<PAGE> 1
U N I T E D S T A T E S
S E C U R I T I E S A N D E X C H A N G E C O M M I S S I O N
W A S H I N G T O N, D C 2 0 5 4 9
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 1998
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 January 31, 1999, NovaCare, Inc. had 62,872,688 shares of common stock,
$.01 par value, outstanding.
<PAGE> 2
NOVACARE, INC. AND SUBSIDIARIES
FORM 10-Q - QUARTER ENDED DECEMBER 31, 1998
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 December 31, 1998
and June 30, 1998 1
- Condensed Consolidated Statements of Operations for the Three
Months Ended December 31, 1998 and 1997 2
- Condensed Consolidated Statements of Operations for
the Six Months Ended December 31, 1998 and 1997 3
- Condensed Consolidated Statements of Cash Flows for the Six
Months Ended December 31, 1998 and 1997 4
- Notes to Condensed Consolidated Financial Statements 5-10
2 Management's Discussion and Analysis of Financial Condition and
Results of Operations 11-19
II OTHER INFORMATION
6 Exhibits and Reports on Form 8-K 20
Signatures 21
</TABLE>
i
<PAGE> 3
NOVACARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1998 AND JUNE 30, 1998
(In thousands, except per share data)
<TABLE>
<CAPTION>
DECEMBER 31, June 30,
1998 1998
----------- -----------
ASSETS (UNAUDITED) (See Note 1)
<S> <C> <C>
Current assets:
Cash and cash equivalents ................................................. $ 15,238 $ 32,760
Accounts receivable, net of allowances at December 31, 1998 and at
June 30, 1998 of $57,550 and $55,060, respectively ...................... 327,755 338,328
Inventories ............................................................... 43,021 38,207
Deferred income taxes ..................................................... 14,580 14,580
Other current assets ...................................................... 27,867 27,978
----------- -----------
Total current assets .................................................. 428,461 451,853
Property and equipment, net .................................................. 83,497 80,857
Excess cost of net assets acquired, net ...................................... 790,541 767,729
Investments in joint ventures ................................................ 15,510 14,881
Other assets, net ............................................................ 47,147 40,722
----------- -----------
$ 1,365,156 $ 1,356,042
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of financing arrangements ................................. $ 30,797 $ 32,074
Accounts payable and accrued expenses ..................................... 137,025 193,025
Income taxes payable ...................................................... 1,003 981
----------- -----------
Total current liabilities ............................................. 168,825 226,080
Financing arrangements, net of current portion ............................... 550,571 476,308
Deferred income taxes ........................................................ 41,684 41,067
Other ........................................................................ 12,814 13,608
----------- -----------
Total liabilities ..................................................... 773,894 757,063
----------- -----------
Minority interest in consolidated subsidiaries ............................... 21,932 18,306
Commitments and contingencies ................................................ -- --
Shareholders' equity:
Common stock, $.01 par value; authorized 200,000 shares;
issued 68,189 shares at December 31, 1998 and issued 67,935 shares
at June 30, 1998 ........................................................ 682 679
Additional paid-in capital ................................................ 273,890 273,157
Retained earnings ......................................................... 337,430 350,255
----------- -----------
612,002 624,091
Less: Common stock in treasury (at cost), 5,307 shares at December 31, 1998
and 5,401 shares at June 30, 1998 ....................................... (42,672) (43,418)
----------- -----------
Total shareholders' equity ............................................ 569,330 580,673
----------- -----------
$ 1,365,156 $ 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
DECEMBER 31,
-------------------------
1998 1997
--------- ---------
<S> <C> <C>
Net revenues ...................................... $ 483,322 $ 398,818
Cost of services .................................. 403,248 312,485
--------- ---------
Gross profit .................................. 80,074 86,333
Selling, general and administrative expenses ...... 54,347 49,566
Provision for uncollectible accounts .............. 8,053 4,837
Amortization of excess cost of net assets acquired 6,356 4,799
Provision for restructure, net .................... 17,800 23,500
--------- ---------
(Loss) income from operations ................ (6,482) 3,631
Gain from issuance of subsidiary stock ............ 151 38,128
Investment income ................................. 123 305
Interest expense .................................. (9,429) (6,695)
Minority interest ................................. (806) (345)
--------- ---------
(Loss) income before income taxes ............. (16,443) 35,024
Income taxes ...................................... 2,055 14,452
--------- ---------
Net (loss) income ............................. $ (18,498) $ 20,572
========= =========
Net (loss) income per share - basic ........... $ (0.29) $ .34
========= =========
Net (loss) income per share - assuming dilution $ (0.29) $ .33
========= =========
</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 SIX MONTHS ENDED
DECEMBER 31,
-------------------------
1998 1997
--------- ---------
<S> <C> <C>
Net revenues ...................................... $ 961,523 $ 755,516
Cost of services .................................. 796,866 590,786
--------- ---------
Gross profit .................................. 164,657 164,730
Selling, general and administrative expenses ...... 106,278 95,038
Provision for uncollectible accounts .............. 15,061 9,948
Amortization of excess cost of net assets acquired 12,488 9,265
Provision for restructure, net .................... 17,800 23,500
--------- ---------
Income from operations ....................... 13,030 26,979
Gain from issuance of subsidiary stock ............ 1,506 38,128
Investment income ................................. 296 446
Interest expense .................................. (18,706) (12,489)
Minority interest ................................. (1,469) (420)
--------- ---------
(Loss) income before income taxes ............. (5,343) 52,644
Income taxes ...................................... 7,482 21,848
--------- ---------
Net (loss) income ............................. $ (12,825) $ 30,796
========= =========
Net (loss) income per share - basic ........... $ (0.20) $ .50
========= =========
Net (loss) income per share - assuming dilution $ (0.20) $ .49
========= =========
</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 SIX MONTHS ENDED
DECEMBER 31,
-------------------------
1998 1997
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income ......................................................... $ (12,825) $ 30,796
Adjustments to reconcile net income to net cash flows provided by operating
activities:
Provision for restructure, net ....................................... 17,800 23,500
Gain from issuance of subsidiary stock ............................... (1,506) (38,128)
Depreciation and amortization ........................................ 28,524 23,932
Provision for uncollectible accounts ................................. 15,061 9,948
Minority interest .................................................... 1,469 420
Deferred income taxes ................................................ 617 5,879
Changes in assets and liabilities, net of effects from acquisitions:
Accounts and notes receivable .................................... (4,067) (44,449)
Inventories ...................................................... (4,846) (2,116)
Other current assets ............................................. (101) (5,231)
Accounts payable and accrued expenses ............................ (55,962) 13,863
Income taxes payable ............................................. 22 5,367
Other, net ....................................................... (2,046) 100
--------- ---------
Net cash flows (used in) provided by operating activities ....... (17,860) 23,881
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Payments for businesses acquired, net of cash acquired .................... (54,315) (91,090)
Net additions to property and equipment ................................... (19,066) (13,612)
Other, net ................................................................ 344 (3,089)
--------- ---------
Net cash flows (used in) investing activities .................... (73,037) (107,791)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from financing arrangements ...................................... 257,280 219,033
Payment of financing arrangements ......................................... (185,195) (166,906)
Proceeds from common stock issued ......................................... 1,285 1,738
Proceeds from the issuance of subsidiary stock ............................ 5 45,709
--------- ---------
Net cash flows provided by financing activities .................. 73,375 99,574
--------- ---------
Net (decrease) increase in cash and cash equivalents ...................... (17,522) 15,664
Cash and cash equivalents, beginning of period ............................ 32,760 22,716
--------- ---------
Cash and cash equivalents, end of period .................................. $ 15,238 $ 38,380
========= =========
Supplemental disclosures of cash flow information:
Interest paid ....................................................... $ 14,849 $ 6,067
========= =========
Income taxes paid ................................................... $ 6,418 $ 10,199
========= =========
</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
DECEMBER 31, 1998
(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 six-month periods ended December
31, 1998 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 second quarter of fiscal 1999 the Company recorded a $17,800
restructure provision composed of the following:
<TABLE>
<CAPTION>
<S> <C>
Outpatient services......................... $ 31,100
Long-term care services..................... (13,300)
-----------
Net restructure provision................... $ 17,800
===========
</TABLE>
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>
<CAPTION>
<S> <C>
Write down of goodwill.................... $ 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) 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. At December 31,
1998, the remaining net book value after the write-down of these assets to
be sold was $6.9 million. The clinics to be disposed of had annualized net
revenues of $16.6 million and annualized operating profit of $0.2 million.
The annualized pre-tax effect of suspending depreciation and amortization
on these assets is $0.8 million. These assets are expected to be sold by
September 30, 1999.
Long-term care services:
In the second quarter of fiscal 1998, the Company recorded a
restructure provision of $23,500 based on an evaluation of the impact of
changes in the Medicare reimbursement system mandated by the Balanced
Budget Act
5
<PAGE> 8
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(In thousands, except per share data)
(Unaudited)
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 Company's prior operating model was
characterized by a high concentration of one-on-one therapy, with licensed
professionals treating individual patients. The Company's revised model (i)
relies more heavily on well-trained therapy assistants and aides closely
supervised by licensed professionals, and (ii) employs simultaneous
therapy, wherein licensed professionals, along with well-trained therapy
assistants and aides, treat multiple patients on a coordinated basis. The
Company had anticipated commencing conversion to the new operating model in
fiscal 1998 and substantially completing the conversion by December 31,
1998.
During the second quarter of fiscal 1999, it became apparent that a
portion of this fiscal 1998 charge would not be required. Delays by the
Health Care Financing Administration ("HCFA") in finalizing regulations
covering Medicare reimbursement under the BBA correspondingly delayed the
conversion of customers to the new operating model. The conversion is
expected to be completed by June 30, 1999. However, a significant portion
of the employee base covered by the restructure reserve voluntarily
resigned to seek new employment during the delay. Additionally, as a result
of changing labor market conditions, the Company implemented a salary
reduction program in September 1998 causing voluntary resignations of
employees covered by the restructure reserve. Finally, more employees than
anticipated obtained employment with national chain customers when these
customer facilities converted to in-house therapy programs.
As a result of these factors, the Company reduced its previously
established provision by $13,300 and determined that $6,750 was required at
December 31, 1998 related to the remaining conversion of the Company's
long-term care segment to the new operating model. This amount is composed
of the following:
<TABLE>
<CAPTION>
<S> <C>
Employee severance costs............................. $ 4,975
Lease terminations................................... 877
Asset write-offs, net of estimated proceeds.......... 748
Other................................................ 150
-------------
Total restructure reserve............................ $ 6,750
=============
</TABLE>
Activity in the fiscal 1998 provision for restructure was as follows:
<TABLE>
<CAPTION>
<S> <C>
Provision for restructure, December 31, 1997....... $ 23,500
Payments and other reductions...................... (3,450)
Reduction of provision for restructure............. (13,300)
-------------
Provision for restructure, December 31, 1998....... $ 6,750
=============
</TABLE>
The tax impacts of the outpatient services provision and the reversal
of the long-term care services provision were offsetting; accordingly, the
after-tax restructure provision was also $17,800.
6
<PAGE> 9
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(In thousands, except per share data)
(Unaudited)
3. GAINS FROM ISSUANCE OF SUBSIDIARY STOCK
In the three- and six-month periods ended December 31, 1998, a
subsidiary of the Company, NovaCare Employee Services, Inc. ("NCES") issued
161 and 597 shares of its common stock in connection with fiscal 1999
acquisitions.
In fiscal 1998, NCES completed an initial public offering, converted
its mandatorily redeemable common stock and issued common stock to former
owners of acquired companies. The initial public offering included 5,750
shares of NCES common stock issued at $9.00 per share. Proceeds received by
NCES from the initial public offering, net of underwriting and issuance
costs, were $45,709.
As a result of these common stock transaction, the Company's percentage
ownership of NCES was 69.3% at December 31, 1998.
The Company recorded gains of $151 ($89 after-tax) and $1,506 ($889
after-tax) in the three- and six-month periods ended December 31, 1998 and
a gain of $38,128 ($22,495 after-tax) in the three- and six-month periods
ended December 31, 1997, for the difference between the Company's
historical cost of its investment in NCES and its portion of NCES equity at
each period-end. The Company will continue to record NCES investment
adjustments through its statement of operations as NCES's equity changes as
a result of capital transactions.
4. 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 ENDED FOR THE SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------------- -----------------------
1998 1997 1998 1997
---------- -------- -------- --------
<S> <C> <C> <C> <C>
NET (LOSS) INCOME ....................... $ (18,498) $ 20,572 $(12,825) $ 30,796
========== ======== ======== ========
WEIGHTED AVERAGE SHARES OUTSTANDING:
WEIGHTED AVERAGE SHARES OUTSTANDING -
BASIC ............................... 62,735 61,260 62,642 61,186
Stock options ......................... -- 1,986 -- 2,083
Contingently issuable shares - assuming
dilution ............................ -- 42 -- 42
---------- -------- -------- --------
WEIGHTED AVERAGE SHARES OUTSTANDING -
ASSUMING DILUTION ................... 62,735 63,288 62,642 63,311
========== ======== ======== ========
NET (LOSS) INCOME PER SHARE - BASIC ... $ (0.29) $ .34 $ (0.20) $ .50
========== ======== ======== ========
NET (LOSS) INCOME PER SHARE - ASSUMING
DILUTION ............................ $ (0.29) $ .33 $ (0.20) $ .49
========== ======== ======== ========
</TABLE>
The Company did not include convertible subordinated debentures,
equivalent to 6,567 shares of common stock, or options to purchase 478 and
302 shares of common stock for the six-months ended December 31, 1998 and
1997, respectively, because their effects are antidilutive. There were no
transactions that occurred subsequent to December 31, 1998 that would have
materially changed the number of shares used in computing net income per
share-basic or net income per share-assuming dilution.
7
<PAGE> 10
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
(In thousands, except per share data)
(Unaudited)
5. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31, June 30,
1998 1998
-------------- ------------
<S> <C> <C>
Accounts payable..................................................... $ 21,874 $ 19,679
Accrued compensation and benefits.................................... 55,093 87,985
Accrued costs of productivity and cost improvement programs.......... 11,836 23,748
Accrued workers' compensation and health claims...................... 17,645 25,000
Deferred and contingent purchase price obligations................... 5,228 8,756
Accrued interest..................................................... 9,948 7,080
Other................................................................ 15,401 20,777
-------------- -------------
$ 137,025 $ 193,025
============== =============
</TABLE>
6. FINANCING ARRANGEMENTS
Financing arrangements consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31, June 30,
1998 1998
-------------- --------------
<S> <C> <C>
$400,000 revolving credit facility (EuroDollar rate plus
0.875% to 1.5%), due June 30, 2003......................... $ 310,500 227,500
Convertible subordinated debentures (5.5%), due January 2000......... 175,000 175,000
Subordinated promissory notes (5% to 10%), through 2007.............. 89,849 98,318
$25,000 revolving credit facility of subsidiary, due
November 17, 2000............................................... 2,000 --
Other................................................................ 4,019 7,564
-------------- --------------
581,368 508,382
Less: current portion............................................... 30,797 32,074
-------------- --------------
$ 550,571 $ 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. As of December 31, 1998, $88,413 of
the line of credit was available after reduction for letters of credit
totaling $1,087 and borrowings.
NCES has a revolving credit facility with a syndicate of lenders. The
credit facility provides for interest to be charged at a variable rate,
depending on certain financial ratios, equal to: (i) the EuroDollar rate
plus a range of 1.375% to 2.50%, or (ii) the lead lender's prime rate plus
a range of .125% to 1.25%. Loans made under the credit facility are
collateralized by a pledge of all of (i) the common stock of NCES's
subsidiaries, (ii) the assets of NCES and its subsidiaries, and (iii) the
Company's interest in the common stock of NCES. As of December 31, 1998,
$23,000 of the NCES line of credit was available, and there were no letters
of credit outstanding.
7. 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.
8
<PAGE> 11
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
(In thousands, except per share data)
(Unaudited)
Certain purchase agreements require additional payments if specific
financials targets and non-financial conditions are met. Aggregate
contingent payments in connection with these acquisitions at December 31,
1998 of approximately $92,987 in cash and common stock of NCES 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. For the six months ended December 31, 1998 and December 31,
1997, the Company paid $9,372 and $5,486 in cash and common stock of NCES,
respectively, and issued 44 and 54 shares, respectively, of the Company's
common stock in connection with businesses acquired in prior years.
8. 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.
Operating results and other financial data are presented for the
principal operating segments of the Company as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
----------------------------- -----------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
NET REVENUES:
Outpatient services ............ $ 151,793 $ 125,330 $ 303,154 $ 239,266
Long-term care services ........ 122,012 164,855 263,645 321,026
Employee services .............. 397,037 302,751 786,199 569,508
----------- ----------- ----------- -----------
Total ...................... 670,842 592,936 1,352,998 1,129,800
Intrasegment elimination -
employee services ........... (187,520) (194,118) (391,475) (374,284)
----------- ----------- ----------- -----------
Consolidated revenues ...... $ 483,322 $ 398,818 $ 961,523 $ 755,516
=========== =========== =========== ===========
GROSS PROFIT:
Outpatient services ............ $ 44,436 $ 37,904 $ 89,679 $ 72,681
Long-term care services ........ 29,370 46,658 63,407 88,561
Employee services .............. 15,902 9,412 30,662 17,740
----------- ----------- ----------- -----------
Total ...................... 89,708 93,974 183,748 178,982
Intrasegment elimination -
employee services ........... (6,267) (4,674) (12,428) (8,642)
Depreciation ................... (3,367) (2,967) (6,663) (5,610)
----------- ----------- ----------- -----------
Consolidated gross profit .. $ 80,074 $ 86,333 $ 164,657 $ 164,730
=========== =========== =========== ===========
(LOSS) INCOME FROM OPERATIONS:
Outpatient services ............ $ 15,022 $ 13,522 $ 33,367 $ 29,715
Long-term care services ........ 13,389 31,773 31,366 56,341
Employee services .............. 4,446 2,287 8,256 4,413
----------- ----------- ----------- -----------
Total ...................... 32,857 47,582 72,989 90,469
Unallocated selling, general and
administrative expenses ..... (21,539) (20,451) (42,159) (39,990)
Provision for restructure ...... (17,800) (23,500) (17,800) (23,500)
----------- ----------- ----------- -----------
Consolidated (loss) income
from operations ......... $ (6,482) $ 3,631 $ 13,030 $ 26,979
=========== =========== =========== ===========
</TABLE>
9
<PAGE> 12
NOVACARE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
-------------------- --------------------
1998 1997 1998 1997
------- ------- ------- -------
<S> <C> <C> <C> <C>
DEPRECIATION AND AMORTIZATION:
Outpatient services ......... $ 7,867 $ 6,129 $ 15,383 $ 11,497
Long-term care services ..... 3,186 2,926 6,397 5,745
Employee services ........... 1,315 905 2,586 1,695
-------- -------- -------- --------
Total ................... 12,368 9,960 24,366 18,937
Unallocated selling, general and
administrative expenses .. 2,093 2,495 4,158 4,995
-------- -------- -------- --------
Consolidated depreciation
and amortization ..... $ 14,461 $ 12,455 $ 28,524 $ 23,932
======== ======== ======== ========
EARNINGS BEFORE INTEREST, INCOME TAXES, DEPRECIATION AND AMORTIZATION
("EBITDA"):
Outpatient services .......... $ 22,889 $ 19,651 $ 48,750 $ 41,212
Long-term care services ...... 16,575 34,699 37,763 62,086
Employee services ............ 5,761 3,192 10,842 6,108
-------- --------- -------- --------
Total .................... 45,225 57,542 97,355 109,406
Unallocated selling, general
and administrative expenses (19,446) (17,956) (38,001) (34,995)
Provision for restructure .... (17,800) (23,500) (17,800) (23,500)
-------- --------- -------- --------
Consolidated EBITDA ...... $ 7,979 $ 16,086 $ 41,554 $ 50,911
======== ========= ======== ========
</TABLE>
<TABLE>
<CAPTION>
AS OF As of
DECEMBER 31, June 30,
1998 1998
---------- ----------
<S> <C> <C>
SEGMENT ASSETS:
Outpatient services ... $ 921,287 $ 876,250
Long-term care services 303,860 326,872
Employee services ..... 113,167 112,583
Unallocated assets .... 26,842 40,337
---------- ----------
$1,365,156 $1,356,042
========== ==========
</TABLE>
10
<PAGE> 13
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 six-month periods ended December 31, 1997 has
been restated to conform to the requirements of SFAS No. 131.
See Note 8 to the Condensed Consolidated Financial Statements for
financial data for each of the Company's operating segments.
In the second quarter of fiscal 1998, the Company's employee services
subsidiary, NovaCare Employee Services, Inc. ("NCES"), sold approximately
5.8 million shares in an initial public offering. NCES issued additional
shares in connection with acquisitions completed in fiscal 1998 and 1999.
In fiscal 1999, the Company recorded gains of $151,000 and $1.5 million for
the three- and six-month periods ended December 31, 1998, 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. As of
December 31, 1998, the Company owns 69.3% of NCES.
Provision for Restructure, Net
In the second quarter of fiscal 1999, the Company recorded a net $17.8
million restructure provision composed of the following (in thousands):
<TABLE>
<S> <C>
Outpatient Services..................... $ 31,100
Long-term care services................. (13,300)
-----------
Net restructure provision............... $ 17,800
===========
</TABLE>
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 as follows (in thousands):
<TABLE>
<S> <C>
Write down of goodwill.................... $ 28,300
Employee Severance and other.............. 2,800
-----------
Total provision for restructure........... $ 31,100
===========
</TABLE>
11
<PAGE> 14
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The estimated net realizable value of PROH assets (principally excess
cost of net assets acquired) 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. At December 31,
1998, the remaining net book value of these assets to be sold is
approximately $6.9 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. The annualized pre-tax effect of suspending
depreciation and amortization on these assets is approximately $0.8
million. These assets are expected to be sold by September 30, 1999.
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
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 Company's prior operating model was characterized by
a high concentration of one-on-one therapy, with licensed professionals
treating individual patients. The Company's revised model (i) relies more
heavily on well-trained therapy assistants and aides closely supervised by
licensed professionals, and (ii) employs simultaneous therapy, wherein
licensed professionals, along with well-trained therapy assistants and
aides, treat multiple patients on a coordinated basis. The Company had
anticipated commencing conversion to the new operating model in fiscal 1998
and substantially completing the conversion by December 31, 1998.
During the second quarter of fiscal 1999 it became apparent that a
portion of this fiscal 1998 charge would not be required. Delays by the
Health Care Financing Administration ("HCFA") in finalizing regulations
covering Medicare reimbursement under the BBA correspondingly delayed the
conversion of customers to the new operating model. The conversion is
expected to be completed by June 30, 1999. However, a significant portion
of the employee base covered by the restructure reserve voluntarily
resigned to seek new employment during the delay. Additionally, as a result
of changing labor market conditions, the Company implemented a salary
reduction program in September 1998 causing voluntary resignations of
employees covered by the restructure reserve. Finally, more employees than
anticipated obtained employment with national chain customers when these
customer facilities converted to in-house therapy programs.
As a result of these factors, the Company determined that $6.8 million
was required at December 31, 1998 related to the conversion of the
Company's long-term care segment to the new operating model.
Accordingly, the Company reversed $13.3 million of the remaining
balance of the restructure reserve at that date.
Regulatory Changes
In the three- and six-month periods ending December 31, 1998, 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
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 15%
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 national nursing
home chain customers to in-house therapy programs.
12
<PAGE> 15
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
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. The
Company believes that while these changes further reduce overall
reimbursement levels, they offer opportunities to therapy service providers
who can provide quality services at a lower cost.
In response to these changes in reimbursement methodology, the Company
is in the process of changing its long-term care service delivery model, as
described under "Provision for Restructure, Net" above, and has implemented
a salary reduction program as a result of changing labor market conditions.
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
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 be able to receive based on negotiated terms of service
contracts with its customers, the Company is unable to determine the impact
that the BBA will have on its financial position or results of operations.
Corporate and Capital Structure Changes
The Company continues to evaluate its strategic alternatives for
obtaining additional capital to fund its growth. Such alternatives could
include placing additional debt through a high-yield offering or private
placement, the offering of equity securities in a private placement, the
separation of the Company's activities into two independent companies, one
of which would operate its outpatient services operating segment and the
other of which would operate its long-term care and employee services
operating segments, and the subsequent offering for sale of equity
securities, or the sale of one or more of the Company's businesses. The
feasibility and timing of these alternatives will depend on a variety of
capital markets, tax, regulatory and operational issues.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED DECEMBER 31, 1998 VS.
DECEMBER 31, 1997
Consolidated net revenues were $483.3 million, an increase of $84.5
million (21%) over fiscal 1998, as continued expansion in the Company's
outpatient services and employee services segments more than offset the
decline in long-term care services segment revenues. 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 and internal growth. The revenue
decline in long-term care services was substantially due to regulatory
changes. The Company acquired one employee services business in the second
quarter of fiscal 1999, compared with 14 outpatient physical therapy and
rehabilitation business, 11 orthotic and prosthetic ("O&P") businesses, one
occupational health business and one employee services business in the
second quarter of last year.
Consolidated gross profit (excluding depreciation) was $83.4 million, a
decrease of $5.9 million (7%) from fiscal 1998. The decrease in gross
profit is due to lower margins in the long-term care services segment due
to regulatory changes. The decrease was partially offset by acquisitions in
the outpatient services and employee services segments and internal growth
in the employee services segment. The decline in gross profit as a
percentage of net revenue ("gross profit margin") to 17% compared to 22%
last year, was due primarily to lower gross profit margins in the long-term
care services segment.
13
<PAGE> 16
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Other operating expenses, excluding the restructure provision, which
consist of selling, general and administrative expenses, depreciation,
amortization of excess cost of net assets acquired and provision for
uncollectible accounts were $72.1 million, an increase of $10.0
million (16%) 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 decreased slightly to 15% from 16%
in fiscal 1998 primarily as a result of increased employee services revenue
where these expenses are typically a smaller percentage of net revenues
compared with the outpatient or long-term care services segments.
Depreciation expense was $8.1 million, an increase of $0.5 million (6%)
over the second quarter of fiscal 1998. The increase was due primarily to
acquisitions and capital expenditures in fiscal 1998 and fiscal 1999.
Amortization of excess cost of net assets acquired ("amortization") was
$6.4 million in the second quarter of fiscal 1999, an increase of $1.6
million (32%) over fiscal 1998 as a result of businesses acquired
subsequent to December 31, 1997.
Interest expense, net of investment income, was $9.3 million, an
increase of $2.9 million (46%) 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 expense for the three months ended December 31, 1998 was
more than 100% of pre-tax income due to the effect of: (i) nondeductible
components of the fiscal 1999 provision for restructure and (ii)
nondeductible amortization on reduced pre-tax income in fiscal 1999
compared to fiscal 1998.
OPERATING RESULTS BY SEGMENT
Outpatient Services
Net revenues for the outpatient services segment were $151.8 million,
an increase of $26.5 million (21%) over fiscal 1998. The increase in net
revenues was due principally to the effect of fiscal 1998 and fiscal 1999
acquisitions.
Gross profit (excluding depreciation) was $44.4 million, an increase of
$6.5 million (17%) over the second quarter of fiscal 1998 resulting
primarily from the inclusion of businesses acquired in fiscal 1998 and
fiscal 1999. Gross profit margin declined to 29% from 30% in the second
quarter of fiscal 1998, principally as a result of pricing pressure in the
outpatient physical therapy and rehabilitation business.
Income from operations (excluding provision for restructure) was $15.0
million, an increase of $1.5 million (11%) over last year. The increase
resulted from the higher gross profit noted above, offset partially by
higher selling, general and administrative expenses, and higher
depreciation and amortization expense. The increase in these costs was
principally the result of acquired businesses.
Long-term Care Services
Net revenues for long-term care services were $122.0 million, a
decrease of $42.8 million (26%) from the second quarter of fiscal 1998. The
decrease in net revenues resulted from the factors previously noted in
"Overview" above as overall pricing and patient volume declined. 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 large chain contracts that brought their
rehabilitation services in-house, partially offset by new contract sales to
small and medium long-term care providers.
14
<PAGE> 17
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Gross profit (excluding depreciation) was $29.4 million, a decrease of
$17.3 million (37%) from last year. The gross profit margin was 24%
compared to 28% last year. The decline in gross profit and gross profit
margin resulted from the lower pricing experienced in fiscal 1999 as a
result of regulatory changes (see "Overview" above), which was only
partially offset by lower salary and wage costs per employee and improved
productivity.
Income from operations (excluding provision for restructure) was $13.4
million, a decrease of $18.4 million (58%) from last year. The lower income
from operations was due to the decline in gross profit and an increase in
the provision for bad debts, partially offset by lower selling, general and
administrative expenses with the introduction of a new operating model in
response to regulatory change.
Employee Services
Employee services net revenues were $397.0 million (before an
intercompany elimination of $187.5 million related to services provided to
the outpatient services and long-term care services segments), an increase
of $94.3 million (31%) over last year's revenues of $302.8 million (before
an intercompany elimination of $194.1 million). This increase in net
revenues is due to an increase of $100.9 million in third-party net
revenues.
The increase in revenues from third parties resulted from acquisitions
completed in fiscal 1998 and fiscal 1999 and internal growth. Revenues
under the NovaCare Contract decreased principally as a result of a 2%
decrease in the average number of worksite employees.
Gross profit (excluding depreciation) was $15.9 million, an increase of
$6.5 million (69%) over the second quarter of fiscal 1998. The gross profit
margin was 4% compared to 3% in the second quarter of fiscal 1998. The
increase in gross profit and gross profit margin resulted from the increase
in net revenues and related scale economies.
Income from operations was $4.4 million, an increase of $2.2 million
(94%) 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 and additional costs
incurred to support internal growth.
RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED DECEMBER 31, 1998 VS.
DECEMBER 31, 1997
Consolidated net revenues were $961.5 million, an increase of $206.0
million (27%) 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.
Employee services growth was due primarily to acquisitions and internal
growth. 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 six months of fiscal 1999, compared to 22 outpatient physical
therapy and rehabilitation businesses, 21 O&P businesses, one occupational
health business, and one employee services business in the first six months
of last year.
Consolidated gross profit (excluding depreciation) was $171.3 million,
an increase of $1.0 million (1%) over fiscal 1998. The reasons for the
gross profit increase are the same as the net revenue increase, with
acquisitions in outpatient services and acquisitions and internal growth in
employee services more than offsetting the impact of regulatory changes in
long-term care services. The decline in gross profit margin to 18% compared
to 23% last year, was due primarily to lower gross profit margins 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
15
<PAGE> 18
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
uncollectible accounts, were $140.5 million, an increase of $20.6 million
(17%) 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 decreased to 15% in the first six months
of fiscal 1999, compared to 16% in fiscal 1998. This decrease resulted
principally from an increase in employee services revenues, where these
expenses are typically a smaller percentage of net revenues compared to
outpatient services or long-term care services.
Depreciation expense was $16.0 million, an increase of $1.3
million (9%) over fiscal 1998, due primarily to acquisitions and capital
expenditures in fiscal 1998 and fiscal 1999. Amortization was $12.5 million
in the first six months of fiscal 1999, an increase of $3.2 million (35%)
over fiscal 1998 as a result of businesses acquired subsequent to December
31, 1997.
Interest expense, net of investment income, was $18.4 million, an
increase of $6.4 million (53%) 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 expense for the six months ended December 31, 1998 was more
than 100% of pre-tax income due to the effect of: (i) nondeductible
components of the fiscal 1999 provision for restructure and (ii)
nondeductible amortization on reduced pre-tax income in fiscal 1999
compared to fiscal 1998.
OPERATING RESULTS BY SEGMENT
Outpatient Services
Net revenues for the outpatient services segment were $303.2 million,
an increase of $63.9 million (27%) over fiscal 1998. The increase in net
revenues was due principally to the effect of fiscal 1998 and fiscal 1999
acquisitions and same-market growth in O&P and occupational health, offset
by a reduction in same-market growth in outpatient physical therapy and
rehabilitation.
Gross profit (excluding depreciation) was $89.7 million, an increase of
$17.0 million (23%) over the first six months of fiscal 1998 resulting
primarily from the inclusion of businesses acquired in fiscal 1998 and
fiscal 1999. Gross profit margin was 30%, unchanged from the same period in
fiscal 1998.
Income from operations (excluding provision for restructure) was $33.4
million, an increase of $3.7 million (12%) over last year. The increase
resulted from the higher gross profit noted above, offset partially by
higher selling, general and administrative expenses and higher depreciation
and amortization expense. 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 $263.6 million, a
decrease of $57.4 million (18%) from the first half of fiscal 1998. The
decrease in net revenues resulted from the factors previously noted in
"Overview" above as overall pricing and patient volume declined. 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 large chain contracts that brought their
rehabilitation services in-house, partially offset by new contract sales to
small and medium long-term care providers.
16
<PAGE> 19
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Gross profit (excluding depreciation) was $63.4 million, a decrease of
$25.1 million (28%) from last year. The gross profit margin was 24%,
compared with 28% in fiscal 1998. The decline in gross profit and gross
profit margin resulted from the lower pricing experienced in fiscal 1999 as
a result of regulatory changes (see "Overview" above), which was only
partially offset by lower salary and wage costs per employee and improved
productivity.
Income from operations (excluding provision for restructure) was $31.4
million, a decrease of $25.0 million (44%) from last year. The lower income
from operations was due to the decline in gross profit and an increase in
the provision for bad debts, partially offset by lower selling, general and
administrative expenses.
Employee Services
Employee services net revenues were $786.2 million (before an
intercompany elimination of $391.5 million related to services provided to
the outpatient services and long-term care services segments), an increase
of $216.7 million (38%) over last year's revenues of $569.5 million (before
an intercompany elimination of $374.3 million). This increase in net
revenues is due to: (i) an increase of $199.5 million in third-party net
revenues and (ii) an increase in net revenues of $17.2 million under the
employee services segment's contract with the outpatient services and
long-term care services segments (the "NovaCare Contract").
The increase in revenues from third parties resulted from acquisitions
completed in fiscal 1998 and fiscal 1999 and internal growth. Revenues
under the NovaCare Contract increased principally as a result of a 5%
increase in the average number of worksite employees.
Gross profit (excluding depreciation) was $30.7 million, an increase of
$12.9 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 revenues and related scale economies.
Income from operations was $8.3 million, an increase of $3.8 million
(87%) 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 and additional costs
incurred to support internal growth.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1998, cash and cash equivalents totaled $15.2 million,
a decrease of $17.5 million from June 30, 1998. During the six months ended
December 31, 1998, the Company used $17.9 million of cash in operating
activities. The unfavorable cash flow from operating activities in fiscal
1999 resulted principally from reduced earnings and the timing of payments
for accounts payable and accrued expenses, particularly
compensation-related payments.
The Company also used $73.0 million of cash in investing activities in
the first six months of fiscal 1999, of which $54.3 million related to
acquisitions and $19.1 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 startup
operations in the outpatient services segment.
To finance these cash requirements, the Company borrowed a net $83.0
million under its $400.0 million long-term credit facility and reduced its
cash balances by $17.5 million. At December 31, 1998, the Company had $88.4
million available under its credit facility after reduction for a letter of
credit of $1.1 million and borrowings of $310.5 million. NCES also borrowed
a net $2.0 million under its $25.0 million credit facility principally to
finance an acquisition. At December 31, 1998, NCES had $23.0 million of its
credit facility available and there were no letters of credit outstanding.
17
<PAGE> 20
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
In order to improve its overall cash flow and reduce its outstanding
borrowings, the Company is in the process of implementing a program to
improve cash flow from operations and reduce acquisition and capital
expenditures. The Company has deferred all significant acquisitions in its
outpatient services and long-term care services operating segments and has
reduced its budget for capital expenditures from levels which were
previously anticipated. In addition, the Company has implemented a program
anticipated to improve cash collections and reduce days sales outstanding.
YEAR 2000 READINESS
During the quarter ended December 31, 1998, 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 (i.e. 1900) rather than twenty-first century dates (i.e. 2000).
NovaCare is currently in the process of implementing its comprehensive
response to the Year 2000 problem. During fiscal 1998, the Company
completed an inventory of its financial and management operating systems
and made a preliminary determination of which programs were or were not
Year 2000 ready. The Company also established a program to test each
significant application which was believed to be Year 2000 ready and to
remediate all significant programs which were not Year 2000 ready. In some
cases, the Company intends to address Year 2000 issues through the
development of new programs, which enhance or provide new functionality to
these financial and management operating systems.
The Company continues to survey its field locations to determine the
impact of embedded chips on physical therapy and office equipment as well
as owned and leased real estate. The Company expects this survey to be
complete by March 31, 1999.
The Company anticipates that the all of its significant computer
applications will be tested and remediated by June 30, 1999 and that
embedded chips which cannot accommodate Year 2000 issues and significantly
affect field operations will be identified and replaced by that date.
The Company estimates the total cost of its Year 2000 effort to be
approximately $6.5 million, including $2.5 million of capital costs for new
computers and related equipment. The estimate of capital costs has been
reduced by $2.5 million from the Company's original estimate at June 30,
1998. This amount does not include costs for computer software developed in
order to provide or improve functionality. At December 31, 1998, the
Company had already spent approximately $1.9 million in this effort, of
which $0.1 million represented capital costs. The Company has increased its
overall information technology budget to accommodate Year 2000 issues and
has not delayed other projects critical to the Company's business.
The Company continues to interview customers, vendors and service
bureaus to determine their exposure to Year 2000 issues, their anticipated
risks and responses to those risks. Contingency planning is underway in the
event that third parties or the Company are unable to successfully
remediate all Year 2000 issues. The Company expects to complete this
contingency planning by March 31, 1999. However, there can be no assurance
that this contingency planning will partially or completely ameliorate the
failure of one or more third parties to successfully identify and resolve
Year 2000 issues.
18
<PAGE> 21
NOVACARE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
If the Company is unsuccessful in completing remediation of
non-compliant systems, correcting embedded chips and if customers or
vendors cannot rectify Year 2000 issues, the Company could incur additional
costs, which may be substantial, to develop alternative methods to 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, 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.
19
<PAGE> 22
NOVACARE, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(A) Exhibit
Number Exhibit Description Page Number
------ ------------------- -----------
27 Financial Data Schedule
20
<PAGE> 23
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)
FEBRUARY 16, 1999 BY/S/ ROBERT E. HEALY, JR.
----------------------------------
ROBERT E. HEALY, JR.,
SENIOR VICE PRESIDENT,
FINANCE & ADMINISTRATION AND
CHIEF FINANCIAL OFFICER
BY/S/ BARRY E. SMITH
----------------------------------
BARRY E. SMITH,
VICE PRESIDENT,
CONTROLLER AND
CHIEF ACCOUNTING OFFICER
21
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONDENSED CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1998 AND THE CONDENSED
CONSOLIDATED STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED DECEMBER 31,
1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH STATEMENT IN FORM
10-Q FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 1998.
</LEGEND>
<CIK> 0000802843
<NAME> NOVACARE, INC.
<MULTIPLIER> 1,000
<CURRENCY> US DOLLARS
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-01-1998
<PERIOD-END> DEC-31-1998
<EXCHANGE-RATE> 1
<CASH> 15,238
<SECURITIES> 0
<RECEIVABLES> 385,305
<ALLOWANCES> 57,550
<INVENTORY> 43,021
<CURRENT-ASSETS> 428,461
<PP&E> 202,256
<DEPRECIATION> (118,759)
<TOTAL-ASSETS> 1,365,156
<CURRENT-LIABILITIES> 168,825
<BONDS> 550,571
0
0
<COMMON> 682
<OTHER-SE> 568,648
<TOTAL-LIABILITY-AND-EQUITY> 1,365,156
<SALES> 0
<TOTAL-REVENUES> 961,523
<CGS> 0
<TOTAL-COSTS> 903,144<F1>
<OTHER-EXPENSES> 29,955<F2>
<LOSS-PROVISION> 15,061
<INTEREST-EXPENSE> 18,706
<INCOME-PRETAX> (5,343)
<INCOME-TAX> 7,482
<INCOME-CONTINUING> (12,825)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (12,825)
<EPS-PRIMARY> (0.20)
<EPS-DILUTED> (0.20)
<FN>
<F1>"TOTAL COSTS" CONSIST OF COST OF SERVICES AND SELLING AND ADMINISTRATIVE
EXPENSES.
<F2>"OTHER EXPENSES" CONSIST OF AMORTIZATION OF GOODWILL, MINORITY INTEREST AND
PROVISION FOR RESTRUCTURE OFFSET BY INVESTMENT INCOME AND GAIN FROM ISSUANCE
OF SUBSIDIARY STOCK.
</FN>
</TABLE>
