<PAGE> 1
U N I T E D S T A T E S
S E C U R I T I E S A N D E X C H A N G E C O M M I S S I O N
W A S H I N G T O N, D C 2 0 5 4 9
FORM 10-Q/A
AMENDMENT NO. 1
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 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 W. NINTH AVENUE, KING OF PRUSSIA, PA 19406
(Address of principal executive office) (Zip code)
Registrant's telephone number: (610) 992-7200
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
As of April 30, 1999, NovaCare, Inc. had 63,155,560 shares of common stock, $.01
par value, outstanding.
<PAGE> 2
NOVACARE, INC. AND SUBSIDIARIES
FORM 10-Q - QUARTER ENDED MARCH 31, 1999
INDEX
<TABLE>
<CAPTION>
PART NO. ITEM NO. DESCRIPTION PAGE NO.
- -------- -------- ----------- --------
<S> <C> <C> <C>
I FINANCIAL INFORMATION
1 Financial Statements
-Condensed Consolidated Balance
Sheets as of March 31, 1999 and
June 30, 1998 1
-Condensed Consolidated Statements of
Operations for the Three Months Ended
March 31, 1999 and 1998 2
-Condensed Consolidated Statements of
Operations for the Nine Months Ended
March 31, 1999 and 1998 3
-Condensed Consolidated Statements of
Cash Flows for the Nine Months Ended
March 31, 1999 and 1998 4
-Notes to Condensed Consolidated
Financial Statements 5-11
2 Management's Discussion and Analysis of
Financial Condition and Results of
Operations 12-21
II OTHER INFORMATION
6 Exhibits and Reports on Form 8-K 22
Signatures 23
</TABLE>
i
<PAGE> 3
NOVACARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF MARCH 31, 1999 AND JUNE 30, 1998
(In thousands, except per share data)
<TABLE>
<CAPTION>
MARCH 31, June 30,
1999 1998
------------ ------------
<S> <C> <C>
ASSETS (UNAUDITED) (See Note 1)
Current assets:
Cash and cash equivalents........................ $ 23,804 $ 32,760
Accounts receivable, net of allowances at
March 31, 1999 and at June 30, 1998 of $42,774
and $55,060, respectively....................... 301,369 338,328
Inventories...................................... 45,135 38,207
Income tax receivable............................ 27,869 --
Deferred income taxes............................ 14,580 14,580
Other current assets............................. 27,771 27,978
------------ ------------
Total current assets.......................... 440,528 451,853
Property and equipment, net........................ 64,541 80,857
Excess cost of net assets acquired, net (principally
goodwill)........................................ 719,592 767,729
Investments in joint ventures...................... 15,203 14,881
Other assets, net.................................. 49,965 40,722
------------ ------------
$1,289,829 $1,356,042
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of financing arrangements...... $540,696 $ 32,074
Accounts payable and accrued expenses.......... 160,796 193,025
Income taxes payable........................... -- 981
------------ ------------
Total current liabilities................... 701,492 226,080
Financing arrangements, net of current portion... 55,267 476,308
Deferred income taxes............................ 41,684 41,067
Other............................................ 6,200 13,608
------------ ------------
Total liabilities........................... 804,643 757,063
------------ ------------
Minority interest in consolidated subsidiaries... 27,501 18,306
Commitments and contingencies.................... -- --
Shareholders' equity:
Common stock, $.01 par value; authorized
200,000 shares; issued 68,371 shares at
March 31, 1999 and issued 67,935 shares at
June 30, 1998................................... 684 679
Additional paid-in capital....................... 274,285 273,157
Retained earnings................................ 225,388 350,255
------------ ------------
500,357 624,091
Less: Common stock in treasury (at cost), 5,307
shares at March 31, 1999 and 5,401 shares at
June 30, 1998................................... (42,672) (43,418)
------------ ------------
Total shareholders' equity.................... 457,685 580,673
------------ ------------
$1,289,829 $1,356,042
============ ============
</TABLE>
The accompanying Notes to Condensed Consolidated Financial
Statements are an integral part of these statements.
1
<PAGE> 4
NOVACARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
MARCH 31,
---------------------------
1999 1998
------------ ------------
<S> <C> <C>
Net revenues....................................... $437,307 $451,767
Cost of services................................... 386,997 358,199
------------ ------------
Gross profit.................................... 50,310 93,568
Selling, general and administrative expenses....... 51,945 52,551
Provision for uncollectible accounts............... 8,378 6,009
Amortization of excess cost of net assets acquired. 6,301 5,230
Provision for restructure, net..................... 111,947 --
------------ ------------
(Loss) income from operations................... (128,261) 29,778
Investment income.................................. 127 171
Interest expense................................... (9,667) (7,628)
Minority interest.................................. (886) (467)
------------ ------------
(Loss) income before income taxes............... (138,687) 21,854
Income taxes....................................... (26,645) 9,209
------------ ------------
Net (loss) income............................... $(112,042) $ 12,645
============ ============
Net (loss) income per share - basic............. $ (1.78) $ .21
============ ============
Net (loss) income per share - assuming dilution. $ (1.78) $ .20
============ ============
</TABLE>
The accompanying Notes to Condensed Consolidated Financial
Statements are an integral part of these statements.
2
<PAGE> 5
NOVACARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDED
MARCH 31,
--------------------------------
1999 1998
----------- -----------
<S> <C> <C>
Net revenues ..................................... $ 1,398,830 $ 1,207,283
Cost of services ................................. 1,183,863 948,985
----------- -----------
Gross profit .................................. 214,967 258,298
Selling, general and administrative expenses ..... 158,223 147,589
Provision for uncollectible accounts ............. 23,439 15,957
Amortization of excess cost of net assets acquired 18,789 14,495
Provision for restructure, net ................... 129,747 23,500
----------- -----------
Income from operations ........................ (115,231) 56,757
Gain from issuance of subsidiary stock ........... 1,506 38,128
Investment income ................................ 423 617
Interest expense ................................. (28,373) (20,117)
Minority interest ................................ (2,355) (887)
----------- -----------
(Loss) income before income taxes ............. (144,030) 74,498
Income taxes ..................................... (19,163) 31,057
----------- -----------
Net (loss) income ............................. $ (124,867) $ 43,441
=========== ===========
Net (loss) income per share - basic ........... $ (1.99) $ .71
=========== ===========
Net (loss) income per share - assuming dilution $ (1.99) $ .69
=========== ===========
</TABLE>
The accompanying Notes to Condensed Consolidated Financial
Statements are an integral part of these statements.
3
<PAGE> 6
NOVACARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDED
MARCH 31,
---------------------------
1999 1998
------------ ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income .................................... $(124,867) $ 43,441
Adjustments to reconcile net income to net cash
flows provided by operating activities:
Provision for restructure, net .................... 129,747 23,500
Gain from issuance of subsidiary stock ............ (1,506) (38,128)
Depreciation and amortization ..................... 42,543 37,165
Provision for uncollectible accounts .............. 23,439 15,957
Minority interest ................................. 2,355 887
Deferred income taxes ............................. 617 5,856
Changes in assets and liabilities, net of effects
from acquisitions:
Accounts and notes receivable .................. 10,564 (66,440)
Inventories .................................... (6,960) (10,595)
Other current assets ........................... (475) (5,982)
Accounts payable and accrued expenses .......... (56,940) 15,761
Income taxes payable ........................... (28,850) 11,089
Other, net ..................................... (3,825) (1,071)
--------- ---------
Net cash flows (used in) provided by operating
activities ..................................... (14,158) 31,440
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Payments for businesses acquired,
net of cash acquired ............................... (56,434) (144,677)
Net additions to property and equipment .............. (28,767) (20,818)
Other, net ........................................... 857 (2,497)
--------- ---------
Net cash flows (used in) investing activities .. (84,344) (167,992)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from financing arrangements ................. 351,280 364,140
Payment of financing arrangements .................... (263,420) (259,389)
Proceeds from common stock issued .................... 1,681 4,855
Proceeds from the issuance of subsidiary stock ....... 5 45,719
--------- ---------
Net cash flows provided by financing activities. 89,546 155,325
--------- ---------
Net (decrease) increase in cash and cash equivalents . (8,956) 18,773
Cash and cash equivalents, beginning of period ....... 32,760 22,716
--------- ---------
Cash and cash equivalents, end of period ............. $ 23,804 $ 41,489
========= =========
Supplemental disclosures of cash flow information:
Interest paid ................................... $ 28,622 $ 15,130
========= =========
Income taxes paid ............................... $ 9,162 $ 14,196
========= =========
</TABLE>
The accompanying Notes to Condensed Consolidated Financial
Statements are an integral part of these statements.
4
<PAGE> 7
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999
(In thousands, except per share data)
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements of NovaCare,
Inc. (the "Company") are unaudited. The balance sheet as of June 30, 1998 is
condensed from the audited balance sheet of the Company at that date. These
statements have been prepared in accordance with the rules and regulations of
the Securities and Exchange Commission and should be read in conjunction with
the Company's consolidated financial statements and the notes thereto for the
year ended June 30, 1998. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with
generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations. In the opinion of Company management,
the condensed consolidated financial statements for the unaudited interim
periods presented include all adjustments (consisting of only normal
recurring adjustments) necessary to present a fair statement of the results
for such interim periods.
Operating results for the three- and nine-month periods ended March 31,
1999 are not necessarily indicative of the results that may be expected for a
full year or any portion thereof.
2. PROVISION FOR RESTRUCTURE, NET
In the nine-months ended March 31, 1999, the Company recorded a net
provision for restructure of $129,747 composed of the following:
<TABLE>
<S> <C>
Long-term care services................... $ 98,647
Outpatient services....................... 31,100
---------
Net restructure provision............ $ 129,747
==========
</TABLE>
LONG-TERM CARE SERVICES
In the second quarter of fiscal 1998 the Company recorded a provision for
restructure of $23,500 based on an evaluation of the impact of changes in the
Medicare reimbursement system mandated by the Balanced Budget Act of 1997
(the "BBA") on the Company's long-term care services segment. The provision
related principally to severance costs associated with personnel changes
required by the Company's revised operating model in the long-term care
services segment. The provision anticipated the severance of approximately
2,975 employees.
During the second quarter of 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. Accordingly, the Company
determined that $6,750 was required to complete the conversion of the
Company's long-term care services segment to the revised operating model and
reversed $13,300 of the remaining balance of the December 31, 1997
restructure reserve at that date. As of March 31, 1999, 1,441 employees have
been terminated related to this charge and the remaining liability is $278.
In the third quarter of fiscal 1999, the Company continued to experience a
significant reduction in revenues in the long-term care services segment.
This decline resulted from a combination of, reduced patient volume (related
to, fewer therapy patients per customer facility, contract cancellations and
fewer treatments per patient) and lower prices reflecting reduced
reimbursement rates under the BBA. In order to mitigate the effect of these
trends, the Company is in the process of implementing a restructure plan
which involves a complete exit of selected long-term care markets with low
customer and therapist concentration. These markets are generally in the
Western United States and include California, Colorado, Texas and the
Northwest. The Company intends to concentrate its efforts in markets that are
believed to have sufficient patient density to support profitable operations.
5
<PAGE> 8
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999
(In thousands, except per share data)
(Unaudited)
Despite implementation of the revised operating plan, the Company has
determined that it will be unable to recover its investment in long-lived
assets in the long-term care services segment. Accordingly, the Company
recorded a provision for restructure of $111,947 in the three months ended
March 31,1999 to write-off all of its investment in these assets and to
provide for the costs of exiting the selected markets, consisting principally
of employee severance costs.
The third quarter provision for restructure consists of the following:
<TABLE>
<S> <C>
Write down of excess cost of net assets
acquired, net............................ $ 73,716
Write down of property and equipment..... 20,748
Employee severance and other............. 17,483
--------
Total fiscal 1999 provision, net..... $111,947
========
</TABLE>
The exit plan calls for the termination of approximately 1,300 employees,
of which approximately 1,200 are direct care providers in the geographic
regions being exited and the remainder are general and administrative support
personnel.
The Company continues to evaluate its alternatives with respect to the
long-term care services segment, which could involve: (i) further efforts to
reduce costs and improve patient density in the segment's remaining markets,
(ii) a complete exit of all long-term care services markets, or (iii) a sale
of the remaining long-term care services segment. The Company believes that
the maximum additional loss that might be incurred under the preceding
scenarios (ii) and (iii) would be approximately $52,000.
OUTPATIENT SERVICES
During the second quarter of fiscal 1999, the Company decided to exit
certain non-strategic markets being served by its outpatient physical therapy
and rehabilitation and occupational health business ("PROH"). The markets
consist of 40 PROH clinics. The decision resulted in a write-down of the
value of the related assets to estimated net realizable value. The related
provision for restructure is as follows:
<TABLE>
<S> <C>
Write down of excess cost of net assets
acquired, net............................. $ 28,300
Employee severance and other.............. 2,800
---------
Total provision for restructure....... $ 31,100
=========
</TABLE>
The estimated net realizable value of PROH assets (principally excess cost
of net assets acquired, net) was determined by reference to the Company's
experience with purchases and sales of comparable assets over the past
several years and in consultation with financial advisors. The clinics to be
disposed of had annualized net revenues of approximately $16,600 and
annualized operating profit of approximately $200. The annualized pre-tax
effect of suspending depreciation and amortization on these assets is
approximately $800. At March 31, 1999, two of the clinics have been sold for
proceeds totaling $483. The net book value of the remaining assets to be sold
is approximately $6,300. All clinics are expected to be sold by September 30,
1999.
6
<PAGE> 9
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999
(In thousands, except per share data)
(Unaudited)
Activity related to the fiscal 1998 and 1999 restructuring charges is as
follows:
FISCAL 1998 PROVISION FOR RESTRUCTURE:
<TABLE>
<CAPTION>
FOR THE NINE MONTHS
ENDED MARCH 31,
----------------------------
1999 1998
------------ ------------
<S> <C> <C>
Beginning balance......................... $ 22,348 $ --
Provision for restructure................. (13,300) 23,500
Less: non cash charges.................... -- (360)
Payments and other reductions............. (8,770) (373)
----------- -----------
Ending balance............................ $ 278 $ 22,767
=========== ============
</TABLE>
FISCAL 1999 PROVISION FOR RESTRUCTURE:
<TABLE>
<CAPTION>
FOR THE NINE MONTHS
ENDED, MARCH 31,
1999
---------------------
<S> <C>
Beginning balance............................ $ --
Provision for restructure.................... 143,047
Less: non cash charges....................... (122,764)
Payments and other reductions................ (383)
---------------------
Ending balance............................... $ 19,900
=====================
</TABLE>
7
<PAGE> 10
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999
(In thousands, except per share data)
(Unaudited)
3. NET (LOSS) INCOME PER SHARE
The following table sets forth the computation and reconciliation of net
(loss) income per share-basic and net (loss) income per share-assuming
dilution:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED MARCH 31, ENDED MARCH 31,
---------------------------- ----------------------------
1999 1998 1999 1998
------------ ---------- ---------- ---------
<S> <C> <C> <C> <C>
NET (LOSS) INCOME .............. $ (112,042) $12,645 $ (124,867) $43,441
=========== ======= =========== =======
WEIGHTED AVERAGE SHARES
OUTSTANDING:
WEIGHTED AVERAGE SHARES
OUTSTANDING - BASIC ......... 62,930 61,486 62,738 61,275
Stock options ................ -- 1,755 -- 1,908
Contingently issuable
shares - assuming dilution .. -- 43 -- 43
----------- ------- ----------- -------
WEIGHTED AVERAGE SHARES
OUTSTANDING - ASSUMING
DILUTION .................... 62,930 63,284 62,738 63,226
=========== ======= =========== =======
NET (LOSS) INCOME PER
SHARE - BASIC ............... $ (1.78) $ .21 $ (1.99) $ .71
=========== ======= =========== =======
NET (LOSS) INCOME PER
SHARE - ASSUMING DILUTION $ (1.78) $ .20 $ (1.99) $ .69
=========== ======= =========== =======
</TABLE>
The Company did not include convertible subordinated debentures,
equivalent to 6,567 shares of common stock, or options to purchase 9,653 and
216 shares of common stock for the three-month periods and 7,066 and 79
shares of common stock for the nine-month periods ended March 31, 1999 and
1998, respectively, because their effects are anti-dilutive. There were no
transactions that occurred subsequent to March 31, 1999 that would have
materially changed the number of shares used in computing net income per
share-basic or net income per share-assuming dilution.
4. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses are summarized as follows:
<TABLE>
<CAPTION>
MARCH 31, June 30,
1999 1998
---------- --------
<S> <C> <C>
Accounts payable .............................. $ 27,146 $ 19,679
Accrued compensation and benefits ............. 67,876 87,985
Accrued costs of productivity and cost
improvement programs ....................... 22,879 23,748
Accrued workers' compensation and
health claims .............................. 16,804 25,000
Deferred and contingent purchase price
obligations ................................ 7,379 8,756
Accrued interest .............................. 4,885 7,080
Other ......................................... 13,827 20,777
-------- --------
$160,796 $193,025
======== ========
</TABLE>
8
<PAGE> 11
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999
(In thousands, except per share data)
(Unaudited)
5. FINANCING ARRANGEMENTS
Financing arrangements consisted of the following:
<TABLE>
<CAPTION>
MARCH 31, June 30,
1999 1998
------------ ------------
<S> <C> <C>
Revolving credit facility (LIBOR plus 3%), due
December 31, 1999 ........................... $337,000 $227,500
Convertible subordinated debentures (5.5%), due
January 2000 ................................... 175,000 175,000
Subordinated promissory notes (5% to 10%),
through 2007 ................................... 80,770 98,318
$25,000 revolving credit facility of subsidiary,
due November 17, 2000 .......................... -- --
Other .......................................... 3,193 7,564
-------- --------
595,963 508,382
Less: current portion ......................... 540,696 32,074
-------- --------
$ 55,267 $476,308
======== ========
</TABLE>
The Company has a revolving credit facility with a syndicate of lenders.
The facility is collateralized by substantially all the common stock of the
Company's subsidiaries and accounts receivable.
Maximum amounts which may be borrowed under the revolving credit facility
are the lesser of (a) projected borrowings plus $10,000 or (b) $375,000
through May 31, 1999; $400,000 from June 1 through July 9, 1999; and $50,000
from the earlier of the sale of the Company's orthotic and prosthetic
business ("O&P") (see note 8) or July 10, 1999. All financial covenants have
been eliminated.
NovaCare Employee Services, Inc. ("NCES") has a revolving credit facility
with a syndicate of lenders. As of March 31, 1999 and 1998, there were no
borrowings or letters of credit outstanding.
6. 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
material adverse effect on the financial position or results of operations of
the Company.
Certain purchase agreements require additional payments if specific
financial conditions are met. Aggregate contingent payments in connection
with these acquisitions at March 31, 1999 of approximately $70,423 in cash
and common stock of NCES have not been included in the initial determination
of cost of the businesses acquired since the amount of such contingent
consideration, if any, is not presently determinable. For the nine-months
ended March 31, 1999 and March 31, 1998, the Company paid $10,991 and $27,594
in cash and common stock of NCES, respectively, and issued 53 and 65 shares,
respectively, of the Company's common stock in connection with businesses
acquired in prior years.
7. OPERATING SEGMENTS
The Company adopted Statement of Financial Accounting Standards ("SFAS")
No. 131, "Disclosures About Segments of an Enterprise and Related
Information" in fiscal 1998. Segment information is presented for outpatient
services, long-term care services and employee services, consistent with the
Company's reporting, organization and management structure.
9
<PAGE> 12
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999
(In thousands, except per share data)
(Unaudited)
Operating results and other financial data are presented for the principal
operating segments of the Company as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
------------------------------- -------------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
NET REVENUES:
Outpatient services ............ $ 145,572 $ 130,928 $ 448,726 $ 370,194
Long-term care services ........ 68,616 176,309 332,261 497,335
Employee services .............. 384,029 338,367 1,170,228 907,875
----------- ----------- ----------- -----------
Total ....................... 598,217 645,604 1,951,215 1,775,404
Intrasegment elimination-
employee services ........... (160,910) (193,837) (552,385) (568,121)
----------- ----------- ----------- -----------
Consolidated revenues ....... $ 437,307 $ 451,767 $ 1,398,830 $ 1,207,283
=========== =========== =========== ===========
GROSS PROFIT:
Outpatient services ............ $ 42,078 $ 37,463 $ 131,757 $ 110,144
Long-term care services ........ 2,365 51,651 65,772 140,212
Employee services .............. 16,717 11,302 47,379 29,042
----------- ----------- ----------- -----------
Total ....................... 61,160 100,416 244,908 279,398
Intrasegment elimination-
employee services ........... (7,690) (3,725) (20,118) (12,367)
Depreciation ................... (3,160) (3,123) (9,823) (8,733)
----------- ----------- ----------- -----------
Consolidated gross profit ... $ 50,310 $ 93,568 $ 214,967 $ 258,298
=========== =========== =========== ===========
(LOSS) INCOME FROM OPERATIONS:
Outpatient services ............ $ 12,938 $ 12,310 $ 46,305 $ 42,025
Long-term care services ........ (12,540) 33,431 18,826 89,772
Employee services .............. 4,872 2,840 13,128 7,253
----------- ----------- ----------- -----------
Total ....................... 5,270 48,581 78,259 139,050
Unallocated selling, general and
administrative expenses ..... (21,584) (18,803) (63,743) (58,793)
Provision for restructure ...... (111,947) -- (129,747) (23,500)
----------- ----------- ----------- -----------
Consolidated (loss)
income from operations .... $ (128,261) $ 29,778 $ (115,231) $ 56,757
=========== =========== =========== ===========
</TABLE>
10
<PAGE> 13
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
-------------------------- --------------------------
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
DEPRECIATION AND AMORTIZATION:
Outpatient services ......... $ 7,691 $ 6,621 $ 23,074 $ 18,118
Long-term care services ..... 2,939 3,063 9,336 8,808
Employee services ........... 1,315 1,041 3,901 2,736
--------- --------- --------- ---------
Total .................... 11,945 10,725 36,311 29,662
Unallocated selling,
general and administrative
expenses ................ 2,074 2,508 6,232 7,503
--------- --------- --------- ---------
Consolidated
depreciation and
amortization ........... $ 14,019 $ 13,233 $ 42,543 $ 37,165
========= ========= ========= =========
EARNINGS BEFORE INTEREST, INCOME TAXES, DEPRECIATION AND AMORTIZATION ("EBITDA"):
Outpatient services ......... $ 20,629 $ 18,931 $ 69,379 $ 60,143
Long-term care services ..... (9,601) 36,494 28,162 98,580
Employee services ........... 6,187 3,881 17,029 9,989
--------- --------- --------- ---------
Total .................... 17,215 59,306 114,570 168,712
Unallocated selling,
general and administrative
expenses ............... (19,510) (16,295) (57,511) (51,290)
Provision for restructure ... (111,947) -- (129,747) (23,500)
--------- --------- --------- ---------
Consolidated EBITDA ...... $(114,242) $ 43,011 $ (72,688) $ 93,922
========= ========= ========= =========
</TABLE>
<TABLE>
<CAPTION>
AS OF As of
MARCH 31, June 30,
1999 1998
------------ ------------
<S> <C> <C>
SEGMENT ASSETS:
Outpatient services ... $ 921,858 $ 876,250
Long-term care services 171,612 326,872
Employee services ..... 127,078 112,583
Unallocated assets .... 69,281 40,337
---------- ----------
$1,289,829 $1,356,042
========== ==========
</TABLE>
8. SUBSEQUENT EVENTS
On April 5, 1999, the Company announced the execution of a definitive
agreement to sell O&P to Hanger Orthopedic Group, Inc. ("Hanger"). Under the
terms of the agreement, Hanger will pay the Company total consideration of
approximately $455,000, including the payment of approximately $417,000 of
cash and the assumption of approximately $38,000 of debt. The transaction is
subject to certain regulatory approvals. Net proceeds from the sale will
principally be used to repay amounts borrowed under the Company's revolving
credit facility agreement.
11
<PAGE> 14
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
Operating Segments
In fiscal 1998, NovaCare, Inc. (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.
Consistent with the Company's reporting, organization and management
structure, the Company presents segment information for outpatient services,
long-term care services and employee services. Segment information for the
three- and nine-month periods ended March 31, 1998 has been restated to
conform to the requirements of SFAS No. 131.
See Note 7 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.
Provision for Restructure, Net
In the nine-months ended March 31, 1999, the Company recorded a net $129.7
million restructure provision composed of the following (in thousands):
<TABLE>
<S> <C>
Long-term care services ...... $ 98,647
Outpatient services .......... 31,100
--------
Net restructure provision $129,747
========
</TABLE>
LONG-TERM CARE SERVICES
In the second quarter of fiscal 1998 the Company recorded a restructure
charge of $23.5 million based on an evaluation of the impact of changes in
the Medicare reimbursement system mandated by the Balanced Budget Act of 1997
(the "BBA") on the Company's long-term care services segment. The provision
related principally to severance costs associated with personnel changes
required by the Company's revised operating model in the long-term care
services segment. The provision anticipated the severance of approximately
2,975 employees.
During the second quarter of 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. Accordingly, the Company
determined that $6.8 million was required to complete the conversion of the
Company's long-term care services segment to the revised operating model and
reversed $13.3 million of the remaining balance of the December 31, 1997
restructure reserve at that date. As of March 31, 1999, 1,441 employees have
been terminated related to this charge and the remaining liability is
approximately $0.3 million.
12
<PAGE> 15
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
In the third quarter of fiscal 1999, the Company continued to experience a
significant reduction in revenues in the long-term care services segment.
This decline resulted from a combination of, reduced patient volume (related
to, fewer therapy patients per customer facility, contract cancellations and
fewer treatments per patient) and lower prices reflecting reduced
reimbursement rates under the BBA. In order to mitigate the effect of these
trends, the Company is in the process of implementing a restructure plan
which involves a complete exit of selected long-term care markets with low
customer and therapist concentration. These markets are generally in the
Western United States and include California, Colorado, Texas and the
Northwest. The Company intends to concentrate its efforts in markets that are
believed to have sufficient patient density to support profitable operations.
Despite implementation of the revised operating plan, the Company has
determined that it will be unable to recover its investment in long-lived
assets in the long-term care services segment. Accordingly, the Company
recorded a provision for restructure of $111.9 million in the three months
ended March 31,1999 to write-off all of its investment in these assets and to
provide for the costs of exiting the selected markets, consisting principally
of employee severance costs.
The third quarter provision for restructure consists of the following (in
thousands):
<TABLE>
<S> <C>
Write down of excess cost of net assets
acquired, net ......................... $ 73,716
Write down of property and equipment .. 20,748
Employee severance and other .......... 17,483
--------
Total fiscal 1999 provision, net .. $111,947
========
</TABLE>
The exit plan calls for the severance of approximately 1,300 employees, of
which approximately 1,200 are direct care providers in the geographic regions
being exited and the remainder are general and administrative support
personnel.
The provision for restructure, net for the long-term care services segment
for the nine months ended March 31, 1999 totaled $98.6 million, consisting of
the fiscal 1999 third quarter provision and the reversal of the fiscal 1998
provision in the second quarter of fiscal 1999.
The Company continues to evaluate its alternatives with respect to the
long-term care services segment, which could involve: (i) further efforts to
reduce costs and improve patient density in the segment's remaining markets,
(ii) a complete exit of all long-term care services markets, or (iii) a sale
of the remaining long-term care services segment. The Company believes that
the maximum additional loss that might be incurred under the preceding
scenarios (ii) and (iii) would be approximately $52.0 million.
OUTPATIENT SERVICES
During the second quarter of fiscal 1999, the Company decided to exit
certain non-strategic markets being served by its outpatient physical therapy
and rehabilitation and occupational health business ("PROH"). The markets
consist of 40 PROH clinics. The decision resulted in a write-down of the
value of the related assets to estimated net realizable value. The related
provision for restructure is as follows (in thousands):
<TABLE>
<S> <C>
Write down of excess cost of net assets
acquired, net ......................... $28,300
Employee severance and other .......... 2,800
-------
Total provision for restructure ... $31,100
=======
</TABLE>
13
<PAGE> 16
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
The estimated net realizable value of PROH assets (principally excess cost
of net assets acquired, net) was determined by reference to the Company's
experience with purchases and sales of comparable assets over the past
several years and in consultation with financial advisors. The clinics to be
disposed of had annualized net revenues of approximately $16.6 million and
annualized operating profit of approximately $0.2 million. The annualized
pre-tax effect of suspending depreciation and amortization on these assets is
approximately $0.8 million. At March 31, 1999, two of the clinics have been
sold for proceeds totaling $0.5 million. The net book value of the remaining
assets to be sold is approximately $6.3 million. All clinics are expected to
be sold by September 30, 1999.
Regulatory Changes
In the three- and nine-month periods ended March 31, 1999, the long-term
care services segment experienced a decline in earnings compared with the
corresponding periods of fiscal 1998. This reduced operating performance (as
discussed below in the long-term care services section of "Results of
Operations") resulted principally from: (i) lower Medicare reimbursement
rates due to salary equivalency guidelines implemented by the Health Care
Financing Administration ("HCFA") effective April 1998 and a prospective
payment system ("PPS") for Medicare Part A services effective for customer
Medicare cost reporting years beginning July 1, 1998 and thereafter, (ii) an
approximately 36% decline in the number of rehabilitation patients per
Company-served long-term care facility, resulting from the regulatory
uncertainty surrounding the level of reimbursement for therapy services for
Medicare patients under the BBA, and (iii) conversion of certain nursing home
chain customers to in-house therapy programs.
In the fourth quarter of fiscal 1998, HCFA implemented salary equivalency
reimbursement guidelines for occupational therapy and speech language
pathology services and revised guidelines for physical therapy services. The
net effect of these guidelines was to reduce the long-term care services
segment's reimbursement rates and gross profit percentage from previous
levels. Additionally, the BBA requires a change from these salary equivalency
guidelines for therapy services to a PPS for Medicare Part A services
effective for Medicare cost reporting periods beginning July 1, 1998 and
thereafter and a fee schedule with annual maximum payments per patient for
Medicare Part B services effective January 1, 1999.
By changing Medicare reimbursement to long-term care facilities from a
cost basis to a fixed fee, the BBA is a fundamental change in the economic
assumptions underlying patient care in long-term care facilities. Due to the
extensive nature of the reimbursement changes specified by the BBA, the
ultimate effect these changes may have on the demand for services and
management's inability to predict what portion of the PPS and fee schedule
rates that the Company will continue to receive based on negotiated terms of
service contracts with its customers, the Company is unable to determine the
final impact that the BBA will have on its financial position or results of
operations.
Sale of Orthotics and Prosthetic Services Business
On April 5, 1999, the Company announced the execution of a definitive
agreement to sell its orthotic and prosthetic services business ("O&P") to
Hanger Orthopedic Group, Inc. ("Hanger"). Under the terms of the agreement,
Hanger will pay the Company total consideration of approximately $455
million, including the payment of approximately $417 million of cash and the
assumption of approximately $38 million of debt. The transaction is subject
to certain regulatory approvals. The net proceeds from the sale will be used
principally to repay amounts borrowed under the Company's revolving credit
facility agreement.
14
<PAGE> 17
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Corporate and Capital Structure Changes
In addition to the sale of the O&P business, the Company continues to
evaluate its strategic alternatives for obtaining capital to fund its ongoing
working capital needs, satisfy its remaining debt obligations and maximize
shareholder value. Such alternatives include the evaluation of the long-term
care services segment as discussed above, replacing current debt with
long-term financing through a high-yield debt offering or private placement
or the sale of one or more of the Company's remaining businesses. The
feasibility and timing of these alternatives will depend on a variety of
capital markets, tax, regulatory and operations issues.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 1999 VS.
MARCH 31, 1998
Consolidated net revenues were $437.3 million, a decrease of $14.5 million
(3%) over fiscal 1998, reflecting a decline in long-term care services
segment revenue which was only partially offset by expansion in the Company's
outpatient services and employee services segments. The revenue decline in
long-term care services was substantially due to regulatory changes which
resulted in: (i) lower pricing, (ii) fewer patients on caseload, (iii)
contract cancellations, and (iv) lower utilization per patient. Growth in the
outpatient services segment resulted primarily from the effect of fiscal 1998
and fiscal 1999 acquisitions. Growth in the employee services segment was due
to a combination of acquisitions completed subsequent to March 31, 1998,
internal growth, and the entry into new markets. The Company made no
acquisitions in the third quarter of fiscal year 1999, compared with 11
outpatient physical therapy and rehabilitation businesses, and 8 O&P
businesses and two occupational health businesses in the third quarter of
last year.
Consolidated gross profit (excluding depreciation expense) was $53.5
million, a decrease of $43.2 million (45%) from fiscal 1998. The decrease in
gross profit was due to lower net revenues in the long-term care services
segment, which was only partially offset by lower salaries and wages. This
gross profit decrease in long-term care services was partially offset by
acquisitions in the outpatient services and employee services segments and
also same market growth and the entry into new markets in the employee
services segment. Gross profit as a percentage of net revenue ("gross profit
margin") declined to 12% compared with 21% last year, due primarily to lower
gross profit margins in the long-term care services segment.
Other operating expenses, excluding the provision for restructure, which
consist of selling, general and administrative expenses, depreciation,
amortization of excess cost of net assets acquired and provision for
uncollectible accounts were $69.8 million, an increase of $2.9 million (4%)
over fiscal 1998. The increase results principally from businesses acquired
during fiscal 1998 and fiscal 1999. As a percentage of net revenues, other
operating expenses increased to 16% from 15% in fiscal 1998 because the
decrease in net revenues from long-term care services was significantly
greater than the decrease in other operating expenses.
Depreciation expense and amortization of excess cost of net assets
acquired ("amortization") was $14.0 million in the third quarter of fiscal
1999, an increase of $800,000 (6%) over fiscal 1998 as a result of businesses
acquired subsequent to March 31, 1998.
Interest expense, net of investment income, was $9.5 million, an increase
of $2.1 million (28%), over fiscal 1998 as a result of increased borrowings
principally associated with the Company's acquisitions, as discussed under
"Liquidity and Capital Resources."
Income tax benefit for the three months ended March 31, 1999 was
approximately 19% of pre-tax loss as compared to income tax expense of 42.1%
on pre-tax income for the same period in fiscal 1998. The decreased rate
resulted from (i) non-deductible components of the provision for restructure,
(ii) non-deductible amortization, and (iii) the inability to use loss
carrybacks in certain states.
15
<PAGE> 18
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
OPERATING RESULTS BY SEGMENT
Outpatient Services
Net revenues for the outpatient services segment were $145.6 million, an
increase of $14.6 million (11%) over fiscal 1998. The increase in net
revenues was due principally to the effect of fiscal 1998 and fiscal 1999
acquisitions ($18.5 million) and an increase in same market volumes ($4.4
million), partially offset by a decrease in pricing ($8.3 million).
Gross profit (excluding depreciation) was $42.1 million, an increase of
$4.6 million (12%) over the third quarter of fiscal 1998 resulting
principally from the inclusion of businesses acquired in fiscal 1998 and
fiscal 1999 ($5.4 million). The decrease in prices of $8.3 million noted
above was principally offset by cost and productivity improvements ($5.2
million)as well as an increase in patient volume ($2.3 million). Gross profit
margin was 29%, unchanged from the third quarter of fiscal 1998.
Income from operations was $12.9 million, an increase of $600,000 (5%)
over last year. The increase resulted from the higher gross profit noted
above, offset partially by higher provision for uncollectible accounts ($2.4
million), selling, general and administrative expenses ($1.2 million), and
amortization ($1.0 million).
Long-term Care Services
Net revenues for long-term care services were $68.6 million, a decrease of
$107.7 million (61%) from the third quarter of fiscal 1998. The decrease in
net revenues resulted from an overall pricing and patient volume decline. The
pricing and patient volume decreases resulted from: (i) overall lower
reimbursement rates adopted through the implementation of salary equivalency
and the BBA, (ii) decreased Medicare patient census in facilities served due
to the uncertainty of long-term care providers with respect to the
reimbursement economics of Medicare patients under the BBA, and (iii) the
loss of chain contracts that brought their rehabilitation services in-house,
partially offset by new contract sales to small and medium-sized long-term
care providers.
Gross profit (excluding depreciation expense) was $2.4 million, a decrease
of $49.3 million (95%) from last year. The gross profit margin was 3%
compared to 29% last year. The decline in gross profit and gross profit
margin resulted from the lower pricing and patient volume experienced in
fiscal 1999 as a result of regulatory changes, which was only partially
offset by lower salary and wage costs per employee.
Long-term care services incurred a loss from operations (excluding
provision for restructure) of $12.5 million, compared with income from
operations of $33.4 million for the third quarter of fiscal 1998. The
decrease was due to the decline in gross profit, partially offset by lower
selling, general and administrative expenses ($3.2 million).
Employee Services
Employee services net revenues were $384.0 million (before an intercompany
elimination of $160.9 million related to services provided to the outpatient
services and long-term care services segments), an increase of $45.7 million
(13%) over last year's revenues of $338.4 million (before an intercompany
elimination of $193.8 million). The increase in net revenues reflects an
increase of $78.6 million in third-party net revenues due to acquisitions
($30.5 million), the entry into new markets ($27.2 million) and same market
growth ($20.9 million). Revenues earned by the employee services segment
under a contract with the Company's outpatient services and long-term care
services segment (the "NovaCare Contract") decreased principally as a result
of a 18% decrease in the average number of worksite employees, primarily in
the long-term care services segment.
16
<PAGE> 19
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Gross profit was $16.7 million, an increase of $5.4 million (48%) over the
third quarter of fiscal 1998. The gross profit margin was 4% compared to 3%
in the third quarter of fiscal 1998. The increase in gross profit and gross
profit margin resulted from the increase in net revenues described above
($3.0 million) and higher margin services under the NovaCare Contract ($2.4
million).
Income from operations was $4.9 million, an increase of $2.0 million (72%)
over last year. The increase resulted from the improvement in gross profit
noted above, partially offset by higher selling, general and administrative
expenses related to acquisitions ($1.1 million) and additional costs incurred
to support internal growth ($0.9 million).
RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED MARCH 31, 1999 VS. MARCH 31,
1998
Consolidated net revenues were $1.40 billion, an increase of $191.5
million (16%) over fiscal 1998, as continued expansion in the Company's
outpatient services and employee services operating segments more than offset
the decline in long-term care services segment revenues. Growth in the
outpatient services segment resulted primarily from acquisitions and same
market growth. Employee services growth was due primarily to acquisitions,
same market growth and the entry into new markets. The revenue decline in
long-term care services was substantially due to regulatory changes. The
Company acquired six outpatient physical therapy and rehabilitation
businesses and two employee services businesses in the first nine months of
fiscal 1999, compared to 33 outpatient physical therapy and rehabilitation
businesses, 29 O&P businesses, three occupational health businesses, and one
employee services business in the first nine months of last year.
Consolidated gross profit (excluding depreciation expense) was $224.8
million, a decrease of $42.2 million (16%) over fiscal 1998. Gross profit
margin declined to 16% compared to 22% last year. The gross profit and gross
profit margin declines were due principally to the impact of regulatory
changes in the long-term care services segment.
Other operating expenses, excluding the restructure provision, which
include selling, general and administrative expenses, depreciation,
amortization of excess cost of net assets acquired and provision for
uncollectible accounts, were $210.3 million, an increase of $23.5 million
(13%) over fiscal 1998. The increase relates principally to businesses
acquired during fiscal 1998 and fiscal 1999. As a percentage of net revenues,
other operating expenses remained unchanged from the prior year at 15%.
Depreciation expense and amortization was $42.5 million in the first nine
months of fiscal 1999, an increase of $5.4 million (14%) over fiscal 1998
primarily as a result of businesses acquired subsequent to March 31, 1998.
During the nine months ended March 31, 1999 and 1998, the Company
recognized pre-tax gains of $1.5 million and $38.1 million, respectively, for
the difference between the Company's historical cost of its investment in
NCES and its portion of NCES equity for the periods then ended. The gains
resulted from NCES shares issued in connection with acquisitions and, in the
prior year, the issuance of 5.8 million NCES shares in connection with NCES'
initial public offering in November 1997. Proceeds from the NCES initial
public offering, net of underwriters' fees and issuance costs, were $45.7
million.
Interest expense, net of investment income, was $28.0 million, an increase
of $8.5 million (43%) over fiscal 1998 as a result of increased borrowings
principally associated with the Company's acquisitions, as discussed under
"Liquidity and Capital Resources."
Income tax benefit for the nine months ended March 31, 1999 was 13.3% of
pre-tax loss compared to income tax expense of 41.7% on pre-tax income in the
prior year. The decreased rate was due to (i) non-deductible components of
the provision for restructure, (ii) non-deductible amortization, and (iii)
the inability to use loss carrybacks in certain states.
17
<PAGE> 20
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
OPERATING RESULTS BY SEGMENT
Outpatient Services
Net revenues for the outpatient services segment were $448.7 million, an
increase of $78.5 million (21%) over fiscal 1998. The increase in net
revenues was due to the effect of fiscal 1998 and fiscal 1999 acquisitions
($74.8 million) and also an increase in same-market volume in outpatient
physical therapy and occupational health rehabilitation ($20.4 million),
partially offset by a decrease in pricing ($16.7 million).
Gross profit (excluding depreciation expense) was $131.8 million, an
increase of $21.6 million (20%) over the first nine months of fiscal 1998
resulting primarily from the inclusion of businesses acquired in fiscal 1998
and fiscal 1999 ($24.9 million). The reduction in prices noted above ($16.7
million) was partially offset by the increase in same market volumes ($7.6
million), as well as cost and productivity improvements ($6.0 million). Gross
profit margin declined slightly to 29% from 30% during fiscal 1998,
principally due to pricing pressure in outpatient physical therapy and
occupational rehabilitation.
Income from operations (excluding provision for restructure) was $46.3
million, an increase of $4.3 million (10%) over last year. The increase
resulted from the higher gross profit noted above, offset partially by higher
selling, general and administrative expenses ($9.0 million) and higher
amortization expense ($3.4 million), provision for uncollectible accounts
($3.4 million) and depreciation ($1.6 million). The increase in these costs
was principally the result of expenses associated with acquired businesses.
Long-term Care Services
Net revenues for long-term care services were $332.3 million, a decrease
of $165.1 million (33%) from the first nine months of fiscal 1998. The
decrease in net revenues resulted from the overall pricing and patient volume
decline. The pricing and patient volume decreases resulted from: (i) the
overall lower reimbursement rates adopted through the implementation of
salary equivalency and the BBA, (ii) decreased Medicare patient census in
facilities served due to the uncertainty of long-term care providers with
respect to the reimbursement economics of Medicare patients under the BBA,
and (iii) the loss of chain contracts that brought their rehabilitation
services in-house, partially offset by new contract sales to small and
medium-sized long-term care providers.
Gross profit (excluding depreciation expense) was $65.8 million, a
decrease of $74.4 million (53%) from last year. The gross profit margin was
20%, compared with 28% in fiscal 1998. The decline in gross profit and gross
profit margin resulted from the lower pricing and patient volume experienced
in fiscal 1999 as a result of regulatory changes which was only partially
offset by lower salary and wage costs per employee.
Income from operations (excluding provision for restructure) was $18.8
million, a decrease of $70.9 million (79%) from last year. The lower income
from operations was due to the decline in gross profit, partially offset by
lower selling, general and administrative expenses.
Employee Services
Employee services net revenues were $1.17 billion (before an intercompany
elimination of $552.4 million related to services provided under the NovaCare
Contract), an increase of $262.4 million (29%) over last year's revenues of
$907.9 million (before an intercompany elimination of $568.1 million). This
increase in net revenues is due to an increase in third-party net revenues
due to acquisitions ($166.0 million), same market growth ($64.4 million) and
the entry into new markets ($49.7 million).
18
<PAGE> 21
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Gross profit was $47.4 million, an increase of $18.3 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 from the increase
in net revenue described above and higher margin services under the NovaCare
Contract.
Income from operations was $13.1 million, an increase of $5.9 million
(81%) 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 ($7.0 million) and higher selling, general and
administrative expenses related to acquisitions ($4.3 million).
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 1999, cash and cash equivalents totaled $23.8 million, a
decrease of $9.0 million from June 30, 1998. During the nine months ended
March 31, 1999, the Company used $14.2 million of cash in operating
activities. The unfavorable cash flow from operating activities in fiscal
1999 resulted principally from the net loss and the timing of payments for
accounts payable and accrued expenses, partially offset by non-cash charges.
Included in the use of cash was $8.8 million related to the 1998 provision
for restructure. The Company anticipates spending an additional $19.9 million
related to the 1998 and 1999 restructure charges.
The Company also used $84.3 million of cash in investing activities in the
first nine months of fiscal 1999, of which $56.4 million related to
acquisitions and $28.8 million was for capital expenditures. Capital
expenditures consisted principally of information systems software and
hardware costs in support of regulatory change in the long-term care services
segment and equipment and leasehold improvements in start-up operations in
the outpatient services segment.
Certain acquisition agreements require additional payments if specific
financial conditions are met. Aggregate contingent payments of approximately
$56.3 million in cash and $14.1 million in NCES common stock have not been
included in the initial determination of cost of the businesses acquired
since the amount of such contingent consideration, if any, is not presently
determinable. Of the $56.4 million of cash paid for acquisitions in the nine
months ended March 31, 1999, $11.0 million was for contingent payments
associated with prior years' acquisitions.
To finance these cash requirements, the Company borrowed a net $109.5
million under its revolving credit facility and reduced its cash balances by
$9.0 million. At March 31, 1999, the Company had borrowings of $337.0 million
outstanding under the revolving credit facility and NCES had no borrowings or
letters of credit outstanding under its $25.0 million credit facility.
The Company has negotiated a series of amendments to the revolving credit
facility. The final amendment, dated April 19, 1999 expires on December 31,
1999. The facility is collateralized by substantially all the common stock of
the Company's subsidiaries and accounts receivable. Maximum amounts which may
be borrowed under the revolving credit facility are the lesser of (a)
projected borrowings plus $10.0 million or (b) $375.0 million through May 31,
1999; $400.0 million from June 1 through July 9, 1999; and $50.0 million from
the earlier of the sale of the Company's O&P business or July 10, 1999. All
financial covenants have been eliminated.
In order to improve its overall cash flow and reduce its outstanding
borrowings, the Company will sell its O&P business and evaluate the future of
its long-term care services segment and its strategic alternatives as
described under "Overview". The Company has deferred all significant
acquisitions and has reduced its budget for capital expenditures.
19
<PAGE> 22
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
YEAR 2000 READINESS
During the quarter ended March 31, 1999, NovaCare continued to address
issues associated with the "Year 2000" problem. The Year 2000 problem occurs
because, historically, certain computer programs have been written using two
digits, rather than four digits, to define the applicable year. The Company's
financial and management operating systems, microprocessors embedded in
physical therapy, office or other equipment ("embedded chips") or computer
systems used by third parties (such as financial institutions, customers or
suppliers) could malfunction when dates occurring after December 31, 1999 are
recognized as twentieth century dates (e.g. 1900) rather than twenty-first
century dates (e.g. 2000).
NovaCare is currently in the process of implementing its comprehensive
response to the Year 2000 problem. At March 31, 1999, the Company had
completed its inventory of financial and management operating systems,
developed strategic and tactical plans for correcting potential problems and
had completed over two-thirds of the field testing required to determine the
state of Year 2000 readiness for these systems. NovaCare anticipates that the
remainder of this testing will be completed by June 30, 1999, with all
significant software modifications to these systems completed by that date.
In some cases, Year 2000 readiness is being addressed through the development
of programs that enhance or provide new functionality to these financial and
management operating systems. These enhanced systems are also expected to be
complete by June 30, 1999. The Company anticipates completion of computer
hardware replacements, modifications and upgrades by September 30, 1999.
NovaCare has completed approximately two-thirds of its assessment
regarding embedded chips. Completion of this assessment is anticipated by
June 30, 1999, with all significant modifications to physical therapy, office
or other equipment completed by September 30, 1999. The Company believes that
the total cost of correcting equipment with embedded chips which are not Year
2000 ready will not exceed $0.1 million and that parts will be available to
correct problems. The Company has contacted 190 suppliers who were deemed
critical to the operation of the Company's business and has received
assurances from those suppliers that the suppliers' business, financial and
management operating systems that affect NovaCare either were or would be
Year 2000 ready by December 31, 1999.
The Company is in the process of developing contingency plans in the event
of a business disruption related to the Year 2000 problem. NovaCare has a
contract with a disaster recovery company for restoring data for mission
critical business systems, as well as serving as an alternative data
processing site. A back-up to this primary contingency plan involves manual
systems that could be implemented within the Company or between the Company
and its customers or suppliers while the issue is diagnosed and repaired.
NovaCare expects to complete these plans and implement them in the field
prior to December 31, 1999. However, there can be no assurance that these
contingency plans will identify all Year 2000 issues that could occur, either
within the Company's control or in the systems of its customers or suppliers,
or that the plans will partially or completely ameliorate Year 2000 issues.
NovaCare has spent $2.7 million in fiscal 1999 related to Year 2000
readiness, of which $0.1 million was for capitalized equipment and software.
The Company anticipates $1.4 million of expenditures during the remainder of
fiscal 1999, of which $0.7 million relates to capitalized equipment and
software for systems that are not Year 2000 ready. During fiscal 2000, the
Company anticipates expenditures of up to $2.0 million, including up to $1.7
million of capital, to complete remediation of computer hardware and embedded
chip equipment which are not Year 2000 ready and to complete and roll out
contingency plans. The Company has increased its overall technology budget to
accommodate Year 2000 issues and has not delayed other projects critical to
the Company's business.
20
<PAGE> 23
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
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,
including customer response to the establishment of salary equivalency
guidelines for certain therapies and the change from cost-based reimbursement
to fee schedules and per diem payments, the number and productivity of
clinicians, pricing of payer contracts, management retention and development,
management's success in integrating acquired businesses and 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, 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.
21
<PAGE> 24
NOVACARE, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
<TABLE>
<CAPTION>
(A) Exhibit
Number Exhibit Description Page Number
------ ------------------- -----------
<S> <C> <C>
10(a) 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.
10(b) 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.
10(c) 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.
27 Financial Data Schedule
</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.
22
<PAGE> 25
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THE
REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE
UNDERSIGNED THEREUNTO DULY AUTHORIZED.
NOVACARE, INC.
------------------------------
(REGISTRANT)
AUGUST 12, 1999 BY /S/ ROBERT E. HEALY, JR.
------------------------------
ROBERT E. HEALY, JR.,
SENIOR VICE PRESIDENT,
FINANCE & ADMINISTRATION AND
CHIEF FINANCIAL OFFICER
AUGUST 12, 1999 BY /S/ BARRY E. SMITH
----------------------------
BARRY E. SMITH,
VICE PRESIDENT,
CONTROLLER AND
CHIEF ACCOUNTING OFFICER
23
