease resulted
principally from an increase in employee services net revenues, where these
operating expenses are typically a smaller percentage of net revenues than in
outpatient services.
<PAGE> 29
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (CONTINUED)
Depreciation expense, including depreciation reported in cost of services
and selling, general and administrative expenses, was $22.1 million, an increase
of $0.2 million over fiscal 1998. The increase resulted primarily from the
effect of acquisitions in fiscal 1998, capital investments, primarily in
information systems and outpatient facilities, offset by a decrease in
depreciation of assets written-off in restructuring. Amortization was $22.9
million, an increase of $4.9 million over fiscal 1998, which increase resulted
principally from the full-year effect of businesses acquired in fiscal year 1998
and acquisitions in fiscal year 1999.
Interest expense was $41.6 million, an increase of $13.3 million over fiscal
1998. Interest expense increased primarily as a result of increased borrowings
as discussed under "Liquidity and Capital Resources".
The Company recorded an income tax benefit in fiscal year 1999 compared to
an income tax expense for fiscal year 1998. The net operating loss and loss on
the sale of discontinued operations for fiscal 1999 have been carried back to
offset prior fiscal years' income. See Note 13 of Notes to Consolidated
Financial Statements for a reconciliation of expected tax benefit to actual tax
benefit and the amount of deferred tax assets and liabilities and valuation
allowances.
OPERATING RESULTS BY SEGMENT
Outpatient Services
Net revenues for the outpatient services segment were $618.8 million in
fiscal 1999, an increase of $83.5 million over fiscal 1998. The increase in net
revenues was due principally to the full-year effect of businesses acquired in
fiscal 1998 ($89.4 million) and same-market growth ($6.2 million), somewhat
offset by a decrease in pricing ($13.4 million).
Gross profit (excluding depreciation) was $182.8 million, an increase of
$19.0 million over fiscal 1998. The increase in gross profit resulted primarily
from the full-year effect of businesses acquired in fiscal 1998 ($30.3 million
increase in gross profit year-over-year) somewhat offset by the decrease in
pricing which was offset by an increase in volume and productivity ($3.4 million
decrease in gross profit year-over-year) and by an increase in cost of products
in the O&P business ($6.7 decrease in gross profit year-over-year). Gross profit
as a percentage of net revenues ("gross profit margin") decreased to 29.5% in
fiscal 1999 compared to 30.6% in fiscal 1998 principally as a result of cost
increases and price decreases which the Company was not able to offset by volume
and productivity increases.
Income from operations was $47.1 million, a decrease of $20.9 million
compared with fiscal 1998. The decrease was due to the higher gross profit noted
above, offset by higher selling, general and administrative expenses,
principally an increase in the provision for bad debts ($24.2 million), the
inclusion of the full-year effect of acquisitions completed in fiscal 1998
($11.4 million) and an increase in other costs ($4.3). The increase in the
provision for uncollectible accounts resulted from a $15.3 million provision
related to PROH receivables aged greater than one year which had been recorded
during and prior to the conversion to centralized billing systems and
subsequently contracted to independent agencies for collection and an increase
in the provision resulting from an increase in net revenues.
Employee Services
Employee services net revenues were $1.5 billion in fiscal 1999 (before an
intercompany elimination of $685.5 million related to services provided to the
outpatient services and long-term care services segments), an increase of $272.9
million over fiscal 1998 net revenues of $1.3 billion (before an intercompany
elimination of $769.5 million). The increase in net revenues reflects
principally an increase of $359.0 million in third party net revenues due to
acquisitions ($200.2 million), entry into new markets ($80.2 million) and same
market growth ($78.6 million),
<PAGE> 30
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (CONTINUED)
somewhat offset by a decrease in the employee services segment's contract with
the outpatient services and long-term care services segments (the "NovaCare
Contract") ($86.3 million).
Gross profit (excluding depreciation) was $64.0 million, an increase of
$22.5 million over fiscal 1998. The gross profit margin was 4% compared to 3% in
fiscal 1998. The increase in gross profit and gross profit margin resulted
primarily from the increase in net revenues described above and higher margin
services under the NovaCare Contract.
Income from operations was $18.0 million, an increase of $7.1 million over
last year. The increase resulted from the improvement in gross profit noted
above, partially offset by additional costs incurred to support same market
growth ($10.0 million) and higher selling, general and administrative expenses
related to acquisitions ($5.4 million).
Income (Loss) from Discontinued Operations
Net revenues for long-term care services were $351.1 million in fiscal 1999,
a decrease of $283.4 million from fiscal 1998. The decrease in net revenues
resulted primarily from lower reimbursement rates and utilization of the
Company's services resulting from significant regulatory changes in the Medicare
reimbursement of long-term care services.
Gross profit (excluding depreciation) was $64.1 million in fiscal 1999, a
decline of $113.7 million from fiscal 1998. The gross profit margin was 18.3% in
fiscal 1999 compared with 28.0% in fiscal 1998. The decrease in gross profit and
gross profit margin resulted primarily from the decrease in net revenues
described above without a corresponding reduction in therapist's compensation
and benefits and other costs of providing services.
Loss before income taxes was $84.6 million in fiscal 1999 compared to income
before income taxes of $90.0 million in fiscal 1998. The decrease in income from
operations resulted primarily from the decrease in gross profit described above
coupled with an increase in selling, general and administrative expenses and a
$98.6 million provision for restructure to exit selected long-term care markets
and to write-off the Company's investment in long-lived assets that the Company
will not be able to recover.
Loss on Sale of Discontinued Operations
Effective June 1, 1999, the Company sold all of the issued and outstanding
stock of its remaining subsidiary of the Company's long-term care services
segment for a nominal amount. Pursuant to the sale agreement, the Company
guaranteed the purchaser working capital of $30.0 million. The purchaser has
agreed to pay the Company the amount, if any, of working capital at June 1, 1999
in excess of $30.0 million or, as applicable, to transfer any remaining accounts
receivable relating to periods as of June 1, 1999 once the working capital
guarantee has been satisfied. As a result of this transaction the Company has
recorded a pretax loss of $36.7 million ($30.8 million after-tax) on the sale
of discontinued operations.
YEAR ENDED JUNE 30, 1998 COMPARED WITH THE YEAR ENDED JUNE 30, 1997
Net revenues for the year ended June 30, 1998 were $1.0 billion, an increase
of $520.6 million over fiscal 1997. Gross profit for fiscal 1998 was $180.2
million, an increase of $68.6 million over fiscal 1997. These increases resulted
principally from acquisitions ($45.0 million increase in gross profit
year-over-year) and internal growth ($23.6 million increase in gross profit
year-over-year).
Other operating expenses were $180.2 million, an increase of $58.6 million
over fiscal 1997. The increase in operating expenses resulted principally from
additional costs incurred in the expansion of the Company's employee services
business ($16.1 million), the inclusion of higher expenses resulting from
acquisitions completed in 1998
<PAGE> 31
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (CONTINUED)
and 1997 ($16.2 million), additional provision for uncollectible accounts
resulting from higher net revenues ($7.9 million) and those costs required to
support internal growth ($18.4 million). As a percentage of net revenues, other
operating expenses decreased to 17.4% in fiscal 1998 compared to 23.6% in fiscal
1997. This decrease resulted principally from an increase in employee services
revenues, where these operating expenses are typically a smaller percentage of
net revenues than in outpatient services.
Depreciation expense, including depreciation reported in cost of services
and selling, general and administrative expenses, was $21.8 million, an increase
of $4.8 million over fiscal 1997. The increase resulted primarily from the
effect of acquisitions in fiscal 1998 and 1997 and capital investments,
primarily in information systems and outpatient facilities. Amortization was
$18.0 million, an increase of $6.6 million over fiscal 1997, which increase
resulted from acquired businesses.
Interest expense was $28.3 million, an increase of $13.1 million over
interest expense of $15.2 million in fiscal 1997. Interest expense increased
primarily as a result of increased borrowings as discussed under "Liquidity and
Capital Resources".
In fiscal 1998, the Company recorded income tax expense on income before
income taxes, whereas in fiscal 1997 the Company recorded an income tax benefit
on loss before income taxes. See Note 13 of Notes to the Consolidated Financial
Statements for a reconciliation of expected tax expense (benefit) to actual tax
expense (benefit).
OPERATING RESULTS BY SEGMENT
Outpatient Services
Net revenues for the outpatient services segment were $535.3 million in
fiscal 1998, an increase of $157.3 million over fiscal 1997. The increase in net
revenues was due principally to businesses acquired in fiscal 1998 and the
full-year effect of businesses acquired in fiscal 1997 ($150.9 million) along
with same-market growth in O&P and occupational health ($6.1 million).
Gross profit (excluding depreciation) was $163.8 million, an increase of
$52.3 million over fiscal 1997. The increase in gross profit resulted primarily
from businesses acquired in fiscal 1998 and the full-year effect of businesses
acquired in fiscal 1997 ($41.6 million increase in gross profit year-over-year),
same market growth in O&P and occupational health ($4.4 million) and cost
reductions in physical rehabilitation ($3.8 million). Gross profit margin
increased to 30.6% in fiscal 1998 compared to 29.5% in fiscal 1997 principally
as a result of improved productivity.
Income from operations was $68.0 million, an increase of $20.4 million
compared with fiscal 1997. The increase was due to the higher gross profit noted
above, partially offset by an increase in the provision for bad debts ($7.9
million) higher depreciation and amortization expense ($8.0 million), and higher
selling, general and administrative expenses ($16.0 million). The increase in
those costs was principally a result of expenses associated with or in support
of businesses acquired.
Employee Services
Employee services net revenues were $1.3 billion in fiscal 1998 (before an
intercompany elimination of $769.5 million related to services provided to the
outpatient services and long-term care services segments), an increase of $877.6
million over fiscal 1997 net revenues of $394.2 million (before an intercompany
elimination of $255.3 million). This increase in total net revenues is due to an
increase in net revenues of $514.2 million under the NovaCare Contract and an
increase of $363.4 million in third party net revenues. Gross profit (excluding
<PAGE> 32
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (CONTINUED)
depreciation) was $41.5 million in fiscal 1998, an increase of $29.3 million
over fiscal 1997. Income from operations was $10.9 million, an increase of $8.0
million over fiscal 1997.
The increases in net revenues, gross profit and income from operations
resulted from: (i) a full year's operation under the NovaCare Contract in fiscal
1998 compared with only five months in fiscal 1997, as well as a 5% increase in
the number of worksite employees covered by the NovaCare Contract in fiscal
1998, (ii) a full year of operations in fiscal 1998 compared to only nine months
in fiscal 1997 (the employee services segment commenced operations October 1,
1996 with the acquisition of its first PEO business), (iii) the full-year effect
of fiscal 1997 acquisitions, (iv) acquisitions completed in fiscal 1998, and (v)
same market growth.
Income (Loss) from Discontinued Operations
Net revenues for long-term care services were $634.5 million in fiscal 1998,
an increase of $86.0 million over fiscal 1997. The increase in net revenues
resulted primarily from new contract sales and price increases on existing
contracts, partially offset by lower reimbursement rates in the fourth quarter
of fiscal 1998 caused by the implementation of the salary equivalency
reimbursement system for speech and occupational therapies.
Gross profit (excluding depreciation) was $177.8 million in fiscal 1998, an
increase of $26.0 million over fiscal 1997. The gross profit margin was 28.0% in
fiscal 1998 compared with 27.6% in fiscal 1997. The improvement in gross profit
and gross profit margin resulted from an increase in new customer contracts
coupled with reduced salary and wage costs per employee, due to the conversion
of the Company's clinical workforce from fixed salary compensation to variable
hourly compensation and improved productivity.
Income before income taxes and before a provision for restructure of $23.5
million, was $113.5 million, an increase of $22.5 million over fiscal 1997. The
increase resulted from the higher gross profit noted above, partially offset by
slightly higher selling, general and administrative costs and higher
depreciation and amortization incurred to support business growth.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
At June 30, 1999, cash and cash equivalents totaled $23.3 million, a
decrease of $9.4 million from June 30, 1998. Cash used in continuing operations
was $102.9 million in fiscal year 1999 compared to $0.7 million in fiscal 1998
and to $6.6 million in fiscal 1997. The $102.2 million increase from fiscal 1998
to 1999 resulted from higher earnings, after non-cash charges, of $2.4 million,
offset principally by the timing of payments and amounts of accounts payable and
accrued expenses and income taxes of $112.0 million.
The $5.9 million decrease in cash flows used in continuing operating
activities in fiscal 1998 compared to fiscal 1997 resulted from an increase in
earnings, after non-cash charges, of $10.1 million coupled with an increase in
accounts payable and accrued expenses and income taxes of $28.3 million, offset
by an increase in accounts receivable, inventories and other assets of $33.2
million.
Cash provided by discontinued operations was relatively constant at $73.3
million in fiscal 1999 and $73.9 million in fiscal 1998 which was up from $53.9
million in fiscal 1997. Although the profitability of the segment was
drastically reduced in the second half of fiscal 1999, the Company continued to
collect accounts receivable that it had recorded in previous quarters.
<PAGE> 33
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (CONTINUED)
Investing activities used $74.3 million of cash in fiscal 1999 compared with
$214.0 million and $187.8 million in fiscal 1998 and 1997, respectively. Cash
paid for acquisitions decreased to $61.1 million in fiscal 1999 compared with
$180.6 million in fiscal 1998, which was an increase from $164.1 million paid in
fiscal 1997. During fiscal 1999, the Company curtailed its acquisition activity
because of capital structure constraints. Capital expenditures for continuing
operations were $22.2 million in fiscal 1999 up from $17.9 million in fiscal
1998 and $14.8 million for fiscal 1997 as the Company continued to invest in
internally and externally developed software and equipment needed for
technological efficiency in clinical and administrative activities in support of
cost reduction initiatives. Capital expenditures for discontinued operations
decreased slightly to $10,957 in fiscal 1999 from $13,221 in fiscal 1998 which
increased from $7,278 in fiscal 1997 as the Company continued, to the date of
sale, to invest in internally and externally developed software needed to
support its clinical programs and outcomes.
The Company's major financing activities consisted of borrowings, net of
repayments, of $92.5 million in fiscal 1999, compared with net borrowings of
$97.3 million in fiscal 1998, compared with net borrowings of $87.0 million in
1997. Also, during fiscal 1998 NCES sold approximately 5.8 million shares to
third parties in an initial public offering, receiving net proceeds of $45.7
million. The net proceeds of the offering were used principally to pay
obligations associated with acquisitions and other debt. As of June 30, 1999,
the Company retained a 67% interest in NCES after reductions in its ownership
interest for the initial public offering and NCES shares issued in the
conversion of its mandatorily redeemable common stock and to sellers of acquired
PEO businesses.
Credit Agreements
The Company has a revolving credit facility with a syndicate of lenders that
is collateralized by substantially all of the Company's assets. The maximum
amount available at June 30, 1999 was $400.0 million.
The terms of the facility were amended during fiscal 1999 to shorten the
maturity date from June 30, 2003 to December 31, 1999 and to change the interest
rate from the London Interbank Offered Rate ("LIBOR") plus a range of 0.875% to
1.5%, depending on certain financial ratios, to LIBOR plus 3%. The Company is
also charged a commitment fee of 0.5% on the average daily available balance.
The entire amount of the facility outstanding at June 30, 1999 was repaid on
July 1, 1999 from the proceeds of the O&P sale. Subsequent to such repayment,
the maximum amount available under the facility was reduced to $35.0 million.
Outstanding letters of credit, which were $1.1 million at June 30, 1999, further
reduce the amount available under the facility.
NCES has a revolving credit facility with a syndicate of lenders that is
collateralized by a pledge of (i) NCES's subsidiaries' common stock, (ii) the
assets of NCES and its subsidiaries, and (iii) the Company's interest in the
common stock of NCES. The facility expires in November 17, 2000 and carries an
interest rate, depending on certain financial ratios, equal to (i) LIBOR plus a
range of 1.375% to 2.5% or (ii) the lead lending bank's prime rate plus a range
of 0.125% to 1.5%. As of June 30, 1999, $23.0 million was available under the
facility.
Capital Structure Alternatives
Due to the Company's lower income from operations and EBITDA, caused
primarily by the impact of regulatory changes in the long-term care services
segment, the Company's cash flow from operations was too low to satisfy its debt
obligations. This situation characterizes a capital structure that is highly
leveraged. The Company's total debt at June 30, 1999 was $605.6 million, of
which $551.3 million is due in less than one year. EBITDA (excluding the
provision for restructure) for the quarter ended March 31, 1999 was a loss of
$2.3 million ($7.3 million positive EBITDA without the long-term care services
segment). In comparison, (i) at June 30, 1998 the Company's total debt was
$508.4 million ($32.1 million current portion) and EBITDA for the quarter ended
June 30, 1998 was $46.2 million, (ii) at September 30, 1998, total debt was
$576.8 million ($35.2 million current portion) and EBITDA for the quarter was
<PAGE> 34
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (CONTINUED)
$33.6 million, and (iii) at December 31, 1998, total debt was $581.4 million
($30.8 million current portion) and EBITDA for the quarter was $25.8 million,
excluding a $17.8 million provision for restructure.
This highly leveraged condition led the Board of Directors and management of
the Company to undertake a strategic analysis, during the fourth quarter of
fiscal 1999, of the Company's alternatives to satisfy the indebtedness.
To partially reduce the Company's debt leverage, on July 1, 1999, the
Company sold its O&P business to Hanger Orthopedic Group, Inc. ("Hanger") for
$445.0 million, including $407.7 million in cash and the assumption of seller
notes of $37.3 million. Of the purchase price, the Company has placed $15.0
million in escrow in conjunction with a $94.0 million working capital guarantee
to Hanger. The final working capital amount is expected to be settled by no
later than October 29, 1999. The proceeds from the transaction were used to
satisfy the entire balance of the Company's revolving credit facility, with
approximately $37 million remaining after transaction-related costs. These funds
have been temporarily invested to satisfy working capital requirements and
future maturities of other debt obligations.
Subsequent to the sale of the O&P business, NovaCare remained highly
leveraged with indebtedness of approximately $221 million consisting primarily
of (i) $175 million of convertible subordinated debentures (the "Debentures")
maturing on January 15, 2000 and (ii) $42 million comprising principally
subordinated seller notes (the "Seller Notes") related to acquisitions and
maturing at various dates through 2007.
The only remaining asset of the Company which would provide sufficient funds
to satisfy the Debentures, is the PROH business. The capital structure
alternatives considered by the Company were either obtaining medium-term (three-
to five-year) financing secured by PROH assets, selling PROH, selling NovaCare
or, in the event all else failed, filing for reorganization under the Bankruptcy
Code. Obtaining secured financing was rejected, because even if adequate secured
financing could be obtained, the Company would be too highly leveraged (debt
would be approximately four times EBITDA) for it to realize sustainable business
growth. Therefore, the Board of Directors and management believes that a sale of
PROH (the"PROH Sale") is the most attractive alternative to maximize value and
has engaged an investment banking firm to solicit offers to purchase PROH. The
PROH Sale requires approval by the stockholders of the Company.
On September 8, 1999, the Company entered into a definitive agreement,
subject to certain conditions, to tender its interest in NCES, 19,400,000
shares, at the price of $2.50 per share (the "NCES Sale"). Under the terms of
the agreement the purchaser will acquire all of the outstanding shares of NCES
for $2.50 per share through a cash tender offer which commenced on September 15,
1999 and is expected to close during October 1999. The Company's tender offer of
its interest in NCES is subject to approval by the Company's stockholders and
the satisfaction of customary closing conditions.
If either the stockholders do not approve the PROH Sale or the conditions to
the PROH Sale are not met, the Board of Directors will explore the alternatives
then available for the future of the Company. Such alternatives include (i)
refinancing the convertible subordinated debentures through a combination of
private equity and/or public or private debt, which management believes would
demand a high interest rate due to the Company's highly leveraged position and,
moreover, there is no assurance that such financing could be obtained, and (ii)
in the event the $200 million sale price condition is not met, seeking to obtain
stockholder approval of a sale of PROH at a lower price. In the event that the
stockholders do not approve the NCES Sale or the closing conditions are not met,
the Board of Directors will explore the alternatives then available to the
Company. Such alternatives include (i) negotiate the NCES Sale with another
buyer, and (ii) distribute the Company's interest in NCES to NovaCare
stockholders pro-rata as a dividend, and (iii) pay existing indebtedness of the
Company with shares of NCES's stock (provided such stock is valued at not less
than $2.50 per share). If the stockholders do not approve the restructuring
proposal, the Company's Board of Directors will explore the alternatives then
available for the future of the Company, including (i) presenting a new
investment
<PAGE> 35
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (CONTINUED)
opportunity to stockholders or (ii) liquidating the Company. If the $175 million
convertible subordinated debentures cannot be paid due to the Company's
inability to (i) obtain stockholders approval of the PROH sale, (ii) meet the
conditions of a PROH sale, or (iii) secure refinancing in the event PROH is not
sold, the alternatives available to the Company will be limited to (i) a sale of
the Company, (ii) negotiating alternative debenture payment terms, including
conversion to common stock, and (iii) protection under the Bankruptcy Code. The
Company is unable to predict the ultimate outcome of the stockholder voting on
these matters or the likelihood of successfully concluding any other available
alternative.
INFLATION
A significant portion of the Company's operating expenses have been subject
to inflationary increases. Prior to fiscal 1999, therapist salary increases
historically have exceeded other medical industry salary rate increases due to
the existing supply shortage and the Company had been unable to offset any
portion of these inflationary increases through charge increases, but has
mitigated somewhat the effect of these salary increases through expanding
services and increasing operating efficiencies. Commencing in 1999, however, the
Company has begun to see an increase in the availability of therapists, due
principally to changes in the regulatory environment affecting the reimbursement
of therapy services. The supply of therapists coupled with the Company's
migration to an operating model that emphasizes the increased use of
well-trained therapy assistants and aides, closely supervised by licensed
professionals, is expected to lessen the overall salaries and wages of the
Company's clinical staff. However, it is uncertain whether the deflation in
clinical staff costs will offset the pricing deflation in health care services.
Management believes that the Company can continue to offset most, if not all, of
the potential effects of inflation through salary and wage deflation, business
expansion and increasing operating efficiencies.
YEAR 2000 READINESS
Historically, certain computer programs have been written using two digits,
rather than four digits, to define the applicable year. This could lead, in many
cases, to a computer's recognizing a date using "00" as 1900 rather than the
year 2000. This phenomenon could result in major computer system failures or
miscalculations, and is generally referred to as the "Year 2000" problem or
issue.
The Company has assessed its exposure to the Year 2000 problem, and has
substantially completed its response to that exposure. Generally, the Company
has Year 2000 exposure in three areas: (i) financial and management operating
computer systems used to manage the Company's business, (ii) microprocessors and
other electronic devices included as components of therapy and other equipment
used by the Company ("embedded chips") and (iii) computer systems used by third
parties, in particular financial institutions, customers and suppliers of the
Company. The Company estimates the remaining cost of this effort to be
approximately $1.0 million, including $0.8 million of capital costs for new
computers and related equipment. This amount does not include costs for computer
software developed in order to provide or improve functionality. As of June 30,
1999, the Company had already spent approximately $3.8 million in this effort.
The Company has increased its overall information technology's budget to
accommodate Year 2000 issues and has not delayed other projects critical to the
Company's business.
The Company has substantially completed Year 2000 testing and remediation on
its financial and management operating systems. All software programs are Year
2000 compliant. All infrastructure components (hardware, telecommunication
devices) are compliant except for a small percentage of noncompliant desktop and
laptop computers which are expected to be remediated by October 1999.
The Company has completed an inventory and assessment of its exposure to
embedded chips in its facilities in the areas of medical, office and
physical-plant equipment. A small percentage of items are affected, and
remediation of the equipment is expected to be completed by September 30, 1999.
<PAGE> 36
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (CONTINUED)
The Company has received written correspondence from its major vendors and
management is satisfied that the Company does not have significant exposure to
Year 2000 problems associated with vendors. The Company continues to interview
payers to determine their exposure to Year 2000 issues, their anticipated risks
and responses to those risks, and expects to be completed with remediation
activities, if any by October 1999.
The Company has established the majority of its business continuity plan
which is expected to be fully executed by October 1999.
If the Company is unsuccessful in completing remediation of non-compliant
hardware or if customers or vendors, which have indicated Year 2000 readiness,
have not or cannot rectify Year 2000 issues, the Company could incur additional
costs, which may be substantial, to develop alternative methods of managing its
business and replacing non-compliant equipment, and may experience delays in
payments by customers or to vendors.
CAUTIONARY STATEMENT
Except for historical information, matters discussed above including, but
not limited to, statements concerning future growth, are forward-looking
statements that are based on management's estimates, assumptions and
projections. Important factors that could cause results to differ materially
from those expected by management include reimbursement system changes, the
productivity of clinicians, pricing of payer contracts, management retention and
development, management's success in developing and introducing new products and
lines of business, the ability of the Company, its customers and suppliers to
complete assessment, testing and remediation of Year 2000 issues, the ability of
the Company to improve its cash flow from operations, the ability to complete
the sale of the physical rehabilitation and occupational health business,
adverse Internal Revenue Service rulings with respect to the employer status of
employee services businesses and the Company's ability to implement the employee
services business model.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company does not engage in trading market risk sensitive instruments and
does not purchase as investments, as hedges or for purposes "other than trading"
instruments that are likely to expose the Company to market risk, whether it be
from interest rate, foreign currency exchange, or commodity price risk. The
Company has entered into no forward or futures contracts, purchased no options
and entered into no swap arrangements.
The Company's primary market risk exposure is that of interest rate risk. A
change in the market interest rate would affect the rate at which the Company
could borrow funds under its credit facilities.
<PAGE> 37
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NOVACARE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
AS OF JUNE 30,
------------------------------
1999 1998
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents .................................. $ 23,277 $ 32,760
Accounts receivable, net of allowance in 1999 and 1998 of
$38,459 and $35,550, respectively ......................... 193,407 187,906
Income tax receivable ...................................... 23,022 --
Inventories ................................................ 44,651 38,207
Deferred income taxes ...................................... 37,422 4,519
Net assets of discontinued operations ...................... 44,388 --
Other current assets ....................................... 22,323 21,365
----------- -----------
Total current assets ............................... 388,490 284,757
Property and equipment, net .................................. 59,744 61,443
Excess cost of net assets acquired, net ...................... 729,947 692,283
Net assets of discontinued operations ........................ -- 216,886
Investment in joint ventures ................................. 15,120 14,881
Deferred income taxes ........................................ 1,669 155
Other assets, net ............................................ 9,895 26,300
----------- -----------
$ 1,204,865 $ 1,296,705
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of financing arrangements .................. $ 551,320 $ 32,074
Accounts payable and accrued expenses ...................... 131,310 145,584
Income taxes payable ....................................... 2,192 981
----------- -----------
Total current liabilities .......................... 684,822 178,639
Financing arrangements, net of current portion ............... 54,237 476,308
Deferred income taxes ........................................ 39,091 29,171
Other ........................................................ 5,031 13,608
----------- -----------
Total liabilities .................................. 783,181 697,726
----------- -----------
Minority interest in consolidated subsidiaries ............... 28,425 18,306
Commitments and contingencies ................................ -- --
Shareholders' equity:
Common stock, $.01 par value; authorized 200,000 shares,
issued 68,561 shares in 1999 and 67,935 shares in 1998 .... 686 679
Additional paid-in capital ................................. 274,603 273,157
Retained earnings .......................................... 160,644 350,255
----------- -----------
435,933 624,091
Less: Common stock in treasury (at cost), 5,308 shares in
1999 and 5,401 shares in 1998 ............................. (42,674) (43,418)
----------- -----------
Total shareholders' equity ......................... 393,259 580,673
----------- -----------
$ 1,204,865 $ 1,296,705
=========== ===========
</TABLE>
The accompanying Notes to Consolidated Financial Statements
are an integral part of these statements.
<PAGE> 38
NOVACARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED JUNE 30,
------------------------------------------------
1999 1998 1997
----------- ----------- ----------
<S> <C> <C> <C>
Net revenues ............................................ $ 1,477,917 $ 1,037,571 $ 516,925
Cost of services ........................................ 1,267,491 857,418 405,356
----------- ----------- ----------
Gross profit ........................................ 210,426 180,153 111,569
Selling, general and administrative expenses ............ 162,719 144,002 96,897
Provision for uncollectible accounts .................... 42,540 18,287 13,514
Amortization of excess cost of net assets acquired ...... 22,866 17,965 11,244
Provision for restructure ............................... 43,395 -- --
----------- ----------- ----------
(Loss) from operations .............................. (61,094) (101) (10,086)
Gain from issuance of subsidiary stock .................. 1,506 38,805 --
Investment (loss) income, net ........................... (650) 594 1,374
Interest expense ........................................ (41,592) (28,285) (15,244)
Minority interest ....................................... (3,135) (1,494) (236)
----------- ----------- ----------
(Loss) income before income tax (benefit) provision . (104,965) 9,519 (24,192)
Income tax (benefit) provision .......................... (23,129) 12,733 (5,402)
----------- ----------- ----------
(Loss) income from continuing operations ............ (81,836) (3,214) (18,790)
(Loss) income from discontinued operations, net of tax .. (76,936) 61,129 57,700
(Loss) on sale of discontinued operations, net of tax ... (30,839) -- --
----------- ----------- ----------
Net (loss) income ................................... $ (189,611) $ 57,915 $ 38,910
=========== =========== ==========
(Loss) income per share from continuing operations:
Basic ........................................... $ (1.30) $ (0.05) $ (0.31)
=========== =========== ==========
Assuming dilution ............................... $ (1.30) $ (0.05) $ (0.31)
=========== =========== ==========
Net (loss) earnings per share:
Basic ........................................... $ (3.02) $ 0.94 $ 0.64
=========== =========== ==========
Assuming dilution ............................... $ (3.02) $ 0.94 $ 0.64
=========== =========== ==========
Weighted average number of shares outstanding:
Basic ........................................... 62,837 61,742 61,031
=========== =========== ==========
Assuming dilution ............................... 62,837 61,742 61,031
=========== =========== ==========
</TABLE>
The accompanying Notes to Consolidated Financial Statements
are an integral part of these statements.
<PAGE> 39
NOVACARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON
SHARES ISSUED STOCK ADDITIONAL
------------------------- ($.01 PAR TREASURY PAID-IN RETAINED
COMMON TREASURY VALUE) STOCK CAPITAL EARNINGS
--------- --------- --------- --------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
Balance at June 30, 1996 .... 66,091 (3,190) $ 661 $ (23,465) $ 253,918 $ 253,430
Issued in connection with
employee benefit plans .... 539 17 5 11 4,284 --
Issued in connection with
acquisitions .............. -- 344 -- 2,474 1,713 --
Repurchase of common stock .. -- (2,761) -- (23,935) -- --
Net income .................. -- -- -- -- -- 38,910
--------- --------- --------- --------- --------- ---------
Balance at June 30, 1997 .... 66,630 (5,590) 666 (44,915) 259,915 292,340
Issued in connection with
employee benefit plans .... 1,305 59 13 465 9,674 --
Issued in connection with
acquisitions .............. -- 130 -- 1,032 3,568 --
Net income .................. -- -- -- -- -- 57,915
--------- --------- --------- --------- --------- ---------
Balance at June 30, 1998 .... 67,935 (5,401) 679 (43,418) 273,157 350,255
ISSUED IN CONNECTION WITH
EMPLOYEE BENEFIT PLANS .... 583 93 7 744 1,249 --
ISSUED IN CONNECTION WITH
ACQUISITIONS .............. 43 -- -- -- 197 --
NET (LOSS) .................. -- -- -- -- -- (189,611)
--------- --------- --------- --------- --------- ---------
BALANCE AT JUNE 30, 1999 .... 68,561 (5,308) $ 686 $ (42,674) $ 274,603 $ 160,644
========= ========= ========= ========= ========= =========
</TABLE>
The accompanying Notes to Consolidated Financial Statements
are an integral part of these statements.
<PAGE> 40
NOVACARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED JUNE 30,
-------------------------------------------
1999 1998 1997
----------- --------- ---------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income ................................................ $ (189,611) $ 57,915 $ 38,910
Adjustments to reconcile net (loss) income to net
cash flows from operating activities of continuing operations:
Loss (income) from discontinued operations, net .................. 76,936 (61,129) (57,700)
Loss on sale of discontinued operations, net ..................... 30,839 -- --
Depreciation and amortization .................................. 44,924 39,799 28,290
Minority interest .............................................. 3,135 1,494 236
Provision for uncollectible accounts ........................... 42,540 18,287 13,514
Deferred income taxes .......................................... (11,070) 19,633 3,874
Non-cash portion of nonrecurring items ......................... 41,889 (38,805) --
Changes in assets and liabilities, net of
effects from acquisitions and dispositions:
Accounts and notes receivable ............................... (46,545) (48,412) (37,746)
Inventories ................................................. (6,476) (14,377) 2,502
Other current assets ........................................ (2,810) (6,451) (781)
Accounts payable and accrued expenses ....................... (48,304) 30,559 3,807
Current income taxes ........................................ (33,180) 1,705 123
Other, net .................................................. (5,182) (887) (1,660)
--------- --------- ---------
Net cash flows (used in) continuing operations ................ (102,915) (669) (6,631)
Net cash flows from discontinued operations ................... 73,277 73,880 53,872
--------- --------- ---------
Net cash flows (used in) provided by operating activities ... (29,638) 73,211 47,241
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Payments for businesses acquired, net of cash acquired ........... (61,053) (180,558) (164,149)
Additions to property and equipment of continuing operations ..... (22,187) (17,894) (14,804)
Additions to property and equipment of discontinued operations ... (10,957) (13,221) (7,278)
Proceeds from the sale of investments ............................ 17,001 -- --
Other, net ....................................................... 2,849 (2,301) (1,544)
--------- --------- ---------
Net cash flows used in investing activities ................. (74,347) (213,974) (187,775)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from debt and credit arrangements ....................... 429,525 470,640 263,200
Payment of debt and credit arrangements .......................... (337,026) (373,299) (176,174)
Proceeds from subsidiary stock issued ............................ 5 45,709 --
Proceeds from common stock issued ................................ 1,998 7,757 3,750
Payment for purchase of treasury stock ........................... -- -- (23,250)
--------- --------- ---------
Net cash flows provided by financing activities ............. 94,502 150,807 67,526
--------- --------- ---------
Net (decrease) increase in cash and cash equivalents ............. (9,483) 10,044 (73,008)
Cash and cash equivalents, beginning of year ..................... 32,760 22,716 95,724
--------- --------- ---------
Cash and cash equivalents, end of year ........................... $ 23,277 $ 32,760 $ 22,716
========= ========= =========
</TABLE>
The accompanying Notes to Consolidated Financial Statements
are an integral part of these statements.
<PAGE> 41
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1999
(IN THOUSANDS, EXCEPT PER SHARE DATA)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations: NovaCare, Inc. ("NovaCare" or the "Company") is a
national leader in two business segments: outpatient services and employee
services. Outpatient services consist of providing outpatient, orthotic and
prosthetic ("O&P") and occupational health rehabilitation services through a
national network of patient care centers. Employee services are comprehensive,
fully integrated outsourcing solutions to human resource issues, including
payroll management, workers' compensation, risk management, benefits
administration, unemployment services and human resource consulting services,
and are generally provided to small and medium-sized businesses. The Company
previously operated in a third segment, long-term care services, providing
rehabilitation and healthcare consulting services on a contract basis to health
care institutions, primarily long-term care facilities. This segment was
disposed of on June 1, 1999.
Operating Segments: The Company has adopted the provisions of Statement of
Financial Accounting Standards ("SFAS") No. 131, "Disclosures about Segments of
an Enterprise and Related Information." SFAS 131 uses a "management approach" to
defining and reporting the activities of operating segments. The management
approach defines operating segments along the lines used by management to assess
performance and make operating and capital decisions. The adoption of SFAS 131
did not affect the Company's results of operations or financial position, but
did affect the disclosure of segment information provided in Note 16.
Principles of Consolidation: The Consolidated Financial Statements include
the accounts of the Company, its majority-owned subsidiaries and companies
effectively controlled through management agreements under the nominee
structure. Under the terms of these agreements, the Company has absolute
authority to change the nominee for an insignificant amount of consideration, as
long as the nominee is duly certified in the state to which the management
agreement pertains. Investments in 20% to 50% of the voting interest of
affiliates are accounted for using the equity method. All significant
intercompany accounts and transactions have been eliminated. The Company
recognizes a minority interest in its Consolidated Balance Sheets and
Consolidated Statements of Operations for the portion of majority-owned
subsidiaries attributable to its minority owners.
Use of Estimates: The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents: The Company considers its holdings of highly
liquid debt and money-market instruments to be cash equivalents if the
securities mature within 90 days from the date of acquisition. These investments
are carried at cost, which approximates fair value.
Net Revenues: Net revenues for outpatient services are reported at the net
realizable amounts from customers and third-party payers. The Company records
revenue under discounted fee-for-service contracts as those services are
provided. Revenue for capitation contracts is recorded in the period that
beneficiaries are entitled to health care service. The cost of patient care
under these arrangements are recorded in the period that the care is provided.
The Company's contracts do not obligate it to provide care after the end of the
contract period. Net revenues generated directly from Medicare and Medicaid
reimbursement programs represented 20%, 11% and 15% of the Company's
consolidated net revenues for fiscal 1999, 1998 and 1997, respectively. Fiscal
intermediaries determine settlement amounts due to or receivable from Medicare
and Medicaid programs. Management believes that adequate provision has been made
in the Consolidated Financial Statements for potential adjustments resulting
from such determinations.
Employee services revenues and related costs of wages, salaries, and
employment taxes pertaining to worksite employees are recognized in the period
in which the employee performs the service. Because the Company is at risk for
all of its direct costs, independently of whether payment is received from its
clients, and consistent with industry practice, all amounts billed to clients
for gross salaries and wages, related employment taxes, and health care and
workers' compensation coverage are recognized as revenue by the Company. In
addition to revenues recognized for direct costs, the Company recognizes
revenues for amounts charged as service fees. Service fees are recognized as
revenues during the period in which service is provided. The Company establishes
an allowance for doubtful accounts based on prior experience.
Inventories: Inventories consist of customized orthotic and prosthetic
merchandise held for sale, work in process and raw materials and are carried at
the lower of cost or market. Cost of inventories is determined by the first-in,
first-out method.
<PAGE> 42
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
JUNE 30, 1999
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Property and Equipment: Property and equipment are stated at cost.
Depreciation is provided on a straight-line basis over the estimated useful
lives of the assets, which principally range from three to seven years for
property and equipment and 30 to 40 years for buildings. Assets under capital
leases and leasehold improvements are amortized over the lesser of the lease
term or the asset's estimated useful life. Property and equipment also include
external and incremental internal costs incurred to develop major business
systems. Capitalized software costs are amortized on a straight-line basis over
three to five years. The cost of assets retired, sold or otherwise disposed of
and the applicable accumulated depreciation are removed from the accounts, and
the resultant gain or loss, if any, is reflected in the Consolidated Statements
of Operations.
Excess Cost of Net Assets Acquired: Assets and liabilities acquired in
connection with business combinations accounted for under the purchase method
are recorded at their respective fair values. Deferred taxes have been recorded
to the extent of the difference between the fair value and the tax basis of the
assets acquired and liabilities assumed. The excess of the purchase price over
the fair value of net assets acquired, including the recognition of applicable
deferred taxes, consists of non-compete agreements, customers lists, assembled
workforce and goodwill and is amortized on a straight-line basis over the
estimated useful lives of the assets which range from five to 40 years.
Impairment of Long-Lived Assets: Effective July 1, 1997, the Company adopted
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of," which establishes accounting standards for
the impairment of long-lived assets, certain identified intangible assets and
goodwill related to those assets to be held and used and for long-lived assets
and certain intangible assets to be disposed of. In accordance with SFAS No.
121, the Company reviews the realizability of long-lived assets, certain
intangible assets and goodwill whenever events or circumstances occur which
indicate recorded cost may not be recoverable. The Company also reviews the
overall recoverability of goodwill based primarily on estimated future
undiscounted cash flows.
If the expected future cash flows (undiscounted) are less than the carrying
amount of such assets, the Company recognizes an impairment loss for the
difference between the carrying amount of the assets and their estimated fair
value. In estimating future cash flows for determining whether an asset is
impaired, and in measuring assets that are impaired, assets are grouped by
geographic region because that is the level at which the Company manages and
operates the business and that is the lowest level for which individual cash
flow data is maintained.
Other Assets: At June 30, 1999 other assets consist principally of deferred
charges and miscellaneous receivables. At June 30, 1998 other assets consist
principally of investments in affordable income housing partnerships, executive
savings plan assets and miscellaneous receivables. Investments in affordable
income housing partnerships are recorded at cost and are subject to an annual
assessment as to carrying value. The executive savings plan is a non-qualified
savings plan offered to Company executives. Contributions made to the fund by
eligible employees are partially matched by the Company. Withdrawals from the
fund by employees are limited to events specified by the plan.
Workers' Compensation: The Company is contractually obligated to provide
workers' compensation coverage for its employees and co-employees. Co-employees
are defined as third-party worksite employees leased by the Company's employee
services segment. The Company accomplishes this through a combination of various
commercial insurance policies and self insurance programs. The Company records
estimated accruals for workers compensation and health care claims, including
estimates for incurred but not reported claims, based upon review of the claims
activity and past experience. Management believes any differences which may
arise between actual settlement of claims and reserves at June 30, 1999 would
not have a material impact on the Company's financial position or results of
operations.
On July 1, 1997, the Company entered into a three-year contract with a
commercial insurance company for worker's compensation coverage. Under this
program, the Company's outpatient services segment and the long-term care
services segment (classified as discontinued operations) worksite employees
continue to be covered under a self insurance program. Third-party worksite
employees are covered under a fixed cost insurance program, which is subject to
certain per incident and aggregate deductibles.
Income Taxes: The Company records deferred tax assets and liabilities for
the expected future tax consequences of events that have been recognized in the
Company's financial statements or tax returns.
Net (Loss) Income Per Share: Basic net (loss) income per share ("EPS") is
calculated using the weighted average number of common shares outstanding during
each period. Net (loss) income per share - assuming dilution, if diluted, is
<PAGE> 43
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
JUNE 30, 1999
(IN THOUSANDS, EXCEPT PER SHARE DATA)
calculated using basic EPS adjusted for the effects of stock options,
contingently issuable shares under certain acquisition agreements and
convertible subordinated debentures.
Comprehensive Income: The Company has adopted the provisions of SFAS No.
130, "Reporting Comprehensive Income." SFAS 130 establishes standards for
reporting and display of comprehensive income and its components of net income
and other comprehensive income in a full set of general-purpose financial
statements. Comprehensive income is defined as the total of net income and all
other non-owner changes in equity. For fiscal years 1999, 1998 and 1997 the
Company's comprehensive income consists of only net income.
2. FINANCIAL RESTRUCTURING PLAN
The accompanying consolidated financial statements have been prepared on a
going concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. As shown in the
consolidated financial statements for the year ended June 30, 1999, the Company
reported a $189,611 net loss and, as of June 30, 1999, substantially all of the
Company's debt is payable in less than one year. Subsequent to June 30, 1999,
all amounts outstanding under the revolving credit facility were repaid,
primarily from the net proceeds from the O&P sale and amounts available under
the revolving credit facility were reduced to $35,000. Additionally, $37,305,
the entire outstanding indebtedness of the O&P business, was assumed by the
buyer of the business as discussed below. Of the remaining debt, $175,000 of
convertible subordinated debentures is due on January 15, 2000. The Company's
ability to make its scheduled debt payments when due is dependent on a number of
future actions, the outcomes of which are uncertain.
As described above, to partially reduce the Company's debt leverage, on July
1, 1999, the Company sold its O&P business to Hanger Orthopedic Group, Inc.
("Hanger") for $445,000, including $408,000 in cash and the assumption of seller
notes of $37,000. Of the purchase price, the Company has placed $15,000 in
escrow in conjunction with a $94,000 working capital guarantee to Hanger. The
final working capital amount is expected to be settled by no later than October
29, 1999. The proceeds from the transaction were used to satisfy the entire
balance of the Company's revolving credit facility, with approximately $37,000
remaining after transaction-related costs. These funds have been temporarily
invested to satisfy working capital requirements and future maturities of other
debt obligations. Net revenues, gross profit and income from operations of the
O&P business for fiscal 1999 was $278,820, $67,454 and $41,602, respectively.
Subsequent to the O&P sale, the Company's balance sheet remained highly
leveraged and management has proposed a financial restructuring plan to its
stockholders in a proxy statement dated August 13, 1999, as amended through
September 10, 1999. A special meeting of the Company's stockholders is to be
held on September 21, 1999 (the "Special Meeting") to consider and vote upon
proposals to approve: (i) the sale of the Company's outpatient physical therapy
and occupational health rehabilitation services business (the "PROH Sale"), (ii)
the sale of the Company's interest in NovaCare Employee Services, Inc. (the
"NCES Sale") and (iii) the adoption of a restructuring proposal.
On September 8, 1999, the Company entered into a definitive agreement,
subject to certain conditions, to tender its 64% (67% as of June 30, 1999)
ownership interest in the outstanding stock of NCES at the price of $2.50 per
share, or an aggregate amount of $48,500. The agreement was reached in
conjunction with a definitive agreement by NCES to sell NCES to an investment
group comprising Patricof & Co. Ventures, Fidelity Ventures Limited and AFLAC
Incorporated (the "Investors"). Under the terms of the agreement by NCES, a new
private company, established by the Investors, will acquire all the stock of
NCES at a price of $2.50 per share of common stock. The Investors intend to
effect the purchase through a cash tender offer to NCES stockholders, which will
commence on September 15, 1999, and a subsequent merger of NCES into a
new private company managed by the Investors. The Company's tender offer of its
ownership interest in NCES is subject to the Company's stockholders approval at
the Special Meeting and the satisfaction of customary closing conditions. The
NCES tender offer is expected to close during October 1999. In the event that
the stockholders of NovaCare vote in favor of the NCES sale, NovaCare intends to
vote all its shares of NCES in favor of a sale of NCES. As the owner of 64% of
the outstanding stock of NCES, NovaCare has the ability to approve such a sale
under Delaware law. The Company expects to record an insignificant pretax gain
on the sale of NCES.
The Company is in the process of seeking buyers for its PROH business. While
to date no definitive agreement has been entered into with respect to the PROH
Sale, the Company is seeking stockholder approval at the Special Meeting to
proceed with the sale when a suitable buyer is identified and a definitive
agreement is negotiated with such buyer. The consummation of the PROH Sale would
<PAGE> 44
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
JUNE 30, 1999
(IN THOUSANDS, EXCEPT PER SHARE DATA)
be subject to the receipt by the Company of not less than $200,000 in cash and
assumption of debt, obtaining a fairness opinion from the Company's financial
advisors in connection with the sale and approval by the Board of Directors of
the Company of the terms of a definitive sale agreement. The Company has
estimated that a valuation of $200,000 for PROH will result in a loss of
approximately $312,120. Management believes that any increase in purchase price
would result in a direct reduction of the loss. The estimated minimum sales
price is based on management's analysis of the business and comparable
valuations of public and private businesses similar to those of PROH. The amount
the Company will ultimately realize could differ materially from the amount
assumed by management in estimating the loss on the proposed disposition of the
PROH business.
If the restructuring proposal is approved at the Special Meeting, the
Company intends to seek to reinvest the net proceeds to the Company from the
PROH Sale and the NCES Sale, after the payment of the Company's $175,000
convertible subordinated debentures due January 15, 2000 and certain other
liabilities, in a new business or businesses. Any such reinvestment would be
subject to the further vote and approval of the stockholders of the Company. If
the Company is unable, or chooses not, to reinvest any proceeds in a new
business or businesses, the Company will liquidate.
If either the PROH Sale is not approved by the stockholders or the
conditions to the PROH Sale are not met, the Board of Directors will explore the
alternatives then available for the future of the Company. Such alternatives
include (i) refinancing the convertible subordinated debentures through a
combination of private equity and/or public or private debt, which management
believes would demand a high interest rate due to the Company's highly leveraged
position and, moreover, there is no assurance that such financing could be
obtained, and (ii) in the event the $200,000 sale price condition is not met,
seeking to obtain stockholder approval of a sale of PROH at a lower price. In
the event that the NCES Sale is not approved by the stockholders or the closing
conditions are not met, the Board of Directors will explore the alternatives
then available to the Company. Such alternatives include (i) negotiate the NCES
Sale with another buyer, (ii) distribute the Company's interest in NCES to
NovaCare stockholders pro-rata as a dividend, and (iii) pay existing
indebtedness of the Company with shares of NCES's stock (provided such stock is
valued at not less than $2.50 per share). If the stockholders do not approve the
restructuring proposal, the Company's Board of Directors will explore the
alternatives then available for the future of the Company, including (i)
presenting a new investment opportunity to stockholders or (ii) liquidating the
Company. If the $175,000 convertible subordinated debentures cannot be paid due
to the Company's inability to (i) obtain stockholder approval of the PROH sale,
(ii) meet the conditions of the PROH sale or (iii) secure refinancing in the
event PROH is not sold, the alternatives available to the Company will be
limited to (i) a sale of the Company, (ii) negotiating alternative debenture
payment terms, including conversion to common stock, and (iii) protection under
the Bankruptcy Code. The Company is unable to predict the ultimate outcome of
the stockholder vote on these matters or the likelihood of successfully
concluding any other available alternative.
3. NET (LOSS) INCOME PER SHARE
A reconciliation of (loss) income per share from continuing operations,
discontinued operations and on the sale of discontinued operations and net
(loss) income per share - all basic and assuming dilution is as follows:
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
---------------------------------
1999 1998 1997
---------- -------- --------
<S> <C> <C> <C>
(Loss) income from continuing operations ............................... $ (81,836) $ (3,214) $(18,790)
(Loss) income from discontinued operations ............................. (76,936) 61,129 57,700
(Loss) from the sale of discontinued operations ........................ (30,839) -- --
---------- -------- --------
Net (loss) income ...................................................... $ (189,611) $ 57,915 $ 38,910
========== ======== ========
Weighted average shares outstanding:
Weighted average shares outstanding-- basic and assuming dilution .. 62,837 61,742 61,031
========== ======== ========
(Loss) income per share from continuing operations:
Basic and assuming dilution ........................................ $ (1.30) $ (0.05) $ (.31)
========== ======== ========
(Loss) income per share from discontinued operations, net of tax:
Basic and assuming dilution ........................................ $ (1.23) $ 0.99 $ 0.95
========== ======== ========
(Loss) per share on the sale of discontinued
operations, net of tax:
Basic and assuming dilution ........................................ $ (0.49) $ -- $ --
========== ======== ========
Net (loss) income per share:
Basic and assuming dilution ........................................ $ (3.02) $ 0.94 $ 0.64
========== ======== ========
</TABLE>
<PAGE> 45
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
JUNE 30, 1999
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The Company did not include convertible subordinated debentures, equivalent
to 6,567 shares of common stock, options to purchase 2,432, 83, or 1,631 shares
in fiscal 1999, 1998 or 1997, respectively, or contingently issuable shares of
41 or 119 in fiscal 1998 or 1997, respectively, because their effects are
antidilutive. There were no transactions that occurred subsequent to June 30,
1999 that would have materially changed the number of shares used in computing
any of the per share amounts presented.
4. PROVISION FOR RESTRUCTURE - NET
During fiscal 1999, the Company's continuing operations reflected provisions
for restructure, net totaling $43,295. These provisions were recognized among
its operating segments as follows:
<TABLE>
<S> <C>
Outpatient services ................................ $30,225
Employee services .................................. 910
Unallocated selling, general and administrative .... 12,260
-------
Total .............................................. $43,395
=======
</TABLE>
The provisions consisted of the following:
<TABLE>
<S> <C>
Write-down of excess cost of net assets acquired, net .. $28,300
Employee severance and related costs ................... 5,431
Lease and technology agreement mitigation costs ........ 8,979
Write-down of property and equipment ................... 685
-------
Total ................................................ $43,395
=======
</TABLE>
During fiscal 1999, the Company recorded a provision for restructure of
$30,200 in connection with its decision to exit certain non-strategic markets
served by its physical rehabilitation and occupational health ("PROH") business
within its outpatient services segment. The markets consisted of 40 PROH
clinics. This decision resulted in a write-down of the value of the related
assets to estimated net realizable value. The provision for restructure consists
principally of the write-down of excess cost of net assets acquired, net
($28,300). The clinics to be disposed of had annualized net revenues of
approximately $16,600 and annualized operating profit of approximately $200. At
June 30, 1999, five of the clinics have been sold for proceeds totaling $923.
The net book value of the remaining assets to be sold is approximately $4,991.
The Company is reevaluating the decision to dispose of these clinics in light of
the proposed PROH sale.
As a result of the Company's decision to exit the long-term care services
operating segment and sell the O&P business included in its outpatient services
segment, the services the Company required of its employee services segment were
substantially reduced. The Company's employee services segment recorded a
provision for restructure of $910, consisting principally of employee severance
costs for 49 employees working at its corporate headquarters and lease
mitigation costs, to reflect the impact of this decision. As of June 30, 1999,
32 employees have been terminated related to this charge.
Also as a result of the Company's decision to exit the long-term care
services operating segment and sell the O&P business, the Company has
implemented a program to substantially reduce its unallocated selling, general
and administrative costs incurred at its Corporate headquarters. This program
(with an aggregate provision of $12,260) involves the termination of 74
employees ($3,060), lease termination cost ($4,800) and equipment and long-term
information service agreement buyouts ($4,400). All of these costs are expected
to be expended by June 30, 2000.
A summary of the activity related to the fiscal 1999 provisions for
restructure, net is as follows:
<TABLE>
<S> <C>
Provision for restructure, net .................................. $ 43,395
Less noncash write-down of excess cost of net assets acquired ... (28,300)
Less noncash write-down of property and equipment ............... (685)
Payments and other reductions ................................... (1,178)
--------
Accrued provision for restructure, June 30, 1999 ................ $ 13,232
========
</TABLE>
<PAGE> 46
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
JUNE 30, 1999
(IN THOUSANDS, EXCEPT PER SHARE DATA)
5. DISCONTINUED OPERATIONS
During fiscal 1999, the Company experienced a severe decline in revenues and
profitability in its long-term care services operating segment. The revenue
decline resulted from a combination of reduced patient volume (primarily related
to fewer therapy patients per customer facility and fewer treatments per
patient) and lower prices. The lower prices in turn reflected reduced
reimbursement rates from the Medicare program for contract therapy services. The
Company implemented a revised operating model in an attempt to mitigate the
effects of the lower reimbursement rates, but continued to experience declining
profitability because it could not sufficiently lower its costs to match the
decline in revenues.
In fiscal 1998, the Company recorded a provision for restructure of $23,500
to recognize the costs of converting to its revised operating model. This
provision was recorded based on the anticipated impact of the changes the
Medicare reimbursement system mandated by the Balanced Budget Act of 1997 (the
"BBA"). The provision related principally to severance costs associated with
personnel changes required by the Company's revised operating model and
anticipated the severance of approximately 2,975 employees. During fiscal 1999,
it became apparent that a portion of this fiscal 1998 charge would not be
required. A significant portion of the employee base covered by the restructure
reserve voluntarily resigned to seek new employment or obtained employment with
customers when these customer facilities converted to in-house therapy programs.
Ultimately, 1,441 employees were terminated related to this provision and
$13,300 was reversed.
In fiscal 1999, the Company recorded a provision for restructure of $111,947
related to its decision to completely exit certain long-term care markets,
principally in the Western United States, where it was determined that low
customer and therapist concentration would preclude a return to profitability.
These markets included California, Colorado, Texas and the Northwest. The
Company determined that it would be unable to recover its investment in
long-lived assets in the long-term care operating segment and, accordingly,
wrote down all of its investment in these assets and recognized the cost,
consisting principally of employee severance costs, of exiting the selected
markets. The exit plan called for the termination of approximately 1,300
employees, of which 1,200 were direct care providers in the geographic regions
exited and the remainder were general and administrative personnel. As of June
30, 1999, 1,198 of the affected employees have been terminated.
The provisions for restructure for the long-term care services segment
consisted of the following:
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
------------------------
1999 1998
-------- --------
<S> <C> <C>
Write-down of excess cost of net assets acquired, net .. $ 73,716 $ --
Write-down of property and equipment ................... 20,748 360
Employee severance and other ........................... 17,483 23,140
Reversal of prior year provision ....................... (13,300) --
-------- --------
Total .................................................. $ 98,647 $ 23,500
======== ========
</TABLE>
A summary of the activity related to the fiscal 1999 and 1998 provisions
for restructure for the long-term care services operating segment is as
following:
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
--------------------------
1999 1998
--------- ---------
<S> <C> <C>
Beginning balance .................................. $ 22,348 $ --
Provision for restructure .......................... 111,947 23,500
Reversal of prior year provision for restructure ... (13,300) --
Less non-cash portion, principally asset
write-offs ...................................... (94,464) (360)
Payments and other reductions ...................... (23,325) (792)
--------- ---------
Ending balance ..................................... $ 3,206 $ 22,348
========= =========
</TABLE>
In spite of these actions, the Company determined that its remaining
operations were unlikely to achieve a sufficient level of profitability to
justify continued operations. Accordingly, the Company sold its remaining
<PAGE> 47
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
JUNE 30, 1999
(IN THOUSANDS, EXCEPT PER SHARE DATA)
long-term care operations to Chance Murphy, Inc. as of June 1, 1999 for a
nominal amount and issued a working capital guarantee of $30,000 to the buyer.
The Company's hospital contracting business, which is immaterial, previously
classified in the Company's long-term care services segment disclosure was not
transferred as part of the sale. The Company has restated its prior Consolidated
Financial Statements to present the operating results of the long-term care
services segment as a discontinued operation.
A provision for loss on discontinued operations has been recorded based on
management's best estimates of the amounts expected to be realized on the sale
of the long-term care services operations. While management's estimates are
based on an analysis of the sale transaction, the amounts the Company will
ultimately realize could differ materially from the amounts assumed in computing
the loss anticipated on the final disposal of the discontinued operations. In
connection with the sale of the long-term care services segment, the Company
recognized a pretax loss of $36,676 ($30,839 after-tax) which included the
$30,000 working capital guarantee and the write down of certain property and
equipment and other assets. Results of operations for the long-term care
services operating segment consisted of the following:
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
------------------------------------------
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Net revenues ....................... $ 351,128 $ 634,534 $ 549,526
(Loss) income before income taxes .. (84,616) 90,027 90,993
Income tax (benefit) provision ..... (7,680) 28,898 33,293
Net (loss) income .................. $ (76,936) $ 61,129 $ 57,700
</TABLE>
Net assets of discontinued operations consist of the following:
<TABLE>
<CAPTION>
AS OF JUNE 30,
--------------------------
1999 1998
--------- ---------
<S> <C> <C>
Accounts receivable from closed operations,
net ........................................ $ 13,660 $ 150,422
Accounts receivable from sold operation, net ... 42,702 --
Property and equipment, net .................... -- 19,414
Excess cost of net assets acquired, net ........ -- 75,446
Deferred income tax assets ..................... -- 12,792
Other receivables .............................. 21,906 9,021
Other assets ................................... 4,421 9,128
Accounts payable and accrued expenses .......... (9,501) (47,441)
Working capital guarantee ...................... (28,800) --
Deferred income tax liabilities ................ -- (11,896)
--------- ---------
Total .......................................... $ 44,388 $ 216,886
========= =========
</TABLE>
Other receivables consist of amounts due from customers related to the
Company's indemnification of the customer for disallowed Medicare charges.
6. GAIN FROM ISSUANCE OF SUBSIDIARY STOCK
In fiscal 1998, NCES completed an initial public offering, converted its
manditorily redeemable common stock, and issued common stock to former owners of
acquired businesses. In fiscal 1999, NCES issued additional common stock to
former owners of acquired businesses. As a result of these common stock
transactions, the Company's percentage ownership of NCES decreased to 66.7% at
June 30, 1999 from 70.9% and 98.7% at June 30, 1998 and 1997, respectively. The
initial public offering included 5,750 shares of NCES common stock issued at
$9.00 per share. Proceeds received by NCES, net of underwriting costs, were
$45,709.
In fiscal 1999 and 1998, the Company recorded pretax gains of $1,506 and
$38,805 ($1,506 and $22,895 after-tax, respectively), representing the
difference between the Company's historical cost of its investment in NCES and
its portion of NCES equity.
<PAGE> 48
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
JUNE 30, 1999
(IN THOUSANDS, EXCEPT PER SHARE DATA)
7. ACQUISITION AND JOINT VENTURE TRANSACTIONS
During the year ended June 30, 1999, the Company acquired four outpatient
services businesses consisting of one PROH business and three O&P businesses;
and two employee services businesses. During the year ended June 30, 1998, the
Company acquired 90 outpatient services businesses consisting of 48 PROH and 42
O&P businesses; and two employee services businesses.
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,
1997:
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
----------------------------------
1999 1998
------------- -------------
<S> <C> <C>
Net revenues ................................. $ 1,487,391 $ 1,243,906
(Loss) income from continuing operations...... (81,697) 2,420
(Loss) income from continuing operations
per share-basic and assuming dilution..... $ (1.30) $ 0.04
</TABLE>
The above pro forma information is not necessarily indicative of the results
of operations that would have occurred had the acquisition been made as of July
1, 1997, or the results that may occur in the future.
Information with respect to businesses acquired in purchase transactions is
as follows (the allocation for fiscal 1999 acquisitions is preliminary):
<TABLE>
<CAPTION>
AS OF JUNE 30,
--------------------------
1999 1998
--------- ---------
<S> <C> <C>
Excess cost of net assets acquired ... $ 805,710 $ 745,473
Less: accumulated amortization ....... (75,763) (53,190)
--------- ---------
$ 729,947 $ 692,283
========= =========
</TABLE>
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
--------------------------
1999 1998
--------- ---------
<S> <C> <C>
Cash paid (net of cash acquired) ...................... $ 46,067 $ 146,643
Deferred purchase price obligations ................... 600 4,600
Notes issued .......................................... 4,825 50,754
Closing costs & other ................................. 1,689 9,528
Subsidiary stock issued................................ 4,200 7,590
--------- ---------
57,964 219,115
Liabilities assumed ................................... 4,423 26,724
--------- ---------
61,804 245,839
Fair value of assets acquired, principally accounts
receivable and property and equipment ............... (4,900) (43,247)
--------- ---------
Cost in excess of fair value of net assets acquired ... $ 56,904 $ 202,592
========= =========
</TABLE>
Certain purchase agreements require additional payments if specific
financial targets and non-financial conditions are met. The Company records the
contingent consideration as an addition to purchase price when the conditions
of the contingency are met. Aggregate contingent payments in connection with
these acquisitions at June 30, 1999 of approximately $50,794 in cash has 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. During the fiscal years ended June 30, 1999, 1998 and 1997, the
Company paid $14,986, $33,935 and $15,223, respectively, in cash and issued 43,
130 and 344 shares of common stock, respectively, in connection with businesses
acquired in prior years.
<PAGE> 49
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
JUNE 30, 1999
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Deferred purchase price obligations represent guaranteed purchase price
amounts due to former owners of businesses acquired. Obligations of $14,829 are
accrued at June 30, 1999, and are included in accounts payable and accrued
expenses.
The Company has formed several joint ventures. The carrying value of these
investments is $15,120 and $14,881 at June 30, 1999 and 1998, respectively. The
Company accounts for investments in joint ventures by the equity method.
8. INVENTORIES
Inventories consisted of the following:
<TABLE>
<CAPTION>
AS OF JUNE 30,
---------------------
1999 1998
------- -------
<S> <C> <C>
Materials and supplies .. $28,859 $24,068
Work in process ......... 12,112 10,840
Finished goods .......... 3,680 3,299
------- -------
$44,651 $38,207
======= =======
</TABLE>
9. PROPERTY AND EQUIPMENT
The components of property and equipment were as follows:
<TABLE>
<CAPTION>
AS OF JUNE 30,
--------------------------
1999 1998
--------- ---------
<S> <C> <C>
Land and buildings ................................ $ 1,779 $ 2,005
Property, equipment and furniture ................. 59,058 60,656
Capitalized software .............................. 33,218 19,155
Leasehold improvements ............................ 28,600 23,239
--------- ---------
122,655 105,055
Less: accumulated depreciation and amortization ... (62,911) (43,612)
--------- ---------
$ 59,744 $ 61,443
========= =========
</TABLE>
Depreciation and amortization expense, including depreciation of property
under capital leases, for fiscal 1999, 1998, and 1997 was $22,058, $21,834 and
$17,046, respectively.
10. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses are summarized as follows:
<TABLE>
<CAPTION>
AS OF JUNE 30,
-----------------------
1999 1998
-------- --------
<S> <C> <C>
Accounts payable ..................................... $ 19,463 $ 12,806
Accrued compensation and benefits .................... 54,123 72,961
Deferred and contingent purchase price obligations ... 14,829 8,756
Accrued provision for restructure .................... 13,232 --
Accrued workers' compensation and health claims ...... 10,528 24,999
Accrued interest ..................................... 8,042 7,080
Other ................................................ 11,093 18,982
-------- --------
$131,310 $145,584
======== ========
</TABLE>
<PAGE> 50
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
JUNE 30, 1999
(IN THOUSANDS, EXCEPT PER SHARE DATA)
11. FINANCING ARRANGEMENTS
Financing arrangements consisted of the following:
<TABLE>
<CAPTION>
AS OF JUNE 30,
-----------------------
1999 1998
-------- --------
<S> <C> <C>
Revolving credit facility due December 31, 1999 ....... $347,000 $227,500
Convertible subordinated debentures (5.5%), due
January 15, 2000 .................................... 175,000 175,000
Subordinated promissory notes (5% to 10%), payable
through 2007 ........................................ 78,584 98,318
$25,000 revolving credit facility of subsidiary, due
November 17, 2000 ................................... 2,000 --
Other ................................................. 2,973 7,564
-------- --------
605,557 508,382
Less: current portion ................................. 551,320 32,074
-------- --------
$ 54,237 $476,308
======== ========
</TABLE>
The Company has a revolving credit facility with a syndicate of lenders that
is collateralized by substantially all of the common stock of the Company's
subsidiaries and accounts receivable. The maximum amount available at June 30,
1999 was $400,000.
The terms of the facility were amended during fiscal 1999 to shorten the
maturity date from June 30, 2003 to December 31, 1999 and to change the interest
rate from the London Interbank Offered Rate ("LIBOR") plus a range of 0.875% to
1.5%, depending on certain financial ratios, to LIBOR plus 3% (weighted average
rate 8.77% at June 30, 1999). The Company has accounted for the payment to amend
the revolving credit facility agreement, which decreased the borrowing capacity
of the Company, as interest expense. The Company records the charges related to
commitment fees as interest expense in the period the commitment was received.
The Company is also charged a commitment fee of .50% on the average daily
available balance. The weighted average interest rate of the facility during
fiscal 1999 was 7.1%.
The entire amount of the facility outstanding at June 30, 1999 was repaid
on July 1, 1999 from the proceeds of the O&P sale. Subsequent to such repayment,
the maximum amount available under the facility was reduced to $35,000 and the
financial covenants were removed. The amount available under the facility is
further reduced by outstanding letters of credit, which were $1,087 at June 30,
1999.
NCES has a revolving credit facility with a syndicate of lenders that is
collateralized by a pledge of (i) NCES's subsidiaries' common stock, (ii) the
assets of NCES and its subsidiaries, and (iii) the Company's interest in the
common stock of NCES. The facility carries an interest rate, depending on
certain financial ratios, equal to (i) LIBOR plus a range of 1.375% to 2.5% or
(ii) the lead lending bank's prime rate plus a range of 0.125% to 1.25% (7.75%
at June 30, 1999). As of June 30, 1999, $23,000 was available under the
facility. The weighted average interest rate of the facility during fiscal 1999
was 7.7%.
The Company has issued $175,000 of convertible subordinated debentures due
January 15, 2000 priced at par to yield 5.5%. The debentures are convertible, at
the option of the holder, into shares of the Company's common stock at a
conversion price of $26.65 per share. The debentures are redeemable, in whole or
in part, at the option of the Company. There is no sinking fund applicable to
the debentures.
The fair value of the convertible subordinated debentures, based on quoted
market prices at June 30, 1999 and 1998, was $161,219 and $166,700,
respectively. The estimated fair value of all other debt and financing
arrangements approximates carrying value.
<PAGE> 51
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
JUNE 30, 1999
(IN THOUSANDS, EXCEPT PER SHARE DATA)
At June 30, 1999, aggregate annual maturities of financing arrangements were
as follows for the next five fiscal years and thereafter:
<TABLE>
<CAPTION>
FISCAL YEAR
- -----------
<S> <C>
2000 ........... $551,320
2001 ........... 23,422
2002 ........... 17,863
2003 ........... 8,585
2004 ........... 1,746
Thereafter ..... 2,621
--------
$605,557
========
</TABLE>
Interest paid on debt during fiscal 1999, 1998 and 1997 amounted to $36,692,
$21,676 and $18,120, respectively.
12. OPERATING LEASES
The Company rents office space and equipment under non-cancelable operating
leases. In an effort to leverage its purchasing power with lessors, the Company
has leased, and concurrently subleased, office space to companies that are
controlled by the Company's Chairman. The Company is fully reimbursed for its
lease costs for this office space under non-cancelable sublease agreements.
Total rent expense charged to operations was $47,882, $37,850 and $27,141 in
fiscal 1999, 1998 and 1997, respectively.
Future minimum lease payments for all non-cancelable leases as of June
30, 1999 are as follows:
<TABLE>
<CAPTION>
FISCAL YEAR OPERATING LEASES SUBLEASES
- ----------- ---------------- ---------
<S> <C> <C>
2000 ............... $ 39,026 $ 395
2001 ............... 30,381 253
2002 ............... 23,723 127
2003 ............... 15,274 44
2004 ............... 6,649 --
Thereafter ......... 7,408 --
-------- --------
Total .............. $122,461 $ 819
======== ========
</TABLE>
13. INCOME TAXES
The components of income tax expense were as follows:
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
----------------------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Current:
Federal ..... $(18,632) $ (9,653) $(10,075)
State ....... 6,573 2,752 799
-------- -------- --------
(12,059) (6,901) (9,276)
-------- -------- --------
Deferred:
Federal ..... (7,610) 15,280 3,016
State ....... (3,460) 4,354 858
-------- -------- --------
(11,070) 19,634 3,874
-------- -------- --------
$(23,129) $ 12,733 $ (5,402)
======== ======== ========
</TABLE>
<PAGE> 52
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
JUNE 30, 1999
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The components of net deferred tax assets (liabilities) as of June 30, 1999
and 1998 were as follows:
<TABLE>
<CAPTION>
AS OF JUNE 30,
------------------------
1999 1998
-------- --------
<S> <C> <C>
Accruals and reserves not currently deductible
for tax purposes ...................................... $ 3,521 $ 4,321
Restructure reserves .................................... 13,584 285
Net operating loss and tax credit carryforwards ......... 49,020 --
Other ................................................... -- 68
-------- --------
Gross deferred tax assets ............................... 66,125 4,674
Valuation allowance ..................................... (27,034) --
-------- --------
Net deferred tax assets ............................. 39,091 4,674
-------- --------
Expenses capitalized for financial statement purposes ... (18,249) (13,104)
Depreciation and capital leases ......................... (239) (238)
Gain from issuance of subsidiary stock .................. (14,109) (15,600)
Other, net .............................................. (6,494) (229)
-------- --------
Gross deferred tax liabilities ........................ (39,091) (29,171)
-------- --------
Net deferred tax asset (liability) .................... $ -- $(24,497)
======== ========
</TABLE>
The Company has recorded a valuation allowance to reflect the estimated
amount of deferred tax assets which relate to Federal and state net operating
loss carry forwards, in excess of amounts carried back to prior years, and tax
credit carryforwards that may not be realized. The change in the valuation
allowance for the fiscal year ended June 30, 1999, is as follows:
<TABLE>
<S> <C>
Balance at beginning of year ......................................... $ --
Increase related to deferred tax assets for net operating loss and
tax credits which may not be realized .............................. (27,034)
--------
Balance at end of year ............................................... $(27,034)
========
</TABLE>
The Company has available net operating loss carryforwards of approximately
$82,857 for tax purposes to offset future taxable income. The net operating loss
carryforwards expire principally in 2018. The Company has $1,500 of alternative
minimum tax credits that have no expiration and $2,520 of low income housing
credits which expire in 2018.
<PAGE> 53
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
JUNE 30, 1999
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The reconciliation of the expected tax (benefit) expense (computed by
applying the federal statutory tax rate to income before income taxes) to actual
tax (benefit) expense was as follows:
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
----------------------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Expected federal income tax
expense (benefit) ................. $(36,738) $ 3,332 $ (8,331)
State income taxes,
less federal benefit .............. 2,023 4,618 1,077
Dividend exclusion and
non-taxable interest income ....... -- -- 59
Non-deductible nonrecurring items .. 259 383 235
Non-deductible amortization of
excess cost of net assets
acquired .......................... 8,914 3,751 2,325
Federal valuation allowance ........ 1,500 -- --
Other, net ......................... 913 649 (767)
-------- -------- --------
$(23,129) $ 12,733 $ (5,402)
======== ======== ========
</TABLE>
Income taxes paid during fiscal 1999, 1998 and 1997 amounted to $8,325,
$15,359 and $21,981, respectively.
14. MINORITY INTEREST
Minority interest resulted from investments in the following entities:
<TABLE>
<CAPTION>
AS OF JUNE 30,
---------------------
1999 1998
------- -------
<S> <C> <C>
NovaCare Employee Services, Inc ... $28,173 $17,863
All other entities ................ 252 443
------- -------
$28,425 $18,306
======= =======
</TABLE>
During fiscal 1999 and 1998, NCES issued equity instruments on its own
behalf. The Company recognizes a minority interest liability for NCES equity
issued to third-party investors plus the portion of NCES net income attributable
to those investors.
15. BENEFIT PLANS
Stock Option Plans:
The Company's stock option plans, as amended, provide for issuance of options to
purchase up to 8,600 shares of common stock to employees, officers and
directors. Under the plans, substantially all options are granted for a term of
up to 10 years at prices equal to the fair market value at the date of grant and
vest ratably over five years.
<PAGE> 54
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
JUNE 30, 1999
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The following summarizes the activity of the stock option plans:
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
-----------------------------------------------------
1999 1998 1997
---------------- ---------------- ---------------
<S> <C> <C> <C>
Options:
Outstanding at beginning of year........ 2,783 2,900 3,188
Granted................................. 4,260 1,020 551
Exercised............................... (17) (881) (364)
Canceled................................ (2,596) (256) (475)
---------------- ---------------- ---------------
Outstanding at end of year.............. 4,430 2,783 2,900
================ ================ ===============
Option price per share ranges:
Outstanding at beginning of year........ $ .12 -- $20.58 $ .09 -- $20.58 $ .09 -- $20.58
Granted................................. 1.25 -- 11.50 12.94 -- 13.56 7.38 -- 13.38
Exercised............................... .12 -- 7.19 .09 -- 14.25 .09 -- 10.63
Canceled................................ .12 -- 20.58 .09 -- 16.50 2.00 -- 16.50
Outstanding at end of year.............. $ .12 -- $20.58 $ .12 -- $20.58 $ .09 -- $20.58
Options exercisable at end of year........ 1,007 1,074 1,464
Exercisable option price ranges........... $ .12 -- $20.58 $ .12 -- $20.58 $ .09 -- $20.58
Options available for grant at end of
year under stock option plans........... 419 267 1,034
</TABLE>
Other Stock Awards:
During 1997, the President of the Company was granted 850 options to purchase
the Company's common stock at an exercise price equal to the fair market value
on the grant date.
The following summarizes the other stock award activity:
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
-------------------------------------------------------
1999 1998 1997
---------------- ---------------- ----------------
<S> <C> <C> <C>
Options:
Outstanding at beginning of year.... 4,100 4,404 3,554
Granted............................. 150 -- 850
Exercised........................... -- (304) --
Canceled............................ -- -- --
---------------- ---------------- ----------------
Outstanding at end of year.......... 4,250 4,100 4,404
================ ================ ================
Option price per share:
Outstanding at beginning of year.... $ 4.88 -- $10.88 $ 2.25 -- $10.88 $ 2.25 -- $ 6.88
Granted............................. 11.50 -- 10.88
Exercised........................... -- 2.25 -- 6.88 --
Canceled............................ -- -- --
Outstanding at end of year.......... $ 4.88 -- $11.50 $ 2.25 -- $10.88 $ 2.25 -- $10.88
Options exercisable at end of year.... 2,950 2,800 2,254
Exercisable option price ranges....... $ 4.88 -- $10.88 $ 4.88 -- $10.88 $ 2.25 -- $10.88
</TABLE>
<PAGE> 55
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
JUNE 30, 1999
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The Company has adopted the disclosure-only provisions of SFAS 123,
"Accounting for Stock-Based Compensation" and applies Accounting Principles
Board Opinion No. 25 and related interpretations in accounting for the plans.
The table below sets forth the pro forma information as if the Company had
adopted the compensation recognition provisions of SFAS 123:
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
----------------------------
1999 1998 1997
------ ------ ------
<S> <C> <C> <C>
Increase/decrease to:
Net loss/net income ..................... $1,654 $2,794 $5,268
Net loss/net income per share-basic ..... .03 .05 .09
Net loss/net income per share-assuming
dilution .............................. $ .03 $ .05 $ .09
Assumptions:
Expected life (years) ................... 4.0 4.0 4.0
Risk-free interest rate ................. 4.63% 5.92% 6.53%
Volatility .............................. 66.00% 37.00% 44.00%
Dividend yield .......................... N/A N/A N/A
</TABLE>
The weighted average fair value of the stock options, calculated using the
Black-Scholes option pricing model, granted during the fiscal years ended June
30, 1999, 1998 and 1997 is $1.66, $4.93 and $4.54, respectively. The remaining
contractual life of all options granted as of June 30, 1999 is 6.73 years.
Retirement Plans:
The Company has defined contribution 401(k) plans covering substantially all
of its employees. Company contributions for fiscal 1999, 1998 and 1997 were
$5,193, $4,508 and $3,916, respectively. The Company established a
non-qualified supplemental benefit plan covering certain key employees. The
Company's matching contributions were $845, $859 and $224 for fiscal 1999, 1998
and 1997, respectively.
16. OPERATING SEGMENTS
The accounting policies of the Company's operating segments are the same as
those described in Note 1, Nature of Operations. Intrasegment revenue relates to
the provision of services by the employee services segment to the outpatient and
discontinued long-term care segments. The Company evaluates the performance of
its segments and allocates resources to them based on income from operations and
earnings before interest, income taxes, depreciation and amortization and
provision for restructure ("EBITDA"). EBITDA is not a measure of performance
under Generally Accepted Accounting Principles ("GAAP"). While EBITDA should not
be considered in isolation or as a substitute for net income, cash flows from
operating activities and other income or cash flow statement data prepared in
accordance with GAAP, or as a measure of profitability or liquidity, management
understands that EBITDA is customarily used as a criterion in evaluating health
care companies. The Company does not allocate investment income, interest
expense, gain on sale of subsidiary stock or minority interest for management
reporting purposes. Unallocated assets consist principally of cash and cash
equivalents, deferred income taxes, property and equipment and other assets.
<PAGE> 56
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
JUNE 30, 1999
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Operating results and other financial data are presented for the principal
operating segments of the Company as follows:
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
-------------------------------------------------
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
NET REVENUES:
Outpatient services ............................. $ 618,782 $ 535,282 $ 378,021
Employee services ............................... 1,544,622 1,271,757 394,193
----------- ----------- -----------
Total ................................... 2,163,404 1,807,039 772,214
Intrasegment elimination -- employee services ... (685,487) (769,468) (255,289)
----------- ----------- -----------
Consolidated net revenues .................... $ 1,477,917 $ 1,037,571 $ 516,925
=========== =========== ===========
GROSS PROFIT:
Outpatient services ............................. $ 182,753 $ 163,750 $ 111,465
Employee services ............................... 64,001 41,547 12,238
Intrasegment elimination -- employee services ... (26,641) (16,646) (5,712)
----------- ----------- -----------
Total ................................... 220,113 188,651 117,991
Depreciation .................................... (9,687) (8,498) (6,422)
----------- ----------- -----------
Consolidated gross profit .................... $ 210,426 $ 180,153 $ 111,569
=========== =========== ===========
(LOSS) INCOME FROM OPERATIONS:
Outpatient services ............................. $ 47,113 $ 68,000 $ 47,551
Employee services ............................... 17,951 10,898 2,931
----------- ----------- -----------
Total ................................... 65,064 78,898 50,482
Unallocated selling, general and
administrative expenses ...................... (82,763) (78,999) (60,568)
Provision for restructure ....................... (43,395) -- --
----------- ----------- -----------
Consolidated (loss) from operations .......... $ (61,094) $ (101) $ (10,086)
=========== =========== ===========
DEPRECIATION AND AMORTIZATION:
Outpatient services ............................. $ 32,269 $ 25,976 $ 18,018
Employee services ............................... 5,252 3,828 1,286
----------- ----------- -----------
Total ................................... 37,521 29,804 19,304
Unallocated selling, general and
administrative expenses ...................... 7,403 9,995 8,986
----------- ----------- -----------
Consolidated depreciation and amortization ... $ 44,924 $ 39,799 $ 28,290
=========== =========== ===========
EBITDA:
Outpatient services ............................. $ 79,382 $ 93,976 $ 65,569
Employee services ............................... 23,203 14,726 4,217
----------- ----------- -----------
Total ................................... 102,585 108,702 69,786
Unallocated selling, general and
administrative expenses ...................... (75,360) (69,004) (51,582)
----------- ----------- -----------
Consolidated EBITDA .......................... $ 27,225 $ 39,698 $ 18,204
=========== =========== ===========
CAPITAL EXPENDITURES:
Outpatient services ............................. $ 19,117 $ 15,110 $ 14,445
Employee services ............................... 3,070 2,784 359
----------- ----------- -----------
Total capital expenditures ................... $ 22,187 $ 17,894 $ 14,804
=========== =========== ===========
ASSETS:
Outpatient services ............................. $ 945,648 $ 913,880 $ 639,461
Employee services ............................... 130,896 112,584 69,719
Unallocated assets .............................. 83,933 53,355 46,918
Net assets of discontinued operations ........... 44,388 216,886 221,822
----------- ----------- -----------
Total assets ............................ $ 1,204,865 $ 1,296,705 $ 977,920
=========== =========== ===========
</TABLE>
<PAGE> 57
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
JUNE 30, 1999
(IN THOUSANDS, EXCEPT PER SHARE DATA)
17. COMMITMENTS AND 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 effect on the financial position or results of operations of
the Company.
The Company's PEO's operations are subject to numerous Federal, state and
local laws related to employment, taxes and benefit plan matters. Generally,
these regulations affect all companies in the United States. However, the
regulatory environment for PEOs is an evolving area due to uncertainties
resulting from the non-traditional employment relationship created by PEOs. Many
Federal and state laws relating to tax and employment matters were enacted prior
to the development of PEO companies and do not specifically address the
obligations and responsibilities of these co-employer relationships. The
Internal Revenue Service ("IRS") has conducted a market segment study of the PEO
industry (the "Market Segment Study") focusing on selected PEOs (not including
the Company) for the purpose of examining the relationship among PEOs, their
clients, worksite employees, and the worksite owners. IRS officials indicate
that the Market Segment Study is near completion and suggest that an
announcement of the IRS' position with respect to PEOs has been delayed pending
the outcome of legislation that has been proposed by the PEO industry. If the
IRS concludes that PEOs are not "employers" of certain worksite employees for
purposes of the Internal Revenue Code, the Company's benefit plans (including
cafeteria, health and welfare, and retirement plans) may lose their favorable
tax status, and the Company may no longer be able to assume its clients' Federal
employment tax withholding obligations. The Company believes that, although
unfavorable to the Company, a prospective application by the IRS of an adverse
conclusion would not have a material adverse effect on the Company's business,
financial position, results of operations and liquidity. While the Company
believes that a retrospective disqualification is unlikely, there can be no
assurance as to the ultimate resolution of these issues.
18. SHAREHOLDER RIGHTS PLAN
Under the terms of a Shareholder Rights Plan adopted in 1995, the Company's
Board of Directors declared a dividend distribution of one right for each
outstanding common share. The rights may not be exercised or traded apart from
the common shares to which they are attached until 10 days after a person or
group has acquired, obtained the right to acquire, or commenced a tender offer
for, at least 20% of the Company's outstanding common shares. In such event,
each right will become exercisable for one common share for a price of $27. If a
person or group acquires, or obtains the right to acquire, 20% or more of the
Company's outstanding common shares, each right will become exercisable for
common shares worth $54 and the rights held by the acquiror will become null and
void. If the Company is involved in a merger and its common shares are changed
or exchanged, or if more than 50% of its assets or earnings power is sold or
transferred, each right will become exercisable for common stock of the acquiror
worth $54. The rights will expire on March 20, 2000 unless earlier redeemed by
the Company for $.001 per right. Subject to its right to extend the redemption
period, the Company may redeem the rights at any time until any person or group
has acquired, or obtained the right to acquire, at least 20% of the Company's
outstanding common shares.
19. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
<TABLE>
<CAPTION>
FOURTH THIRD SECOND FIRST
QUARTER QUARTER QUARTER QUARTER
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
YEAR ENDED JUNE 30,1999:
Net revenues...................................... $ 396,504 $ 373,503 $ 366,249 $ 341,661
Gross profit...................................... 55,052 49,980 52,677 52,717
(Loss) income from continuing operations.......... (29,434) (10,633) (36,414) (5,355)
(Loss) income from discontinued operations,
net of tax...................................... (4,471) (101,409) 17,916 11,028
(Loss) on sale of discontinued operations,
net of tax...................................... (30,839) -- -- --
Net (loss) income................................. (64,744) (112,042) (18,498) 5,673
(Loss) per share from continuing
operations - basic and assuming dilution........ $ (0.47) $ (0.17) $ (0.58) $ (0.09)
(Loss) income per share from discontinued
operations, net of tax.......................... $ (0.07) $ (1.61) $ 0.29 $ 0.18
(Loss) per share on the sale of discontinued
operations, net of tax.......................... $ (0.49) $ -- $ -- $ --
Net (loss) income per share - basic
and assuming dilution........................... $ (1.03) $ (1.78) $ (0.29) $ 0.09
YEAR ENDED JUNE 30,1998:
Net revenues....................................... $ 310,740 $ 281,147 $ 239,494 $ 206,190
Gross profit....................................... 55,499 44,114 41,719 38,821
(Loss) income from continuing operations........... (2,848) (9,550) 12,835 (3,651)
Income from discontinued operations, net of tax.... 17,322 22,195 7,737 13,875
Net (loss) income.................................. 14,474 12,645 20,572 10,224
(Loss) income per share from continuing
operations -- basic and assuming dilution........ $ (0.05) $ (0.16) $ 0.21 $ (0.06)
(Loss) income per share from discontinued
operations, net of tax........................... $ 0.28 $ 0.37 $ 0.12 $ 0.23
Net income per share -- basic and
assuming dilution................................ $ 0.23 $ 0.21 $ 0.33 $ 0.17
</TABLE>
Results for all interim periods presented have been restated to reclassify
the Company's long-term care services segment to discontinued operations.
<PAGE> 58
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
JUNE 30, 1999
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Results for the fourth quarter of fiscal 1999 include a $12,260 pretax
provision for restructure related primarily to the consolidation and
reorganization of the Company's corporate support services activities, a $15,340
pretax provision for bad debts related to certain receivables determined by
management to be uncollectible and a $30,839 after-tax loss on sale of
discontinued operations. Results for the third quarter of fiscal 1999 include an
$111,947 pretax provision for restructure within discontinued operations related
to the exit of certain long-term care markets. Results for the second quarter of
fiscal 1999 include a $31,100 pretax provision for restructure related to the
exit of certain PROH markets and a $13,300 reversal of a portion of a previously
established restructure charge within discontinued operations related to the
conversion to the Company's revised long-term care operating model. Results for
the second quarter of fiscal 1998 include a $23,500 pretax provision for
restructure within discontinued operations related to the conversion to the
Company's revised long-term care operating model.
<PAGE> 59
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of NovaCare, Inc.
In our opinion, the consolidated financial statements listed in the index
appearing under Item 14(a)(1) on page 69 present fairly, in all material
respects, the financial position of NovaCare, Inc. and its subsidiaries at June
30, 1999 and 1998, and the results of their operations and their cash flows for
each of the three years in the period ended June 30, 1999, in conformity with
generally accepted accounting principles. In addition, in our opinion, the
financial statement schedule listed in the index appearing under item 14(a)(2)
presents fairly, in all material respects, the information set forth therein
when read in conjunction with the related consolidated financial statements.
These financial statements and financial statement schedule are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in Note
2, "Financial Restructuring Plan", to the financial statements, the Company has
$175 million of convertible subordinated debentures due on January 15, 2000. To
enable the Company to generate sufficient funds to make the required payment on
the convertible debentures, the Board of Directors on August 5, 1999 voted to
seek approval from the shareholders for the sale of the Company's two remaining
business units (the outpatient physical rehabilitation and occupational health
rehabilitation services business, and the Company's interest in NovaCare
Employee Services, Inc.) and the adoption of a restructuring proposal. In a
proxy statement dated August 13, 1999 (as amended through September 10, 1999)
the Company's shareholders have been asked to consider and vote upon these
proposals at a special meeting of the shareholders to be held on September 21,
1999. Adoption of these proposals could result in the ultimate liquidation of
the Company. Should these matters not be approved, or should the transactions
not be consummated as set forth in the proxy statement, management would need to
seek other means to obtain sufficient funds to repay the convertible debentures
when due. The results of the shareholder vote will determine the alternatives
available to the Company. These matters raise substantial doubt about the
Company's ability to continue as a going concern. Management's plans in regard
to these matters are described in Note 2. The consolidated financial statements
do not include any adjustments that might result from the outcome of these
uncertainties.
PRICEWATERHOUSECOOPERS LLP
Philadelphia, PA
August 30, 1999 except for the third
and fourth paragraphs of Note 2 as to
which the date is September 10, 1999.
<PAGE> 60
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
The Registrant has had no changes in or disagreements with accountants on
accounting and financial disclosure of the type referred to in Item 304 of
Regulation S-K.
<PAGE> 61
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The directors and executive officers of NovaCare are as follows:
<TABLE>
<CAPTION>
NAME POSITION AGE
---- -------- ---
<S> <C> <C>
John H. Foster............................... Chairman of the Board of Directors 57
Timothy E. Foster............................ Chief Executive Officer and Director 47
James W. McLane.............................. President, Chief Operating Officer and Director 60
E. Martin Gibson............................. Director 61
Siri S. Marshall............................. Director 51
Stephen E. O'Neil............................ Director 66
George W. Siguler............................ Director 52
Daniel C. Tosteson........................... Director 74
Robert E. Healy, Jr.......................... Senior Vice President, Finance and Administration
and Chief Financial Officer 46
Steven M. Wise............................... Senior Vice President, Information Systems and
Chief Information Officer 43
Richard S. Binstein.......................... Vice President, General Counsel and Secretary 38
Susan J. Campbell............................ Vice President, Investor Relations 48
Richard A. McDonald.......................... Vice President and Treasurer 52
Barry E. Smith............................... Vice President, Controller and Chief Accounting
Officer 46
James T. Walmsley............................ Vice President, Reimbursement 49
</TABLE>
No family relationships exist among any of the directors or executive
officers of NovaCare. Executive officers serve at the discretion of the NovaCare
Board of Directors.
JOHN H. FOSTER has been Chairman of the Board of NovaCare since December
1984. From 1984 to May 1997, he was also Chief Executive Officer of the Company.
He is a director of NovaCare Employee Services, Inc., ("NCES"), the Company's
64% owned subsidiary. Mr. Foster is also Chairman of the Board and Chief
Executive Officer of Integra, Inc., a national behavioral health services
company, Chairman of the Board of XYAN, Inc., an internet-based digital imaging
company, and a director of Corning Incorporated, an international corporation
with business interests in specialty materials and communications, Mr. Foster is
founder and Chairman of the Board of Foster Management Company, an investment
advisor.
TIMOTHY E. FOSTER has been Chief Executive Officer of the Company since May
1997. From October 1994 until May 1997, he was President and Chief Operating
Officer. He served as Senior Vice President, Finance and Administration and
Chief Financial Officer of NovaCare from November 1988 to October 1994,
Treasurer from March 1992 to October 1994, Secretary of the Company from
September 1987 to May 1994 and has been a director since December 1984. Mr.
Foster currently serves as a director of Integra, Inc., a national behavioral
health services company, a position he has held since February 1995, as well as
a director of NCES. Since 1996, Mr. Foster has been a partner in certain
investment partnerships managed by Foster Management Company.
JAMES W. McLANE has been President and Chief Operating Officer and a
director of the Company since May 1997. From 1991 to 1997, Mr. McLane served as
Chief Executive Officer of Aetna Health Plans and as Executive Vice President of
Aetna Life and Casualty.
E. MARTIN GIBSON has been a director of the Company since March 1992. Mr.
Gibson, who is retired, served as Chairman and Chief Executive Officer of
Corning Lab Services, Inc., a subsidiary of Corning Incorporated, from 1990
until December 1994. He currently serves as a director of IT Group, Inc., an
environmental management company, Hardinge Brothers, Inc., a manufacturer of
machine tools, and Sensus Corp., a private biotechnology company, and as the
Chairman of the Board of NCES.
<PAGE> 62
SIRI S. MARSHALL has been a director of the Company since May 1994. Ms.
Marshall is Senior Vice President, Corporate Affairs and General Counsel of
General Mills, Inc., a food manufacturing company. She joined General Mills in
1994 from Avon Products, Inc. where she was Senior Vice President, General
Counsel and Secretary. She is a Director of Jafra Cosmetics International and
The American Arbitration Association, and a Trustee of the Minneapolis Institute
of Arts.
STEPHEN E. O'NEIL has been a director of the Company since December 1984.
Mr. O'Neil has been a Principal of The O'Neil Group, a private investment firm,
since 1981. He is a director of Brown-Forman Corporation, Castle Convertible
Fund, Inc., Spectra Fund, Inc., Alger Fund, Inc., Alger American Fund and NCES.
GEORGE W. SIGULER has been a director of the Company since September 1986.
Since January 1996, he has been a managing director of Siguler Guff & Company,
LLC, an investment management firm. From September 1991 to January 1996, Mr.
Siguler was a managing director of Mitchell Hutchins Institutional Investors
Inc. Mr. Siguler is a director of Business Mortgage Investors, Inc. and
Commonfund Capital, Inc.
DANIEL C. TOSTESON, M.D., has been a director of the Company since April
1991. He is Dean Emeritus of the Faculty of Medicine and Caroline Shields Walker
Distinguished Professor of Cell Biology, Harvard University. From 1977 to 1997,
Dr. Tosteson was Dean of the Faculty of Medicine and Caroline Shields Walker
Professor of Cell Biology, Harvard University and President of Harvard Medical
Center. Dr. Tosteson has been President of the American Academy of Arts and
Sciences since 1997 and was a Member of the Board of Trustees of Duke University
from 1987 until 1995.
ROBERT E. HEALY, JR. has been Senior Vice President, Finance and
Administration and Chief Financial Officer since December 1995. From January
1994 to December 1995, he was Vice President, Finance and Chief Financial
Officer of NovaCare's Long-term Care Services segment. He served as Vice
President, Finance and Chief Accounting Officer of the Company from March 1992
to January 1994.
STEVEN M. WISE has been Senior Vice President, Information Systems and Chief
Information Officer since January 1998. He was Vice President, Information
Systems and Chief Information Officer from December 1995 to January 1998. He
joined NovaCare in 1993 as Director, Systems and Programming, for the Contract
Rehabilitation Division.
RICHARD S. BINSTEIN has been Vice President, General Counsel and Secretary
since January 1999. From February 1998 through January 1999, he was Vice
President, Acting General Counsel and Secretary. He joined NovaCare in January
1997 as Assistant General Counsel. Prior to joining the Company, he was a
practicing attorney with the law firm of Proskauer Rose.
SUSAN J. CAMPBELL has been Vice President, Investor Relations of NovaCare
since April 1992. She joined NovaCare in March 1993 as Director of Investor
Relations and also served as Vice President, Communications from April 1995 to
March 1998.
RICHARD A. McDONALD has been Vice President and Treasurer since August 1996
and was Director, Treasury Services from May 1995 until August 1996. Prior to
joining the Company, he was a financial consultant to Continental Medical
Systems, Inc. He served as an assistant treasurer with American Healthcare
Management from 1990 until 1994.
BARRY E. SMITH has been Vice President, Controller and Chief Accounting
Officer of the Company since December 1995 and was Vice President of Finance of
the Long-term Care Services segment from March 1995 to October 1997. He was Vice
President of Finance of the Medical Rehabilitation Hospital Division from
February 1994 through the sale date of the division in April 1995.
JAMES T. WALMSLEY has been Vice President, Reimbursement of NovaCare since
January 1994 and was Director of Reimbursement from April 1992 to January 1994.
<PAGE> 63
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth information for the fiscal years ended June
30, 1999, 1998 and 1997 concerning the compensation paid or awarded to the Chief
Executive Officer and each of the four other most highly compensated executive
officers of the Company.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM
ANNUAL COMPENSATION COMPENSATION ALL OTHER
NAME AND -------------------------------------- AWARDS COMPENSATION
PRINCIPAL POSITION YEAR SALARY ($) BONUS ($) OTHER ($) (1) OPTIONS (#) (2)
------------------ ---- ---------- --------- ------------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
John H. Foster (3) 1999 $300,000 $ - $ 45,135 200,000 $ 94,933
Chairman of the Board 1998 580,266 487,670 128,374 - 100,584
1997 553,899 - 66,627 - 36,303
Timothy E. Foster (4) 1999 500,000 875,000 13,600 400,000 66,526
Chief Executive Officer 1998 500,000 243,835 7,395 - 71,381
1997 495,482 194,550 - 31,091
James W. McLane (5) 1999 465,000 815,000 595 550,000 42,402
President and Chief Operating 1998 457,500 195,068 - - 27,213
Officer 1997 70,274 - 850,000 -
Robert E. Healy, Jr. (6) 1999 302,093 570,000 - 320,000 139,916
Senior Vice President and 1998 274,151 180,000 - - 39,726
Chief Financial Officer 1997 212,500 125,373 - - 15,535
Richard S. Binstein (7) 1999 157,500 365,000 - 49,500 48,921
Vice President, General Counsel 1998 120,000 34,905 - - 3,287
and Secretary 1997 55,000 4,611 - - 918
</TABLE>
(1) This amount represents the Company's incremental cost of personal use of
Company aircraft, after deducting payments received by the Company for such
use.
(2) Other than the loan forgiveness of $25,000 in 1999 for Richard Binstein and
payments to Mr. Binstein and Robert E. Healy, Jr. of $12,500 and $96,509,
respectively, for the cancellation of certain outstanding stock options in
1999, these amounts represent contributions to the Company's 401(k) plan and
its supplemental deferred compensation plan and term life and long-term
disability insurance payments.
(3) John H. Foster served as Chairman of the Board and Chief Executive Officer
of the Company until May 1997, when he relinquished the position of Chief
Executive Officer.
(4) Timothy E. Foster became Chief Executive Officer of the Company in May 1997.
From October 1994 to May 1997, he was President and Chief Operating Officer
of the Company. Prior to such time he served as Senior Vice President -
Finance and Administration, Chief Financial Officer and Treasurer of the
Company.
(5) James W. McLane became President and Chief Operating Officer in May 1997.
(6) Robert E. Healy, Jr. became Senior Vice President, Finance and
Administration and Chief Financial Officer in December 1995. Prior to such
time he served as Vice President, Finance and Chief Financial Officer of the
Company's Long-term Care Services segment.
(7) Richard S. Binstein became Vice President, General Counsel and Secretary in
January 1999. Mr. Binstein joined the Company in January 1997 as Assistant
General Counsel.
<PAGE> 64
The following table sets forth the number and value of options exercised by
the executive officers of the Company named in the Summary Compensation Table
during the fiscal year ended June 30, 1999 and the number and value of options
held by such executive officers at June 30, 1999.
AGGREGATED OPTION EXERCISES IN FISCAL YEAR 1999
AND FISCAL YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF
SECURITIES VALUE OF
UNDERLYING UNEXERCISED
UNEXERCISED IN-THE-MONEY
OPTIONS AT OPTIONS
JUNE 30, 1999(#) AT JUNE 30, 1999($)(1)
--------------------- ----------------------
NAME SHARES ACQUIRED VALUE EXERCISABLE/ EXERCISABLE/
---- UPON EXERCISE REALIZED UNEXERCISABLE UNEXERCISABLE
--------------- -------- --------------------- ----------------------
<S> <C> <C> <C> <C>
John H. Foster - - 1,650,001 / 599,999 -
Timothy E. Foster - - 900,001 / 699,999 -
James W. McLane - - 400,000 / 1,000,000 -
Robert E. Healy, Jr. - - 61,237 / 245,931 -
Richard S. Binstein - - 0 / 49,500 -
</TABLE>
(1) In-the-money options are those for which the fair market value of the
underlying Common Stock exceeds the exercise price of the option. The
value of in-the-money options is determined in accordance with
regulations of the Securities and Exchange Commission by subtracting the
aggregate exercise price of the option from the aggregate year-end value
of the underlying Common Stock.
EMPLOYMENT AGREEMENTS
In July 1994, the Company entered into an employment agreement with John H.
Foster, Chairman of the Board of the Company. The agreement was amended on
February 2, 1995, July 1, 1998, September 1, 1998 and May 30, 1999. The term of
the agreement expires on June 30, 2000 and the agreement provides for automatic
one-year extensions commencing one year prior to termination in June 2000 and
continuing on each subsequent anniversary until either party shall give the
other notice of non-extension. The agreement provides for Mr. Foster to receive
an annual base salary, currently $300,000, subject to increases in accordance
with the policies of the Company, and to be eligible for an annual cash bonus
opportunity equal to 100% of base salary. In the event of Mr. Foster's death,
disability or voluntary termination, he shall be entitled to pro-rated bonus
compensation for the fiscal year during which such event occurs. The agreement
also provides that if Mr. Foster is terminated by the Company without cause, or
if Mr. Foster resigns subsequent to a change in control of the Company, a
material diminution of his position, authority or compensation or his removal by
the Company as Chairman of the Board, then Mr. Foster shall be entitled to (i)
severance pay in the form of salary continuation at a rate equal to the greater
of his then annual salary or $580,000 and certain other benefits for a period of
two years from the date of such event, and (ii) bonus compensation in an amount
equal to (a) the greater of 100% of his then annual salary or $580,000, prorated
for the year in which such termination occurs, plus (b) a final bonus equal to
the greater of $870,000 or 150% of his then annual base salary. The agreement
also provides that if Mr. Foster resigns subsequent to a change in control of
the Company, amounts otherwise payable to Mr. Foster under his agreement shall
be reduced by amounts paid to him as salary for the period from and after July
1, 1999 and shall be further reduced to the extent, if any, necessary so that no
payment is treated as an "excess parachute payment" under the Internal Revenue
Code of 1986, as amended. The agreement also provides that Mr. Foster shall be
entitled to the advance of certain expenses in connection with legal proceedings
arising in connection with his service as an officer or director of the Company
and certain other benefits.
<PAGE> 65
In May 1999, the Company entered into employment agreements, described
below, with Timothy E. Foster, a director and the Chief Executive Officer of the
Company, James W. McLane, a director and the President and Chief Operating
Officer of the Company, Robert E. Healy, Jr., a Senior Vice President and the
Chief Financial Officer of the Company, and Richard S. Binstein, Vice President,
General Counsel and Secretary of the Company (collectively, the "May 1999
Employment Agreements"), superseding prior employment agreements between each
such executive and the Company. Pursuant to certain "change of control" and
constructive termination provisions in such prior employment agreements, upon
the completion of the Company's sale of the LTC and O&P businesses (and
resulting restructuring and/or reorganization), Messrs. Foster, McLane and Healy
contractually may have had the right to terminate their employment with the
Company and to receive substantial severance payments. In order to induce these
key senior executives to waive their right to trigger such termination
provisions and to satisfy the requirements of the Company's senior lenders, all
of the Company's outside directors, upon the recommendation of the Compensation
Committee of the Board of Directors, unanimously approved the May 1999
Employment Agreements, which contain certain signing, transaction and retention
bonus payments based, in part, on the execution of the transactions outlined in
the Company's Proxy Statement, dated August 13, 1999. The signing, transaction
and retention bonus payments contained in the May 1999 Employment Agreements are
in lieu of severance.
On May 30, 1999, the Company entered into an employment agreement with
Timothy E. Foster, Chief Executive Officer of the Company, superseding Mr.
Foster's then existing employment agreement with the Company. The term of the
agreement continues through July 1, 2001. Upon execution of the agreement, Mr.
Foster received a signing bonus of $875,000, which amount (net of taxes) must be
repaid to the Company by Mr. Foster if he voluntarily terminates his employment
with the Company prior to January 1, 2000. The agreement provides for Mr. Foster
to receive an annual base salary, currently $500,000, subject to increases as
determined by the Compensation Committee of the Board of Directors, and to be
eligible for certain transaction and retention bonuses. The transaction bonuses
set forth in the agreement are as follows: (i) a transaction bonus equal to
$475,000 payable upon the sale or other disposition of the Company's interest in
NCES, and (ii) a transaction bonus equal to $400,000 upon the sale of the
Company's Physical Rehabilitation and Occupational Health ("PROH") business (or
the earlier repayment of the Company's Subordinated Debentures, under certain
circumstances). The retention bonuses set forth in the agreement are as follows:
(i) a retention bonus equal to $500,000 payable on January 2, 2000, provided Mr.
Foster is then employed by the Company and (ii) a retention bonus equal to
$500,000 payable on the earlier of June 30, 2000 or the date the Company
implements a plan of liquidation (provided the PROH sale has been completed). In
addition, if Mr. Foster's employment with the Company continues beyond June 30,
2000, the agreement provides for additional retention bonuses to be paid to Mr.
Foster, in an amount equal to $500,000, on each January 2 and June 30
thereafter, provided that Mr. Foster is then employed by the Company. Under the
agreement, Mr. Foster is not eligible for any additional stock option grants.
The agreement also provides that if Mr. Foster is terminated by the Company
without cause, then Mr. Foster shall be entitled to payment of the
aforementioned transaction bonuses (if then unpaid) and payment of a pro rata
portion of the aforementioned retention bonuses, as well as continuation of his
rights and benefits under the Company's benefit plans and programs for a two
year period following such termination of employment. The agreement also
provides that Mr. Foster shall be entitled to the advance of certain expenses in
connection with legal proceedings arising in connection with his service as an
officer or director of the Company and certain other benefits.
On May 30, 1999, the Company entered into an employment agreement with James
W. McLane, President and Chief Operating Officer of the Company, superseding Mr.
McLane's then existing employment agreement with the Company. The term of the
agreement continues through July 1, 2001. Upon execution of the agreement, Mr.
McLane received a signing bonus of $815,000, which amount (net of taxes) must be
repaid to the Company by Mr. McLane if he voluntarily terminates his employment
with the Company prior to January 1, 2000. The agreement provides for Mr. McLane
to receive an annual base salary, currently $465,000, subject to increases as
determined by the Compensation Committee of the Board of Directors, and to be
eligible for certain transaction and retention bonuses. The transaction bonuses
set forth in the agreement are as follows: (i) a transaction bonus equal to
$362,500 payable upon the sale or other disposition of the Company's interest in
NCES, and (ii) a transaction bonus equal to $450,000 upon the sale of the PROH
business (or the earlier repayment of the Company's Subordinated Debentures,
under certain circumstances). The retention bonuses set forth in the agreement
are as follows: (i) a retention bonus equal to $350,000 payable on January 2,
2000, provided Mr. McLane is then employed by the Company and (ii) a retention
bonus equal to $350,000 payable on the earlier of June 30, 2000 or the date the
Company sells the PROH business. In addition, if Mr. McLane's employment with
the Company continues beyond June 30, 2000, the agreement provides for
additional retention bonuses to be paid to Mr. McLane, in an amount equal to
$350,000, on each January 2 and June 30 thereafter, provided that Mr. McLane is
then employed by the Company. Under the agreement, Mr. McLane is not eligible
for any additional stock option grants. The agreement also provides that if Mr.
McLane is terminated by the Company without cause, then Mr. McLane shall be
entitled to payment of the aforementioned transaction bonuses (if then unpaid)
and payment of a pro rata portion of the aforementioned retention bonuses, as
well as continuation of his rights and
<PAGE> 66
benefits under the Company's benefit plans and programs for a two year period
following such termination of employment. The agreement also provides that Mr.
McLane shall be entitled to the advance of certain expenses in connection with
legal proceedings arising in connection with his service as an officer or
director of the Company and certain other benefits.
On May 30, 1999, the Company entered into an employment agreement with
Robert E. Healy, Jr., Senior Vice President, Finance and Administration and
Chief Financial Officer of the Company, superseding Mr. Healy's then existing
employment agreement with the Company. The term of the agreement continues
through July 1, 2001. Upon execution of the agreement, Mr. Healy received a
signing bonus of $570,000, which amount (net of taxes) must be repaid to the
Company by Mr. Healy if he voluntarily terminates his employment with the
Company prior to January 1, 2000. The agreement provides for Mr. Healy to
receive an annual base salary, currently $325,000, subject to increases as
determined by the Compensation Committee of the Board of Directors, and to be
eligible for certain transaction and retention bonuses. The transaction bonuses
set forth in the agreement are as follows: (i) a transaction bonus equal to
$317,500 payable upon the sale or other disposition of the Company's interest in
NCES, and (ii) a transaction bonus equal to $250,000 upon the sale of the PROH
business (or the earlier repayment of the Company's Subordinated Debentures,
under certain circumstances). The retention bonuses set forth in the agreement
are as follows: (i) a retention bonus equal to $245,000 payable on January 2,
2000, provided Mr. Healy is then employed by the Company and (ii) a retention
bonus equal to $245,000 payable on the earlier of June 30, 2000 or the date the
Company implements a plan of liquidation (provided the PROH sale has been
completed). In addition, if Mr. Healy's employment with the Company continues
beyond June 30, 2000, the agreement provides for additional retention bonuses to
be paid to Mr. Healy, in an amount equal to $245,000, on each January 2 and June
30 thereafter, provided that Mr. Healy is then employed by the Company. Under
the agreement, Mr. Healy is not eligible for any additional stock option grants.
The agreement also provides that if Mr. Healy is terminated by the Company
without cause, then Mr. Healy shall be entitled to payment of the aforementioned
transaction bonuses (if then unpaid) and payment of a pro rata portion of the
aforementioned retention bonuses, as well as continuation of his rights and
benefits under the Company's benefit plans and programs for a two year period
following such termination of employment. The agreement also provides that Mr.
Healy shall be entitled to the advance of certain expenses in connection with
legal proceedings arising in connection with his service as an officer or
director of the Company and certain other benefits.
On May 30, 1999, the Company entered into an employment agreement with
Richard S. Binstein, Vice President, General Counsel and Secretary of the
Company, superceding Mr. Binstein's then existing employment agreement with the
Company. The term of the agreement continues through July 1, 2001. Upon
execution of the agreement, Mr. Binstein received a signing bonus of $335,000,
which amount (net of taxes) must be repaid to the Company by Mr. Binstein if he
voluntarily terminates his employment with the Company prior to January 1, 2000.
The agreement provides for Mr. Binstein to receive an annual base salary,
currently $190,000, subject to increases as determined by the Compensation
Committee of the Board of Directors, and to be eligible for certain transaction
and retention bonuses. The transaction bonuses set forth in the agreement are as
follows: (i) a transaction bonus equal to $180,000 payable upon the sale or
other disposition of the Company's interest in NCES, and (ii) a transaction
bonus equal to $150,000 upon the sale of the Company's PROH business (or the
earlier repayment of the Company's Subordinated Debentures, under certain
circumstances). The retention bonuses set forth in the agreement are as follows:
(i) a retention bonus equal to $145,000 payable on January 2, 2000, provided Mr.
Binstein is then employed by the Company and (ii) a retention bonus equal to
$145,000 payable on the earlier of June 30, 2000 or the date the Company
implements a plan of liquidation (provided the PROH sale has been completed). In
addition, if Mr. Binstein's employment with the Company continues beyond June
30, 2000, the agreement provides for additional retention bonuses to be paid to
Mr. Binstein, in an amount equal to $145,000, on each January 2 and June 30
thereafter, provided that Mr. Binstein is then employed by the Company. Under
the agreement, Mr. Binstein is not eligible for any additional stock option
grants. The agreement also provides that if Mr. Binstein is terminated by the
Company without cause, then Mr. Binstein shall be entitled to payment of the
aforementioned transaction bonuses (if then unpaid) and payment of a pro rata
portion of the aforementioned retention bonuses, as well as continuation of his
rights and benefits under the Company's benefit plans and programs for a two
year period following such termination of employment. The agreement also
provides that Mr. Binstein shall be entitled to the advance of certain expenses
in connection with legal proceedings arising in connection with his service as
an officer or director of the Company and certain other benefits.
COMPENSATION OF DIRECTORS OF NOVACARE
The Company provides each non-employee director with an annual retainer of
$25,000. The Company pays each director a fee of $1,000 per meeting attended,
plus out-of-pocket expenses. In addition, committee members receive a fee of
$1,000, plus out-of-pocket expenses, for each non-telephonic committee meeting
attended that is not scheduled in conjunction with a meeting of the full Board,
and a fee of $500, plus out-of-pocket expenses, for each non-telephonic
committee meeting attended in conjunction with a
<PAGE> 67
meeting of the full Board and for each telephonic meeting of the Board or any
committee of the Board. As part of the compensation paid to non-employee
directors for the fiscal year ended June 30, 1999, the Company granted to each
non-employee director options to purchase 15,000 shares of the Company's Common
Stock.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
E. Martin Gibson, as Chairman, Stephen E. O'Neil and Siri S. Marshall served
on the Compensation Committee of the Board of Directors for the entire 1999
fiscal year. No insider served on the Committee and there were no interlocks.
12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
The following table shows the number of shares and percentage of the
Company's outstanding Common Stock deemed to be beneficially owned as of June
30, 1999, by (i) all persons known to the Company to be the beneficial owners of
more than 5% of its common stock, (ii) each director of the Company and (iii)
the directors and officers of the Company as a group. Unless otherwise
indicated, the beneficial owners have sole voting and investment power with
respect to all shares owned.
<TABLE>
<CAPTION>
Name of Beneficial Owner (a) Amount and Nature of Percentage of
- ---------------------------- Beneficial Ownership Outstanding Shares
--------------------- ------------------
<S> <C> <C>
John H. Foster .................................................... 4,151,214 (b) 5.9%
Timothy E. Foster ................................................. 900,001 (c) 1.3%
E. Martin Gibson .................................................. 50,000 (d) *
Siri S. Marshall .................................................. 39,200 (e) *
James W. McLane ................................................... 437,504 (f) *
Stephen E. O'Neil ................................................. 47,500 (g) *
George W. Siguler ................................................. 51,400 (h) *
Daniel C. Tosteson ................................................ 53,400 (i) *
Directors and Officers as a group (16 persons) .................... 5,893,261 (j) 8.2%
</TABLE>
* Less than one percent
(a) Information as to the interests of the directors and officers has been
furnished in part by them. The inclusion of information concerning
shares held by or for their spouses or children or by corporations in
which they have an interest does not constitute an admission by such
persons of beneficial ownership thereof. Unless otherwise indicated,
all persons have sole voting and dispositive power as to all shares
they are shown as owning.
(b) Includes 1,650,001 shares of the Company's Common Stock presently
issuable upon the exercise of options. Mr. John Foster beneficially
owns 8,000 shares of NCES Common Stock presently issuable upon exercise
of options.
(c) Consists of 900,001 shares of the Company's Common Stock presently
issuable upon the exercise of options. In addition, Mr. Timothy Foster
owns 18,000 shares of NCES Common Stock, 8,000 of such shares presently
issuable upon exercise of options.
<PAGE> 68
(d) Includes 47,400 shares of the Company's Common Stock presently issuable
upon the exercise of options. In addition, Mr. Gibson owns 41,667
shares of NCES Common Stock, 26,667 of such shares presently issuable
upon exercise of options.
(e) Includes 37,200 shares of the Company's Common Stock presently issuable
upon the exercise of options. In addition, Ms. Marshall owns 6,667
shares of NCES Common Stock presently issuable upon exercise of
options.
(f) Includes 430,000 shares of the Company's Common Stock presently
issuable upon the exercise of options, and 7,504 shares of the
Company's Common Stock issuable upon the conversion of the Debentures.
In addition, Mr. McLane owns 12,000 shares of NCES Common Stock, 2,000
of such shares presently issuable upon exercise of options.
(g) Includes 47,400 shares of the Company's Common Stock presently issuable
upon the exercise of options. In addition, Mr. O'Neil owns 13,334
shares of NCES Common Stock presently issuable upon exercise of
options.
(h) Includes of 47,400 shares of the Company's Common Stock presently
issuable upon the exercise of options. In addition, Mr. Siguler owns
6,667 shares of NCES Common Stock presently issuable upon exercise of
options.
(i) Consists of 53,400 shares of the Company's Common Stock presently
issuable upon the exercise of options. In addition, Mr. Tosteson owns
6,667 shares of NCES Common Stock presently issuable upon exercise of
options.
(j) Includes 3,359,993 shares of the Company's Common Stock presently
issuable upon exercise of options. In addition, officers and directors
own 130,552 shares of NCES Common Stock, 93,002 of such shares
presently issuable upon exercise of options.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Since January 1993, the Company has subleased office space to certain
companies controlled by John H. Foster, Chairman of the Board of the Company, in
his capacity as chairman of the board, chief executive officer or general
partner of the principal stockholders of such companies. The Company paid base
rent at an annual rate of $14.00 per square foot through December 1997 and
$17.50 per square foot from January 1998 through December 2003. The companies
controlled by Mr. Foster will pay base rent at a rate equal to the Company's
cost, including reimbursement for leasehold improvements made by the Company,
through December 2003 for their respective areas under sublease as follows:
Foster Management Company, 5,728 square feet; and Integra, Inc., 6,760 square
feet.
Timothy E. Foster, Chief Executive Officer and a director of the Company,
serves as a director of Integra, Inc, a company controlled by John H. Foster.
In the ordinary course of business, the Company purchases printing and
copying related services from XYAN, Inc., a national internet-based digital
imaging company controlled by John H. Foster, Chairman of the Board of the
Company, in his capacity as chairman of the board of, and general partner of
various venture capital investment funds that own interests in, that company.
The negotiated rates paid by the Company to XYAN, Inc. for these services were
determined at arms-length. During the fiscal years ended June 30, 1998 and 1999,
the Company paid XYAN, Inc. approximately $1,850,000 and $1,150,000,
respectively, for services provided. In addition, as of September 1999, the
Company had a prepaid balance of $510,000, representing a prepayment for
services made by the Company to XYAN, Inc. in exchange for preferential national
pricing. The Company is currently applying all charges for services provided by
XYAN, Inc. against the prepaid balance and expects to fully realize the prepaid
balance in the fiscal year ending June 30, 2000.
<PAGE> 69
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
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PAGE
NUMBER
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(1) FINANCIAL STATEMENTS:
Consolidated Balance Sheets at June 30, 1999 and 1998........................ 37
Consolidated Statements of Operations for each of the three
years in the period ended June 30, 1999...................................... 38
Consolidated Statements of Changes in Shareholders' Equity for
each of the three years in the period ended June 30, 1999.................... 39
Consolidated Statements of Cash Flows for each of the three
years in the period ended June 30, 1999...................................... 40
Notes to Consolidated Financial Statements................................... 41-58
Report of Independent Accountants............................................ 59
(2) FINANCIAL STATEMENT SCHEDULES:
II -- Valuation and Qualifying Accounts for each of the three
years in the period ended June 30, 1999...................................... 71
(3) EXHIBITS (NUMBERED IN ACCORDANCE WITH ITEM 601 OF REGULATION
S-K):
The exhibits required to be filed are listed in the index
to exhibits
</TABLE>
(b) Current Reports on Form 8-K:
On April 7, 1999, the Company filed a Current Report on Form 8-K dated April
2, 1999 with the Securities and Exchange Commission reporting information under
Item 5, Other Events.
On June 16, 1999, the Company filed a Current Report on Form 8-K dated June
1, 1999 with the Securities and Exchange Commission reporting the sale of the
Company's long-term care services business under Item 2, Acquisition or
Disposition of Assets.
On June 30, 1999, the Company filed Form 8-K/A as an amendment to the
Current Report filed June 16, 1999 on Form 8-K.
<PAGE> 70
POWER OF ATTORNEY
The Registrant and each person whose signature appears below hereby appoint
John H. Foster and Timothy E. Foster as attorneys-in-fact with full power of
substitution, severally, to execute in the name and on behalf of the Registrant
and each such person, individually and in each capacity stated below, one or
more amendments to the annual report which amendments may make such changes in
the report as the attorney-in-fact acting in the premises deems appropriate and
to file any such amendment to the report with the Securities and Exchange
Commission.
---------------
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
NOVACARE, INC.
By:
----------------------------------
(ROBERT E. HEALY, JR.,
SENIOR VICE PRESIDENT, FINANCE AND
ADMINISTRATION AND CHIEF FINANCIAL
OFFICER)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/S/ JOHN H. FOSTER Chairman of the Board and Director September 20, 1999
--------------------------------
(JOHN H. FOSTER)
/S/ TIMOTHY E. FOSTER Chief Executive Officer and Director September 20, 1999
--------------------------------
(TIMOTHY E. FOSTER)
/S/ JAMES W. MCLANE President, Chief Operating Officer September 20, 1999
-------------------------------- and Director
(JAMES W. MCLANE)
/S/ ROBERT E. HEALY, JR. Senior Vice President, Finance and September 20, 1999
-------------------------------- Administration and Chief Financial
(ROBERT E. HEALY, JR.) Officer
/S/ BARRY E. SMITH Vice President, Controller and Chief September 20, 1999
-------------------------------- Accounting Officer
(BARRY E. SMITH)
/S/ E. MARTIN GIBSON Director September 20, 1999
--------------------------------
(E. MARTIN GIBSON)
/S/ SIRI S. MARSHALL Director September 20, 1999
--------------------------------
(SIRI S. MARSHALL)
/S/ STEPHEN E. O'NEIL Director September 20, 1999
--------------------------------
(STEPHEN E. O'NEIL)
/S/ GEORGE W. SIGULER Director September 20, 1999
--------------------------------
(GEORGE W. SIGULER)
/S/ DANIEL C. TOSTESON, M.D. Director September 20, 1999
--------------------------------
(DANIEL C. TOSTESON, M.D.)
</TABLE>
<PAGE> 71
SCHEDULE II
NOVACARE, INC.
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED JUNE 30, 1999, 1998 AND 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
BALANCE AT CHARGED TO BALANCE
BEGINNING COSTS AND AT END
DESCRIPTION OF PERIOD EXPENSES OTHER DEDUCTIONS OF PERIOD
- -------------------------------------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Year ended June 30, 1999:
Allowance for uncollectible accounts $ 35,550 42,540 86 (1) (41,580) $ 38,459
1,863 (2)
Year ended June 30, 1998:
Allowance for uncollectible accounts $ 17,170 18,287 8,127 (1) (15,247) $ 35,550
7,213 (2)
Year ended June 30, 1997
Allowance for uncollectible accounts $ 5,859 13,514 5,010 (1) (10,412) $ 17,170
3,199 (2)
</TABLE>
(1) Allowances for doubtful accounts related to acquired receivables.
(2) Charged against net revenues.
<PAGE> 72
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT PAGE
NUMBER EXHIBIT DESCRIPTION NUMBER
- ------- ------------------- ------
<S> <C> <C>
2 (a) (i) Stock Purchase Agreement dated as of April 2, 1999 by and among --
NovaCare, Inc., NC Resources, Inc., Hanger Orthopedic Group, Inc.
and HPO Acquisition Corp. (incorporated by reference to Exhibit 2(a)
to the Company's Current Report on Form 8-K dated July 1, 1999).
(ii) Amendment No. 1 to Stock Purchase Agreement made as of May 19, --
1999 by and among NovaCare, Inc., NC Resources, Inc., Hanger
Orthopedic Group, Inc. and HPO Acquisition Corp. (incorporated by
reference to the Exhibit 2 (b) to the Company's Current Report on
Form 8-K dated July 1, 1999).
(iii) Amendment No. 2 to Stock Purchase Agreement made as of June --
30, 1999 by and among NovaCare, Inc., NC Resources, Inc., Hanger
Orthopedic Group, Inc. and HPO Acquisition Corp. (incorporated by
reference to Exhibit 2(c) to the Company's Current Report on Form
8-K dated July 1, 1999).
2 (b) (i) Stock Purchase Agreement dated as of June 1, 1999 by and among --
NovaCare, Inc., NC Resources, Inc. and Chance Murphy, Inc.
(incorporated by reference to Exhibit 2(a) to the Company's Current
Report on Form 8-K dated June 1, 1999).
(ii) Amendment No. 1 to Stock Purchase Agreement made as of June 1, --
1999 by and among NovaCare, Inc., NC Resources, Inc. and Chance
Murphy, Inc. (incorporated by reference to Exhibit 2(b) to the
Company's Current Report on Form 8-K dated June 1, 1999).
3 (a)* Certificate of Incorporation of the Company, as amended to date --
(incorporated by reference to Exhibit 3(a) to the Company's
Quarterly Report on Form 10-Q for the quarter ended March 31, 1992).
3 (b) By-laws of the Company, as amended to date (incorporated by --
reference to Exhibit 3 to the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 1995).
4 (a) Stock Option Plan, as amended to date (incorporated by reference to --
Exhibit 4(a) to the Company's Annual Report on Form 10-K for the
year ended June 30, 1997).
4 (b)* Form of Indenture dated as of January 15, 1993 between the Company --
and Pittsburgh National Bank relating to 51/2% Convertible
Subordinated Debentures Due 2000 (incorporated by reference to
Exhibit 4 to Registration Statement on Form S-3 No. 33-55710).
4 (c) 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).
4 (d) 1998 Stock Option Plan (incorporated by reference to Exhibit 4 to --
Registration Statement Form S-8 No. 333-70653).
10 (a) (i) Employment Agreement dated as of October 9, 1996 between the --
Company and Barry E. Smith (incorporated by reference to Exhibit
10(c) to the Company's Quarterly Report on Form 10-Q for the quarter
ended December 31, 1997).
(ii) Amendment dated as of October 1, 1998 to the Employment --
Agreement dated as of October 9, 1996 between the Company and Barry
E. Smith (incorporated by reference to Exhibit 10(h) to the
Company's Quarterly
</TABLE>
<PAGE> 73
<TABLE>
<S> <C> <C>
Report on Form 10-Q for the quarter ended September 30, 1998).
10 (b) Stock Purchase Agreement dated as of May 1, 1997 between NovaCare --
Employee Services, Inc. and James W. McLane (incorporated by
reference to Exhibit 10(i) to the Company's Annual Report on Form
10-K for the year ended June 30, 1998).
10 (c) (i) Employment Agreement dated as of March 18, 1998 between the --
Company and Ronald G. Hiscock (incorporated by reference to Exhibit
10(a) to the Company's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1998).
(ii) First Amendment dated as of October 8, 1998 to the Employment --
Agreement dated as of March 18, 1998 between the Company and Ronald
G. Hiscock (incorporated by reference to Exhibit 10(f) to the
Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1998).
10 (d) (i) Amendment No. 2 to the Amended and Restated Employment Agreement
dated as of May 30, 1999 between the Company and John H. Foster.
(ii) Amended and Restated Employment Agreement dated as of July 1, --
1998 between the Company and John H. Foster (incorporated by
reference to Exhibit 10(a) to the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 1998).
(iii) Amendment dated September 1, 1998 to the Amended and Restated --
Employment Agreement dated as of July 1, 1998 between the Company
and John H. Foster (incorporated by reference to Exhibit 10(b) to
the Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1998).
10 (e) (i) Employment Agreement dated as of May 30, 1999 between the --
Company and Timothy E. Foster (incorporated by reference to Exhibit
10(a) to the Company's Current Report Form 8-K dated July 1, 1999).
10 (f) Employment Agreement dated as of May 30, 1999 between the Company --
and James W. McLane (incorporated by reference to Exhibit 10(b) to
the Company's Current Report on Form 8-K dated July 1, 1999).
10 (g) Employment Agreement dated as of May 30, 1999 between the Company --
and Robert E. Healy, Jr. (incorporated by reference to Exhibit 10(c)
to the Company's Current Report on Form 8-K dated July 1, 1999).
(h) (i) Revolving Credit Facility Agreement dated as of May 27, 1994 by --
and among NovaCare and certain of its subsidiaries and PNC Bank,
First Union National Bank of North Carolina, Mellon Bank, N.A.,
Nations Bank of North Carolina, N.A., CoreStates Bank, N.A., and
National Westminster Bank, N.A. (incorporated by reference to
Exhibit 10(g) to the Company's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1994).
(ii) Revolving Credit Facility Credit Agreement First Amendment --
dated as of September 20, 1994 by and among NovaCare and certain of
its subsidiaries and PNC Bank, N.A., First Union National Bank of
North Carolina, Mellon Bank, N.A., Nations Bank of North Carolina,
N.A., CoreStates Bank, N.A., and National Westminster Bank, N.A.
(incorporated by reference to Exhibit 10(a) to the Company's
Quarterly Report on Form 10-Q for the quarter ended December 31,
1994).
(iii) Revolving Credit Facility Agreement Second Amendment dated as --
of November 28, 1994 by and among NovaCare and certain of its
subsidiaries and PNC Bank, N.A., First Union National Bank of North
Carolina, Mellon Bank, N.A., Nations Bank of North Carolina, N.A.,
</TABLE>
<PAGE> 74
<TABLE>
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CoreStates Bank, N.A., National Westminster Bank, N.A., and Fleet
Bank of Massachusetts, N.A. (incorporated by reference to Exhibit
10(b) to the Company's Quarterly Report on Form 10-Q for the quarter
ended December 31, 1994).
(iv) Revolving Credit Facility Agreement Third Amendment dated as --
of May 15, 1995 by and among NovaCare and certain of its
subsidiaries and PNC Bank, N.A., First Union National Bank of North
Carolina, Mellon Bank, N.A., Nationsbank, N.A. (Carolina),
CoreStates Bank, N.A., NatWest Bank, N.A., and Fleet Bank of
Massachusetts, N.A. (incorporated by reference to Exhibit 10(a) to
the Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1995).
(v) Revolving Credit Facility Agreement Fourth Amendment dated as --
of May 19, 1995 by and among NovaCare and certain of its
subsidiaries and PNC Bank, N.A., First Union National Bank of North
Carolina, Mellon Bank, N.A., Nationsbank, N.A. (Carolina),
CoreStates Bank, N.A., NatWest Bank, N.A., and Fleet Bank of
Massachusetts (incorporated by reference to Exhibit 10 (a) to the
Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1995).
(vi) Revolving Credit Facility Agreement Fifth Amendment dated as --
of June 30, 1996 by and among NovaCare and certain of its
subsidiaries and PNC Bank, N.A., First Union National Bank of North
Carolina, Mellon Bank, N.A., Nationsbank, N.A. (Carolina),
CoreStates Bank, N.A., and Fleet Bank of Massachusetts (incorporated
by reference to Exhibit 10(j) (vi) to the Company's Annual Report on
Form 10-K for the year ended June 30, 1996).
(vii) Revolving Credit Facility Agreement Sixth Amendment dated as --
of June 30, 1996 by and among NovaCare and certain of its
subsidiaries and PNC Bank, N.A., CoreStates Bank, N.A., First Union
National Bank of North Carolina, Fleet Bank of Massachusetts, N.A.,
Mellon Bank, N.A. and Nationsbank, N.A. (incorporated by reference
to Exhibit 10(j)(vii) to the Company's Annual Report on Form 10-K
for the year ended June 30, 1996).
(viii) Revolving Credit Facility Agreement Seventh Amendment dated --
as of November 4, 1996 by and among NovaCare and certain of its
subsidiaries and PNC Bank, N.A., First Union National Bank of North
Carolina, Mellon Bank, N.A., Nationsbank, N.A. (Carolina),
CoreStates Bank, N.A., and Fleet Bank of Massachusetts, N.A.
(incorporated by reference to Exhibit 10(a) to the Company's
Quarterly Report on Form 10-Q for the quarter ended September 30,
1996).
(ix) Revolving Credit Facility Agreement Eighth Amendment dated as --
of January 30, 1997 by and among NovaCare and certain of its
subsidiaries and PNC Bank, N.A., First Union National Bank of North
Carolina, Mellon Bank, N.A., Nationsbank, N.A., CoreStates Bank,
N.A., Fleet Bank of Massachusetts, N.A., The Bank of New York, and
SunTrust Bank (Central Florida), N.A. (incorporated by reference to
Exhibit (10)(j)(ix) to the Company's Annual Report on Form 10-K for
the year ended June 30, 1998).
(x) Revolving Credit Facility Agreement Ninth Amendment dated as of --
January 30, 1997 by and among NovaCare and certain of its
subsidiaries and PNC Bank, N.A., First Union National Bank of North
Carolina, Mellon Bank, N.A., Nationsbank, N.A., CoreStates Bank,
N.A., Fleet Bank of Massachusetts, N.A., The Bank of New York, and
SunTrust Bank (Central Florida), N.A. (incorporated by reference to
Exhibit 10(j)(x) to the Company's Annual Report on Form 10-K for the
</TABLE>
<PAGE> 75
<TABLE>
<S> <C> <C>
year ended June 30, 1998).
(xi) Revolving Credit Facility Agreement Tenth Amendment dated as of --
March 31, 1997 by and among NovaCare and certain of its subsidiaries
and PNC Bank, N.A., First Union National Bank of North Carolina,
Mellon Bank, N.A., Nationsbank, N.A., CoreStates Bank, N.A., Fleet
National Bank, The Bank of New York, and SunTrust Bank (Central
Florida), N.A. (incorporated by reference to Exhibit 10(j)(xi) to
the Company's Annual Report on Form 10-K for the year ended June 30,
1997).
(xii) Revolving Credit Facility Agreement Eleventh Amendment dated --
as of June 27, 1997 by and among NovaCare and certain of its
subsidiaries and PNC Bank, N.A., First Union National Bank of North
Carolina, Mellon Bank, N.A., Nationsbank, N.A., CoreStates Bank,
N.A., Fleet National Bank, The Bank of New York, SunTrust Bank
(Central Florida), N.A., and Bank One (Kentucky), N.A. (incorporated
by reference to Exhibit 10(j)(xii) to the Company's Annual Report on
Form 10-K for the year ended June 30, 1998).
(xiii) Revolving Credit Facility Agreement Twelfth Amendment dated --
as of September 30, 1997 by and among NovaCare and certain of its
subsidiaries and PNC Bank, N.A., First Union National Bank, Mellon
Bank, N.A., NationsBank, N.A., Corestates Bank, N.A., Fleet Bank,
The Bank of New York, SunTrust Bank (Central Florida) N.A., Bank One
(Kentucky) N.A., The Fuji Bank, Limited (New York Branch), Crestar
Bank, Bank of Tokyo-Mitsubishi Trust Company, and AmSouth Bank
(incorporated by reference to Exhibit 10(a) to the Company's
Quarterly Report on Form 10-Q for the quarter ended September 30,
1997).
(xiv) Revolving Credit Facility Agreement Thirteenth Amendment dated --
as of November 17, 1997 by and among NovaCare and certain of its
subsidiaries and PNC Bank N.A., Corestates Bank, N.A., First Union
National Bank, Fleet National Bank, Mellon Bank, N.A., The Bank of
New York, SunTrust Bank (Central Florida) N.A., Bank One (Kentucky)
N.A., The Fuji Bank, Limited (New York Branch), Crestar Bank, Bank
of Tokyo-Mitsubishi Trust Company, AmSouth Bank (incorporated by
reference to Exhibit 10(b) to the Company's Quarterly Report on Form
10-Q for the quarter ended March 31, 1998).
(xv) Revolving Credit Facility Agreement Fourteenth Amendment dated --
as of February 24, 1998 by and among NovaCare and certain of its
subsidiaries and PNC Bank, N.A., Corestates Bank, N.A., First Union
National Bank, Fleet National Bank, Mellon Bank, N.A., The Bank of
New York, SunTrust Bank (Central Florida) N.A., Bank One (Kentucky)
N.A., The Fuji Bank, Limited (New York Branch), Crestar Bank, Bank
of Tokyo-Mitsubishi Trust Company, AmSouth Bank (incorporated by
reference to Exhibit 10(c) to the Company's Quarterly Report on Form
10-Q for the quarter ended March 31, 1998).
(xvi) Revolving Credit Facility Agreement Fifteenth Amendment dated --
as of February 27, 1998 by and among NovaCare and certain of its
subsidiaries and PNC Bank, N.A., Corestates Bank, N.A., First Union
National Bank, Fleet National Bank, Mellon Bank, N.A., The Bank of
New York, SunTrust Bank (Central Florida) N.A., Bank One (Kentucky)
N.A., The Fuji Bank, Limited (New York Branch), Crestar Bank, Bank
of Tokyo-Mitsubishi Trust Company, AmSouth Bank (incorporated by
reference to Exhibit 10(d) to the Company's Quarterly Report on Form
10-Q for the quarter ended March 31, 1998).
(xvii) Revolving Credit Facility Agreement Sixteenth Amendment dated
as of March 30, 1998 by and among NovaCare and certain of its
</TABLE>
<PAGE> 76
<TABLE>
<S> <C> <C>
subsidiaries and PNC Bank, N.A., Corestates Bank, N.A., First Union
National Bank, Fleet National Bank, Mellon Bank, N.A., The Bank of
New York, SunTrust Bank (Central Florida) N.A., Bank One (Kentucky)
N.A., The Fuji Bank, Limited (New York Branch), Crestar Bank, Bank
of Tokyo-Mitsubishi Trust Company, AmSouth Bank (incorporated by
reference to Exhibit 10(e) to the Company's Quarterly Report on Form
10-Q for the quarter ended March 31, 1998).
(xviii) Revolving Credit Facility Agreement Seventeenth Amendment --
dated as of June 30, 1998 by and among NovaCare and certain of its
subsidiaries and PNC Bank, N.A., First Union National Bank, Fleet
National Bank, Mellon Bank, N.A., Nations Bank, N.A., The Bank of
New York, SunTrust Bank (Central Florida) N.A., Bank One (Kentucky)
N.A., The Fuji Bank, Limited (New York Branch), Crestar Bank, Bank
of Tokyo-Mitsubishi Trust Company, AmSouth Bank, Bank of America NT
& SA, Comerica Bank, Credit Lyonnais (New York Branch), Cooperative
Centrale Raiffersen-Boerenleenbank B.A., "Rabobank Nederaland", (New
York Branch), The Tokai Bank, Limited (New York Branch), Toronto
Dominion (Texas), Inc. (incorporated by reference to Exhibit 10(i)
(xviii) to the Company's Annual Report on Form 10-K for the year
ended June 30, 1998).
(xix) Revolving Credit Facility Agreement Eighteenth Amendment dated --
as of December 18, 1998 by and among NovaCare and certain of its
subsidiaries and PNC Bank N.A., First Union National Bank, Fleet
National Bank, Mellon Bank, N.A., Nations Bank, N.A., The Bank of
New York, SunTrust Bank (Central Florida) N.A., Bank One (Kentucky)
N.A., The Fuji Bank, Limited (New York Branch), Crestar Bank, Bank
of Tokyo-Mitsubishi Trust Company, AmSouth Bank, Bank of America NT
and SA, Comerica Bank, Credit Lyonnais (New York Branch),
Cooperative Centrale Raiffersen- Boerenleenbank B.A., "Rabobank
Nederland" (New York Branch), The Tokai Bank, Limited (New York
Branch), Toronto Dominion (Texas), Inc. (incorporated by reference
top Exhibit 10(a) to the Company's Quarterly Report on Form 10-Q for
the quarter ended March 31, 1999).
(xx) Revolving Credit Facility Agreement Nineteenth Amendment dated --
as of March 31, 1999 by and among NovaCare and certain of its
subsidiaries and PNC Bank N.A, First Union National Bank, Fleet
National Bank, Mellon Bank, N.A., Nations Bank, N.A., The Bank of
New York, SunTrust Bank (Central Florida) N.A., Bank One (Kentucky)
N.A., The Fuji Bank, Limited (New York Branch), Crestar Bank, Bank
of Tokyo-Mitsubishi Trust Company, AmSouth Bank, Bank of America NT
and SA, Comerica Bank, Credit Lyonnais (New York Branch),
Cooperative Centrale Raiffersen-Boerenleenbank B.A., "Rabobank
Nederland" (New York Branch), The Tokai Bank, Limited (New York
Branch), Toronto Dominion (Texas), Inc. (incorporated by reference
to Exhibit 10(b) to the Company's Quarterly Report on Form 10-Q for
the quarter ended March 31, 1999).
(xxi) Revolving Credit Facility Agreement Twentieth Amendment dated --
as of April 19, 1999 by and among NovaCare and certain of its
subsidiaries and PNC Bank N.A, First Union National Bank, Fleet
National Bank, Mellon Bank, N.A., Nations Bank, N.A., The Bank of
New York, SunTrust Bank (Central Florida) N.A., Bank One (Kentucky)
N.A., The Fuji Bank, Limited (New York Branch), Crestar Bank, Bank
of Tokyo-Mitsubishi Trust Company, AmSouth Bank, Bank of America NT
and SA, Comerica Bank, Credit Lyonnais (New York Branch),
Cooperative Centrale Raiffersen-Boerenleenbank B.A., "Rabobank
Nederland" (New York Branch), The Tokai Bank, Limited (New York
Branch), Toronto Dominion (Texas), Inc. (incorporated by reference
to Exhibit 10(c) to the Company's Quarterly Report on Form 10-Q for
the quarter ended
</TABLE>
<PAGE> 77
<TABLE>
<S> <C> <C>
March 31, 1999).
(xxii) Revolving Credit Facility Agreement Twenty First Amendment --
dated as of April 19, 1999 by and among NovaCare and certain of its
subsidiaries and PNC Bank N.A, First Union National Bank, Fleet
National Bank, Mellon Bank, N.A., Nations Bank, N.A., The Bank of
New York, SunTrust Bank (Central Florida) N.A., Bank One (Kentucky)
N.A., The Fuji Bank, Limited (New York Branch), Crestar Bank, Bank
of Tokyo-Mitsubishi Trust Company, AmSouth Bank, Bank of America
N.A., Comerica Bank, Credit Lyonnais (New York Branch), Cooperative
Centrale Raiffersen-Boerenleenbank B.A., "Rabobank Nederland" (New
York Branch), The Tokai Bank, Limited (New York Branch), Toronto
Dominion (Texas), Inc.
10 (i) Supplemental Benefits Plan as amended to date (incorporated by --
reference to Exhibit 10(k) to the Company's Annual Report on Form
10-K for the year ended June 30, 1998).
21 Subsidiaries of the Company. --
23 Consent of Independent Accountants. --
24 Power of Attorney (see "Power of Attorney" in Form 10-K). --
27 Financial Data Schedules. --
</TABLE>
Copies of the exhibits filed with this Annual Report on Form 10-K or
incorporated by reference herein do not accompany copies hereof for distribution
to shareholders of the Company. The Company will furnish a copy of any of such
exhibits to any stockholder requesting the same.
Exhibits denoted by an asterisk were filed prior to the Company's adoption
of filing via EDGAR.
<PAGE> 1
AMENDMENT NO. 2 TO AMENDED AND RESTATED EMPLOYMENT AGREEMENT
This Amendment No. 2 to the Amended and Restated Employment Agreement
(the "Amendment") made as of the 30th day of May, 1999, 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 parties have heretofore entered into an Amended and
Restated Employment Agreement dated as of July 1, 1998, as amended by Amendment
No. 1 thereto dated as of September 1, 1998, (the "Employment Agreement"); and
WHEREAS, the parties now wish to amend the Employment Agreement further
as hereinafter set forth.
NOW, THEREFORE, in consideration of the premises and the mutual
agreements hereinafter set forth, the parties hereby agree as follows:
1. Section 6.7 of the Agreement shall be modified to include the
following clause at the end of the first sentence thereof:
"and further provided that amounts payable to the Executive pursuant to
this Section 6.7 shall be reduced by amounts paid as salary to the
Executive for the period from and after July 1, 1999; and further
provided that amounts payable to the Executive pursuant to this Section
6.7 shall be reduced to the extent, if any, required so that no amounts
payable pursuant to this Section 6.7 shall be treated as "excess
parachute payments" within the meaning of Section 280G of the Internal
Revenue Code of 1986, as amended (it being agreed that the Executive's
"base amount" for the period 1994 through 1998 is not less than the
amount set forth on Exhibit A)."
2. Section 6.7 of the Agreement shall be further modified to include
the following as the final two sentences thereof:
"Without limiting the generality of clause (C) of this Section 6.7,
substantially all of the business and/or assets of the Company shall be
deemed to have been disposed of upon the closing of a sale or other
disposition of any Major Operating Business (as hereinafter defined) of
the Company if the sale of such Major Operating Business (whether in
the form of a sale or other disposition of assets, sale or other
disposition of the
<PAGE> 2
stock of the corporation(s) operating the Business or a combination
thereof) has been approved by the shareholders of the Company or is
pursuant to a plan approved by the shareholders of the Company. The
term "Major Operating Business" shall include each of the following
businesses of the Company: (a) the long-term care services business,
(b) the business of NovaCare Employee Services, Inc., (c) the orthotics
and prosthetics business, and (d) the physical rehabilitation and
occupational health business.
3. In all other respects the Employment Agreement shall remain in full
force and effect without change.
IN WITNESS WHEREOF, the parties hereto have executed this Amendment as
of the date first above written.
NOVACARE, INC.
By: /s/ Timothy E. Foster
---------------------------------
Timothy E. Foster
Chief Executive Officer
/s/ John H. Foster
---------------------------------
John H. Foster
<PAGE> 3
Exhibit A
Calculation of "Base Amount" under I.R.C. ss. 280G(b)(3)(A) for John H.
Foster based on wages and other compensation as shown in Box 1 of Form W-2
issued by NovaCare, Inc.:
1994 $ 827,792
1995 $ 411,846
1996 $1,043,031
1997 $ 747,644
1998 $ 382,090
----------
Total $3,412,403
Base Amount = 3,412,403 / 5 = 682,480
Base Amount times 3 = (682,480 x 3) = $2,047,440
The Base Amount would be increased by amounts deferred under a 401(k)
plan or Section 125 "cafeteria" plan.
If the relevant "change of control" occurs after December 31, 1999, the
calculation would be based on compensation paid from 1995 through 1999.
<PAGE> 1
NOVACARE, INC.
1016 WEST NINTH AVENUE
KING OF PRUSSIA, PA 19406
Dated as of August 6, 1999
PNC Bank, National Association,
as Agent
One PNC Plaza
249 Fifth Avenue
Pittsburgh, PA 15222-2707
Attn: Frank Taucher, Senior Vice President
RE: Twenty-First Amendment to Credit Agreement (the "Twenty-First
Amendment")
Dear Frank:
We refer to that certain Credit Agreement, dated as of May 27, 1994, as
amended (the "Credit Agreement"), by and among NovaCare, Inc. ("NovaCare") and
certain of its Subsidiaries, the Banks party thereto and PNC Bank, National
Association, as agent for the Banks ("Agent"). Defined terms used herein, not
otherwise defined herein, shall have the meanings given to them under the Credit
Agreement as amended hereby.
The parties hereto in consideration of their mutual covenants and
agreements hereinafter set forth, and intending to be legally bound hereby,
covenant and agree as follows:
AGREEMENT
1. Waiver of Certain Provisions of Credit Agreement.
The Agent on behalf of the Banks hereby waives the compliance with the
provision of Section 2.04 [Voluntary Reduction of Commitment] which requires
five (5) Business Days' prior written notice by the Borrowers to the Agent in
order for the Borrowers to permanently reduce the Revolving Credit Commitments
to $35,000,000 effective on the Twenty-First Amendment Effective Date.
2. Amendments to Credit Agreement.
The parties hereto do hereby modify and amend the Credit Agreement as
follows:
(a) The cover page of the Credit Agreement is hereby amended by
deleting in the first line the number "$400,000,000" and inserting in lieu
thereof the number "$35,000,000."
<PAGE> 2
Recital paragraph 1, page 1, is hereby amended by deleting the number
"$400,000,000" and inserting in lieu thereof the number "$35,000,000."
(b) Section 1.01 [Certain Definitions] of the Credit Agreement is
hereby amended by the deletion of the definition of the term "Annual Permitted
Acquisition Amount," and the addition of the following new definitions:
"GP Therapy shall mean GP Therapy, L.L.C., a Georgia limited liability
corporation."
"Twenty-First Amendment Effective Date shall mean as of August 6, 1999
which is the effective date of the Twenty-First Amendment to this Agreement."
(c) Subsection (b) of Section 2.01 [Revolving Credit Borrowing;
Limitations on Revolving Facility Usage] is hereby deleted in its entirety and
the following is inserted in lieu thereof;
"(b) During the period commencing on the Twenty-First
Amendment Effective Date through and including the Expiration Date, the
Borrowers shall not request Revolving Credit Loans or the issuance of
Letters of Credit which would result in the Revolving Facility Usage
exceeding $35,000,000, and the Banks shall not be obligated to fund any
Revolving Credit Loans or to issue any Letter of Credit which would
result in the Revolving Facility Usage exceeding $35,000,000. The
Borrowers shall make a mandatory repayment of principal, whether or not
the Agent has given notice to such effect, in order that the Revolving
Facility Usage during any period does not exceed the amount during such
period as specified above."
(d) Subsection (ix) [Repayment Plan] of Section 8.01(m)[Certificates of
Borrowers; Other Reports and Information] is hereby amended by deleting the date
"September 15, 1999" and inserting the date "September 30, 1999" in lieu
thereof.
(e) Subsection (o) [Cooperation with Agent] is hereby amended by adding
the following after the first sentence of such subsection:
"It is acknowledged and agreed that effective on the
date hereof, the Agent and the Banks suspended the requirement that
Ernst & Young LLP, independent financial advisor of the Agent and the
Banks, review each Forecast Extension and each Forecast Reconciliation.
It is expressly agreed that in the event that at any time on or after
the Twenty-First Amendment Effective Date the Borrowers have an
aggregate balance of cash on hand and in bank accounts of less than
$15,000,000, the Borrowers shall provide prompt notice (the "Shortfall
Notice") to the Agent and the Agent shall engage financial advisors, at
the expense of the Borrowers, to review each Forecast Extension and
each
-2-
<PAGE> 3
Forecast Reconciliation required to be delivered on or after the date
of the Shortfall Notice."
(f) Section 8.02(d) [Liquidations, Mergers, Consolidations,
Acquisitions] is hereby amended and restated to read as follows:
"(d) Liquidations, Mergers, Consolidations,
Acquisitions. Each of the Loan Parties shall not, and shall not permit
any of its Subsidiaries to, dissolve, liquidate or wind-up its affairs,
or become a party to any merger or consolidation, or acquire by
purchase, lease or otherwise all or substantially all of the assets or
capital stock or other ownership interests of any other person,
provided that
(i) any wholly-owned Subsidiary of NovaCare
may consolidate or merge into another Loan Party which is wholly-owned
by one or more of the other Loan Parties, and
(ii) any Loan Party may acquire all of the
member interests in or certain assets of GP Therapy and all of the
stock in or assets of Occupational Health Care Company, Inc.
("OHC")(each a "Permitted Acquisition"), provided that each of the
following requirements is met;
(A) the equity interests acquired
by a Loan Party in G P Therapy and in OHC shall be pledged to the Agent
for the benefit of the Banks on a first priority perfected basis in
accordance with Section 11.18, a security interest in all assets
acquired by a Loan Party of GP Therapy and OHC shall be granted to the
Agent for the benefit of the Banks on a first priority perfected basis,
G. P. Therapy and OHC shall join this Agreement as a Borrower or a
Guarantor pursuant to Section 11.18 and shall have otherwise complied
with Section 11.18 as a "Joining Subsidiary" as defined in Section
11.18,
(B) the applicable board of
directors or other equivalent governing body shall have approved such
Permitted Acquisition,
(C) no Potential Default or Event
of Default shall exist immediately prior to and after giving effect to
such Permitted Acquisition,
(D) after giving effect to such
Permitted Acquisition there shall be Available Revolving Credit
Commitments of at least Five Million Dollars ($5,000,000),
-3-
<PAGE> 4
(E) the Consideration paid by the
Loan Parties for the acquisition of all of the member interests or
certain assets of in G. P. Therapy shall not exceed One Million Dollars
($1,000,000), and
(F) the Consideration paid by the
Loan Parties for the acquisition of all of the stock in or assets of
OHC shall not exceed an aggregate of Five Million Dollars ($5,000,000),
with the cash portion of such Consideration paid by the Loan Parties,
directly or indirectly, not to exceed Two Million Dollars
($2,000,000)."
3. Other Matters.
(a) Each Loan Party acknowledges that it has no claim, counterclaim,
setoff, action or cause of action of any kind or nature whatsoever against all
or any of the Agent, the Banks or any of the Agent's or the Banks' directors,
officers, employees, agents, attorneys, legal representatives, successors and
assigns (the Agent, the Banks and their directors, officers, employees, agents,
attorneys, legal representatives, successors and assigns are collectively
referred to as the "Lender Group"), that directly or indirectly arise out of or
are based upon or in any manner connected with any "Prior Event" (as defined
below), and each Loan Party hereby releases the Lender Group from any liability
whatsoever should any nonetheless exist with respect to such claims. As used
herein the term "Prior Event" means any transaction, event, circumstance,
action, failure to act or occurrence of any sort or type, whether known or
unknown, which occurred, existed, was taken, permitted or begun prior to the
execution of this Twenty-First Amendment and occurred, existed, was taken,
permitted or begun in accordance with, pursuant to or by virtue of any terms of
this Twenty-First Amendment or any Loan Document or oral or written agreement
relating to any of the foregoing.
(b) Schedule 1.1 (E) [Excluded Entities], Schedule 6.01(c)
[Subsidiaries] and Schedule 8.02(i)(v) [Restricted Investments in Excluded
Entities] are amended and restated in their entirety to read as attached hereto.
4. Closing Fees and Certain Matters Regarding Financial Advisors.
The Borrowers jointly and severally agree to reimburse the Agent on
demand for all costs, expenses and disbursements relating to this Twenty-First
Amendment which are payable by the Borrower as provided in Section 10.05 of the
Credit Agreement. The Borrowers shall promptly deliver such certificates,
resolutions and opinions in form and substance satisfactory to the Agent as the
Agent shall have reasonably requested from time to time. The Borrowers jointly
and severally agree to reimburse the Agent for the benefit of the Banks on
demand for all reasonable fees and out-of-pocket expenses of Blank Rome Comisky
& McCauley LLP, counsel to the Banks (or any substitute therefor), other local
counsel engaged by the Banks, any financial advisors and other experts engaged
by the Banks.
-4-
<PAGE> 5
5. Conditions of Effectiveness.
The effectiveness of the waiver in Section 1 above and this
Twenty-First Amendment is expressly conditioned upon the occurrence and
completion of all of the following: (i) payment by the Borrowers of all costs,
expenses and disbursements submitted on or before the date hereof to the
Borrowers pursuant to Section 4 hereof, and (ii) the Agent's receipt of
counterparts of this Twenty-First Amendment duly executed by the Borrowers, the
Guarantors, the Agent and the Required Banks.
This Twenty-First Amendment shall be dated as of and shall be effective
as of the date and year first above written subject to satisfaction of all
conditions precedent to effectiveness as set forth in this Section 5, which date
shall be the Twenty-First Amendment Effective Date.
6. Consent of Banks.
Pursuant to Section 11.01 of the Credit Agreement, this Twenty-First
Amendment shall require the written consent of the Required Banks, which shall
be evidenced by the execution and delivery by the Required Banks to the Agent of
counterparts of this Twenty-First Amendment.
7. Full Force and Effect.
Each of the following documents, as amended through and including this
Twenty-First Amendment, shall remain in full force and effect on and after the
date of this Amendment:
(a) the Credit Agreement, except as expressly modified and
amended by this Twenty-First Amendment,
(b) each of the Schedules attached to the Credit Agreement,
except as expressly modified and amended by this Twenty-First Amendment;
(c) each of the Exhibits attached to the Credit Agreement; and
the Notes, the Guaranty Agreements, the Security Agreement,
the Pledge Agreements, the Agent's Fee Letter, the Subordination Agreement
(Intercompany), the Borrower Agency Agreement and all other Loan Documents.
On and after the date hereof, each reference in the Credit Agreement to
"this Agreement," "hereunder" or words of like import shall mean and be a
reference to the Credit Agreement, as previously amended and as amended by this
Twenty-First Amendment, and each reference in each other Loan Document to the
"Credit Agreement" shall mean and be a reference to the Credit Agreement, as
previously amended and as amended by this Twenty-First Amendment. No novation is
intended by this Twenty-First Amendment.
-5-
<PAGE> 6
The parties hereto do not amend or waive any provisions of the
Credit Agreement or the other Loan Documents except as expressly set forth
herein.
8. Counterparts.
This Twenty-First Amendment may be executed by different
parties hereto in any number of separate counterparts, each of which, when so
executed and delivered, shall be an original, and all of such counterparts shall
together constitute one and the same instrument.
9. Governing Law.
This Twenty-First Amendment shall be deemed to be a contract
under the laws of the Commonwealth of Pennsylvania and for all purposes shall be
governed by and construed and enforced in accordance with the internal laws of
the Commonwealth of Pennsylvania without regard to its conflict of laws
principles.
-6-
<PAGE> 7
[Signature Page 1 of 19 to Twenty-First Amendment]
IN WITNESS WHEREOF, the parties hereto, by their officers thereunto
duly authorized, have executed this Amendment as of the day and year first above
written.
<TABLE>
<S> <C>
BORROWERS AND GUARANTORS:
ATTEST: NOVACARE, INC., a Delaware corporation, and each of the
BORROWERS and GUARANTORS listed on Schedule A attached
hereto
By: By:
-------------------------------- ------------------------------------------
Richard S. Binstein, Secretary Richard A. McDonald, the Vice President of
each Borrower and Guarantor listed on
Schedule A attached hereto which is a
corporation and of each general partner of
each Guarantor listed on Schedule A attached
hereto which is a partnership
[Seal]
ATTEST: NOVAFUNDS, INC., a Delaware corporation, and each of the
GUARANTORS listed on Schedule B attached hereto
By: By:
-------------------------------- ------------------------------------------
Andrew T. Panaccione, Secretary Robert C. Campbell, the Vice President of
each Borrower and Guarantor listed on
Schedule B attached hereto
[Seal]
- --------------------
</TABLE>
<PAGE> 8
[Signature Page 2 of 19 to Twenty-First Amendment]
AGENT:
PNC BANK, NATIONAL ASSOCIATION, as Agent
By:
--------------------------------------
Title:
-----------------------------------
BANKS:
PNC BANK, NATIONAL ASSOCIATION
By:
--------------------------------------
Title:
-----------------------------------
<PAGE> 9
[Signature Page 3 of 19 to Twenty-First Amendment]
FIRST UNION NATIONAL BANK
By:
----------------------------------------
Name:
----------------------------------------
Title:
----------------------------------------
<PAGE> 10
[Signature Page 4 of 19 to Twenty-First Amendment]
FLEET NATIONAL BANK
By:
----------------------------------------
Name:
----------------------------------------
Title:
----------------------------------------
<PAGE> 11
[Signature Page 5 of 19 to Twenty-First Amendment]
MELLON BANK, N.A.
By:
----------------------------------------
Name:
----------------------------------------
Title:
----------------------------------------
<PAGE> 12
[Signature Page 6 of 19 to Twenty-First Amendment]
NATIONSBANK, N.A.
By:
----------------------------------------
Name:
----------------------------------------
Title:
----------------------------------------
<PAGE> 13
[Signature Page 7 of 19 to Twenty-First Amendment]
THE BANK OF NEW YORK
By:
----------------------------------------
Name:
----------------------------------------
Title:
----------------------------------------
<PAGE> 14
[Signature Page 8 of 19 to Twenty-First Amendment]
SUNTRUST BANK, CENTRAL FLORIDA, N.A.
By:
----------------------------------------
Name:
----------------------------------------
Title:
----------------------------------------
<PAGE> 15
[Signature Page 9 of 19 to Twenty-First Amendment]
BANK ONE, KENTUCKY, NA
By:
----------------------------------------
Name:
----------------------------------------
Title:
----------------------------------------
<PAGE> 16
[Signature Page 10 of 19 to Twenty-First Amendment]
THE FUJI BANK, LIMITED
NEW YORK BRANCH
By:
----------------------------------------
Name:
----------------------------------------
Title:
----------------------------------------
<PAGE> 17
[Signature Page 11 of 19 to Twenty-First Amendment]
CRESTAR BANK
By:
----------------------------------------
Name:
----------------------------------------
Title:
----------------------------------------
<PAGE> 18
[Signature Page 12 of 19 to Twenty-First Amendment]
BANK OF TOKYO - MITSUBISHI TRUST COMPANY
By:
----------------------------------------
Name:
----------------------------------------
Title:
----------------------------------------
<PAGE> 19
[Signature Page 13 of 19 to Twenty-First Amendment]
AMSOUTH BANK
By:
----------------------------------------
Name:
----------------------------------------
Title:
----------------------------------------
<PAGE> 20
[Signature Page 14 of 19 to Twenty-First Amendment]
BANK OF AMERICA, N.A.
By:
----------------------------------------
Name:
----------------------------------------
Title:
----------------------------------------
<PAGE> 21
[Signature Page 15 of 19 to Twenty-First Amendment]
COMERICA BANK
By:
----------------------------------------
Name:
----------------------------------------
Title:
----------------------------------------
<PAGE> 22
[Signature Page 16 of 19 to Twenty-First Amendment]
CREDIT LYONNAIS NEW YORK BRANCH
By:
----------------------------------------
Name:
----------------------------------------
Title:
----------------------------------------
<PAGE> 23
[Signature Page 17 of 19 to Twenty-First Amendment]
COOPERATIEVE CENTRALE RAIFFEISEN-
BOERENLEENBANK B.A., "RABOBANK
NEDERLAND", NEW YORK BRANCH
By:
----------------------------------------
Name:
----------------------------------------
Title:
----------------------------------------
By:
----------------------------------------
Name:
----------------------------------------
Title:
----------------------------------------
<PAGE> 24
[Signature Page 18 of 19 to Twenty-First Amendment]
THE TOKAI BANK, LIMITED NEW YORK BRANCH
By:
----------------------------------------
Name:
----------------------------------------
Title:
----------------------------------------
<PAGE> 25
[Signature Page 19 of 19 to Twenty-First Amendment]
TORONTO DOMINION (TEXAS), INC.
By:
----------------------------------------
Name:
----------------------------------------
Title:
----------------------------------------
<PAGE> 26
STATE OF GEORGIA
COUNTY OF FULTON
On the _____ day of ___________, 1999 personally appeared
___________________, as the __________ President of SunTrust Bank, Central
Florida, National Association, and before me executed the attached Twenty-First
Amendment dated as of _____________, 1999 to the Credit Agreement between
NovaCare, Inc., with SunTrust Bank, Central Florida, National Association, as
Lender.
IN WITNESS WHEREOF, I have hereunto set my hand and official seal, in
the state and county aforesaid.
_________________________________________________________
Signature of Notary Public, State of ____________________
_________________________________________________________
(Print, Type or Stamp Commissioned Name of Notary Public)
Personally known _______________________; OR Produced
Identification __________________________________________
Type of identification produced: ________________________
_________________________________________________________
<PAGE> 27
SCHEDULE A
<TABLE>
<CAPTION>
BORROWER ("B") /
ENTITY GUARANTOR ("G")
- -------------------------------------------------------------------------------------- ----------------
<S> <C>
NovaCare, Inc. (a Delaware corporation) B
RehabClinics, Inc. B
Rehab Managed Care of Arizona, Inc. B
Affiliated Physical Therapists, Ltd. G
American Rehabilitation Center, Inc. G
American Rehabilitation Clinic, Inc. G
Athens Sports Medicine Clinic, Inc. G
Ather Sports Injury Clinic, Inc. G
Atlantic Health Group, Inc. G
Atlantic Rehabilitation Services, Inc. G
Boca Rehab Agency, Inc. G
Buendel Physical Therapy, Inc. G
C.E.R. - West, Inc. G
Cenla Physical Therapy & Rehabilitation Agency, Inc. G
Center for Evaluation & Rehabilitation, Inc. G
Center for Physical Therapy and Sports Rehabilitation, Inc. G
CenterTherapy, Inc. G
Central Missouri Rehabilitation Services, Inc. G
Central Missouri Therapy, Inc. G
Champion Physical Therapy, Inc. G
CMC Center Corporation G
Coplin Physical Therapy Associates, Inc. G
Crowley Physical Therapy Clinic, Inc. G
Douglas Avery and Associates, Ltd. G
Douglas C. Claussen, R.P.T., Physical Therapy, Inc. G
Elk County Physical Therapy, Inc. G
Fine, Bryant & Wah, Inc. G
Francis Naselli, Jr. & Stewart Rich Physical Therapists, Inc. G
Gallery Physical Therapy Center, Inc. G
</TABLE>
<PAGE> 28
<TABLE>
<CAPTION>
BORROWER ("B") /
ENTITY GUARANTOR ("G")
- -------------------------------------------------------------------------------------- ----------------
<S> <C>
Georgia Health Group, Inc. G
Georgia Physical Therapy of West Georgia, Inc. G
Georgia Physical Therapy, Inc. G
Greater Sacramento Physical Therapy Associates, Inc. G
Grove City Physical Therapy and Sports Medicine, Inc. G
Gulf Breeze Physical Therapy, Inc. G
Gulf Coast Hand Specialists, Inc. G
Hand Therapy and Rehabilitation Associates, Inc. G
Hand Therapy Associates, Inc. G
Hangtown Physical Therapy, Inc. G
Hawley Physical Therapy, Inc. G
Human Performance and Fitness, Inc. G
Indianapolis Physical Therapy and Sports Medicine, Inc. G
Industrial Health Care Company, Inc. G
JOYNER SPORTS SCIENCE INSTITUTE, Inc. G
JOYNER SPORTSMEDICINE INSTITUTE, INC. G
Kentucky Rehabilitation Services, Inc. G
Kesinger Physical Therapy, Inc. G
Lynn M. Carlson, Inc. G
Marilyn Hawker, Inc. G
Mark Butler Physical Therapy Center, Inc. G
Medical Plaza Physical Therapy, Inc. G
Metro Rehabilitation Services, Inc. G
Michigan Therapy Centre, Inc. G
MidAtlantic Health Group, Inc. G
Mill River Management, Inc. G
Mitchell Tannenbaum I, Inc. G
Mitchell Tannenbaum II, Inc. G
Mitchell Tannenbaum III, Inc. G
Monmouth Rehabilitation, Inc. G
New England Health Group, Inc. G
New Mexico Physical Therapists, Inc. G
</TABLE>
<PAGE> 29
<TABLE>
<CAPTION>
BORROWER ("B") /
ENTITY GUARANTOR ("G")
- -------------------------------------------------------------------------------------- ----------------
<S> <C>
Northside Physical Therapy, Inc. G
NovaCare (Arizona), Inc. G
NovaCare (Colorado), Inc. G
NovaCare (Texas), Inc. G
NovaCare Easton & Moran Physical Therapy, Inc. G
NovaCare Holdings, Inc. G
NovaCare Management Company, Inc. G
NovaCare Management Services, Inc. G
NovaCare Occupational Health Services, Inc. G
NovaCare Outpatient Rehabilitation East, Inc. G
NovaCare Outpatient Rehabilitation I, Inc. G
NovaCare Outpatient Rehabilitation West, Inc. G
NovaCare Outpatient Rehabilitation, Inc. G
NovaCare Rehab Agency of Amarillo, Inc. G
NovaCare Rehab Agency of Beaumont, Inc. G
NovaCare Rehab Agency of El Paso, Inc. G
NovaCare Rehab Agency of Las Vegas, Inc. G
NovaCare Rehab Agency of Lubbock, Inc. G
NovaCare Rehab Agency of Northern California, Inc. G
NovaCare Rehab Agency of Oklahoma, Inc. G
NovaCare Rehab Agency of Oregon, Inc. G
NovaCare Rehab Agency of Reno, Inc. G
NovaCare Rehab Agency of San Antonio, Inc. G
NovaCare Rehab Agency of San Diego, Inc. G
NovaCare Rehab Agency of Southern California, Inc. G
NovaCare Rehab Agency of Washington, Inc. G
NovaCare Rehab Agency of Wyoming, Inc. G
NovaCare Rehabilitation, Inc. G
NovaCare Service Corp. G
Ortho Rehab Associates, Inc. G
Orthopedic and Sports Physical Therapy of Cupertino, Inc. G
</TABLE>
<PAGE> 30
<TABLE>
<CAPTION>
BORROWER ("B") /
ENTITY GUARANTOR ("G")
- -------------------------------------------------------------------------------------- ----------------
<S> <C>
Peter Trailov R.P.T. Physical Therapy Clinic, Orthopaedic Rehabilitation & Sports G
Medicine, Ltd.
Peters, Starkey & Todrank Physical Therapy Corporation G
Physical Focus Inc. G
Physical Rehabilitation Partners, Inc. G
Physical Therapy Clinic of Lee's Summit, Inc. G
Physical Therapy Enterprises, Inc. G
Physical Therapy Institute, Inc. G
Physical Therapy Services of the Jersey Cape, Inc. G
Pro Active Therapy, Inc. G
Professional Therapeutic Services, Inc. G
Quad City Management, Inc. G
RCI (Colorado), Inc. G
RCI (Exertec), Inc. G
RCI (Illinois), Inc. G
RCI (Michigan), Inc. G
RCI (S.P.O.R.T.), Inc. G
RCI (WRS), Inc. G
RCI Nevada, Inc. G
Rebound Oklahoma, Inc. G
Redwood Pacific Therapies, Inc. G
Rehab Provider Network of Florida, Inc. G
Rehab Provider Network - California, Inc. G
Rehab Provider Network - Delaware, Inc. G
Rehab Provider Network - Georgia, Inc. G
Rehab Provider Network - Illinois, Inc. G
Rehab Provider Network - Indiana, Inc. G
Rehab Provider Network - Maryland, Inc. G
Rehab Provider Network - Michigan, Inc. G
Rehab Provider Network - New Jersey, Inc. G
Rehab Provider Network - Ohio, Inc. G
Rehab Provider Network - Oklahoma, Inc. G
Rehab Provider Network - Pennsylvania, Inc. G
</TABLE>
<PAGE> 31
<TABLE>
<CAPTION>
BORROWER ("B") /
ENTITY GUARANTOR ("G")
- -------------------------------------------------------------------------------------- ----------------
<S> <C>
Rehab Provider Network - Virginia, Inc. G
Rehab Provider Network - Washington, D.C., Inc. G
Rehab Provider Network of Colorado, Inc. G
Rehab Provider Network of Nevada, Inc. G
Rehab Provider Network of New Mexico, Inc. G
Rehab Provider Network of North Carolina, Inc. G
Rehab Provider Network of Texas, Inc. G
Rehab Provider Network of Wisconsin, Inc. G
Rehab World, Inc. G
Rehab/Work Hardening Management Associates, Ltd. G
RehabClinics (COAST), Inc. G
RehabClinics (GALAXY), Inc. G
RehabClinics (New Jersey), Inc. G
RehabClinics (PTA), Inc. G
RehabClinics (SPT), Inc. G
RehabClinics Abilene, Inc. G
RehabClinics Dallas, Inc. G
RehabClinics Pennsylvania, Inc. G
Rehabilitation Management, Inc. G
Robert M. Bacci, R.P.T. Physical Therapy, Inc. G
S.T.A.R.T., Inc. G
Scott G. Knoche, Inc. G
SG Rehabilitation Agency, Inc. G
SG Speech Associates, Inc. G
Sierra Nevada Physical Therapy Corporation G
South Jersey Physical Therapy Associates, Inc. G
South Jersey Rehabilitation and Sports Medicine Center, Inc. G
Southpointe Fitness Center, Inc. G
Southwest Emergency Associates, Inc. G
Southwest Medical Supply Company G
Southwest Physical Therapy, Inc. G
Southwest Therapists, Inc. G
</TABLE>
<PAGE> 32
<TABLE>
<CAPTION>
BORROWER ("B") /
ENTITY GUARANTOR ("G")
- -------------------------------------------------------------------------------------- ----------------
<S> <C>
Sporthopedics Sports and Physical Therapy Centers, Inc. G
Sports Therapy and Arthritis Rehabilitation, Inc. G
Star Physical Therapy Inc. G
Stephenson-Holtz, Inc. G
The Center for Physical Therapy and Rehabilitation, Inc. G
The Orthopedic Sports and Industrial Rehabilitation Network, Inc. G
Theodore Dashnaw Physical Therapy, Inc. G
Treister, Inc. G
Union Square Center for Rehabilitation & Sports Medicine, Inc. G
Valley Group Physical Therapists, Inc. G
Vanguard Rehabilitation, Inc. G
Wayzata Physical Therapy Center, Inc. G
West Side Physical Therapy, Inc. G
West Suburban Health Partners, Inc. G
Western Missouri Rehabilitation Services, Inc. G
Worker Rehabilitation Services, Inc. G
Yuma Rehabilitation Center, Inc. G
Advanced Orthopedic Services, Ltd. (RehabClinics Dallas, Inc. is general partner) G
Land Park Physical Therapy (Union Square Center for Rehabilitation & Sports G
Medicine, Inc. is general partner)
</TABLE>
<PAGE> 33
SCHEDULE B
<TABLE>
<CAPTION>
BORROWER ("B") /
ENTITY GUARANTOR ("G")
- -------------------------------------------------------------------------------------- ----------------
<S> <C>
NovaFunds, Inc. B
NC Cash Management, Inc. G
NC Resources, Inc. G
NovaMark, Inc. G
NovaStock, Inc. G
</TABLE>
<PAGE> 1
Exhibit 21
SUBSIDIARIES OF THE COMPANY
A.D. Craig Company, a California corporation
Advance Orthotics, Inc., a Texas corporation
Advanced Orthopedic Systems, Inc., a California corporation
Advanced Orthopedic Technologies (Clayton), Inc., a New Jersey corporation
Advanced Orthopedic Technologies (Lett), Inc., a West Virginia corporation
Advanced Orthopedic Technologies (New Jersey), Inc., a New Jersey corporation
Advanced Orthopedic Technologies (New Mexico), Inc., a New Mexico corporation
Advanced Orthopedic Technologies (New York), Inc., a New York corporation
Advanced Orthopedic Technologies (OTI), Inc., a New York corporation
Advanced Orthopedic Technologies (Parmeco), Inc., a West Virginia corporation
Advanced Orthopedic Technologies (SFV), Inc., a California corporation
Advanced Orthopedic Technologies (Virginia), Inc., a Virginia corporation
Advanced Orthopedic Technologies (West Virginia), Inc., a West Virginia
corporation
Advanced Orthopedic Technologies Management Corp., a New York corporation
Advanced Orthopedic Technologies, Inc., a Nevada corporation
Advanced Orthopedic Technologies, Inc., a New York corporation
Advanced Orthotics and Prosthetics, Inc., a Washington corporation
Affiliated Physical Therapists, Ltd., an Arizona corporation
American Rehabilitation Center, Inc., a Missouri corporation
American Rehabilitation Clinic, Inc., a Missouri corporation
American Rehabilitation Systems, Inc., a Georgia corporation
Artificial Limb and Brace Center, an Arizona corporation
Athens Sports Medicine Clinic, Inc., a Georgia corporation
Ather Sports Injury Clinic, Inc., a California corporation
Atlanta Prosthetics, Inc., a Georgia corporation
Atlantic Health Group, Inc., a Delaware corporation
Atlantic Rehabilitation Services, Inc., a New Jersey corporation
Boca Rehab Agency, Inc., a Delaware corporation
Bowman-Shelton Orthopedic Service, Incorporated, an Oklahoma corporation
Buendel Physical Therapy, Inc., a Florida corporation
C.E.R. - West, Inc., a Michigan corporation
CCISUB, Inc., a North Carolina corporation
CMC Center Corporation, a California corporation
Cahill Orthopedic Laboratory, Inc., a New York corporation
Cenla Physical Therapy & Rehabilitation Agency, Inc., a Louisiana corporation
Center for Evaluation & Rehabilitation, Inc., a Michigan corporation
Center for Physical Therapy & Sports Rehabilitation, Inc., a New Mexico
corporation
CenterTherapy, Inc., a Minnesota corporation
Central Missouri Rehabilitation Services, Inc., a Missouri corporation
Central Missouri Therapy, Inc., a Missouri corporation
Central Valley Prosthetics & Orthotics, Inc., a California corporation
Certified Orthopedic Appliance Co., Inc., an Arizona corporation
Champion Physical Therapy, Inc., a Pennsylvania corporation
Coplin Physical Therapy Associates, Inc., a Minnesota corporation
Crowley Physical Therapy Clinic, Inc., a Louisiana corporation
Dale Clark Prosthetics, Inc., an Iowa corporation
Douglas Avery & Associates, Ltd., a Virginia corporation
<PAGE> 2
Douglas C. Claussen, R.P.T., Physical Therapy, Inc., a California corporation
E.A. Warnick-Pomeroy Co., Inc., a Pennsylvania corporation
Elk County Physical Therapy, Inc., a Pennsylvania corporation
Employee Benefits Management, Inc., a Florida corporation
Employers' Risk Management, Inc., a Florida corporation
Fine, Bryant & Wah, Inc., a Maryland corporation
Francis Naselli, Jr. & Stewart Rich Physical Therapists, Inc., a Pennsylvania
corporation
Frank J. Malone & Son, Inc., a Pennsylvania corporation
Fresno Orthopedic Company, a California corporation
G.P. Therapy, L.L.C., a Georgia limited liability company
Gallery Physical Therapy Center, Inc., a Minnesota corporation
Georgia Health Group, Inc., a Georgia corporation
Georgia Physical Therapy of West Georgia, Inc., a Georgia corporation
Georgia Physical Therapy, Inc., a Georgia corporation
Gill/Balsano Consulting, L.L.C., a Delaware limited liability corporation
Greater Sacramento Physical Therapy Associates, Inc., a California corporation
Grove City Physical Therapy and Sports Medicine, Inc., a Pennsylvania
corporation
Gulf Breeze Physical Therapy, Inc., a Florida corporation
Gulf Coast Hand Specialists, Inc., a Florida corporation
Hand Therapy and Rehabilitation Associates, Inc., a California corporation
Hand Therapy Associates, Inc., an Arizona corporation
Hangtown Physical Therapy, Inc., a California corporation
Hawley Physical Therapy, Inc., a California corporation
High Desert Institute of Prosthetics and Orthotics, a California corporation
Human Performance and Fitness, Inc., a California corporation
Indianapolis Physical Therapy and Sports Medicine, Inc., an Indiana corporation
Industrial Health Care Company, Inc., a Connecticut corporation
J.E. Hanger, Incorporated, a Missouri corporation
JOYNER SPORTS SCIENCE INSTITUTE, Inc., a Pennsylvania corporation
JOYNER SPORTSMEDICINE INSTITUTE, INC., a Pennsylvania corporation
Joyner/Wendt-Bristol, L.L.C.
Kentucky Rehabilitation Services, Inc., a Kentucky corporation
Kesinger Physical Therapy, Inc., a California corporation
Kroll's, Inc., a Minnesota corporation
Lynn M. Carlson, Inc., an Arizona corporation
Marilyn Hawker, Inc., an Arizona corporation
Mark Butler Physical Therapy Center, Inc., a New Jersey corporation
McKinney Prosthetics/Orthotics, Inc., an Illinois corporation
Meadowbrook Orthopedics, Inc., a Michigan corporation
Medical Arts O&P Services, Inc., a Wisconsin corporation
Medical Plaza Physical Therapy, Inc., a Missouri corporation
Metro Rehabilitation Services, Inc., a Michigan corporation
Michigan Therapy Centre, Inc., a Michigan corporation
MidAtlantic Health Group, Inc., a Delaware corporation
Mitchell Tannenbaum I, Inc., an Illinois corporation
Mitchell Tannenbaum II, Inc., an Illinois corporation
Mitchell Tannenbaum III, Inc., an Illinois corporation
Monmouth Rehabilitation, Inc., a New Jersey corporation
NC Cash Management, Inc., a Delaware corporation
NC Resources, Inc., a Delaware corporation
NCES Finance, Inc., a Delaware corporation
<PAGE> 3
NCES Holdings, Inc., a Delaware corporation
NCES Licensing , Inc., a Delaware corporation
New England Health Group, Inc., a Massachusetts corporation
New Mexico Physical Therapists, Inc., a New Mexico corporation
Northland Regional Orthotic and Prosthetic Center, Inc., a Minnesota
corporation
Northside Physical Therapy, Inc., an Ohio corporation
NovaCare (Arizona), Inc., an Arizona corporation
NovaCare (Colorado), Inc., a Delaware corporation
NovaCare (Texas), Inc., a Texas corporation
NovaCare Administrative Employee Services of New York, Inc., a New York
corporation
NovaCare Administrative Employee Services, Inc., a Florida corporation
NovaCare Easton & Moran Physical Therapy, Inc., a California corporation
NovaCare Employee Services Club Staff, Inc., a Florida corporation
NovaCare Employee Services Easy Staff, Inc., a Florida corporation
NovaCare Employee Services Northeast, Inc., a New York corporation
NovaCare Employee Services Resource One, Inc., a Florida corporation
NovaCare Employee Services TPI, Inc., a New York corporation
NovaCare Employee Services West, Inc., an Arizona corporation
NovaCare Employee Services of America, Inc., a Florida corporation
NovaCare Employee Services of Boston, Inc., a Delaware corporation
NovaCare Employee Services of Florida, Inc., a Florida corporation
NovaCare Employee Services of New York, Inc., a New York corporation
NovaCare Employee Services of Orlando, Inc., a Florida corporation
NovaCare Employee Services, Inc., a Delaware corporation
NovaCare Management Company, Inc., a Delaware corporation
NovaCare Management Services, Inc., a Delaware corporation
NovaCare Occupational Health Services, Inc., a Delaware corporation
NovaCare Orthotics & Prosthetics, Inc., a Delaware corporation
NovaCare Orthotics & Prosthetics East, Inc., a Delaware corporation
NovaCare Orthotics & Prosthetics Holdings, Inc., a Delaware corporation
NovaCare Orthotics & Prosthetics West, Inc., a California corporation
NovaCare Outpatient Rehabilitation East, Inc., a Delaware corporation
NovaCare Outpatient Rehabilitation I, Inc., a Kansas corporation
NovaCare Outpatient Rehabilitation, Inc., a Kansas corporation
NovaCare Outpatient Rehabilitation West, Inc., a Delaware corporation
NovaCare Rehab Agency of Amarillo, Inc., a Texas corporation
NovaCare Rehab Agency of Beaumont, Inc., a Texas corporation
NovaCare Rehab Agency of El Paso, Inc., a Texas corporation
NovaCare Rehab Agency of Las Vegas, Inc., a Nevada corporation
NovaCare Rehab Agency of Lubbock, Inc., a Texas corporation
NovaCare Rehab Agency of Northern California, Inc., a California corporation
NovaCare Rehab Agency of Oklahoma, Inc., an Oklahoma corporation
NovaCare Rehab Agency of Oregon, Inc., an Oregon corporation
NovaCare Rehab Agency of Reno, Inc., a Nevada corporation
NovaCare Rehab Agency of San Antonio, Inc., a Texas corporation
NovaCare Rehab Agency of San Diego, Inc., a California corporation
NovaCare Rehab Agency of Southern California, Inc., a California corporation
NovaCare Rehab Agency of Washington, Inc., a Washington corporation
NovaCare Rehab Agency of Wyoming, Inc., a Wyoming corporation
NovaCare Rehabilitation, Inc., a Minnesota corporation
<PAGE> 4
NovaCare Service Corp., a Delaware corporation
NovaCare, Inc., a Delaware corporation
NovaFunds, Inc., a Delaware corporation
NovaMark, Inc., a Delaware corporation
NovaStock, Inc., a Delaware corporation
Opus Care, Inc., an Illinois corporation
Ortho East, Inc., a Massachusetts corporation
Ortho-Fab Laboratories, Inc., an Illinois corporation
Ortho Rehab Associates, Inc., a Florida corporation
Orthopedic and Sports Physical Therapy of Cupertino, Inc., a California
corporation
Orthopedic Appliances, Inc., an Iowa corporation
Orthopedic Rehabilitative Services, Ltd., an Illinois corporation
Orthotic & Prosthetic Rehabilitation Technologies, Inc., a Florida corporation
Orthotic and Prosthetic Associates, Inc., a Massachusetts corporation
Orthotic Specialists, Inc., a Michigan corporation
Paralign Staffing Technologies, Inc., an Arizona corporation
Peter Trailov R.P.T. Physical Therapy Clinic, Orthopaedic Rehabilitation &
Sports Medicine, Ltd., an Illinois corporation
Peters, Starkey & Todrank Physical Therapy Corporation, a California
corporation
Physical Focus, Inc., a Delaware corporation
Physical Rehabilitation Partners, Inc., a Louisiana corporation
Physical Restoration Laboratories, Inc. an Illinois corporation
Physical Therapy Clinic of Lee's Summit, Inc., a Missouri corporation
Physical Therapy Enterprises, Inc., an Arizona corporation
Physical Therapy Institute, Inc., a Louisiana corporation
Physical Therapy Services of the Jersey Cape, Inc., a New Jersey corporation
Pro Active Therapy of Ahoskie, Inc., a North Carolina corporation
Pro Active Therapy of Gaffney, Inc., a South Carolina corporation
Pro Active Therapy of Greenville, Inc., a North Carolina corporation
Pro Active Therapy of North Carolina, Inc., a North Carolina corporation
Pro Active Therapy of Rocky Mount, Inc., a North Carolina corporation
Pro Active Therapy of South Carolina, Inc., a South Carolina corporation
Pro Active Therapy of Virginia, Inc., a Virginia corporation
Pro Active Therapy, Inc., a North Carolina corporation
Professional Insurance Planners of Florida, Inc., a Florida corporation
Professional Orthotics and Prosthetics, Inc., a New Mexico corporation
Professional Orthotics and Prosthetics, Inc. of Santa Fe, a New Mexico
corporation
Professional Therapeutic Services, Inc., an Ohio corporation
Progressive Orthopedic , a California corporation
Prosthetics-Orthotics Associates, Inc. an Illinois corporation
Protech Orthotic and Prosthetic Center, Inc., an Illinois corporation
Quad City Management, Inc., an Iowa corporation
RCI (Colorado), Inc., a Delaware corporation
RCI (Exertec), Inc., a Delaware corporation
RCI (Illinois), Inc., an Illinois corporation
RCI (Michigan), Inc., a Delaware corporation
RCI (S.P.O.R.T.), Inc., a Delaware corporation
RCI (WRS), Inc., an Illinois corporation
RCI Nevada, Inc., a Delaware corporation
Rebound Oklahoma, Inc., an Oklahoma corporation
Redwood Pacific Therapies, Inc., a California corporation
<PAGE> 5
Rehab Managed Care of Arizona, Inc., a Delaware corporation
Rehab Provider Network - California, Inc., a California corporation
Rehab Provider Network - Delaware, Inc., a Delaware corporation
Rehab Provider Network - Georgia, Inc., a Georgia corporation
Rehab Provider Network - Illinois, Inc., an Illinois corporation
Rehab Provider Network - Indiana, Inc., an Indiana corporation
Rehab Provider Network - Maryland, Inc., a Maryland corporation
Rehab Provider Network - Michigan, Inc., a Michigan corporation
Rehab Provider Network - New Jersey, Inc., a New Jersey corporation
Rehab Provider Network - Ohio, Inc., an Ohio corporation
Rehab Provider Network - Oklahoma, Inc., an Oklahoma corporation
Rehab Provider Network - Pennsylvania, Inc., a Pennsylvania corporation
Rehab Provider Network - Virginia, Inc., a Virginia corporation
Rehab Provider Network - Washington, D.C., Inc., a District of Columbia
corporation
Rehab Provider Network of Colorado, Inc., a Colorado corporation
Rehab Provider Network of Florida, Inc., a Florida corporation
Rehab Provider Network of Nevada, Inc., a Nevada corporation
Rehab Provider Network of New Mexico, Inc., a New Mexico corporation
Rehab Provider Network of North Carolina, Inc., a North Carolina corporation
Rehab Provider Network of Texas, Inc., a Texas corporation
Rehab Provider Network of Wisconsin, Inc., a Wisconsin corporation
Rehab World, Inc., a Delaware corporation
Rehab/Work Hardening Management Associates, Ltd., a Pennsylvania corporation
RehabClinics (COAST), Inc., a Delaware corporation
RehabClinics (GALAXY), Inc., an Illinois corporation
RehabClinics (New Jersey), Inc., a Delaware corporation
RehabClinics (PTA), Inc., a Delaware corporation
RehabClinics (SPT), Inc., a Delaware corporation
RehabClinics Abilene, Inc., a Delaware corporation
RehabClinics Dallas, Inc., a Delaware corporation
RehabClinics Pennsylvania, Inc., a Pennsylvania corporation
RehabClinics, Inc., a Delaware corporation
Rehabilitation Fabrication, Inc., a Massachusetts corporation
Rehabilitation Management, Inc., a Delaware corporation
Reid Medical System, Inc., a Florida corporation
Robert M. Bacci, R.P.T. Physical Therapy, Inc., a California corporation
Robin-Aids Prosthetics, Inc., a California corporation
S.T.A.R.T., Inc., a Massachusetts corporation
SG Rehabilitation Agency, Inc, a Pennsylvania corporation
SG Speech Associates, Inc., a Pennsylvania corporation
Salem Orthopedic & Prosthetic, Inc., an Oregon corporation
San Joaquin Orthopedic, Inc., a California corporation
Scott G. Knoche, Inc., a Missouri corporation
Sierra Nevada Physical Therapy Corporation, a California corporation
South Jersey Physical Therapy Associates, Inc., a New Jersey corporation
South Jersey Rehabilitation and Sports Medicine Center, Inc., a New Jersey
corporation
Southern Illinois Prosthetic & Orthotic, Ltd., an Illinois corporation
Southern Illinois Prosthetic & Orthotic of Missouri, Ltd., a Missouri
corporation
Southpointe Fitness Center, Inc., a Pennsylvania corporation
Southwest Emergency Associates, Inc., an Arizona corporation
Southwest Medical Supply Company, a New Mexico corporation
<PAGE> 6
Southwest Physical Therapy, Inc., a New Mexico corporation
Southwest Therapists, Inc., a New Mexico corporation
Sporthopedics Sports and Physical Therapy Centers, Inc., a California
corporation
Sports Therapy and Arthritis Rehabilitation, Inc., a Delaware corporation
Star Physical Therapy, Inc., a Florida corporation
Stephenson-Holtz, Inc., a California corporation
T.D. Rehab Systems, Inc., a New Jersey corporation
T.J. Corporation I, L.L.C., a Delaware limited liability corporation
T.J. Partnership I, a Delaware general partnership
Texoma Health Care Center, Inc., a Texas corporation
The Center for Physical Therapy and Rehabilitation, Inc., a New Mexico
corporation
The Orthopedic Sports and Industrial Rehabilitation Network, Inc., a
Pennsylvania corporation
Theodore Dashnaw Physical Therapy, Inc., a California corporation
Treister, Inc., an Ohio corporation
Tucson Limb & Brace, Inc., an Arizona corporation
Union Square Center for Rehabilitation & Sports Medicine, Inc., a California
corporation
University Orthotic & Prosthetic Consultants, Ltd., a Pennsylvania corporation
Valley Group Physical Therapists, Inc., a Pennsylvania corporation
Vanguard Rehabilitation, Inc., an Arizona corporation
Wayzata Physical Therapy Center, Inc., a Minnesota corporation
West Side Physical Therapy, Inc., an Ohio corporation
West Suburban Health Partners, Inc., a Minnesota corporation
Western Missouri Rehabilitation Services, Inc., a Missouri corporation
Worker Rehabilitation Services, Inc., an Illinois corporation
Yuma Rehabilitation Center, Inc., an Arizona corporation
<PAGE> 1
Exhibit 23
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statements on Form S-8 (No. 33-88744, 33-88745, 33-88746 and 333-70653) of
NovaCare, Inc. of our report dated August 30, 1999, except for third and fourth
paragraphs of Note 2 as to which the date is September 10, 1999, which report
includes an explanatory paragraph addressing matters which raise substantial
doubt about the Company's ability to continue as a growing concern, relating to
the financial statements and financial statement schedule, which appears on
page 59 of this Form 10-K.
PricewaterhouseCoopers LLP
Philadelphia, PA
September 20, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AS OF JUNE 30, 1999 AND THE CONSOLIDATED STATEMENT OF
OPERATIONS FOR THE YEAR ENDED JUNE 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH STATEMENT IN FORM 10-K FOR THE YEAR ENDED JUNE 30, 1999.
</LEGEND>
<CIK> 0000802843
<NAME> NOVACARE,INC.
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<PERIOD-START> JUN-30-1998
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<CASH> 23,277
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<RECEIVABLES> 231,866
<ALLOWANCES> 38,459
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<CURRENT-ASSETS> 388,490
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0
0
<COMMON> 686
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<CGS> 0
<TOTAL-COSTS> 1,430,210<F1>
<OTHER-EXPENSES> 68,540<F2>
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<EPS-BASIC> (3.02)<F3>
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<FN>
<F1>"TOTAL COSTS" CONSIST OF COST OF SERVICES AND SELLING AND ADMINISTRATIVE
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<F2>"OTHER EXPENSES" CONSIST OF AMORTIZATION OF GOODWILL, MINORITY INTEREST,
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