0000893220-95-000585.txt : 19950918 0000893220-95-000585.hdr.sgml : 19950918 ACCESSION NUMBER: 0000893220-95-000585 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19950630 FILED AS OF DATE: 19950915 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: NOVACARE INC CENTRAL INDEX KEY: 0000802843 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-MISC HEALTH & ALLIED SERVICES, NEC [8090] IRS NUMBER: 133247827 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-10875 FILM NUMBER: 95574085 BUSINESS ADDRESS: STREET 1: 1016 W NINTH AVE STREET 2: P O BOX 928 CITY: KING OF PRUSSIA STATE: PA ZIP: 19406 BUSINESS PHONE: 6109927200 MAIL ADDRESS: STREET 1: 1016 WEST NINTH AVENUE CITY: KING OF PRUSSIA STATE: PA ZIP: 19406 FORMER COMPANY: FORMER CONFORMED NAME: INSPEECH INC DATE OF NAME CHANGE: 19891019 10-K 1 FORM 10-K, NOVACARE, INC. 1 [NOVACARE LOGO] -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED JUNE 30, 1995 Commission file number 1-10875 NOVACARE, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 13-3247827 (STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.) 1016 WEST NINTH AVENUE, KING OF PRUSSIA, PA 19406 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICE) (ZIP CODE)
Registrant's telephone number, including area code: (610) 992-7200 Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered COMMON STOCK, PAR VALUE $.01 PER SHARE NEW YORK STOCK EXCHANGE, INC. 5 1/2% CONVERTIBLE SUBORDINATED NEW YORK STOCK EXCHANGE, INC. DEBENTURES DUE 2000
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM 405 OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED, TO THE BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION STATEMENTS INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY AMENDMENT TO THIS FORM 10-K. [ ] AS OF AUGUST 31, 1995, 65,580,226 SHARES OF COMMON STOCK WERE OUTSTANDING, AND THE AGGREGATE MARKET VALUE OF THE SHARES OF COMMON STOCK HELD BY NON-AFFILIATES WAS APPROXIMATELY $518,316,810. (DETERMINATION OF STOCK OWNERSHIP BY NON-AFFILIATES WAS MADE SOLELY FOR THE PURPOSE OF RESPONDING TO THIS REQUIREMENT AND THE REGISTRANT IS NOT BOUND BY THIS DETERMINATION FOR ANY OTHER PURPOSE.) DOCUMENTS INCORPORATED BY REFERENCE PART III INCORPORATES INFORMATION BY REFERENCE FROM PORTIONS OF THE REGISTRANT'S PROXY STATEMENT FOR THE 1995 ANNUAL MEETING OF STOCKHOLDERS TO BE HELD ON OCTOBER 26, 1995. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 2 NOVACARE, INC. AND SUBSIDIARIES FORM 10-K -- FISCAL YEAR ENDED JUNE 30, 1995 CONTENTS AND CROSS REFERENCE SHEET FURNISHED PURSUANT TO GENERAL INSTRUCTION G(4) OF FORM 10-K
FORM 10-K FORM 10-K FORM 10-K PART NO. ITEM NO. DESCRIPTION PAGE NO. --------- --------- ------------------------------------------------------------ --------- I 1 Business.................................................... 1 The Company............................................... 1 Rehabilitation Industry Background........................ 1 Business Strategy......................................... 2 Contract Therapy Services................................. 3 Outpatient Rehabilitation Services........................ 5 Orthotic and Prosthetic Services.......................... 6 Value-added Services...................................... 6 Statistical Data.......................................... 7 Competition............................................... 8 Reimbursement/Government Relations........................ 9 Government Regulation..................................... 11 Insurance................................................. 12 Employees................................................. 12 Executive Officers of the Registrant...................... 13 2 Properties.................................................. 14 3 Legal Proceedings........................................... 15 4 Submission of Matters to a Vote of Security Holders......... 15 II 5 Market for Registrant's Common Equity and Related Stockholder Matters....................................... 15 6 Selected Financial Data..................................... 16 7 Management's Discussion and Analysis of Financial Condition and Results of Operations................................. 17 8 Financial Statements and Supplementary Data................. 23 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................................. 40 III 10 Directors and Executive Officers of the Registrant.......... 40 11 Executive Compensation...................................... 40 12 Security Ownership of Certain Beneficial Owners and Management................................................ 40 13 Certain Relationships and Related Transactions.............. 40 IV 14 Exhibits, Financial Statement Schedules and Reports of Form 8-K....................................................... 41 Signatures.......................................................................... 42
i 3 PART I ITEM 1. BUSINESS THE COMPANY NovaCare, Inc. (together, unless the context otherwise requires, with its majority-owned subsidiaries, "NovaCare" or the "Company") was organized and formed in 1985 and is the leading national provider of medical rehabilitation services outside the medical rehabilitation hospital setting. Rehabilitation is the process that restores individuals disabled by trauma or disease to their optimal level of functionality and self-sufficiency. NovaCare's comprehensive medical rehabilitation services include (i) providing rehabilitation therapy and subacute services on a contract basis, primarily to nursing facilities and other health care institutions, (ii) operating medical rehabilitation hospitals (until April 1, 1995, the effective date of the sale of such hospitals, discussed later), (iii) providing outpatient rehabilitation services through a national network of patient care centers and (iv) delivering orthotic and prosthetic ("O&P") rehabilitation services through a national network of patient care centers. Effective April 1, 1995, the Company sold the stock of a subsidiary which owned all eleven of the Company's medical rehabilitation hospitals, in a transaction valued at $242.9 million. In connection with the sale, the Company reduced its long-term debt by $151.7 million and invested the remaining net proceeds in short-term investments. The sale substantially enhanced the Company's liquidity, reducing its net-debt-to-capitalization ratio to less than 10% at June 30, 1995. REHABILITATION INDUSTRY BACKGROUND Depending on an individual's diagnostic and therapeutic needs, rehabilitation services are delivered in a variety of settings, including rehabilitation hospitals, rehabilitation units in general hospitals, nursing facilities, comprehensive outpatient rehabilitation facilities, rehabilitation agencies and clinics, schools and patients' homes. These services are provided by physiatrists and other qualified rehabilitation physicians, occupational, physical and respiratory therapists, rehabilitation nurses, speech-language pathologists, audiologists, psychologists, social workers, orthotists, prosthetists, recreational therapists, music therapists and rehabilitation counselors. Recent industry analysis suggests that medical rehabilitation is a $12-15 billion industry, projected to grow at a rate of 10-12% per year through the end of the decade. The industry's growth has been fueled primarily by the following factors: Demand for services. Advances in technology and the aging population continue to drive demand. The need for rehabilitation services is significant. Technological advances in medical care have improved survival rates for patients who have suffered severe injury or disease. The U.S. Bureau of the Census reported in a 1991 survey that 33 million Americans had a disability and could not perform basic physical activity or needed assistance to do so. The Bureau of the Census statistics also show that the fastest growing segment of the population is the group over 65 years of age. This group has the highest requirement for rehabilitation services. Approximately 75% of strokes and 70% of amputations occur in persons over the age of 65. Almost 50% of Americans over 75 years of age currently require some form of rehabilitation. Demand has also increased as a result of higher quality of life expectations among disabled individuals. Cost-effectiveness of services. A major factor in the growth of the rehabilitation industry is the recognition by payors (insurance companies, managed care plans, employers, government programs and individual patients) of the benefits of rehabilitation in reducing lifetime costs of care. A recent study by the Health Insurance Association of America suggested that $11.00 in medical costs were saved for every $1.00 spent on rehabilitation, while a recent study by the Insurance Company of North America found that $17.00 in total outlays could be saved for every $1.00 spent on rehabilitation. Efforts to reduce workers' compensation expenses have also 1 4 stimulated demand for rehabilitation of injured workers and work-hardening and injury-prevention programs in the work place. Reimbursement for services. Rehabilitation services are covered for payment by Medicare and Medicaid and are typically covered by commercial health insurance policies, including managed care plans. Under the Omnibus Budget Reconciliation Act of 1987, nursing facilities that participate in the Medicare program are required to offer physical therapy, occupational therapy and speech-language pathology services to improve the functionality of patients. BUSINESS STRATEGY The Company's management has formally set forth the Company's values -- what NovaCare stands for, what motivates its employees, and what sets NovaCare apart -- and communicated them and discussed them with each of its employees. These values include the Company's: Credo Helping Make Life a Little Better Purpose To effectively meet the rehabilitation needs of our patients through clinical leadership Beliefs Respect for the Individual Service to the Customer Pursuit of Excellence Commitment to Personal Integrity
It is management's belief that a strong commitment to these values will enable the Company's employees to build the business and their careers, and that these values are a foundation upon which NovaCare's business plans are built. Emphasis on Rehabilitation Services NovaCare's overall long-term strategy is to maintain its position as the largest provider of low-cost, clinically excellent, medical rehabilitation services outside the medical rehabilitation hospital setting. The Company's strategy is based on the belief that: - These services will continue to experience steady or growing demand because, in the long term, health care payor cost-containment efforts are likely to drive patients toward lower-cost services outside the medical rehabilitation hospital setting. - The continued aging of the population will increase the demand for medical rehabilitation services, as the elderly consume a disproportionate amount of rehabilitation care. - Purchasers of medical rehabilitation services will increase their emphasis on clinical outcomes in the selection of rehabilitation providers. - Substantial cost reductions in the delivery of rehabilitation services will result from clinical improvements and innovation. - Larger providers of rehabilitation services are better positioned to provide clinical leadership, realize economies of scale to contain costs, attract quality management personnel and train and recruit therapists. - Rehabilitation care is not capital intensive, allowing for internal growth without the use of substantial capital resources. Internal Growth The Company has experienced substantial growth in the past few years, largely from acquisitions. Management has curtailed its acquisition plans in order to preserve liquidity in light of anticipated regulatory changes relating to contract therapy services, the largest portion of the Company's business, 2 5 and recent government efforts to reform health care. See "Reimbursement/Government Relations," discussed later. In addition, the increasing penetration of managed care in the outpatient rehabilitation customer base is expected to affect the historical increases in profitability experienced by the outpatient rehabilitation business. Management believes the industry has yet to fully reflect the effects of these uncertainties in the pricing of businesses available to be acquired. Management's immediate strategic focus is to concentrate on fundamental management issues, such as the Company's positioning for the anticipated changes in the reimbursement structure, the development of relationships with managed care networks and the training and retention of effective management personnel, that will enhance the Company's internal growth during this period of uncertainty in the industry. The Company has substantially enhanced its sales and marketing efforts in the contract therapy services business to replace the anticipated loss of business from Beverly Health and Rehabilitation ("Beverly") (see "Contract Therapy Services," discussed later) and other national multi-facility nursing home companies. In the second half of fiscal 1995 the Company has achieved new contract sales with estimated annual revenues in excess of those lost due to contract cancellations. Cost Containment A central aspect of the Company's strategy is to position itself as a low-cost provider of rehabilitation services. Clinical improvements and innovation are expected to lower the cost of rehabilitation service delivery. The Company's management is devoting a substantial portion of its efforts to such clinical objectives in addition to managing other costs. Management believes its efforts in these areas will allow the Company to operate successfully in an increasingly fixed-reimbursement environment. Quality Outcome Measurement Management believes that payors will ultimately demand that low cost be accompanied by proof of quality outcomes. The Company has committed resources to develop systems that capture outcomes in a useable format. Management believes that, as payors become more sophisticated and require providers to prove the delivery of quality service, the Company's commitment to outcomes measurement, coupled with its emphasis on clinical performance, will enhance its competitive position. CONTRACT THERAPY SERVICES NovaCare provides multi-disciplinary rehabilitation therapy services on a contract basis, principally to nursing facilities. The multi-disciplinary team comprises physical therapists, occupational therapists, and speech-language pathologists working together to improve the ability of patients to perform the activities of daily living. Physical therapy effects improved muscular and neural responses in an effort to improve patients' physical strength and range of motion. Occupational therapy is the evaluation and treatment of physical, cognitive and psychosocial performance deficits in activities of daily living. Speech-language pathology is the diagnosis and treatment of speech, language, voice and swallowing disorders. NovaCare is the largest contract therapy provider to the long-term care industry with a market share of approximately 13%, as measured by net revenues. As of June 30, 1995, NovaCare provided these services in more than 2,000 facilities located in 40 states. For the year ended June 30, 1995, contract therapy services represented 65% of the Company's net revenues and 75% of earnings before interest, taxes, depreciation, amortization, nonrecurring charges and minority interest ("Adjusted EBITDA"), exclusive of operations relating to the medical rehabilitation hospital division. Analysts estimate that the market for therapy services delivered under contract to nursing facilities is approximately $4 billion. A recent management-sponsored survey indicated that 73% of nursing facility rehabilitation services are performed on a contract basis. 3 6 The long-term care industry has typically contracted for therapy services for the following reasons: Insufficient caseload. The average nursing facility of approximately 100 beds has insufficient and/or irregular caseload, which makes it uneconomical to operate its own therapy program with the full-time employment of therapists and the associated costs of administration. Supply of therapists. There is an inadequate supply of therapists and the work force is characterized by high turnover. Consistent staffing levels are difficult to maintain, which jeopardizes service levels and quality. Expertise. Therapy revenues represent a relatively small percentage of a nursing facility's total revenues and operating activities. Reimbursement and regulatory complexities concerning appropriate utilization, documentation, denials management and quality oversight, if inadequately administered, can seriously erode the profitability of therapy programs staffed by and managed by employees of the nursing facility. As a result, nursing facilities frequently choose to contract for specialized expertise. In the current unsettled environment, NovaCare believes that it is well-positioned to compete effectively with other contractors due to: (i) a nationwide recruiting organization and substantial staffing capabilities, (ii) a multi-disciplinary team approach to therapy that is designed to deliver a high level of quality, (iii) reimbursement and regulatory expertise to assist nursing facility operators in their dealings with third-party payors, principally Medicare, (iv) sophisticated management information systems to assist operators in analyzing clinical outcomes, therapy utilization, claim denials, staffing and marketing and educational activities and (v) marketing support to increase the visibility of nursing facilities as a setting for quality rehabilitation. The supply of therapists is growing at a rate of less than 5% per year, yet the demand for therapists is growing at 8% to 10% per year. The Bureau of Labor Statistics estimates that the shortage of therapists will continue into the first decade of the next century. The principal limitations on the supply of therapists are the lack of funding to increase the number and size of educational programs and increasingly stringent accreditation requirements. Despite this imbalance, NovaCare has been successful in hiring a disproportionate number of therapists due in part to its "employer of choice" programs and systems support. The number of full-time-equivalent therapists employed in the Company's contract therapy business increased 11% during fiscal 1995 to 5,654. Employer of Choice Programs. NovaCare's employer of choice initiatives comprise defined career ladders for clinicians, clinical training and competitive compensation programs and benefits as well as management and technological support designed to attract and retain therapists. At June 30, 1995, NovaCare employed 53 recruiters, which management believes is the largest clinical recruiting organization in the U.S. Over the past two years, one-fifth of the therapists in NovaCare's contract therapy business joined NovaCare as a result of employee referrals. Systems Support. In fiscal 1995, NovaCare enhanced its proprietary information system, NovaNet PLUS, which is designed to streamline administrative activities, capture information of value to customers and reduce therapist record-keeping burdens. Management believes that this innovative system and NovaCare's leadership in outcomes measurement continue to increase NovaCare's attractiveness as an employer of therapists. Employee turnover in the rehabilitation industry is high relative to other industries because of the supply/demand imbalance. Also affecting turnover is the aggressive recruiting that occurs within the industry and the demographics of the largely young, female and mobile therapist population. Furthermore, therapist turnover rates in nursing facilities are traditionally higher than in other therapy settings due to the increased difficulties in treating geriatric patients. Total therapist turnover was 38% in fiscal 1995, compared with 32% in 1994. In part, this was due to a restructuring of the business during 4 7 the second half of fiscal 1994 that temporarily disrupted most clinicians' supervisory relationships. Also, contract turnover during fiscal 1995 (20% annualized) had a destabilizing effect on the therapists' work environment. These occurrences resulted in both employee-initiated and Company-initiated terminations. Management believes the turnover effects of the restructuring have substantially decreased but the effects of contract turnover will continue throughout fiscal 1996. NovaCare contracts predominantly with nursing home companies for the provision of rehabilitation therapy to their patients. Contracts are generally written for a period of two years and include automatic renewals for one year. Contracts are typically terminable upon 30 to 90 days notice by either party. Nursing facility operators have from time to time attempted to provide therapy services on an in-house basis, with varying degrees of success. A recent multi-year study of the costs of in-house programs compared with the costs of contract therapy indicated higher average therapy costs per patient care hour in nursing facilities with in-house programs. The study surveyed over 15,000 nursing facilities and examined several years of Medicare cost reports for nursing facilities with in-house therapy programs. Nevertheless, a number of national multi-facility nursing home companies have begun, or have announced that they plan to begin, to discontinue contracting for therapists and to staff and manage the function directly, effectively taking therapy programs "in-house." A recent management-sponsored survey indicated that 7% (based on number of beds) of such companies plan to transition to providing services on an in-house basis within the next two years. These recent decisions appear to be related, at least in part, to a desire to gain greater clinical control over therapy programs rather than due to cost-containment initiatives. This trend has been exacerbated by the recent consolidation activity in the nursing home industry. In the third quarter of fiscal 1995, the Company announced it had reached an agreement with its largest customer, Beverly, to transition Beverly to an in-house provider of therapy services over the next two years. Beverly facilities covered under the agreement represented approximately $77 million of the Company's annual net revenues in fiscal 1995. Management currently anticipates a reduction of approximately half of such net revenues will occur in the last six months of fiscal 1996 as a result of the in-house transition. However, management is currently unable to reliably predict whether circumstances may change, either positively or negatively, to alter this assessment. NovaCare is compensated for its contract services on a fee-for-service basis, and generally collects payment for services from the nursing facility, which in turn may receive reimbursement from Medicare, Medicaid, private insurance or the patient. Payments from Medicare and Medicaid are subject to complex regulations. Medicare regulations are subject to anticipated changes that may have a material effect on the contract therapy services business. See "Reimbursement/Government Relations," discussed later. NovaCare generally indemnifies its customers against medical denials of reimbursement by third party payors, including Medicare. NovaCare has established internal utilization and documentation standards and systems to minimize denials. During the past two fiscal years, on average, less than 2% of NovaCare's services were ultimately denied payment. OUTPATIENT REHABILITATION SERVICES Management believes that NovaCare is the largest provider of freestanding outpatient rehabilitation services in the U.S., with a national network of 400 centers, comprising stand-alone clinics, hospital-based clinics and employer on-site clinics. Through these settings, licensed physical and occupational therapists develop individual treatment plans to rehabilitate patients recovering from musculoskeletal trauma and/or surgery. For the year ended June 30, 1995, outpatient rehabilitation services represented 24% of the Company's consolidated net revenues and 36% of consolidated Adjusted EBITDA, exclusive of operations related to the medical rehabilitation hospital division. Outpatient rehabilitation services include general rehabilitation, which is designed to return injured and post-operative patients to their optimal functional capacity; sports rehabilitation, which is designed to minimize the "down-time" of injured sports participants and safely return them to sports 5 8 activities; industrial rehabilitation and work hardening, which are designed to reduce work-related injuries and rehabilitate and strengthen injured patients to allow a rapid, safe return to normal job activities; and hospital-based services, which involve the provision of inpatient and outpatient rehabilitation services on a contract basis to acute care hospitals. Patients are generally referred by physicians (most commonly orthopedists, physiatrists, primary care physicians, internists and neurologists), managed care insurers, workers' compensation insurers, case managers, industrial companies and rehabilitation nurses. In a number of states, patients can obtain outpatient therapy services by "direct access," that is, without a physician's referral. Analysts estimate that the outpatient rehabilitation industry approximates $7 billion and is growing at a rate of 4-6% per year. NovaCare's share of the industry total, based on fiscal 1995 revenues, is approximately 3%. The size of the industry segment of private clinics not affiliated with hospitals is estimated at $4 billion. The private clinics market is highly fragmented, with the nine largest firms comprising less than 20% of the market. ORTHOTIC AND PROSTHETIC SERVICES NovaCare is the largest custom O&P patient care services organization in the U.S. with approximately 8% market share. Services are provided by 324 orthotists and prosthetists, referred to as practitioners, through 125 patient care centers. For the year ended June 30, 1995, O&P services represented 11% of the Company's consolidated net revenues and 9% of consolidated Adjusted EBITDA, exclusive of operations related to the medical rehabilitation hospital division. Orthotic rehabilitation involves the fitting, design and fabrication and use of custom-made braces and support devices for treatment of musculoskeletal conditions resulting from illness, injury or congenital anomalies. Prosthetic rehabilitation involves the fitting, fabrication and use of custom-made artificial limbs typically required by people who have suffered the loss of a limb from vascular diseases, diabetes, cancer or trauma. During fiscal 1995, the Company acquired Sabolich Prosthetic and Research Center, a nationally renowned leader in prosthetic research, design and patient care, providing services at four patient care centers throughout the U.S. The principal referral source for O&P rehabilitation services is the orthopedic surgeon. However, other specialized physicians, such as physiatrists and vascular surgeons, and managed care payors have emerged as important referral sources. Secondary referral sources include physical therapists, orthopedic nurses, orthopedic technicians and other rehabilitation professionals. The O&P rehabilitation industry is estimated to be a $1 billion industry. According to industry sources, O&P patient care services in the United States are currently provided through more than 1,100 patient care centers. VALUE-ADDED SERVICES The Company recently established a separate division focusing on the delivery of management and consulting services to health care and long-term care institutions. Such services currently include subacute program development and management and nursing facility rehabilitation program management and consulting. Additional services are being developed. Prior to the establishment of a separate division these services were reported as a component of contract therapy services. Subacute Services NovaCare manages subacute programs for nursing facilities on a contract basis. Subacute care is defined as a level of care for patients with medically stable but frequently complex conditions requiring extensive nursing services, rehabilitation services and physician oversight in an inpatient setting. These patients do not require the intensity or scope of services found in an acute care hospital. Subacute care providers bridge the gap between more costly acute care settings and lower cost nursing facilities, which typically lack the intensive integrated services required for these higher acuity 6 9 patients. At June 30, 1995, NovaCare managed distinct subacute units in 58 nursing facilities, with 23 additional units in various stages of development or under consideration. Subacute care is a rapidly growing industry. Analysts estimate that the subacute industry is approximately $4 billion today, and is projected to be a $10-15 billion industry by the end of the decade. Demand for subacute services is driven by the desire of payors to contain the costs of health care and by Medicare's prospective payment system, which encourages the early discharge of patients from acute care hospitals. Rehabilitation Program Consulting The Company provides rehabilitation program consulting and management services to nursing home operators through its Cannon & Associates organization. The Company had arrangements to provide such services to 539 nursing homes at June 30, 1995. STATISTICAL DATA The table below sets forth certain operating statistics for rehabilitation services during the last three years ended June 30. Because of the shortage of therapists and unmet demand, previously discussed, billable hours relating to contract therapy services fluctuate principally as a result of (i) the number of full-time-equivalent employees ("FTE's") available for service and (ii) productivity as measured by the number of billable hours per FTE per week. Employee turnover is one factor that adversely affects productivity.
1995 1994 1993 ----- ----- ----- CONTRACT SERVICES Facilities Served........................................... 2,019 2,142 1,901 Billable Hours (000s)....................................... 8,266 7,625 5,513 FTE's: Physical Therapists....................................... 2,573 2,259 1,561 Occupational Therapists................................... 1,897 1,698 1,280 Speech-Language Pathologists.............................. 1,184 1,154 931 Billable Hours/FTE/Week Physical Therapists....................................... 33.5 33.3 32.1 Occupational Therapists................................... 25.3 26.5 26.5 Speech-Language Pathologists.............................. 23.8 25.5 25.8 Total Employee Turnover..................................... 38% 32% 27% OUTPATIENT SERVICES Number of Patient Care Centers.............................. 400 305 137 Visits (000s)............................................... 2,363 1,450 576 Visits/FTE/Day.............................................. 13.1 12.6 12.8 O&P SERVICES Number of Patient Care Centers.............................. 125 121 116 Patients Billed (000s)...................................... 162 147 143
7 10 The table below sets forth the percentage of net revenues by payor source for the years ended June 30. Contract billings are those contract therapy services billings to providers of services (e.g., nursing homes that have contracted directly with Medicare). These services are principally to patients insured by Medicare.
1995 1994 1993 --- --- --- Contract billings................................................ 52% 54% 55% Private insurance, self pay...................................... 26% 23% 21% Medicare and Medicaid............................................ 18% 20% 22% Managed Care..................................................... 4% 3% 2% --- --- --- 100% 100% 100% === === ===
COMPETITION The health care industry in general, and rehabilitation in particular, are highly competitive and subject to continual changes in methods of service delivery and provider selection. Rehabilitation is largely a local market business and competition varies considerably among markets. NovaCare competes in the geographic markets where it provides contract therapy services and where its outpatient rehabilitation and O&P rehabilitation patient care centers are located. The primary competitive factors in such local markets are quality of patient care services, charges for services and responsiveness to meeting the needs of patients, customer health care facilities, referral sources and payors. Key competitive factors in the contract therapy services business include the ability to provide therapy staff to meet the therapy needs at customer facilities and the ability to provide management and clinical support to such staff. NovaCare competes in local markets with other national and regional and local contract therapy providers. NovaCare believes that its ability to recruit therapists allows it to compete successfully with other contract therapy providers in the markets where NovaCare provides services. The demographics of potential customers are expected to change as some larger nursing home chains attempt to take their services in-house. This may increase the competition for remaining customers. Although the Company intends to expand its customer contracts in the nursing home industry, the successful development of such in-house programs by a large number of customers could adversely affect the Company's ability to maintain its contract therapy services business at present levels. See "Contract Therapy Services," previously discussed. In the outpatient rehabilitation business, key competitive factors include the ability to develop and maintain relationships with referral sources and to provide sufficient geographic coverage to allow the Company, alone or with other providers, to compete successfully for patients from managed care payors, workers' compensation payors and employers in manufacturing and service industries. The Company competes in local markets with other national and regional and local outpatient therapy service providers, as well as hospital-based outpatient clinics and physician-directed therapy practices. Some of these competitors may have greater patient referral, personnel and geographic resources in certain local markets than does the Company. Management believes that the Company competes successfully within its local markets based on a reputation with referral sources for quality and service, an ability to provide geographic coverage and competitive prices. Competition in the O&P business is marked by an ability to compete for patient referrals from physicians, rehabilitation professionals, hospitals and payor sources. Competition in the O&P industry is highly fragmented; however, there are several regional providers with multiple facilities in certain local markets. The primary competitive factors in the industry are quality of patient care services, staffing, geographic coverage, reimbursement support and, to a lesser extent, pricing. Many practitioners generate patient referrals due to long-term relationships with referring physicians. Referral source relationships often continue through a multi-generational succession of practices. Management 8 11 believes the Company competes successfully within local markets because of strong referral relationships and quality of patient care services. National and local sponsorship and support of organizations for injured and disabled individuals enhance NovaCare's visibility and competitive position. In addition, NovaCare has developed affiliations with academic institutions and has provided funding for the development of a number of university physical therapy and occupational therapy programs. REIMBURSEMENT/GOVERNMENT RELATIONS Reimbursement for medical rehabilitation services is available through Medicare, Medicaid, commercial insurance, managed care programs, veterans benefits, workers' compensation and other government programs. Medicare is a federally funded health program which provides health insurance coverage for certain disabled persons and persons age 65 or older. Medicaid is a health insurance program, jointly funded by the federal and state governments, which provides health insurance coverage for certain financially or medically needy persons regardless of age. Medicaid benefits supplement Medicare benefits for financially needy persons age 65 or older. Congress has provided, through the Medicare program, for coverage of contract therapy services, outpatient rehabilitation services and O&P devices and patient care services. Medicare reimbursement rules are different for a number of these services. Moreover, in many states Medicaid reimburses for rehabilitation services for eligible recipients. A substantial portion of NovaCare's business, in effect, is reimbursed by Medicare, and a small portion by Medicaid. As a result, regulations regarding Medicare and Medicaid eligibility, certification and reimbursement are important to NovaCare's activities and changes in these programs or regulations could adversely affect NovaCare's business. The 104th Congress will consider health care reform and balanced budget proposals. Consideration is expected on measures which will control health care costs. Legislative changes to slow the annual rate of growth of Medicare and Medicaid are expected. Such changes may impact reimbursement for rehabilitation. Contract Therapy Services Contract therapy services are covered and reimbursed in one of two ways. NovaCare may bill a facility, which, in turn, invoices the third-party payor, such as Medicare, or NovaCare may provide services through its own certified rehabilitation agency, which directly bills the third-party payor. In most cases, NovaCare bills the facility. Medicare reimburses the nursing facility for contract therapy services on a cost basis, and reimbursement levels are determined based on a reasonable-cost standard. Specific guidelines exist for evaluating the reasonable cost of physical therapy. General guidelines exist for evaluating the reasonable cost of occupational therapy and speech-language pathology services. When a nursing facility contracts with a third party, such as NovaCare, for physical therapy services, a standard rate system applies. This system is called salary-equivalency. The physical therapy salary-equivalency rates have been adjusted annually based on a 1983 standard but do not adequately reflect salary inflation since 1983. As a result, physical therapy contract services are essentially a break-even business for many contractors, including NovaCare. The Health Care Financing Administration ("HCFA"), the federal agency responsible for the rules governing Medicare and Medicaid, has indicated it intends to issue specific reimbursement guidelines for occupational therapy and speech-language pathology services and to recalculate and update the existing guidelines for physical therapy services. Proposed rules governing such guidelines are expected for public comment in the last quarter of calendar year 1995. Final rules are expected to be promulgated in the second quarter of calendar year 1996. Management believes that, when occupational therapy and speech-language pathology services guidelines are established, HCFA will recalculate and update the physical therapy salary-equivalency 9 12 guidelines in consideration of the substantial increases in salary and services standards since these guidelines were last revised. Because the nature and magnitude of these changes are not certain at this time, there are no assurances with respect to the impact such changes may have on NovaCare. NovaCare is actively involved with industry trade groups working to ensure that such final rules are based on timely, accurate and relevant data. Management is taking steps which it believes will help to mitigate any adverse economic impact of these changes. There can be no assurance that future (i) legislation, either health care or budgetary, (ii) regulatory changes or (iii) interpretations of regulations, will not have a material adverse effect on the future operations of the Company. Until such time as salary-equivalency guidelines are formally promulgated, contract occupational therapy and speech-language pathology services are evaluated based upon the reasonableness of costs incurred by the provider under a "prudent buyer" standard. During the past two years, HCFA has issued several directives to its fiscal intermediaries instructing them on how to ensure therapy costs are reasonable. One such advisory issued in April 1995 was controversial as it included a series of data tables with incomplete instructions. Responding to concerns raised by the nursing home and rehabilitation sectors, HCFA clarified its guidance in a June 1995 directive reiterating that fiscal intermediaries must apply the "prudent buyer" principle when evaluating whether a facility's costs are substantially out-of-line. Intermediaries are instructed to consider relevant facts and circumstances concerning a facility's contracting costs. The attention being given by HCFA to these instructions has increased scrutiny of contracting practices. NovaCare is working with its customers to resolve issues raised by fiscal intermediaries in cost report audits. Over the past 15 years, numerous proposals for some form of prospective payment system have been suggested for nursing facilities. NovaCare is part of an ongoing industry effort that works closely with federal regulators in assessing alternatives to present reimbursement systems. Legislation has been introduced in the 104th Congress to implement a comprehensive prospective payment system for nursing homes including a separate payment for ancillary services, including therapy services. This measure and related ideas may be considered as part of Medicare reforms and/or cost containment legislation. NovaCare is actively involved in the trade groups assisting the Congress in evaluating these payment strategies. NovaCare also receives reimbursement by Medicare for a portion of its contract therapy services provided through certified rehabilitation agencies. See "Government Regulation," discussed later. NovaCare's certified rehabilitation agencies file annual cost reports under the Medicare program which are used to determine cost settlements for the prior year and interim payment rates for the upcoming year. Funds received under various state programs and Medicare are subject to audit with respect to proper application of the various payment formulas. These audits can result in retroactive adjustments of payments received from the program by NovaCare. If, as a result of such audits, it is determined that overpayments for services were made to NovaCare, the excess amount must be repaid by NovaCare to the government. If, on the other hand, it is determined that an underpayment was made, the government agency will make an additional payment to NovaCare. Outpatient Rehabilitation Services The principal sources of reimbursement for outpatient rehabilitation are managed care plans, commercial and workers' compensation insurance, motor vehicle insurance and individual patients. Medicare and other government health insurance programs represent approximately 11% of revenues. Workers' compensation is a statutorily defined employee benefit which varies on a state-by-state basis. Workers' compensation laws generally require employers to pay for employees' costs of medical treatment, lost wages, legal fees and other costs associated with work-related injuries and disabilities and, in certain jurisdictions, mandatory vocational rehabilitation. Companies provide such coverage to their employees through either the purchase of insurance from private insurance companies, participation in state-administered funds or through self-insurance. Workers' compensation represented approximately 32% of fiscal 1995 outpatient rehabilitation revenues. 10 13 Managed care plans represented approximately 12% of fiscal 1995 outpatient rehabilitation revenues. NovaCare receives revenues under managed care plans either on a discounted fee-for-service basis or, in a growing number of cases, on the basis of capitated fees per covered member per month. NovaCare receives reimbursement by Medicare for outpatient rehabilitation services primarily through NovaCare's certified rehabilitation agencies. See "Government Regulation," discussed later. Orthotics and Prosthetics Services O&P rehabilitation patient care services are reimbursed primarily by commercial insurance, managed care plans, individual patients, workers' compensation, Medicare and other government programs. In fiscal 1995, Medicare and other government programs, including Medicaid, represented approximately 41% of NovaCare's revenues for O&P patient care services. Medicare reimbursement is based on fee schedules established by HCFA. See "Government Regulation," discussed later. GOVERNMENT REGULATION The health care industry, including rehabilitation services, is subject to extensive federal, state and local regulation. The various layers of regulation affect NovaCare's business by requiring licensure or certification of its employees and facilities and controlling reimbursements for services provided. Government and other third-party payors' health care policies and programs have been subject to changes in payment and methodologies for a number of years. Efforts to reform the nation's health care system could induce additional changes. See "Reimbursement/Government Relations," previously discussed. NovaCare operates certified rehabilitation agencies to facilitate billing for outpatient services and a portion of its contract therapy services. In order to receive Medicare reimbursement directly, outpatient centers must be certified by Medicare as rehabilitation agencies or comprehensive outpatient rehabilitation facilities, or the therapists must be certified as independently practicing therapists. The certification criteria relate to the type of facility and its equipment, record keeping, staffing and service as well as compliance with all state and local laws. In addition, certain states require facilities to obtain state licensure as a health facility as a requirement for reimbursement. As of June 30, 1995, NovaCare operated 20 and 55 certified rehabilitation agencies for contract therapy services and outpatient rehabilitation services, respectively. Management believes its operations are structured to comply with all applicable rules and regulations. In order to participate in the Medicare program, NovaCare's O&P patient care centers are required to secure and maintain a supplier number. This process requires certain disclosures and procedural requirements, which change periodically. All of NovaCare's O&P patient care centers presently maintain such a supplier number. In most states, the employment of therapists by business corporations is a permissible practice. However, several states, including states in which NovaCare operates outpatient centers, have enacted legislation or regulations or have interpreted existing physical or occupational therapy licensing laws to restrict business corporations, such as NovaCare, from practicing physical or occupational therapy through the direct employment of therapists. Management believes its operations are structured to comply with applicable laws and regulations. Various state and federal laws and regulations govern relationships between providers of health care services and physicians, including employment or service contracts and investment relationships. These laws and regulations include the fraud and abuse provisions of the Medicare and Medicaid statutes, which prohibit the payment, receipt or offering of any direct or indirect remuneration for the referral of or to induce a referral of Medicare or Medicaid patients or for the ordering or providing of Medicare or Medicaid covered services, items or equipment and the self-referral provisions of federal and state law which generally prohibit referrals by a physician to persons with whom the physician has 11 14 certain types of financial relationships. Violations of these provisions may result in civil or criminal penalties for individuals or entities and/or exclusion from participation in the Medicare and Medicaid programs. Management believes it is in compliance with these laws and regulations and has established a broad-based compliance program to ensure conformity to these rules as well as to other laws and regulations. INSURANCE The Company maintains professional liability insurance in amounts deemed appropriate by management based upon historical claims and the nature and risks of the business. The Company also maintains property and general liability insurance for the customary risks inherent in the operation of businesses in general. While NovaCare believes its insurance policies to be adequate in amount and coverage for its current operations, there can be no assurance that any future claims will not exceed the limits of those policies or that such insurance will continue to be available. EMPLOYEES As of June 30, 1995, NovaCare had approximately 11,000 employees. NovaCare's employees are not represented by any labor union. Management believes that its relationships with its employees are favorable. 12 15 EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of NovaCare are as follows:
NAME POSITION AGE ---------------------------- ---------------------------------------------------------- --- John H. Foster.............. Chairman of the Board, Chief Executive Officer and 53 Director Timothy E. Foster........... President, Chief Operating Officer and Director 43 C. Arnold Renschler, M.D.... Senior Vice President and Chief Clinical Officer and 53 Director Daryl A. Dixon.............. President and General Manager, Contract Services Division 35 Ronald G. Hiscock........... President and General Manager, Orthotic and Prosthetic 44 Division James C. New................ President and General Manager, Outpatient Rehabilitation 50 Division Peter D. Bewley............. Senior Vice President, General Counsel and Secretary 49 Bruce J. Colburn............ Senior Vice President, Chief Financial Officer and 40 Treasurer Laurence F. Lane............ Senior Vice President, Regulatory Affairs 50 Arthur T. Locilento, Jr..... Senior Vice President, Human Resources 52 Scott Marber................ Senior Vice President, Corporate Sales and Marketing 39 Susan J. Campbell........... Vice President, Communications and Investor Relations 44 James T. Walmsley........... Vice President, Reimbursement 45
No family relationships exist among any of the directors or executive officers of NovaCare. Executive officers serve at the discretion of the NovaCare Board of Directors. JOHN H. FOSTER has been Chairman of the Board and Chief Executive Officer of NovaCare since December 1984. Mr. Foster is also Chairman of the Board and Chief Executive Officer of Apogee, Inc., a national mental health services company; a Director of The Pet Practice, Inc., a veterinary services company; and a Director of Corning Incorporated, an international corporation with business interests in specialty materials, communications, laboratory services and consumer products. Mr. Foster is founder and Chairman of the Board of Foster Management Company, an investment advisor, and general partner of various venture capital investment funds. He was also the founder, Chairman of the Board and Chief Executive Officer of RehabClinics, Inc., which was acquired by NovaCare in February 1994, and founder, Chairman of the Board and Chief Executive Officer of Orthopedic Services, Inc., which was acquired by NovaCare in March 1992. TIMOTHY E. FOSTER has been President and Chief Operating Officer since October 1994. He served as Senior Vice President, Finance and Administration and Chief Financial and Accounting Officer of NovaCare from November 1988 to October 1994, Treasurer of NovaCare from March 1992 to October 1994, and has been a Director of NovaCare since December 1984. Mr. Foster currently serves as a Director of Apogee, Inc., a national mental health services company, a position he has had since February 1995. C. ARNOLD RENSCHLER, M.D. has been Senior Vice President and Chief Clinical Officer of NovaCare since May 1994 and has been a Director of NovaCare since 1990. He currently acts as President and General Manager of the Company's Value-added Services Division. Dr. Renschler served as President and General Manager, Medical Rehabilitation Hospital Division of NovaCare from January 1994 to May 1995. Between July 1992 and January 1994, he served as President and General Manager of NovaCare's Contract Services Division. Dr. Renschler was President and Chief Operating Officer of NovaCare from January 1990 until September 1992. DARYL A. DIXON has been President and General Manager of NovaCare's Contract Services Division since January 1994. He joined NovaCare in February 1992 as Regional Vice President in the Contract Services Division and was Vice President, Operations of the Contract Services Division from November 1992 until January 1994. From 1982 to 1992, he held various positions at Manor HealthCare, Inc., a nursing home management company. RONALD G. HISCOCK has been President and General Manager of NovaCare's Orthotics and Prosthetics Division since April 1995. He joined NovaCare in June 1992 as the East Region President 13 16 for the Orthotics and Prosthetics Division and was the Division's Vice President of Operations from July 1994 through March 1995. Prior to joining NovaCare, he spent 23 years in senior management positions with Sears Roebuck & Company and Montgomery Ward. JAMES C. NEW has been President and General Manager of NovaCare's Outpatient Rehabilitation Division since February 1994. From May 1991 to February 1994, he was President and Chief Operating Officer of RehabClinics, Inc., which was acquired by NovaCare in February 1994. From 1988 to 1991, he was President and Chief Operating Officer of Greater Atlantic Health Services, Inc., a health maintenance organization. PETER D. BEWLEY has been Senior Vice President, General Counsel and Secretary of NovaCare since May 1994. Most recently, Mr. Bewley was at Johnson & Johnson, where he was Associate General Counsel since 1977. BRUCE J. COLBURN has been Senior Vice President, Chief Financial Officer and Treasurer since May 1995. Most recently, Mr. Colburn was Senior Vice President and Chief Financial Officer of Primary Health Systems, L.P., an acute care hospital management company, and remains a limited partner. In 1994, Mr. Colburn was Senior Vice President, Finance of OrNda Healthcorp, an acute care hospital management company, and prior to that held various financial officer positions with American Healthcare Management, Inc. (acquired by OrNda Healthcorp in 1994). From 1985 to 1990, Mr. Colburn served as an executive with Ernst & Young's National Accounting and Auditing Group. LAURENCE F. LANE has been Senior Vice President, Regulatory Affairs of NovaCare since October 1994. From November 1986 to October 1994 he was Vice President, Regulatory Affairs. ARTHUR T. LOCILENTO, JR. has been Senior Vice President, Human Resources of NovaCare since October 1994. From March 1988 to October 1994, he was Vice President, Human Resources. SCOTT MARBER has been Senior Vice President, Corporate Sales and Marketing since August 1995. From 1990 to 1995, Mr. Marber was at Olsten Kimberly QualityCare, a provider of home health care services, where he was Vice President of Sales and National Accounts. From 1986 to 1990, he was Vice President, Sales and Marketing for Private Healthcare Systems, a managed care partnership between certain providers of health care services and insurance companies. SUSAN J. CAMPBELL has been Vice President, Communications and Investor Relations of NovaCare since April 1995. She joined NovaCare in March 1993 as Director of Investor Relations and was Vice President, Investor Relations from April 1994 to April 1995. Ms. Campbell was Vice President, Investor Relations, First Fidelity Bancorporation from 1982 to 1993. JAMES T. WALMSLEY has been Vice President, Reimbursement of NovaCare since January 1994 and Director of Reimbursement since April 1992. Prior to joining NovaCare, he was Vice President, Reimbursement and Regulatory Affairs for National Medical Enterprise's Specialty Hospital Division. From 1982 to 1990, he worked in the Management Consulting Services Group of Price Waterhouse. ITEM 2. PROPERTIES NovaCare's principal executive offices are located at 1016 West Ninth Avenue, King of Prussia, Pennsylvania, where NovaCare leases approximately 78,072 square feet of office space. The lease for this office space expires in July 2005. NovaCare leases other office and center space at approximately 550 locations in various cities within the United States. Such space aggregates approximately 1,200,000 square feet under lease arrangements which typically are three years or less in duration. NovaCare leases expire at various times through 2020. NovaCare anticipates that it will be able to renew its leases upon their expiration or lease other facilities on comparable terms if leases are not renewed. NovaCare believes that it has adequate capacity for its present needs and planned expansion in the near future. NovaCare also has sublease agreements for approximately 13,000 square feet of office space, expiring June to September 2000, with companies in which NovaCare's Chairman of the Board and Chief Executive Officer is a Director and/or an Executive Officer. 14 17 ITEM 3. LEGAL PROCEEDINGS NovaCare is a party to various claims, legal actions and complaints arising in the ordinary course of business. In the opinion of management and legal counsel, all such matters are adequately covered by insurance, or, if not covered, are without merit or are of such kind, or involve such amounts, that unfavorable disposition would not have a material adverse effect on the financial position or results of operations of NovaCare. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS NovaCare's common stock is traded on the New York Stock Exchange (NYSE) under the symbol NOV. On August 31, 1995, there were 2,471 holders of record of common stock. The following table sets forth the high and low sales prices per share of common stock as reported on the NYSE Composite Tape for the relevant periods.
COMMON STOCK PRICES ------------------ HIGH LOW ------- ------- YEAR ENDED JUNE 30, 1995 First Quarter............................................ $16.88 $10.63 Second Quarter........................................... 11.25 7.13 Third Quarter............................................ 9.88 7.38 Fourth Quarter........................................... 9.50 7.38 YEAR ENDED JUNE 30, 1994 First Quarter............................................ $14.88 $11.50 Second Quarter........................................... 15.63 11.75 Third Quarter............................................ 18.88 14.00 Fourth Quarter........................................... 19.13 15.75
With the exception of 2-for-1 stock splits of common stock effected in the form of stock dividends in June 1987 and July 1991, no other dividends have been paid or declared on common stock since NovaCare's initial public offering on November 5, 1986. NovaCare does not expect to declare any cash dividends on common stock in the foreseeable future. 15 18 ITEM 6. SELECTED FINANCIAL DATA The following selected financial data should be read in conjunction with NovaCare's consolidated financial statements and the accompanying notes presented elsewhere herein. NOVACARE, INC. AND SUBSIDIARIES FIVE YEAR FINANCIAL SUMMARY (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED JUNE 30, ---------------------------------------------------- 1995 1994 1993 1992 1991 -------- -------- -------- -------- -------- STATEMENT OF OPERATIONS DATA: Net revenues................................ $905,359 $789,745 $582,342 $392,278 $252,532 Adjusted EBITDA(1).......................... $116,703 $136,476 $ 96,737 $ 68,537 $ 41,805 Income from operations...................... $143,881 $108,208 $ 78,819 $ 54,527 $ 32,562 Net interest (expense) income............... $(17,893) $(11,773) $ (2,841) $ 1,355 $ (910) Income before income taxes.................. $125,584 $ 95,892 $ 75,542 $ 55,461 $ 31,338 Income taxes................................ $ 63,660 $ 37,678 $ 27,906 $ 18,868 $ 11,199 Net income.................................. $ 61,924 $ 58,214 $ 47,636 $ 36,593 $ 20,139 Net income applicable to common stock(2).... $ 61,924 $ 58,214 $ 47,585 $ 36,483 $ 19,942 Net income per common share................. $ .95 $ .90 $ .79 $ .64 $ .39
AS OF JUNE 30, ---------------------------------------------------- 1995 1994 1993 1992 1991 -------- -------- -------- -------- -------- BALANCE SHEET DATA: Working capital............................. $255,126 $194,324 $265,908 $ 97,608 $ 95,983 Total assets................................ $852,557 $850,541 $611,567 $312,566 $232,123 Total indebtedness.......................... $225,015 $344,602 $206,415 $ 37,528 $ 27,968 Total liabilities........................... $364,922 $434,837 $282,587 $ 88,587 $ 58,615 Stockholders' equity........................ $487,635 $415,704 $328,980 $223,979 $173,508
--------------- (1) Adjusted EBITDA represents earnings before interest, income taxes, depreciation, amortization of excess cost of net assets acquired, merger and other nonrecurring items and minority interest. (2) Gives effect to dividends, whether or not declared, on 10% mandatorily redeemable preferred stock issued by a consolidated subsidiary in fiscal 1991 which was redeemed in fiscal 1993 and on 10% cumulative preferred stock issued by a consolidated subsidiary in fiscal 1990 which was redeemed in fiscal 1991. 16 19 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS NOVACARE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW During fiscal 1995, the Company's net income, excluding the after-tax effect of nonrecurring items, declined to $40.1 million compared with $63.1 million in fiscal 1994. Nonrecurring items in fiscal 1995 consisted of an $88.2 million pretax gain on the sale of the of the stock of a subsidiary, a $29.9 million pretax restructuring charge and a $1.0 million pretax charge relating to the settlement of certain shareholder litigation. Hospitals Division Sale Effective April 1, 1995, the Company sold the stock of a subsidiary, which owned all eleven of the Company's medical rehabilitation hospitals, in a transaction valued at $242.9 million. In fiscal 1995 this subsidiary contributed $110.6 million to consolidated net revenues and $19.4 million to consolidated earnings before interest, taxes, depreciation, amortization, nonrecurring items, and minority interest. The transaction resulted in a pretax gain on sale of $88.2 million. In connection with the sale the Company reduced its long-term debt by $151.7 million and invested the remaining net proceeds in short-term investments for general corporate purposes. Restructuring Charge As discussed in Note 2 to the accompanying consolidated financial statements, the Company recorded a pretax restructuring charge of $29.9 million related to a plan, adopted and approved in the fourth quarter of fiscal 1995, to consolidate specific administrative functions, including certain finance operations, and to consolidate, and to a lesser extent, close certain underperforming locations. The plan was developed in a effort to reduce the costs of providing services in certain locations and reduce overall administrative costs. Of the total restructuring charge, $14.5 million relates to amounts to be paid in cash, of which $2.7 million was paid in the fourth quarter of fiscal 1995. The noncash portion of the charge relates to the write-off of certain assets, principally goodwill related to facilities closed or to be closed. The Company estimates that the plan, when fully implemented will reduce or eliminate approximately $12 million to $15 million of annual expenses. Shareholder Litigation Following the Company's announcement in September 1994 that first quarter fiscal 1995 earnings would not meet analyst's expectations, the price of the Company's stock dropped sharply and a suit was filed against the Company and its Chairman alleging that the Company's first quarter fiscal 1995 operating problems were not disclosed early enough. The Company and the Chairman denied the allegations and mounted a vigorous defense. Settlement of the suit in March 1995 resulted in a $1 million pretax charge representing both settlement and legal costs. RESULTS OF OPERATIONS General Trends During the periods discussed below, the Company's results of operations have been affected by certain industry trends, sale of the Company's medical rehabilitation hospital business and changes in the Company's debt structure. 17 20 NOVACARE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED) Industry Trends During the past year, the Company and other rehabilitation providers faced, and will continue to face, a number of risks creating an environment of uncertainty as to the future growth and profitability of the industry. These risks include (i) the potential impact of any Congressional proposals addressing health care reform and a "balanced budget," (ii) pending regulatory pressure to reduce certain reimbursement rates, discussed later, (iii) increasing competition among providers of rehabilitation services for existing business and (iv) increased penetration in the outpatient setting by managed care payors, with attendant lower rates of reimbursement. Additionally, national multi-facility nursing home companies are showing an increasing tendency to provide therapy services in-house rather than to contract for such services. The 104th Congress will consider health care reform and balanced budget proposals. Consideration is expected on measures which will control health care costs. Legislative changes to slow the annual rate of growth of Medicare and Medicaid are expected. Such changes may impact reimbursement for rehabilitation. There can be no assurance that future (i) legislation, either health care or budgetary, (ii) regulatory changes or (iii) interpretations of regulations, will not have a material adverse effect on the future operations of the Company. HCFA is in the process of reviewing existing reimbursement requirements for contract therapy services and is expected to propose salary-equivalency guidelines for speech-language pathology and occupational therapy services in the last quarter of calendar year 1995. Management believes that, if speech-language pathology and occupational therapy services guidelines are established, HCFA will recalculate and update the physical therapy salary-equivalency guidelines in consideration of the substantial increases in salary and services standards since these guidelines were last revised. Final rules are expected to be promulgated in the second quarter of calendar year 1996. NovaCare is actively involved with industry trade groups working to ensure that such final rules are based on timely, accurate and relevant data. Because the nature and magnitude of these changes are not certain at this time, there are no assurances with respect to the impact such changes may have on NovaCare. Management is taking steps which it believes will help to mitigate any adverse economic impact of these changes. Until such time as salary-equivalency guidelines are formally promulgated, contract occupational therapy and speech-language pathology services are evaluated based upon the reasonableness of costs incurred by the provider under a "prudent buyer" standard. During the past two years, HCFA has issued several directives to its fiscal intermediaries instructing them on how to ensure therapy costs are reasonable. One advisory issued in April 1995 was controversial as it included a series of data tables with incomplete instructions. Responding to concerns raised by the nursing home and rehabilitation sectors, HCFA clarified its guidance in a June 1995 directive reiterating that fiscal intermediaries must apply the "prudent buyer" principle when evaluating whether a facility's costs are substantially out-of-line. Intermediaries are instructed to consider relevant facts and circumstances concerning a facility's contracting costs. The attention being given by HCFA to these instructions has increased scrutiny of contracting practices. NovaCare is working with its customers to resolve issues raised by fiscal intermediaries in cost report audits. 18 21 NOVACARE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED) Year Ended June 30, 1995 Compared with the Year Ended June 30, 1994. Net revenues for the year ended June 30, 1995 increased over the prior year by $115.6 million or 14.6% to $905.4 million and earnings before interest, taxes, depreciation, amortization, nonrecurring items and minority interest ("Adjusted EBITDA") decreased by $19.8 million or 14.5% to $116.7 million. Because of the net nonrecurring pretax gain of $57.4 million, the Company reported net income for the year ended June 30, 1995, of $61.9 million compared with net income of $58.2 million for the year ended June 30, 1994. Fiscal 1994 included pretax nonrecurring charges $5.8 million related to a merger transaction. Excluding the after-tax effect of nonrecurring items, the Company's net income declined to $40.1 million for fiscal 1995 compared with $63.1 million for fiscal 1994. The principal reasons for the net revenues increase during this period were (i) an increase in contract therapy services billable hours of 641,000 hours or 8.4%, combined with an aggregate increase in net revenue per billable hour of approximately 3%, (ii) an increase in outpatient rehabilitation visits of 913,000 visits or 63.0% resulting primarily from 25 acquisitions in fiscal 1995 and the full effect of 42 acquisitions during fiscal 1994 and (iii) an increase in O&P patients billed of 15,000 or 10.2% combined with an aggregate increase in net revenue per patient of 12.4%. These increases were offset by a decrease in the net revenues applicable to the medical rehabilitation hospital division of $26.4 million due to its sale effective April 1, 1995, compared with a full year of operations recorded in fiscal 1994. The decrease in Adjusted EBITDA for the year ended June 30, 1995, as contrasted with the increase in net revenues, principally resulted from an increase in the costs of contract therapy services as a percentage of net revenues. The increase resulted primarily from (i) salary rate increases for therapists well in excess of aggregate net revenues per billable hour rate increases, (ii) an overall decrease in therapist productivity primarily due to increased employee turnover and contract turnover and (iii) a decrease in the percentage of billable hours in the higher-margin occupational therapy and speech-language pathology services. To a lesser extent, the decrease in Adjusted EBITDA resulted from the decrease in the Adjusted EBITDA applicable to the medical rehabilitation hospital division of $6.0 million due to its sale effective April 1, 1995, compared with a full year of operations recorded in fiscal 1994 and from an increase in corporate expenses. Depreciation and amortization for the year ended June 30, 1995 increased by $7.7 million as compared with the prior year, primarily due to the placing in service of certain internally-developed software during the year and the full-year effect of acquisitions made during fiscal 1994. Interest expense, net of investment income, increased $6.1 million compared with the year-earlier period principally as a result of increased borrowings under the Credit Facility to fund acquisitions partially offset by an increase in short-term investments in the fourth quarter of fiscal 1995 in connection with the sale of the Company's medical rehabilitation hospital division, previously discussed. Income tax expense as a percentage of pretax income increased to 50.7% for the year ended June 30, 1995 from 39.3% for the previous year. The increase in the rate principally resulted from a higher rate of state income taxes related to net nonrecurring items and the nondeductible write-off of goodwill in connection with the restructuring charge recorded in fiscal 1995. Year Ended June 30, 1994 Compared with the Year Ended June 30, 1993. Net revenues for the year ended June 30, 1994 increased over the prior year by $207.4 million or 35.6% to $789.7 million and Adjusted EBITDA increased by $39.7 million or 41.1% to $136.5 million. The Company reported net income for the year ended June 30, 1994 of $58.2 million compared with 19 22 NOVACARE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED) net income of $47.6 million for the year ended June 30, 1993. Fiscal 1994 and 1993 included pretax nonrecurring charges $5.8 million and $5.7 million, respectively, relating to merger transactions and other nonrecurring items. The principal reasons for the net revenues increase during this period are (i) an increase in contract therapy services billable hours of 2.1 million hours or 38.3%, offset by an aggregate decrease in net revenue per billable hour of approximately 6%, (ii) an increase in outpatient rehabilitation visits of 874,000 visits or 151.7% resulting primarily from 42 acquisitions during fiscal 1994 and the full effect of 27 acquisitions in the prior fiscal year and (iii) an increase in net revenues attributable to the medical rehabilitation hospital division of $34.1 million due principally to the acquisition of Rehabilitation Hospital Corporation of America ("RHCA") in October 1993. The substantial increase in Adjusted EBITDA for the year ended June 30, 1994 principally resulted from increases in net revenues. Additional factors affecting the increase included (i) substantially higher margins relating to outpatient centers acquired, (ii) substantially higher margins relating to the RHCA acquisition, and (iii) leveraging of corporate overhead resulting in only a 2% increase in corporate expenses despite the 35.6% increase in overall net revenues. Depreciation and amortization for the year ended June 30, 1994 increased by $10.3 million as compared with the prior year, primarily due to acquisitions. Interest expense, net of investment income, increased $8.9 million compared with the year-earlier period principally as a result of financed acquisitions. Income tax expense as a percentage of pretax income increased to 39.3% for the year ended June 30, 1994 from 36.9% for the previous year. The increase in the rate principally resulted from the increased amortization of nondeductible goodwill in connection with acquisitions. LIQUIDITY AND CAPITAL RESOURCES At June 30, 1995, the Company working capital increased $60.8 million to $255.1 million compared with $194.3 million at June 30, 1994. Exclusive of working capital relating to the medical rehabilitation hospital division, working capital increased during this period by $86.5 million. The increase in working capital principally resulted from (i) approximately $85 million of cash, in excess of amounts used to repay indebtedness, generated from the sale of the hospital division, (ii) the liquidation in the fourth quarter of fiscal 1995 of the $22.4 million portfolio long-term municipal securities at a nominal loss and (iii) an increase in other current assets of $16.9 million principally relating to amounts receivable in connection with the hospital division sale offset by an increase in accounts payable and accrued expenses principally relating to the recording of the restructuring charge liability and current income taxes payable. Prior to the sale of the hospital division, the Company's cash portion of working capital was managed primarily through a revolving credit arrangement, whereby excess cash generated through operations or otherwise was used to reduce amounts outstanding under the existing $175.0 million Revolving Credit Facility Credit Agreement (the "Credit Facility"). When cash requirements arose, the Credit Facility was drawn upon for such needs. The Credit Facility was classified as long-term debt on the Company's balance sheet. In connection with the sale, the Company paid all outstanding amounts drawn on the Credit Facility. Prospectively, excess cash has been invested in short-term securities and management intends to continue to invest excess cash in short-term securities. The Company used $29.5 million of cash for capital expenditures, including capitalized software costs, in fiscal 1995 compared with $28.0 million in fiscal 1994 and anticipates spending up to 20 23 NOVACARE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED) $34.1 million in fiscal 1996. Capital expenditures generally relate to costs incurred in connection with internally-developed software and normal leasehold renovations and equipment replacement. In fiscal 1995, the Company also paid $60.9 million for acquisitions, principally relating to 25 acquired outpatient rehabilitation centers, and $10.8 million on earnout arrangements relating to previous acquisitions. The Company currently does not plan to pursue acquisitions of businesses to the extent of amounts paid for such purposes in fiscal 1995; however, such plans are subject to change. In addition, cash payments relating to earnout arrangements are expected to amount to $12.2 million in fiscal 1996, subject to the fulfillment of various requirements in the existing earnout arrangements. In fiscal 1995, cash payments for capital expenditures, businesses acquired and earnouts were principally financed through use of the Credit Facility. In connection with the sale of the hospital division, the Company is in the process of amending the Credit Facility, upon which no amounts are currently drawn, to reflect the sale and other matters. At June 30, 1995, commitment availability had been reduced by $6.3 million for issued letters of credit. The Company believes that the cash flows generated by the Company's operations, together with its existing cash and availability of credit under the Credit Facility, will be sufficient to meet the Company's short and long-term cash needs. Inflation A significant portion of the Company's operating expenses are subject to inflationary increases, particularly therapist salary increases, which historically have exceeded other medical industry salary rate increases due to the existing supply shortage of therapists. The Company has historically been unable to substantially offset inflationary increases through charge increases, but has somewhat mitigated the effect by expanding services and increasing operating efficiencies. In the existing regulatory environment and to the extent that inflation occurs in the future, the Company will unlikely be able to pass on the increased costs associated with providing health care services to customers insured by government or managed care payors. RECENTLY ISSUED ACCOUNTING STANDARDS In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed of " ("SFAS121"), which the Company is required to adopt no later than the first quarter of fiscal year 1997. SFAS 121 establishes accounting standards for the impairment of long-lived assets, certain identifiable intangibles, and goodwill related to those assets to be held and used and for long-lived assets and certain intangible assets to be disposed of. Management does not believe the adoption of SFAS 121 will have a material effect on the Company's financial position or results of operations. FORWARD OUTLOOK Future trends for net revenues and profitability continue to be difficult to predict. The Company faces a number of risks. See "Results of Operations -- Industry Trends," previously discussed. Nursing facility operators have from time to time attempted to provide therapy services on an in-house basis, with varying degrees of success. A recent multi-year study of the costs of in-house programs compared with the costs of contract therapy indicated higher average therapy costs per patient care hour in nursing facilities with in-house programs. The study surveyed over 15,000 nursing facilities and examined several years of Medicare cost reports for nursing facilities with in-house therapy programs. Nevertheless, a number of national multi-facility nursing home companies have 21 24 NOVACARE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED) begun, or have announced that they plan to begin, to discontinue contracting for therapists and to staff and manage the function directly, effectively taking therapy programs "in-house." A recent management-sponsored survey indicated that 7% (based on number of beds) of such companies plan to transition to providing services on an in-house basis within the next two years. These recent decisions appear to be related, at least in part, to a desire to gain greater clinical control over therapy programs rather than due to cost-containment initiatives. This trend has been exacerbated by the recent consolidation activity in the nursing home industry. In the third quarter of fiscal 1995, the Company announced it had reached an agreement with its largest customer, Beverly, to transition Beverly to an in-house provider of therapy services over the next two years. Beverly facilities covered under the agreement represented approximately $77 million of the Company's annual net revenues in fiscal 1995. Management currently anticipates a reduction of approximately half of such net revenues will occur in the last six months of fiscal 1996 as a result of the in-house transition. However, management is currently unable to reliably predict whether circumstances may change, either positively or negatively, to alter this assessment. Outpatient rehabilitation services net revenues applicable to managed care payors represented 12.0% of total outpatient net revenues. The Company expects this percentage to increase in fiscal 1995, adversely affecting net revenues per visit. The Company's strategy is to continue to develop relationships with managed care networks in order to increase volume and gain market share. Over the past year, NovaCare's stock price has been subject to significant volatility. If net revenues or earnings fail to meet expectations of the investment community, there could be an immediate and significant adverse impact on the trading price for the Company's stock. Because of stock market forces beyond NovaCare's control and the nature of NovaCare's business, such changes can be sudden. The Company believes it has positioned itself for long-term success. However, due to the existing material uncertainties surrounding government regulation, net revenues and profitability trends cannot be precisely determined at this time. 22 25 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA NOVACARE, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
AS OF JUNE 30, --------------------- 1995 1994 -------- -------- ASSETS Current assets: Cash and cash equivalents............................................ $158,636 $ 38,024 Marketable securities................................................ -- 35,104 Accounts receivable, net of allowance in 1995 and 1994 of $19,718 and $32,731, respectively............................................. 192,652 215,727 Inventories.......................................................... 11,213 7,996 Deferred income taxes................................................ 16,748 13,946 Other current assets................................................. 34,571 24,208 -------- -------- Total current assets......................................... 413,820 335,005 Marketable securities, net............................................. -- 53,318 Property and equipment, net............................................ 63,659 93,739 Excess cost of net assets acquired, net................................ 352,115 342,938 Deferred income taxes.................................................. 1,470 517 Other assets, net...................................................... 21,493 25,024 -------- -------- $852,557 $850,541 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of financing arrangements............................ $ 32,684 $ 61,518 Accounts payable and accrued expenses................................ 93,088 72,997 Income taxes payable................................................. 32,922 6,166 -------- -------- Total current liabilities.................................... 158,694 140,681 Financing arrangements, net of current portion......................... 192,331 283,084 Deferred income taxes.................................................. 8,147 3,211 Other.................................................................. 5,750 7,861 -------- -------- Total liabilities............................................ 364,922 434,837 -------- -------- Stockholders' equity: Common stock, $.01 par value; authorized 200,000 shares, issued 65,476 in 1995 and issued 64,228 shares in 1994................... 656 643 Additional paid-in capital........................................... 250,857 240,619 Retained earnings.................................................... 238,149 176,225 -------- -------- 489,662 417,487 Less: Common stock in treasury (at cost), 187 shares in 1995 and 17 shares in 1994............................................. (1,614) (305) Deferred compensation........................................ (413) (662) Valuation allowance on securities available for sale......... -- (816) -------- -------- Total stockholders' equity................................... 487,635 415,704 -------- -------- $852,557 $850,541 ======== ========
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 23 26 NOVACARE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
FOR THE YEARS ENDED JUNE 30, ---------------------------------- 1995 1994 1993 -------- -------- -------- Net revenues............................................... $905,359 $789,745 $582,342 Operating costs: Salaries, wages and benefits............................. 576,764 462,378 328,416 Rental expense........................................... 36,365 27,613 21,250 Supply costs............................................. 21,797 18,285 18,459 Other.................................................... 137,812 130,540 107,716 Provision for uncollectible accounts..................... 15,918 14,453 9,764 Depreciation............................................. 19,253 15,289 8,602 Amortization of excess cost of net assets acquired....... 10,937 7,225 3,589 Merger and other nonrecurring items...................... (57,368) 5,754 5,727 -------- -------- -------- Income from operations................................ 143,881 108,208 78,819 Investment income.......................................... 5,405 5,304 4,880 Interest expense........................................... (23,298) (17,077) (7,721) Minority interest.......................................... (404) (543) (436) -------- -------- -------- Income before income taxes............................ 125,584 95,892 75,542 Income taxes............................................... 63,660 37,678 27,906 -------- -------- -------- Net income............................................ $ 61,924 $ 58,214 $ 47,636 ======== ======== ======== Net income applicable to common stock................. $ 61,924 $ 58,214 $ 47,585 ======== ======== ======== Net income per common share........................... $ .95 $ .90 $ .79 ======== ======== ======== Weighted average number of common shares outstanding......................................... 65,163 64,663 60,167 ======== ======== ========
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 24 27 NOVACARE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS)
COMMON SHARES STOCK ADDITIONAL DEFERRED ----------------- ($.01 PAR TREASURY PAID-IN RETAINED COMP- VALUATION ISSUED TREASURY VALUE) STOCK CAPITAL EARNINGS ENSATION ALLOWANCE ------ -------- ------------ -------- ---------- -------- -------- ---------- Balance at June 30, 1992......... 54,389 (160) $543 $ (189) $154,235 $ 68,688 $ (508) $ -- Issued in connection with employee benefit plans......... 630 100 6 118 8,105 -- (3) -- Issued in connection with acquisitions................... 799 -- 8 -- 9,281 -- -- -- Sale of common stock in initial public offering, net of issuance costs (RehabClinics, Inc.).......................... 5,600 -- 56 -- 39,056 -- -- -- Sale of common stock............. 738 -- 8 -- 2,633 -- (924) -- Amortization of deferred compensation................... -- -- -- -- -- -- 282 -- Accrued dividend on mandatorily redeemable preferred stock..... -- -- -- -- -- (51) -- -- Net income....................... -- -- -- -- -- 47,636 -- -- ------ -------- ----- -------- ---------- -------- -------- ---------- Balance at June 30, 1993......... 62,156 (60) 621 (71) 213,310 116,273 (1,153) -- Adjustment for pooling of interests...................... 554 -- 6 (1) 7,247 1,738 155 -- Issued in connection with employee benefit plans......... 367 60 4 72 4,552 -- -- -- Issued in connection with acquisitions................... 1,151 -- 12 -- 15,510 -- -- -- Valuation allowance resulting from the application of SFAS No. 115........................ -- -- -- -- -- -- -- (816) Repurchase of common stock....... -- (17) -- (305) -- -- -- -- Amortization of deferred compensation................... -- -- -- -- -- -- 336 -- Net income....................... -- -- -- -- -- 58,214 -- -- ------ -------- ----- -------- ---------- -------- -------- ---------- BALANCE AT JUNE 30, 1994......... 64,228 (17) 643 (305) 240,619 176,225 (662) (816) ISSUED IN CONNECTION WITH EMPLOYEE BENEFIT PLANS......... 302 52 4 453 3,497 -- -- -- ISSUED IN CONNECTION WITH ACQUISITIONS................... 946 29 9 250 6,741 -- -- -- VALUATION ALLOWANCE RESULTING FROM THE APPLICATION OF SFAS NO. 115........................ -- -- -- -- -- -- -- 816 REPURCHASE OF COMMON STOCK....... -- (251) -- (2,012) -- -- -- -- AMORTIZATION OF DEFERRED COMPENSATION................... -- -- -- -- -- -- 249 -- NET INCOME....................... -- -- -- -- -- 61,924 -- -- ------ -------- ----- -------- ---------- -------- -------- ---------- BALANCE AT JUNE 30, 1995......... 65,476 (187) $656 $(1,614) $250,857 $238,149 $ (413) $ -- ====== ======== ===== ======== ========== ========= ========= ==========
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 25 28 NOVACARE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
FOR THE YEARS ENDED JUNE 30, ------------------------------------- 1995 1994 1993 --------- --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income..................................................................... $ 61,924 $ 58,214 $ 47,636 Adjustments to reconcile net income to net cash flows from operating activities: Gain on sale of hospital operations.......................................... (88,243) -- -- Depreciation and amortization................................................ 30,190 22,514 12,191 Minority interest............................................................ 404 543 436 Provision for uncollectible accounts......................................... 15,918 14,453 9,764 Deferred income taxes........................................................ (1,525) (2,704) (2,850) Noncash portion of nonrecurring items........................................ 15,415 667 1,315 Changes in assets and liabilities, net of effects from acquisitions: Accounts and notes receivable.............................................. (31,164) (44,875) (55,399) Other current assets....................................................... (1,487) (6,074) (3,190) Accounts payable and accrued expenses...................................... 10,279 (9,662) 19,586 Income taxes payable....................................................... 28,982 2,498 1,071 Other, net................................................................. 2,925 (1,888) (1,188) --------- --------- --------- Net cash flows provided by operating activities............................ 43,618 33,686 29,372 --------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Marketable securities: Purchase of marketable securities(1)......................................... -- (146,496) (502,845) Proceeds from sales of marketable securities(1).............................. -- 171,872 432,026 Purchase of available for sale securities.................................... (61) -- -- Proceeds from sales of available for sale securities......................... 38,206 -- -- Maturities of held-to-maturity securities.................................... 50,006 -- -- --------- --------- --------- Net cash proceeds from (outlay for) marketable securities.................. 88,151 25,376 (70,819) --------- --------- --------- Acquisition of businesses: Payments for businesses acquired, net of cash acquired....................... (60,929) (134,973) (39,772) Additional payments for businesses acquired in prior years................... (10,830) (14,799) (2,551) --------- --------- --------- Net cash outlay for acquisitions of businesses............................. (71,759) (149,772) (42,323) --------- --------- --------- Additions to property and equipment............................................ (22,238) (17,727) (12,257) Capitalized software costs..................................................... (7,291) (10,234) (2,471) Proceeds from sale of hospital operations...................................... 206,838 -- -- Other, net..................................................................... (5,513) (6,771) (4,964) --------- --------- --------- Net cash provided by (used in) investing activities........................ 188,188 (159,128) (132,834) --------- --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from long-term debt and credit agreements............................. 74,077 184,208 181,447 Payment of long-term debt and credit agreements................................ (187,206) (122,409) (36,589) Proceeds from common stock issued and exercise of warrants..................... 1,935 3,529 45,195 Redemption of preferred stock.................................................. -- -- (1,261) --------- --------- --------- Net cash flows (used in) provided by financing activities.................. (111,194) 65,328 188,792 --------- --------- --------- Net increase (decrease) in cash and cash equivalents........................... 120,612 (60,114) 85,330 Cash and cash equivalents, beginning of year................................... 38,024 102,324 16,994 Adjustments for poolings of interests.......................................... -- (4,186) -- --------- --------- --------- Cash and cash equivalents, end of year......................................... $ 158,636 $ 38,024 $ 102,324 ========= ========= =========
--------------- (1) Security classification prior to adoption of FAS 115. The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 26 29 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1995 (IN THOUSANDS, EXCEPT PER SHARE DATA) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation: The Consolidated Financial Statements include the accounts of NovaCare, Inc., its majority-owned subsidiaries and companies effectively controlled through management agreements (collectively, "NovaCare" or the "Company"). All significant intercompany accounts and transactions have been eliminated. Certain amounts in the 1994 and 1993 consolidated financial statements have been reclassified to conform with the 1995 presentation. Cash and Cash Equivalents: The Company considers its holdings of highly liquid debt and money-market instruments to be cash equivalents if the securities mature within 90 days from the date of acquisition. Net Revenues: Net revenues are reported at the net realizable amounts from customers, third party payors, and others for services rendered. Net revenues generated from Medicare and Medicaid reimbursement programs represented 18%, 20%, and 22% of the Company's net revenues for fiscal 1995, 1994, and 1993, respectively. Settlement amounts due to or receivable from Medicare and Medicaid programs are determined by fiscal intermediaries. The difference between the final determination and estimated amounts accrued is accounted for as an adjustment to revenues in the year of final determination. Management believes that adequate provision has been made in the consolidated financial statements for potential adjustments. Investments: As of June 30, 1994, NovaCare adopted Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities ("SFAS 115"). The effect of SFAS 115 is dependent upon classification of the investment and, in certain cases, determination as to the nature of the decline in market value below the cost basis of an investment. Investments with maturities of greater than one year are classified as noncurrent. Realized gains and losses on the sales of securities are computed using the specific identification method. Inventories: Inventories consist of orthotic and prosthetic merchandise held for resale, work in process and raw materials, and are carried at the lower of cost, determined on the first-in, first-out basis, or market. Property and Equipment: Property and equipment are stated at cost. Depreciation is provided on a straight-line basis over the estimated useful lives of the assets, which principally range from three to seven years for property and equipment and 30 to 40 years for buildings. Assets under capital leases and leasehold improvements are amortized over the lesser of the lease term or the asset's estimated useful life. Property and equipment also includes external and incremental internal costs incurred to develop major business systems. Capitalized software costs are amortized on a straight-line basis over three to five years. Excess Cost of Net Assets Acquired: Assets and liabilities acquired in connection with business combinations accounted for under the purchase method are recorded at their respective fair values. Deferred taxes have been recorded to the extent of the difference between the fair value and the tax basis of the assets acquired and liabilities assumed. The excess of the purchase price over the fair value of net assets acquired, including the recognition of applicable deferred taxes, is amortized on a straight-line basis over a 40 year period. The Company performs an annual assessment of the recoverability of goodwill based on estimated future cash flows. Other Assets: Other assets consist principally of deferred financing fees, investments in affordable income housing partnerships and notes receivable. Deferred financing fees are amortized over the term of the related debt obligations and are included as a component of interest expense. Investments 27 30 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1995 (IN THOUSANDS, EXCEPT PER SHARE DATA) in affordable income housing partnerships are recorded at cost and are subject to an annual assessment as to carrying value. Income Taxes: The Company follows Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"). SFAS 109 is an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. Net Income Per Common Share: Net income per common share has been computed by dividing net income applicable to common stock by the weighted average number of common shares outstanding during the year, giving effect to dilutive stock options and warrants. Net income applicable to common stock in fiscal 1993 gives effect to dividends, whether or not declared, on the 10% mandatorily redeemable preferred stock during the period such stock was outstanding. Recently Issued Accounting Standards: In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed of " ("SFAS 121"), which the Company is required to adopt no later than the first quarter of fiscal year 1997. SFAS 121 establishes accounting standards for the impairment of long-lived assets, certain identifiable intangibles, and goodwill related to those assets to be held and used and for long-lived assets and certain intangibles to be disposed of. Management does not believe the adoption of SFAS 121 will have a material effect on the Company's financial position or results of operations. 2. MERGER AND OTHER NONRECURRING ITEMS The following table sets forth the Company's merger and other nonrecurring charges for each of the three years in the period ended June 30, 1995.
1995 1994 1993 -------- ------ ------ Gain on sale of hospital operations.................... $(88,243) $ -- $ -- Settlement of shareholder litigation................... 1,000 -- -- Productivity and cost reduction program: Employee severance costs............................. 7,042 -- 1,741 Lease terminations................................... 6,847 -- 1,348 Asset write-offs..................................... 15,415 -- 1,315 Other................................................ 571 -- 1,323 Merger expenses: Professional fees.................................... -- 2,305 -- Name change.......................................... -- 1,600 -- Printing and filing fees............................. -- 775 -- Other................................................ -- 1,074 -- -------- ------ ------ $(57,368) $5,754 $5,727 ======== ====== ======
Effective April 1, 1995, the Company sold its rehabilitation hospitals to HEALTHSOUTH Corporation for $242,888 which consisted of cash of $232,394 and debt and cash assumed by HEALTHSOUTH of $19,156 and $8,662, respectively. Of the cash portion of the purchase price, $16,894 was unpaid at June 30, 1995 and is included as a component of other current assets. Substantially all of this amount was received in July 1995. Had the sale of the rehabilitation hospitals taken place on July 1, 1993 pro forma unaudited net revenues for the fiscal years ended June 30, 1995 and 1994 would have been 28 31 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1995 (IN THOUSANDS, EXCEPT PER SHARE DATA) $794,904 and $653,349, respectively and pro forma unaudited income from operations, adjusted for nonrecurring items, would have been $72,250 and $95,391, respectively. The gain is partially offset by a charge for productivity and cost reduction programs in certain operations of the Company, including costs to close certain contract services facilities, orthotic and prosthetic branches, and outpatient centers in selected markets. The program also contemplates consolidation of certain finance and other administrative functions. The asset write-offs consist of goodwill in the amount of $10,713 associated with facilities, branches or centers the Company is closing and certain fixed assets related to those facilities in the amount of $4,702, the remainder of the charges are cash in nature. Employee severance costs incurred in the productivity and cost reduction program of $7,042 represent the accumulation of termination benefits set forth in the Company's severance policy, of which $1,797 was paid as of June 30, 1995. At June 30, 1995, approximately $11,730 remained accrued for facility, branch and clinic closure and administrative consolidation costs. The Company anticipates all activities will be completed by June 30, 1996. As described in Note 3, during fiscal 1994 the Company acquired all of the outstanding common stock of RehabClinics, Inc. ("RCI") in a transaction accounted for as a pooling of interests. Certain nonrecurring expenses were incurred as a result of the merger. Substantially all charges were cash in nature. In 1993, the Company initiated a reorganization of certain of its business units to reduce its cost structure. This reorganization consisted of the consolidation of certain orthotic and prosthetic patient care and fabrication centers, the closing of certain community re-entry programs and the consolidation of certain functions at the corporate headquarters. 3. MERGER AND ACQUISITION TRANSACTIONS During fiscal 1995, the Company acquired 25 businesses which provide outpatient rehabilitation services, one business which provides orthotic and prosthetic rehabilitation services and two businesses which provide contract therapy services. On February 4, 1994, the Company issued approximately 14,000 shares of its common stock to acquire all of the outstanding common stock of RCI. The merger has been accounted for as a pooling of interests and, accordingly, the Company's financial statements and notes thereto have been restated to combine the accounts and operations of the Company and of RCI for all periods presented. During fiscal year 1994, the Company purchased all the common stock of Rehabilitation Hospital Corporation of America ("RHCA"). The principal stockholder of RHCA was a limited partnership in which the Company's chairman of the board and chief executive officer was a general partner. The Company also acquired 42 businesses which provide outpatient rehabilitation services, five businesses which provide orthotic and prosthetic rehabilitation services, and two businesses which provide contract therapy services. The acquisitions were accounted for as purchases and, accordingly, the aggregate purchase price was allocated to assets and liabilities acquired based on their fair values at the date of acquisition. The results of operations of businesses acquired have been included in the consolidated results of the Company from the effective date of each acquisition. 29 32 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1995 (IN THOUSANDS, EXCEPT PER SHARE DATA) The following unaudited pro forma consolidated results of operations of the Company give effect to each of the acquisitions, accounted for as purchases, as if they occurred on July 1, 1993:
YEARS ENDED JUNE 30, --------------------- 1995 1994 -------- -------- Net revenues................................................... $911,285 $915,100 Net income..................................................... 62,293 67,097 Net income per common share.................................... $ .96 $ 1.04
The above pro forma information, which is inclusive of the results of the medical rehabilitation hospitals, is not necessarily indicative of the results of operations that would have occurred had the acquisitions been made as of July 1, 1993, or of the results which may occur in the future. Information with respect to businesses acquired in purchase transactions was as follows (the allocation for fiscal 1995 acquisitions is preliminary):
AS OF JUNE 30, --------------------- 1995 1994 -------- -------- Excess cost of net assets acquired............................. $379,605 $362,932 Less: accumulated amortization................................. (27,490) (19,994) -------- -------- $352,115 $342,938 ======== ========
YEARS ENDED JUNE 30, --------------------- 1995 1994 -------- -------- Cash paid (net of cash acquired)............................... $ 60,929 $134,973 Value of common stock issued................................... -- 9,767 Notes issued................................................... 12,620 7,257 Other consideration............................................ 1,377 1,658 -------- -------- 74,926 153,655 Liabilities assumed............................................ 7,027 89,455 -------- -------- 81,953 243,110 Fair value of assets acquired, principally accounts receivable and property and equipment................................... 7,891 98,630 -------- -------- Cost in excess of fair value of net assets acquired........................................... $ 74,062 $144,480 ======== ========
Certain purchase agreements require additional payments if specific financial targets and non-financial conditions are met. Aggregate contingent payments in connection with these acquisitions at June 30, 1995 of approximately $35,715 in cash and 1,105 shares of common stock have not been included in the initial determination of cost of the businesses acquired since the amount of such contingent consideration, if any, is not presently determinable. During the fiscal years ended June 30, 1995, 1994 and 1993, the Company paid $10,830, $14,799 and $2,551, respectively, in cash and issued 975, 348 and 341 shares of common stock, respectively, in connection with businesses acquired in prior years. 30 33 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1995 (IN THOUSANDS, EXCEPT PER SHARE DATA) 4. INVESTMENTS IN CASH EQUIVALENTS AND MARKETABLE SECURITIES The following represents the fair value, cost basis and gross unrealized holding gains and losses for each major security type as of June 30, 1994. The fair value of marketable securities is estimated based upon quoted market prices for those investments.
AS OF JUNE 30, 1994 ------------------------------------------------------------- FAIR COST GROSS UNREALIZED GROSS UNREALIZED VALUE BASIS HOLDING GAINS HOLDING LOSSES ------- ------- ---------------- ---------------- Held to Maturity: U.S. Treasury securities.............. $49,165 $49,675 $ -- $ 510 ------- ------- ---- ------- Available for sale: Municipal bonds....................... 37,267 38,098 10 841 Preferred stock unit trusts........... 1,171 1,149 45 23 Asset backed securities............... 309 316 -- 7 ------- ------- ---- ------- 38,747 39,563 55 871 ------- ------- ---- ------- Total marketable securities............. $87,912 $89,238 $ 55 $1,381 ======= ======= ==== =======
Investments in U.S. Treasury securities represented 56% of the total investments at June 30, 1994. Securities of no other issuer exceeded 10% of total investments during fiscal years 1995 or 1994. For the years ended June 30, 1995, 1994 and 1993, investment income consisted of the following:
YEARS ENDED JUNE 30, ------------------------------ 1995 1994 1993 ------ ------- ------- Interest income........................................ $5,700 $ 4,965 $ 4,010 Dividend income........................................ -- -- 804 Gross realized gain on sales of marketable securities........................................... 67 392 1,566 Gross realized loss of sales of marketable securities........................................... (362) (1,553) -- Reserve for loss on marketable securities.............. -- 1,500 (1,500) ------ ------- ------- $5,405 $ 5,304 $ 4,880 ====== ======= =======
5. INVENTORIES Inventories consisted of the following:
AS OF JUNE 30, ------------------ 1995 1994 ------- ------ Finished goods.................................................... $ 857 $ 944 Work in process................................................... 1,447 434 Raw materials..................................................... 8,909 6,618 ------- ------ $11,213 $7,996 ======= ======
31 34 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1995 (IN THOUSANDS, EXCEPT PER SHARE DATA) 6. PROPERTY AND EQUIPMENT The components of property and equipment were as follows:
AS OF JUNE 30, --------------------- 1995 1994 -------- -------- Land and buildings............................................. $ 4,576 $ 32,367 Property, equipment and furniture.............................. 64,086 68,360 Capitalized software........................................... 21,641 17,252 Leasehold improvements......................................... 7,866 11,183 -------- -------- 98,169 129,162 Less: accumulated depreciation and amortization................ (34,510) (35,423) -------- -------- $ 63,659 $ 93,739 ======== ========
7. FINANCING ARRANGEMENTS Financing arrangements consisted of the following:
AS OF JUNE 30, --------------------- 1995 1994 -------- -------- Convertible subordinated debentures (5.5%), due January 2000... $175,000 $175,000 Revolving credit facility (prime rate plus .5% or LIBOR plus .88%), expiring May 27, 1997................................. -- 69,563 Reverse repurchase agreements (5.65%), payable through September 30, 1995........................................... 18,000 43,281 Subordinated promissory notes (5% to 9%), payable through 2005......................................................... 26,867 30,580 West Virginia commercial development revenue bonds (9.5% to 12%), payable through 2015................................... -- 17,715 Notes (6% to 12%), payable through November 2000............... 720 3,736 Capitalized lease obligations, payable through 2000............ 4,428 4,680 Other obligations.............................................. -- 47 -------- -------- 225,015 344,602 Less: current portion.......................................... 32,684 61,518 -------- -------- $192,331 $283,084 ======== ========
The Company has in place a revolving credit facility with a syndicate of lenders providing for a total commitment of up to $175,000, upon which no amounts are currently drawn. The Company currently is in the process of amending the revolving credit facility to reflect the recent sale of the hospital division and other matters. The Company is charged a fee of .25% per annum on the unused portion of the commitment. At June 30, 1995, total credit availability had been reduced by $6,260 for issued letters of credit. During fiscal 1995 and 1994, the Company entered into reverse repurchase agreements with primary government dealers. In the reverse repurchase agreements, the Company sold U.S. government securities subject to an agreement to repurchase those securities at a mutually agreed upon date and price, which approximates market. These transactions were accounted for as loans to the Company collateralized by the underlying securities which are held by the primary government dealers. The 32 35 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1995 (IN THOUSANDS, EXCEPT PER SHARE DATA) agreements required the Company to maintain investments in U.S. government securities with market value, including accrued interest, to be at least 102% of the dollar amount sold as collateral. On January 20, 1993, the Company issued $175,000 of convertible subordinated debentures due January 15, 2000, priced at par to yield 5.5%. The debentures are convertible, at the option of the holder, into shares of the Company's common stock at a conversion price of $26.65 per share. Subsequent to January 14, 1996, the debentures are redeemable, in whole or in part, at the option of the Company. There is no sinking fund applicable to the debentures. The fair value of the Company's convertible subordinated debentures based on quoted market prices at June 30, 1995 and 1994 was $151,375 and $160,125, respectively. The estimated fair value of all other debt and financing arrangements approximates carrying value. At June 30, 1995, aggregate annual maturities of financing arrangements were as follows for the next five fiscal years and thereafter:
FISCAL YEAR ------------------------------------------------------------------ 1996.............................................................. $ 32,684 1997.............................................................. 7,279 1998.............................................................. 5,087 1999.............................................................. 3,359 2000.............................................................. 176,491 Thereafter........................................................ 115 -------- $225,015 ========
Interest paid on debt during fiscal 1995, 1994 and 1993 amounted to $20,377, $17,258 and $4,895, respectively. 8. ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses are summarized as follows:
AS OF JUNE 30, ------------------- 1995 1994 ------- ------- Accounts payable......................................... $15,721 $12,899 Accrued compensation and benefits........................ 37,984 38,532 Accrued costs of productivity and cost improvement program................................................ 11,730 -- Accrued interest......................................... 5,158 5,424 Other.................................................... 22,495 16,142 ------- ------- $93,088 $72,997 ======= =======
The balance for the productivity and cost improvement program relates solely to the 1995 program discussed in Note 2. 33 36 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1995 (IN THOUSANDS, EXCEPT PER SHARE DATA) 9. INCOME TAXES The components of income tax expense were as follows:
YEARS ENDED JUNE 30, ------------------------------- 1995 1994 1993 ------- ------- ------- Current: Federal............................................. $53,258 $36,988 $27,930 State............................................... 11,927 3,394 2,826 ------- ------- ------- 65,185 40,382 30,756 ------- ------- ------- Deferred: Federal............................................. (1,182) (2,410) (2,223) State............................................... (343) (294) (627) ------- ------- ------- (1,525) (2,704) (2,850) ------- ------- ------- $63,660 $37,678 $27,906 ======= ======= =======
The components of net deferred tax assets as of June 30, 1995 and 1994 were as follows:
1995 1994 ------- ------- Cash basis accounting for tax purposes........................... $ 661 $ 796 Accruals and reserves not currently deductible for tax purposes....................................................... 8,334 12,660 Acquired operating loss carryforward............................. -- 3,464 Restructuring reserve............................................ 8,413 -- Other............................................................ 810 2,185 ------- ------- Gross deferred tax assets.............................. 18,218 19,105 ------- ------- Expenses capitalized for financial statement purposes............ (3,608) (771) Depreciation and capital leases.................................. (3,207) (3,618) Other, net....................................................... (1,332) -- ------- ------- Gross deferred tax liabilities......................... (8,147) (4,389) ------- ------- Valuation allowance on acquired operating loss carry forward.............................................. -- (3,464) ------- ------- Net deferred tax asset................................. $10,071 $11,252 ======= =======
34 37 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1995 (IN THOUSANDS, EXCEPT PER SHARE DATA) The reconciliation of the expected tax expense (computed by applying the federal statutory tax rate to income before income taxes) to actual tax expense was as follows:
YEARS ENDED JUNE 30, ------------------------------- 1995 1994 1993 ------- ------- ------- Expected federal income tax expense................... $43,954 $33,562 $25,684 State income taxes, less federal benefit.............. 7,530 1,767 2,041 Non-deductible nonrecurring items..................... 9,178 1,217 -- Non-deductible amortization of excess cost of net assets acquired..................................... 2,370 1,954 1,222 Dividend exclusion and non-taxable interest income.... (401) (676) (636) Change in valuation allowance......................... -- -- (864) Other, net............................................ 1,029 (146) 459 ------- ------- ------- $63,660 $37,678 $27,906 ======= ======= =======
Income taxes paid during fiscal 1995, 1994 and 1993 amounted to $37,604, $37,817 and $28,501, respectively. 10. LEASES The Company is obligated under capital leases for office space and office, transportation and therapy equipment. One capital lease obligation for office space expires in fiscal 2016. All other capital leases expire over the next five years. Hospital facility land and buildings were principally leased under operating leases. Included in property and equipment in the accompanying Consolidated Balance Sheets are the following assets held under capital leases:
AS OF JUNE 30, ------------------- 1995 1994 ------- ------- Property, equipment and furniture................................ $ 7,265 $13,157 Less: accumulated amortization................................... (2,498) (8,856) ------- ------- $ 4,767 $ 4,301 ======= =======
The Company also rents office space and office, transportation and therapy equipment under non-cancelable operating leases. In an effort to leverage its purchasing power with lessors, the Company has leased and concurrently subleased certain office space to companies that are related through ownership by the Company's Chairman and Chief Executive Officer. The Company is fully reimbursed for its lease costs for the aforementioned office space under noncancelable sublease agreements. 35 38 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1995 (IN THOUSANDS, EXCEPT PER SHARE DATA) Future minimum lease commitments for all non-cancelable leases as of June 30, 1995 are as follows:
CAPITAL OPERATING SUB-LEASE FISCAL YEAR LEASES LEASES RECEIVABLES ----------------------------------------------------- ------- --------- ----------- 1996................................................. $ 1,995 $20,268 $ 399 1997................................................. 1,679 17,968 267 1998................................................. 866 15,654 264 1999................................................. 230 13,693 277 2000................................................. 16 10,666 203 Thereafter........................................... 116 8,554 -- ------- -------- ------- Total minimum lease payments......................... 4,902 $86,803 $ 1,410 ======== ======= Less: amount representing interest................... 474 ------- Present value of minimum payments under capital lease obligations.......................... $ 4,428 =======
11. BENEFIT PLANS Stock Option Plan: The Company's 1986 Stock Option Plan, as amended, provides for issuance of options to purchase up to 5,800 shares of common stock to employees, officers and directors. Under the plan, substantially all options are granted for a term of up to 10 years at prices equal to the fair market value at the date of grant and are generally exercisable at the rate of 20% per year, on a cumulative basis, commencing principally one year after the date of grant. The following summarizes the activity of this stock option plan:
YEARS ENDED JUNE 30, ------------------------------------------------ 1995 1994 1993 ------------ ------------- ------------- Options: Outstanding at beginning of year............. 2,771 2,239 2,253 Granted...................................... 1,162 1,068 601 Exercised.................................... (77) (277) (426) Canceled..................................... (1,207) (259) (189) ----------- ------------ ------------ Outstanding at end of year................... 2,649 2,771 2,239 =========== ============ ============ Option price per share ranges: Outstanding at beginning of year............. $ .09-$23.50 $ .09-$23.50 $ .09-$29.13 Granted...................................... 7.25- 13.00 10.16- 16.75 16.50- 23.50 Exercised.................................... .09- 14.38 .09- 16.50 .09- 19.50 Outstanding at end of year................... .09- 21.00 .09- 23.50 .09- 23.50 Options exercisable at end of year............. 1,109 897 773 Exercisable option price ranges................ $ .09-$21.00 $ .09-$23.50 $ .09-$20.58 Options available for grant at end of year under the 1986 Stock Option Plan............. 2,114 1,957 966
36 39 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1995 (IN THOUSANDS, EXCEPT PER SHARE DATA) Deferred Compensation: Deferred compensation represents common stock issued to certain key employees wherein the recipient becomes fully vested at the end of a five-year period. Compensation expense is charged to income over the vesting period. Other Stock Awards: During fiscal 1994, the Company granted certain of its officers 2,750 non-qualified options to purchase the Company's common stock at an exercise price equal to 150% of the fair market value on the grant date. In prior years, the Company granted certain of its officers non-qualified options to purchase the Company's common stock at exercise prices equal to the fair market value on the grant date. Certain of these options were awarded to an officer, who is also a stockholder, in lieu of compensation. The following summarizes the other stock award activity:
YEARS ENDED JUNE 30, ---------------------------------------------- 1995 1994 1993 ------------ ------------ ------------ Options: Outstanding at beginning of year............ 4,708 1,958 1,862 Granted..................................... -- 2,750 300 Exercised................................... (4) -- (204) ----------- ----------- ----------- Outstanding at end of year.................. 4,704 4,708 1,958 =========== =========== =========== Option price per share: Outstanding at beginning of year............ $2.55-$19.50 $2.25-$17.00 $2.25-$17.00 Granted..................................... -- 19.50 15.38 Exercised................................... 2.25 -- 2.25 Outstanding at end of year.................. 2.25- 19.50 2.25- 19.50 2.25- 17.00 Options exercisable at end of year............... 1,914 1,118 758 Exercisable option price ranges.................. $2.25-$19.50 $2.25-$17.00 $2.25-$15.38
Retirement Plans: The Company has defined contribution 401(k) plans covering substantially all of its employees. Company contributions for fiscal 1995, 1994 and 1993 were $3,878, $3,715 and $2,160, respectively. In fiscal 1992, the Company established a non-qualified supplemental benefit plan covering certain key employees. The Company's matching contribution was $302, $192 and $161 for fiscal 1995, 1994 and 1993, respectively. 12. COMMITMENTS AND CONTINGENCIES The Company is subject to legal proceedings and claims which arise in the ordinary course of its business. In the opinion of management, the amount of ultimate liability, if any, with respect to these actions will not have a materially adverse effect on the financial position or results of operations of the Company. 37 40 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1995 (IN THOUSANDS, EXCEPT PER SHARE DATA) 13. SHAREHOLDER RIGHTS PLAN Under the terms of a Shareholder Rights Plan adopted in 1995, the Company's Board of Directors declared a dividend distribution of one right for each outstanding common share. The rights may not be exercised or traded apart from the common shares to which they are attached until 10 days after a person or group has acquired, obtained the right to acquire, or commenced a tender offer for, at least 20% of the Company's outstanding common shares. In such event, each right will become exercisable for one common share for a price of $27. If a person or group acquires, or obtains the right to acquire, 20% or more of the Company's outstanding common shares, each right will become exercisable for common shares worth $54 and the rights held by the acquiror will become null and void. If the Company is involved in a merger and its common shares are changed or exchanged, or if more than 50% of its assets or earnings power is sold or transferred, each right will become exercisable for common stock of the acquiror worth $54. The rights will expire on March 20, 2000 unless earlier redeemed by the Company for $.001 per right. Subject to its right to extend the redemption period, the Company may redeem the rights at any time until any person or group has acquired, or obtained the right to acquire, at least 20% of the Company's outstanding common shares. 14. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
FOURTH THIRD SECOND FIRST QUARTER QUARTER QUARTER QUARTER -------- -------- -------- -------- YEAR ENDED JUNE 30, 1995: Net revenues.................................. $201,450 $240,898 $232,201 $230,810 Income from operations........................ 78,049 21,456 21,310 23,066 Net income.................................... 33,036 8,953 8,887 11,048 Net income per common share................... $ .51 $ .14 $ .14 $ .17 YEAR ENDED JUNE 30, 1994: Net revenues.................................. $213,182 $204,000 $196,132 $176,431 Income from operations........................ 32,764 29,524 21,404 24,516 Net income.................................... 19,226 15,956 9,337 13,695 Net income per common share................... $ .30 $ .25 $ .14 $ .21
Income from operations for all periods reflects the amortization of excess cost of net assets acquired as a component of income from operations to conform to the 1995 presentation. Results for the fourth quarter of fiscal 1995 included a pretax gain of $88,243 on the sale of hospital operations and $29,875 charge related to a productivity and cost improvement program. Results for the third quarter of fiscal 1995 included a $1,000 charge for settlement of certain shareholder litigation. 38 41 REPORT OF INDEPENDENT ACCOUNTANTS To the Stockholders and Board of Directors of NovaCare, Inc. In our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) and (2) on page 41 present fairly, in all material respects, the financial position of NovaCare, Inc. and its subsidiaries at June 30, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 1995, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PRICE WATERHOUSE LLP Philadelphia, PA August 3, 1995 39 42 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES The Registrant has had no changes in or disagreements with accountants on accounting and financial disclosure of the type referred to in Item 304 of Regulation S-K. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT For information concerning this item, see "Item 1 -- Business -- Executive Officers of the Registrant" and the table and text under the caption "Name of Nominee and Biographical Information" and "Section 16(a) Reporting Requirements" of the Proxy Statement to be filed with respect to the 1995 annual meeting of stockholders to be held on October 26, 1995 (the "Proxy Statement"), which information is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION For information concerning this item, see the table and text under the captions "Executive Compensation", "Compensation of Directors of the Company", "Compensation Committee Interlocks and Insider Participation" and "Employment Agreements" of the Proxy Statement, which information is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT For information concerning this item, see the table and text under the captions "Shares of Common Stock Owned Beneficially as of September 1, 1995" and "Information Concerning Certain Stockholders" of the Proxy Statement, which information is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS For information concerning this item, see the text under the caption "Certain Transactions" of the Proxy Statement, which information is incorporated herein by reference. 40 43 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this report: (1) FINANCIAL STATEMENTS
PAGE NUMBER ------ Consolidated Balance Sheets at June 30, 1995 and 1994............... 23 Consolidated Statements of Operations for each of the three years in the period ended June 30, 1995...................................... 24 Consolidated Statements of Changes in Stockholders' Equity for each of the three years in the period ended June 30, 1995................ 25 Consolidated Statements of Cash Flows for each of the three years in the period ended June 30, 1995...................................... 26 Notes to Consolidated Financial Statements.......................... 27 Report of Independent Accountants................................... 39 (2) FINANCIAL STATEMENT SCHEDULES: VIII --Valuation and Qualifying Accounts for each of the three years in the period ended June 30, 1995................................... 43 (3) EXHIBITS (NUMBERED IN ACCORDANCE WITH ITEM 601 OF REGULATION S-K) The exhibits required to be filed are listed in the index to Exhibits............................................................ 44
(b) Current Reports on Form 8-K: During the quarter ended June 30, 1995, the Company filed a current report on Form 8-K dated May 19, 1995, with respect to Item 2 and Item 7(b) with respect to the Disposition of Assets and Proforma Financial Information. 41 44 POWER OF ATTORNEY The Registrant and each person whose signature appears below hereby appoint John H. Foster and Timothy E. Foster as attorneys-in-fact with full power of substitution, severally, to execute in the name and on behalf of the Registrant and each such person, individually and in each capacity stated below, one or more amendments to the annual report which amendments may make such changes in the report as the attorney-in-fact acting in the premises deems appropriate and to file any such amendment to the report with the Securities and Exchange Commission. ------------------------ SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. NOVACARE, INC. By: /s/ BRUCE J. COLBURN ------------------------------------ (BRUCE J. COLBURN, SENIOR VICE PRESIDENT, CHIEF FINANCIAL OFFICER, TREASURER AND CHIEF ACCOUNTING OFFICER) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE ----------------------------------------------- ----------------------------------- ------------------- /s/ JOHN H. FOSTER Chairman of the Board, Chief September 12, 1995 ----------------------------------------------- Executive Officer and Director (JOHN H. FOSTER) /s/ TIMOTHY E. FOSTER President, Chief Operating Officer September 12, 1995 ----------------------------------------------- and Director (TIMOTHY E. FOSTER) /s/ BRUCE J. COLBURN Senior Vice President, Chief September 12, 1995 ----------------------------------------------- Financial Officer, Treasurer and (BRUCE J. COLBURN) Chief Accounting Officer /s/ C. ARNOLD RENSCHLER, M.D. Senior Vice President, Chief September 12, 1995 ----------------------------------------------- Clinical Officer, Director (C. ARNOLD RENSCHLER, M.D.) /s/ E. MARTIN GIBSON Director September 12, 1995 ----------------------------------------------- (E. MARTIN GIBSON) /s/ SIRI S. MARSHALL Director September 12, 1995 ----------------------------------------------- (SIRI S. MARSHALL) /s/ STEPHEN E. O'NEIL Director September 12, 1995 ----------------------------------------------- (STEPHEN E. O'NEIL) /s/ GEORGE W. SIGULER Director September 12, 1995 ----------------------------------------------- (GEORGE W. SIGULER) /s/ ROBERT G. STONE, JR. Director September 12, 1995 ----------------------------------------------- (ROBERT G. STONE, JR.) /s/ DANIEL C. TOSTESON, M.D. Director September 12, 1995 ----------------------------------------------- (DANIEL C. TOSTESON, M.D.)
42 45 SCHEDULE VIII NOVACARE, INC. VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED JUNE 30, 1995, 1994 AND 1993 (IN THOUSANDS)
BALANCE AT CHARGED TO BALANCE BEGINNING COSTS AND AT END DESCRIPTION OF PERIOD EXPENSES OTHER DEDUCTIONS OF PERIOD -------------------------------------- ---------- ---------- ------ ---------- --------- Year ended June 30, 1995: Allowance for uncollectible accounts......................... $ 17,692 15,918 643(2) 18,230 $16,023 Allowance for Medicare denials and other allowances................. $ 15,039 -- 5,887(3) 17,231 $ 3,695 Year ended June 30, 1994: Allowance for uncollectible accounts......................... $ 11,303(1) 14,453 647(2) 8,711 $17,692 Allowance for Medicare denials and other allowances................. $ 13,324 -- 67,151(3) 65,436 $15,039 Year ended June 30, 1993: Allowance for uncollectible accounts......................... $ 8,178 9,764 313(2) 7,125 $11,130 Allowance for Medicare denials and other allowances................. $ 7,388 -- 38,912(3) 32,976 $13,324
--------------- (1) Differs from balance at end of prior period due to changes in fiscal year of merged subsidiary from December 31 to June 30. (2) Allowances for doubtful accounts related to acquired receivables. (3) Charged against net revenues. 43 46 INDEX TO EXHIBITS
EXHIBIT PAGE NUMBER EXHIBIT DESCRIPTION NUMBER --------- --------------------------------------------------------------------- ----------- 2 Stock Purchase Agreement dated as of February 3, 1995 by and among -- NovaCare, Inc., NC Resources, Inc., and HEALTHSOUTH Corporation (incorporated by reference to Exhibit 2 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995). 3(a)* Certificate of Incorporation of the Company, as amended to date -- (incorporated by reference to Exhibit 3(a) to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1992). 3(b) By-laws of the Company, as amended to date. 4(a)* Stock Option Plan, as amended to date (incorporated by reference to -- Exhibit 4(a) to the Company's Annual Report on Form 10-K for the year ended June 30, 1994). 4(b)* Form of Indenture dated as of January 15, 1993 between the Company -- and Pittsburgh National Bank relating to 5 1/2% Convertible Subordinated Debentures Due 2000 (incorporated by reference to Exhibit 4 to Registration Statement on Form S-3 No. 33-55710). 4(c) Rights Agreement dated as of March 9, 1995 by and between NovaCare, -- Inc. and American Stock Transfer & Trust Company, as Rights Agent (incorporated by reference to Exhibit 99(a) to the Company's current report on Form 8-K dated March 14, 1995). 10(a)* Form of Warrant Certificate (incorporated by reference to Exhibit -- 10(a) to the Company's Annual Report on Form 10-K for the year ended June 30, 1994). 10(b)* Employment Agreement dated as of December 10, 1993 between the -- Company and James C. New (incorporated by reference to Exhibit 10(d) to the Company's Annual Report on Form 10-K for the year ended June 30, 1994). 10(c) Employment Agreement dated July 1, 1994 between the Company and John -- H. Foster (incorporated by reference to Exhibit 10(a) to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995). 10(d) Amendment dated February 2, 1995 to the Employment Agreement dated as -- of July 1, 1994 between the Company and John H. Foster (incorporated by reference to Exhibit 10(b) to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995). 10(e)* Employment Agreement dated as of January 3, 1994 between the Company -- and C. Arnold Renschler, M.D. (incorporated by reference to Exhibit 10(f) to the Company's Annual Report on Form 10-K for the year ended June 30, 1994). 10(f) Amendment dated May 25, 1995 to the Employment Agreement between the Company and C. Arnold Renschler, M.D. dated as of January 3, 1994. 10(g) Employment Agreement between the Company and Timothy E. Foster dated -- as of December 2, 1994 (incorporated by reference to Exhibit 10(c) to the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 1994). 10(h) (i) Revolving Credit Facility Agreement dated as of May 27, 1994 by -- and among NovaCare and certain of its subsidiaries and PNC Bank, First Union National Bank of North Carolina, Mellon Bank, N.A., Nations Bank of North Carolina, N.A., CoreStates Bank, N.A. and National Westminster Bank, N.A. (incorporated by reference to Exhibit 10(g) to the Company's Annual Report on Form 10-K for the year ended June 30, 1994).
44 47
EXHIBIT PAGE NUMBER EXHIBIT DESCRIPTION NUMBER --------- --------------------------------------------------------------------- ----------- (ii) Revolving Credit Facility Credit Agreement First Amendment dated -- as of September 20, 1994 by and among NovaCare and certain of its subsidiaries and PNC Bank, N.A., First Union National Bank of North Carolina, Mellon Bank,. N.A., Nations Bank of North Carolina, N.A., CoreStates Bank, N.A., and National Westminster Bank, N.A. (incorporated by reference to Exhibit 10(a) to the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 1994). (iii) Revolving Credit Facility Agreement Second Amendment dated as -- of November 28, 1994 by and among NovaCare and certain of its subsidiaries and PNC Bank, N.A., First Union National Bank of North Carolina, Mellon Bank, N.A., Nations Bank of North Carolina, N.A., CoreStates Bank, N.A., National Westminster Bank, N.A., and Fleet Bank of Massachusetts, N.A. (incorporated by reference to Exhibit 10(b) to the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 1994). 10(i) Employment Agreement dated as of January 6, 1995 between the Company and Daryl A. Dixon and Promissory Note of Daryl A. Dixon in favor of the Company dated January 6, 1995. 10(j)* Supplemental Benefits Plan (incorporated by reference to Exhibit -- 10(h) to the Company's Annual Report on Form 10-K for the year ended June 30, 1994). 13 Annual Report to Stockholders for the fiscal year ended June 30, 1995. 21 Subsidiaries of the Company. 23 Consent of Independent Accountants. 24 Power of Attorney (see "Power of Attorney" in Form 10-K). 27 Financial Data Schedules.
Copies of the exhibits filed with this Annual Report on Form 10-K or incorporated by reference herein do not accompany copies hereof for distribution to stockholders of the Company. The Company will furnish a copy of any of such exhibits to any stockholder requesting the same. Exhibits denoted by an asterisk were filed prior to the Company's adoption of filing via EDGAR. 45 EX-3.B 2 BY-LAWS OF THE COMPANY 1 EXHIBIT 3-B NOVACARE, INC. -------------------- BY-LAWS -------------------- As in effect on February 2, 1995 2 NOVACARE, INC. BY-LAWS ARTICLE I Offices The registered office of the Corporation shall be in the City of Dover, County of Kent, State of Delaware. The Corporation may also have offices at such other places, both within and without the State of Delaware, as may from time to time be designated by the Board of Directors. ARTICLE II Books The books and records of the Corporation may be kept (except as otherwise provided by the laws of the State of Delaware) outside of the State of Delaware and at such place or places as may from time to time be designated by the Board of Directors. ARTICLE III Stockholders Section 1. Annual Meetings. The annual meeting of the stockholders of the Corporation for the election of Directors and the transaction of such other business as may properly come before said meeting shall be held at the principal business office of the Corporation or at such other place or places either within or without the State of Delaware as may be designated by the Board of Directors and stated in the notice of 2 3 the meeting, on the first Monday of May in each year, if not a legal holiday, and, if a legal holiday, then on the next day not a legal holiday, at 10:00 o'clock in the forenoon, or such other day as shall be determined by the Board of Directors. Written notice of the place designated for the annual meeting of the stockholders of the Corporation shall be delivered personally or mailed to each stockholder entitled to vote thereat not less than ten (10) and not more than sixty (60) days prior to said meeting, but at any meeting at which all stockholders shall be present, or of which all stockholders not present have waived notice in writing, the giving of notice as above described may be dispensed with. If mailed, said notice shall be directed to each stockholder at his address as the same appears on the stock ledger of the Corporation unless he shall have filed with the Secretary of the Corporation a written request that notices intended for him be mailed to some other address, in which case it shall be mailed to the address designated in such request. Section 2. Special Meetings. Special meetings of the stockholders of the Corporation shall be held whenever called in the manner required by the laws of the State of Delaware for purposes as to which there are special statutory provisions, and for other purposes whenever called by resolution of the Board of Directors, or by the Chairman of the Board, or by the President, or by the holders of a majority of the outstanding shares of capital stock of the Corporation the holders of which are entitled to vote on matters that are to be voted on at such meeting. Any such special meeting of stockholders may be held at the principal business office of the Corporation or at such other place or places, either within or without the State of 3 4 Delaware, as may be specified in the notice thereof. Business transacted at any special meeting of stockholders of the Corporation shall be limited to the purposes stated in the notice thereof. Except as otherwise expressly required by the laws of the State of Delaware, written notice of each special meeting, stating the day, hour and place, and in general terms the business to be transacted thereat, shall be delivered personally or mailed to each stockholder entitled to vote thereat not less than ten (10) and not more than sixty (60) days before the meeting. If mailed, said notice shall be directed to each stockholder at his address as the same appears on the stock ledger of the Corporation unless he shall have filed with the Secretary of the Corporation a written request that notices intended for him be mailed to some other address, in which case it shall be mailed to the address designated in said request. At any special meeting at which all stockholders shall be present, or of which all stockholders not present have waived notice in writing, the giving of notice as above described may be dispensed with. Section 3. List of Stockholders. The officer of the Corporation who shall have charge of the stock ledger of the Corporation shall prepare and make, at least ten (10) days before every meeting of stockholders, a complete list of the stockholders entitled to vote at said meeting, arranged in alphabetical order and showing the address of each stockholder and the number of shares registered in the name of each stockholder. Such list shall be open to the examination of any stockholder, for any purpose germane to the meeting, during ordinary business hours for a period of at least ten (10) days prior to the meeting, either at a place within the 4 5 city where the meeting is to be held, which place shall be specified in the notice of the meeting, or, if not so specified, at the place where the meeting is to be held. The list shall also be produced and kept at the time and place of the meeting during the whole time thereof, and may be inspected by any stockholder who is present. Section 4. Quorum. At any meeting of the stockholders of the Corporation, except as otherwise expressly provided by the laws of the State of Delaware, the Certificate of Incorporation or these By-Laws, there must be present, either in person or by proxy, in order to constitute a quorum, stockholders owning a majority of the issued and outstanding shares of the capital stock of the Corporation entitled to vote at said meeting. At any meeting of stockholders at which a quorum is not present, the holders of, or proxies for, a majority of the stock which is represented at such meeting, shall have power to adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum shall be present or represented. At such adjourned meeting at which a quorum shall be present or represented any business may be transacted which might have been transacted at the meeting as originally noticed. If the adjournment is for more than thirty (30) days, or if after the adjournment a new record date is fixed for the adjourned meeting, a notice of the adjourned meeting shall be given to each stockholder of record entitled to vote at the meeting. Section 5. Organization. The Chairman of the Board, or in his absence the President, or in his absence any Vice President, shall call to order meetings of the stockholders and shall act as chairman of such meetings. The Board of Directors or 5 6 the stockholders may appoint any stockholder or any Director or officer of the Corporation to act as chairman of any meeting in the absence of the Chairman of the Board, the President and all of the Vice Presidents. The Secretary of the Corporation shall act as secretary of all meetings of the stockholders, but in the absence of the Secretary the presiding officer may appoint any other person to act as secretary of any meeting. Section 6. Voting. Except as otherwise provided in the Certificate of Incorporation or these By-Laws, each stockholder of record of the Corporation shall, at every meeting of the stockholders of the Corporation, be entitled to one (1) vote for each share of stock standing in his name on the books of the Corporation on any matter on which he is entitled to vote, and such votes may be cast either in person or by proxy, appointed by an instrument in writing, subscribed by such stockholder or by his duly authorized attorney, and filed with the Secretary before being voted on, but no proxy shall be voted after three (3) years from its date, unless said proxy provides for a longer period. If the Certificate of Incorporation provides for more or less than one (1) vote for any share of capital stock of the Corporation, on any matter, then any and every reference in these By-Laws to a majority or other proportion of capital stock shall refer to such majority or other proportion of the votes of such stock. The vote on all elections of Directors and on any other questions before the meeting need not be by ballot, except upon demand of any stockholder. When a quorum is present at any meeting of the stockholders of the Corporation, the vote of the holders of a majority of the capital stock entitled to vote 6 7 at such meeting and present in person or represented by proxy shall decide any question brought before such meeting, unless the question is one upon which, under any provision of the laws of the State of Delaware or of the Certificate of Incorporation, a different vote is required in which case such provision shall govern and control the decision of such question. Section 7. Consent. Except as otherwise provided by the Certificate of Incorporation, whenever the vote of the stockholders at a meeting thereof is required or permitted to be taken in connection with any corporate action by any provision of the laws of the State of Delaware or of the Certificate of Incorporation, such corporate action may be taken without a meeting, without prior notice and without a vote, if a consent in writing, setting forth the action so taken, shall be signed by the holders of outstanding capital stock of the Corporation having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted. Prompt notice of the taking of the corporate action without a meeting by less than unanimous written consent shall be given to those stockholders who have not consented thereto in writing. Section 8. Judges. At every meeting of the stockholders of the Corporation at which a vote by ballot is taken, the polls shall be opened and closed, the proxies and ballots shall be received and taken in charge, and all questions touching the qualifications of voters, the validity of proxies and the acceptance or rejection of votes shall be decided by, two (2) judges. Said judges shall be appointed by the Board of 7 8 Directors before the meeting, or, if no such appointment shall have been made, by the presiding officer of the meeting. If for any reason any of the judges previously appointed shall fail to attend or refuse or be unable to serve, judges in place of any so failing to attend, or refusing or unable to serve, shall be appointed in like manner. ARTICLE IV Directors Section 1. Number, Election and Term of Office. The business and affairs of the Corporation shall be managed by the Board of Directors. The number of Directors which shall constitute the whole Board shall be not less than three (3) nor more than twelve (12). Within such limits, the number of Directors may be fixed from time to time by vote of the stockholders or of the Board of Directors, at any regular or special meeting, subject to the provisions of the Certificate of Incorporation. Directors need not be stockholders. Directors shall be elected at the annual meeting of the stockholders of the Corporation, except as provided in Section 2 of this Article, to serve until the next annual meeting of stockholders and until their respective successors are duly elected and have qualified. In addition to the powers by these By-Laws expressly conferred upon them, the Board may exercise all such powers of the Corporation as are not by the laws of the State of Delaware, the Certificate of Incorporation or these By-Laws required to be exercised or done by the stockholders. Section 2. Vacancies and Newly Created Directorships. Except as hereinafter provided, any vacancy in the office of a Director occurring for any reason 8 9 other than the removal of a Director pursuant to Section 3 of this Article, and any newly created Directorship resulting from any increase in the authorized number of Directors, may be filled by a majority of the Directors then in office or by a sole remaining Director. In the event that any vacancy in the office of a Director occurs as a result of the removal of a Director pursuant to Section 3 of this Article, or in the event that vacancies occur contemporaneously in the offices of all of the Directors, such vacancy or vacancies shall be filled by the stockholders of the Corporation at a meeting of stockholders called for the purpose. Directors chosen or elected as aforesaid shall hold office until the next annual meeting of stockholders and until their respective successors are duly elected and have qualified. Section 3. Removals. At any meeting of stockholders of the Corporation called for the purpose, the holders of a majority of the shares of capital stock of the Corporation entitled to vote at such meeting may remove from office, with or without cause, any or all of the Directors. Section 4. Regular Meetings. Regular meetings of the Board of Directors may be held without notice at such time and place, either within or without the State of Delaware, as shall from time to time be determined by resolution of the Board. Section 5. Special Meetings. Special meetings of the Board of Directors may be called by the Chairman of the Board or by the President or any two Directors on notice given to each Director, and such meetings shall be held at the principal business office of the Corporation or at such other place or places, either within or without the State of Delaware, as shall be specified in the notices thereof. 9 10 Section 6. Annual Meetings. The first meeting of each newly elected Board of Directors shall be held as soon as practicable after each annual election of Directors and on the same day, at the same place at which regular meetings of the Board of Directors are held, or at such other time and place as may be provided by resolution of the Board. Such meeting may be held at any other time or place which shall be specified in a notice given, as hereinafter provided, for special meetings of the Board of Directors. Section 7. Notice. Notice of any meeting of the Board of Directors requiring notice shall be given to each Director by mailing the same, addressed to him at his residence or usual place of business, at least forty-eight (48) hours, or shall be sent to him at such place by facsimile transmission, courier, telegraph, cable or wireless, or shall be delivered personally or by telephone, at least twelve (12) hours, before the time fixed for the meeting. At any meeting at which every Director shall be present or at which all Directors not present shall waive notice in writing, any and all business may be transacted even though no notice shall be given. Section 8. Quorum. At all meetings of the Board of Directors, the presence of one-third or more of the Directors constituting the Board shall constitute a quorum for the transaction of business. Except as may be otherwise specifically provided by the laws of the State of Delaware, the Certificate of Incorporation or these By-Laws, the affirmative vote of a majority of the Directors present at the time of such vote shall be the act of the Board of Directors if a quorum is present. If a quorum shall not be present at any meeting of the Board of Directors, the Directors present thereat may 10 11 adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum shall be present. Section 9. Consent. Unless otherwise restricted by the Certificate of Incorporation or these By-Laws, any action required or permitted to be taken at any meeting of the Board of Directors may be taken without a meeting, if all members of the Board consent thereto in writing, and the writing or writings are filed with the minutes of proceedings of the Board. Section 10. Telephonic Meetings. Unless otherwise restricted by the Certificate of Incorporation or these By-Laws, members of the Board of Directors may participate in a meeting of the Board by means of conference telephone or similar communications equipment by means of which all persons participating in such meeting can hear each other, and participation in a meeting pursuant to this Section 10 shall constitute presence in person at such meeting. Section 11. Compensation of Directors. Directors, as such, shall not receive any stated salary for their services, but, by resolution of the Board, a fixed sum and expenses of attendance, if any, may be allowed for attendance at each regular or special meeting of the Board; provided that nothing herein contained shall be construed to preclude any Director from serving the Corporation in any other capacity and receiving compensation therefor. Section 12. Resignations. Any Director of the Corporation may resign at any time by giving written notice to the Board of Directors or to the Chairman of the Board or to the President or the Secretary of the Corporation. Any such resignation shall 11 12 take effect at the time specified therein, or, if the time be not specified, upon receipt thereof; and unless otherwise specified therein, acceptance of such resignation shall not be necessary to make it effective. Section 13. Right to Advancement of Expenses. Any right to indemnification conferred upon the Directors pursuant to the Certificate of Incorporation of the Corporation, these By-Laws, the laws of the State of Delaware or otherwise shall include the right to be paid by the Corporation the expenses incurred in defending any action, suit or proceeding, whether civil, criminal, administrative or investigative, in advance of its final disposition (hereinafter an "advancement of expenses"); provided, however, that if the laws of the State of Delaware require, an advancement of expenses incurred by a Director in his or her capacity as a Director (and not in any other capacity in which service was or is rendered by such Director) shall be made only upon delivery to the Corporation of an undertaking, by or on behalf of such Director, to repay all amounts so advanced if it shall ultimately be determined by final judicial decision from which there is no further right to appeal that such Director is not entitled to be indemnified for such expenses under this Section 13 or otherwise. The right to advancement of expenses conferred in this Section 13 shall be a contract right and such right shall continue to any person entitled to such right who has ceased to be a Director and shall inure to the benefit of such person's heirs, executors and administrators. 12 13 ARTICLE V Officers Section 1. Number, Election and Term of Office. The officers of the Corporation shall be a Chairman of the Board, a President, one or more Vice Presidents, a Secretary and a Treasurer, and may at the discretion of the Board of Directors include one or more Assistant Treasurers and Assistant Secretaries. The officers of the Corporation shall be elected annually by the Board of Directors at its meeting held immediately after the annual meeting of the stockholders, and shall hold their respective offices until their successors are duly elected and have qualified. Any number of offices may be held by the same person. The Chairman of the Board may from time to time appoint such other officers and agents as the interest of the Corporation may require and may fix their duties and terms of office. Section 2. Chairman of the Board. The Chairman of the Board shall be the chief executive officer of the Corporation and shall have general and active management of the business of the Corporation, and shall see that all orders and resolutions of the Board are carried into effect. He shall ensure that the books, reports, statements, certificates and other records of the Corporation are kept, made or filed in accordance with the laws of the State of Delaware. He shall preside at all meetings of the Board of Directors and at all meetings of the stockholders. He shall cause to be called regular and special meetings of the stockholders and of the Board of Directors in accordance with these By-Laws. He may sign, execute and deliver in the name of the Corporation all deeds, mortgages, bonds, contracts or other 13 14 instruments authorized by the Board of Directors, except in cases where the signing, execution or delivery thereof shall be expressly delegated by the Board of Directors or by these By-Laws to some other officer or agent of the Corporation or where any of them shall be required by law otherwise to be signed, executed or delivered. He may sign, with the Treasurer or an Assistant Treasurer, or the Secretary or an Assistant Secretary, certificates of stock of the Corporation. He shall appoint and remove, employ and discharge, and fix the compensation of all servants, agents, employees and clerks of the Corporation other than the duly elected or appointed officers, subject to the approval of the Board of Directors. In addition to the powers and duties expressly conferred upon him by these By-Laws, he shall, except as otherwise specifically provided by the laws of the State of Delaware, have such other powers and duties as shall from time to time be assigned to him by the Board of Directors. Section 3. President. The President shall be the chief operating officer, or, if the office of Chairman of the Board shall be vacant, the chief executive officer of the Corporation. At the request of the Chairman of the Board, or in the case of his absence or inability to act, or if the office of Chairman of the Board shall be vacant, the President shall perform the duties of the Chairman of the Board, and when so acting, shall have all the powers of the Chairman of the Board. He may sign, with the Treasurer or an Assistant Treasurer, or the Secretary or an Assistant Secretary, certificates of stock of the Corporation. In addition to the powers and duties expressly conferred upon him by these By-Laws, he shall, except as otherwise specifically provided by the laws of the State of Delaware, have such other powers 14 15 and duties as shall from time to time be assigned to him by the Chairman of the Board or by the Board of Directors. Section 4. Vice Presidents. The Vice Presidents shall perform such duties as the Chairman of the Board, the President or the Board of Directors shall require. Any Vice President shall, during the absence or incapacity of the President, assume and perform his duties. Section 5. Secretary. The Secretary may sign all certificates of stock of the Corporation. He shall record all the proceedings of the meetings of the Board of Directors and of the stockholders of the Corporation in books to be kept for that purpose. He shall have custody of the seal of the Corporation and may affix the same to any instrument requiring such seal when authorized by the Board of Directors, and when so affixed he may attest the same by his signature. He shall keep the transfer books, in which all transfers of the capital stock of the Corporation shall be registered, and the stock books, which shall contain the names and addresses of all holders of the capital stock of the Corporation and the number of shares held by each; and he shall keep such stock and transfer books open daily during business hours to the inspection of every stockholder and for transfer of stock. He shall notify the Directors and stockholders of their respective meetings as required by law or by these By-Laws, and shall perform such other duties as may be required by law or by these By-Laws, or which may be assigned to him from time to time by the Board of Directors. 15 16 Section 6. Assistant Secretaries. The Assistant Secretaries shall, during the absence or incapacity of the Secretary, assume and perform all functions and duties which the Secretary might lawfully do if present and not under any incapacity. Section 7. Treasurer. The Treasurer shall have charge of the funds and securities of the Corporation. He may sign all certificates of stock. He shall keep full and accurate accounts of all receipts and disbursements of the Corporation in books belonging to the Corporation and shall deposit all monies and other valuable effects in the name and to the credit of the Corporation in such depositories as may be designated by the Board of Directors. He shall disburse the funds of the Corporation as may be ordered by the Board, and shall render to the Chairman of the Board or the President or the Directors, whenever they may require it, an account of all his transactions as Treasurer and an account of the business and financial position of the Corporation. Section 8. Assistant Treasurers. The Assistant Treasurers shall, during the absence or incapacity of the Treasurer, assume and perform all functions and duties which the Treasurer might lawfully do if present and not under any incapacity. Section 9. Treasurer's Bond. The Treasurer and Assistant Treasurers shall, if required so to do by the Board of Directors, each give a bond (which shall be renewed every six (6) years) in such sum and with such surety or sureties as the Board of Directors may require. Section 10. Transfer of Duties. The Board of Directors or the Chairman of the Board in its or his absolute discretion may transfer the power and duties, in whole or 16 17 in part, of any officer to any other officer, or persons, notwithstanding the provisions of these By-Laws, except as otherwise provided by the laws of the State of Delaware. Section 11. Vacancies. If the office of Chairman of the Board, President, Vice President, Secretary or Treasurer, or of any other officer or agent becomes vacant for any reason, the Board of Directors may choose a successor to hold office for the unexpired term. Section 12. Removals. At any meeting of the Board of Directors called for the purpose, any officer or agent of the Corporation may be removed from office, with or without cause, by the affirmative vote of a majority of the entire Board of Directors. Section 13. Compensation of Officers. The officers shall receive such salary or compensation as may be determined by the Board of Directors. Section 14. Resignations. Any officer or agent of the Corporation may resign at any time by giving written notice to the Board of Directors or to the Chairman of the Board or the President or the Secretary of the Corporation. Any such resignation shall take effect at the time specified therein or, if the time be not specified, upon receipt thereof; and unless otherwise specified therein, acceptance of such resignation shall not be necessary to make it effective. ARTICLE VI Contracts, Checks and Notes Section 1. Contracts. Unless the Board of Directors shall otherwise specifically direct, all contracts of the Corporation shall be executed in the name of the Corporation by the Chairman of the Board, the President or a Vice President. 17 18 Section 2. Checks and Notes. All checks, drafts, bills of exchange and promissory notes and other negotiable instruments of the Corporation shall be signed by such officers or agents of the Corporation as may be designated by the Board of Directors. ARTICLE VII Stock Section 1. Certificates of Stock. The certificates for shares of the stock of the Corporation shall be in such form, not inconsistent with the Certificate of Incorporation, as shall be prepared or approved by the Board of Directors. Every holder of stock in the Corporation shall be entitled to have a certificate signed by, or in the name of the Corporation by, the Chairman of the Board, the President or a Vice President, and by the Treasurer or an Assistant Treasurer or the Secretary or an Assistant Secretary certifying the number of shares owned by him and the date of issue; and no certificate shall be valid unless so signed. All certificates shall be consecutively numbered and shall be entered in the books of the Corporation as they are issued. Where a certificate is countersigned (1) by a transfer agent other than the Corporation or its employee, or, (2) by a registrar other than the Corporation or its employee, any other signature on the certificate may be facsimile. In case any officer, transfer agent or 18 19 registrar who has signed or whose facsimile signature has been placed upon a certificate shall have ceased to be such officer, transfer agent or registrar before such certificate is issued, it may be issued by the Corporation with the same effect as if he were such officer, transfer agent or registrar at the date of issue. All certificates surrendered to the Corporation shall be cancelled and, except in the case of lost or destroyed certificates, no new certificates shall be issued until the former certificates for the same number of shares of the same class of stock shall have been surrendered and cancelled. Section 2. Transfer of Stock. Upon surrender to the Corporation or the transfer agent of the Corporation of a certificate for shares duly endorsed or accompanied by proper evidence of succession, assignment or authority to transfer, it shall be the duty of the Corporation to issue a new certificate to the person entitled thereto, cancel the old certificate and record the transaction upon its books. ARTICLE VIII Registered Stockholders The Corporation shall be entitled to treat the holder of record of any share or shares of stock as the holder in fact thereof and, accordingly, shall not be bound to recognize any equitable or other claim to, or interest in, such share or shares on the part of any other person, whether or not it shall have express or other notice thereof, save as expressly provided by the laws of the State of Delaware. ARTICLE IX Lost Certificates Any person claiming a certificate of stock to be lost or destroyed, shall make an affidavit or affirmation of the fact and advertise the same in such manner as the Board 19 20 of Directors may require, and the Board of Directors may, in its discretion, require the owner of the lost or destroyed certificate, or his legal representative, to give the Corporation a bond in a sum sufficient, in the opinion of the Board of Directors, to indemnify the Corporation against any claim that may be made against it on account of the alleged loss of any such certificate. A new certificate of the same tenor and for the same number of shares as the one alleged to be lost or destroyed may be issued without requiring any bond when, in the judgment of the Directors, it is proper so to do. ARTICLE X Fixing of Record Date In order that the Corporation may determine the stockholders entitled to notice of or to vote at any meeting of stockholders or any adjournment thereof, or to express consent to corporate action in writing without a meeting, or to receive payment of any dividend or other distribution or allotment of any rights, or to exercise any rights in respect of any change, conversion or exchange of stock or for the purpose of any other lawful action, the Board of Directors may fix, in advance, a record date, which shall not be more than sixty (60) nor less than ten (10) days before the date of such meeting, nor more than sixty (60) days prior to any other action. A determination of stockholders of record entitled to notice of or to vote at a meeting of stockholders shall apply to any adjournment of the meeting; provided, however, that the Board of Directors may fix a new record date for the adjourned meeting. 20 21 ARTICLE XI Dividends Subject to the relevant provisions of the Certificate of Incorporation, dividends upon the capital stock of the Corporation may be declared by the Board of Directors at any regular or special meeting, pursuant to law. Dividends may be paid in cash, in property, or in shares of the capital stock of the Corporation, subject to the provisions of the Certificate of Incorporation. Before payment of any dividend, there may be set aside out of any funds of the Corporation available for dividends such sums as the Directors from time to time, in their absolute discretion, think proper as a reserve or reserves to meet contingencies, or for equalizing dividends, or for repairing or maintaining any property of the Corporation, or for such other purpose as the Directors shall think conducive to the interest of the Corporation, and the Directors may modify or abolish any such reserve in the manner in which it was created. ARTICLE XII Waiver of Notice Whenever any notice whatever is required to be given by statute or under the provisions of the Certificate of Incorporation or these By-Laws, a waiver thereof in writing signed by the person or persons entitled to said notice, whether before or after the time stated therein, shall be equivalent thereto. 21 22 ARTICLE XIII Seal The corporate seal of the Corporation shall have inscribed thereon the name of the Corporation, the year of its organization and the words "Corporate Seal, Delaware." ARTICLE XIV Amendments Subject to the provisions of the Certificate of Incorporation, these By-Laws may be altered, amended or repealed or new By-Laws may be adopted by the stockholders or by the Board of Directors, at any regular meeting of the stockholders or of the Board of Directors or at any special meeting of the stockholders or of the Board of Directors if notice of such alteration, amendment or repeal of the By-Laws or of adoption of new By-Laws be contained in the notice of such special meeting. 22 EX-10.F 3 EMPLOYMENT AGREEMENT, C. ARNOLD RENSCHLER, M.D. 1 EXHIBIT 10-F [NOVACARE LETTERHEAD] May 26, 1995 C. Arnold Renschler, M.D. 408 Barbara Lane Bryn Mawr, PA 19010 Dear Arnie: This confirms our understanding with respect to the terms of your continued employment by NovaCare (the "Company"). The terms and conditions of your agreement with the Company dated as of January 3, 1994 (the "Agreement"), a copy of which is attached hereto and which is incorporated herein by reference, are hereby ratified and affirmed except as specifically modified below: 1. The first and last sentences of Paragraph 2 of the Agreement are deleted in their entirety and the following is substituted in place of the first sentence: "2. Position, Duties. The Employee shall serve as the Company's Senior Vice President, Chief Clinical Officer and President and General Manager, NewCo, a professional services consulting and management division, yet to be named." 2. You have been granted, subject to the approval of the Compensation Committee of the Board of Directors, a non qualified stock option, pursuant to the NovaCare 1986 Stock Option Plan (the "Plan"), to purchase 110,000 shares of NovaCare common stock at $7.375, the exercise price at the close of business yesterday. Such options shall vest over five years in annual cumulative installments of 20% per year, commencing May 25, 1996, and shall become fully vested immediately (1) if you are directed to report, without your prior written approval, to someone other than John H. Foster or Timothy E. Foster, or (2) if there is a change of control of the Company. "Change of control" for purposes of this paragraph shall mean that voting control of twenty percent or more of the common shares of the Company vests in a person (as defined in Section 13(d)(3) of the Securities Exchange Act of 1934) other than a group of which you are a member. You remain eligible for annual option grants pursuant to paragraph 3.4 of the Agreement. 3. Paragraph 8.1 of the Agreement is amended by substituting for the first portion of the second sentence thereof ending with "... or (b)" the following: 2 C. Arnold Renschler, M.D. May 26, 1995 Page 2 "The Employee agrees that, in consideration of his employment hereunder, the Employee will not, for a period of one (1) year commencing on the date of termination for any reason of his employment with the Company, (a) engage, directly or indirectly, whether as principal, agent, distributor, representative, consultant, stockholder (other than an investment of not more than 5% of the stock or equity of any corporation the stock of which is publicly traded), employee or otherwise, in any activity or business venture which is competitive with any business conducted or proposed to be conducted by the Company as of the date of termination of his employment with the Company (it being understood and agreed that the Employee shall not be considered to have violated the foregoing covenant if, subsequent to his employment by the Company, he engages in the skilled nursing facility, including sub-acute services (other than contract sub-acute services), assisted living or senior living housing business or the physician services (other than contract rehabilitation management) business), or (b) ..." Except as modified above, the Agreement remains in full force and effect. If you agree to the foregoing, please sign the enclosed executed copy of this letter and return it to me. Sincerely, /s/ TIMOTHY E. FOSTER --------------------- Timothy E. Foster Agreed to: /s/ C. ARNOLD RENSCHLER, Date: 5/26/95 --------------------------------- -------------- C. Arnold Renschler, M.D. 073 Enclosure EX-10.I 4 EMPLOYMENT AGREEMENT, DARYL A. DIXON 1 EXHIBIT 10(i) EMPLOYMENT AGREEMENT AGREEMENT dated as of the 6th day of January, 1995 by and between NOVACARE, INC., a Delaware corporation (the "Company"), and DARYL A. DIXON (the "Executive"). W I T N E S S E T H : WHEREAS, the Executive has heretofore been employed in the Contract Services Division of the Company, and the Company wishes to continue to retain the Executive and the Executive wishes to continue to serve the Company, upon the terms and conditions hereinafter set forth. NOW, THEREFORE, in consideration of the premises and the mutual agreements hereinafter set forth, the parties hereto hereby agree as follows: 1. EMPLOYMENT, TERM, AUTOMATIC EXTENSION. 1.1 Employment. The Company agrees to employ the Executive, and the Executive agrees to serve in the employ of the Company, for the term set forth in Section 1.2, in the positions and with the responsibilities, duties and authority set forth in Section 2 and on the other terms and conditions set forth in this Agreement. 1.2 Term. The term of the Executive's employment under this Agreement shall commence on the date hereof and shall terminate on the fifth anniversary of the date hereof, unless extended or sooner terminated in accordance with this Agreement. 1.3 Automatic Extension. As of the fourth anniversary hereof, and as of each subsequent anniversary (each, an "Automatic Renewal Date"), unless either party shall have given a notice of non-extension prior to such Automatic Renewal Date, the term of this Agreement shall be extended automatically for a period of one year to the anniversary of the expiration date of the then current term of this Agreement. Once a notice of non-extension shall have been given by either party, there shall be no further automatic extension of this Agreement. 2. POSITION, DUTIES. The Executive shall serve the Company in the position of President and General Manager - Contract Services Division. The Executive shall perform, faithfully and diligently, such duties, and shall have such responsibilities, appropriate to said position, as shall be assigned to him from time to time by the Chief Executive Officer, the Chief Operating Officer and the Board of Directors of the Company. The Executive shall report to the Chief Operating Officer of the Company. The Executive shall devote his full business time and attention to the performance of his duties and responsibilities hereunder. 2 2 3. SALARY, INCENTIVE BONUS, STOCK OPTIONS. 3.1 Salary. During the term of this Agreement, in consideration of the performance by the Executive of the services set forth in Section 2 and his observance of the other covenants set forth herein, the Company shall pay to the Executive, and the Executive shall accept, a base salary at the rate of $300,000 per annum, payable in accordance with the standard payroll practices of the Company. The Executive shall be entitled to such increases in base salary, commencing January 1, 1996 and thereafter during the term hereof, as shall be determined by the Chief Operating Officer and approved by the Compensation Committee of the Board of Directors of the Company in their sole discretion, taking account of the performance of the Contract Services Division, the Company and the Executive, and other factors generally considered relevant to the salaries of officers holding similar positions with enterprises comparable to the Company. In no event shall the base salary of the Executive be decreased during the term of this Agreement. 3.2 Bonus. (a) In addition to the base salary provided for in Section 3.1, the Executive shall have a bonus opportunity of fifty percent (50%) of his base salary (the "Target Bonus") with respect to each fiscal year of the Company ending during the term of this Agreement, as determined by the Contract Services Division Executive Compensation Plan (the "Plan"). The determination as to the amount, if any, of the bonus which the Executive has earned shall be in the sole discretion of the Company, based on the success of the Executive in meeting annual objectives under the Plan; provided, however, that for the 1995 and 1996 fiscal years of the Company, the Executive shall be entitled to a guaranteed bonus in an amount equal to sixty percent (60%) of the Target Bonus for the applicable fiscal year. The bonus shall be payable upon or within a reasonable period of time after the receipt of the Company's audited financial statements for the applicable fiscal year in accordance with the Company's normal practices. (b) In the event of the termination of employment of the Executive pursuant to Section 6.1 (Death), 6.2 (Disability), Section 6.4 (Without Cause) or 6.5 (Voluntary Termination) of this agreement, the Executive (or his estate or other legal representative) shall be entitled to a bonus for the fiscal year in which such termination takes place in an amount equal to the product of (i) the bonus or guaranteed bonus for such fiscal year determined pursuant to Section 3.2, multiplied by (ii) a fraction, the numerator of which is the number of days from the beginning of such fiscal year to the date of termination, and the denominator of which is 365. In the event of the termination of employment of the Executive pursuant to Section 6.3 (Due Cause) of this Agreement, the Executive shall 3 3 not be entitled to a bonus for the fiscal year of the Company in which such termination takes place. The Executive shall not be entitled to a bonus for any fiscal year of the Company subsequent to the fiscal year in which the termination of his employment takes place. 3.3 Stock Options. As of the date (the "Grant Date") of the meeting of the Compensation Committee of the Board of Directors next following the execution of this Agreement, the Company shall grant to the Executive incentive stock options to purchase 25,000 shares of the Company's common stock, par value $.01 per share ("Options"), at an exercise price per share equal to the market value of the Company's common stock on the Grant Date. The Options shall: (i) have a term of ten (10) years from the Grant Date; (ii) become exercisable as to 20% of the shares covered thereby on the first anniversary of the Grant Date, as to an additional 20% of such shares on each of the next three anniversaries of the Grant Date and as to the final 20% of such shares on a date thirty (30) days prior to the fifth anniversary of this agreement; (iii) become exercisable in full upon a Change in Control of the Company (as hereinafter defined), whether or not the employment of the Executive shall be terminated. The Options shall be granted under the 1986 Stock Option Plan of the Company and shall be evidenced by a Stock Option Certificate embodying the foregoing terms and other terms and conditions of such Stock Option Plan not inconsistent with the foregoing terms. For purposes of this Agreement, a Change in Control of the Company shall be deemed to have occurred if: (A) a "person" (meaning an individual, a partnership, or other group or association as defined in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, other than the Executive or a group including the Executive), either (i) acquires twenty percent (20%) or more of the combined voting power of the outstanding securities of the Company having a right to vote in elections of directors and such acquisition shall not have been approved within sixty (60) days following such acquisition by a majority of the Continuing Directors (as hereinafter defined) then in office or (ii) acquires fifty percent (50%) or more of the combined voting power of the outstanding securities of the Company having a right to vote in elections of directors; or 4 4 (B) Continuing Directors shall for any reason cease to constitute a majority of the Board of Directors of the Company; or (C) all or substantially all of the business and/or assets of the Company is disposed of by the Company to a party or parties other than a subsidiary or other affiliate of the Company, in which the Company owns less than a majority of the equity, pursuant to a partial or complete liquidation of the Company, sale of assets (including stock of a subsidiary of the Company) or otherwise. For purposes of this Agreement, the term "Continuing Director" shall mean a member of the Board of Directors of the Company who either was a member of the Board of Directors on the date hereof or who subsequently became a Director and whose election, or nomination for election, was approved by a vote of at least two-thirds of the Continuing Directors then in office. 4. EXPENSE REIMBURSEMENT. During the term of this Agreement, the Company shall reimburse the Executive for all reasonable and necessary out-of-pocket expenses incurred by him in connection with the performance of his duties hereunder, upon the presentation of proper accounts therefor in accordance with the Company's policies. 5. BENEFITS. 5.1 Benefit Plans. During the term of this Agreement, the Executive will be eligible to participate in all employee benefit plans and programs (including, without limitation Supplemental Benefits Plan, 401(k) Plan, group life, disability, hospitalization, surgical and major medical insurance plans of the Company) offered by the Company from time to time to its senior executive officers, subject to the provisions of such plans and programs as in effect from time to time. 5.2 Vacation. The Executive shall be entitled to four (4) weeks vacation per annum. 5.3 Professional Licensure & Association Dues. During the term of this Agreement, the Company shall pay the Executive's professional licensure and association dues and costs associated with continuing education credits including travel and living expenses. 5.4 Loan. (a) The Company agrees to make a loan to the Executive in the principal amount of $450,000. Such loan shall be made promptly following the execution of this Agreement, shall bear no interest, and shall be payable in equal annual 5 5 installments of $90,000 over five years and in full on the fifth anniversary of the date hereof. The loan shall be evidenced by a Promissory Note to be executed by the Executive embodying the foregoing terms and other standard terms and conditions. Notwithstanding the foregoing, $90,000 of the principal amount of such loan shall be forgiven on each anniversary of the date hereof (beginning on the first anniversary) that the Executive is employed by the Company until the fifth anniversary hereof (when the full amount of the loan will have been forgiven). (b) On the first business day of 1996, 1997, 1998, 1999, 2000 and 2001, the Company shall pay to the Executive the Additional Payment set forth in the second column of Schedule A attached hereto opposite such year, in reimbursement of a portion (equal to such Additional Payment) of the additional federal, state and local income, health insurance and other taxes to which it is projected he will become subject as a result of the interest-free loan from the Company referred to in this Section 5.4. In the event of the termination of the Executive's employment pursuant to Section 6.1 (Death) or Section 6.2 (Disability), a pro rata portion of the Additional Payment applicable to the calendar year during which termination occurred shall become due and payable thirty (30) days after the date of termination. In the event of termination of the Executive's employment pursuant to Section 6.4 (Without Cause) the Company shall continue to pay Additional Payments pursuant to Schedule A. 6. TERMINATION OF EMPLOYMENT. 6.1 Death. In the event of the death of the Executive, the Company shall pay to the estate or other legal representative of the Executive the base salary provided for in Section 3.1 (at the annual rate then in effect) accrued to the date of the Executive's death and not theretofore paid to the Executive. Any unpaid balance of the loan referred to in Section 5.4 shall be forgiven on the date of termination of employment. Rights and benefits of the estate or other legal representative of the Executive (a) with respect to stock options shall be determined in accordance with the applicable option grant and (b) under the benefit plans and programs of the Company shall be determined in accordance with the provisions of such plans and programs. Neither the estate or other legal representative of the Executive nor the Company shall have any further rights or obligations under this Agreement. 6.2 Disability. If the Executive shall become incapacitated by reason of sickness, accident or other physical or mental disability and shall be entitled to payment of benefits under the Company's Supplemental Benefits Plan disability provision, the employment of the Executive hereunder may be terminated by the Company or the Executive. In the event of such termination, the Company shall pay to the Executive the 6 6 difference between disability income and the base salary then in effect for twenty-four (24) months following termination. Any unpaid balance of the loan referred to in Section 5.4 shall be forgiven on the date of termination of employment. Rights and benefits of the Executive (a) with respect to stock options shall be determined in accordance with the applicable option grant and (b) under the other benefit plans and programs of the Company shall be determined in accordance with the terms and provisions of such plans and programs. Neither the Executive nor the Company shall have any further rights or obligations under this Agreement, except as provided in Sections 7, 8 and 9. 6.3 Due Cause. The employment of the Executive hereunder may be terminated by the Company at any time for Due Cause (as hereinafter defined). In the event of such termination, the Company shall pay to the Executive the base salary provided for in Section 3.1 (at the annual rate then in effect) accrued to the date of such termination and not theretofore paid to the Executive. Any unpaid balance of the loan referred to in Section 5.4 shall be paid by the Executive to the Company within sixty (60) days after the date of termination of employment. Rights and benefits of the Executive or his transferee (a) with respect to stock options shall be determined in accordance with the applicable option grant and (b) under the benefit plans and programs of the Company shall be determined in accordance with the provisions of such plans and programs. For purposes hereof, "Due Cause" shall include (a) the Executive's willful and continuing failure to discharge his duties and responsibilities under this Agreement or (b) any material act of dishonesty involving the Company or (c) conviction of (i) a felony or (ii) any crime or offense involving moral turpitude. After the satisfaction of any claim of the Company against the Executive incidental to such Due Cause, neither the Executive nor the Company shall have any further rights or obligations under this Agreement, except as provided in Sections 7, 8 and 9. 6.4 Termination by the Company Without Cause. The Company may terminate the Executive's employment at any time for whatever reason it deems appropriate or without reason; provided, however, that in the event that such termination is not pursuant to Section 6.1 (Death), 6.2 (Disability), 6.3 (Due Cause) or 6.5 (Voluntary Termination), the Company shall pay to the Executive severance pay in the form of salary continuation for a period of two (2) years commencing on the date of termination, at a rate equal to the base salary provided for in Section 3.1 (at the annual rate then in effect). The Executive shall be under no obligation to seek other employment and shall be under no obligation to offset any amounts earned from such other employment (whether as an employee, a consultant or otherwise) against such payments. During the two (2) year severance pay period referred to in this Section 6.4, the Company shall continue to carry the group life, disability, Supplemental 7 7 Benefits Plan (excluding Company match payable during severance period), hospitalization, surgical and major medical insurance coverage for the Executive which were being provided to the Executive immediately prior to the termination of his employment (or such other benefits as shall be provided to senior executives of the Company in lieu of such benefits from time to time during such two (2) year period) on the same basis, including Company payment of premiums and Company contributions, as such benefits are provided to other senior executives of the Company. Any unpaid balance of the loan referred to in Section 5.4 shall continue to be forgiven by the Company in installments as provided in Section 5.4 (but without regard to the requirement that the Executive be employed by the Company). Rights and benefits of the Executive or his transferee (a) with respect to stock options shall be determined in accordance with the applicable option grant and (b) under the other benefit plans and programs of the Company shall be determined in accordance with the provisions of such plans and programs. Neither the Executive nor the Company shall have any further rights or obligations under this Agreement, except as provided in Sections 7, 8 and 9. 6.5 Voluntary Termination. The Executive may terminate his employment with the Company at any time upon thirty (30) days' prior written notice to the Company. In the event of such termination, the Company shall pay to the Executive the base salary provided for in Section 3.1 (at the annual rate then in effect) accrued to the date of such termination and not theretofore paid to the Executive. Any unpaid balance of the loan referred to in Section 5.4 shall be paid by the Executive to the Company within sixty (60) days after the date of termination of employment. Rights and benefits of the Executive or his transferee (a) with respect to stock options shall be determined in accordance with the applicable stock option grant and (b) under the benefit plans and programs of the Company shall be determined in accordance with the provisions of such plans and programs. Neither the Executive nor the Company shall have any further rights or obligations under this Agreement, except as provided in Sections 7, 8 and 9. 7. CONFIDENTIAL INFORMATION. 7.1 Nondisclosure. The Executive shall, during the term of this Agreement and at all times thereafter, treat as confidential and, except as required in the performance of his duties and responsibilities under this Agreement, not disclose, publish or otherwise make available to the public or to any individual, firm or corporation any confidential information (as hereinafter defined). 7.2 Confidential Information Defined. For the purposes hereof, the term "confidential information" shall mean all information acquired by the Executive in the course of the 8 8 Executive's employment with the Company in any way concerning the products, projects, activities, business or affairs of the Company or the Company's customers, including, without limitation, all information concerning trade secrets and the products or projects of the Company and/or any improvements therein, all sales and financial information concerning the Company, all customer and supplier lists, all information concerning projects in research and development or marketing plans for any such products or projects, and all information in any way concerning the products, projects, activities, business or affairs of customers of the Company which is furnished to the Executive by the Company or any of its agents or customers, as such; provided, however, that the term "confidential information" shall not include information which (a) becomes generally available to the public other than as a result of a disclosure by the Executive, (b) was available to the Executive on a non-confidential basis prior to his employment with the Company or (c) becomes available to the Executive on a non-confidential basis from a source other than the Company or any of its agents or customers provided that such source is not bound by a confidentiality agreement with the Company or any of such agents or customers. 8. INTERFERENCE WITH THE COMPANY. 8.1 Restrictions. The Executive acknowledges that the services to be rendered by him to the Company are of a special and unique character. In order to induce the Company to enter into this Agreement, and in consideration of his employment hereunder, the Executive agrees, for the benefit of the Company, that he will not, during the period of his employment with the Company and thereafter, for the Applicable Period (as hereinafter defined) commencing on the date of termination of his employment with the Company: (a) engage, directly or indirectly, (x) whether as principal, consultant, employee, partner, agent, stockholder, limited partner or other investor (other than an investment of (i) not more than five percent (5%) of the stock or equity of any corporation the capital stock of which is publicly traded or (ii) not more than five percent (5%) of the ownership interest of any partnership or other entity) or otherwise, within the United States of America, with any firm or person in any activity or business venture which is in competition with any line or lines of business being conducted by the Company or any subsidiary of the Company at the date of termination of the Executive's employment with the Company, accounting for ten percent (10%) or more of the Company's consolidated gross sales, revenues or earnings before taxes for the fiscal year ended immediately prior to the conduct in question ("Competing Business"), except that, as to any entity whose business is diversified and that has derived during each of the preceding three calendar years less 9 9 than fifty percent (50%) of its revenues from Competing Business, the Executive may so engage in that part of the business that is not Competing Business, provided that the Company, prior to the Executive's having accepted such engagement, shall receive separate written assurances satisfactory to the Company from such entity and from the Executive that the Executive will not render services directly or indirectly to the part(s) of the entity engaged in Competing Business or (y) as a principal, consultant, employee, partner, agent, stockholder, limited partner or other investor of or with Manor Care, Inc. (the "Competition Restriction); or (b) solicit or entice or endeavor to solicit or entice away from the Company any person who was an "officer" (as such term is used in Rule 16a-1 under Section 16 of the Securities Exchange Act of 1934) of the Company, either for his own account or for any individual, firm or corporation, whether or not such person would commit any breach of his contract of employment by reason of leaving the service of the Company (the "Solicitation Restriction"); or (c) employ, directly or indirectly, any person who was an officer (as defined above) of the Company at any time during the one year period ending on the date of termination of the Executive's employment with the Company, except that this restriction shall not apply in the case of any person whose employment shall have been terminated by the Company (the "Hiring Restriction"). 8.2 Time Periods. As used in this Section 8, the term "Applicable Period" shall mean: (a) twelve (12) months in the case of a termination of employment pursuant to Section 6.3 (Due Cause) or Section 6.5 (Voluntary Termination); (b) twenty-four (24) months as to the Competition and Solicitation Restrictions and twelve (12) months as to the Hiring Restriction in the case of a termination of employment pursuant to Section 6.4 (Without Due Cause) or in the case of a termination of employment upon or following expiration of the term of this Agreement; and (c) twenty-four (24) months as to the Competition and Solicitation Restrictions and twelve (12) months as to the Hiring Restriction in the case of a termination pursuant to Section 6.2 (Disability), but only if the Company gives notice to the Executive within thirty (30) days of the date of termination of employment of its intention to enforce such restrictions against the Executive, and subject to the Company's continued payment to the Executive during such twenty-four (24) month 10 10 period of the base salary provided for in Section 3.1 (at the annual rate in effect at the date of termination). 8.3 Payment in the Event of Breach. In the event that the Executive shall breach the Competition Restriction referred to in Section 8.1(a)(y) (relating to Manor Care, Inc.), the Executive shall repay to the Company on demand an amount equal to the sum of (i) the unpaid balance of the loan referred to in Section 5.4, plus (ii) the amount of the loan theretofore forgiven by the Company pursuant to Section 5.4, plus (iii) the amount theretofore paid to the Executive by the Company pursuant to Section 5.4(b). The Executive acknowledges and agrees that the loan, forgiveness of the loan and payments to be made to him, all as provided in Section 5.4, are made by the Company in consideration of the agreement by the Executive to the Competition Restriction referred to in Section 8.1(a)(y) (relating to Manor Care, Inc.) and, accordingly, that the payment to be made by him to the Company pursuant to this Section 8.3 in the event of the breach of such covenant by the Executive is fair and reasonable. Further, it is understood and agreed that the foregoing payment shall be in addition to, and not in lieu of, any other right or remedy which the Company may have at law or in equity against the Executive in the event of breach of such covenant. 9. EQUITABLE RELIEF. In the event of a breach or threatened breach by the Executive of any of the provisions of Sections 7 or 8 of this Agreement, the Executive hereby consents and agrees that the Company shall be entitled to an injunction or similar equitable relief from any court of competent jurisdiction restraining the Executive from committing or continuing any such breach or threatened breach or granting specific performance of any act required to be performed by the Executive under any of such provisions, without the necessity of showing any actual damage or that money damages would not afford an adequate remedy and without the necessity of posting any bond or other security. Nothing herein shall be construed as prohibiting the Company from pursuing any other remedies at law or in equity which it may have. 11 11 10. SUCCESSORS AND ASSIGNS. 10.1 Assignment by the Company. The Company shall require any successors (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform if no such succession had taken place. As used in this Section, the "Company" shall mean the Company as hereinbefore defined and any successor to its business and/or assets as aforesaid which otherwise becomes bound by all the terms and provisions of this Agreement by operation of law and this Agreement shall be binding upon, and inure to the benefit of, the Company, as so defined. 10.2 Assignment by the Executive. The Executive may not assign this Agreement or any part thereof without the prior written consent of a majority of the Board of Directors of the Company; provided, however, that nothing herein shall preclude one or more beneficiaries of the Executive from receiving any amount that may be payable following the occurrence of his legal incompetency or his death and shall not preclude the legal representative of his estate from receiving such amount or from assigning any right hereunder to the person or persons entitled thereto under his will or, in the case of intestacy, to the person or persons entitled thereto under the laws of intestacy applicable to his estate. The term "beneficiaries", as used in this Agreement, shall mean a beneficiary or beneficiaries so designated to receive any such amount or, if no beneficiary has been so designated, the legal representative of the Executive (in the event of his incompetency) or the Executive's estate. 11. GOVERNING LAW. This Agreement shall be deemed a contract made under, and for all purposes shall be construed in accordance with, the laws of the Commonwealth of Pennsylvania applicable to contracts to be performed entirely within such state. In the event that a court of any jurisdiction shall hold any of the provisions of this Agreement to be wholly or partially unenforceable for any reason, such determination shall not bar or in any way affect the Company's right to relief as provided for herein in the courts of any other jurisdiction. Such provisions, as they relate to each jurisdiction, are, for this purpose, severable into diverse and independent covenants. Service of process on the parties hereto at the addresses set forth herein shall be deemed adequate service of such process. 12 12 12. ENTIRE AGREEMENT. This Agreement contains all the understandings and representations between the parties hereto pertaining to the subject matter hereof and supersedes all undertakings and agreements, whether oral or in writing, if any there be, previously entered into by them with respect thereto. 13. AMENDMENT, MODIFICATION, WAIVER. No provision of this Agreement may be amended or modified unless such amendment or modification is agreed to in writing and signed by the Executive and by a duly authorized representative of the Company other than the Executive. Except as otherwise specifically provided in this Agreement, no waiver by either party hereto of any breach by the other party hereto of any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of a similar or dissimilar provision or condition at the same or any prior or subsequent time, nor shall the failure of or delay by either party hereto in exercising any right, power or privilege hereunder operate as a waiver thereof to preclude any other or further exercise thereof or the exercise of any other such right, power or privilege. 14. ARBITRATION. Any controversy or claim arising out of or relating to this Agreement, or any breach thereof, shall, except as provided in Section 9, be settled by arbitration in accordance with the rules of the American Arbitration Association then in effect and judgment upon such award rendered by the arbitrator may be entered in any court having jurisdiction thereof. The arbitration shall be held in the area where the Company then has its principal place of business. The arbitration award shall include attorneys' fees and costs to the prevailing party. 15. NOTICES. Any notice to be given hereunder shall be in writing and delivered personally or sent by certified mail, postage prepaid, return receipt requested, addressed to the party concerned at the address indicated below or at such other address as such party may subsequently designate by like notice: If to the Company: NovaCare, Inc. 1016 West Ninth Avenue King of Prussia, Pennsylvania 19406 Attention: Chief Operating Officer 13 13 If to the Executive: Daryl A. Dixon 6 Trotter Way Collegeville, PA 19426 16. SEVERABILITY. Should any provision of this Agreement be held by a court or arbitration panel of competent jurisdiction to be enforceable only if modified, such holding shall not affect the validity of the remainder of this Agreement, the balance of which shall continue to be binding upon the parties hereto with any such modification to become a part hereof and treated as though originally set forth in this Agreement. The parties further agree that any such court or arbitration panel is expressly authorized to modify any such unenforceable provision of this Agreement in lieu of severing such unenforceable provision from this Agreement in its entirety, whether by rewriting the offending provision, deleting any or all of the offending provision, adding additional language to this Agreement, or by making such other modifications as it deems warranted to carry out the intent and agreement of the parties as embodied herein to the maximum extent permitted by law. The parties expressly agree that this Agreement as so modified by the court or arbitration panel shall be binding upon and enforceable against each of them. In any event, should one or more of the provisions of this Agreement be held to be invalid, illegal or unenforceable in any respect, such invalidity, illegality or unenforceability shall not affect any other provisions hereof, and if such provision or provisions are not modified as provided above, this Agreement shall be construed as if such invalid, illegal or unenforceable provisions had never been set forth herein. 17. WITHHOLDING. Anything to the contrary notwithstanding, all payments required to be made by the Company hereunder to the Executive or his beneficiaries, including his estate, shall be subject to withholding of such amounts relating to taxes as the Company may reasonably determine it should withhold pursuant to any applicable law or regulation. In lieu of withholding such amounts, in whole or in part, the Company, may, in its sole discretion, accept other provision for payment of taxes as permitted by law, provided it is satisfied in its sole discretion that all requirements of law affecting its responsibilities to withhold such taxes have been satisfied. 14 14 18. SURVIVORSHIP. The respective rights and obligations of the parties hereunder shall survive any termination of this Agreement to the extent necessary to the intended preservation of such rights and obligations. 19. TITLES. Titles of the sections and paragraphs of this Agreement are intended solely for convenience and no provision of this Agreement is to be construed by reference to the title of any section or paragraph. * * * 15 15 IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first above written. NOVACARE, INC. By /s/ TIMOTHY E. FOSTER -------------------------- Timothy E. Foster President and Chief Operating Officer /s/ DARYL A. DIXON ------------------------------ Daryl A. Dixon 16 16 SCHEDULE A
Year Additional Payment ---- ------------------ 1996 $8,741.25 1997 6,993.00 1998 5,244.75 1999 3,496.50 2000 1,748.25
17 PROMISSORY NOTE $450,000 January 6, 1995 FOR VALUE RECEIVED, the undersigned, DARYL A. DIXON (the "Borrower"), hereby promises to pay to NOVACARE, INC., a Delaware corporation (the "Lender"), the principal sum of Four Hundred Fifty Thousand Dollars ($450,000), without interest. Principal shall be payable in five equal annual installments of $90,000 on January 6 of each year beginning January 6, 1996 and ending January 6, 2000. Any principal that is not paid when due (whether at the stated maturity, by acceleration or otherwise) shall thereafter bear interest at the rate of seven percent (7%) per annum until paid in full. All payments hereunder shall be made in money of the United States of America which at the time of payment is legal tender for the payment of public and private debts, at the offices of the Lender, 1016 West Ninth Avenue, King of Prussia, Pennsylvania 19406 (or at such other office as the Lender may from time to time designate by notice to the Borrower). Section 1. Prepayment. 1.1 Optional. This Promissory Note may be prepaid in full or in part, at any time and without notice, at the option of the Borrower, without charge, premium or penalty therefor. 1.2 Mandatory. This Promissory Note shall be prepaid within sixty (60) days after termination of the employment of the Borrower with the Lender. Section 2. Events of Default, Etc. 2.1 Events of Default. If any one or more of the following events ("Events of Default") shall happen: (a) default shall be made by the Borrower in the payment of principal or interest under this Promissory Note when and as the same shall become due and payable; or (b) default shall be made by the Borrower in the due performance or observation of any other covenant, agreement or provision contained in this Promissory Note to be performed or observed by the Borrower, or a breach shall exist in any representation or warranty by the Borrower contained herein and such default or breach shall continue for a period of ten (10) days after notice to the Borrower with respect thereto; or (c) the Borrower shall: (i) admit in writing his inability to pay his debts generally as they become due; 18 2 (ii) file a petition in bankruptcy under the bankruptcy laws of the United States or any other jurisdiction (as such laws are now or in the future amended) or any admission seeking the relief therein provided; (iii) make an assignment for the benefit of his creditors; (iv) consent to the appointment of a receiver or trustee for all or a substantial part of his property or to the filing of a petition against him under said bankruptcy laws; or (v) be adjudicated a bankrupt; or (d) a proceeding shall have been instituted seeking a decree or order for relief in respect of the Borrower in an involuntary case under applicable bankruptcy, insolvency or other similar law now or hereafter in effect, or for the appointment of a receiver, liquidator, assignee, custodian, trustee, sequestrator (or similar official) of the Borrower or for any substantial part of his property and such proceeding shall remain undismissed or unstayed and in effect for a period of thirty (30) days or such court shall enter a decree or order granting the relief sought in such proceeding; or (e) a court of competent jurisdiction shall assume custody of or sequester all or substantially all the property of the Borrower; or (f) an attachment shall be made on any substantial part of the property of the Borrower; then in each and every case the Lender may (unless every such Event of Default shall have been made good and cured) by notice in writing to the Borrower declare the unpaid principal of this Promissory Note to be forthwith due and payable and thereupon such principal together with interest accrued to the date of payment shall become so due and payable without presentation, protest or further demand or notice of any kind, all of which are hereby expressly waived; provided that in the case of an Event of Default specified in subsections (c), (d), (e) or (f) above, no notice to the Borrower shall be required and upon the occurrence of such Event of Default the unpaid principal of this Promissory Note together with interest accrued to the date of payment shall become immediately due and payable. 2.2 Collection Costs. The Borrower covenants that if default be made in any payment on this Promissory Note, the Borrower will pay to the Lender such further amount, to the extent lawful, as shall be sufficient to cover the cost and 19 3 expense of collection, including reasonable compensation to counsel of the Lender for all services rendered in that connection. 2.3 Cumulative Powers. All powers and remedies given hereunder to the Lender shall, to the extent permitted by law, be deemed cumulative and shall not be exclusive of any other powers and remedies available to the Lender hereunder, by judicial proceedings or otherwise, to enforce the performance or observance of the covenants and agreements contained in this Promissory Note, and every power and remedy given hereunder or by law to the Lender may be exercised from time to time, and as often as shall be deemed expedient by the Lender. Section 3. Miscellaneous. 3.1 No Waiver. No waiver by the Lender of any breach hereof or default hereunder shall be deemed a waiver of any preceding or succeeding breach or default and no failure of the Lender to exercise any right or privilege hereunder shall be deemed a waiver of the Lender's rights to exercise the same or any other right or privilege at any subsequent time or times. 3.2. Notice. Each notice or communication required or permitted hereunder shall be deemed validly given and received if delivered personally or if sent by registered or certified mail, return receipt requested, addressed as follows: (a) If to the Lender: 1016 West Ninth Avenue King of Prussia, Pennsylvania 19406 (b) If to the Borrower: 6 Trotter Way Collegeville, PA 19426 or to such other address as the party to whom notice is to be given may subsequently designate by like notice. A notice given in accordance with the preceding sentence shall be deemed to have been duly given upon receipt, if delivered personally, or upon mailing, if given by registered or certified mail, return receipt requested. 3.3 Waiver of Presentment and Notice of Dishonor. The Borrower and all endorsers, guarantors and any other parties that may be liable under this Promissory Note hereby waive presentment, notice of dishonor, protest and all other demands and notices in connection with the delivery, acceptance, performance or enforcement of this Promissory Note. 20 4 3.4. Binding Effect. This Promissory Note shall be binding upon the Borrower and his heirs, personal representatives, successors and assigns and shall inure to the benefit of the Lender and its successors and assigns. 3.5. Governing Law. This Promissory Note shall be construed and enforced in accordance with the laws of the Commonwealth of Pennsylvania without regard to the principles of conflicts of law thereof. 3.6. Contemporaneous Agreement. This Note is being delivered in conjunction with a certain Employment Agreement dated this date between Lender and Borrower and is subject to certain terms and conditions set forth in the Employment Agreement. 3.7. Headings. The headings of the Sections and subparagraphs of this Promissory Note are inserted for convenience only and shall not constitute a part hereof. IN WITNESS WHEREOF, the Borrower has duly executed and delivered this Promissory Note as of the date first above written. /s/ DARYL A. DIXON ----------------------------------- Daryl A. Dixon EX-13 5 ANNUAL REPORT TO STOCKHOLDERS 1 NOVACARE 1995 ANNUAL REPORT [FIGURE 1] 2 NOVACARE'S CREDO, PURPOSE AND BELIEFS Our values are the strong foundation upon which we build our company. They are also the basis upon which we establish our reputation. Our Credo, Helping Make Life a Little Better, exemplifies all that we do. It is our guiding principle, our North Star. From clinician to staff support person, we are united in this commitment. Our purpose, to effectively meet the rehabilitation needs of our patients through clinical leadership, represents our philosophy and reason for being. Everything we do supports our purpose. We are dedicated to patient care and clinical leadership. Our beliefs reflect the values we strive to uphold each day: Respect for the individual, Service to the customer, Pursuit of excellence, Commitment to personal integrity. These four characteristics define the NovaCare employee and our relationships with our patients, our customers and co-workers. NOVACARE, INC. NovaCare, Inc. is the leading post-acute rehabilitation company in the United States and is the nation's largest employer of rehabilitation professionals. NovaCare's 10,000 clinicians treat nearly 40,000 patients per day in nursing homes, outpatient rehabilitation centers, orthotic and prosthetic patient care centers and hospitals. Rehabilitation therapy and subacute services are provided both directly and under contract with other health care facilities in 43 states. NovaCare has the leading market share in operating rehabilitation programs for nursing homes, serving 2,000 facilities; offers the largest network of outpatient rehabilitation centers, numbering 400; and holds the number one position in orthotic and prosthetic patient care services with 125 centers. NovaCare's objective is to realize economies of scale within the medical rehabilitation industry and be the value leader--providing the highest level of clinical outcomes at the lowest possible cost. NovaCare is committed to clinical excellence and leadership in the development of practices and technology that will improve the lives of individuals requiring rehabilitation. 3 FINANCIAL HIGHLIGHTS NovaCare, Inc. and Subsidiaries
In thousands, except per share data. For the years ended June 30, 1995 1994 % Change =============================================================================================================================== NET REVENUES $ 905,359 $ 789,745 +15 NET INCOME 61,924 58,214 +6 NET INCOME PER COMMON SHARE 0.95 0.90 +6 WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING 65,163 64,663 +1 Before merger and other nonrecurring items 1995 1994 % Change =============================================================================================================================== NET INCOME $ 40,072 $ 63,053 -36 NET INCOME PER COMMON SHARE 0.61 0.98 -38 As of June 30, 1995 1994 % Change =============================================================================================================================== TOTAL ASSETS $ 852,557 $ 850,541 -- TOTAL LIABILITIES 364,922 434,837 -16 STOCKHOLDERS' EQUITY 487,635 415,704 +17 Ratios 1995 1994 =============================================================================================================================== ADJUSTED EBITDA MARGIN 13% 17% RETURN ON AVERAGE EQUITY BEFORE MERGER AND OTHER NONRECURRING ITEMS 9% 17%
(1) Adjusted EBITDA margin represents earnings before interest, income taxes, depreciation, amortization of excess cost of net assets acquired, and merger and other nonrecurring items. (1) 4 [FIGURE 2] John H. Foster, (right), Chairman and Chief Executive Officer and Timothy E. Foster, President and Chief Operating Officer FISCAL 1995 HAS BEEN A CHALLENGING YEAR--A YEAR OF DEPRESSED MARGINS IN OUR LARGEST DIVISION, CONTRACT SERVICES, WHERE WE OPERATE REHABILITATION THERAPY PROGRAMS IN NURSING FACILITIES. TO OUR SHAREHOLDERS: Fiscal 1995 has been a challenging year--a year of depressed margins in our largest division, contract services, where we operate rehabilitation therapy programs in nursing facilities. As a result, earnings before nonrecurring items decreased to $.61 per share from $.98 per share in fiscal 1994. Reported earnings of $.95 per share reflected profits from the sale of our rehabilitation hospital division, partially offset by restructuring charges. The $243-million hospital division sale generated an attractive return on investment and an $88-million pretax profit. This enabled us to repay all bank debt while substantially increasing cash-on-hand, leaving us with the industry's strongest balance sheet. A 1995 OVERVIEW The problems in our contract services division are both industry-related and internal. A restructuring of this division in 1994 destabilized relationships with our clinicians, managers and customers. This resulted in increased therapist and customer turnover and lower therapist productivity. STABILIZING CONTRACT SERVICES During the year we focused on stabilizing our workforce. We reduced therapist staff in over-staffed markets, terminated lower profitability contracts and developed new therapist orientation, clinical training and support programs. Our 500 supervisors will undergo manager training this year. We just completed the roll-out of our proprietary information system, NovaNet PLUS, which will support our therapists, customers and managers with enhanced analytical capabilities and record keeping, including patient outcomes tracking. By the end of fiscal 1995, we had improved productivity, as measured by patient care time, to within four percent of historic levels, and had reduced annualized therapist-initiated turnover to 30% from a peak of 35% at mid-year. Customer turnover, however, remained unacceptably high. Total revenues increased because our sales force successfully replaced lost contracts, but in the transition, productivity suffered. We expect our clinical, management training and systems initiatives, together with a new focus on smaller customers, to firm up our customer base. (2) 5 STRENGTH IN OTHER DIVISIONS Revenues in our outpatient rehabilitation division increased by 74% over fiscal 1994, reflecting acquisitions early in the year. During the year, we introduced WIN(TM) (for "Work Injury Network"), which includes work-injury rehabilitation and prevention programs we manage for more than 1,500 companies. Results so far indicate that companies who partner with NovaCare through WIN(TM) spend substantially less than the national average on workers' compensation costs. Another success in our outpatient business was the expansion of our managed care relationships. We ended the year with nearly 375 regional and national contracts. Revenues from our orthotics and prosthetics patient care centers increased 22% in fiscal 1995, reflecting strong internal growth and the acquisition in August 1994 of Sabolich Prosthetics, a premier research organization and prosthetics provider. In 1995 we received extensive national media attention for a breakthrough technological advancement in prosthetics--a device that gives amputees the ability to feel pressure and sense hot and cold. We continued to expand our subacute services in 1995, ending the year with a total of 58 subacute programs that we manage for nursing facilities. Subacute care, which serves patients who no longer need the extensive services of a more costly acute care hospital but are too ill to return home, is one of the health care industry's fastest growing areas. LOOKING AHEAD Fiscal 1996 will be a year of aligning our internal operations to meet customer needs--a time to fine-tune our operations and stabilize results, to realize economies of scale and to better position our contract services business for changes taking place in that industry. MULTIPLE CHALLENGES IN CONTRACT SERVICES After ten years of growth characterized by demand for services that far outstripped the available supply of therapists, the contract services industry today faces serious challenges: Planned adoption of "salary equivalency" rates to limit Medicare reimbursement for speech-language pathology and occupational therapy creates uncertainty as to revenues and profitability; some larger nursing homes are choosing to employ their own therapists rather than contract for services; managed care payors are driving prices and utilization down; and, consolidation in the nursing home and contract services industries is disrupting long-standing relationships. FISCAL 1996 WILL BE A YEAR TO BETTER POSITION OUR CONTRACT SERVICES BUSINESS FOR CHANGES TAKING PLACE IN THAT INDUSTRY. [FIGURE 3] (3) 6 KEYS TO FUTURE SUCCESS Considered together, the challenges in our industry suggest that the successful players will be the customer-focused, low-cost providers. We believe our commitment to investing in clinical leadership, technology and systems, training, and outcomes measurement will continue to distinguish NovaCare as the enduring industry leader. Service to the customer--meeting the needs of the health care provider, referral source, payor and patient--is a principal tenet of our organization. Over the course of the year, through customer discussions and market research, we have studied customer needs and new opportunities in this changing environment. In response, we recently created a new division to develop and deliver management and consulting services to help health care institutions enhance their post-acute programs. Today's health care customers measure service in terms of value--maximum outcomes at the lowest possible cost. With leading market share positions in each of our core businesses, we are able to make critical investments in systems and technology to increase our clinical and administrative efficiency and track and report patient outcomes. This year, our NovaNet PLUS system was recognized by Microsoft Corporation for innovation in the health care industry. We are therefore well-positioned to recognize economies of scale and deliver value to the customer. A major thrust in 1996, to ensure we are the customer-focused, low-cost provider, is to reduce expenditures throughout the organization. We will consolidate and/or close locations that are not sufficiently profitable or that don't fit our strategic marketing focus. And, we will seek to realize economies available through centralization of certain administrative functions. These savings will be reinvested in clinical programs and systems and training projects to keep NovaCare at the forefront in customer service and clinical efficiency. We pride ourselves on being clinical leaders. Clinical leadership supports the long-term growth of our business and advances the rehabilitation industry. Clinical innovations attract and retain customers, enhance clinical efficiency and improve the lives of patients. With 85% of our employees directly involved in patient care, efficiencies at the clinical level are closely tied to low-cost provider status. Because clinical leadership is vital to profitable growth, we will continue to commit resources to enhance the professional contributions of our employees and to refine and expand our services. COMPANIES WHO PARTNER WITH NOVACARE THROUGH WIN(TM) (FOR "WORK INJURY NETWORK") SPEND SUBSTANTIALLY LESS THAN THE NATIONAL AVERAGE ON WORKERS' COMPENSATION COSTS. [FIGURE 4] (4) 7 Finally, training is key to the success of any enduring service organization. At NovaCare, new employees must learn and internalize our values, culture and best practices. New clinical practices and systems enhancements must be taught. And, because there are no other large-scale practices from which to attract experienced managers, we must train and develop our managers from within. Once developed, they are a unique resource--a competitive advantage. TEN YEARS OF ACCOMPLISHMENT NovaCare marked its tenth anniversary in 1995. As we look back over our first decade, we are truly gratified by our accomplishments. Ten years ago on May 10, 1985, NovaCare had its start as a speech-language pathology company named InSpeech, Inc., with 150 employees. Today, we hold leading market positions in contract services, outpatient rehabilitation and orthotics and prosthetics, and are the nation's largest employer of rehabilitation professionals. We were particularly pleased, in celebration of our tenth anniversary, to be able to make a grant to the Harvard School of Public Health to help establish a professorship of health policy and management. The gift celebrates not only the end of a successful first decade but our ongoing commitment to clinical leadership and the measurement of clinical outcomes in rehabilitation. We look forward to our second decade with confidence. We are the clinical, technological and market leader in an industry that is growing 10-12% per year. Fueling this growth is a population of senior Americans that is projected to double over the next four decades. THE CHALLENGE OF THE FUTURE It has been a fantastic decade. One that, of course, we wish we were ending on a stronger earnings note. Nevertheless, our financial position is solid. We're confident in our ability to make the necessary adjustments to resume our growth. Adding to our confidence is the appointment in October of Timothy E. Foster to president and chief operating officer of NovaCare. Tim is one of our founding directors and was most recently NovaCare's chief financial officer. His in-depth knowledge of our customers, employees and industry is particularly important today with the transitions taking place in our industry. WE RECEIVED EXTENSIVE MEDIA ATTENTION FOR A BREAKTHROUGH TECHNOLOGICAL ADVANCEMENT IN PROSTHETICS -- A DEVICE THAT GIVES AMPUTEES THE ABILITY TO FEEL PRESSURE AND SENSE HOT AND COLD. [FIGURE 5] (5) 8 Amidst the turmoil and demands of change, we have a necessary constant--our NovaCare values--developed by a team of employees in 1988, following an earlier difficult period of disruption and change. Expressed as our credo, purpose and beliefs, our values are our guide to doing the right thing for our patients, customers, employees and investors. We've found over the years that doing the right thing often takes a little longer. And, this is certainly not the time for quick fixes. It's the time to do the right things to create an organization that's right for the next, inevitable round of changes in the health care industry. On behalf of your board and management, I offer my appreciation to you, our shareholders, for your continuing confidence and support. We also extend our sincere thanks to our employees. It is through their past and future efforts that we will be able to continue Helping Make Life a Little Better. /s/ JOHN H. FOSTER ------------------------------------ John H. Foster Chairman and Chief Executive Officer September 12, 1995 WE LOOK FORWARD TO OUR SECOND DECADE WITH CONFIDENCE. WE ARE THE CLINICAL, TECHNOLOGICAL AND MARKET LEADER IN AN INDUSTRY THAT IS GROWING 10-12% PER YEAR. [FIGURE 6] (6) 9 CONSOLIDATED BALANCE SHEETS NovaCare, Inc. and Subsidiaries
In thousands, as of June 30, 1995 1994 ===================================================================================================================== ASSETS CURRENT ASSETS: CASH AND CASH EQUIVALENTS $158,636 $ 38,024 MARKETABLE SECURITIES -- 35,104 ACCOUNTS RECEIVABLE, NET 192,652 215,727 INVENTORIES 11,213 7,996 DEFERRED INCOME TAXES 16,748 13,946 OTHER CURRENT ASSETS 34,571 24,208 --------------------------------------------------------------------------------------------------------------------- TOTAL CURRENT ASSETS 413,820 335,005 MARKETABLE SECURITIES, NET -- 53,318 PROPERTY AND EQUIPMENT, NET 63,659 93,739 EXCESS COST OF NET ASSETS ACQUIRED, NET 352,115 342,938 DEFERRED INCOME TAXES 1,470 517 OTHER ASSETS, NET 21,493 25,024 --------------------------------------------------------------------------------------------------------------------- $852,557 $850,541 ===================================================================================================================== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: CURRENT PORTION OF FINANCING ARRANGEMENTS $ 32,684 $ 61,518 ACCOUNTS PAYABLE AND ACCRUED EXPENSES 93,088 72,997 INCOME TAXES PAYABLE 32,922 6,166 --------------------------------------------------------------------------------------------------------------------- TOTAL CURRENT LIABILITIES 158,694 140,681 FINANCING ARRANGEMENTS, NET OF CURRENT PORTION 192,331 283,084 DEFERRED INCOME TAXES 8,147 3,211 OTHER LIABILITIES 5,750 7,861 --------------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES 364,922 434,837 --------------------------------------------------------------------------------------------------------------------- COMMITMENTS AND CONTINGENCIES -- -- STOCKHOLDERS' EQUITY: COMMON STOCK, $.01 PAR VALUE; AUTHORIZED 200,000 SHARES, ISSUED 65,476 IN 1995 AND ISSUED 64,228 SHARES IN 1994 656 643 ADDITIONAL PAID-IN CAPITAL 250,857 240,619 RETAINED EARNINGS 238,149 176,225 --------------------------------------------------------------------------------------------------------------------- 489,662 417,487 LESS: COMMON STOCK IN TREASURY (AT COST), 187 SHARES IN 1995 AND 17 SHARES IN 1994 (1,614) (305) DEFERRED COMPENSATION (413) (662) VALUATION ALLOWANCE ON SECURITIES AVAILABLE FOR SALE -- (816) --------------------------------------------------------------------------------------------------------------------- TOTAL STOCKHOLDERS' EQUITY 487,635 415,704 --------------------------------------------------------------------------------------------------------------------- $852,557 $850,541 =====================================================================================================================
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. (7) 10 CONSOLIDATED STATEMENTS OF OPERATIONS NovaCare, Inc. and Subsidiaries
In thousands, except per share data, for the years ended June 30, 1995 1994 1993 ============================================================================================================================= NET REVENUES $905,359 $789,745 $582,342 OPERATING COSTS: SALARIES, WAGES AND BENEFITS 576,764 462,378 328,416 RENTAL EXPENSE 36,365 27,613 21,250 SUPPLY COSTS 21,797 18,285 18,459 OTHER 137,812 130,540 107,716 PROVISION FOR UNCOLLECTIBLE ACCOUNTS 15,918 14,453 9,764 DEPRECIATION 19,253 15,289 8,602 AMORTIZATION OF EXCESS COST OF NET ASSETS ACQUIRED 10,937 7,225 3,589 MERGER AND OTHER NONRECURRING EXPENSES (57,368) 5,754 5,727 ----------------------------------------------------------------------------------------------------------------------------- INCOME FROM OPERATIONS 143,881 108,208 78,819 INVESTMENT INCOME 5,405 5,304 4,880 INTEREST EXPENSE (23,298) (17,077) (7,721) MINORITY INTEREST (404) (543) (436) ----------------------------------------------------------------------------------------------------------------------------- INCOME BEFORE INCOME TAXES 125,584 95,892 75,542 INCOME TAXES 63,660 37,678 27,906 ----------------------------------------------------------------------------------------------------------------------------- NET INCOME $ 61,924 $ 58,214 $ 47,636 ============================================================================================================================= NET INCOME APPLICABLE TO COMMON STOCK $ 61,924 $ 58,214 $ 47,585 ============================================================================================================================= NET INCOME PER COMMON SHARE $ .95 $ .90 $ .79 ============================================================================================================================= WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING 65,163 64,663 60,167 =============================================================================================================================
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. (8) 11 NOVACARE, INC. AND SUBSIDIARIES DIRECTORS JOHN H. FOSTER Chairman of the Board and Chief Executive Officer TIMOTHY E. FOSTER President and Chief Operating Officer E. MARTIN GIBSON Retired Chairman and Chief Executive Officer, Corning Lab Services, Inc. SIRI S. MARSHALL Senior Vice President, General Counsel and Secretary, General Mills, Inc. STEPHEN E. O'NEIL Private Investor C. ARNOLD RENSCHLER, M.D. Senior Vice President and Chief Clinical Officer GEORGE W. SIGULER Managing Director, Mitchell Hutchins Institutional Investors, Inc. ROBERT G. STONE, JR. Retired Chairman of the Board, Kirby Corporation DANIEL C. TOSTESON, M.D. Dean of the Faculty of Medicine, Harvard Medical School MANAGEMENT Office of the Chairman JOHN H. FOSTER Chairman of the Board and Chief Executive Officer TIMOTHY E. FOSTER President and Chief Operating Officer JAMES C. NEW President and General Manager, Outpatient Rehabilitation Division C. ARNOLD RENSCHLER, M.D. Senior Vice President and Chief Clinical Officer SENIOR MANAGERS PETER D. BEWLEY Senior Vice President, General Counsel and Secretary SUSAN J. CAMPBELL Vice President, Communications and Investor Relations BRUCE J. COLBURN Senior Vice President, Chief Financial Officer and Treasurer DARYL A. DIXON President and General Manager, Contract Services Division RONALD G. HISCOCK President and General Manager, Orthotics & Prosthetics Division LAURENCE F. LANE Senior Vice President, Regulatory Affairs ARTHUR T. LOCILENTO, JR. Senior Vice President, Human Resources SCOTT MARBER Senior Vice President, Corporate Sales and Marketing PAUL K. ROSS Senior Vice President, Information Systems JAMES T. WALMSLEY Vice President, Reimbursement Note: No family relationships exist among any of the directors or officers. SHAREHOLDER INFORMATION CORPORATE HEADQUARTERS NovaCare, Inc. 1016 West Ninth Avenue King of Prussia, PA 19406 (610) 992-7200 STOCK TRADING NovaCare, Inc., common stock and 5.5% convertible subordinated debentures, due in 2000, are traded on the New York Stock Exchange under the symbols "NOV" and "NOV/2000," respectively. INFORMATION REQUESTS Investors, analysts and others seeking information should contact: NovaCare's Communications and Investor Relations Department, (610) 992-7495 SHAREHOLDER RECORDS Shareholders desiring to change the name, address or ownership of stock or to report lost certificates should contact: American Stock Transfer Company 40 Wall Street, 46th Floor New York, NY 10005 (718) 921-8200 12 [NOVACARE LOGO] ------------------------- NOVACARE, INC. 1016 WEST NINTH AVENUE KING OF PRUSSIA, PA 19406 EX-21 6 SUBSIDIARIES OF THE COMPANY 1 EXHIBIT 21 SUBSIDIARY LISTING Affiliated Physical Therapists, Ltd. ASK Colorado Health Care Services, P.C. Atlantic Rehabilitation Services, Inc. Boca Rehab Agency, Inc. Buendel Physical Therapy, Inc. C.O.A.S.T. Institute Physical Therapy, Inc. CR Services Corp. Cannon and Associates, Inc. Cenla Physical Therapy & Rehabilitation Agency, Inc. Center for Physical Therapy & Sports Rehabilitation, Inc. CenterTherapy, Inc. Coplin Physical Therapy Associates, Inc. Crowley Physical Therapy Clinics, Inc. Douglas Avery & Associates, Ltd. Douglas C. Claussen, R.P.T., Physical Therapy, Inc. FD Capital Corporation Francis Naselli, Jr. & Stewart Rich Physical Therapists, Inc. Galaxy Service Corporation Georgia Physical Therapy of West Georgia, Inc. Georgia Physical Therapy, Inc. Greater Sacramento Physical Therapy Associates, Inc. Gulf Breeze Physical Therapy, Inc. Gulf Coast Hand Specialist, Inc. Hand Therapy and Rehabilitation Associates, Inc. Hand Therapy Associates, Inc. Hawley Physical Therapy, Inc. Heartland Rehabilitation, Inc. 2 SUBSIDIARY LISTING Indianapolis Physical Therapy and Sports Medicine, Inc. Irwin Lehrhoff & Associates, Inc. (OR) Irwin Lehrhoff & Associates, Inc. (TX) Jana B. Mason L.P.T., Inc. Jana B. Mason Therapy Associates, Inc. Jim All, Inc. Kesinger Physical Therapy, Inc. Life Dimensions of California, Inc. Life Dimensions, Inc. Lynn M. Carlson, Inc. McFarlen & Associates, Inc. MedStat, P.C. Mill River III, Inc. Mill River Management, Inc. Mitchell Tannenbaum I, Inc. Mitchell Tannenbaum II, Inc. Mitchell Tannenbaum III, Inc. Monmouth Rehabilitation, Inc. NACC, Inc. National Rehab Services NC Occupational Therapy, P.C. NC Physical Therapy, P.C. NC (Wisconsin), S.C. NC Resources, Inc. New Mexico Physical Therapists, Inc. Northside Physical Therapy, Inc. NovaCare (Arizona), Inc. 3 SUBSIDIARY LISTING NovaCare (Colorado), Inc. NovaCare (Illinois), Inc. NovaCare (Texas), Inc. NovaCare Easton & Moran Physical Therapy, Inc. NovaCare Management Business Trust NovaCare Management Services, Inc. NovaCare Northside Therapy, Inc. NovaCare Orthotics & Prosthetics East, Inc. NovaCare Orthotics & Prosthetics Holdings, Inc. NovaCare Orthotics & Prosthetics West, Inc. NovaCare Orthotics & Prosthetics, Inc. NovaCare Outpatient Rehabilitation, Inc. NovaCare Outpatient Rehabilitation I, Inc. NovaCare Rehab Agency of Alabama, Inc. NovaCare Rehab Agency of Florida, Inc. NovaCare Rehab Agency of Georgia, Inc. NovaCare Rehab Agency of Illinois, Inc. NovaCare Rehab Agency of North Carolina, Inc. NovaCare Rehab Agency of Northern California NovaCare Rehab Agency of Ohio, Inc. NovaCare Rehab Agency of Oklahoma, Inc. NovaCare Rehab Agency of Pennsylvania, Inc. NovaCare Rehab Agency of South Carolina, Inc. NovaCare Rehab Agency of Southern California NovaCare Rehab Agency of Virginia, Inc. NovaCare Rehabilitation Agency of Tennessee, Inc. NovaCare Rehabilitation Agency of Wisconsin, Inc. 4 SUBSIDIARY LISTING NovaCare SMC, Inc. NovaCare Service Corp. NovaCare Speech Therapy and Audiology, Inc. NovaCare, Inc. NovaCare, Inc. (Delaware) O & P Services, Inc. OSI Midwest, Inc. Ortho Rehab Associates, Inc. Orthopedic and Sports Physical Therapy of Cupertino, Inc. Peters, Starkey, Todrank Physical Therapy Corporation Physical Focus, Inc. Physical Rehabilitation Partners, Inc. Physical Therapy Institute, Inc. Quad City Management, Inc. Quad City Regional Spine Institute, P.C. R.E. Huck Co. RCI (Colorado), Inc. RCI (Exertec), Inc. RCI (Illinois), Inc. RCI (Michigan), Inc. RCI (S.P.O.R.T.), Inc. RCI (WRS), Inc. RCI Nevada, Inc. Rebound Oklahoma, Inc. Redwood Pacific Therapies, Inc. Rehab Advantage, Inc. Rehab Managed Care of Arizona, Inc. 5 SUBSIDIARY LISTING Rehab Provider Network - California, Inc. Rehab Provider Network - Delaware, Inc. Rehab Provider Network - Illinois, Inc. Rehab Provider Network - Indiana, Inc. Rehab Provider Network - Louisiana, Inc. Rehab Provider Network - Maryland, Inc. Rehab Provider Network - Michigan, Inc. Rehab Provider Network - New Jersey, Inc. Rehab Provider Network - Ohio, Inc. Rehab Provider Network - Oklahoma, Inc. Rehab Provider Network - Pennsylvania, Inc. Rehab Provider Network - Virginia, Inc. Rehab Provider Network - Washington, D.C., Inc. Rehab Provider Network of Florida, Inc. Rehab Provider Network of Georgia, Inc. Rehab Provider Network of Nevada, Inc. Rehab World, Inc. Rehab/Work Hardening Management Associates, Ltd. RehabClinics (Coast), Inc. RehabClinics (New Jersey), Inc. RehabClinics (PTA), Inc. RehabClinics (SPT), Inc. RehabClinics Abilene, Inc. RehabClinics Dallas, Inc. RehabClinics Pennsylvania, Inc. RehabClinics, Inc. Robert M. Bacci, R.P.T. Physical Therapy, Inc. 6 SUBSIDIARY LISTING S.T.A.R.T., Inc. SG Rehabilitation Agency, Inc. SG Speech Associates, Inc. Southwest Medical Supply Company, Inc. Southwest Physical Therapy, Inc. Southwest Therapists, Inc. Sporthopedics Sports and Physical Therapy Centers, Inc. Sports Therapy and Arthritis Rehabilitation, Inc. Sprint Physical Therapy, P.C. Star Physical Therapy, Inc. Start to Finish Physical Therapy, P.C. Stephenson-Holtz, Inc. The Center for Physical Therapy and Rehabilitation, Inc. Theodore Dashnaw Physical Therapy, Inc. Therex, P.C. TJ Corporation I, L.L.C. Union Square Center for Rehabilitation & Sports Medicine, Inc. Vanguard Rehabilitation, Inc. Wayzata Physical Therapy Center, Inc. West Suburban Health Partners, Inc. Western Rehab Services, Inc. Workers Rehabilitation Services, Inc. Young's Orthopedic Service, Inc. EX-23 7 CONSENT OF INDEPENDENT ACCOUNTANTS 1 EXHIBIT 23 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (Nos. 33-88744; 33-88745; 33-88746) of NovaCare, Inc. of our report dated August 3, 1995 appearing on page 39 of this Form 10-K. PRICE WATERHOUSE LLP Philadelphia September 12, 1995 EX-27 8 FINANCIAL DATA SCHEDULE
5 This schedule contains summary financial information extracted from the Condensed Consolidated Balance Sheet as of June 30, 1995 and the Condensed Consolidated Statement of Operations for the year ended June 30, 1995 and is qualified in its entirety by reference to such statements in Form 10-K for the fiscal period ended June 30, 1995. 1,000 YEAR JUN-30-1995 JUL-01-1994 JUN-30-1995 158,636 0 212,370 19,718 11,213 413,820 98,169 34,510 852,557 158,694 192,331 656 0 0 486,979 852,557 0 905,359 0 772,738 (32,179) 15,918 23,298 125,584 63,660 61,924 0 0 0 61,924 .95 .95 "Total Costs" consist of salaries, wages and benefits, rent expense, supply costs and other. "Other expenses" consist of depreciation, amortization, merger and other nonrecurring items, minority interest and investment income.